The Bank of England’s response to Out

Posted on July 27, 2016

Contagion Thesis Derided by Fraternity Proven by Kristin Forbes...Kristin Forbes, professor of management and global economics at the MIT Sloan School of Management, poses for a portrait at her home in Boston, Massachusetts, U.S., on Tuesday, Jan. 22, 2013. When Forbes sought tenure at the Massachusetts Institute of Technology early last decade, some colleagues said her research focus on financial contagion led to a dead end. Her reaction: Full speed ahead. Photographer: Kelvin Ma/Bloomberg©Bloomberg

Kristin Forbes of the Monetary Policy Committee suggests the bank should keep calm and carry on

Is Britain’s economy sliding into recession? The short answer is that no one knows. Uncertainty, however, is no excuse for ducking important decisions and the Bank of England must decide what to do about Brexit next week.

The starting point is a UK economy growing faster than expected in the second quarter, at 0.6 per cent. With global growth rates also improved and financial markets shrugging off the initial shock of Brexit, fears of a catastrophic global crisis can be banished. A stronger global economy will naturally help but also means Britain cannot credibly threaten to bring down the EU if European politicians reject the UK government’s Brexit wish list.

    Hard facts regarding the post-referendum UK economy are scarce. Retail appears only a little subdued, tax revenues remain weak and the picture for property sales looks bleaker in central London than the rest of the country. More abundant surveys of households and companies have been dire, whether they have sought to measure attitudes to Brexit or early indications of output, orders and exports. The surveys point to a recession but they are sometimes a false friend to economists.

    Against this backdrop the BoE’s Monetary Policy Committee has to decide whether to seek an economic stimulus to keep inflation as close as possible to the 2 per cent medium-term target and output as close as possible to sustainable levels. One response, suggested by the MPC’s Kristin Forbes, is to follow the British edict from the second world war to “keep calm and carry on”. But the evidence of a significant confidence shock, which threatens to lower corporate investment and raise household saving rates, argues more persuasively for a monetary stimulus to limit any preventable economic damage.

    The risks of too much stimulus generating too rapid growth and inflation are minor relative to those of standing by as the economy slides. With the risks involved, it is better to act decisively or, as Andy Haldane, BoE chief economist, puts it, “to run the risk of using a sledgehammer to crack a nut”.

    With the BoE reluctant to set a negative interest rate, it cannot cut its policy rate more than 0.5 percentage points; the right action involves a package comprising a rate cut, restarting quantitative easing and expanding the Funding for Lending Scheme.

    Clear communication of the economic situation and policy intentions should help prevent an impression of panic at the central bank, even though everyone knows there are many legitimate questions about the effectiveness of these monetary tools. In any case, monetary policy works on output and inflation with a delay, so action on August 4, when the MPC next meets, will struggle to prevent a downturn which was already on the cards. Companies take time to reverse mothballed investments.

    Smart Money

    UK stocks aren’t cheap enough given Brexit unknowns

    A news broadcast on a TV is pictured in front of the German share price index DAX board, at the stock exchange in Frankfurt, Germany, June 24, 2016, after Britain voted to leave the European Union in the EU BREXIT referendum. REUTERS/Ralph Orlowski

    Wide range of outcomes suggests political uncertainty will play a dominant role

    The other imperative for action cannot be spoken by the bank’s officials. The BoE must be seen to act decisively to cover its back. The institution needs a defence against possible accusations from Brexiters that it was seeking the downturn it had predicted before the referendum. Such a course from the MPC is likely to bridge the policy gap between now and November when the government will decide whether there is a need for additional fiscal stimulus.

    No one should be under any illusions that monetary or fiscal stimulus solves Britain’s Brexit challenge. All the most serious threats to prosperity come in the longer term through redundant investment linked to Britain’s membership of the EU, lost skills from more restrictive migration policies, weaker competition and a more inward looking and backward attitude. Necessary as they are, monetary or fiscal policies cannot boost the UK economy’s supply capacity.

    Brexit is likely to hurt and the BoE can offer only an anaesthetic for the pain.

    chris.giles@ft.com

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