Theresa May dropped a bombshell in her keynote speech to the Conservative conference this week when she said there had been undesirable side-effects from the ultra-low interest rates and money creation that have been part of the economic landscape for the past seven years.
Noting that the spoils of the growth generated by these unconventional policies had been unevenly divided, May said the approach had boosted asset prices, which helped the better off much more than it did those struggling to get by. “A change is going to come and we are going to deliver it,” the prime minister said.
That was the cue for a flurry of speculation. Was this a signal to the Bank of England not to cut interest rates when it next meets in November? Was May about to send Mark Carney back to Canada? Was she rethinking the wisdom of Gordon Brown’s decision, taken in the first week of Tony Blair’s 1997 government, to grant the Bank independence?
Clarification was called for, and it was quickly provided. The government said it had no intention of meddling with the Bank’s independence and the chancellor, Philip Hammond, went out of his way on Thursday to praise Carney – widely thought to have done well during the immediate chaos following the Brexit vote – while on a visit to Wall Street.
That was sensible. With the pound hitting fresh 31-year-lows every day this week and some analysts talking about a sterling crisis, it is not a great idea to suggest to financial markets that you are thinking about defenestrating the governor of your central bank.
So what did May really mean? What sort of change can we expect?
Put simply, the prime minister was expressing doubts about the macroeconomic strategy George Osborne pursued. The previous chancellor, whom she sacked in July, believed the Bank of England should bear the responsibility for generating sufficient demand in the economy via its control over interest rates and quantitative easing (QE).
Fiscal policy – the Treasury’s tax and spending decisions – would, by contrast be kept tight in order to repair the damage to the public finances caused by the deep recession of 2008-09.
Economists argued from the outset about whether the mix was right, with some calling for tighter monetary policy balanced by less austerity.
The results of Osborne’s approach were not especially impressive. Britain’s recovery from recession was sluggish, and deficit reduction was much slower than planned. A Bank of England study showed that QE did help to boost activity, but that the benefits tended to go to the richest 5%, who own 40% of the UK’s assets. The money created by QE did more to boost asset prices than it did the real economy.
May’s misgivings were echoed by the International Monetary Fund this week. The IMF thinks monetary policy is being asked to do too much, and that the continued use of unconventional measures, long after they were expected to be phased out, is hurting bank profitability and could result in solvency problems for pension funds and insurance companies. The Bank for International Settlements thinks the same.
As to what May will do, she has two main options. First, if the Bank wants to do any more QE it will have to secure the Treasury’s permission. That could legitimately be refused without impairing the Bank’s independence. Second, Hammond could change the mix by easing fiscal policy in his autumn statement. That would make the need for more QE redundant and reduce the need for further interest rate cuts.
