Sunday, January 11, 2009
Tories out of step as the Bank wheels out its big guns
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


Every day, sometimes on several occasions, an e-mail arrives in my inbox on behalf of George Osborne, the Conservative shadow chancellor.

Issued in response to a minor economic indicator or flaky forecast, these missives, apart from rather demeaning the office of shadow chancellor, are usually harmless enough and can be safely ignored.

Last week, however, came one that summed up the Tory problem: opposition by soundbite. For weeks, a debate has raged about whether central banks should engage in "quantitative easing", the technique employed by the Japanese authorities in 2001-6 to lift their economy out of stagnation and deflation.

The US Federal Reserve, cutting its Fed Funds rate to a 0%-0.25% range last month, signalled that it would formalise quantitative easing. Once you are at zero, you need other measures. Quantitative easing is often described as "printing money", though it is not. More on this in a moment.

When, in an interview, Alistair Darling, the chancellor, confirmed that the Treasury and Bank of England were considering quantitative easing, as widely reported in recent weeks, Osborne was on the case.

"The very fact that the Treasury is speculating about printing money shows that Gordon Brown has led Britain to the brink of bankruptcy," he railed. "Printing money is the last resort of desperate governments when all other policies have failed. It can't be ruled out as a last resort in the fight against deflation, but in the end printing money risks losing control of inflation and all the economic problems that high inflation brings."

This was a silly soundbite. Apart from Fed chief Ben Bernanke, the case for quantitative easing is being pushed by most economists who think the money supply matters, which should be the Tory position.

It is favoured, for example, by the shadow monetary policy committee, which meets under the auspices of the Institute of Economic Affairs, the favourite think tank of Margaret Thatcher and her former economic adviser, the late Sir Alan Walters.

Osborne and his leader, David Cameron, have had a bad crisis. Baited by Brown as the "do nothing" party, they have been provoked into small, largely irrelevant initiatives. Even Brown's enemies do not hold him entirely responsible for the worst advanced-country downturn since 1945. Cameron and Osborne, overplaying the blame card, invite ridicule and allow Brown to get away with things he should carry the can for, such as over-spending in the good times.

A Tory shadow chancellor should be well regarded by the City. Instead, Alistair Darling is winning grudging approval. Oppositions need to make the intellectual case. The Tories, guided by Sir Geoffrey Howe, did so brilliantly during the 1974-79 crisis-hit Labour government. So far this Conservative opposition hasn't.

I write this with regret. We need a credible, constructive opposition to give people confidence that, come a change of government, the economy will be in safe hands.

Ken Clarke, ranked by readers as best chancellor over 30 years, has been a wasted asset for the Tories since May 1997. John Redwood, a former cabinet minister, appears to understand the crisis and was impressive on the radio the other day.

Economic opposition is a crowded scene. For the first time that I can remember, a Liberal Democrat shadow chancellor has made the running. I do not agree with everything Vince Cable says but he enjoys a high reputation and his manner is of a reassuring doctor he tells you it is bad but offers prescriptions to make it better. The Tory boys do not have his bedside manner and sometimes appear to relish the gloom, which I am sure is not their intention.

Back to "printing money". The Bank limited itself to a half-point cut to 1.5% last week, though taking us, as every schoolboy knows, to the lowest rate since 1694. That seemed sensible, despite figures on Friday showing an alarming plunge in manufacturing output. It leaves shots in the locker and time to think about other measures.

"Printing money", to be clear, is not the same as printing money. This is not a cash economy. The value of notes and coins in circulation is 51.6 billion, less than 3% of 1.9 trillion of "broad" money in Britain, M4, consisting of bank deposits and the corresponding lending. Printing money means getting broad money growing faster through so-called quantitative easing.

How? One way is for the Bank to buy government bonds or commercial securities from banks or their customers. This creates a credit in the central bank's reserve account, which can then be the basis for increased bank lending. It also drives down interest rates throughout the economy.

Or, in a situation where the government is borrowing large amounts, as now, it can "underfund" its budget deficit by issuing fewer gilts than needed, or by selling them direct to the Bank. The effect is to boost broad money, M4. Or, if none of this works, the central bank can lend directly into the economy, using the banks as its agents.

None of this is easy, or inevitable. The Tories have proposed a 50 billion loan guarantee scheme for small firms, which Cameron wants to "shake the prime minister" to introduce. But Treasury officials fear that losses under such a scheme could amount to 12 billion, making guarantee costs prohibitive.

Guaranteeing issuance of new mortgage-backed and other asset-backed securities, recommended by former HBOS chief Sir James Crosby, would work a lot better if other countries did it too; the closure of these markets is a worldwide phenomenon. So far, however, there has been little discussion about co-ordinated action.

The truth is that there are many helpful things that can be done but no single silver bullet. In the meantime, we should not forget one thing. The Bank has wheeled out some pretty big guns in cutting rates from 5% to 1.5% since October. Barack Obama sketched out his huge fiscal plan last week.

As the Bank put it when cutting rates on Thursday: "The committee noted that the recent easing in monetary and fiscal policy, the substantial fall in sterling and the prospective decline in inflation would together provide a considerable stimulus to activity as the year progressed."

Policymakers need to be imaginative. But they also need to have faith in the fact that, in the end, policy will work.

PS: Thanks to the readers who submitted 2009 forecasts, to compare with the professionals. I now have a fat file to lock away and consult at the end of the year.

Amateurs are less afraid of looking silly than experts, so the range is wider. For gross domestic product it runs from a rise of 1.5% to a fall of 8%, worse than in 1931. There may have been confusion over the current account, some thinking of the budget deficit. Even so, pick from a surplus of 30 billion down to a deficit of 150 billion. Similarly, readers are split between Japanese-style deflation and the return of double-figure inflation.

Many think Lord Mandelson will be prime minister before the year is out, while others offered post-prime ministerial roles for Brown debt counselling was a favourite. Nationalisation of the banking sector is expected by many.

The real winners will come in a year's time, but books are on their way to David Appleby, for his Mandelson-Cable government of national unity, and Jonathan Grant, reminding us that "creative destruction" pioneered by Joseph Schumpeter is a feature of recessions. Some retailers dying this winter should have been put out of their misery years ago. Other businesses will eventually rise as these fall. We will emerge different but in some ways stronger.

From The Sunday Times, January 11 2009