Seven years ago this week, the Bank of England cut interest rates to 0.5% – the lowest since the central bank was founded in 1694.
In a drastic bid to stem the fallout from the global financial crisis, then governor Mervyn King and his fellow policymakers also kicked off the process of pumping tens of billions of pounds into the economy.
Unsurprisingly, Labour chancellor Alistair Darling welcomed the flood of money. The economy had been battered by recession, house prices were falling and unemployment was high.
There have been two changes of government since then. And at the Bank too, a new man is in charge; Mark Carney came over from Canada to replace King in 2013. All of the nine people who voted for those record low borrowing costs in March 2009 have left the monetary policy committee.
Those years have seen periodic warnings from economists and policymakers that interest rates would have to rise soon. But the dog never barked and here we are: marking yet another year of record low rates.
They have been seven lean years for savers but seven years of tailwinds if you happen to be a finance minister. Ultra-loose monetary policy was the backdrop throughout the coalition’s time in office. It was the first government since the 1940s to enjoy unchanged borrowing costs for its entire term. The way things are going, this parliament may be little different.
As if to mark this unenviable anniversary, a whole host of commentators have been coming out to say monetary policy cannot do all the heavy lifting.
As finance ministers around the world were setting off for the G20 meeting in Shanghai, the International Monetary Fund issued a call for them to boost public spending on infrastructure to fuel global growth. The power of monetary policy was beginning to wane, the IMF said, and those governments that could safely increase their spending should step up to the plate and act together. In a separate report on the UK, the IMF urged the government to be ready to ease back on austerity should the economy slow further.
That all echoed pleas by the Organisation for Economic Co-operation and Development (OECD) for its rich-country members to let up on austerity and collectively agree to spend more on infrastructure projects. Low interest rates and money creation by central banks were no longer enough for recovery, the thinktank warned.
Carney has been quick to dismiss the argument put forward recently that central bankers are out of ammunition. But he also joined the chorus calling for finance ministers to do their bit. Speaking in Shanghai on Friday, he accused the G20 of failing to adopt measures to boost global growth. “The G20 needs to use the time purchased by monetary policy to develop a coherent and urgent approach to supply-side policies,” he said. The Bank governor was scathing about progress on a 2014 pledge to lift the level of G20 GDP by at least 2% by 2018. “Less than half of the measures have been implemented, and only around one third of the promised impact on global GDP has been delivered,” Carney observed.
As it happened, the Shanghai meeting ended with their joint recognition that “monetary policy alone cannot lead to balanced growth”. But based on past pledges, central bankers should not get their hopes up that much will change.
One has to wonder why it has taken so long for warnings about austerity to be voiced. Until recently the OECD had strongly backed George Osborne’s deficit reduction programme. Such support emboldened the chancellor to talk about “fixing the roof while the sun is shining”.
And how did he respond to the latest warnings? With defiance. “Storm clouds” were gathering in the world economy, with dangers for the UK, Osborne said in Shanghai. Time to get down off the roof, then, one would think. Most certainly not, the chancellor insisted. After UK growth slowed last year, it was in fact more important than ever to keep cutting, Osborne told the BBC in an interview.
“So we may need to undertake further reductions in spending because this country can only afford what it can afford – and we will address that in the budget, because I’m absolutely clear we’ve got to root our country in the principle that we must live within our means,” he said.
So it appears if you are Osborne, you do not need sunshine to cut spending after all. Not that any of his tinkering with the roof since 2010 has really been carried out in the glow of economic fair weather: just rays of artificial light from a loose monetary policy. Now that storm clouds are gathering, Osborne’s austerity looks even more ill-timed.
That view is backed up in new research from economists at the University of California, Davis. Only a strong economy can bear a programme of austerity without significant output losses, argue professors Òscar Jordà and Alan Taylor in the February issue of the Economic Journal. According to their analysis, a fiscal consolidation of 1% of GDP translates into a loss of 3.5% of real GDP over five years when implemented in a slump, rather than a loss of just 1.8% in a boom.
Applying that to the UK post-2007, they found that, without austerity, UK real output in 2013 would have been steadily climbing above its 2007 peak, rather than staying 2% below.
Right now, the UK and world economies are looking shaky and yet Osborne refuses to put aside his wrecking ball. It is time he realised that central banks can only do so much.
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