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National Institute of Economic and Social Research
The economic history of the UK over the past 30 years can be summarised as a period of quite successful microeconomic reform, leading to relatively high productivity growth, interspersed with episodes of disastrous macroeconomic mismanagement. Unfortunately, we are living through such an episode at present. This is the slowest recovery in the UK’s recorded economic history. NIESR forecasts that real per capita gross domestic product, the simplest measure of how prosperous we are as a country, will not return to its 2008 peak until 2018.
This reflects both the aftermath of the global financial crisis, and a mistaken policy response. Prime Minister David Cameron called that response ‘fiscal conservatism and monetary activism’. The ‘fiscal conservatism’ side of it – described by the International Monetary Fund as a ‘large and frontloaded’ fiscal consolidation plan – clearly had a substantial and negative impact on growth. The halving of public sector net investment especially is now almost universally recognised as a major policy error. But the impact of ‘monetary activism’ is far less clear. Although the Bank of England did indeed expand its quantitative easing programme, this has become subject to diminishing marginal returns. Many members of the Monetary Policy Committee seem to have lost faith that more QE would achieve much. Meanwhile, the financial sector remains dysfunctional. It is manifestly failing to fulfil its primary function of channelling credit to the real economy. What is the response of the policy-making establishment? At the moment, it appears to be to pass the buck. The retiring governor of the Bank of England, Sir Mervyn King, blames the supply side of the economy, and says ‘generalised monetary stimulus’ is not the answer, while Chancellor George Osborne wants the Bank to do more. So can the incoming Bank governor, Mark Carney, who recently made his debut at the Commons Treasury select committee, break the policy logjam? Carney, currently governor of the Bank of Canada, takes on his new role on July 1. He has shown that he will be more willing than his predecessor to consider changing either the remit given to the Bank, or the way the Bank implements policy, perhaps by not just keeping interest rates low but pre-committing to keeping them low, as the US Federal Reserve has done. But we should not delude ourselves that these changes would in themselves be a panacea. There is a case for changing the remit – but then the Bank (rightly) has not made hitting the inflation target a short-term priority over the past few years. Markets already expect interest rates to stay low, so for the Bank just to promise that this will happen might not change much in the real world. The point is that the changes currently being mooted are not about policy – they are about communications, expectations and targets. But if we want things to be different, then we will have to do something different, not just talk about it. And the current governor is right about one thing – monetary policy alone is highly unlikely to be enough to put us back on track for sustainable and balanced growth. This will require the chancellor and governor to work together, not try to shuffle responsibility on to the other. They could start by taking the advice of others. They could listen to former Monetary Policy Committee member Adam Posen, who has called for aggressive action to boost both private and public investment. He says this should be achieved through public infrastructure spending, investment tax credits and other measures to encourage private investment. He also recommends reform of the banking sector, and for quantitative easing to be channelled not just through gilt purchases but through direct lending to the private sector, especially smaller companies. Meanwhile, Angus Armstrong, director of macroeconomic research here at NIESR, has put forward radical proposals for reform of the UK mortgage market. The government should also listen to the London School of Economics’ Growth Commission, which has pointed to years of inadequate investment in skills, infrastructure and innovation. It proposes a new approach to infrastructure investment to overcome our chronic short-termism. And as both the Growth Commission and the Organisation for Economic Co-operation and Development have argued, a more liberal and sensible approach to immigration policy is needed for both foreign students and highly skilled workers and professionals. Such a change could boost innovation and exports while not costing anything – indeed quite the reverse.
All these measures would be good for the economy both in the short term – boosting demand, and hence output and jobs – and in the longer term, by helping to address the UK’s chronic problem of underinvestment in both the private and public sectors. With the new governor, the March Budget, the IMF’s belated but welcome recognition of the need for fiscal stimulus, and the almost complete consensus among economists that the UK needs more investment, there is now an opportunity for the policy-making establishment to change course. We would all be better off if they took it.