Hamish McRae: Loose monetary policy is starting to look perverse
Europe is cutting budget deficits much more swiftly than we are. For now they are taking more pain
Wednesday 24 October 2012
Today, unless there is some huge upset, the third-quarter GDP figures will show that the UK economy has started to grow again. Actually, if you judge by a series of current activity indicators rather than these official GDP figures, it has been growing all the time. There is a view that eventually these figures will be revised to show some growth – a view reflected in these columns. But it is not very strong growth, perhaps around 1 per cent a year, and that leads to the question: what on earth can we do to boost it?
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It was an issue raised by Sir Mervyn King, the outgoing Governor of the Bank of England, in a speech this week. There were two substantive points. One was that while there were further things the Bank could do to ease monetary conditions, there were concerns about the effectiveness of such policies. The other was that extreme measures, such as writing off a chunk of the national debt held by the Bank, were mistaken.
On the first, there is a practical issue as to whether there should be another bout of quantitative easing in November. The Monetary Policy Committee is split and we will have to see which way it jumps. I don't think there is any doubt that the policy was effective in its early stages, for it reversed the collapse of house prices and cut the rate of interest on longer-term bonds, especially gilts.
But now, the balance is more questionable. Has inflation been higher than it otherwise would have been? Well, yes. Are pension funds damaged by the policy, with all the knock-on effect on company balance sheets and the living standards of those nearing retirement? Well, yes.
So while you can justify an extreme policy – underfunding the deficit – in an emergency, it becomes much harder to do so as things return to normal. As for Sir Mervyn's other point, the idea of just writing off part of the national debt, he was referring to a hint dropped by Lord Turner, one of the candidates to succeed him as governor. He warned that this might be seen as a move towards loosening fiscal policy – I suppose the point being that if governments had the freedom to write off debts there would be much less discipline on their spending and taxation decisions.
Frankly, the idea seems so outrageous that it simply is not going to happen. The UK managed to finance the Napoleonic Wars, the First World War and the Second World War without writing off the national debt. To do so now, after what has been, in employment terms, a less serious recession than the 1980s or the 1990s, would be unthinkable. If we ever look like going down that route, head for the hills.
Indeed I think we may be at a stage where loose monetary and fiscal policies have become not just ineffective but perverse. You cannot prove this because there is no comparable data. We have never had this combination of policy before in peacetime, either here or, I think, in any other developed country. But I have been fascinated by some work published this week by the Office for National Statistics on well-being.
In a nutshell, we are less happy than we should be, given the level of national income or personal income. Why? Well, the ONS took into account two other indicators: the level of inflation and public sector debt as a percentage of GDP. If you look at what it calls real actual household income, we are number four in Europe, behind Germany, Austria and France. But it may be that we are depressed by inflation, which until recently has been well above that of the eurozone, and by the rise in the national debt.
If this is right – and I think we should always be careful in interpreting calculations of national well-being – it may be that the loose monetary policy (insofar as it led to higher inflation) and the loose fiscal policy (which directly increased national debt) have made us unhappier that we "ought" to be.
This is very tentative stuff, so don't take this too directly, but it does make intuitive sense that people should be worried about economic policies they feel are irresponsible or unsustainable. It is why Tony Blair and Gordon Brown tried so hard to show, ahead of the 1997 election, that Labour would be a financially responsible government: the independence of the Bank of England and the golden rule. Maybe now we feel the Coalition is not being responsible enough, and that makes us worried.
That leads to a final point. Might there be dangers in our relatively slow correction of the fiscal deficit? Slow, that is, by European standards. As you can see from the top graph, while the published GDP data for the UK and the eurozone is broadly similar (and not very encouraging in either case), the economic activity indicator developed by Goldman Sachs shows the UK economy making somewhat better progress. This would square with the modestly better business opinion shown in the bottom graph.
But Europe is cutting budget deficits much more swiftly than we are, and not just in the crisis countries. For the moment they are taking more pain than we are. For example, new car sales in the first nine months of this year are down in every major European market bar one: the UK. But in a couple of years' time European budget deficits almost everywhere will be below 3 per cent of GDP, the Maastricht reference limit. We may not get there until 2016, and we will do so only by making cuts in public spending that will be far greater than anything to date. We have back-loaded our correction; they have taken it up front.
So what can be done? The phrase is "structural policies". What is meant by this are the detailed regulatory and other policies designed to clear roadblocks on the path to growth. We have done a lot to our labour market, with the result that unemployment is lower than in most European countries. It is also relatively easy to start a business, with the result that we have high rates of business formation. But we need to press on with things such as planning controls and other regulations that curb growth. Not easy; no magic wand; has to be done.
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