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|  | JULY 1, 2004
By Stanley Reed Inside the Bank of England [Page 3 of 3] SHEDDING ITS SKIN. For starters, the old system, which came of age in the post World War II years, fell short on transparency and professionalism. Back then investors could be forgiven for suspecting that whim and political expediency lay behind rate decisions. And they were often right. The Prime Minister occasionally became involved, and there was much less policy discussion than today. In contrast, in the seven years since Prime Minister Tony Blair and Chancellor Brown made the bank independent, Britain has definitively shed its reputation for economic mismanagement. Unemployment, now just 4.8%, continues to fall, and prosperity extends far from London. Thanks to the growth of service businesses, once-gritty Rust Belt northern cities such as Leeds and Manchester are booming. "Overall, the bank has been very effective," says Danny Gabay, a former Bank of England economist who now serves as director of Fathom Financial Consulting in London. "It has achieved something that previously eluded Britain: a sense of stability."
Now voters, who used to consider Labour hopeless at economic management, say they trust the party more than the Tories on economic matters. After all, ill-advised monetary policy robbed Thatcher of many of the benefits that might have been expected during her tenure as Prime Minister. Rate cuts by Chancellor Lawson in 1987 and 1988, for instance, overstimulated the economy, stoking inflation and contributing to the long recession of the early 1990s. Voters give most of the credit for the decision to make the bank independent to Brown, strengthening his hand in any potential contest for Labour Party leadership. In another twist, the bank's effectiveness convinces many Britons that they have no need to adopt the euro and enter the realm of the ECB. Why swap the BOE for the ECB? many Britons ask. AVOIDING CATASTROPHE. Despite its role-model status, bank officials admit it hasn't been independent long enough to have a proven track record. Some critics say the central bank went too far in the slowdown of 2001-2002 in trying to offset a sharp drop in exports and investment by stoking consumer demand. In particular, they criticize two rate cuts in 2003 before the bank began its march upward. "The BOE is now reaping the whirlwinds of a policy error," says Gabay, who thinks that rates could go as high as 6%. But other observers are less pessimistic. Ben Broadbent, an economist at Goldman, Sachs & Co. in London, says that while house prices may be rising fast, the rest of the British economy is not in the midst of an out-of-control boom as it was before the last recession in the early 1990s. Instead, spending has been in line with income growth. One issue is that the economy relied on consumption to avoid recessions in 2001 and 2002 when investment and exports plummeted. The bank, he says, now hopes to achieve more balance. "Even if the housing market does weaken" the massive 20% or so that Goldman is forecasting, Broadbent doubts "that will have catastrophic effects," because business investment and exports are picking up. The British have not had an economic catastrophe for some time. It's up to the BOE -- old in years, but young in its independence -- to make sure one doesn't happen now.
 With Rich Miller in Washington and David Fairlamb in Frankfurt Reed is BusinessWeek's London bureau manager Get BusinessWeek directly on your desktop with our RSS feeds.  Add BusinessWeek news to your Web site with our headline feed. Click to buy an e-print or reprint of a BusinessWeek or BusinessWeek Online story or video. To subscribe online to BusinessWeek magazine, please click here. Learn more, go to the BusinessWeekOnline home page  | | |
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