At the Mansion House dinner on 15 June, the Chancellor, George Osborne, and the Governor of the Bank of England, Sir Mervyn King, announced a new monetary policy initiative to increase bank credit. The idea is to stimulate borrowing by both firms and households and thereby boost aggregate demand.
There are two parts to the new measures:
1. Funding for lending. The aim here is to provide banks with cheap loans (i.e. at below market rates) on condition that they are used to fund lending to firms and households. Some £80 billion of loans, with a maturity of 3 to 4 years, could be made available to banks under the scheme. The details are still being worked out, but the scheme could work by the Bank of England supplying Treasury bills to the banks in return for less secure assets. The banks could then borrow against these bills in the market in order to lend to customers.
2. Providing extra liquidity to banks through six-month repos. The Bank of England will begin pumping up to £5bn a month into the banking system to improve their liquidity. This is an activation of the ‘Extended Collateral Term Repo Facility’ (see also), which was created last December, to provide six-month liquidity to banks against a wide range of collateral.
But whilst it is generally accepted that a lack of borrowing by firms and households is contributing to the slowdown of the UK economy, it is not clear how the new measures will solve the problem.
In terms of the supply of credit, banks have become more cautious about lending because of the increased risks associated with both the slowdown in the UK economy and the euro crisis. They claim that the issue is not one of a shortage of funding for lending, but of current uncertainties. They are thus likely to remain reluctant to lend, despite the prospect of extra loans from the Bank of England.
In terms of the demand for credit, both businesses and consumers remain cautious about borrowing. Even if bank loans are available, firms may not want to invest given the current uncertainties about the UK, eurozone and world economies. Consumers too may be reluctant to borrow more when people’s jobs may be at stake or at least when there is little prospect of increased wages. Even if banks were willing to lend more, you cannot force people to borrow.
Britain fights euro zone threat with credit boost Reuters, Matt Falloon and Sven Egenter (14/6/12)
Debt crisis: emergency action revealed to tackle ‘worst crisis since second world war’ Guardian, Larry Elliott, Jill Treanor and Ian Traynor (14/6/12)
Q&A: Funding for lending scheme Financial Times, Norma Cohen (15/6/12)
Bank lending plan: How will it work? BBC News (15/6/12)
Bank of England’s loans to high street banks start next week Guardian, Phillip Inman (15/6/12)
Mervyn King: Bank of England and Treasury to work together The Telegraph (15/6/12)
Bank of England offers £80bn loans Channel 4 News, Sarah Smith (15/6/12)
Bank funding scheme plans unveiled Independent, Holly Williams (15/6/12)
Banking: King hits panic button Independent, Ben Chu (15/6/12)
Bankers raise doubts on credit scheme Financial Times, Patrick Jenkins and Sharlene Goff (15/6/12)
We should not pin our hopes on Britain’s plan A-plus Financial Times, Martin Wolf (15/6/12)
Throwing money at banks won’t solve economic crisis, Ed Balls says Guardian, Patrick Wintour (15/6/12)
UK lending plan faces risk of low take-up BloombergBusinessweek, Robert Barr (15/6/12)
Will Bank of England’s new lending schemes work? BBC News, Robert Peston (15/6/12)
Bank and Treasury’s plan A-plus for UK BBC News, Stephanie Flanders (15/6/12)
Questions
- How would the schemes incentivise banks to lend more?
- Explain what is meant by the Extended Collateral Term Repo Facility. How similar is it to the long-term repo operations of the ECB (see the news item More bank debt to ease bank debt)?
- What factors are likely to determine the take-up of loans from banks?
- Will the new arrangements have any implications for taxpayers? Explain.
- To what extent are fiscal and monetary policy currently complementary?
- What is the significance of calling the new measures ‘Plan A-plus’? What would ‘Plan B’ be?
In the second part of this blog, we look at an interview with the Guardian given by Robert Chote, Chair of the UK’s Office of Budget Responsibility. Like Mervyn King’s, that we looked at in Part 1, Robert Chote’s predictions are also gloomy.
In particular, he argues that if Greece leaves the euro, the effects on the UK economy could be significant, not just in the short term, but in the long term too.
The concern is that you end up with an outcome in the eurozone that creates the same sort of structural difficulties in the financial system and in the economy that we saw in the past recession, and that that has consequences both for hitting economic activity in the economy, but also its underlying potential. And it’s the latter which has particular difficulties for the fiscal position, because it means not just that the economy weakens and then strengthens again – ie, it goes into a hole and comes out – but that you go down and you never quite get back up to where you started. And that has more lingering, long-term consequences for the public finances.
The interview looked not just at the effects of the current crisis in the eurozone on the eurozone, British and world economies, but also at a number of other issues, including: the reliability of forecasts and those of the OBR in particular; relations between the OBR and the Treasury; allowing the OBR to cost opposition policies; the economic effect of cutting the 50p top rate of income tax; the sustainability of public-sector pensions; and tax increases or spending cuts in the long term.
In Part 3 we look at attempts by the G8 countries to find a solution to the mounting crisis.
Articles
Robert Chote interview: ‘I would not say in the past there’s been rigging’ Guardian, Andrew Sparrow (18/5/12)
UK ‘may never fully recover’ if Greece exits euro Guardian, Andrew Sparrow, Helena Smith and Larry Elliott (18/5/12)
British economy may ‘never quite recover’ from a severe Euro collapse The Telegraph, Rowena Mason (18/5/12)
OBR report
Economic and fiscal outlook Office for Budget Responsibility (March 2012)
Questions
- Why is it very difficult to forecast the effects of a Greek withdrawal from the euro?
- Why may Greek withdrawal have an effect on long-term potential output in the UK and the rest of Europe?
- Why are economic forecasts in general so unreliable? Does this mean that we should abandon economic forecasting?
- Why are public finances “likely to come under pressure over the longer term”?
- Why might the cut in the top rate of income tax from 50% to 45% have little impact on economic growth? Distinguish between income and substitution effects of the tax cut.
This has been a week of gloomy prognostications. On Wednesday 16 May, the Bank of England published its quarterly Inflation Report – and it makes worrying reading.
The forecast of UK economic growth for 2012 has been reduced from 1.2% in the previous report to 0.8%. But the rate of inflation is forecast to remain above the 2% target well into next year. However, at the two-year horizon, inflation is now forecast to be 1.6% – below the target, thus giving the MPC scope for further quantitative easing.
In the introduction to the report, the Governor, Mervyn King, writes:
Over the past year or so, two factors have hampered the recovery and rebalancing by more than expected. First, higher-than-expected world commodity and energy prices have squeezed real take-home pay, dampening consumption growth. Second, credit conditions, far from easing, have in some cases become tighter. The direct and indirect exposures of UK banks to the euro-area periphery have affected funding costs as the challenges of tackling the indebtedness and lack of competitiveness in those countries have intensified.
And at the news conference launching the report, he said:
We have been through a big global financial crisis, the biggest downturn in world output since the 1930s, the biggest banking crisis in this country’s history, the biggest fiscal deficit in our peace time history and our biggest trading partner – the euro area – is tearing itself apart without any obvious solution.
The idea that we could reasonably hope to sail serenely through this with growth close to the long run average and inflation at 2% strikes me as wholly unrealistic. We’re bound to be buffeted by this and affected by it.
The following articles look at the Bank of England’s predictions and at the challenges facing the UK economy as the crisis in the eurozone deepens and as inflation in the UK remains stubbornly above target. They also look at the issue of the extent to which capacity has been lost as a result of the continuing weakness of the UK economy. As The Economist article states:
Business surveys suggest only a small proportion of firms are operating below capacity. That finding looks odd given the economy’s output is still 4% below its level at the start of 2008, and is much farther below the level it would have reached if GDP growth had continued at its long-term rate. The picture painted by surveys could be right if a chunk of the economy’s potential has been written off for good. But Sir Mervyn King, the bank’s governor, doubts this. There is “no obvious reason” why the economy could not rejoin its pre-crisis path, though it might take a decade or two to get there, he said on May 16th.
We look in more detail at the question of lost capacity in Part 2.
Articles
Bank of England cuts growth forecasts: Sir Mervyn King’s speech in full The Telegraph (16/5/12)
Bank of England sees inflation up and growth falling Independent, Ben Chu (17/5/12)
Hard going The Economist (19/5/12)
Bank of England optimism dented again Financial Times, Chris Giles (16/5/12)
Eurozone is ‘tearing itself apart’, says Mervyn King. True, but the UK’s problems are as intractable as ever The Telegraph, Philip Aldrick (16/5/12)
Inflation Report
Inflation Report: portal page Bank of England
Inflation Report: May 2012 Bank of England (16/5/12)
Additional Data
Statistical annex to European Economy. Spring 2012 European Commission, Economic and Financial AffairsAnnual macro-economic database European Commission, Economic and Financial Affairs (11/5/12) (see particularly section 6.5)
Forecasts for the UK economy HM Treasury
Questions
- What explanations are given for the rate of CPI inflation remaining persistently above the 2% target?
- Why have the prospects for economic growth worsened since the publication of the February Inflation Report?
- How might it be possible to have a narrowing (negative) output gap and yet a stagnant economy?
- Why may capacity have been lost since the financial crisis of 2008?
- Why has M4 declined despite the programme of quantitative easing? (See M4 in record fall despite QE.)
- What scope is there for monetary policy in achieving faster economic growth without pushing inflation above the 2% target?
The UK is officially back in recession: or to be more accurate, a double-dip recession.
The generally accepted definition of a recession is two or more quarters of negative growth in real GDP. According to figures released by the Office for National Statistics, the UK economy shrank by 0.2% in quarter 1, 2012, having shrunk by 0.3% in quarter 4, 2011.
(Click on the following link for a PowerPoint of the above chart: Double dip 2)
As you can see from the chart (click chart for a larger version), these declines are tiny compared with the recession of 2008/9. Nevertheless, with the eurozone economy slowing (Britain’s largest export market), and with cuts to government expenditure set to bite harder in the coming months, there are worries that there may be more quarters of negative growth to come.
So what are the causes of this double-dip recession? Are they largely external, in terms of flagging export markets; or are they internal? Is the new recession the direct result of the tight fiscal policy pursued by the Coalition government?
And what is to be done? Is there no option but to continue with the present policy – the government’s line? Or should the austerity measures be reined in? After all, as we saw in the last blog post (Economic stimulus, ‘oui’; austerity, ‘non’), the mood in many European countries is turning against austerity.
The following articles explore the causes and policy implications of the latest piece of bad news on the UK economy.
Articles
Double-dip recession a terrible blow for George Osborne Guardian, Larry Elliott (25/4/12)
Double-dip recession figures mark another bad day for George Osborne Guardian, Larry Elliott (25/4/12)
UK double-dip recession: what the economists say Guardian (25/4/12)
Feared double dip recession becomes reality as British economy contracts again in first quarter of 2012 Daily Record (25/4/12)
Britain in double-dip recession as growth falls 0.2pc The Telegraph, Angela Monaghan and Szu Ping Chan (25/4/12)
Did the eurozone crisis cause the double-dip recession? Guardian, Polly Curtis (25/4/12)
UK’s double-dip recession Financial Times, Chris Giles (25/4/12)
UK is in ‘double dip’ recession FT Adviser, Rebecca Clancy and John Kenchington (25/4/12)
Flanders explains GDP figure BBC News, Stephanie Flanders (25/4/12)
No recovery for UK: No let up for ONS BBC News, Stephanie Flanders (25/4/12)
Double-dip recession: There’s always fantasy island BBC News, Paul Mason (25/4/12)
UK double-dip recession to drag on into summer, economists warn The Telegraph, Philip Aldrick (26/4/12)
George Osborne can stop the rot, but only by spending as he slashes The Telegraph, Jeremy Warner (25/4/12)
Double dip has arrived – and Osborne is running out of escape routes Independent, Ben Chu (26/4/12)
Britain’s bosses tell the ONS: it’s bad, but not a recession Independent, Tom Bawden, Lucy Tobin , Gideon Spanier (26/4/12)
The Chancellor received plenty of warning Independent, David Blanchflower (26/5/12)
Data
Gross Domestic Product: Preliminary Estimate, Q1 2012 ONS (25/4/12)
Preliminary Estimate of GDP Time Series Dataset 2012 Q ONS (25/4/12)
World Economic Outlook Database IMF (17/4/12)
Business and Consumer Surveys (for all individual EU countries and for the EU as a whole) European Commission: Economic and Financial Affairs
Consumer Confidence Nationwide Building Society
Questions
- Assess the current state of the UK economy and its likely course over the coming few months.
- Why may looking at the business surveys provide a truer picture of the state of the UK economy than the official measure of GDP?
- Why has the UK economy gone back into recession?
- Compare the policy approaches of the Coalition government with those of the Labour opposition.
- How important is it for the UK to retain its AAA credit rating?
A negative outlook for the UK economy – at least that’s what Moody’s believes. The credit rating agency has put the UK economy’s sovereign credit rating, together with 2 other European nations (France and Austria) on the ‘negative outlook’ list.
The UK currently has a triple A rating and we have been able to maintain this despite the credit crunch and subsequent recession. However, with weak economic data and the continuing crisis in the eurozone, Moody’s took the decision to give the UK a ‘negative outlook’, which means the UK, as well as France and Austria have about a 30% chance of losing their triple A rating in the next 18 months.
Both Labour and the Coalition government have claimed this decision supports their view of the economy. Labour says this decision shows that the economy needs a stimulus and the Coalition should change its stance on cutting the budget deficit. However, the Coalition says that it shows the importance the Credit ratings agencies attach to budget deficits. Indeed, Moody’s statement showed no signs that it feels the UK should ease up on its austerity measures. The statement suggested the reverse – that a downgrade would only occur if the outlook worsened or if the government eased up on its cuts. The Coalition’s focus on cutting the deficit could even be something that has prevented the UK being put on the ‘negative watch’ list, as opposed to the ‘negative outlook’ list. The former is definitely worse than the latter, as it implies a 50% chance of a downgrade, rather than the current 30%.
The triple A rating doesn’t guarantee market confidence, but it does help keep the cost of borrowing for the government low. Indeed, the UK government’s cost of borrowing is at an historic low. A key problem therefore for the government is that there is a certain trade-off that it faces. Moody’s says that 2 things would make the UK lose its rating – a worsening economic outlook or if the government eases on its austerity plans. However, many would argue that it is the austerity plans that are creating the bad economic outlook. If the cuts stop, the economy may respond positively, but the deficit would worsen, potentially leading to a downgrade. On the other hand, if the austerity plans continue and the economy fails to improve, a downgrade could also occur. The next few days will be crucial in determining how the markets react to this news. The following articles consider this issue.
The meaning of ‘negative’ for Mr Osborne and the UK BBC News, Stephanomics, Stephanie Flanders (14/2/12)
Relaxed markets remain one step ahead of Moody’s move The Telegraph, Philip Aldrick (14/2/12)
George Osborne tries to be positive on negative outlook for economy Guardian, Patrick Wintour (14/2/12)
Moody’s wants it may cut AAA-rating for UK and France Reuters, Rodrigo Campos and Walter Brandimarte (14/2/12)
Moody’s rating decision backs the Coalition’s path of fiscal consolidation The Telegraph, Damian Reece (14/2/12)
Moody’s rating agency places UK on negative outlook BBC News (14/2/12)
Britain defends austerity measures New York Times, Julia Werdigier 14/2/12)
Questions
- What does a triple A rating mean for the UK economy?
- Which factors will be considered when a ratings agency decides to change a country’s credit rating? What similarities exist between the UK, France and Austria?
- Which political view point do you think Moody’s decision backs? Do you agree with the Telegraph article that ‘Moody’s rating decision backs the Coalition’s path of fiscal consolidation’?
- If a country does see its credit rating downgraded, what might this mean for government borrowing costs? Explain why this might cause further problems for a country?
- How do you think markets will react to this news? Explain your answer.
- What action should the government take: continue to cut the deficit or focus on the economic outlook?
- Why has the eurozone crisis affected the UK’s credit rating?
At the Mansion House dinner on 15 June, the Chancellor, George Osborne, and the Governor of the Bank of England, Sir Mervyn King, announced a new monetary policy initiative to increase bank credit. The idea is to stimulate borrowing by both firms and households and thereby boost aggregate demand.
