Britain has just celebrated Guy Fawkes Night, remembering the time that a group of plotters including Mr Fawkes hatched a plot to destroy and rebuild the way government was done. For a few weeks earlier this Autumn, another group of plotters briefly took the reins of power in the UK and attempted to redraw economic policy. The attempt was short-lived, and the ousting of the plotters was ignominious and memorable, if (thankfully) less violent than the end of Guy Fawkes. Some damage had already been done, with markets pricing a ‘moron risk premium’ into sterling-denominated assets during the brief Truss government — a premium that has not yet entirely dissipated.
It is easy to see what motivated the more recent plotters. UK macroeconomic policy has been nothing short of a disaster for at least the last decade, and arguably longer. This failure has been particularly evident since the start of the pandemic, with the UK considerably underperforming its G7 peers economically while also suffering worse health outcomes. Indeed, following the Q3 contraction, the UK is now the only G7 economy still smaller than it was prior to the pandemic. At Fathom’s Emergency Monetary Policy Forum on Friday, four former Bank rate-setters called for a dramatic reset in UK monetary and fiscal policy, to tackle the profound economic problems of inflation and low productivity.
In an event hosted by Fathom Consulting and Chatham House, four distinguished former members of the Bank of England’s Monetary Policy Committee — Willem Buiter, Charles Goodhart, Dame DeAnne Julius and Dr Sushil Wadhwani — concluded that the Bank had made significant errors in fulfilling its policy remit, and that a change of course was required. For its own part, Fathom is calling for a radical rethink of macroeconomic policy in the round.
The key conclusions of the Forum were, first, that UK economic policy has failed since the Global Financial Crisis. The economy’s rate of growth has fallen from around 2% per year prior to the GFC to just above zero now. In Fathom’s opening presentation to the forum, we argued that it was low-for-long interest rates that have eroded the economy’s productivity. The forum was told: “We are overheating with growth at 0 in the UK. That’s a pretty damning indictment. There has to be a better way.” In other words, the UK is now in need of a policy reset.
On bank rate: too little, too late
The view of both the panellists and those present in the audience was that interest rates should have been raised far earlier and far quicker than has been the case. The audience at Chatham House concurred: in polling, 75% believed the Bank had delayed too long, with 37% believing it should have started hiking rates last summer, and a further 38% that it should have commenced Quantitative Tightening at the same time too. According to Mr Goodhart, the Bank may have missed the boat: “You have to raise rates early and raise them aggressively”.
Models don’t make forecasts, economists do
There was unanimous agreement among the panellists that the Bank’s projection which accompanied its November Monetary Policy Report was unrealistic. This projection showed inflation drifting smoothly back to target without further interest rate hikes over the horizon, something that our panellists considered fanciful. Dame DeAnne also alluded to the possibility that the Bank’s overemphasis on its macro model as a means of justifying policy decisions might be harming its credibility – don’t blame the model for unjustified assumptions, blame the forecasters.
The Bank risks losing credibility
Fathom has suggested in previous Global Outlook forecasts that the Bank was attempting to use its credibility to talk down the significance of rising inflation in the hopes that this would avoid the need to hike rates: to ‘Fake it till you make it’. One of our panellists, Dr Sushil Wadhwani, suggested that the Bank’s dovish rhetoric which accompanied its 75-basis point rate hike in November was both confusing and pointless.
Rates may need to go higher than the MPC expects
The more rate hikes are delayed, the higher they may have to go. A year ago, when Bank Rate was 0.1%, the idea that it might reach 2-3% was considered high. It is a telling reflection on the times that panellists and audience members were throwing about numbers like 5–6% and nobody batted an eyelid.
In Fathom’s view, it is possible that a good outcome from the recent ‘kerfuffle’ (in Mr Buiter’s understatement) can still be achieved. To the extent that perennially low interest rates are part of the problem in the UK and elsewhere, part of the ‘solution’ might be to run a period of substantially higher inflation. That would get higher inflation firmly embedded in expectations, creating a manageable degree of uncertainty about the competence of the macroeconomic policy authorities, driving nominal and real interest rates up at all maturities. Such an outcome would slay the zombies — the unproductive activities that have been allowed to dominate the UK economy (and others) since the Great Financial Crisis — and could move the economy onto a stronger trend growth path in the long term.
Fathom would not have done it like this. But, as the saying goes, you should never let a crisis go to waste: take the opportunity to plot a different, better path for the UK economy.
The views expressed in this article are the views of the author, not necessarily those of Refinitiv Lipper or LSEG.
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