Sunday, March 24, 2013
Don't bet on the Bank to pump up the recovery
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.

What is left to say on the budget? By now, most people will have devoured the detail and it hasn't yet unravelled, though it is a bit battered around the edges.

Given George Osborne’s fourth budget was put together with considerably more care than his third, the chances of a big unravelling are not that high. Though this was a budget that disappointed on growth and borrowing, as foreshadowed last week, it was reasonably well-constructed.

On content, while it did not tick every box I set out last Sunday, it did quite a few of them, as well as a few I had not suggested. With little to play with, the chancellor found a lot to say.

This was never a budget with a large-scale assault on spending to pay for aggressive tax cuts. It was never going to be a “Plan B” spending budget.

Instead, there were positive, if modest, measures on jobs, including a new £2,000 employment allowance. Stamp duty is scrapped for “gazelles” (fast-growing firms) and there are funds for an industrial strategy aimed at replicating car industry success in 11 other sectors. The corporation tax cut to 20% in 2015 and a personal allowance in 2014 of £10,000 will top the list of coalition achievements.

Achieving the £10,000 target for the allowance may move it beyond the stealth tax cut described here last week. “Your first £10,000 free of tax” is not a bad slogan.

Some reaction to the Help to Buy scheme - equity loans and mortgage guarantees - was just silly. Anything that increases housebuilding and gets housing turnover up, as this scheme can if the details are got right, is welcome.

Housing turnover is half pre-crisis levels. Boosting it improves economic efficiency - allowing people to move for job reasons - and generates additional spending. When people move, they tend to improve.

There has even been some mildly encouraging post-budget news. The day after the budget official figures showed public borrowing in the first 11 months of the year nearly £3bn below last year’s levels, a significantly wider margin that the wafer-thin full-year £0.1bn deficit reduction predicted by the Office for Budget Responsibility.

The OBR had access to some but not all the figures, and March could be a bad month. But it is also quite possible some of the chancellor’s scramble to secure a face-saving deficit reduction this year will prove to have been unnecessary. There was also a welcome post-budget announcement of a 2.1% jump in retail sales last month.

One good retail sales figure does not, of course, turn muted growth into a strong recovery. It is how to generate that recovery, built on what Osborne described as combining “monetary activism with fiscal responsibility and supply side reform”, that I want to concentrate on.

What exactly might monetary activism mean? On budget day the Treasury published a 68-page review of monetary policy, the main conclusion of which was that the 2% inflation target, “which applies at all times”, should be kept.

So, sensibly, there was no adoption of a target range for inflation, or replacing the 2% target with one for the money value of gross domestic product. Though “at all times” means the Bank can choose when and how quickly it tries to hit the target, it was important to retain it.

The Bank has also been tasked with three things. When it is missing the inflation target it will have to set out clearly the trade-offs causing it do so so, for example if trying to get it down too quickly would push unemployment up too much. The Bank will be required to communicate.

It will be required to ensure that decisions by its new financial policy committee are co-ordinated with those of the monetary policy committee. To take a simple example, it would be odd if the FPC were reining back credit growth by recommending tougher capital controls on the banks while the MPC was trying to get more lending into the economy.

The Bank has also been set a specific task of investigating, in its August inflation report, whether it should issue what is known in the jargon as forward guidance based on intermediate thresholds.

That is a mouthful but in practice it means that the Bank would follow America’s Federal Reserve in, say, committing itelf to undertake further quantitative easing on a montholy or quarterly basis, until such time as unemployment drops below a certain level. The significance of the August inflation report is that it will be the first under Mark Carney, the new governor, who used such forward guidance in 2009 to signal to the markets that interest rates would stay low.

Is it a good idea? Sir Mervyn King has always insisted that the MPC takes one month at a time, not tying its hands for future meetings. Forward guidance would do that and could also run into the problem of leads and lags in monetary policy.

Suppose the MPC said it would do £25bn of QE each quarter until such time as unemployment is back to its pre-crisis level of 1.5m. Apart from the fact that the new norm for unemployment could be 2.5m rather than 1.5m, because of the damage the economy’s has suffered, the Bank could find itself overdosing on QE because it takes time for monetary policy decisions to be reflected in real economic data.

Would such guidance work? There is a lot of scepticism around. At a time when nobody expects a rise in Bank rate for the foreseeable future and most in the City expect more QE, why should forward guidance make any difference.

The circumstances when it might could be if growth picks up and the markets get it into their heads that interest rates will quickly rise in response. Guidance from the Bank that they won’t could prevent fear of higher rates nipping recovery in the bud.

Similarly, as it did last month, the Bank could make a habit of signalling to the markets that it will “look through” above-target inflation. The risk, of course, is that it looks through high inflation for so long getting back to 2% becomes unattainable.

The bottom line is that Osborne wants the Bank to become less opaque and mysterious, and more transparent. That, and the imaginative use of even more unconventional policies than the Bank has employed so far (an easy example of which is buying other assets than gilts) might help growth at the margin. But we should not expect it, on its own, to transform a slow-growing economy into something stronger. That will take time and patience.