For a brief moment, I thought Theresa May was trying to hypnotise the assembled throng at the Conservative party conference last week. As she implored the country to “come with me”, I thought she was tempting us to “trust in me”. Fleetingly, I had visions of her inner Kaa.
But perhaps she was only trying to hypnotise the Bank of England. After all, the most striking section of her speech related to fiscal and monetary policy.
“…we must…invest in the things that matter, the things with a long-term return. That is how we will address the weaknesses in our economy, improve our productivity, increase economic growth and ensure everyone gets a fair share.”
Does this mean the Tories are now in the business of “picking winners”, rejecting the Thatcherite view that markets know best? If so, how will they avoid the “bridges to nowhere” problems that dogged Japanese policymakers in the 1990s or the “airport in every town” Spanish infrastructure curse in the run-up to the global financial crisis?
This elevation of fiscal policy reflects the prime minister’s doubts about the efficacy of monetary policy. Thanks to super-low interest rates and quantitative easing, the BoE “provided the necessary emergency medicine after the financial crash” but there have been “some bad side-effects”, she said.
“People with assets have got richer. People without them have suffered. People with mortgages have found their debts cheaper. People with savings have found themselves poorer. A change has got to come. And we are going to deliver it.”
She’s right about the redistributional effects of QE. The original idea was to buy gilts to drive their yields lower, encouraging pension funds, insurers and the like to buy riskier assets such as equities and corporate bonds. The hope was that companies would increase investment via the capital markets rather than having to rely on the — broken — banks.
Yet the policy only worked up to a point. Asset prices certainly rose. But there was scant evidence of any recovery in investment. Meanwhile, the UK’s productivity performance proved to be lamentable. The consequence was a recovery that, by past standards, was unusually weak.
Mrs May correctly observes that QE led to the creation of winners and losers. Mark Carney, BoE governor, agrees. However, in his view, while “every monetary …action has distributional consequences….it is not for the central bank to address those distributional consequences. It is for broader government to offset them if they so choose.”
That may be true, but if QE’s macroeconomic stimulus consequences are invisible while the microeconomic distributional consequences are all too visible, it’s hardly surprising that the BoE is dragged into the political debate.
In the past, monetary policy might have occasionally rewarded some at the expense of others but, over time, the winners and losers cancelled each other out: periods of higher interest rates that benefited savers would be offset by periods of lower interest rates that supported borrowers. Today, with interest rates at rock bottom and likely to stay there for some time, the symmetry is lost. Monetary policy is in danger of rewarding some people on a seemingly permanent basis while others permanently lose out.
There is a way around this. The BoE could argue that the distributional consequences of its monetary efforts limit the policy’s effectiveness. If the “winners” tend to be those who are already financially asset rich and are prone to save, rather than spend, their windfall gains, any stimulus is likely to be relatively muted. Worse, if the “losers” tend to be those whose meagre savings are mostly in cash and whose real spending power is made more vulnerable by sterling’s weakness, stimulus may prove to be counterproductive.
Seen in this light, the Bank should work with the government to change the distributional effects of monetary stimulus. Rather than seeing the benefits channelled to those who are unlikely to spend — investment-shy companies, wealthy individuals — why not adopt a distributional policy aimed not at “fairness” but at effectiveness?
One possibility would be for the BoE to create a “gilt purchase fund” — its size to be determined by the Monetary Policy Committee according to the demand shortfall in the economy. This could be used by the government to stimulate spending directly. A VAT cut or an increase in infrastructure spending, for example, might do more for economic activity than attempts to drive up the value of financial assets.
Such an approach would be in line with the central bank-led helicopter money scheme of former Federal Reserve chairman Ben Bernanke. The BoE would still enjoy monetary “dominance” over the fiscal authority — there would be no open cheque book — but its gilt purchases would have a more effective immediate impact on economic activity. And, by having a say in the “distribution” of monetary stimulus, the government could claim to have made monetary policy both fairer and more effective.
Such an arrangement would not be plain sailing. Offering stimulus while the UK has a large current account deficit and sterling is decidedly shaky won’t be easy. Neither will boosting productivity through infrastructure spending alone. Far better, however, to find a constructive new relationship between monetary and fiscal policy at the zero rate bound than to be reduced to a policy spat between Whitehall and Threadneedle Street in which there can only be losers.
Stephen King is HSBC’s senior economic adviser and the author of ‘When the Money Runs Out’
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