With interest rates at an all time low, and with QE having run out of steam, it looks like conventional monetary policy is, as least for now, a dead duck. Low interest rates and quantitative easing were supposed to be sufficient to lift the UK economy out of the doldrums and into growth, increased private investment and rapid job creation - so much for the textbooks.
Today, in his fourth budget speech, the Chancellor was forced to revise down his growth forecast for this year to a 0.6%, although the OBR injected some positive news by forecasting a return to somewhat stronger growth of 1.8% from 2014 and 2.3% in 2015 – however, still below the UK’s long run trend rate of growth. Worse still, public debt is predicted to rise – not fall - as weak growth has reduced tax receipts, and will continue to do so for some while yet.
It is against the backdrop of grim news, not to mention the UK's credit rating downgrade, that Mr Osborne stood up today to put us all in the picture and to offer some policy initiatives. The ‘picture’ is one of a much worse than predicted net trade, with exports slumping as the Eurozone stalls, and the global economy remains stagnant. So all eyes were on the Chancellor to see what he could conjure up by way of monetary, fiscal and supply-side initiatives to get the domestic economy growing, and, of course, confirm what many already knew, had they been following the Evening Standard’s Tweet of its front page, “Things Can Only Get Bitter” headline.
Slightly less embarrassing was the Chancellor’s downward revision of the OBR’s forecast for global economic growth and world trade since the Autumn Statement. The OBR has yet to deliver an accurate forecast for growth, and it was not long ago that much fuss was being made of the incorrect multiplier estimates used by the OBR when analysing the impact of government policy on growth. In terms of the ineffectiveness of existing monetary policy to stimulate consumer spending, investment and jobs, the Chancellor accepted that the UK had to “develop new monetary tools”, as other countries need to do, and he confirmed that the Asset Purchase Facility would remain, and there will be ‘extensions’ to the Funding for Lending Scheme, as well as the introduction of a new Business Bank – hardly headline grabbing initiatives. However, perhaps the most interesting and telling adjustment to monetary policy is a change to the remit of the Bank of England’s MPC.
While confirming the primacy of price stability, and reaffirming the commitment to a 2% inflation target, the Chancellor announced a loosening of the monetary rules by allowing the MPC to shift its gaze to the ‘intermediate and medium term’ targeting of inflation while taking into account the ‘trade-offs’ that arise from policy decisions – in short, just like the Fed, the MPC can, during times of low growth and high unemployment, maintain a low interest rate regime even if in the short run inflation creeps up out of the target range of 2% (+/- 1%). For example, interest rates could be allowed to remain at near-zero unless unemployment breached an agreed threshold - say 6% - which presumably coincides with the rate at which the Bank of England believes demand pressure will begin to exert too strong a pull on the price level. The details of how this is to operate are to be made clearer in due course. The new Governor of the Bank of England, Mark Carney, has been charged with providing the detail of how this might work on the ground.
In terms of the housing market, fresh thinking is also necessary, and this duly came by way of the Help to Buy initiative. This scheme, which aims to boost the housing market – for so long a barometer of economic prosperity - has two components – firstly, for individuals who can put down a 5% deposit on a newly built home the government will offer an equity loan worth up to 20% of its value. The second element is the Mortgage Guarantee (worth up to £130 bn) – available to all homeowners - which will enable lenders to increase their lending into the housing market. Critics have been quick to point out that, with house-building so low, excess demand created by easier mortgage credit will simply sow the seeds of the next house price boom.
As was widely expected (and not just due to Twitter) the Government brought forward it plans to raise the personal allowance to £10,000 next year, rather than at the end of the end of the Parliament.
The problem is, with the deficit reduction plan still the only plan in town, Budgets are becoming more about politics and less about economics – some might say that this has always been the case. Certainly, for Budget watchers, it is the body language, the rhetoric and the coalition shenanigans that provide the interest and intrigue.
The difficulty with policy these days is that there is a diminishing return to its effects. In the old days, 2p off income tax was worth a celebration – partly because it would come as a surprise, and partly because it meant something to most people. There is a kind of creeping inelasticity in response to economic policies – the more we know and understand the less we are surprised and maybe the more cynical we get. Certainly, 1p off a pint of beer is, indeed, small beer, and while a reduction in Corporation tax to 20% is a headline grabber will it really stimulate investment at a time when domestic and overseas demand is so sluggish? Small and Medium sized business's are more interested in current market conditions and order books than the possibility of retaining more of their profit at a later date. Reducing corporation tax when the economy is on the up makes great sense, but it is certainly not an active demand booster in the short term.
With changes at the Bank of England many are asking whether the Treasury also needs a shake-up, starting with the Chancellor and his assistants. Maybe it really is time for thinking outside the box. Like him or loathe him, Education Secretary Michael Gove has certainly shown the way with his planned reforms of secondary education. I am not sure how much Mr Gove knows about the economy (he has an English degree), but maybe he should be mugging up on his A Level Economics, as he could well make an excellent Robin to Mr Osborne’s Batman, should the Chancellor require a new chief assistant.