Finance: Research, Policy and Anecdotes

The UK conundrum of monetary and macro-prudential polici...

For teachers of Business Economics to MBA students, like me, the current macro-economic situation in the UK gives plenty of material for class room discussions. The rising inflation we are observing are driven by higher import costs rather than by demand, with lower growth and higher inflation as result. The public discussions among MPC members on what to do about this shows the conundrum they are facing: raise interest rates to counter inflation and you might slow down the sluggish economy further – lower interest rates to increase growth and you might get even more inflation. No surprise that observers now focus on the profiles of individual MPC members, as recently the FT.


On top of this comes the discussion of whether sluggish growth is ultimately part of the adjustment process to a permanently lower GDP per capita level in the UK after Brexit.  Paraphrasing the Bank of England governor Mark Carney, monetary policy can help smooth the process towards the new equilibrium but it cannot make up for the damage that is being and will be done with Brexit. An important reminder for politicians as they negotiate Brexit with the European Union.


Then is there is the issue of private indebtedness, which has been increasing, especially due to car loans and (somewhat less) credit card debt. Is this part of the adjustment process towards lower income levels or driven by the prospect of a bright future?  Declining consumer confidence suggests it is the former.  Higher interest rates would simply squeeze consumers further, so the application of macro-prudential tools (counter-cyclical capital buffers, to be more precise) seems adequate.  They do not seem binding in most cases and have to be implemented over a 12-month window anyway. But the FPC has already provided some forward guidance to the effect that these buffers might be increased further, thus sending a clear signal to banks to dampen credit growth.  This application of monetary and macro-prudential tools shows the clear advantage of coordinated monetary and macro-prudential tools, by having overlap in membership of FPC and MPC.


What about fiscal policy? The recent elections have sent a clear signal that the electorate had just about enough of austerity and there is increasing pressure to loosen the public purse. The FT has calculated that the 1 billion pounds promised to Northern Ireland to buy Theresa May 2 more years in 10 Downing Street would translate into 60 billion if applied across the UK or 0.2% of GDP; not a big number prima facie, but significant as the fiscal deficit is still at 2% (eight years after the end of the last recession) and debt above 80% of GDP.  Though relaxing austerity might have the benefit of reducing pressure on consumer and thus their tendency to incur more debt, it might put more pressure on interest rates. Certainly challenging times for everyone!