Sunday, February 10, 2013
Carney's no messiah but can he work miracles?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

In the past few days we have heard for the first time in Britain from the new Bank of England governor, we had a report on the economy from the Organisation for Economic Co-operation and Development (OECD) and we have had the Institute for Fiscal Studies’ always insightful Green Budget.

Any of these, in a normal week, would provide sufficient material for a column. Let me deftly, I hope, combine them.

Regular readers will not need reminding of the difference between fiscal and monetary policy, though the lines may have become a little blurred.

Fiscal policy, the preserve of the chancellor, is being tightened, through tax hikes and spending cuts. That leaves monetary policy, which from July 1 will be under the leadership of Mark Carney, to do the heavy-lifting or, as George Osborne put it: “Action by the Bank of England can and should continue to support the economy”.

The Bank, which on Thursday left interest rates unchanged at 0.5%, as it has for nearly four years, and maintained the amount of quantitative easing (QE) at £375 billion, would argue that this is precisely what it has done.

This loose money/tight fiscal demarcation - cut the deficit but keep the economy afloat with the lowest interest rates on record, topped up with QE - is the OECD’s favoured prescription. In its annual survey of Britain’s economy, it said that “monetary policy is the primary tool to stimulate the economy” and that “the fiscal stance remains appropriate”.

It backed Osborne’s decision in his December autumn statement to allow the so-called automatic stabilisers to operate - don’t raise taxes or cut spending further to offset a deterioration in the public finances due to weak growth - but does not think the solution to Britain’s growth problems lie with a “Plan B” or any other junking of the coalition’s fiscal strategy.

The question, however, is why loose money/tight fiscal, having generated strong recovery in the 1930s, late 1970s, 1980s (eventually) and 1990s, has struggled this time. Compared with the 1990s, sterling has fallen a lot more - 25% versus 14% - interest rates are plainly lower (real interest rates more so), and QE was not even a twinkle in the Bank’s eye then.

One explanation is that a damaged banking system means monetary policy is far less effective than usual, and there is plainly some truth in that. The other is that it could have been done a lot better.

Carney, in a marathon evidence session to the House of Commons Treasury committee, was urbane, polite about his new colleagues and mainly gave straight answers. He dismissed Lord (Adair) Turner’s idea of a “helicopter drop” of money (not literally) to boost the economy.

Advocates of a ripping-up of the Bank’s existing framework, and its replacement by a money GDP target with a more explicit commitment to growth, did not receive much encouragement. He praised what he described, and which Sir Mervyn King has taken to calling, Britain’s “flexible” inflation targeting regime. If that means the Bank doesn’t hit the target very often, it is a pretty good description.

But coming through the new governor’s testimony - accompanied by a 45-page written submission - were two messages. The first was that monetary policy has not yet reached the end of the road; I doubt if he would have taken the job merely to mop up what was done under King.

The second is that the Bank under Carney will be more open in the way it communicates its actions (there was a hint of that with the long statement that accompanied its no-change decision on rates). And it will be more imaginative in its use of “unconventional” policy - I cannot imagine him being content merely to carry on buying large quantities of gilts (UK government bonds). It will look for new ways of stimulating the economy.

The Bank’s slavish commitment to QE through gilt purchases, which has run into quite significant opposition for its effects on pensioners, is in some ways forgivable. Nothing quite like this, or at least on this scale, had been tried in Britain until 2009.

But if the definition of insanity is doing the same thing over and over again and expecting different results, there is an element of this in the Bank’s decision to persist with its existing model of QE. Quite what a new model might be is not clear but at the very least should widen the range of assets the Bank is prepared to buy.

If monetary policy could be improved, so very clearly could fiscal policy. The IFS’s Green Budget was clear that spending cuts and tax hikes were necessary, without them the budget deficit would still be around 11% of GDP and public sector debt would be on a trajectory that would take it to 250% of GDP in the coming decades.

But the IFS was also clear of the serious shortcomings in fiscal policy. Both Labour and the coalition thought the path to budgetary salvation lay with slashing public investment: the element of spending that has the biggest impact on growth.

Under current plans, meanwhile, welfare spending will rise from 28.5% of all government spending by 2010 to 32.5% by 2017-18. Some would say welfare feeds directly into the economy because those who receive it spend everything they get.

But the lion’s share of extra welfare is going to the elderly and, while those on low incomes do spend what they receive, that is not true for old people as a whole: they have relatively low propensity to spend.

If the “welfare up/investment down” split looks illogical, so does the fact that, in spite of headline government commitments to squeezing public sector pay, it has continued to go up, managers choosing instead to shed workers, which they will continue to do, to the tune of 1.2m in all.

There is also, as the IFS identified, a huge question about whether cuts to departmental spending can be delivered. These, real-terms reductions of a third in non-ringfenced departments by 2017-18, have barely begun. Only 21% have so far been delivered. Small wonder the IFS thinks tax hikes after the 2015 election will be used an alternative to some of them.

So there is a lot of work to be done to improve the effectiveness - and deliverability - of fiscal and monetary policy. Faster growth, the IFS notes, would help resolve some of the fiscal dilemmas.

As the excitement over Carney’s arrival has grown, I have taken to paraphrasing Monty Python and saying: He’s not the Messiah, he’s only a central banker. If he can deliver the growth that gets the government out of the fiscal mess, however, he really would be a miracle-worker. It promises to be an interesting year.