Economic consensus is crumbling, but the Bank of England has not got the memo
The writer is chair and chief investment officer of Marshall Wace, an alternative asset manager. He writes in a personal capacity.
The UK’s new policy mix unveiled at last week’s “mini-Budget” is not only radical in a British context — it is also a rebuke to prevailing western economic orthodoxy.
Since 2010, the G7 policy framework has been one of tight fiscal and loose monetary policy. Call it Osbornomics or Draghonomics. This combination of fiscal austerity and monetary largesse has not been a success.
Austerity has not prevented government debt ratios steadily climbing to historic highs. Some may think the UK’s ratio of debt to gross domestic product is out of control, but it is still the second lowest in the G7 at 97 per cent.
Meanwhile quantitative easing has fuelled asset inflation for the super-rich and has more or less abolished risk pricing in financial markets. And over the past two years, when combined with Covid-19 fiscal boosterism, it has produced inflation which is still out of control.
But now the global policy consensus is in the process of pivoting — from the tight fiscal/loose monetary combination to its opposite. The UK is leading this shift, but the US is doing the same thing, with President Joe Biden’s new Inflation Reduction Act introducing a spending boost of $467bn, matched by a much more hawkish Federal Reserve.
A distinctive feature of the UK’s fiscal pivot is the emphasis on reducing the burden of tax on work and business. This is sensible. The lion’s share of the UK tax burden falls on work in some form or another, largely because it is the easiest kind of tax to collect. It may be easier to collect, but it is probably what we should tax least.
I would like to see even more support (through the fiscal system) for the growth industries of the future. Biden’s IRA gives huge support to the renewables industry and to the domestic electric vehicles industry, assuring American leadership in the only growth industry in which the US was not already dominating Europe. But the more libertarian new British government is too influenced by Ayn Rand for that.
However, the bigger problem for Liz Truss’s government is the Bank of England. It seems that the governor, Andrew Bailey, did not get the memo. Our central bank has been behind the curve since inflation first started to rise sharply in 2021. Initially the BoE was in good company. But now it is starting to lag its counterparts around the developed world.
The Bank of England effectively lost control of the UK bond market last Thursday when it raised interest rates by 50 base points, instead of the 75bp that the Fed and the European Central Bank raised by. Its timidity is now having an impact on both the gilt market and sterling. That is the essential context for the market reaction to the mini-Budget. Once you lose market confidence it is doubly hard to win it back.
This cannot be what Truss, and her chancellor Kwasi Kwarteng, wanted at all. They had been hoping for and hinting at a more muscular stance from the BoE to underpin financial market confidence in the UK, even at the expense of some short-term pain.
It cannot be long before the BoE’s mandate comes under review — perhaps starting with the appointment of a new commission to look at the merits of the present single mandate, as opposed either to a dual mandate, such as inflation plus employment (such as the Fed has) or nominal GDP targeting.
Central bank independence is one thing, but immunity from accountability quite another. If Bailey and his colleagues on the monetary policy committee are not careful, they are going to find the growing scrutiny from Westminster very uncomfortable indeed.