Growth is all very well but the UK economy is “a long way” from normality, the Bank of England’s Paul Fisher has warned this morning (14th November 2013), a day after the Bank raised its economic growth forecast. On Wednesday 13th November, the governor of the Bank of England, Mr Carney struck a positive tone on the UK’s economic prospects, saying the “UK recovery had taken hold”.
Paul Fisher, the MPC member, told Radio 5 today that the “fears of head winds have receded” and the long-awaited recovery has “come through in a rush.” But he said:
“We’ve got a long way to go before the economy gets back to normality.”
He stressed that the 7pc unemployment rate is a “threshold not a trigger” for an interest rate rise and argued “it would be a while before the economy can sustain an increase.”
We argue in our new report Sovereign Money: Paving the Way for a Sustainable Recovery that the current economic recovery is unsustainable.
Recent economic figures suggest that government policies (such as Help to Buy) have finally been successful in encouraging households to borrow more, mainly for mortgages. This has led to an increase in house prices, and a subsequent increase in spending due to the ‘wealth effect’. However, while economic output is increasing, the expansion will not be sustainable if private debts continue to increase at a faster rate than private incomes. Given that mortgage lending does not directly increase economic output, the government is essentially relying on the increase in spending generated by the higher house prices to incentivise businesses to invest. This is however a dangerous strategy, given excessive private debt was the primary cause of the financial crisis. Unless the increase in spending incentivises large amounts of business investment, the private debt-to-income ratio is likely to increase further, setting the stage for a future crisis and/or recession.
[sws_pullquote_right] The pivotal advantage of SMC is that unlike the government’s current growth strategies, which all rely on an over-indebted household sector going even further into debt, SMC requires no increase in either household debt or government debt.
In fact, SMC can actually reduce the overall levels of household debt. It would also make banks more liquid and the economy fundamentally safer. [/sws_pullquote_right] However, there is a way out of this ‘Catch-22’ situation: the government can increase private sector incomes and spending without increasing public debt. It can do this by creating money and using it to finance an increase in spending, a reduction in taxes or a “citizens’ dividend”.
We term this policy ‘Sovereign Money Creation’ (SMC). It is fundamentally different from Quantitative Easing (QE), which involved the central bank buying part of the government’s debt after it was issued (and so didn’t directly affect government spending at all). QE injected its newly created spending power into the financial markets, relying on indirect effects to boost spending in the real economy. In contrast, SMC actually increases government spending beyond what it would otherwise be, and so gets newly created money directly into the real economy. The increase in spending will increase private sector incomes, economic output and employment.
Most importantly, SMC would allow the private sector to reduce its debt-to-income ratio. Therefore, Sovereign Money Creation, if implemented in the near future, would make the current economic recovery sustainable.
In the longer term, SMC could also become an important macroprudential tool. Before the crisis the central bank had one policy lever, interest rates, but two targets, price stability and financial stability. While the countercyclical capital ratios that have been brought in since the crisis to prevent excessive bank lending may be useful in preventing asset price bubbles, they are less effective at constraining the level of private debt to a safe level given current incomes. However, SMC can be used to ensure that aggregate demand is maintained even as other monetary polices – such as countercyclical capital buffers – are used to restrict bank lending and prevent an unsustainable boom from continuing. This means that there would no longer be a trade-off between financial stability and economic growth.
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