The power of recommendation is one of the two key powers of the Financial Policy Committee. The working assumption of most FPC-watchers is that this power will be used in very specific ways: most often to make a recommendation to a specific regulatory authority to take a specific action, or to the Treasury, to recommend that the FPC be granted powers of direction over specific tools.

Author: Richard Barwell

Published: 18 September 2023

The power of recommendation is one of the two key powers of the Financial Policy Committee. The working assumption of most FPC-watchers is that this power will be used in very specific ways: most often to make a recommendation to a specific regulatory authority to take a specific action, or to the Treasury, to recommend that the FPC be granted powers of direction over specific tools.

Interior of boardroom with armchairs by asbe, Getty Images

Interior of boardroom with armchairs by asbe, Getty Images

However, the theoretical scope of this power is broad, and has always been understood as such by members of the Committee. Several former FPC members have used more or less the same form of words to describe the scope of this power: to make recommendations to anyone about anything that would help meet its objectives (Fisher (2014), Kohn (2016)).

The goal of this blog is not to review the uses to which the FPC has actually put this power of recommendation over the past or what could be done in the present day, given the established precedent on how that power has been used up until this point. Instead, this blog considers how broad the scope of that power might actually be, and asks: how far could the FPC reasonably go in making recommendations in the pursuit of financial stability? In particular, does “anyone about anything” stretch to elected officials and government policy?

We begin by placing the discussion about the effectiveness of recommendation in historical context, referencing the upbeat assessment of the power of the Governor’s eyebrows and Mervyn King’s downbeat assessment of central bank sermons. We then establish a simplistic necessary condition on issuing controversial recommendations and sketch out why it is unlikely to be sufficient. Finally, to put some context around this discussion, we then consider a few hypothetical examples of ‘courageous’ recommendations that a committee of technocrats concerned with financial stability might contemplate.

The effectiveness of unorthodox recommendations: eyebrows and sermons

The Financial Policy Committee and its power of recommendation may be a relatively recent addition to the world of economic policy, but there is a long tradition of central bankers making verbal interventions, whether in public or behind closed doors, in the pursuit of financial stability. There is a debate among central bankers about effective those “recommendations” were.

It is often claimed that the Governor, the Deputy Governors, the Executive Directors, indeed anyone in a senior position empowered to speak on behalf of the Bank of England had significant power to influence the course of events in financial markets. Indeed, the received wisdom is that the Governor didn’t actually have to say anything at all to achieve the desired result. For example, a Spectator article from the early 1980s states:

“the most powerful force in the City of London is, proverbially, the Governor of the Bank of England’s raised eyebrows. They represent an authority based on custom, respect, and mutual convenience, rather than any force of law … there is nothing to gain and all to lose by unlearning Rule One of the City: when the Governor raises his eyebrows, that is that.”

The Governor’s eyebrows have obtained near mythical status in some quarters, but clearly the individual or institution on the receiving end had to understand what precisely the Governor was recommending that they do and why, and have good reasons to comply – or as one who was there at the time put it (Tucker (2009)):

“I think that it was not some special magic talismanic power. I think what the Bank could do is convey to people home truths in a calm way and with authority.”

In contrast to this upbeat assessment, Mervyn King once warned that there was a limit to what a central bank could achieve in financial stability policy through words alone:

“the Bank finds itself in a position rather like that of a church whose congregation attends weddings and burials but ignores the sermons in between .. . experience suggests that attempts to encourage a better life through the power of voice is not enough … So it is not entirely clear how the Bank will be able to discharge its new statutory responsibility if we can do no more than issue sermons or organise burials.”

So, what determines the effectiveness of a central bank recommendation on financial stability? Where recommendations to other regulatory bodies are concerned, the FPC can be confident that there will be a response. Recommendations can be made on a “comply or explain” basis: the PRA or FCA has to implement the recommendation or make a public statement to explain why it has not done so.

The focus of this blog is instead on a more unorthodox use of the power of recommendation to a different audience where the obligation to comply or explain will not exist. In some cases, there may still be the implicit or explicit threat of future policy action by the FPC or some other body (most obviously, the government) if the recipient does not comply which will increase the chance of a positive response. Otherwise, the effectiveness of an unorthodox recommendation will typically depend on the extent to which the Committee convinces the recipient to change behaviour or failing that creates external pressure on the recipient to comply with the recommendation (note: there may be circumstances where senior management doesn’t need persuading but needs a reputable third party – the FPC – to make the case in public, to counteract pressure being applied by some lobby group to preserve the status quo). In short, the recommendation would have to backed up by a communication strategy to build that constituency for change.

Pressure on the senior management of a private institution or public body may come from various sources: from the general public; from customers; from market participants and counterparties; from the media; from politicians; or from shareholders. This is the transmission mechanism of an unorthodox recommendation: the FPC seeks to persuade these various stakeholders of the merits of its arguments in the hope that they each apply pressure using whatever economic and political power is at their disposal.

The effectiveness of an unorthodox FPC recommendation, the eyebrows or a sermon will therefore depend in large part on how persuasive the overall message is – that is, the recommendation itself and the wider communication strategy around it – and that likely hinges on two factors: the content of the message and how it is delivered.

The obvious mechanism through which central bank communication influences behaviour is by releasing private information (that was previously held by the institution). New information can then trigger a change in behaviour. Unorthodox recommendations and the communication around them are no different. The more information that is released into the public domain, and the more the audience trusts the central banks as a producer or intermediary of information, the more effective the message. Indeed, there is even the risk that central bank communication about financial stability issues could prove too powerful: statements of concern relating to a particular institution could all too easily precipitate a crisis and become self-fulfilling.

The way that the FPC phrases an unorthodox recommendation, and the way it communicates that recommendation to the wider group of stakeholders, will also impact the effectiveness of the recommendation. The more the message satisfies the Truman test (“Give me a one-handed economist. All my economists say ‘on the one hand . . .’, then ‘but on the other . . .’”) by emphasising stark conclusions and the conviction with which the FPC holds that view, whilst downplaying the caveats and uncertainty, the more likely it is that the message will have traction. Of course, in a world where nothing is known with certainty, such strident messages could easily be wrong and are more likely to cause offence for those on the receiving end.

A necessary condition for telling uncomfortable truths

Just because you can, doesn’t mean that you should. There may be circumstances where the FPC believes that there would be a positive impact on the outlook for financial stability if the Committee made a public unorthodox recommendation, but the FPC nonetheless reached the conclusion that it should not make that recommendation public. So, what are the practical limits on ‘to anyone, about anything’?

There are three obvious dimensions along which the FPC might have cause for concern leading it to self-censor: knowledge; mandate; recipient.

The first point is straightforward: the content of your message should reflect the strength of your analysis. If you don’t know that much about a particular topic then perhaps it is wise to keep your thoughts to yourself, or at the very least, don’t express strong views on the matter. As a simple rule of thumb, the greater the mismatch between the certainty implicit in the message and the uncertainty around the supporting analysis, the more controversial that communication is along this dimension. To be fair, policymakers tend to avoid making statements about the future that imply a degree of conviction that macroeconomics and finance seldom provide. Nonetheless, to fix ideas, one can distinguish here between, say, commentary about the near-term risks to financial stability and a cost-benefit analysis of fundamental structural change in the financial system (e.g., the end of fractional banking). The latter is inherently more uncertain than the former and so firm conclusions on the latter are inherently more contentious than a similarly framed comments on the former.

Irrespective of the controversy that a message might generate, it is also worth emphasising that if the audience believes that the analytical foundations of the message are weak then it is likely to have a more modest impact. After all, as discussed above, it is the release of valuable private information that allows central bank communication to have power.

There has been a renewed focus in recent years on the second factor that defines the extent of controversy: the extent to which the message and subject matter are linked to the mandate of the central bank. Central banks have accumulated new responsibilities and new policy instruments since the financial crisis. Macroprudential policy is a case in point. Furthermore, years of monetary policy activism and innovation (and fiscal caution) has led to central banks becoming portrayed as the potential policy solution to an ever-increasing set of problems. Indeed, central banks are often referred to as the “only game in town”, expected to take action almost irrespective of policy remits. This has caused concern in some quarters (see, above all, Paul Tucker’s book Unelected Power) about well-intentioned over-reach today and an implicit threat to central bank independence tomorrow and led to calls for a new constitutional arrangement that would in turns constrain and legitimise the power these unelected officials undoubtedly wield. In the context of our discussion, the further the content of the message is from the mandate, the more controversial that message could be. Unfortunately, the incomplete nature of the macroprudential mandate complicates any evaluation of how far the message is from the mandate (Barwell (2021)).

The final dimension of controversy that we consider is the impact on, and identity of the recipient. The first aspect is obvious. The greater the private cost to the individual or institution from complying with a recommendation, the more contentious that recommendation is. It is one thing to ask an individual or institution to go against its private interest, it is another to recommend that an institution or individual go against a recognised norm, an established mandate or responsibility. Such recommendations are inherently controversial. The second aspect of the recipient question is a more pragmatic consideration. The more powerful or important the recipient, the more contentious the recommendation is. We have in mind here not only domestic institutions: in theory the FPC could make an unorthodox recommendation to an international or supranational institution. Of course, the FPC would only make such a recommendation if the actions (or inaction) of those institutions were having a material impact on domestic financial stability, in which case, almost by definition, those institutions would have to be very powerful.

The question of making recommendations to the UK government is of particular interest here. Clearly, it would be inappropriate for the FPC to make recommendations about aspects of government policy where there is no tangible link with the pursuit of financial stability. However, it is possible to imagine circumstances where government policy might be having a meaningful detrimental impact on financial stability (given the scale and complexity of the government’s role in a modern economy). The FPC could choose to speak out in these circumstances. We should be under no illusion about what that implies: the purpose of the public recommendation is to build a constituency to put pressure on the politicians to do something that they would prefer not to do and something that might run counter to the manifesto they were elected upon (we take it as read that the politicians were not persuaded of the merits of the FPC’s case when it was discussed in private).

Crudely speaking, one can therefore think about quantifying the potential controversy associated with publishing a particular recommendation as the product of a “score” on each of these dimensions (knowledge; mandate; recipient), with perhaps different weights attached to different scores. The combined score could be thought of as capturing the cost associated with such unorthodox recommendations. The more unsure you are of your analytical position, the more uncertain you are whether the subject matter is intimately connected to your mandate and the more your recommendation is likely to cut across the interests of the recipients and in particular challenge elected politicians the more controversial it is.

We are not original in highlighting these soft constraints on central bank communication. One of the principles that Tucker highlights In Unelected Power is “the imperative of self-restraint among the mighty” – the principle that unelected officials like central bankers should avoid interfering in affairs that are not directly linked to their legal objectives. He considers the question of whether and how central bankers should speak about the policies of elected officials and concludes that central bankers should stand ready to give advice in private and if necessary be ready to repeat that advice in public “but in doing so the intimate connection with their formal mandate must be explicit” and their advice must be “able to withstand tough scrutiny”.

Of course, the practical limits on the power of recommendation are not purely defined by how controversial the recommendation is likely to prove. The controversy needs to be weighed against the potential benefit of making the statement. The greater the anticipated reduction in probability or severity of some current or future financial crisis, the stronger the case for controversial communication. A necessary condition for issuing these contentious unorthodox recommendations is that perceived benefits must exceed the perceived cost associated with the controversy that the recommendation is likely to generate.

Reputational considerations: why necessary and not sufficient

We view the condition that the perceived benefits of speaking out must outweigh the controversy that making the recommendation public will likely cause as a necessary but not sufficient condition for speaking uncomfortable truths to power. There may be occasions when that condition is met but central bankers will still conclude that discretion is the better part of valour for fear of damage to the reputation of the institution. We focus on two arguments here – one more compelling than the other.

It is always possible that a recommendation might be ignored when the recipient has discretion over whether to comply. It is arguably probable in the case of controversial recommendations that are the focus of this blog.

There is an argument that recommendations which are liable to be completely ignored are probably better left unsaid. The Committee risks being viewed as impotent, which might then damage its credibility and capacity to influence behaviour in other circumstances. However, it seems pessimistic to assume that a recommendation is guaranteed to fall on deaf ears, that the FPC will fail to build an effective constituency for change among relevant stakeholders. One can never know in advance how a forceful message will be received.

Moreover, if we take a longer-term perspective then the argument for speaking out becomes more compelling, A recommendation that is ignored today but is subsequently vindicated by future events is likely to enhance the institution’s reputation in the long run. Conversely, the FPC may be criticised after the fact if it chose not to speak up.

The other reputational argument is perhaps more compelling. Controversial public statements could invite criticism, and not all of it reasonable and considered. Once the central bank’s opinion is in the public domain it has little control over how those words are used or mis-used. The central bank may be accused of overstepping its mandate and interfering in matters which it has no business commenting upon. The central bank may be perceived as taking sides in a political debate.

Central bankers may be concerned about the potential damage to the institution’s reputation in these circumstances. There may even be residual concerns about potential calls for the central bank’s responsibilities and independence to be curtailed. Policymakers are likely to weigh these reputational costs carefully against the benefits that might flow from controversial recommendations.

Courageous recommendations: a few hypothetical examples

FPC members appear to believe that they can make recommendations to anyone about anything. In the final section of this blog we consider some hypothetical examples which should help to tease out the practical limits of the power of recommendation.

To our way of thinking, the acid test of the ‘to anyone, about anything’ claim is whether the unelected officials on the FPC would be willing to make public recommendations to elected politicians so our focus here is primarily on various circumstances where the need to make a recommendation might arise.

Our first two hypothetical examples of courageous FPC recommendations relate to fiscal policy. We begin with comments about the state of the public finances. There is, after all, a precedent here, of sorts, for central bankers to intervene on such a sensitive issue. Mervyn King once made the following remark about the elected government’s plans:

“where the scale of deficits is truly extraordinary. This reflects the scale of the global downturn, but it also reflects the fact that we came into this crisis with fiscal policy on a path that wasn’t sustainable and a correction was needed”

Whether you believe the Governor’s views around the pace of deficit reduction at that time were appropriate or not, one must presumably concede that there could be circumstances where the Bank might have valid concerns about whether the public finances were on a sustainable footing and the threat that posed to financial and monetary stability. Recent experience in the Eurozone debt crisis illustrates how concerns around sovereign debt sustainability can undermine financial stability. The question then is whether it would ever be appropriate for the Bank to voice those concerns in public, and if so, whether an FPC recommendation might be a useful vehicle to raise those concerns in a controlled manner (as opposed to say a speech by a specific individual).

Recent events suggest another situation in which the FPC might in theory make a recommendation to the Chancellor about the stance of fiscal policy. The MPC has been obliged to raise interest rates at a very rapid pace in response to the persistent strength of wage and price inflation. The burden of that monetary tightening will not be evenly spread across the population. For example, those individuals falling off a fixed rate mortgage in the coming months will have a very different experience to those who own their home with no mortgage outstanding.

In the worst-case scenario where inflation stays very high for an extended period and there is pressure on the MPC to continue tightening the stance of monetary policy, the FPC might start to have concerns about the consequences of the MPC’s strategy in terms of the extent of financial distress in segments of the household and corporate populations. At some point, the FPC might conclude that a more balanced tightening in macroeconomic policy might be considered preferable to the MPC doing all the heavy lifting. Tighter fiscal policy could act as a substitute for some of the tightening in monetary policy in this hypothetical scenario. Moreover, the fiscal adjustment could be calibrated to impact a different subset of the population — potentially selected on the basis of ability to pay — than those who might otherwise bear the brunt of a spike in mortgage rates.

Once again, we have a question about whether the FPC would ever be willing to recommend that the Chancellor raise taxes or cut spending. But there is an additional question now, and that is whether it would be politically problematic within the Bank, for the FPC to ask the Chancellor to give the MPC a helping hand, not least given the cross-membership of the two committees?

The third example we consider relates to another sensitive area of economic policy that has direct implications for financial stability here in the United Kingdom: the overall approach to regulation of shadow banks.

In a first best word, the global regulatory community would move as one with common purpose to tackle the problem of the risks to financial stability posed by shadow banking. Ever since the last financial crisis, policymakers have been patiently waiting for this coordinated programme of reform to begin. But progress has been slow. It has not proved possible to convince everyone to begin in earnest, and without the most important jurisdictions on-board, nobody wants to move unilaterally for fear that activity will simply migrate elsewhere. However, that means the risks from shadow banking remain everywhere. The FPC is no doubt cognisant of this.

A courageous recommendation in this context would be for the FPC to recommend either to domestic or European policymakers to accept that global progress is likely to be limited on this front for the foreseeable future, and therefore local authorities must reluctantly look for consensus amongst those global partners willing and able to take action and then push ahead. The drawback with this recommendation is clear: the tension with the government’s broader objectives, and in particular towards the financial services sector. Pushing ahead with unilateral reform of shadow banking might not be considered compatible with the FPC’s secondary objective to support the economic policy of the Government. After all, the FPC has been informed that

“the government is committed to securing a financial sector that is both secure and globally competitive over the long term. This includes taking forward an ambitious agenda to unleash the potential of the UK financial services sector.”

The final unorthodox recommendation we consider is almost certainly a non-starter given the current design of the policy committees within the Bank – whether the FPC would ever be willing to make a recommendation to the MPC. The hypothetical rationale for such a recommendation would be that the current monetary strategy was perceived to complicate the pursuit of financial stability. Governor King, highlighted one possible tension between the conduct of monetary policy and macroprudential policy in the immediate aftermath of the financial crisis:

“we need to take actions now that will dampen the adjustment in the short term while recognising that the adjustment will ultimately need to be made. This is the paradox of policy at present – almost any policy measure that is desirable now appears diametrically opposite to the direction in which we need to go in the long term. Spending now supports the economy, but in the long run we need to save more and borrow less.”

The MPC and FPC could have conceivably disagreed on the appropriate way to manage that policy paradox, given the implicit difference in their respective policy horizons. The MPC understandably took the view that more debt today (and therefore tomorrow) was a price worth paying to support spending and inflation today. But the FPC might have reached a different conclusion: that lower inflation today might be a price worth paying to start making progress on reducing debt today (and therefore tomorrow). In theory, the FPC might have communicated its concerns to the MPC and recommended a less aggressive monetary strategy, tolerating a weaker path of spending and inflation.

The reality of the current institutional set-up is that the Governor and three of the Deputy Governors (Monetary Policy, Markets and Banking, Financial Stability) sit on both the FPC and MPC, and more broadly, the internal members hold the balance of power in both committees (Barwell (2023)). It seems almost inconceivable that a consensus could ever emerge on the FPC to make a public recommendation to the MPC to change strategy given that set-up – at least, not without the prior consent of the MPC. After all, a financial stability knock-out clause was included in the forward guidance on Bank Rate that the MPC published in August 2013, and the FPC’s judgement that the clause should be activated was eventually to be made public, even if it was first communicated in private. All that being said, it is not inconceivable that a courageous individual member of the FPC might want to propose making a recommendation to the MPC within the current institutional set-up.

Conclusion

The power of recommendation is a key instrument of macroprudential policy in the UK. The conventional use of that tool is to make comply or explain recommendations to regulatory bodies like the PRA or FCA. However, members of the FPC argue that the tool can in principle be used to make recommendations to anyone about anything that is relevant to the FPC’s remit.

The recipients of such unorthodox recommendations would not be obliged to respond. If the FPC wants a private institution or public body to comply then it will have to persuade them of the merits of the recommendation, or perhaps more likely, convince a wide group of relevant stakeholders – depending on the recipient the public, customers, financial market participants, the media, politicians, shareholders – of the need for action, and then rely on those groups to apply pressure on the institution concerned. In other words, the recommendation would have to backed up by a communication strategy to build that constituency for change.

The limits of the power of recommendation will primarily reflect a trade-off between the degree to which the message is controversial – how confident is the FPC of its message? how intimately connected is the message to the FPC’s mandate? how far does the message challenge the interests of the recipient? and, how powerful is that recipient? – versus the perceived benefit of speaking out. The latter must dominate the former for controversy communication to be justified. However, this is likely a necessary condition that implies an overly ambitious limit. Fear of reputational damage is likely to lead to a more conservative approach to communication.

This blog has sketched out a few examples of controversial recommendations. Our point is not to suggest that the FPC should issue any of the recommendations discussed here. However, it might be useful for the current membership of the FPC to reflect on the limits of this power: do they really believe they could recommend anything to anyone, in the pursuit of financial stability? In a quiet moment, it might be wise for the Committee to give some thought on how a courageous recommendation would be produced and delivered and how would the broader communication strategy be executed to build pressure on the institution concerned to take action, before the time actually comes to act.