August 12, 2012 6:46 pm
It has become a regular feature of the Bank of England’s inflation report to postpone the recovery’s estimated date of arrival. Last week was no exception. Not only did Sir Mervyn King, BoE governor, downgrade the 2012 growth forecast to zero. His forecast for two years out, too, was worse than the BoE has ever predicted before.
Such a depressing forecast has led some observers to expect further loosening of monetary policy. The fact that rates faced by businesses and households are edging up strengthens the case for more monetary action to match a fiscal loosening the treasury has in effect allowed by extending the time allocated for fiscal consolidation.
For now, though, the BoE’s Monetary Policy Committee seems set to wait and see how its most recent policy will affect the economy. The new “Funding for Lending” scheme that was activated at the turn of the month offers banks financial incentives to offer more credit to UK borrowers. One must hope that it will prompt UK banks to act like banks again.
The sclerosis in UK banks’ balance sheets is clogging up the financial arteries through which central bank cash multiplies. The money printed by the BoE is not turning into lending: in spite of £125bn of bond purchases in the nine months to June, broad money – credit to the economy – rose by just £30bn. The printing-presses may be working overtime in Threadneedle Street, but the distributors of the cash are off sick.
Sir Mervyn underlined the MPC’s determination not to let the broad money supply shrink like it did in the Great Depression. That is the right goal. But the dysfunction of the banks is so serious that to reach it, patiently nursing the banking system back to health is not enough. The BoE must also find ways around the banking system to get the money into the hands of those who will spend it.
QE aims to do this, but has disappointed. More radical options – involving direct monetisation of spending – are finally being discussed. Instead of the ideological opposition Sir Mervyn expressed last week, it behoves the BoE to offer pragmatic and rigorous analyses of what benefits and drawbacks such policies might bring.
Falling productivity and exports show that the UK’s economic sluggishness is not all about insufficient demand at home. But weak domestic demand is an important brake on growth, too – one, moreover, that the BoE is well placed to lift. To do so, it must find alternatives to a policy transmission process that is so clearly failing.
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