Wednesday, 14 September 2011

What does the UK economy need now? More credit creation and a state owned bank.

The world is slipping into another financial crisis. Greece looks ever more likely to default, while Italy and Spain may soon be shut out of financial markets. Interest rates in advanced economies are close to zero. Budget deficits have exploded and governments dare not try another stimulus. Today's crisis is very different from the one emerged during the frightening summer of 2007, not least because Policymakers have no room for manoeuvre.

Nevertheless, there are a brave few who are ready to offer a way out the trap. One such courageous soul is Adam Posen, external member of the monetary policy committee of the Bank of England. In a recent speech, he passionately argued for further actions to tackle the renewed risks of a double dip recession and a further financial crisis.

Posen has a smooth way with words. According to him, the advanced economies are not confronted with policy ineffectiveness. No, the enemy of the global economy is "policy defeatism". What is the antidote to defeatism? Credit creation.

Here again, the choice of words is crucial. At the heart of every financial institution is a balance sheet. If a credit is created, then so is a debt. Mr Pozen could have just as easily said that what the world needs now is more debt creation. However, given that UK households, businesses and public sector are drowning in debt, that terminology doesn't sound so reassuring.

The advocates of a further round of QE, like Posen, face another presentational difficulty. The UK economy has already enjoyed a massive injection of central bank debt creation. The results have been rather disappointing. The economy has barely grown. Inflation has stabilised at around 5 percent while earnings growth is barely two percent.  Unemployment remains high, and asset prices are falling.

There are no soothing words that can paint over these difficulties. Instead, Posen adopts a different approach. The results of the first round of quantitative easing were very much as he had anticipated. Given the magnitude of the initial financial crisis, quantitative easing could never have returned the UK economy to its pre-crisis growth trajectory.The first rounds of QE prevented the economy from falling into an historically unprecedented depression. And the conclusion? The UK needs a further round of central bank debt creation in the order of £50 billion.

Pozen doesn't stop there. UK also needs a special public institution that will lend to small businesses. The idea is that a state-owned bank could neatly avoid the pitfalls of our current dysfunctional credit system. Instead of bankers pursuing profits, we would have honest civil servants determining who gets credit and who does not. Social need not private profit would determine the allocation of credit.

Posen describes his scheme is a good version of Fannie Mae and Freddie Mac. Playing with words can only partially obscure a truly awful idea. Describing a proposed state-owned bank as a "good version" of two financial disasters doesn't exactly provide a coherent argument.

It is hard to say how politicians in Whitehall will react to this kind of quasi-socialist policy advice. While George Osborne has his faults, he is unlikely to snort this kind of nonsense up his nostrils. So far, Mr Osborne has tried to establish a modicum of fiscal stability for the UK. It will be a long journey, but at least the coalition is walking in the right direction. Labour's absurd VAT cut was rescinded and the painful process of reducing government expenditure is underway. It is hard to see how further public sector debt creation and a state-owned bank fit into that stategy.


Joel said...

Explain this.....

Posen is an American. Why is he on the MPC?

Mark said...

He replaced the other American, "Danny" Blanchflower: they seem to like to have someone to ensure that UK policy blows up.