Central banks do indeed rule by changing interest rates. But by far the most important influence is what they say they’re going to do to interest rates:
However, Mr Bailey said that increasing rates to the 5.25pc level recently expected by markets would trigger a two-year recession and cut household real incomes by £800 in 2023.
He said this should serve “as a reminder that we should not increase Bank Rate too far”, and added: “We can’t make promises about future interest rates but based on where we stand today, we think Bank Rate will have to go up by less than currently priced in financial markets.”
Expectations management that’s called.
This is also why the ‘Tater’s idea that central banks should lose their independence is such a bad idea. Because the power of management depends upon belief in those expectations. And it’s just one of those things, that markets are more likely to believe someone independent of the political process than they are someone a part of it.
Think on it. Imagine Spud was in political power (or the people who were believed his ideas) then we’d get interest rates right now being lowered, spending and money printing increasing. This would increase inflation substantially. For entirely political reasons. Well, OK. But that’s different from the current BoE aim of getting us back to 2% inflation.
Therefore, political control would mean that the aim of 2% inflation could – would – be over-ruled whenever there was political reason to do so. Belief in the Bank doing what it says it would do would therefore decrease.
As is in fact the main finding of the effects of central bank independence. It’s not that they’ve conquered inflation. It’s that interest rates have been lower in the same circumstances than they would have been with political control of them. The risk premium for some Chancellor doing the Barber dash for growth with both loose fiscal and monetary policy has receded. The absence of that risk premium is the amount by which interest rates have been lower than they would have been with political control.