How To Do More
by Adam S. Posen, Peterson Institute for International Economics
Op-ed in the London Evening Standard
September 13, 2011
© London Evening Standard
Both the UK and the global economy are facing a familiar foe at present: policy defeatism. Whether in Western Europe in the Twenties, in America and elsewhere in the Thirties, or in Japan in the Nineties, every major financial crisis-driven downturn has been followed by premature abandonment of the macroeconomic stimulus policies that are necessary to sustained recovery.
Each and every time, this was because of unduly influential voices claiming some combination of the destructiveness of further policy stimulus, the ineffectiveness of further policy stimulus, or the political corruption from further policy stimulus. Each and every time those voices were wrong—and they are wrong again.
The right thing to do now is for the Bank of England and the other G7 central banks to engage in further monetary stimulus.
If anything, it is past time for us to do so. The economic outlook has turned out to be as grim as forecasts based on historical evidence predicted it would be, given the nature of the recession, the fiscal consolidation underway, and the simultaneity of similar problems across the world.
Sustained high inflation is not a threat in such an environment, and in fact the inflation which we have suffered because of temporary factors in the UK is about to peak. If we do not undertake the policy of stimulation the outlook calls for, then our economies and our people will suffer avoidable and potentially lasting damage.
That is why I propose that the Bank of England purchase at least £50billion in gilts over the next three months. But we need not stop there: I also propose that the Bank and the Government work together to create, capitalise, and make liquid new institutions for lending to new businesses and SMEs. Our current credit allocation problems and the resulting investment shortfall is one of the biggest specific barriers to recovery and to sustainable price stability in Britain.
The Bank can remove this barrier to growth of new and smaller businesses while acting completely within the bounds of our legal mandate, and our responsibility to stay out of politics and out of specific investment decisions.
I propose this specific programme because, at its core, our economic problem today is the private sector's inability to finance and take enough constructive risks. This is because of both the excessive debt accumulated by many households and the losses our banking system incurred through mismanagement.
Non-financial corporations are sitting on piles of cash rather than investing it. Investors are demanding higher risk premiums to invest in even well-rated corporate bonds and in equities in general.
Even growing businesses cannot get investors interested, as seen in the dearth of initial public offerings. Some correction from the risk-taking behaviour of the boom years is justified, but this has gone too far and persisted with no sign of let-up.
Although it is rational for any given individual or even any one bank to cut back on risk as a result of this legacy of bad debt, that means that a substantial number of worthwhile real investment projects are going unfunded and thus foregone.
The cost of this investment shortfall to the immediate growth outlook is substantial, and the longer-term costs are even greater in terms of impeded restructuring, diminished capacity, and foregone innovation and productivity growth.
Expansionary monetary policy, both on its own and in concert with constructive investment-supporting policies by government, can provide the risk financing and the risk-bearing capacity the economy now lacks. We will know expansionary monetary policy has done enough for long enough when long-term interest rates rise because of demand for capital from our private sector taking on risky investments.
At the moment, when there is too much risk aversion in the private sector, the British public can ill afford unjustified risk aversion on the part of its monetary policymakers as well.
Almost certainly, even if we were to do everything right on monetary policy (and we certainly will not get everything right, despite the best intentions), there will still be suffering and problems with economic adjustment.
And the benefits of those policies which are right might not be immediately apparent, given the other negative forces at work.
Nevertheless, the Bank can do more for our economic recovery effectively, beneficially, and without political taint. And we can do more without causing high inflation—in fact, doing more is necessary to meet the inflation target in two years' time.
Therefore, we must do more to fulfil our responsibility to the British people. We are obliged to look past the unfounded fears, and do the right thing with the monetary tools at our disposal.