This week marks 10 years since the Bank of England introduced its quantitative easing (QE) programme, setting in motion the creation of hundreds of billions of pounds of new public money. The decade since has been marked by dysfunctional economic policy. While the Bank kept the taps turned on, the government pulled in the opposite direction – reducing public spending and investment through austerity, thus deflating the economy.
To coincide with the anniversary, QE is back on the agenda, with the Governor of the Bank of England appearing before select committees in Parliament to discuss the Bank’s potential response to an economic downturn following a no-deal Brexit.
Estimates vary dramatically, but the Bank itself thinks no-deal could lead GDP to be almost 8% lower by 2023 (the Treasury, for its part, estimates a loss of 9.3% of GDP after 15 years). A financial panic or a slump in consumer spending could catalyse a relatively serious downturn.
If the record following 2009 is anything to go by, it is unlikely the economic institutions of government will coordinate their response to a crisis. The Bank began cutting interest rates in July 2007, which by March 2009 reached 0.5%. At the same time, it launched QE, using the newly created Asset Purchase Facility to undertake £75 billion of purchases on the secondary market for UK government debt.
Those purchases rose over time – in November 2009, the MPC increased the total volume of purchases to £200 billion. The most recent increase, to £445 billion (not including the Term Funding Scheme, another measure taken to stimulate lending) occurred in August 2016 after the Brexit vote.
Meanwhile, in the 2009 to 2010 financial year, the government ran a large deficit of around 10% of GDP, owing to bank bailouts and a stimulus package. But since then, austerity has shrunk the deficit by on average 1% of GDP each year. It’s evident that the Bank of England’s QE policy and the government’s fiscal policy have been pulling in opposite directions.
A double-whammy for inequality
There is an acute need for investment across the UK to correct regional inequality (often labelled as the cause of the popular disenchantment manifest in the Brexit vote). Deprivation in ‘left-behind areas’ is closely linked to a loss of dynamism and flagging growth. Regionally, productivity in the UK is extremely uneven. When measured by gross value added (GVA) per head, productivity in London is 72% higher than the national average, and twice as high as in seven of eleven other UK regions. This compares unfavourably to major EU economies like France and Germany (see Figures 1 and 2 in this ONS publication).
Monetary policy has done nothing to alleviate this skew in the UK’s economic model, and has contributed to some of its more damaging consequences. Bank lending to non-financial businesses has hardly increased since the crisis. Instead, most of the new money has remained in financial markets, exacerbating a concentration of wealth in the south east of the UK and among wealthier households. Mortgage lending has resumed its steady climb. House prices, especially in London, are increasingly unaffordable.
The Bank’s analysis in 2018 showed that its extraordinary monetary policy increased the wealth of the average household in the richest 10% by over £350,000. The distribution of household financial wealth – which includes bank accounts, ISAs, and stocks and shares – has become even more wildly unequal (a 10 percentage point rise in the Gini coefficient between 2010 and 2016, according to the ONS Wealth and Assets Survey).
The Bank’s mandate is to support price stability and financial stability, not to reduce inequality. It is therefore a failure of government more broadly to imagine a different role the Bank could play. Policymakers could look for win-wins where expansionary monetary policy can help, rather than harm, social cohesion.
Brexit: chance to make a change
There might not seem to be many win-wins around when it comes to Brexit. But the policy response to a possible recession could be one of them.
It would be devastating for the UK if the same mistakes were repeated only a decade on from the financial crisis. Mark Carney, the Bank of England’s Governor, has indicated that it is more likely interest rates will have to be cut than raised in the event of no deal. Other members of the Monetary Policy Committee have hinted at more asset purchases. Without action from the Treasury, that would destroy any hope of saving for poorer households and young people. Meanwhile, those with plenty of financial and property assets will cash out once again.
As Positive Money showed even before the Brexit vote, there are several options for increasing the money supply without undertaking QE. Two in particular would help unburden the UK’s most deprived regions and households. Both would require coordinating policy across the Treasury and the Bank of England.
The first would be a ‘helicopter drop’ – a policy it is hard to believe doesn’t already feature in central bank toolkits. The Bank could buy a certain volume of government bonds, with a promise to roll them over in perpetuity, on the condition that they are immediately scheduled to go out to households in the form of a one-off tax break of the same value for every taxpayer.
UK households, saddled with debt and collectively spending more than they earn, could make very good use of a windfall from the government. Theresa May’s recent announcement of £1.6 billion for ‘left-behind’ communities via the ‘Stronger Towns Fund’ equates to approximately 0.08% of GDP. Imagine a central bank stimulus that would exactly counteract the annual impact of austerity, namely 1% of the UK’s GDP, or around £20 billion (less than half the original expansion of the Bank’s balance sheet agreed in March 2009). On average, that would hand every one of the UK’s 27.2 million households almost £750. Those households that spend the money will contribute directly to extra demand and inflation. Moreover, the policy is equal by design, but the extra cash would mean the most to those struggling to pay their bills.
The second option – a sort of ‘strategic QE’ – would target the supply side of the economy as well as demand. It should be possible to design a mechanism whereby a portion of newly created reserves are used to purchase bonds in a new public entity designed to deliver strategic investment (like a National Development Bank). It would probably be preferable for the Bank of England to simply credit the Treasury (purchasing perpetual, no-interest bonds), clearly marking the increase in reserves for the purpose of strategic investment by a new public body.
Consider that the Green Investment Bank was capitalised with only £3.8 billion of initial funds. Public money creation at a scale nowhere near the initial round of QE stimulus could help establish a new entity to tackle the country’s most pressing challenges, including decarbonisation and the housing crisis.
New legislation could establish special facilities – indeed, much like the Asset Purchase Facility itself – whereby the Bank of England could choose to make money available for the government to inject into the economy where it is most needed. Under today’s macroeconomic conditions, central banks need to be capable of targeting nominal demand. These extra stimulus tools would let them to choose how to do so, while leaving the government in control of distributional choices.
Given the utter lack of political bandwidth as 29th March looms, these changes seem unlikely. However, Brexit might be the wake-up call we need to revamp how – and with whose interests in mind – Britain fights recessions.