The governor made mistakes but has also pressed for necessary reforms.
The knives are out for Sir Mervyn (“The Sun” ) King. Commentators who once stood in awe now rush to condemn him.This is not a pretty sight. It is also unfair to someone who, while not being the right man to manage the UK’s biggest financial crisis ever, has made important contributions to re-thinking the financial system post-crisis as well as to monetary policy.
The governor made some bad errors in the early stages of the crisis, in 2007 and the first part of 2008, when he sometimes seemed paralysed by indecision. The role of the central bank and government in a general crisis of confidence is to make clear quickly and unequivocally that they stand 100% behind the banking system, while mercilessly punishing individual banks that have been imprudent. Neither of these happened. Although the Labour government must take part of the blame, the Bank should have been better prepared (I pointed this out at the time). His opposition to general liquidity support for the system was costly.
Drawing public attention to the alleged need of UK banks for more capital early in 2008 was badly timed, contributing to a further slide in bank shares through the year (However, I do not agree with those who say the entire episode could have been solved by injection of sufficient liquidity – the underlying losses were too large).
These errors resulted from several factors. First, there was the narrow focus on inflation targeting as a necessary and sufficient condition for stability. Secondly, MK made no attempt to conceal his poor opinion of bankers, making little attempt to cultivate contacts with the City. This not only deprived himself of the information that he could have gained from communicating with them but also eroded the trust essential to the ability to take action in a crisis (I commented on this at the time also). Thirdly, he allowed legitimate concern with moral hazard to get in the way of saving the financial system. Fourthly, he felt compelled to analyse and understand a situation fully before taking action – a luxury afforded to academics but not to central bankers.
Benefits of hindsight
Can MK be criticised more broadly for allowing the economy to become unbalanced?
He welcomed the narrowing of the Bank’s remit and warned everyone not to venture from their narrowed patch. Like Bernanke, he thought housing didn’t matter – or that price rises were justified by fundamentals. The Greenspan doctrine, that it is better to mop up after asset bubbles than try to prevent them, held sway.
This all looks bad now but was shared by other central banks, the press and nearly all economists.
Right calls on several issues
Since then MK has been right on several big issues. He was right to support the need for fiscal retrenchment; given the euro-crisis; in 2010 the incoming UK government had no option. He was right to place radical reform of the banking system on the agenda. He was right to try to sustain monetary growth; and also to insist on the limitations of QE. He is right to criticise Basel 3.
He says it is too early to ditch inflation targeting. But, the book argues, only when central banks abandon it, can policy move out of the cycle of errors that lie behind the crises of the past 40 years. That point of view is the start of the brief survey of alternatives that I conduct in The Money Trap. The survey reaches the conclusion that the only satisfactory alternative involves the reconstruction of the monetary and banking system as we know it.
In sum, the “Sun King” played a part in getting the UK stuck so deeply in the money trap. But from the disaster of 2007-12, he has drawn the right lessons in at least one key area – bank reform. Perhaps, in time, he will draw the right lessons for a broader reform of national and international monetary policies and the entire system. But this can happen only when he is no longer a governor.