15 June 2017

The Tories are paying the price for loose monetary policy


Britain is about to complete its first lost decade. A second one would leave young people marooned on stagnant wages, shut out of the housing market and unable to start families. So here’s a lesson for the Conservatives from the election: don’t go into the next one without a strong story on the economy.

After the 2008 Crash, commentators thought it would be the Left’s big moment. But, rather than the crash itself, it has been the post-Crash policies – the drip, drip of fiscal Chinese water torture and ultra-low interest rates – that have sent voters, sick of austerity, skidding into Jeremy Corbyn’s arms. This has left the Tories  with something of a political dilemma: persist with the the seemingly interminable fiscal torture or follow Labour down the tempting path of abandoning fiscal responsibility. While the latter option may be a crowd-pleaser, it would be the surest way of handing the next election to Jeremy Corbyn and John McDonnell.

George Osborne is much to blame for the current public mood. Treasury mandarins used to say that when Chancellor, Osborne talked a great story on austerity and reducing the deficit without actually achieving very much. Not only did it perpetuate the idea of the Tories as the nasty party, it wasn’t particularly effective.

Comparisons with Ireland, the US and France bear this out. The UK ran a top-of-the-cycle deficit of 2.67 per cent of GDP (thank you, Gordon Brown), lower than the US but slightly worse than France. Despite opting for a large fiscal stimulus and boosted by the huge additions to GDP from the fracking revolution, the US deficit fell faster than the UK’s, and by 2012 had very nearly caught up with us (8.24 per cent vs. 8.86 per cent). Indeed, the UK deficit went backwards that year. By 2014, the US and Ireland – both from worse starting positions – had overtaken the UK (the US budget sequester requiring across-the-board spending cuts to take effect in 2013).

Only France (average deficit reduction of 0.54 per cent of GDP per year) has had a slower pace of deficit reduction than the UK (1.02 per cent per annum). Without even having a formal deficit reduction plan, the US (1.41 per cent of GDP per annum) shrunk its deficit 38 per cent faster than the UK. Ireland (1.89 per cent of GDP per annum) was 85 per cent faster.

Ultra-low interest rates and Quantitative Easing – thanks again to George Osborne – have also conspired to create an electoral battleground favourable to Labour. In 2013, Osborne described Mark Carney’s appointment as Governor of the Bank of England as heralding a new era of growth-promoting monetary activism. At which point ultra-loose monetary policy went from being a counter-cyclical tool to being a permanent fixture of the post-Crash economy.

Capitalism, however, cannot work properly when the price of capital is manipulated by central banks to be close to zero.

As the Bank’s chief economist, Andy Haldane, recently conceded, there is a link between near zero interest rates and weak productivity growth, arguing that 4 per cent interest rates would have boosted productivity growth. He also knew this would come at a cost. “Should monetary policymakers have sacrificed 1.5 million jobs for the sake of an extra 1 or 2 per cent of productivity? Hand on heart, I can tell you this one would not knowingly have done so,” Haldane said two months ago.

However, according to a 2014 estimate by the Office for Budget Responsibility (OBR), in a high productivity scenario, public sector net debt would fall to 56.7 per cent by 2019-20, while under a low productivity scenario, debt would rise to 86.6 per cent. Income tax receipts have repeatedly fallen short of the OBR’s expectations because it assumed productivity growth would return to its historical average.

Higher productivity is the driver of income growth and living standards, of opportunities for younger people and the best way of reducing the deficit. Yet because of the link between monetary policy and productivity growth, the Bank has ended up in the economy’s driving seat, with the fate of a minority Conservative government sitting alongside. Meanwhile a new generation of new voters is convinced that capitalism is to blame for the poor performance of an economy which is alienating them.

But the Bank, remember, has only been doing what it was encouraged to do by Chancellor George Osborne. In his remit to the Monetary Policy Committee he required the MPC to support the four pillars of the Government’s economic policies, the first being “monetary activism and credit easing, stimulating demand, maintaining price stability and supporting the flow of credit in the economy”.

Happily, Theresa May’s Government hasn’t followed Osborne’s lead. The remit given to the MPC by Philip Hammond at the time of the March budget was decidedly more conventional, and rightly so: this week’s alarming inflation numbers are a further sign that all is not well with the economy or monetary policy.

A return to monetary normalcy, difficult though it will be, is the prerequisite for lifting economic performance and getting the economy battle-ready for an election in five years’ time. If the economy isn’t fixed well before then, the prospects for a successful Brexit and keeping Jeremy Corbyn out of No 10 are not promising.

Rupert Darwall is the author of 'The Age of Global Warming: A History' (2013)