King urges wider independence

The Government should apply the lessons learnt from the success of handing independence to set interest rates to the Bank of England to other areas of public policy, Mervyn King said last night.

The Governor of the Bank of England said ministers should "think imaginatively" about using it in areas where collective decisions were needed, such as pensions and climate change.

"Pensions policy, for example, has for years been bedevilled by a combination of extraordinary technical complexity, which means that decisions take a long time to reach and the reversal of policies adopted by earlier generations," he said.

"This is very much an area where we have been unable to constrain future collective decisions and it is one that would benefit from greater stability of policy."

He said that in the international arena, climate change and global trade were key areas where it was vital to get current consumers and politicians to behave in a way that did not wreak damage on future generations.

The decision in 1997 by the incoming Labour government to hand the power to set interest rates to a nine-strong committee of economists at the Bank has been hailed at one of the most successful policies of the Blair administration.

It has helped drive inflation down to the lowest levels for half a century, in part by persuading people that they can expect low inflation going forward when they set prices and wages.

Mr King also announced that Adam Smith, the father of modern economics, would become the first Scotsman to adorn a Bank of England banknote. He said the design of the new £20 note to be launched next spring would include an image showing a pin factory that gave birth to his breakthrough concept of the division of labour.

The image of the Scottish economist will replace that of Sir Edward Elgar which currently features on the £20 note.

Speaking in Adam Smith's home town of Kirkcaldy, Mr King said he hoped that visitors to the UK would take home a lesson in the virtues of free trade.

"I hope they will absorb the lesson that specialisation in production and trade across the world are the way to improve living standards in all countries - rich and poor alike," he said.

"And perhaps when they return home they will press their own politicians to support the opening up of trade, which has been at the heart of the British government's efforts to reform the world economy."

His comment will be seen as a side-swipe at European capitals that have blocked Gordon Brown's calls for cuts in EU agricultural subsidies as a way of unlocking the stalled talks on a new global trade deal.

Adam Smith is best known from his treatise, An Inquiry into the Causes and Nature of the Wealth of Nations, that coined the phrase "invisible hand" to describe the way that individuals acting in their own self interest collectively acted for the good of the whole.

In his speech, which gave no hint of the outcome of the Bank's decision on interest rates next week, Mr King said that inflation generally tended to undermine people's trust in holding paper money such as £20 notes.

"Inflation arises when collective political commitment to maintain price stability weakens," he said. "When high rates of inflation are anticipated, people wisely avoid holding paper money."