Britain’s economy cannot recover unless its damaged banking system is restructured, the newest member of the Bank of England’s monetary policy committee warned on Monday night.
Adam Posen, a highly regarded US academic who is an expert on Japan’s “lost decade”, said that the UK remained far more dependent on a small number of large banks to finance its businesses than many other developed economies and had fewer alternatives to bank lending.
In a speech to the Cass Business School, Mr Posen warned that economies that fix their banking systems, or where borrowers can tap alternatives such as the wider capital markets, are those that recover more quickly.
“I have argued that the banking system must be largely fixed before macroeconomic stimulus is needed to be withdrawn,” he said.
He added: “The alternative is likely to result in a stillborn recovery, a double-dip (though less severe) recession, and/or persistently slow growth.”
Mr Posen added that there are questions about how far and how long public policy stimulus can substitute for private sector demand and growth, drawing parallels with Japan during the 1990s.
“The closer one looks, the more worrisome this specific parallel becomes, given the concentration of the UK banking system in a few major, mostly still troubled banks, and the relative underdevelopment of alternative non-bank channels for getting capital to non-financial businesses in the UK,” said Mr Posen.
Meanwhile, he noted that the UK has only 8.5 banks per 1m people, far short of the Group of Seven average of 13.26 banks for the same number of population, while its private sector bond market capitalisation is by far the lowest of its G7 peers as a ratio of gross domestic product.
Moreover, its market for short-term private sector securities, such as commercial paper, as a ratio of GDP is significantly lower than that of Canada, France, Germany and the US, with only Japan and Italy having a less developed alternative channel to bank lending.
Britain’s banking structure “could impede the return of trend growth in the UK to its previous rate and which could, if things worsen, put on persistent deflationary pressure (as ongoing banking structural problems did and do in Japan)”, he added.
Separately, however, he scotched suggestions that the £175bn devoted so far to quantitative easing in the UK – the vast majority of which involves gilts purchases rather than corporate bonds – could sow the seeds of future inflation, dismissing supporters of such a view as “nutters”.
“If the Bank could create inflation easily under such circumstances, and if the majority of market participants and households believed that – not just the nutters – then we would be halfway home,” said Mr Posen.
He added that there was a wealth of empirical evidence to show that expanding money supply often bears little relationship to periods of rapid price increases, even in normal times, “let alone for times when the financial sector is so troubled and there is downward pressure on wage growth and prices”.
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