Strip the Bank of England of its power

Times UK ^ | 7/3/09

[FromLori]

Leaving a team of ‘wise men’ to set interest rates is absurd. Market forces will always do it better

Mervyn King, Governor of the Bank of England, complained recently that he lacked the powers required to fulfil his new statutory role of ensuring stability in the banking system. A more powerful Bank of England would do a better job.

He is wrong. The economy would benefit from a weaker Bank of England, stripped of its principal power: namely, the power to set interest rates. This is not intended as a criticism of Mr King or of the other members of his Monetary Policy Committee. No one should be allowed to set interest rates.

Interest rates are simply prices for borrowing. As with all prices, they should be determined by supply and demand in a free market. When they are fixed by a wise man, or by a wise committee, they no longer carry information about the preferences of consumers and the scarcity of resources. On the contrary, no matter how wise the dictator, interest rates set by diktat are sure to be a kind of misinformation, leading those who act on them into error.

To see why, start with the price of something more straightforward. Suppose that global warming changed the popularity of British summer holiday destinations, so that more people wanted to visit Edinburgh and fewer wanted to visit Brighton. Competition for the limited supply of hotel rooms in Edinburgh would bid up their prices, while Brighton hoteliers would have to cut prices to find willing buyers.

[JLS]

Central banks of course can not set interest rates. Interest rates are set by people voting their time values of money with their own money. Central banks can only alter the expected inflation part of interest rates.