Yesterday’s triple whammy of a rate cut, increased quantitative easing and a Term Funding Scheme (“TFS”) by the Bank of England was both unexpected and necessary. More importantly, it gave rise to the finest BoE governor related headline of all time (“Carney rips his shirt off” – disturbing imagery but well done BBC News).
Almost all commentators agree that this set of measures represented the Bank doing something proactive about the obviously flagging economy. Criticisms that the Bank is sending panic signals by acting before a recession has set in are clearly nonsense as surely prevention is better than cure. Secondly, critics have bemoaned the fate of pensioners whose returns will be negatively impacted.
However, the fact is that we are at the very limits of monetary policy’s usefulness. We are at what is known as the Zero Lower Bound (“ZLB”) of interest rates, effectively meaning that they can’t be cut much further (they’re expected to reach 0.1% inside the next few months). As rate cuts represent monetary policy’s principal tool for stimulating an economy, the Bank can only do so much once it reaches the ZLB.
By introducing the TFS, the Bank has introduced an innovative approach to improving the likelihood of increased lending to consumers and businesses. It effectively provides an extra buffer for commercial banks’ margins on these loans, encouraging them to do more business more affordably. However, innovation can only get you so far and once the ZLB is reached, it becomes necessary to consider other complimentary policies to add economic stimulus (which will almost certainly be needed).
Now we need the Chancellor to react appropriately. Principally, this means the Chancellor playing his part and boosting the economy through fiscal policy. This may be by boosting infrastructure investment or through tax cuts (which can be implemented more quickly) or, preferably, a mixture of the two.
A departure from the questionable (at best) policies of fiscal austerity applied over the last few years has already been signalled. Now, to stave off a recession, Philip Hammond needs to contribute with policies which match and reinforce the Bank’s actions. Indeed, he needs to approach this with the same proactive attitude as Mark Carney. Just as long as he keeps his shirt on.