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The Monetary Policy Committee should be scrapped and replaced with a simple rule for the Bank of England to target nominal GDP automatically.
Quantitative Easing should replace interest rates as the Bank’s main tool for conducting policy.
In the long run, the Bank should be stripped of its powers to control monetary policy and private banks be given currency-issuing powers instead.

The Bank of England should abolish the Monetary Policy Committee, use Quantitative Easing instead of interest rates to conduct normal monetary policy, and switch from an inflation target to targeting the total amount of nominal spending in the economy, also known as nominal GDP, argues a new paper from the Adam Smith Institute released today.

The Bank should prefer a rules-based system like this to the discretionary system it currently uses but, the paper argues, it should ultimately look toward ending monetary intervention altogether. The UK’s monetary regime should eventually aim towards the ‘free banking’ systems that brought financial stability to 18th and 19th century Scotland and elsewhere.

The paper, Sound Money: an Austrian proposal for free banking, NGDP targets, and OMO reforms, is a comprehensive critique of the flaws in the way the Bank of England currently does monetary policy and offers a superior means of achieving their goals of macroeconomic stability.

Quantitative easing should be extended to the market generally rather than being an interaction with a few preferred dealers, so as to minimise distortions caused by buying from select financial institutions, it says. It should be made open-ended, with the purpose of stabilising the growth path of nominal GDP—the total amount of spending in the economy—letting the market determine how much of that nominal GDP is real output and how much is inflation.

Author of the report, Prof Anthony J Evans, concludes that, after a century of failure, it may even be time to strip central banks of their powers over monetary policy entirely entirely, and let private banks issue their own notes.

The paper takes inspiration from the free banking systems of the 19th century, especially those in Switzerland and Scotland, but also from the monetary economics of Nobel Prizewinners Milton Friedman and Friedrich Hayek, who both argued that central bank discretion tends to push the economy away from rather than towards stabilisation.

Friedman showed how the central bank’s unwillingness to accommodate massive spikes in money demand in the late 1920s and early 1930s led to the US Great Depression—and how industrial production rocketed at the fastest pace in history when Franklin Delano Roosevelt raised the money supply to meet market demand by going off gold in 1933. This has played out again in the recent financial crisis, where a free banking system would have seen less fanning of the pre-crisis flames and more water afterwards—tighter policy in the run up and easier policy during and following the crash.

The paper’s author, Prof Anthony J Evans, said:

Since the financial crisis The Bank of England have made important changes to how they conduct monetary policy - such as the introduction of Quantitative Easing and Forward Guidance - and the government have made bold interventions into the banking system. However these drastic measures have failed to identify the root cause of the problem, which is the monetary regime.

Whilst inflation targeting has been discredited, and all but abandoned, it has not been replaced by a coherent and consistent strategy. This paper not only provides constructive advice on how to reform current policy, it places this in the context of a more comprehensive programme for sound money.

If you're going to engage in QE, make it adhere to Bagehot's law. If you're going to target a macroeconomic indicator, target NGDP. But if you want to stop central banks from introducing monetary distortions in the first place, move to free banking.

ASI Director Eamonn Butler added:

The Bank of England – and America’s Federal Reserve – have done a very poor job of managing our money. They have created artificial booms, followed by genuinely painful busts, through decades of following their unreliable ‘discretion’. You cannot fly a modern economy by the seat of your pants: it's time to replace the Bank’s bumbling with rational rules.

ASI Head of Research Ben Southwood added:

With oil price shocks that lead the Bank of England to ‘look through’ first above-target, then below-target, inflation for dozens of consecutive months, inflation targeting has become extremely flexible.

We should go from this de facto abandonment and make it de jure as well, with a simple, clear goal that’s easy for markets to understand and plan based on.

Notes to Editors:

To read Sound Money: an Austrian proposal for free banking, NGDP targets, and OMO reforms click here.

The Adam Smith Institute is a free market, libertarian think tank based in London. It advocates classically liberal public policies to create a richer, freer world.