How to solve a problem like the BoE governor? John Kemp

LONDON Fri Apr 27, 2012 9:24am EDT

The Governor of the Bank of England Mervyn King attends a service for the Order of the British Empire, at St Paul's Cathedral in London March 7, 2012. REUTERS/Luke MacGregor

The Governor of the Bank of England Mervyn King attends a service for the Order of the British Empire, at St Paul's Cathedral in London March 7, 2012.

Credit: Reuters/Luke MacGregor

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LONDON (Reuters) - The race to succeed Mervyn King at the helm of the Bank of England when his second five-year term ends in June 2013 is now well underway, with contenders jockeying for position, though the UK government insists the formal search will not start until the autumn.

The field is thought to include five economists and policymakers, plus a couple of long-shots from the banking world, according to a race guide published by the Financial Times ("MPs look to monitor the next bank governor" April 20) and a recent survey by FT columnist Samuel Brittan ("The BoE needs neither a bureaucrat nor a dictator" April 26).

The Bank's own deputy governor for financial stability, Paul Tucker, has emerged as the internal candidate, representing continuity. In 156 meetings of the rate-setting Monetary Policy Committee he and King have attended together since 2002, they have disagreed only 8 times, most recently in August 2009 and before that January 2007.

Other establishment candidates are: Adair Turner, chairman of the Financial Services Authority and Mr Fix-it for both the previous Labour government and the Coalition on pensions and financial reform; Gus O'Donnell, former permanent secretary at the Treasury and head of the civil service, a legendary safe pair of hands; and economist John Vickers, former Bank chief economist, head of the competition watchdog, as well as main author of the recent Independent Commission on Banking report on structural reform of the UK financial sector.

If the government wants to go outside Britain's relatively narrow pool of political economists, there is always Bank of Canada Governor Mark Carney, who has cultural and educational links to Britain and has had a good financial crisis. Or even someone from the world of commercial banking, though given public anger about bankers in the wake of the financial crisis, an appointment from the private sector seems a long-shot.

But in appointing a new governor, ministers cannot avoid rendering a judgment on the Bank's controversial performance under King.

WANTED: A SUPERHUMAN

All the front-runners have impeccable credentials as competent administrators and policymakers. All could do the job, probably well. To use the Italian term for potential successors to the pope, they are all very "papabile".

The choice comes down to what sort of institution the government wants the Bank to be in future. After a rocky start, the Bank has had a good crisis, seizing control of the most interesting bits of financial regulation from the discredited Financial Services Authority, and establishing a condominium over monetary and fiscal policy with the Treasury.

The Bank's role has morphed. In the 1970s and 1980s, it was dismissed as the "East End branch of the Treasury", handling debt auctions and money market operations. Now it has emerged as one of the most powerful central banks in the world, and by far Britain's most powerful economic and financial regulator.

In the 1990s and early 2000s, the Bank's power grew steadily, culminating in operational independence in 1997. It became fiercely independent, operating at arm's length from government. Now austerity and quantitative easing have made it more of a partner.

The coalition government's austerity program owed much of its inspiration to the Bank governor. The combination of fiscal retrenchment with highly expansionary monetary policy and quantitative easing has turned the Bank from an independent executive agency into more of an equal with the government and the Treasury.

However, while King has been an effective empire builder, many outside the Bank doubt whether any one institution and governor will be able to cope with the immense remit he has put together, or handle the inherent conflicts between different parts of the Bank's mandate in a convincing and transparent way.

"The planned job is so far-reaching that only superhumans need apply" according to the FT's Brittan, a view echoed by the opposition Labour Party's chief financial spokesman Ed Balls.

CONTINUITY OR REFORM?

Promoting Tucker would signal the government is content for the King era to be extended.

Parachuting in an establishment fixer from outside would draw a line under recent controversies and bring the Bank to heel, curbing its independence and forcing it to accept a more collective approach.

Canada's Carney would mark the most radical break, indicating the Bank should return to a focus on technical excellence, inflation control and prudent financial supervision, quitting the political arena.

Outsiders are divided about whether King's reign has been successful or not. There is no questioning his fierce intellectual firepower and ability to win battles with other agencies on behalf of the Bank.

The economic record is more mixed. As governor, and before that deputy governor and chief economist, he presided over the biggest, most destructive boom and bust cycle in the United Kingdom for decades. But King was hardly alone in failing to appreciate or mitigate the dangers, though neither was he particularly prescient in heeding the risks.

More recently, King has been an ardent advocate of fiscal austerity coupled with monetary expansion. So views about his track record divide between those who think the current policy mix has averted a sovereign debt crisis and will eventually lead to a resumption of growth, versus those who think it has unnecessarily prolonged the downturn and plunged the economy back into recession.

On the technical side, King has appeared intolerant of alternative views, using his undoubted brilliance to cow critics rather than listen to them.

The Bank's inflation forecasts have proved uniformly wrong for the last five years, and show no signs of improving. For a central bank that is supposed to be inflation targeting the repeated forecast failures raise worrying questions about the institution's credibility and its ability to learn from its mistakes.

As the internal candidate and King's lieutenant, Tucker therefore carries heavy baggage. Ministers might be tempted to choose an outsider to draw a line under the controversies of the past and show the Bank will be different in future, more collegial, more open and more humble about its limitations.

And yet. From the government's perspective, King has been an immensely useful supporter. His willingness to keep interest rates low and engage in repeated rounds of quantitative easing, ignoring the overshoot on inflation, has bought crucial time for the austerity program to deliver.

For as much as the government (and the Bank itself) lament continued high inflation, ministers would clearly prefer rising prices to even bigger increases in unemployment and a (deeper) recession. King may be criticized by outsiders for his performance on inflation, but ministers are quietly grateful.

King has been a vital shield for austerity, defending it even as doubts mount about its effectiveness. The last thing ministers want is for the new governor to restore credibility to the inflation target process by raising interest rates.

So when ministers sit down to make a final choice, the real question they face is whether to continue the King era, or seek something different. And if there is to be a change, should it be a more consensual member of the political-economic establishment, or an outsider with technocratic credentials?

(John Kemp is a Reuters market analyst. The views expressed are his own)

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