21 June 2018
Politicising the Bank
A narrower not wider remit is the way forward.
by Frank O’Nomics
Britain has a productivity problem and the Labour Party wants the Bank of England to solve it. Our productivity growth considerably lags that of Germany, France and the US, progressing at a mere 0.2% per annum on average for the past 11 years. This has not always been the case – we managed growth of 2.1% a year in the preceding decade. The reasons for the decline have been the subject of many academic investigations but the essence seems to be largely very low levels of business investment which, despite low interest rates, £375bn of quantitative easing and help from the Bank with loans to small businesses and households via the £26bn Funding for Lending Scheme, refuses to show any sign of picking up. Last year’s investment numbers looked a little more encouraging at +2.4%, but they are now forecast to slip to 0.9% this year.
Never fear, Graham Turner at GFC Economics has proposed a long-term solution to the productivity problem, and the Labour Party has adopted his proposal. Mr Turner’s idea is that the Bank of England’s mandate should be expanded to include productivity, to ensure that productivity growth hits 3% – the timeframe is not defined but one assumes this is an annual target (otherwise what is the point). A Strategic Investment Board will coordinate with the Treasury and business departments with a view to boosting lending into what are deemed to be productive sectors. There is something of the economics of Pollyanna surrounding these ideas – there are so many reasons that mean they will not work and, worse, areas where such an approach could cause major problems. Perhaps the only good thing resulting from the announcement is that it leads us to realise that, rather than expanding the Bank’s mandate, we should actually be shrinking it, or at least making it more focused.
The Bank of England’s mission is to promote monetary and financial stability for the United Kingdom via the actions of the Financial Policy Committee and the Monetary Policy Committee. This process requires a great deal of effort monitoring the state of the domestic and international economies at a time when a great deal of the Bank’s resource is devoted to analysing the consequences of Brexit. Adding productivity growth to the mandate would stretch those resources a lot further. However, quite apart from feasibility issues there are a number of other fundamental problems. First, the approach risks making the Bank take decisions that should be the province of an elected body – in essence it would become political. Channeling resources to the areas that most need it is more the province of fiscal policy and government spending than of an artificially contrived lending policy. Second, the very idea of targeting productive sectors ignores the fact that the open market for funds should be doing this in the normal course of business anyway. Lenders and investors seek the best returns dependent on the perceived risks. Pushing money to areas that are not getting funds, risks ignoring market dynamics and realising losses rather than gains – making productivity potentially negative. It is far better for the government to reduce current economic uncertainty, thereby encouraging commercial lenders to invest with confidence. The Bank is currently doing its part by devoting its time and resources to assessing the effects of Brexit. In doing that they provide advice to government on the implications of its policies.
The GFC proposals go further, with a plan to force RBS to focus lending on small and medium sized companies. Beyond the obvious irony of the problems that this bank got into in this area recently, it is likely that the bank will not be a state-owned entity for much longer. Placing undue restrictions on an independent, quoted bank will not encourage new shareholders.
The prospect of changing the Bank’s mandate is, however, not an unreasonable one. The current target for the MPC is to set policy towards meeting an inflation objective of 2%. If inflation is more than 1% higher or lower, the Bank has to write an open letter to the Chancellor of the Exchequer explaining how it will get it back on track. The Bank last wrote a letter in February because CPI had hit 3.1%. However, the Bank has some latitude as to whether to raise raising rates if CPI is high and the economic outlook is uncertain. In fact, while inflation has been consistently above 2%, and wage growth, energy prices and the outlook for sterling suggests that this will continue for quite some time, very weak industrial production and Brexit uncertainty look likely to leave the MPC unmoved at its June meeting. A move in August may also be difficult given that the meeting occurs before key data is released later that month.
It might be reasonable to argue that low business investment is partly the result of a fear of inflation eroding the potential returns. Further, the maintenance of low interest rates perpetuates “zombie” companies who would otherwise fold, and thereby help overall productivity in the longer-term. If the MPC had a more rigorous mandate to focus on containing inflation, this could have a positive impact on longer-term productivity.
Looking for ways to improve UK productivity is laudable. The revision of BCC estimates for UK GDP growth to 1.3% for this year, if correct, would leave growth at it’s lowest since 2009, and the forecast for 2019 is only a little better at 1.4%. However, shifting the responsibility away from fiscal policy and government spending, towards making it part of the Bank’s mandate is not the solution and could make the problem worse. Much will depend on the reduction of Brexit uncertainty over time, and it is to be hoped that a wave of business investment will be released when this happens. In the interim, the Bank of England should be encouraged to focus on its mandate of maintaining financial stability and keeping inflation in check.