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11 August 2016

Why the Bank of England’s stimulus bazooka won’t be enough to save the economy

The markets have been spooked by Brexit. If we want to improve the economy long term, we need to thing about our reputation, not monetary tonics.

By Felix Martin

As far as the economic consequences of the Brexit vote are concerned, the Bank of England has seen enough. Having held fire at its meeting in July in the immediate aftermath of the EU referendum, the Bank’s Monetary Policy Committee voted unanimously on 3 August to fire a three-barrelled stimulus bazooka.

I was not in the City that day but in the Lakes, holidaying with a brilliant scientist friend who is a director of the European Bioinformatics Institute (EBI) in Cambridge­shire – one of the world’s leading centres for genomics research. I came away convinced that the true economic impact of Brexit has less to do with the short-term gyrations of interest rates and the financial markets and more to do with our long-term ability to maintain our position at the technological frontier. When it comes to Brexit, we should be worrying less about institutions such as the Bank and more about institutions such as the EBI.

But to begin with the Bank: the first barrel of its new bazooka is aimed at households and businesses. The Bank cut its overnight interest rate from 0.5 per cent to 0.25 per cent – an all-time low – and high-street banks were urged to pass the reduction on to mortgage borrowers without delay.

The second barrel is trained on institutional investors. The Bank expanded its programme of quantitative easing (QE), its bond-buying blitz that aims to encourage pension funds and insurance companies to sell their holdings of safe-haven government and corporate bonds and lend to the kinds of business that drive growth instead.

The third barrel targets banks. The Funding for Lending scheme will become the Term Funding Scheme, in which the Bank of England will lend directly and cheaply to the high-street banks, as long as they step up their lending in turn.

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The Bank has chosen to act because the most recent business surveys suggest a precipitous drop in confidence. As a result, in the Bank’s view, “The outlook for growth in the short to medium term has weakened markedly” – and unemployment is likely to rise. The fall in the value of sterling may cushion the blow, but the Bank believes that more help is required, hence the rate cut, the expansion of QE and the renewed push to encourage banks to lend.

Will it work? It depends on what you mean by “work”. It’s important to understand the limits of monetary policy as a tool of economic management. A collapse in business and consumer confidence of the sort suggested by the surveys is a shock to demand. If companies and households believe that there are harder times ahead, they are likely to rein in spending and present less demand for goods and services. The Bank’s actions are designed to address this by making credit more freely available. To simplify it only slightly, the idea is that, with lower monthly mortgage payments, households will spend more and so generate more jobs.

It is easy to be sceptical about whether this indirect approach will be a game-changer when interest rates are already at historic lows. Won’t households just redeploy any savings from interest payments to pay down mortgage principal, adding nothing to spending on output? And if demand is the problem, why not tackle it directly by increasing public investment, for example?

These are important questions. Yet the Bank also warned that the real risks of the Brexit vote stem not from the short-term impact on the economy’s demand for goods and services but from the long-term consequences for its capacity to supply them.

A few days with my scientist friend were enough to convince me that this diagnosis is correct. The institute that he runs is one of the world’s leading centres for research in genomics – the marriage of data science and genetics that is allowing us to decode and understand the human genome. The poten­tial applications of its research output in medicine, technology, agriculture and areas we cannot even imagine yet are vast.

The truths of science know no national boundaries. Economically, however, where they are researched and discovered matters, because it is usually there that the businesses that exploit them are built. Institutes such as the EBI are valuable economic assets. When Theresa May talks of the need for a proper industrial strategy, it is the hi-tech businesses spun out of institutes such as the EBI that she is dreaming of.

Yet the referendum result has been a cause of woe, not celebration, for my friend. The reason has little to do with Brexit: the EBI was established by a special intergovernmental treaty, so our EU membership has no impact on the legal status of the institute or its staff. The problem is the everyday experience of many of the non-British scientists working there since the vote.

I am sure that readers will have heard the same kinds of stories in other contexts. Casual xenophobia in the street. An excuse for bullying at school. A feeling among a tiny but vocal minority that the referendum result is a licence to be rude and racist to strangers. These things have always happened now and then; but since the vote, an alarming number of my friend’s non-British staff and their families have been made to feel publicly unwelcome, or worse. This epidemic of low-level yobbery on institutions that depend on foreign talent to be the best in the world – our economic Premier League teams – is demoralising. Since the growth of the UK’s productive capacity depends on them, the effect on our economic future is potentially devastating.

It is time for all sides in the Brexit debate to reaffirm the UK’s reputation as a tolerant society that is open to foreign trade, foreign capital, foreign ideas and the foreign people who come up with them. It is on that reputation – not on the monetary tonics of the Bank of England – that our long-term economic future hangs. 

This article appears in the 10 Aug 2016 issue of the New Statesman, From the Somme to lraq