The Bank of England’s fiscal agenda

The outgoing Governor of the Bank of England, Sir Mervyn King, seems to have used his imminent retirement as an excuse to announce what the government probably did not want to hear, that the central bank through its Quantitative Easing (QE) policies was in reality doing little more than buying the government time to find a longer term solution to the current and ongoing economic crisis. To its credit, the Bank of England has succeeded in preventing a liquidity crisis and it has managed to prevent nominal GDP from declining sharply over recent years. But what it has obviously failed to do is to generate much by the way of real growth.

This shouldn’t surprise in that the received wisdom has long been that central banks can do relatively little to stimulate real variables such as GDP volumes or employment, since they can only act on nominal variables. Against this backcloth, central banks have traditionally focused on fostering stable and predictable monetary conditions, but the conventional wisdom associated with normal cycles clearly doesn’t apply in what is an unusual period of debt-de-leveraging and associated depression-like conditions.

But it’s common sense and consistent with the economics theory of ‘Rational Expectations’, that stable financial markets, currency markets and credit conditions will over the longer term make it significantly easier for companies and households to manage their affairs efficiently – and therefore given that the last decade has been anything other than stable and predictable, we should not be surprised that UK and indeed global GDP continues to languish, as last week’s crop of European GDP figures once again revealed.

Moreover, we may suspect that Sir Mervyn is also all too aware that few countries have addressed the challenge of de-leveraging by physically repaying their debt.  Instead, there are three more typical routes forward. Thus, the value of the debt can be inflated away and this is clearly not an optimum outcome for savers or economic efficiency. Equally, debt burdens can simply be grown out of, as indeed the USA did in the mid-1990s. The US at that time was of course helped by the arrival of the internet/tech boom and by its generally pro-business climate and we suspect that this is what King quite rightly is drawing attention to in his most recent comments. We ought also to acknowledge that in some periods and historic examples, de-leveraging has been addressed with repudiation, write-off, or write down of debt and this can lead to considerable wealth adjustment of and within economies.

In thinking through the challenges for the UK and its regions, it’s noteworthy that the most vibrant US economic growth, innovation and entrepreneurism over the last two or three decades have typically been situated around the major universities and in other areas in which there is some form of pro-business environment and critical scale of services. In the UK, Cambridge and perhaps the Thames Valley show some of these positive features and it seems that what Sir Mervyn is saying is that if the country wants to see more endogenous, non-inflationary and therefore sustainable growth, it needs to create more business positive locations and opportunities through reform of tax and regulation, and with support from targeted infrastructure spending.

On the wish list for UK regions must be effective communications and transport, including widely available high quality/capacity broadband and the ability to reach a major airport in short order, as well as local planning that supports the building of required facilities, and a functioning high quality education system.  To deliver on this wish list for the regions of the UK, requires targeted infrastructure investment spending programmes, effective reform programmes and a transformation of the education system, and arguably the constraint on getting the steps taken is politics. Big picture investment doesn’t deliver quick paybacks, however critical for the long term, and in an age of austerity, measures that don’t translate into votes don’t get financed. As a result, we may suspect that the onus for supporting the economy and fending off deflation remains with the central bank here and in many other developed de-leveraging economies. Financial markets seem relaxed for now, but we should not assume that the problems are all resolved.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla