Press Story

Current macroeconomic policy is not fit for purpose, and conventional methods to boost the economy are not fit to respond to a future recession, according to a new report from IPPR, the progressive policy think tank.

The report notes that recessions in the UK economy have historically occurred every 10-15 years, and the last one was 10 years ago. Even though the Bank of England is now seeking to raise interest rates, it is likely that they will still be extremely low by historical standards (well under 5%) when the next recession occurs.

At the same time Quantitative Easing (the policy under which the Bank of England buys government and corporate bonds), which was devised to stimulate the economy when interest rates hit near-zero in 2010, will still be operating: there is little sign that the £445bn of current bond holdings will be withdrawn. This will leave the Bank of England with few powers to stimulate the economy when output turns down and unemployment rises.

The report notes that in all three of the last recessions (1980-81, 1990-91, 2008-9) interest rates were reduced by 4.5%-5% to sustain demand. In the latter case this was not sufficient to restore growth, leading to the introduction of QE. But in the next recession, an interest rate reduction of this size will not be available.

Meanwhile QE has been an unreliable source of stimulus, with adverse distributional effects as asset prices have risen. It has benefited wealthy homeowners and shareholders at the expense of pensioners and young people renting homes.

To ensure that macroeconomic policy has sufficient levers to boost demand in the next recession, the IPPR report proposes 3 sets of reforms:

Creation of a National Investment Bank (NIB), to which the Bank of England could delegate an economic stimulus as an alternative to QE when interest rates are near-zero. Under normal circumstances such a Bank would help to provide lending for infrastructure, housing, innovation and business growth. But when interest rates are at their ‘effective lower bound’, the Bank of England could ask the NIB to raise its lending as an additional economic stimulus, and could buy its bonds to ensure adequate funding.

New fiscal rules, including the separation of borrowing for current spending from borrowing for investment. While borrowing for current spending should be balanced over a rolling five-year period, public investment (which supports long-term growth) should have a separate target as a percentage of GDP. Overall debt should be determined on the basis of its long-term impact on the economy. These proposed rules would provide stronger protection of Government investment during recessions and increased flexibility to increase overall spending when interest rates are close to zero.

A change in the Bank of England’s monetary policy mandate. The Bank’s Monetary Policy Committee (MPC) should be able to target unemployment and/or the level of nominal GDP alongside inflation, or as a guide to its inflation target. This would reduce the risk of monetary policy being over-tightened during a recession.

Such reforms would provide the government and the Bank of England with a more effective set of policy measures to combat the next recession.

Alfie Stirling, author of the report, said:

“Current macroeconomic policy is dangerously ill-equipped to tackle the next recession, whenever it comes. Interest rates will already be too low to allow for the cut that will be needed to stimulate demand. We are heading for a car crash if nothing is changed. The policy reforms we propose would provide new mechanisms for the Bank and government to steer the economy out of a future crisis.”

Michael Jacobs, Director of the IPPR Commission on Economic Justice, said:

“The Government’s current fiscal rules are not fit for purpose. Counting borrowing for investment together with borrowing current spending deprives the economy of much needed investment when interest rates are at historic lows. Pursuing austerity in an attempt to achieve a balanced budget has given us nearly a decade of slow growth, and the Bank of England has run out of tools to compensate. We badly need a new approach.”

CONTACT

Florri Burton 07867 388895 / 020 7470 6154 / f.burton@ippr.org

NOTES

Just About Demand Managing: Reforming the UK’s Macroeconomic Policy Framework, by Alfie Stirling, is available now and can be found at: https://www.ippr.org/research/publications/just-about-managing-demand

IPPR is the UK’s pre-eminent progressive think tank. Our mission is to open up opportunity, power and prosperity to everyone through conducting rigorous research and generating big ideas. With more than 40 staff in offices in London, Manchester, Newcastle and Edinburgh, IPPR is Britain’s only national think tank with a truly national presence.

The IPPR Commission on Economic Justice is a landmark initiative to rethink economic policy for post-Brexit Britain. The Commission brings together leading figures from across society to examine the challenges facing the UK economy and make practical recommendations for reform. Its Interim Report, Time for Change: A New Vision for the British Economy, was published in September 2017. Its final report will be published in September.