My Lords, I am not sure. Noting the expectation of higher prices, unions would press for higher wages and employers would lay off workers to compensate. That was the dreaded wage/price spiral of the 1970s. Policy makers concluded, and legislators concurred, that inflation must be curbed at all costs. At the time of the Bank of England Act, the winning argument was that the relegation of the Government's "growth and employment objectives" would prevent the manipulation of economic activity by unscrupulous politicians in search of votes. In any case, the control of inflation was said to be the best guarantor of growth and employment.
In October 2008, that fine theory met its Waterloo when we discovered that you could have, according to the deputy governor of the Bank of England,
"the largest financial crisis in human history", during a period of low inflation. By focusing only on inflation, as Section 11 directed them to do, Bank of England officials were blindfolded to the disaster that could occur in a low-inflation environment. That error was compounded by obliging the Bank to monitor the wrong kind of inflation. Whereas the Bank's consumer price index—the CPI—keeps a close eye on the price of a packet of peas and a loaf of bread, it overlooks the very aspects of inflation which led to the current crisis.
For the past five years, "debt inflation" was 9.5 per cent a year, which is almost five times the Bank of England's CPI inflation target. But where is debt inflation in the CPI? It is not included. During the same period, the inflation rate of one asset class—residential property—was 13 per cent per annum. Where is that in the CPI? It is not included. What about the cost of acquiring and holding these property assets; that is, mortgage interest? It is not included.
The Bank's measure of inflation was irrelevant and out of touch because the world had changed. The era of hand signals from Threadneedle Street to discourage troublesome unions was over. Millions of people had become investors in a new asset class: they were home owners. They adopted a simple model. I borrow money and I buy an asset. The price goes up, I exit the asset, I repay the loan and I keep the profit. This was the joy of debt as taught by the masters of private equity, and why should not private individuals do the same? So they did, in their millions. By creating the false impression that low inflation meant economic stability, the Bank of England Act 1998 encouraged the view that it was safe to borrow and safe to invest. As many noble Lords have said, UK average household debt has more than doubled in 10 years, and British households have taken on more than twice as much debt as their EU counterparts. Yet the rate of inflation as monitored by the Bank of England in accordance with the Act excluded debt inflation, asset class inflation and mortgage interest inflation, the very causes of the current crisis.
Nor did the Act consider how a change in the inflation rate of a certain asset class could bring about a dramatic collapse in the economy, notwithstanding low inflation. As the current chairman of the Federal Reserve, Ben Bernanke, put it, there is no one correct method for valuing an asset class. There are two methods. The first is the price a normal seller would receive from a normal buyer who looks to the value of the asset at maturity. The second is the price a distressed seller would accept from a reluctant buyer who thinks only of short-term risk. That change in valuation method, completely unforeseen in Section 11 of the Bank of England Act, created this crisis.
Experts tell us that the UK will have the worst of this crash because, in conformity with its exclusive brief to control inflation, the Bank of England kept UK interest rates at 5 per cent, the highest level among the G7 countries, until this October, while the US, for example, cut interest rates by more than half from 5.25 per cent to 2 per cent in April. The record seems to show that the top officials at the Bank were like top generals given the wrong orders. All noble Lords know the importance of language. We are often mocked for endlessly debating minute amendments to legislation such as "delete 'a' and insert 'the'". In the case of the Bank of England Act 1998, three words really have changed history. It is time to delete them from the statute book.