‘The world has turned upside down. A Labour Government is elected and the new Chancellor's first move is to hand over control of macroeconomic policy to the Bank of England.’
The Times, 7 May 1997
‘One good way to understand the development of institutions is to analyze crucial turning points when people consciously try to change the way the institutions work.’
William Riker, ‘The Experience of Creating Institutions’, p. 122
This article looks at the politics surrounding a pivotal change in the rules of the game governing British political economy. On 6 May 1997, the newly elected Labour government surprised friends and foes by announcing that the power to set interest rates would be transferred from the Treasury to the Bank of England. Giving the Bank operational responsibility for setting interest rates should be seen as a seminal event. This momentous change in the ‘constitution of economic policy’Footnote 1 was regarded by Tony Blair as ‘the biggest decision in economic policy-making since the war’.Footnote 2 Many commentators went further and argued that the move was ‘the most significant shake-up at the Bank of England in its 300-year history’.Footnote 3 In hindsight, one might argue that central bank independence (CBI) in Britain was simply an idea whose time has come. Yet the paradox is that at the time nobody saw it coming. Although New Labour had signalled financial reform in its election manifesto, the issue was barely mentioned during the campaign. Indeed, ‘Brown got through fifty interviews and press conferences during the campaign without being seriously questioned over his plans for the Bank of England’.Footnote 4 Even the most perceptive journalists were astonished by Brown's bold and unexpected move.Footnote 5 According to the Financial Times: ‘Labour's election manifesto had seemed to suggest this momentous change in the conduct of economic policy was on a fairly distant horizon.’Footnote 6
The adoption of central bank independence in Britain poses an explanatory puzzle: if independence is supposed to enable a central bank to resist pressures from elected politicians, why might those politicians have an incentive to establish independent central banks in the first place?Footnote 7 Britain is a crucial empirical case for interpreting competing theories of monetary governance. As Michael King shows, this institutional change does not sit well with theories based on structural changes in the global financial system, economic competition among states, or external coercion by international financial institutions.Footnote 8 More critically, this case defies the expectations of the partisan literature. This sweeping institutional reform was introduced by the Labour party, which had nationalized the Bank in 1946, and whose constituents are not likely to prefer price stability over job creation. The Conservatives, the party representing business and financial interests, had resisted several attempts to introduce central bank independence in the period 1988–97. Finally, this rapid constitutional transformation cannot be easily explained on the basis of existing theory such as North's notion of ‘relative price shocks’ or Schofield's concept of ‘belief cascades’.Footnote 9
The aim of this article is to provide a political economy account of the origins of central bank independence in Britain. As a point of departure, I assume that to remove monetary policy from the political sphere is a political act.Footnote 10 Given this assumption, this article stresses the strategic nature of institutional creation and assesses the role of political entrepreneurs in the process of institution-building. In particular, I will claim that William Riker's notion of heresthetic is a useful analytical tool for understanding the logic of institutional formation. I will focus on two mechanisms which I suggest were at work in the thinking of the ‘founding fathers’.Footnote 11 First, building on Jon Elster's reformulation of his original thesis on ‘Ulysses and the Sirens’,Footnote 12 I will argue that pre-commitment strategies are about binding others rather than being acts of self-binding. Secondly, I will contend that institutional commitments fulfil not only constraining functions, but also enabling ones. By revisiting the political rationality of pre-commitment, I will shed new light on the credibility story underpinning the making of central bank independence in Britain. My account challenges economic narratives based on the idea of self-binding and complements political narratives constructed around the influence of epistemic communities and the benefits of depoliticization.
The article proceeds by setting out an analytical narrative of Gordon Brown's decision to grant operational independence to the Bank of England. An analytic narrative seeks to convert descriptive historical accounts into analytical ones by using theoretically relevant language. Its basic methodological assumption is that ‘theory linked to data is more powerful than either data or theory alone’.Footnote 13 The data come from the abundant secondary literature on New Labour's policies and politics. In line with McLean's advice,Footnote 14 the article engages with the trade of the historian and analyses parliamentary debates, politicians’ biographies and memoirs, hundreds of newspaper articles and media reports, and a wealth of lectures and policy speeches given by the key actors involved in the process. But satisfactory answers to complex empirical puzzles depend not only on the evidence available, but also on what we bring into the analysis.Footnote 15 Theory should guide empirical explorations.Footnote 16
Case studies are not always good for testing theories. However, they are good for uncovering missing mechanisms, developing new ideas and dealing with causal complexity.Footnote 17 This case study aims to contribute to the comparative literature on the political economy of monetary institutions.Footnote 18 Econometric studies do not reach a consensus regarding the factors that determine the choice of monetary institutions, and they cannot resolve disagreement about the precise processes by which politics affects the choice of these institutions.Footnote 19 Theories of institutional change are still underdeveloped, and game-theoretic models of credibility are too abstract for dealing with the nuances of historical situations. Happily, there is a rich variety of sources for New Labour's economic project, including the early move towards Bank independence. To date, few of these narratives have sought to draw implications from their observations of political behaviour. An analytically informed analysis of a seminal episode of institutional development may, therefore, have both empirical and theoretical value.
This article proceeds as follows. The first section reviews political economy theories of central bank independence, seeking to identify the puzzles of the British case. The second presents the theoretical framework of this article, drawing ideas from the works of Elster and Riker. The third section discusses the economic and political context of the institutional reform. The fourth section offers an analytical narrative of the origins of central bank independence in Britain. Key findings and implications of this research are summarized in the conclusion.
Britain's puzzling road to central bank independence
What explains the choice of monetary institutions in general and independent central banks in particular? An established literature has looked at the costs and benefits of alternative monetary regimes from an economic perspective.Footnote 20 The starting point of this approach is the macroeconomics of time-inconsistency. Time-inconsistency models point to the welfare losses that arise when a policy announced for some future period is no longer optimal when it is time to implement the policy. Economists have proposed institutional responses to the credible-commitment problem of time-inconsistent plans. Following Kydland and Prescott, some scholars have advocated ‘rules rather than discretion’ in the governance of monetary affairs.Footnote 21 Others have observed that credibility may be achieved by delegating powers to suitably designed institutions.Footnote 22 For example, Giavazzi and Pagano discussed the advantages of handing over power to a conservative foreign bank.Footnote 23 Following the same line, Rogoff argued that the right incentives could be generated by setting up an independent central bank that is staffed with inflation-averse officials.Footnote 24
It is often assumed that there is a strong economic case for insulating central banks from the influence of elected politicians. However, Kathleen McNamara argues that this conventional wisdom should not be taken for granted.Footnote 25 On the one hand, some studies have found that high central bank independence (CBI) is correlated with low-inflation performance, often at no costs in terms of output stabilization.Footnote 26 On the other hand, other scholars have shown that the apparent correlation between CBI and low inflation is not causal.Footnote 27 In fact, it is highly sensitive to measures of independence, the time period chosen, and especially to the countries included in the sample.Footnote 28 But even assuming that there is a strong economic case for choosing an independent central bank, the political logic of delegation remains a paradox. If independent central banks did nothing but limit the ability of governments to manipulate monetary policy for their own short-term gain, governments would never choose an independent central bank.Footnote 29 Delegation may be a way to achieving credible commitments.Footnote 30 But the core question remains: ‘Why did the same politicians who always preferred to have their hands on the monetary lever, suddenly opt to delegate such far-reaching powers to an independent technocratic institution?’Footnote 31
A body of research has exposed the limitations of the economic approach. This literature questions the apolitical nature of traditional optimal currency area and time-inconsistency models, which rely on the unwarranted assumption that monetary choices are made by benevolent social planners motivated by welfare considerations. By neglecting the role of politics, the argument goes, approaches that focus solely on countries’ structures or expected economic performance have little explanatory power to account for the observed pattern of currency arrangements.Footnote 32 Hence, a theory of monetary institutions should incorporate the ‘political incentives and constraints that shape governments’ decisions on monetary institutions’Footnote 33 and acknowledge the fact that ‘monetary phenomena are always and everywhere political’.Footnote 34
Political economy accounts of variations in central bank independence can be divided into five groups of explanations. First, institutional explanations claim that independent central banks tend to emerge in countries with a federal form of government and/or many veto players.Footnote 35 Secondly, distributional or partisan explanations contend that central banks should be more independent in countries where anti-inflationary social interests are powerful, and that conservative parties, more concerned about inflation than unemployment and redistribution, should be more likely to support the institutionalization of price stability.Footnote 36 However, an alternative and more counterintuitive partisan argument is that left-wing parties lacking anti-inflation credibility may choose CBI to signal a commitment to responsible economic policies.Footnote 37 Thirdly, international ideational accounts suggest that, in the context of increasing economic openness and capital mobility, national politicians have been forced to grant CBI in order to achieve market confidence by reassuring international financial markets.Footnote 38 According to this logic, the growing popularity of this regime is rooted in a process of social diffusion of (appropriate) organizational models led by influential epistemic communities.Footnote 39 Fourthly, strategic explanations argue that political actors establish monetary commitments to lock in the policy preferences of the enacting coalition,Footnote 40 address the problem of political survival,Footnote 41 or to make it possible to shift the blame when something goes wrong.Footnote 42 Finally, integrative approaches to the politics of central banking examine the interaction of international, national and micro-institutional incentives.Footnote 43
The British case appears to defy conventional theories regarding the adoption of central bank independence.Footnote 44 To start with, governments of highly centralized countries with few veto players have little incentives to support a politically independent central bank.Footnote 45 This case also contradicts partisan and interest-group explanations. While the Labour party surprisingly instigated this flagship neo-liberal reform in 1997, the powerful City of London, which was meant to be among the key winners of this institutional change, did not take the lead in the constitution-making process. Given that decisions over interest rates were bound to have significant distributive effects, it is also striking that neither the business community nor the Bank of England itself actively lobbied for independence. Finally, the British experience is not consistent with the most popular strategic argument, which contends that monetary commitments are used to constrain future governments.
At first glance, this case offers support to the hypothesis that politicians hand over policy tools to signal credibility to financial markets. Yet even though the binding implications of open markets featured strongly in the way the founding fathers perceived their own interests, the British road to independence was dominated by domestic considerations.Footnote 46 King argues that while the diffusion of ideas through epistemic communities is the key mechanism explaining central bank reform in Britain, ‘policy failure and paradigm innovation are insufficient conditions for the adoption of new ideas by politicians’.Footnote 47 Politicians’ incentives for adopting ideas have to be accounted for. King's argument is that ‘Bank of England independence provided electoral gains for New Labour by making the party more attractive to voters. In particular, this policy was designed to win the support of homeowners that represent the median voter in the British context’.Footnote 48 King's account is compelling, but it is not without problems. Had electoral considerations been central, the decision would have been taken before the election, not after.Footnote 49 Moreover, the process of policy learning was less than straightforward. Ed Balls, for many the real intellectual father of the reform,Footnote 50 used to believe that an independent central bank was the right instrument for ‘escaping’ rather than strengthening monetarism.Footnote 51
The move towards central bank independence was entirely consistent with one of the defining governing strategies of the Blair government, the politics of depoliticization. In a path-breaking work, Peter Burnham claimed that by granting operational independence in the area of monetary policy to the Bank of England, New Labour could off-load responsibility for unpopular policies and enhance its much-needed governing competence in the eyes of both markets and voters.Footnote 52 Burnham correctly assumes that depoliticization is an intensely political process. He is also right in underlining the role of economic competence. However, our argument is that the founding fathers were more interested in enforcing governing competence through time than in signalling economic responsibility. At the same time, it is likely that the blame avoidance argument has been overstated. Some scholars suggest that, given the British constitutional settlement, trying to shift the blame through policy delegation is not always the best strategy.Footnote 53 There is little evidence suggesting that blame avoidance was a key motivation influencing this institutional change. King argues that ‘the British case supports the hypothesis that an epistemic community of monetary experts has the ability to influence policy if they can convince a key politician to champion this reform’.Footnote 54 This implies that the incentives of those key politicians, the constitution-makers, should be at the centre of the analysis. Was the Bank of England reform really about signalling economic competence and appealing to the median voter? Was it really about shifting the blame for unpopular decisions? To what extent were the founding fathers constrained by the actions and expectations of influential epistemic communities? In short, what were the micro-foundations of this radical institutional change?
These reflections suggest that the political economy of monetary governance has a critical analytical gap, namely its isolation from the rich theoretical literature on institutions. It is striking, for example, that most scholars writing about the political economy of monetary institutions and the politics of central banking in Britain in particular make practically no reference to the works of leading political economists such as Douglass North and William Riker.Footnote 55 In the next section, I will draw some lessons from the scholarship on political institutions.
ANALYTICAL TOOLS: HERESTHETIC AND CONSTRAINT THEORY
‘The key for understanding the process of change is the intentionality of the players enacting institutional change and their comprehension of the issues.’
Douglass North, Understanding the Process of Economic Change, p. 3
Why do institutions emerge? Rational-choice scholars conceptualize institutions as negotiated solutions to problems of co-ordination and co-operation.Footnote 56 But we should not neglect an important part of the story: political institutions are also weapons of coercion and redistribution. They are the structural means by which political winners pursue their own interests, often at great expense to political losers.Footnote 57 Institutions are not usually created to be socially efficient; they are created ‘to serve the interests of those with bargaining power to create new rules’.Footnote 58 Moreover, they are products of ‘struggles among unequal actors’.Footnote 59 Since institutions have distributional effects, the ‘politics of structural choice’Footnote 60 should be rigorously investigated. If there is a systematic relationship between institutions and outcomes, a political actor ‘may operate on the cause in order to modify its effects’.Footnote 61 In this context, the politics of institutional change can be analysed from the perspective of heresthetic.
Heresthetic
‘Heresthetic … may not happen as often as Riker claims, but when it does, it matters.’
Iain McLean, Rational Choice and British Politics, p. 556
Heresthetic is the art of political manipulation. It is about ‘structuring the world so you can win’.Footnote 62 This concept is used in electoral politics to describe the strategy of bringing about a new alternative to divide an existing majority, upsetting the prevailing equilibrium. As a case in point, Abraham Lincoln famously split and then defeated a solid Democratic majority by introducing a new dimension of political competition, that is, slavery. Political scientists mainly focus on the way electoral equilibria are broken by increasing or fixing dimensionality. But Riker's lessons are more general. Skilful herestheticians outmanœuvred political adversaries by redefining political situations, reframing policy alternatives, manipulating agendas, voting strategically and changing the process by which collective decisions are taken.Footnote 63 Indeed, heresthetic is essentially ‘the art of constructing choice situations so as to be able to manipulate outcomes’.Footnote 64 In Riker's words, it is about: ‘Setting up situations .. in such a way that even those who do not wish to do so are compelled by the structure of the situation to support the heresthestician's purpose’.Footnote 65
One of the key arguments of this article is that heresthetic is also about the strategic manipulation of institutions. Social decisions are made by aggregating the opinions of relevant people. New institutionalism contends that social outcomes depend as much on the procedure of aggregation as on the tastes of participants. If institutions mediate the relationship between preferences and outcomes, it is always possible to manipulate outcomes by redesigning institutions. In this context, the logic of heresthetic can inform the politics of institutional change.Footnote 66 In certain moments of history, the introduction (or elimination) of dimensions involves the manipulation of institutional structures, as actors struggle to shape the mechanisms transforming preferences into outcomes in order to prevail in future political contests. Hence, heresthetical manœuvres are a source of institutional change. However, while some politicians are strong on heresthetic, others are not.Footnote 67 We will see that this issue played a key role in explaining the evolution of bank independence in Britain.
The concept of heresthetic is also a reminder that political agency matters in the process of institutional change. One way of incorporating agents into a model of institutional origins is to look at the behaviour of ‘political entrepreneurs’, who engage in institution building to make profits.Footnote 68 Transforming institutions is costly though. Political entrepreneurs must invest time and energy in the design of institutions from which they seek to secure political gains. In the remainder of this section, we will discuss two types of motivations: (1) the notion of binding others; and (2) the enabling functions of institutional pre-commitments.
From Self-Binding to Binding Others
‘In politics, people never try to bind themselves, only to bind others.’
Jon Elster, Ulysses Unbound
The idea of self-binding is omnipresent in the credibility-based narratives explaining the choice of monetary arrangements. Several scholars have employed the metaphors of tying one's hands and burning one's own ships to describe the pre-commitment options available for achieving credibility in strategic interaction.Footnote 69 These metaphors have been widely applied to account for the evolution of fiscal and monetary commitments.Footnote 70 Correspondingly, Ulysses’ self-binding logic is often used to explain the rise of independent central banking. As one expert put it:
Perhaps the principal reason why central banks are given independence from elected politicians is that the political process is apt to be too short sighted. Knowing this, politicians willingly and wisely cede day-to-day authority over monetary policy to a group of independent central bankers who are told to keep inflation in check … The reasoning is the same as Ulysses’: He knew he would get better long-run results by tying himself to the mast, even though he wouldn't always feel very good about it in the short run!Footnote 71
The abusive use of the self-binding rhetoric induces misleading interpretations of the political logic of institutional solutions to problems of credible commitment. Moreover, scholars writing on monetary commitments seem to be unaware of Elster's important U-turn on the rationale of self-binding. In Ulysses Unbound, he explicitly revisits and reformulates some of the key arguments of his influential Ulysses and the Sirens. In particular, he argues that: ‘the transfer of concepts used to study individuals to the behaviour of collectivities, as if these were individuals writ large, can be very misleading’. For one thing, ‘constitutions may bind others rather than being acts of self-binding’.Footnote 72 By removing the assumption that governments are unitary actors, Elster now claims that pre-commitment devices, like granting central banks independence, are not self-binding in an intentional sense. On the contrary, many alleged cases of self-binding institutions turn out, on a closer inspection, to confirm the dictum that in politics ‘people want to bind others, not themselves’.Footnote 73
More formally, Elster shows that self-binding entails the following four analytical options: (1) An agent A binds the same agent A (of course, most of the times A needs assistance from B to bind himself); (2) An agent B imposes a constraint on an agent A because A has asked him to do so; (3) An agent B binds A because B believes that A would have asked to be bound had he known all the facts about the case and been capable of making an informed decision; and (4) A person binds himself merely for the purpose of creating a constraint that will also limit the freedom of others.Footnote 74 It is the last of these options that provides the most useful framework for understanding the Britain's path to independence. By strategically delegating power, Gordon Brown did not want to bind himself. Instead, the institutional choice was meant to constrain potential challengers while simultaneously increasing the capacity of the Treasury to control other departments’ plans, enabling Brown to play a more powerful role than any previous Chancellor.
Enabling Political Institutions
‘Common sense suggests that it is always preferable to have more options than fewer … very often common sense fails .. Sometimes it is simply the case that less is more; people may benefit from being constrained.’
Jon Elster, Ulysses Unbound
By reading too much into the self-binding metaphor, most works on credibility overestimate the constraining dimension of institutional commitments. Institutional constraints are not only about limiting power. Indeed, the democratic paradox of constitutional pre-commitment is that constraints can be power-enhancing. As James Madison famously claimed, constraints can promote freedom. In this context, Stephen Holmes argues that ‘pre-commitments are not disabling, but enabling’.Footnote 75 In Douglass North's terms, institutions reduce the transaction costs of certain exchanges by increasing the costs of engaging in certain forms of (undesirable) behaviour.
This dialectic relationship between the constraining and enabling features of government commitments refers to Thomas Schelling's classic thesis: in strategic bargaining ‘weakness is often strength’.Footnote 76 This enabling function reinforces the benefit-side of a ruler's equation. Herestheticians are not seduced by discipline per se, but rather by the profits attached to the institutionalization of discipline.
Some classic works on political economy support the proposition that less is more in the creation of commitments through institutions. For example, North and Weingast show that a ‘fiscal boom’ was one of the outcomes of the constitutional reforms that took place during Britain's Glorious Revolution.Footnote 77 Hilton Root's research on France's historical political economy also emphasizes the enabling implications of tying one's hands. He wrote: ‘the King supported the expansion of corporate society because corporate institutions enabled him to obtain credit’.Footnote 78 We will see below that the logic of enabling political institutions can also inform the evolution of Gordon Brown's prudence. In a curious way, the strategy of constrained discretion ended up liberating rather than binding the Treasury. The government was able to exploit unprecedented political and financial opportunities, creating the conditions for significant increases in government spending.
The Context of Institutional Choice
The overriding aim of central bank independence is to induce low and stable levels of inflation. British inflationary history has been problematic. During the so-called post-war settlement, governments put the emphasis on demand management through fiscal means with monetary policy performing a subordinate, supporting role.Footnote 79 The stagflation of the mid-1970s dislocated this framework. Inflation reached record levels in 1975, as Britain was particularly hit by the dismantling of the Bretton Woods system and the oil crisis. The dramatic failure of traditional income policies to provide an adequate response to the new reality, epitomized in the International Monetary Fund (IMF) crisis of 1976 and the winter of discontent of 1978/79, brought about a ‘new politics’ and a ‘new policy paradigm’.Footnote 80 In the context of the Thatcher revolution, the conquest of inflation – rather than unemployment – became the government's new priority. Inflation was eventually controlled, helped by structural changes. However, endless disputes over monetary and exchange-rate policy (for example, the quarrel between fixers and floaters) were one of the dominant features of the Conservative years.Footnote 81 In the event, the ERM crisis of 1992 raised serious questions about both the consistency and appropriateness of Britain's monetary framework.
It is certainly tempting to explain the origins of central bank independence in Britain as the predictable outcome of its traumatic monetary history and the politics of economic decline. However, this conclusion would be misleading. The shock in relative prices of the mid-1970s critically challenged the core beliefs underpinning the post-war British model of political economy. This belief cascade in turn led to a radical change in the institutional foundations of economic policy. Actually, Britain experienced a ‘movement from a Keynesian mode of policymaking to one based on monetarist economic theory’.Footnote 82 It should be pointed out though that CBI was one among a range of monetary commitments that might have been consistent with monetarism and the rational-expectations revolution.Footnote 83 And indeed the Conservatives sought alternative mechanisms to anchor their anti-inflation strategy, including money supply limits, external commitments and inflation targets.Footnote 84 The founding fathers were also aware of the available options. In the words of Ed Balls, economic adviser to Gordon Brown: ‘Of course, there is more than one route to stability for countries and regions – and different successful models of central bank independence – depending on their history, institutions and track record’.Footnote 85
This argument also applies to the role of globalization. Many authors stress the importance of the processes of Europeanization and internationalization for explaining New Labour's policy formation.Footnote 86 It is probably true that globalization has created constrains on autonomous and discretionary economic policy,Footnote 87 on the one hand, and incentives for delegation in the name of credibility, on the other. It is also probably true that New Labour's leaders consciously sought to adapt to the pressures imposed by economic integration, financial liberalization and heightened capital mobility.Footnote 88 However, it should be noted again that alternative institutional configurations, other than central bank independence, might have been consistent with the imperatives of globalization.
Political economists largely focus on changes in economic relative prices to explain the emergence of fiscal and monetary rules. But political relative prices are important as well. New Labour faced powerful political incentives, both electoral and coalitional, to endorse the main tenets of the neo-liberal consensus in an attempt to recapture the political centre of British politics.Footnote 89 Colin Hay shows that economic policy in general, and monetary policy in particular, were key elements of New Labour's reckless ‘politics of accommodation’.Footnote 90 Labour had to overcome the problem of being seen as the party of devaluation, inflation and high taxation.Footnote 91 In a bid to signal that the party had learned the hard lessons of the past, its 1997 manifesto committed to macroeconomic stability, control of inflation and fiscal prudence. Critically, Labour proposed ‘a robust and stable framework of monetary and fiscal discipline’.Footnote 92
The adoption of central bank independence in Britain cannot be fully explained by looking only at the economic and political underpinnings of New Labour, as most analysts implicitly do. At most, the structure of incentives described above affected the rational-choice calculations of the institutional framers by providing the context of decision. Those factors might have made possible a range of feasible options. They are hardly the essence of decision. Important puzzles remain. Why did CBI, one of the flagship institutions of neo-liberalism, not emerge during the height of conservative hegemony? Why did this radical institutional change not coincide with the rise of financial interests and the monetarist paradigm? If Blair and Brown wanted to use CBI to signal competence through repositioning, why did they not announce this radical reform before the election? In order to answer these questions, we should focus on the beliefs and motivations of the founding fathers.
Bank of England reform as heresthetic
Evolution? No, Heresthetic!
‘The power to constrain an adversary may depend on the power to bind oneself … freedom may be freedom to capitulate, and to burn bridges behind one may suffice to undo an opponent’.
Thomas Schelling, The Strategy of Conflict, p. 22
‘My intention is to lock into our policy making system a commitment to consistently low inflation in the long term.’
Gordon Brown, ‘Remit for the Monetary Policy Committee’
Actors maximize their goals by either changing their strategies under given rules or by changing the institutions that transform their strategies into outcomes. Most of the time they do the former, but they may occasionally do the latter. They attempt to shape political outcomes by manipulating the rules of the game. As the many examples included in Iain McLean's Rational Choice and British Politics show:
Once in a while there comes a politician who sees further than the others. Such a politician can see opportunities where others do not, in opening up or closing down political dimensions. This may lead to the enactment of radical and unexpected policies. It may turn a persistently losing coalition into a winning coalition. It may save a party whose social base is eroding. It may protect a party from overstretch.Footnote 93
Institutional reform is always an outcome of both evolution and design, a complex interaction of continuity and change, a blend of the old and the new. The making of central bank independence in Britain was not an exception. For some, it was a bold and radical reformulation of the monetary constitution. For others, it was simply the consolidation of the monetary arrangements introduced by Lamont following the ERM fiasco of 1992. In a lecture given to mark the first ten years of the Bank of England's Monetary Policy Committee, Mervyn King, in his capacity of Governor of the Bank of England, played around the ambiguity between evolution and design as he claimed that ‘although the announcement in 1997 of independence for the Bank of England was a bolt from the blue, it was a long time in the making’.Footnote 94
However, in the very same paragraph King added that ‘granting independence to the Bank of England was the dramatic constitutional change that convinced financial markets of the United Kingdom's conversion to stability as the basis of macroeconomic policy’ and that the decision was ‘both unexpected and far-reaching’. In another lecture given in 1999, King argued that ‘the Monetary Policy Committee has broken new ground in British constitutional history. In its three hundred year history probably no change has been as significant as operational independence and the creation of the Monetary Policy Committee’.Footnote 95 According to Eddie George (the previous Governor), this sweeping reform transformed the old Bank of England into the ‘The New Lady of Threadneedle Street’.Footnote 96 Detailed analysis of yield curves on UK government bonds also showed that Brown's announcement on 6 May 1997 was ‘a complete surprise to the financial markets’.Footnote 97 It is evident that the key players perceived this reform as a turning point, a radical departure from existing practices and traditions.
Evolutionary accounts of the politics of central bank independence in Britain suggest that this was simply an idea whose time had come.Footnote 98 But Brown's largely unforeseen decision to move swiftly towards granting operational independence to the Bank of England was nevertheless hailed as ‘an audacious stroke’, ‘a political masterstroke’, a ‘revolutionary move’, ‘a pre-emptive and brilliantly orchestrated manoeuvre’.Footnote 99 The always well-informed Andrew Rawnsley argued that ‘expert and inexpert opinion agreed that Brown had pulled off an astonishing coup de théâtre and a strategic masterstroke’.Footnote 100 This pivotal decision, not mentioned explicitly in the party manifesto,Footnote 101 was announced only five days after the election. More tellingly, Brown deliberatively waited until the eve of polling day to discuss with Blair his intention to go for an early announcement of CBI. According to Rawnsley, this was partly tactics: ‘it would give Blair little time to consult others who might be cool about the idea’.Footnote 102 It was both striking and illuminating that this decision – for many the biggest change in economic policy making since the war – was not discussed in the Cabinet, let alone referred to a formal consultation process. As Brown thought that making the move quickly was essential, the project was presented to Eddie George on a take-it-or-leave-it basis.Footnote 103 This ‘great political coup’Footnote 104 had all the fingerprints of heresthetic.
Iain McLean argued that the decisions to cede control over interest rates and to establish the golden rule to borrow only for government's capital spending were indeed ‘heresthetic moves’.Footnote 105 He suggested that the key motive behind the move was to avoid the blame when the economy goes wrong. The depoliticization literature has also assumed that New Labour surrendered control over monetary policy to evade responsibility for unpopular decisions such as interest rate increases.Footnote 106 Indeed, this motivation of avoiding the blame loomed large in both media analyses and parliamentary debates. And as might be expected, it was one of the preferred lines of argument used by Conservative MPs in the House of Commons. As Peter Lilley put it: ‘the Bill is yet another example of the Government's desire to remove power from the House and from elected representatives and give it away to appointed officials. They want to escape the blame for difficult decisions’.Footnote 107
Blame avoidance might have been one of the motives of the group around Gordon Brown. However, the strategic implications of the decision to surrender key tools for managing the economy were much broader. Heresthetic is about restructuring games to achieve political ends. Brown sought to reconstruct the British political system by manipulating the institutions of economic decision making. By removing monetary policy from the realm of party competition (fixing dimensionality in Riker's analytics), Brown could achieve vital strategic aims. For one thing, he was able to consolidate his reputation for economic competence by sending the ultimate signal to the markets. For another, he bought a powerful institutional insurance for enforcing internal discipline and policy cohesiveness in the context of a coalition of groups within the Labour party that was moving towards the right.
It is widely accepted that Brown moved promptly towards independence in order to reassure markets about New Labour's modern and business-friendly economic framework. This idea was surely in the mind of the founding fathers, who certainly used independence to signal a decisive break with the ‘old dogmas of the past’.Footnote 108 But this strategic decision was not only about signalling change; it was mainly about enforcing change over time. Essentially, the institutional change aimed at reshaping the structure of the political economy game. The real objective was to enforce a new paradigm of economic policy. In his 2005 Mansion House speech, Brown said: ‘in the 1950s Britain managed decline, then in the 1960s we mismanaged decline and then in the 1970s we declined to manage. And our stop-go history is now legendary – so much part of our psychology that it was essential in 1997 to start a new chapter by making the Bank of England independent’.Footnote 109 In the same spirit, Balls admitted that the early move to independence provided ‘a unique opportunity to reshape the objectives, institutions and practice of British macroeconomic policy’.Footnote 110
William Keegan concluded his insightful chapter on the Bank of England reform with the following words: ‘the battleground simply moved’.Footnote 111 This is precisely what heresthetic is all about; it is about reframing the rules of decision making, and by implication, shifting the parameters of political competition. By changing dimensionality, the institutional framers sought to induce a more consensual approach to economic policy making, attacking the roots of the pervasive conflicts of the past. Constitutional change was not only concerned with credibility, but also with legitimacy. According to Balls, ‘the new framework had to be capable of rebuilding and entrenching public support and establishing a new cross-party political and parliamentary consensus for long-term stability – a new consensus about goals and a new consensus about the institutional arrangements needed to deliver those goals’.Footnote 112 Brown believed that institutionalizing a new consensus was needed for moving beyond the ‘endless and sterile divisions between capital and labour, between state and market and between public and private sectors’.Footnote 113
Gordon Brown is not a typical heresthetician, though. Political entrepreneurs, who are active in the game of framing institutions, are usually people who strongly believe in the political power and the mediating role of institutions. Brown's policies did not seem to be informed by the institutions-do-matter mantra. Actually, Brown's interest in heresthetic comes from a different source, namely his ability and propensity to ‘think and act strategically’.Footnote 114 As Keegan put it, ‘the MPC episode brought out Brown's strategic and long-term approach’.Footnote 115 Other commentators point out that the Chancellor was determined to make Labour's conversion irreversible. Stephen argues that ‘if a single, overriding, feature defined the economic policy of the first Blair government, it was the Chancellor's construction of permanent monetary and fiscal frameworks to keep it in the path of virtue’.Footnote 116 In Brown's own words: ‘Improving the institutional arrangements for economic policy will be accorded a high priority by the government in order to deliver long term economic stability and rising prosperity.’Footnote 117
In hindsight, it appears that Brown had clear incentives to alter the dimensionality of the economic policy game by shifting decision-making power from Whitehall to the Square Mile. But this begs the further question as to why this did not happen before. An article in the Financial Times nicely captured the reaction of the City. It stated: ‘Mr Gordon Brown's decision to give the Bank of England operational autonomy may have been unexpected. But it is welcome. It should have been taken by the Tories’.Footnote 118 And indeed this radical institutional change should have been championed by the Conservatives in the name of sound money, financial stability and wage restraint. The Tories could have also delivered a pre-emptive strike and moved strategically towards independence just before leaving office. This would have locked in the interests of the Conservative coalition, just as Pinochet did in order to constrain the Chilean democratic transition. Intriguingly, they failed to do so. Why?
PATHS NOT TAKEN
In the period 1988–97, the Conservative governments of Thatcher and Major seriously considered but eventually rejected a number of proposals for central bank independence.Footnote 119 In November 1988, Chancellor Lawson sent a memo to Prime Minister Thatcher, proposing an independent Bank of England. The PM and the Chancellor had famously clashed over interest rates. In her memoirs, Mrs Thatcher recalled: ‘I was always more sensitive to the political implications of interest rates rises – particularly their timing … Prime Ministers have to be. I was also acutely conscious of what interest rate changes meant for those with mortgages … I was cautious about putting up interest rates unless it was necessary.’Footnote 120 In this context, Lawson contended that independence would strengthen the use of monetary policy to fight inflation, making the commitment to stable prices a permanent feature of British economic policy. He also argued that the change would enhance government's ability to resist electoral pressures. Interestingly, he also pointed out strategic considerations:
‘I was anxious above all to entrench our counterinflationary commitment and policies against the vagaries of future governments, possibly of a different political complexion’.Footnote 121
The proposal was turned down by Mrs Thatcher, who believed that monetary policy, interest rates and the value of the pound were not technical affairs; they were rather at the heart of economic policy, if not quintessential to democratic politics.Footnote 122 Paradoxically, heresthetic considerations were probably behind her decision. She might have calculated that removing monetary issues from party political competition was bound to benefit Labour. According to Peston, a senior official of that government confessed that ‘she recognized that such a move would reduce the electorate's fear of a Labour government’.Footnote 123 A deliberate ‘non-decision’ of this sort was probably one of the motivations. However, cognitive considerations played a crucial role as well. Would-be institutional reformers should be confident about the political power of institutions. Margaret Thatcher did not seem to share this belief. In her own words: ‘My reaction was dismissive … I do not believe that changing well-tried institutional arrangements generally provides solutions to underlying political problems – and the control of inflation is ultimately a political problem’.Footnote 124
Chancellor Lamont and Prime Minister Major also clashed over monetary policy. Major wished to see interest rates ‘as low as possible, but my frustration was with delays in implementing cuts that were to be taken’.Footnote 125 Following his predecessor, Lamont also proposed making the Bank of England independent.Footnote 126 But Major, like Thatcher, also rejected the move. Major recalled: ‘Norman … wanted to grant independence to the Bank of England. I disliked this proposal on democratic grounds, believing that the person responsible for monetary policy should be answerable for it in the House of Commons. I also feared that the culture of an independent bank would ensure that interest rates went up rapidly but fell only slowly’.Footnote 127 Again, dimensionality seemed to be an issue. According to Lamont, one of the reasons why Major objected to CBI was because ‘people were frightened how Labour would handle monetary policy and he didn't want to remove that fear’.Footnote 128 Lamont launched a futile counterattack: ‘I said there were some indications that Labour might move in the direction of independence, but the PM wouldn't budge. Reluctantly I had to forget the idea’.Footnote 129
The Conservatives were trapped in a strategic conundrum. While some key players (notably Lawson and Lamont) were persuaded about the potential gains of central bank independence, other players (notably Thatcher and Major) failed to see the benefits of removing monetary policy from the space of political competition. A further dimensionality problem undermined the position of the advocates of reform. Many observers viewed central bank independence as a step towards Europe, always a divisive issue within the Conservative coalition.Footnote 130
This analysis of the paths not taken underscores the role of Tony Blair as a founding father of bank independence. The conventional wisdom is that the decision was Brown's and that Blair was simply notified of the change, rather than seriously contributing to it.Footnote 131 However, the incoming prime minister could have emulated its predecessor and vetoed the proposal. By acquiescing to Brown's strategy, he played a decisive role in the process of institutional formation. According to Rawnsley, Blair liked the boldness of the plan and was enthused by the political dividend of winning the instant approval of the City.Footnote 132 The reform was also consistent with Blair's declared aims: appealing to the radical centre, disciplining the Labour party through modernization and strengthening the core executive.Footnote 133 In short, Blair perceived that good economics was in this case good politics. As he observed in his memoirs:
I had no doubt it [central bank independence] was right … it was the perfect ‘riposte’ to those worried about the economic credentials of an incoming Labour government, so although the rationale was ultimately to put long term economics before short term politics, there were very good political reasons for doing so.Footnote 134
This discussion reveals the limitations of evolutionary accounts of institutions based on relative price shocks or policy learning. There is a tendency to see bank independence as the end of a continuum that started with the 1992 ERM debacle. Yet nothing was inevitable. As Peston argues: ‘if the Tories had won the 1997 election, they would not have given independence to the Bank’.Footnote 135 The making of central bank independence in Britain tells us that, using Douglass North's language, institutional change requires both intentionality and comprehension of the issues. The evolution of relative price shocks and ideas created opportunities for change. But crucially, those opportunities were seized by the decisive action of a group of strategically-oriented politicians. Furthermore, some groups that would eventually profit from the institutionalization of discipline failed to take decisive steps to promote change, probably because they did not perceive the ultimate benefits of the reform.
The following anecdote highlights the importance of intentionality. Having made the decision about Bank of England reform very soon after the election, Brown, who had only quite recently been converted to the independence cause,Footnote 136 called Lamont to reveal his plans. When Lamont picked up the phone, he heard Brown saying: ‘we have decided to take your advice’. Lamont commented that ‘it wasn't my advice of course, it was their own decision.Footnote 137 He probably felt intellectually satisfied, but politically outplayed. The Conservatives enforced the monetarist paradigm in Britain, but ironically failed to deliver one of its flagship institutions. Ultimately, they were outmanœuvred by their political opponents. By deciding to play the CBI card, New Labour unambiguously committed to sound economic management and thereby radically reshaped the structure of the economic policy game.
The parliamentary debate over the 1998 Bank of England Act suggests that Brown's bid to manipulate dimensionality was successful. The Conservatives looked disconcerted. Peter Lilley claimed that: ‘controlling inflation by interest policy is a technical matter than cannot simply be handed over to a group of experts. It involves considerable discretion, and that discretion affects people's livelihoods, their jobs, the value of their savings, the viability of their businesses and the burden of their debts’.Footnote 138 Former Chancellor Ken Clarke argued that ‘hitting the inflation target can be damaging to the levels of unemployment and growth’.Footnote 139 Clifton-Brown complained that ‘bankers are always cautious. The proposal is therefore likely to be deflationary’.Footnote 140 Surreally, the Tories were favouring discretion and concerned about the implications of the reform for growth and unemployment. The heresthetic manœuvre definitively turned the world upside down.Footnote 141
In order to maximize support, herestheticians engage in the ‘strategic use of rhetoric’.Footnote 142 This proved to be the case during the Bank of England reform. While most non-partisan commentators cited the experiences of New Zealand, the United States and above all Germany to illustrate the potential payoffs of independence, Brown preferred to frame the reform as ‘a British solution to meet British needs’.Footnote 143 He also claimed that ‘this is a long-term policy for long-term prosperity’Footnote 144 and that ‘the new monetary arrangements will form part of our wider strategy to improve the performance of the British economy in the long term’.Footnote 145 So much for the long term. As Lord Keynes reminded us, in the long run we are all dead. What about the short-term gains of this institutional reform? Herestheticians would prefer not to talk openly about them. But they are vitally important nonetheless.
Gordon Unbound: the politics of self-binding revisited
Self-Binding? No, Binding Others!
‘I am cutting the politicians and the politics out of setting interest rates’
Gordon Brown, The Sun, 7 May 1997
Economists tend to emphasize the welfare gains of institutional pre-commitments. However, they rarely discuss the political rationale of voluntary self-binding. Why, and under which conditions, does a self-interested politician willingly sacrifice freedom of action in favour of technocratic institutions? Politicians adopt pre-commitment strategies only if they can realize effective political profits.
Gordon Brown and his advisers claimed that the new institutional arrangements would enhance significantly the ‘credibility of UK monetary policy’.Footnote 146 Credibility is an elusive concept though. It is partly about promoting macroeconomic consistency by realigning inter-temporal incentives. But credibility also has important political dimensions. After all, the strategy of Ulysses applied to the design of monetary institutions is ‘to entrust economic policy to persons that will not be tempted by the Sirens of partisan politics’.Footnote 147 This means that the pressures undermining the credibility of economic policies stem from the dynamics of public opinion and the demands of intra-party coalition-building. Governments are not unitary actors. And they are constantly faced with severe common-pool resource problems.
There are two competing arguments about the political dimension of credibility. On the one hand, Bernhard suggests that bank independence sought to increase cabinet stability by removing intra-party conflicts over monetary policy.Footnote 148 On the other hand, King claims that the British case does not provide support to the coalitional hypothesis because ‘only a few leftists remained in the Labour party … [so] Blair and Brown did not fear a threat from Labour backbenchers against their policies’.Footnote 149 In the light of the empirical evidence, Bernhard's case carries greater weight. The heresthetic move was perceived by its proponents within the Labour party as a political weapon for enforcing policy changes and party discipline in a coalition moving right. King's position is not entirely consistent with the large scholarship on the cognitive and political underpinnings of New Labour. A consistent view emerges from this literature that Blair and Brown were obsessed with exorcizing the past and strengthening the grip of the core executive. As Philip Stephens clearly put it:
The failure of his party's past loomed large. Brown had seen too many Labour Chancellors lurch from profligate post-election boom to fatal pre-election bust. Stability, rules, discipline, prudence, transparency: the mantras were more than election slogans. They were the means by which the New Labour government would exorcise the past. The party, as Blair would often remind his colleagues, had never secured two full terms in office. It had foundered instead on the rocks of successive economic crises. Stafford Cripps in 1948, James Callaghan in 1967, Denis Healey in 1976 – all had been humiliated by the financial markets. The sterling crises in those years had been symptom as much as a cause of the failure of self-discipline. Subsequent elections defeats were proof that the Labour way of governing had been bad politics as well as bad economics.Footnote 150
Since 1994, the architects of New Labour had promoted radical programmatic, organizational and symbolic changes aimed at signalling an unmistakable break with the past.Footnote 151 Moreover, they endorsed a reckless politics of accommodation, even at the risk of overshooting the position of the median voter.Footnote 152 Notwithstanding its large parliamentary majority, the newly elected leaders wanted to avoid the fate suffered by past Labour governments. Andrew Rawnsley's books show that Blair and Brown were obsessed with proving their competence by pleasing the markets and finding ways of enforcing internal discipline. This thinking shaped the politics of central bank independence. As Ed Balls confessed:
Establishing and retaining credibility is important for any central bank or government – but particularly for a new government from a political party which has been out of power for almost two decades and which has seen substantial changes in its party constitution and policy in a short space of years.Footnote 153
Self-binding is the dominant narrative in most accounts of bank independence in Britain. As an article put it, ‘by tying his hands to an independent monetary policy, Mr Brown should be able to avoid those perennial financial crises that have bedevilled previous Labour governments’.Footnote 154 Tying his hands? Actually this was not an act of self-binding in an intentional sense. Moreover, this self-binding rhetoric is at odds with conventional views regarding Gordon Brown's decision-making style. Brown had a determination to maximize his authority at the expense of others.Footnote 155 This apparent paradox regarding Brown's behaviour can be resolved by realizing that governments are not unitary actors, but coalitions of conflicting interests and ideas. Once we move from the logic of individual to collective choice, pre-commitment strategies are about binding others, rather than acts of self-binding. By formally tying his hands, Brown really intended to bind others.Footnote 156 Following Elster's logic, he formally bound himself merely for the purpose of creating a constraint that would also limit the freedom of action of others.
Then, whose hands? The markets and the media supported the move because they fully understood that the reform aimed at binding politicians, including sectors of Brown's own party. The Chancellor did not hide this intention. In several speeches, he argued that ‘interest rate decisions will be free from any political influence’ and that ‘we must remove the suspicion that short-term party political considerations are influencing the setting of interest rates’.Footnote 157 In a speech at the CBI national conference, Brown pleased the audience by saying that: ‘the perception that monetary policy decisions have been dominated by short-term political considerations has grown. I believe we are agreed it is right to take these decisions out of politics, and to free them from short-term political pressures’.Footnote 158 Stephens also highlights that ‘at the core of Brown's approach was the conviction that Britain's sad record of postwar economic mismanagement showed that politicians could not be trusted’.Footnote 159
Which politicians were targeted by the strategic move? The Sun pointed, maliciously, to Old Labour: ‘Brown's brilliant bid to defy Lefties’.Footnote 160 An article in The Guardian also argued that the reform ‘cuts the new government adrift of all the Old Labour expectations like public sector unions expecting favours. In future the chancellor will be able to say it's not within his power to make special cases: the Bank rules’.Footnote 161 In the same line, Peter Lilley claimed: ‘they want to remove any influence from Labour Back Benchers, whose demands for higher spending and laxer policy have wrecked every previous Labour Government’.Footnote 162 Another Conservative MP stated:
The Chancellor and his senior colleagues must hope that the change will provide him with a defence against his Back Benchers, who will not be as cringing in their parliamentary behaviour as they have been so far. When things start to go wrong on the economic front, as undoubtedly they will in the nature of things, and when unemployment starts rising, as undoubtedly it will at some point in the cycle, I hope that Labour Back Benchers will not allow themselves to be bought off with the excuse that the measures causing unemployment are not in the control of the Government but are the responsibility of the hard-hearted people on the Monetary Policy Committee of the Bank of England.Footnote 163
Stories about left-leaning Labour MPs’ discontent over the reform attracted some attention, mainly during the debate of the Bank of England Act. In the House of Commons, Diane Abbott complained that: ‘It was remarkable to see a Labour government elected in triumph with the biggest majority since the war, within days … hand over one of the most important levers of economic policy to an unelected quango’.Footnote 164 According to Austin Mitchell, the institutional choice implied that the ‘Government are now giving up power to an oligarchy whose interests point in the opposite direction of those of the people.’
The Old Labour issue has probably been overstated. The politics of interest rate setting in Britain is uniquely complex.Footnote 165 We should remember that even Thatcher and Major, concerned about the reaction of small businesses and people with mortgages, were too willing to accommodate demands for lower interest rates.Footnote 166 In the United States and even in pro-stability Germany, politicians and central bankers have also engaged in fierce arguments about monetary policy.Footnote 167 We should also remember that governments face pervasive collective action problems which compromise sound public finances. One journalist argued that ‘the chancellor has armed himself with a potent new reason to resist demands from spending ministers’.Footnote 168 The intellectual master of the reform was fully aware of the importance of protecting the Chancellor from civil servants and other ministers. In his now famous Euro-Monetarism, Balls argued: ‘No one has mastered the art of boom–bust economics better than the British Treasury … Power to set monetary policy remains in the hands of government ministers and unaccountable Treasury civil servants who seem to be able to live on despite their errors, while hapless Chancellors take the blame’.Footnote 169
Brown not only feared demands from party insiders and spending ministers, but also from interest groups. One of his biographers explained that ‘his study of the twentieth-century had convinced him that good policies and ideas were often derailed by interest groups and the pressures of the moment … This conclusion permeated his entire strategy’.Footnote 170 The group around Brown knew that pressures would not only be exerted by the unions, who tend to be the usual suspects. Business interests could also exert strong pressure on chancellors. Richard Lambert, the Director General of the Confederation of British Industry, repeatedly demanded that the Bank of England should keep interest rates as low as possible to support economic activity.Footnote 171 The Chancellor had strong reasons for trying to bind vested interests through political manipulation. In doing so, he was also constraining the Tories, which would find it more difficult to use their influence strategically over market actors to bully the Labour government.
Interest-group dynamics were also important because a commitment to increasing productivity was one of the pillars of New Labour's political economyFootnote 172 and CBI would be inextricably linked to the politics of wage bargaining.Footnote 173Euro-Monetarism provided an interesting discussion of Britain's poor record on wage restraint. Balls argued that wage restraint should be a central element of a non-monetarist economic policy. He stated: ‘the independent central bank should pay, and state that it is paying, particular attention to the rate of average earnings inflation in setting monetary policy. If employers and workers ignore the public interest and push settlements higher, then the Bank would have to raise interest rates’.Footnote 174 In his 1999 Mais Lecture, Brown outlined New Labour's approach to industrial relations:
The Bank of England [has] to meet an inflation target of 2.5 per cent. The target has to be met. Unacceptably high wage rises will not therefore lead to higher inflation but higher interest rates. It is in no one's interest if today's pay rise threatens to become tomorrow's mortgage rise. So wage responsibility – to rescue a useful phrase from a woeful context – is a price worth paying to achieve jobs now and prosperity in the long term. It is moderation for a purpose.Footnote 175
Constraining? No, Enabling!
‘Central bank independence liberated the Treasury.’
Ed Balls, Delivering Economic Stability
Binding others was clearly a powerful incentive in the calculation of the founding fathers. But the institutionalization of discipline involved other political benefits. According to Elster, pre-commitment is justified ‘because, rather than merely foreclosing options, it makes available possibilities which would otherwise lie beyond reach’.Footnote 176 This is Schelling's old lesson: in bargaining, weakness is often strength. Robert Peston, in his authoritative Brown's Britain, brilliantly captured this strategic dimension of the institutional move. He argues: ‘Brown's eureka was to recognize that less is more, that to give up some responsibilities – notably the control of interest rates, but also important areas of financial regulation, such as oversight of insurance companies – would reinforce the powers that matter.’Footnote 177
Peston's remarks refer to the paradox of institutional pre-commitment. As Holmes argues, a voluntary abdication of power can be power-enhancing. Self-binding institutions are not only constraining: they are also enabling.Footnote 178 Brown was not necessarily persuaded by the constraining, but he was surely keen on the enabling. Ironically, he bought some real freedom by sacrificing some formal powers. One effect of the reform was ‘to give Brown and the Treasury greater independence from Downing Street and far greater authority over other departments’.Footnote 179 As Lee put it:
by ceding responsibility for monetary policy to the Bank of England's Monetary Policy Committee (MPC), the Treasury was given the space and opportunity to intervene, in a way unprecedented in peacetime, in economic and social policy. The creation of the MPC made possible the new developmental role for the Treasury.Footnote 180
The empowerment of Brown's Treasury through ‘constrained discretion’ was not only rhetorical.Footnote 181 It had real effects. One government official argued:
independence strengthened the Treasury's hand more generally in respect of economic policy, fiscal policy, public spending and the minimum wage. In the old days, the Treasury sanction was not a credible threat. But suddenly we were in a position where we could say: If you do that and it is perceived as imprudent, well the Monetary Policy Committee might raise interest rates. It's out of our hands.Footnote 182
Following the same line, Ed Balls observed that ‘far from weakening the ability of the Treasury to ensure public spending discipline, the risk that the Monetary Policy Committee might respond with a rate rise has proved a useful and effective deterrent to profligate departmental proposals on more than one occasion’.Footnote 183 One analyst put it this way: ‘previous Labour governments had felt captured by the Treasury, Brown captured the Treasury’.Footnote 184
In the same vein, Rawnsley argues that Gordon Brown:
was less interested in operating the levers of macro-economic management than any previous incumbent in the Treasury, and independence for the Bank would be both a confidence-building marker with the markets and offer more freedom to devote himself to the structural, social and employment reform that really engaged the new Chancellor.Footnote 185
Peston also shows that ‘there have been other examples of Brown and the Treasury being empowered by the imposition of rules or reforms that appeared to limit their own freedom’ – notably the golden rules and the five tests for the single currency.Footnote 186 Herestheticians know that binding commitments can play positive roles, ultimately enhancing policy capacity. Balls and O'Donnell clearly knew this too: ‘Central bank independence liberated the Treasury. Handing over the monthly process of decision-making on interest rates … created the time, space and long-term credibility for the Chancellor and senior Treasury management to concentrate on other levers of economic policy and the Government's wider economic objectives.’Footnote 187
We might risk falling into the functionalist trap, explaining the emergence of a given institution on the basis of its results. However, some evidence suggests that Team Brown fully understood ex ante the strategic benefits of delegation. In his 1992 Fabian pamphlet, Ed Balls defended independence by emphasizing that a more transparent, accountable and predictable monetary policy would enhance credibility, meaning that ‘a Labour chancellor would be free to concentrate on many other aspects of policy’.Footnote 188 According to one commentator, Ball's explicit message to Brown was: ‘You should make the Bank independent. You should lose control in order to gain control.’Footnote 189
Remarkably, the founding fathers did not try to hide this fundamental dimension of institutional reform. On the contrary, they were unusually candid about the enabling implications of ‘making Labour credible’.Footnote 190 It is often forgotten that Balls's earlier writings aimed at denouncing the perils of a rigid rules-based approach to monetary policy. His central argument was that both the domestic and European brands of monetarism, which sought to link inflation expectations to intermediate monetary targets and to a one-size-fits-all German monetary policy respectively, were economically and politically misconceived.Footnote 191 Both Brown and Balls rejected the simplistic idea that governments could achieve credibility by tying themselves to fixed monetary rules.Footnote 192 They also contended that ‘the answer is not no rules, but the right rules’.Footnote 193 Thus a post-monetarist path to stability should allow for both discretion and flexibility. As Brown repeatedly argued:
In an open economy the discretion necessary for effective economic policy is possible only within a framework that guarantees the public interest is met, one that commands public trust and market credibility.
In the era of open capital markets, it is only within a credible framework that governments will command the trust to exercise the flexibility they require.Footnote 194
Many commentators have failed to understand the cognitive and motivational nuances of this institutional choice. The institutional designers were not seeking to buy credibility by tying themselves to the mast of strict binding commitments, as advocated by Giavazzi and Pagano. On the contrary, Balls was concerned with finding ways of ‘escaping the straitjacket of ERM and EMU’, including its deflationary effects.Footnote 195 Similarly, they were not uncritically embracing the central tenets of neoliberalism. They were rather interested in building flexibility into the system. In a lecture in which he denounced the ‘failures of monetarism’ and the rigidity of the Stability and Growth Pact, Balls declared that a clear pre-commitment to credible institutional arrangements should ‘allow the necessary flexibility so that policy can respond in the short term to surprise economic events’.Footnote 196 Brown's economic framework was less about constraining and more about enabling than is often assumed. Indeed, the constraining element of the much-discussed ‘constrained discretion’ concept was only incorporated by Balls following a suggestion made by Mervyn King.Footnote 197 This is hardly surprising. While the central banker was interested in constraining politicians, the economist political operator was keen on buying flexibility through pre-commitment.
The enabling features of institutional commitment may be the key to understanding some of the tensions associated with Brown's chancellorship. Earlier assessments of his policies put the emphasis on prudence.Footnote 198 In its first term in office, New Labour broadly honoured its pre-election budget pledges and introduced the so-called golden rules establishing that over the economic cycle the government would only borrow to invest and that public debt would be held at a stable level.Footnote 199 The enactment of CBI was also supposed to induce budget discipline. This new macroeconomic framework enforced tight budgets in the early years. However, over time the corset was loosened and then removed altogether. In History of Modern Britain, Andrew Marr remarks:
perhaps the most striking aspect of Brown's running of the economy was the stark, dramatic shape of public spending. For his first two years he stuck fiercely to the promise he had made about continuing Conservative spending levels … Then there was an abrupt and dramatic shift and public spending soared, particularly on health … So there were the lean years followed by the fat years, famine then feast, squeeze then relax.Footnote 200
Fiscal policy was ‘tight in the first years of New Labour but loosened significantly in subsequent years’.Footnote 201 This fiscal cycle led to the prudence for a purpose narrative.Footnote 202 As one commentator put it: ‘Indeed, the early [fiscal and monetary] restraint was ‘to allow Brown, over time, to spend more than if he had splurged initially and then had been forced to tighten his belt, which had been the fate of his Labour predecessors at 11 Downing Street.’Footnote 203
As in many other historical experiences, the institutionalization of monetary discipline involved a critical fiscal dimension. Opening financial opportunities was one of the cornerstones of the strategy of constrained discretion. As Ben Clift and Jim Tomlinson have lucidly argued, New Labour's decisive pursuit of market credibility ‘was expressly concerned to create some space for fiscal activism’.Footnote 204 The mechanism was the following: as potential owners of government bonds thought inflation would be lower, they started paying more for government debt, freeing up the Chancellor to spend more while keeping taxes down.Footnote 205 This implies that, by strengthening monetary and fiscal governance, New Labour ended up creating conditions for a huge increase in education and health spending. Again, this is not a functionalist speculation. A Labour MP made the following point in the parliamentary debate:
Gavyn Davis, the chief economist at Goldman Sachs, has estimated that, if yields on long bonds fall eventually by a full point, the Government's funding costs will be reduced by about 3.5 billion. The sum could be invested in the economy and could be used for extra public spending. A fall in bond yields would also reduce the cost of investment for private investment for private investors, and hence boost the economy in that way.Footnote 206
Back in May 1997, most analysts assumed that an independent central bank implied a more prudent fiscal policy. As one newspaper remarked: ‘the chancellor is more likely to follow a sensible fiscal policy if he has good reason to expect monetary policy will not accommodate it than if he can make it do so’.Footnote 207 However, the Bank of England reform ended up giving Brown ‘more freedom to tax and spend’.Footnote 208 In the context of enhanced credibility, both public and private borrowing soared, compromising financial sustainability. Eventually, New Labour policies came full circle, from prudence to increasing public and private imprudence.Footnote 209 The paradox of constitutional commitments squares the prudence and the prudence-for-a-purpose narratives. It has been suggested that Brown was able to be a real socialist because he previously won the confidence of the financial markets.Footnote 210 In the logic of heresthetic, he could afford to do it because he previously reshaped the structure of the political game by manipulating the monetary constitution. But prudence for a purpose was not an unintended consequence of the institutional move. It was the natural implication of the successful implementation of an enabling pre-commitment strategy. As Brown once claimed: ‘this extra public spending comes not at the expense of prudence but because of our prudence’.Footnote 211 Gordon was not bound, but unbound!
To sum it up, the making of central bank independence in Britain was underpinned by typical New Labour strategic thinking. The attempt to institutionalize a ‘post-monetarist approach to economic policy’Footnote 212 was based on a peculiar reading of the evolution of economic ideas and changes in the world economy.Footnote 213 It was also based on an explicit attempt to move beyond ‘the old methods of old left or old right’,Footnote 214 squaring the circle between the seemingly irreconcilable Friedman and Keynes.Footnote 215 In this framework, achieving credibility and stability were not aims, but only means to an end. Gordon Brown repeatedly argued that central bank independence was not the government's main objective. Tellingly, he began his Mais Lecture by saying: ‘my first words from the Treasury, as I became Chancellor and announced the independence of the Bank of England, were to reaffirm, for this Government, our commitment to the goal first set out in 1944 of high and stable levels of growth and employment’:Footnote 216 in other words, traditional values in a modern setting.
CONCLUSIONS AND IMPLICATIONS
‘Looking at historical situations or tempering formal models through empirical analysis is the best way to understand ourselves and the world in which we live.’
Norman Schofield, ‘Constitutional Political Economy’, p. 299
This article combines theory and historical narratives to explain a seminal constitutional change in contemporary Britain. The main argument is that Gordon Brown's surprise decision to change the British monetary constitution in 1997 was an act of political manipulation in a Rikerian sense. Conceptualizing the Bank of England reform as a heresthetic move throws new light on the motivations of New Labour. The political strategists deliberately removed an unpleasant issue from party politics in order to signal governing competence and enforce a new model of political economy. But we have observed that the institutional choice was not self-binding in an intentional sense. Indeed, Brown adopted a pre-commitment strategy to bind others, including members of his own government and powerful interest groups. Similarly, the reform was not driven by the logic of constraining. On the contrary, the institutionalization of discipline sought to achieve in-built flexibility through constrained discretion, enabling the Chancellor to achieve important economic and political goals. All these findings are well grounded in extant empirical evidence to date; but they are also subject to revision in the light of alternative interpretations of available evidence or the emergence of new evidence.Footnote 217
Theories of endogenous institutions are still underdeveloped,Footnote 218 probably because there is an element of contingency regarding the sufficient causes of rapid change.Footnote 219 Yet we can still identify patterns of political behaviour through the study of crucial instances of institutional development. This research confirms that there should not be a distinction between in-period choices (choices given rules) and constitutional choices (choices about the rules) as far as politicians’ motivations are concerned. The idea of a ‘pristine design stage’ is a myth.Footnote 220 If anything, incentives for political manipulation are higher during constitutional moments. Politicians can obtain substantive benefits by manipulating the mechanisms transforming preferences into outcomes. This implies that the notion of heresthetic has leverage beyond the sphere of electoral competition. This concept crucially induces us to focus on the intentions and beliefs of a small group of strategic-oriented politicians who consciously seek to profit from reshaping the structure of political games. Decisions over interest rates have massive distributive implications, not least in Britain. In this context, it is striking that the main proponents of price stability did not manage to make the Bank of England independent during the Conservative era. This further confirms that policy suppliers have a great deal of influence in the constitution-making process.
This article speaks to current debates about credibility and institutions, central bank independence, and the relationship between monetary and fiscal governance. The dominant story about the merits of self-binding and the credibility gains from depoliticizing monetary commitments may risk obscuring the politics of institutional change. Self-binding is a strategic hook aimed at outmanœuvring adversaries. Politicians design institutionally binding commitments in order to bind others rather than themselves. Insofar as commentators have recognized the power of the binding-others argument, it tends to be made with reference to future governments. This research suggests that binding others is also a strategic option to enforce the cohesiveness of ruling coalitions in a transition context. In the British case, Brown surrendered key policy tools with the objective of creating a constraint that would limit the freedom of potential challengers. Institutionalized commitments are also power-enhancing. Politicians, even the Gordon Browns of this world, are not interested in self-discipline, but in the political profits associated with the institutionalization of discipline. These two motivations – binding others and enabling – may help us understand why politicians delegate power to technocratic institutions, complementing explanations based on epistemic communities and depoliticization.
Greater central bank independence has emerged in the last decades as the paradigm of good economic governance.Footnote 221 This monetary consensus should not be taken for granted though. Both the theoretical and empirical cases for independence are not uncontroversial. Works documenting an apparent association between CBI and low inflation are still undermined by causality issues, measurement errors, omitted-variable biases and sampling problems.Footnote 222 More importantly, the effects of central bank independence on inflation may be contingent on countries’ underlying political and societal constraints.Footnote 223 The new monetary orthodoxy entails significant ‘institutional paradoxes’.Footnote 224 Finally, the logics of delegation and democratic accountability are not easily reconciled.Footnote 225 These remaining uncertainties call for more in-depth and context-specific analysis of the evolution and implications of monetary institutions. This case study has shown that the cognitive and political underpinnings of central banking reforms are more nuanced than often suggested.
Economists often assume that hard monetary commitments would enforce budget discipline. But history shows that institutional innovations aimed at controlling rulers’ discretion may induce financial revolutions which relax the existing budget constraints of private and public agents.Footnote 226 In the worst case scenario, the politics of cheap money leads to a financial disaster. Examples are not in short supply. In Argentina, an ultra-hard monetary arrangement created the conditions for an unsustainable financial bubble which burst tragically in December 2001. In Greece, the combination of the single currency with independent national budget policies encouraged fiscal profligacy, leaving the country on the verge of financial meltdown.Footnote 227 In Britain, the conscious pursuit of credibility through constrained discretion facilitated fiscal activismFootnote 228 and fuelled an unhealthy housing boom. The established thinking has typically argued that the problem was not the monetary frameworks, but over-expansionary fiscal policies. Yet this article suggests that the softening of budget constraints were not unintended consequences, but intrinsic to the making of constitutional commitments. This argument may contribute to the debate about the contradictions and limits inherent in the New Labour project.Footnote 229
I wish to conclude by saying that the crucial anomalies brought about by the current financial crisis should ideally encourage a rethinking of the role of institutions on economic policy-making.Footnote 230 Are monetary institutions really solving problems of credible commitment, or simply reallocating them?Footnote 231 Is there an institutional fix to politics? What are the limits of using external commitments to induce domestic discipline?Footnote 232 What is the role of institutional complementarities, including the interactions between monetary, fiscal and financial governance? All these issues must be seriously addressed in further research.
