For the Covid-19 economic recovery look to the Treasury, not the Bank

Earlier this year both of the big jobs in UK economic management changed hands. Within weeks of Rishi Sunak taking over from Sajid Javid at the Treasury, Andrew Bailey was replacing Mark Carney at the Bank of England.

In the months since, Sunak has barely been out of the news and he will remain centre stage after the decision to put England back into lockdown. In the past few weeks alone, the chancellor has announced and recalibrated the job support scheme. Now he has been forced to reinstate the furlough, with the Treasury back to paying 80% of the wages of those unable to work.

Bailey, by contract, has had a much lower profile. The Bank moved quickly to cut interest rates and create money in the early stages of the crisis, and was part of the international action to ensure that financial markets did not freeze up completely.

But since then the Bank has been like the solid cricket batsman holding up an end so that a stroke maker at the other end can make some runs. As the International Monetary Fund (IMF) made clear in its annual health check on the UK economy, the Bank and the Treasury work well together but there is no doubt which in recent months has been the junior partner.

The new lockdown in England means there will be heightened interest this week when the Bank’s monetary policy committee (MPC) announces the results of its latest deliberations, but if, as expected, Threadneedle Street says it is expanding its quantitative easing (known as QE, or money creation) programme by £100bn the impact on the economy will be modest.

Interest rates are already at their lowest point in the Bank’s 326-year history – at 0.1% – and the MPC is thinking about whether to follow the example of the European Central Bank (ECB) and take them negative. This looks unlikely, both because there are concerns about the impact of negative rates on the profitability of banks and because there is scant evidence in the eurozone – or in the other places where they have been tried – that they succeed in one of their principle aims: raising inflation rates.

Indeed, there is more than a hint of angels dancing on pin heads about the Bank’s negative interest rate debate. Put simply, what Sunak decides to do about furloughed workers makes a material difference to the economy; whether official rates are pegged at 0.1% or -0.1% doesn’t.

The contrast with the last crisis and its aftermath is stark. Then, the Bank did most of the heavy lifting to support the economy. It cut interest rates from 5% to 0.5% and announced the first tranche of QE. The Conservative chancellor after the 2010 election, George Osborne, expected the Bank to provide the growth stimulus so that he could tackle the budget deficit with spending cuts and tax increases.

This division of responsibility was rooted in widespread belief that short-term tweaks to the economy were best achieved through monetary policy – the stuff the Bank of England does – while fiscal policy, the responsibility of the Treasury, takes longer to have any impact.

Times have changed. One example of that was the IMF’s advice to the chancellor last week to carry on spending for as long as it takes for the economy to recover. Another is a new paper from the right-of-centre thinktank Policy Exchange written by Warwick Lightfoot, special adviser to three Conservative chancellors.

Lightfoot says monetary policy was already at the limits of what it could achieve even before the pandemic arrived, and that the debate about negative interest rates illustrates that. The Bank of England, like other central banks, argues it still has plenty of ammunition and says studies demonstrate the effectiveness of monetary policy. This is true, although the studies show less of an impact when conducted by outside economists as opposed to when central banks mark their own homework.

The fact that central bankers – including Christine Lagarde at the ECB and Jerome Powell at the US Federal Reserve – keep piling pressure on finance ministries to boost their economies drives home Lightfoot’s central point: active fiscal policies to stimulate demand are now the key to macro-economic management.

But what of the traditional concerns on the political right that higher government borrowing leads to inflation and higher interest rates, which crowd out private investment by making it more expensive?

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Those were legitimate concerns in the 1970s, Lightfoot says, but are no longer relevant. There is no expectation that inflation or interest rates are going to rise, and that means the cost of servicing government borrowing is going to remain low. International capital flows means that the actions of the Fed are often more significant to the costs of financing Sunak’s borrowing than are the Bank of England’s. All this means, the paper says, that policymakers can feel less constrained than they were in the past and any “lack of demand in the economy and spare capacity should be remedied by macro-economic stimulus”, mostly provided by the Treasury.

Policy Exchange has close links to the Tory hierarchy so it will be interesting to see if Sunak shows any interest in the paper’s proposal that he should explore opportunities to lock in the present historically very low rates of interest by issuing 50 or 100-year gilts – the government bonds sold to cover the state’s borrowing. There is also a case for permanent non-repayable bonds offering a slightly higher rate of interest.

During the financial crisis those who said fears about borrowing were overstated found it hard to get a hearing. This paper shows where the new centre of gravity lies. Lightfoot says he has changed his mind because the caravan has moved on. It certainly has.


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