Monetary Policy

A Design for Life

By, 04/21/2008

Story Highlights:

  • The Bank of England and European Central Bank are considering policies similar to the Federal Reserve's.
  • The BOE hasn't changed since the Great Depression, and what worked then doesn't necessarily work now.
  • The Fed has a history of innovation and evolution, making them a choice example for central banks who want to improve technology.


When John Winthrop led the Puritans to the New World in 1630, he stated the colony would be "a city upon a hill," watched and imitated by the world. Three hundred seventy-eight years later, the US is indeed a model for other nations (though they likely grumble otherwise)—apparently even on monetary policy. As the world seeks to curb the "credit crunch," some central banks seem to be taking cues from America's Fed.

In Europe, France's Nicolas Sarkozy and Italy's Silvio Berlusconi claim they want the European Central Bank (ECB) to adopt the Fed's "dual mandate" of promoting growth and fighting inflation. The ECB currently focuses primarily on restraining inflation, which is fine in Germany, but slower-growth countries—especially Spain—wish the ECB would be more stimulative. Meanwhile, ye jolly olde Bank of England (BOE) is about to unveil its own Fed-inspired overhaul.

Mervyn King Ready to Rock Bank of England's Foundations
By Staff, The Telegraph

The BOE remained quiet when "credit crunch" fears began, as Governor Mervyn King opposed the so-called moral hazard of "saving" failing banks. But Northern Rock's woes changed his tune. After the "Big Five" British banks asked for a US-style discount window, King joined Gordon Brown and Alistair Darling in studying the Fed for new ways to provide liquidity. Brown in particular is doing his homework, meeting with Ben Bernanke on his current trip to the US. The plan isn't yet final, but early indications suggest Fed influence is sticking.

Just as the Fed now accepts subprime mortgage-backed securities (MBS) as collateral, the BOE will likely allow banks to temporarily exchange MBS for gilts (treasury securities) to use as collateral to secure capital on the open market. Like the Fed, the BOE wants to shore up liquidity without increasing money supply. Also like the Fed, the BOE is wary of appearing to "bail out" distressed companies. Just as the Fed is not actually nationalizing subprime debt, the BOE is keen to demonstrate accepting MBS as collateral does not constitute a purchase—a sticking point for taxpayers leery of shouldering further burdens after Northern Rock.

Why is the BOE looking for American guidance? Simple—the Fed has demonstrated innovation and evolution, inventing new facilities and adapting to changing markets. By contrast, the BOE's tactics are fundamentally unchanged since the Great Depression—the only tools in its arsenal are money supply and interest rate adjustments. This was adequate when UK banks were mainly funded by depositors and shareholders, but with funding increasingly coming from MBS and other newer vehicles, failure to adapt has disadvantaged the BOE.

Meanwhile, the Fed has been instituting new facilities. The Term Auction Facility and Term Securities Lending Facility are market-based solutions that can provide fresh liquidity sans increasing money supply or lowering rates—in our view an effective strategy. The Fed's expanded arsenal lets them respond creatively and quickly, flexibility the BOE currently doesn't have.

One of the best ways to foster continued global economic expansion is for central banks to become more efficient. If other banks follow the BOE (and potentially ECB), and adopt improved technology from their peers, risk of disruptive monetary policy lessens. The Fed's beacon is a great start, and we think Winthrop would be especially pleased to see his initial vision for America come true in this fashion—after all, imitation is the highest form of flattery!

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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