The latest YouGov/Sunday Times poll taken on the 15 and 16 September finds that only 2 per cent of respondents think that the state of Britain’s economy at the moment is quite good and none thinks it is “very good”. In addition, just 4 per cent think the coalition is managing the economy “very well”, including only 11 per cent of Tories and 5 per cent of Lib Dems; in contrast, 29 per cent think it is being managed “fairly badly” and 27 per cent “very badly”. Plus, 58 per cent of respondents expect their financial situation will get worse over the next 12 months, including 44 per cent of Tory voters; 67 per cent of Labour voters and 52 per cent of Lib Dem voters. This is worrying for the coalition.
So what is the coalition government planning to do about this? Not much — as Vince Cable made clear in his speech to the Lib Dem conference, there isn’t much new on the fiscal horizon. Existing plans to cut regulation, protect the science budget, the Green Deal and the Regional Growth Fund simply haven’t delivered, so far. Jaguar Land Rover’s plans to build a new engine plant in the West Midlands are a start. The much hoped-for expansion in exports isn’t happening and unemployment is rising again, especially among the young. The planned investment in infrastructure is simply too timid to compensate for the drastic cuts in public investment already in train. Note that the latest data shows that of the 80,000 increase on the rolling quarter, unemployment among those aged between 18 and 24 increased by 77,000; there was also an increase of 38,000 in the number in this age group who had been unemployed for at least 12 months. The government should act but it isn’t.
The one big hope coalition ministers have is that the Bank of England will do more quantitative easing (QE). This is now the coalition’s plan B. Much as I agree with the need to do more QE, the exhortations of ministers including Osborne and Cable compromise, to some degree, the independence of the MPC. I recall a meeting in the spring of 2008 when, at one of our policy meetings, Mervyn King told the Treasury representative present at these meetings to tell Gordon Brown to stop interfering with monetary policy. The independence of the MPC was always going to be compromised once King interfered with fiscal policy, saying that he supported what the coalition was doing. That made it fair game for politicians to do the same on monetary policy. The coalition needs to act to slow down the speed of its austerity programme and provide incentives for firms to invest and hire. The automatic stabilisers are not sufficient. Monetary policy is most effective when it works with fiscal policy, rather than against it.
I have been predicting for some time that the FOMC, which is the equivalent of the MPC in the United States, will ease first at its meeting on 20 and 21 September. Due to the complicated issues, the meeting has been extended by an extra day, which the markets are interpreting as meaning the Fed will act, as it probably will. The situation is broadly similar in the US, where fiscal policy makers are tightening when they should be loosening. The talk is that it will implement “Operation Twist”, which involves selling short-dated Treasury debt and using the proceeds to buy long bonds at this meeting. The idea behind such a plan would be to flatten the yield curve and lower long-term interest rates, and hence stimulate the economy. The intention is to lower longer-run rates because short-term rates are so low - in both the US and the UK, markets are not expecting interest rates to hit 1 per cent for five years, as I have predicted for some time. The question is whether the Fed will also increase the scale of their asset purchases, perhaps by not only purchasing more treasuries but also mortgage-backed securities - backed by Fannie Mae and Freddie Mac — because of the parlous state of the US housing market. If they don’t expand the scale of their asset purchases at this meeting, I suspect they will do so at their next meeting, set for 1 and 2 November.
An interesting paper by Michael Joyce, Matthew Tong and Robert Woods, published in the latest Bank of England Quarterly Bulletin, suggests that previous rounds of QE have had a major impact. Between March 2009 and January 2010, the Bank of England purchased £200bn of assets with the aim of injecting money into the economy. Our aim was to boost nominal spending and inflation in order to meet the inflation target in the medium term. The evidence presented in that article found that the effects were economically significant. Gilt yields fell by an average of 100 basis points. The authors found a peak effect on the level of real GDP of between 1$DF and 2 per cent and a peak effect on annual CPI inflation of between $F0 and 1$DF percentage points. Further analysis suggested that these asset purchases had an equivalent impact as a cut in bank rate of between 150 to 300 basis points.
Adam Posen’s rightly well publicised recent speech, which argued against policy defeatism and suggested forcefully that the MPC should do more QE, is on the money. The main reason he argues for doing so is because UK consumption growth has fallen off a cliff. Adam suggests purchasing more gilts, “tilted toward the longer-end of the maturity spectrum”, as in the US, as well as addressing the “investment gap by increasing the availability of credit to SMEs and new firms”. His proposal to stimulate lending to small firms is broadly similar to the view I set out in last week’s column, although some of the details differ. Vince Cable seems to be on board. At his speech to the Lib Dem conference this week, he argued: “A lot of responsibility rests on the Bank of England to relax monetary policy further linked to small business lending.”
I fully expect that the MPC will start a new round of asset purchases, perhaps at its next meeting set for 5-6 October, or more likely at the 9-10 November meeting. The exact timing will depend on the data and what happens in the eurozone. The hope is that the MPC will start to target small business lending. The chances that the MPC will act will be increased if the Fed moves, not least because this is now a world of competitive QE. QE depreciates the currency, which gives the economy a boost: and the pound has fallen over the past few days in expectation of such an announcement. QE works. Osborne has to sort out his fiscal policy mess.
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