Both of the big jobs in UK economic management changed hands earlier this year. Within weeks of Rishi Sunak taking over from Sajid Javid at the Treasury, Andrew Bailey replaced Mark Carney at the Bank of England.
Sunak has barely been out of the news in the months since, 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.
Since then, however, the Bank has been like the solid cricket batsman holding up an end so that the stroke maker at the other end can notch up 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 has been the junior partner in recent months.
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. If though, as expected, Threadneedle Street says it will expand its quantitative easing (QE) or money creation programme by £100bn, the impact on the economy will be modest.
Interest rates are already at their lowest 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 principal aims: raising inflation rates.
Indeed, there is more than a hint of angels dancing on pinheads 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% does not.
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 the 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, a special adviser to three Conservative chancellors.
Lightfoot says monetary policy was already at the limits of what it could achieve even before the pandemic, 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?
Those were legitimate concerns in the 1970s, Lightfoot says, but they 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 mean the Fed’s actions 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 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.