Economists question Bank stance on spending cuts

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Leading economists have questioned the Bank of England’s nonchalance over the effect on the economy of huge cuts in public spending planned by the government.

While the interest rate-setting monetary policy committee, and in particular Mervyn King, Bank governor, have said they expect only a small hit to growth from public sector retrenchment, notes from a forum held by the Bank last month show that many City and academic economists are less sanguine.

Economists present at the event said there was less room for the Bank to offset public spending cuts with lower interest rates, because the accelerator pedal of monetary policy had already been pushed to the floor. Meanwhile, they said, leading economies worldwide were planning to take an axe to public spending simultaneously, potentially amplifying the pain.

“Two factors suggested that the planned contraction in UK fiscal policy could have a larger effect than those measured historically,” said notes from the monetary policy round-table, which operates as a sounding board for the Bank to canvass the opinions of external economists.

“First, monetary policy might not be able to loosen as much to compensate,” the notes said. “Second, many countries were contracting at the same time.”

Although normally a cut in government spending might lead to a fall in the exchange rate and boost demand from overseas, when many countries were doing this at once “this stimulus would be limited”.

The average forecast for growth next year is 2 per cent among independent economists, but the Bank believes growth will be 2.8 per cent.

Economists at the meeting said that there was “a difficult trade-off” over the right amount of spending cuts because high debt and deficits also posed a threat to growth.

The Bank’s monetary policy committee argued that fiscal consolidation could have “some dampening effects on demand”, but these might be offset by stronger investor confidence and lower long-term interest rates.

Mr King, meanwhile, has said the recent downgrade in the Bank’s forecasts had little to do with cuts announced in the June Budget.

One economist who attended the conference said: “A number of people felt that the Bank’s view is relatively optimistic.”

Another said that some economic models, including those used by the International Monetary Fund and the Organisation for Economic Co-operation and Development, suggested the effects of large public spending cuts – with the economy still depressed and banks unable to lend – “are just awful, much bigger than anything Mervyn would say”.

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