Over the past few years, falls in asset prices have left banks, businesses and households poorer than they thought they were. Debts have, therefore, been becoming a heftier burden. While the private sector is paying down its debts and tightening its belt, it will be a weak source of demand.
Without a serious commitment to fiscal rectitude and close co-operation between the financial regulator, the Bank and the Treasury, the UK risks wrecking its credibility.
Published: May 13 2009 20:12 | Last updated: May 13 2009 20:12
Wednesday was a withering day for green shoots. The latest quarterly Bank of England inflation report downgraded its growth expectations and lifted its inflation forecasts. Mervyn King, governor of the Bank of England, went to great pains to stress how little we know about where we are. Amid all this uncertainty, one thing is certain: the authorities must work together on their recession-exit strategies.
As Mr King said, this is not a typical 20th-century postwar recession; it is rooted in the UK’s crisis-shredded balance sheets. Over the past few years, falls in asset prices have left banks, businesses and households poorer than they thought they were. Debts have, therefore, been becoming a heftier burden. While the private sector is paying down its debts and tightening its belt, it will be a weak source of demand.
The authorities have familiar problems to face. For example, when is it time to withdraw policy support? Tighten too rapidly, and they will trample any green shoots. Too slowly, and they will nurture an unsustainable blossoming. But the strange character of this recession and the policies deployed to defeat it means there are new aspects to the problem of how to withdraw anti-crisis policies without sacrificing credibility.
Demand has been supported by loose fiscal and monetary policy. Given the dangers of falling prices, which would increase the debt burden further, aggression in preventing deflation has been particularly important. The banks have also been shored up with a recapitalisation programme and an array of state insurance schemes.
This is a topsy-turvy world where financial regulators are changing capital requirements to encourage lending to support macroeconomic goals. Fiscal policy has reprised its role as a tool of demand management while central banks buy more government debt to increase the money supply. The lines between financial, fiscal and monetary policy have become indistinct.
As John Gieve, former deputy governor of the Bank, has argued, there is a need for greater co-ordination between these policymakers. There is, in particular, a serious concern that fiscal policy and banking policy will be adjusted at a pace designed to suit politicians’ electoral timetables. If so, monetary policy would be the only economic lever still being operated with the economy in mind. Without a serious commitment to fiscal rectitude and close co-operation between the financial regulator, the Bank and the Treasury, the UK risks wrecking its credibility.
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