PM May's speech at the annual Tory party conference is being viewed as a massive change in policy direction. In a populist speech, in some ways, she talked about a need for greater fairness, to help those, the poorest that have been most affected by austerity. As well as talking about greater intervention to attend to market failures, she signaled changes in economic policy to, if you like, a greater emphasis on Keynesian policies.
Clearly her speech made sense from a political viewpoint. May is laying claim to the centre ground of politics which has been vacated by the Labour party. Labour continues to shift to the hard left, and under an unelectable leader does its best to make sure it is the case it will not be elected. Corbyn has refused to make any attempts to unify the parliamentary party with his latest reshuffle electing only his very closest allies, which is likely to lead to further infighting. Corbyn also refuses to acknowledge that the levels of immigration seen is a problem, a key issue for many traditional working class supporters. But at the same time, May's speech also tried to appeal to UKIP supporters by emphasising the importance of control of borders and by adopting about the only non-Brexit UKIP policy - namely allowing new grammar schools. UKIP continues to implode struggling with finding a raisin d'etre and a new leader to follow the highly successful Nigel Farage. But what I would say is that Theresa May should be judged not by what she says but what she does. Many new administrations start off with such sentiments of fairness but fail to follow through not least because of events as well as other priorities. This is not to say she is not committed to making a fairer society.
A shift from monetary stimulus to fiscal stimulus makes sense from both a fairness and macroeconomic point of view. When the coalition government came to power in 2010, it inherited a massive structural budget deficit partly due to the global financial crisis but largely reflecting years of irresponsible spending from the previous Labour administration. The government was left with little choice but to cut spending and raise taxes. This resulted in a greatly reduced budget deficit albeit that debt continues to accumulate and targets to balance the budget have been missed.
At the same time, monetary policy was eased. And in common with most other advanced countries we have experienced ultra low interest rates. Base rate was cut to a record low 0.5% over seven years ago and further to 0.25% in August. Quantitative easing (QE) has seen some £375bn of gilts purchased, with a further programme announced in August of an additional £60bn of gilts and £10bn of corporate bonds in response to the Brexit vote and largely unfounded fears that the economy would be plunged into recession.
Now there is no doubt that monetary policy has been overburdened and there have been many side effects from the semi-permanent monetary stimulus. One of these side effects has been the distributional consequences. Economic policy has favoured holders of fixed assets and mortgage holders as against savers and potentially pension holders. A Bank of England study found for example that QE did boost growth but that the benefits tended to go to the richest 5% who own 40% of assets. And of course spending cuts have impacted on the poorer too.
It is not good that savers cannot get a decent return as it disincentivises, especially people to do so for retirement, increasing the prospect that people will rely on the government and increase their own already high household debt. Similarly long-term investors like pension funds and insurance companies can no longer earn a real rate of return threatening their solvency. It is also not good if the burden of providing a pension falls on the government when we have an ageing population. Corporate pension fund deficits reached a record high at £459bn at the end of August due to plunging bond yields which have also raised fears that firms might cut their investment plans. Although as has been pointed out by our UK economists at Oxford Economics, assets held by defined benefit schemes have actually increased by £135bn in the four months to August. Bank's profitability have been badly impacted by low interest rates too, affecting their ability to lend.. And while most people would not be sad about bank'statement plight, it could also contribute for the need for expensive bailouts given the pivotal role that banks do play in the economy. As it is not good for savers, low interest rates are great for borrowers. However again we are storing up problems for the future in building up such debt. If and when interest rates rise again, we are likely to see many distressed borrowers given the highly leveraged position of the household sector. Finally, ultra low interest rates lead to the mis-pricing of financial markets pushing up equity and bond prices. In addition they lead to a mis-allocation of capital with a rash of low-return capital projects.
There is no doubt that monetary policy has been asked to do too much and that it has reached the end of its effectiveness. Thus for example, negative interest rates will not work in the UK. But with a greatly reduced budget deficit and long term rates close to zero, this is an ideal time to ease fiscal policy a little to meet the uncertainty regarding the medium term impact of Brexit. The government has built up a lot of policy credibility so can afford some slippage towards its aim of balancing the budget. It certainly makes little sense to remain committed to reach budget balance by 2020 at such a time. Increased spending on infrastructure can boost growth and boost the supply side of the economy without "crowding out" the private sector given the low cost of funding. But it will still be important to not waste money on cost ineffective and spurious projects which offer political rather than any economic returns. It will be important to identify "shovel ready" projects. We shall have to wait until the Autumn Statement on 23 November to see what exactly the Chancellor does to reset fiscal policy, but there was speculation already yesterday of the re-introduction of government backed high interest fixed-term bonds (and not just for the over 65s) which could be a good move.
*Patrick Dennis is a British Economist currently working with Oxford Economics. He has spent nearly 40 years working as an economist in the City of London and its environs. He served as Chief Economist at the Industrial Bank of Japan and was also senior economist for both National Westminster Bank and Royal Bank of Scotland. He holds a postgraduate degree from Corpus Christi College, Oxford University.
This post had previously appeared at http://ukmacroeconomicspolitics.blogspot.ae/2016/10/a-shift-from-monetary-to-fiscal.html
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