A Social Democratic Future

Policy paths towards equality and efficiency

Main navigation

Economic policy

Starmer’s Story Must Be Labour’s Story

by

Christened by working class parents to commemorate the Labour founder, Keir Hardie, the young Starmer trod an upward mobile professional journey through grammar school, redbrick university, and Oxbridge into select Bar Chambers. Becoming a doughty legal defender of organised strikers, anti-capitalist campaigners and death row inmates, he then ‘took silk’ as a QC, providing a pathway to his appointment Director of Public Prosecutions in 2008 – an establishment role he excelled in, exhibiting rationality and competence tinged with radicalism.

Succeeding Frank Dobson – a former Health Secretary but unsuccessful first Labour London Mayoralty candidate – to the inner city, and still largely working class, safe seat of St.Pancras, Starmer quickly but quietly learnt his Westminster ropes. In October 2016, Jeremy Corbyn appointed him Shadow Brexit Secretary – an appointment based not on political affinity, but on a recognition that his skill profile best matched the requirements of the post, surmounting concerns within Corbyn’s inner circle that it would simply provide Starmer with a stage for a continuing audition for the top job.

Which it did. By far the most effective Shadow performer in the Commons, Starmer effectively critiqued the Brexit position of both May and Johnson governments. Elected Labour leader in April 2020 at the height of the first Covid wave, he soon established himself as a measured but effective leader of the opposition, whose gravitas contrasted sharply and favourably with both a Prime Minister almost habitually reliant on bluster and boosterism and with a predecessor invariably out of his depth at the dispatch box.

But doubts began to surface that Labour’s new leader, while brilliant at discharging a brief and in forensically unpicking an opponent’s case, lacked the ability to create and personify a political counter narrative that could resonate within, yet alone beyond, Westminster. It was also noted that his six Brexit tests and espousal of a ‘People’s Vote’ had proved counter-productive in political and economic outcome terms. After a honeymoon period, apart from taking the whip away from Corbyn, his leadership style was characterised by caution and indecision with a proclivity to tack to the prevailing wind of the day in a way that often smacked more of tactical opportunism than strategic vision.

Since 1945 only three Labour leaders, Clement Attlee, Harold Wilson, and Tony Blair have won electoral power at Westminster – all following a long hiatus for Labour in Opposition. The first two did so not by dint of their personalities but rather by their ability to manage and to link a desire for change within the population, the last by a more presidential project that personified ‘New’ Labour’s colonisation of the centreground.

The December 2019 Tory capture of ‘Red Wall’ seats won with an enlarged working-class support base, along with the party’s practical collapse in Scotland, means that to become the fourth, Starmer  – discounting a return of a substantial number of SNP seats in Scotland back to Labour – must secure the largest ever electoral swing that Labour has ever achieved in England of over 12% compared to 10.7% in 1945.

Has Starmer really got what it must take to overcome not only that unprecedented electoral challenge – likely to be compounded by boundary changes favouring the Conservatives – but also concurrently the immense structural social democratic wider political challenge of reconciling necessary fiscal and political responsibility with the accommodation of ever-rising rising demand and need for increased health, social care, and education social expenditure, on top of equitable social security reform – the true underlying fiscal crisis of the state – as well as the secular tendency for education and age rather than social class associational factors to determine voting behaviour, requiring the cultural and the economic to be ever finely balanced in political calculation.

In the short term, policy reviews and prescriptions can wait. Starmer must first build a sustainable value base that can support and illuminate a coherent overarching political strategy chiming with majority concerns covering affordable housing, quality neighbourhood schools, and the building safe and secure communities endowed with well-paid jobs, that some of the more thoughtful members of his Shadow Cabinet, like Rachel Reeves, have begun to build.

Starmer cannot recreate Blair’s presentational elan, but he can mesh such a strategic framework to his personal back story: the son of a disabled mother and toolmaker father who forged a successful career by hard work and application, subsequently marked by public service. He should dare the Mail and Telegraph to sneer at such an epitome of Middle England endeavour and aspiration for honest and in the scheme of things modest material reward.

Starmer as a person and Starmerism as a political project should be joined and projected, linking, by way of contrast, the entitlement and real elitism of the Prime Minister’s back story to his opportunistic and hollow ‘chancer’ policies.

A case in point is the Johnson’s government’s Levelling Up agenda. It relies upon a mix of big ticket and local bus depot-type infrastructural projects with thinly spread centrally determined funding-streams, themselves subject to manipulation for party political advantage.  Starmer must seize as Labour’s own, the emerging overlapping consensus, manifested recently by Bank of England’s chief economist Andy Haldane speaking on behalf of the soon to be defunct Industrial strategy council, that sustained local growth needs to be rooted in local strategies, covering not only infrastructure, but skills, sectors, education and culture, measured by defined understandable transformational outcomes: improved educational attainment and opportunity, the generation of new and well-paying jobs, and the spread and mainstreaming of affordable housing.

He will also need to tap an enlarged fiscal space for government borrowing, evidenced by Biden’s Stimulus and Climate Change Package, taking the opportunity to be both bold and lucky, as Johnson did to combine ‘ getting Brexit done’ with electoral success.  Unlike Johnson, he also must be honest and straight-talking about linking future social benefit and justice to contribution. It is not just about the economy, but also about values and vision. The policies will follow.

Winning the Final Straight

by

The polls, although tightening with the squeezing of  the Liberal Democrat and Brexit party vote share, continue to project a comfortable working majority for Boris Johnson on 12 December.

Labour itself seems resigned to limiting losses of seats in Brexit-voting areas in the Midlands and North, the same areas, as Brexit and Lies that Matter pointed out,  which will suffer the most from a bad-Johnson Brexit.

The 2017 Corbyn effect has not materialized this time round. His lamentable  failure to lance the anti-semitism boil, and his similar – but different – inability or unwillingness to relate to ‘Middle England’ in a way that his electorally successful predecessors – Attlee, Wilson, and Blair – did in varying ways, continues to dog his party’s prospects.

The actual result on Thursday, of course, cannot be predicted precisely in today’s uncertain political environment.

The young and undecided could still tilt towards Labour on the day.

Local circumstances and issues could intervene and disrupt the national pattern given the vagaries of our current electoral system.

The parties’ respective manifesto commitments, or, rather, lack of substantive ones that can be trusted, could still induce an unexpected decisive and late electoral effect.

Significant electoral shifts, however, invariably follow a wider groundswell of the popular mood. Yet that remains stubbornly stuck in muted cynical mode.

The Conservative’s resurrection of their ‘triple-lock’ commitment not to increase income, national insurance, and VAT rates compares with Labour’s to fund additional expenditure from increased taxes on companies and income-tax payers earning over 80k.

Although clear blue water, accordingly, has opened-up between Labour and Conservative on tax and spending, neither party have articulated a future economic and social vision that engages and resonates with the wider electorate.

It will be tragic if the lies of an entitlement-laden and amoral former Etonian prime minister allows him to win the day because Labour neglected to engage and enthuse Middle England voters, at a time when the intellectual tide has turned in favour of, and national need calls out for, a radical but feasible socialist or social democratic – call it what you will – programme in government.

To deny Johnson a working majority Labour must continue re-orient and its Prioritise its message, but with much more Focus, Consistency and Honesty.

It should mesh its vision and Brexit policy much more clearly, highlighting how a bad-Johnson Brexit will sunder the UK, undermine peace in Northern Ireland (NI), and generate unnecessary economic costs, acting as a deadweight drag or worse on growth and  hence the public finances across the UK.

This when the maintenance, let alone the improvement, of public services to an aging population in reality, will require increased borrowing to fund rising real current expenditures and/or higher taxes, which, if not direct, will be of the less transparent stealth variety, difficult to limit in incidence to higher income groups, even when intended. Funding social care is a case in point; honesty on that score is needed.

To be successful, both in electoral and sustainable strategic policy template terms, ‘Goody-bag’ giveaways and unattainable maximalist gestures should to be downplayed. Measures that interlock economic justice and efficiency should instead be prioritised.

Institutional reform to secure demonstrable efficiency in the selection, planning and delivery of infrastructural investment must be integral, and not subsidiary, to the design and operation of fiscal rule reform: greater fiscal latitude for productive public investment must go hand-in-hand with greater demonstrable efficiency in its selection and execution, as set out in  Making Public Investment Smart.

Individuals are empowered, in practice, to take control over their future by having pathways to suitable, available, and improved education, housing and job opportunities, forged and opened-up across the country, pushing up productivity and expanding economic opportunity to lower income households.

That, in turn, will depend upon high quality transport, digital, and social infrastructure in housing, education, and, to a degree, cultural services within existing high-productivity cities and areas – the London-Oxford-Cambridge triangle is a case in point – to maximise their potential to generate more growth through the further complementary agglomeration of productive firms and people.

At the same time, coastal and smaller cities and towns, especially in sub-regions located north of a line drawn between the Humber and Wash and in Cornwall, that have borne the brunt of decades of de-industrialisation, losing jobs not replaced by relatively stagnant or declining service sectors – the same areas that tend to the most exposed to the loss of EU Structural Funds – will also rely upon targeted and efficient productive investment in economic and social infrastructure.

Is the answer then, growth-friendly general or ‘place-blind’ policies to improve education, healthcare, infrastructure, and affordable housing?

Or more place-based policies to tackle regional inequality, where subsidies, grants, and public infrastructural investment are targeted to individuals and firms, according to location?

Both, according to International Monetary Fund (IMF) researchers in a recent world-wide survey of regional inequality, pointing out that the high cost of housing in high income regions and cities restricts domestic migration, while the rejuvenation of declining areas requires an expanded supply of locally available better paid jobs, supported both by an improved local skills base on the supply side and by rising demand for locally-produced goods and services.

A conclusion echoed in another recent paper on innovation policy, endorsed no less by Dominic Cummings, Johnson’s  human lodestar: an example of  the flow of the intellectual tide mentioned above, but all much more in accord with the Labour manifesto than the Conservative one .

In the UK context, that means partnerships between Whitehall, devolved, and local government to attract and sustain private investment to lagging sub-regions and areas com, where possible linked to university and other sources of expertise that can lead best to the cluster development of productive enterprises, combined with targeted and efficient productive public investment in site preparation, affordable housing, education and skills, and above all in improved connectivity allowing people to access quality employment opportunities within reach of their existing homes.

Reducing the friction of travel Trans-Pennine and within the West Midlands are two of the more obvious examples of productive public infrastructural investment contributing to long-term prosperity.

Another practical example of the potential of public investment to raise productivity and growth in a balanced and equitable way is a sustained increased in investment on affordable housing to a broad steady-state level, meshed with the planned expansion of apprentice and training opportunities targeted to indigenous young people.

Besides its social impacts that should help to mitigate and avoid existing and future labour bottlenecks within the industry, while enhancing human capital and productivity outcomes and making them more balanced in income and spatial distributional terms, thus interlocking economic justice and efficiency in practice.

The costs of providing infrastructural investment should be reduced by directly tackling market failure and rent-capture. Speculation in land largely explains the escalating cost of buying a home,  as is increasingly recognized across the political spectrum, most recently by the Conservative-leaning Financial Times journalist,Liam Halligan, in his recent book, ‘Home Truths’.  Another example of the current flow of that tide that Labour is not harnessing.

The land root of the current crisis of housing affordability, indeed, must be overcome for real progress to be made in a way that impacts on the majority of those wishing to buy and rent affordable housing, not just those most likely to qualify for social housing.

It is quite likely that a Johnson Conservative Brexit government will pivot towards variations of such measures – at least in early rhetoric before the inevitable capture and perversion of ends and process by the same vested interests that fund the party, choke them.

Labour should occupy that ground during the last week of the campaign.

A Way Out of the Brexit Impasse

by

The prime minister clearly hoped that her Chequers package could at least be sold to the warring factions in her own party. The swift resignations of her Foreign and Brexit secretaries soon put paid to that. The European Research Group (ERC) of hard-Brexiteers, led by Jacob Rees Mogg (JCM), were emboldened to openly rebel. The government then went on to accept amendments from him that seemingly contradicted the principles on which its and her own package was based.

That, in turn, prompted 12 Conservative Remainer MP’s to table an amendment of their own requiring the government to consider staying in the customs union if no EU agreement had not been reached by the end of January 2019 – their initial promise to give ‘a fair wind’ to the new approach blown away by May’s apparent craven capitulation.  It was defeated by a mere three votes, and then only after four Labour MP’s, including Frank Field, defied their own party’s three-line whip to vote with the government.

May’s decision, on the surface, puzzling.  She had earlier – at least according to some reports – advised Conservative Remainers to hold fire on their amendment and to wait for the EU to knock-back her then-forthcoming Chequers offer. She could have then told Parliament that the only way that to avoid either NI/Ireland border infrastructure or an Irish Sea border, as well as the maximum economic disruption of a disorderly exit, would be to accept, in effect, the UK staying in a CU equivalent to the existing one beyond the already-agreed two-year transition or implementation period slated to end in December 2020, where no tariffs or quotas or intrusive border ‘rules of origin’ checks would be needed, or levied, or conducted on goods travelling between the EU and UK. The UK would continue to levy, collect, and remit the EU’s applicable Common External Tariff (CET) on all goods imported into the UK from the rest of the world (ROW).

Such a position with government support could have been expected to pass Parliament given Labour Party support for the UK to remain a customs union.

Although Mrs. May had previously provided the Trade Secretary, Liam Fox, with personal assurances about his ability to sign independent trade deals with the ROW, that does not explain why the prime minister felt that it was necessary to capitulate to JRM and his ERG band of fundamentalist Brexiteers. Their two ‘wrecking’ amendments, covering VAT and the EU collection of tariffs on behalf of the UK, would have almost certainly been rejected by the Commons, had her government not accepted them.

Most likely, her motivation was to persuade potential rebels to desist from depositing enough letters of no confidence in her to trigger a summer leadership contest. Yet, by accepting JRM’s amendments, she served to strengthen their position and stiffen their intransigence against the Chequers package. Such appeasement has and will continue to undermine her future political negotiating positions, both internally with her party and externally with the EU, making her ouster as Conservative party leader and prime minister more likely than less.

Putting that political misstep aside, the yawning core contradiction at the heart of the entire Brexit process was inescapably and openly laid bare by Chequers: the economic damage that it entails can only be mitigated by the UK retaining as much of the tangible benefits of EU customs union and single market membership that it can. But that in return requires the UK to accept some of the obligations of EU membership along with an accompanying loss of domestic UK control over their content and of their future development: making the UK a rule-taker without representation.

If the point of leaving was to wrest wholly in practice and effect any EU direct control of ‘our money, laws, and borders’ back to Westminister, such a Brexit-in-Name only (BINO), as it is called by its detractors, seems, in logic at least, pointless: the UK might as well not leave. But that would be contrary to the June 2016 referendum result. On the other hand, exiting with no deal to trade on World trade Organisation (WTO) rules, as extolled by the ERG, would result in the most economically most damaging, and politically (and quite possibly socially) calamitous consequences: a conclusion disputed, or brushed away, only by most fervent Brexiteers.

As Parliament went into its summer recess, individual members of the ERC group – that could number between 60 and 100 MP’s in total – swore that they will vote against any future withdrawal deal aligned to the July Brexit White Paper, which fleshed out the Chequers package. The Labour party, on its part, confirmed that it will continue to oppose such a deal because it would not meet the – albeit unrealizable (short of continuing de facto CU and SM membership) – six ‘Starmer’ tests. And, the Conservative Remainers, alienated by May accepting the ERC amendments, were once again cast outside the government tent.

If the Labour Party and the ERG stick to their existing guns, any deal based on the white paper package will be rejected by Parliament later this autumn, thus shortening the political odds on a UK ‘no deal’ exit, occurring by default. That outcome is far from certain, however: a season is a very, very, long time in politics.

Neither a responsible government nor opposition could engineer, or even countenance, a no deal exit; that is unless they simply washed their hands of its known anticipated consequences on the national interest. Even if they did, many of the potential political ramifications or fall-out from such an outcome, either by design or default, are too unappealing, or too uncertain, for both main parties to stake their future electoral prospects on.

The looming prospect of ‘no deal’ itself could cause the EU, however, to modify or fudge its own previously declared red lines to accommodate a compromise deal with the May government that could then possibly garner the grudging acquiescence of Parliament. It is to that prospect, we turn.

The european dimension

The facilitated customs arrangement (FCA) provides the cornerstone of the UK negotiating position. It is designed to avoid the need for the NI backstop included in the draft withdrawal treaty. The other main pillar on which May’s package rests is UK regulatory alignment with the EU, but only to the extent necessary for the UK to continue to benefit from frictionless trade in goods with the EU27 and with no border infrastructure to be placed between the two Irelands.

That pitch jars with the mood-music coming from, not only from Barnier and the European Commission, but also from key political leaders, that has hitherto maintained the steady tune that the four freedoms of the single market – goods, services, capital, and people – are both inviolable and indivisible.

But as summer simmered in early August, some suggestions of a possible softening of the EU’s absolute position began to emerge. Thee separate treatment of goods and services could perhaps be countenanced, subject to the adoption of interpretation and enforcement mechanisms that would give the final say to its own institutions, most particularly the ECJ.

The EU and UK red-lines could both be blurred or fudged, by, for example, providing the European Free Trade Association (EFTA) court a similar role in deciding disputes that it currently  commands in the existing European Economic Association (EEA) governance structure.  That arrangement already involves Norway, for example, opting out of membership of the customs union, and the acceptance of some associated frictions in the free movement of goods.

Freedom of movement is the main elephant in the room for the UK, and some tweaking of its application could be creatively presented by both parties as part of a movement to a negotiated and  comprehensive replacement arrangements.

That the EU might be prepared to row back on its own stated negotiation red lines should not come as that much of a surprise. A no deal exit would cause one of its members, the Republic of Ireland, almost as much – or even – greater economic harm than it would wreck on the departing UK, whose domestic manufacturing and farming sectors would bear the brunt of the pain both immediately and longer-term. The EU’s other 26 members would also suffer some economic loss, most marked for the Benelux countries geographically closest to the UK.

A chaotic UK exit would put in jeopardy both the £40bn divorce payment and the residence rights of EU nationals working in the UK. At its most existential, the diplomatic credentials and reputation of the EU with the ROW would be soiled, perhaps permanently. The UK exit is a particular situation; at the end of the day: needs must.

Yet it is difficult to discern why the EU should allow the UK – a state that has chosen to leave its ‘club’ and become a non-member third-party –  the benefit of the  special customs arrangement represented by the FCA, while allowing the UK also to continue to benefit from FTA’s agreed between the EU and the ROW.

In particular, the proposed dual tariff structure of the FCA provides an inherent incentive to fraud and smuggling that along with its other added complexities and inefficiencies makes the prospect of its 27 remaining members suffering consequential trading and revenue, almost inevitable. That makes its adoption most unlikely as, http://www.asocialdemocraticfuture.org/2018-brexit-white-paper/, pointed out.

In that light, the EU should also do itself, as well as the UK, a favour by putting the FCA out of its misery as soon it can, without precipitating Mrs May out of office, although that might mean waiting until after the Conservative Party conference in October.

Brussels could then push the UK to maintain an equivalent CU with the EU until such time that a replacement FTA can be mutually agreed and put in place, as a ‘price’ for offering the UK some measure of flexibility on FOM. Of course, no real economic price would be paid by the UK by accepting de facto continuing membership of the CU. Its manufacturing businesses would benefit from the greater certainty of the maintenance of frictionless trade for a longer period; it is only the illusionary prospect of securing substantive new trade deals in goods outside the EU in the short-term that would be lost.

The real issue is whether the resulting political price for the government – and for Mrs May in particular – would be too high.

The domestic political dimension.

Any variant of the Chequers package is sure to be rejected by a sizeable segment of Conservative ERG members. But they set their face against the Brexit White Paper even in its July pristine published state. They, therefore, have already shot their bolt:  no deal is their unshakeable article of almost religious faith, whatever happens.

Mrs May can be expected to stand firm behind her Chequers banner and now face down their messianic zeal for a disorderly exit, relying on the silent majority of her more Brexit-agnostic MP’s to carry her through.

But if she does, could the ERG unseat her in the autumn? Possible but unlikely. Not only are the majority of Conservative MP’s not wedded to a hard-Brexit outcome, which even if they were, would not pass Parliament, but a new hard-Brexiteer Conservative leader would face another general election.   That precise same prospect is likely to deter Conservative MP’s from exposing both their party’s Brexit record and their divisions to a leadership contest and then to a volatile electorate.

That electorate could well vote in a ‘hard-left’ Labour government led by the populist Jeremy Corbyn, and trust it to negotiate a vague soft-Brexit aligned to Starmer’s six principles under a jobs and prosperity banner. A new Labour  government can be expected to seek an extended Article 50 timetable – a need that Labour would make clear during the election had been generated  by Tory incompetence and extremism.

Even if the Conservatives won, the ensuing chaos and economic damage caused by a disorderly exit would quite likely render it a short-lived victory that then made the party subsequently unelectable for a generation.

It is possible that the Conservatives,  if a leadership contest was forced onto Mrs May, would elect a compromise candidate, such as Jeremy Hunt or Sajid Javid, promising a harder line with Brussels in the negotiation,  but with no deal as the backstop rather than the desired destination. This assumes that the constituency members, who would decide such an election, would be amenable to any whiff of Brexit compromise. The deep Tory divisions would still be exposed by such a contest.

Some suggestion has been made that such a ‘compromise’ leader could oversee a UK exit according to a vague and skeleton withdrawal agreement and its accompanying political declaration minimally acceptable to the EU, before exiting in March, but then backtrack to a more hard-Brexit arrangement, presented as ‘what the people voted for in 2016’.

The EU, however, can be expected to include provisions within the withdrawal divorce treaty that would make that difficult. Nor could it be expected that Parliament would be fooled by such duplicity.

Turning to the Labour party, it might hope that a parliamentary vote rejecting any final package based on Chequers would also precipitate an election bringing it then to power. An election fought ‘on what happens next for Brexit’, however, is just as likely to expose Labour’s own Brexit fault-lines.  Its outcome could well prove to be another stalemate that second time around could also induce a splintering of existing party alignments. Its current leadership could well decide, in that light, that betting on the altar of Brexit the once-in the-lifetime opportunity to implement the socialist transformative programme, which is its main preoccupation, was not justified by the odds.

Some on the left, most notably Paul Mason, How Labour could unite the country have argued that Labour should complement its opposition to the Chequers package by publishing the single market and migration approach that, after getting the Article 50 exit date extended beyond March 2019,  as the new elected government it would progress with Brussels.  Labour should also promise the electorate  a second referendum on the final deal that it was then able to secure with the EU27.

This presupposes, of course, that Labour voting against the variant of Chequers package that is offered to Parliament would result in a general election and that sufficient time was left to extend Article 50. It is questionable whether a Corbyn-led government would wish to be distracted from its domestic transformative programme by such a second referendum and its connected complexities and uncertainties.

It is certainly unlikely that either the May government or the present Parliament will concede a second referendum.  Indeed, the cross-cutting complexities of the Brexit permutations are not amenable to a vote between binary alternatives, underscoring that the 2016 referendum was inappropriate in the first place: there was no precipitating new overarching ‘new destiny’ issue; party political management reasons rather led to it.

A second referendum offering Brexit multiple-options would be problematic in content – for example, see the permutations offered in https://infacts.org/theres-more-than-one-way-to-count-a-three-way-peoples-vote/  – and could well be indeterminate  in result, notwithstanding that this time round it would be billed the ‘People’s vote’. There is no simple solution to the complex problem of Brexit. Pretending otherwise is likely to cause more problems than solution.

Anything short of an astounding vote to Remain, would simply lay the ground for Leaver demands for yet another and a third vote, compounding divisions within and between the constituent countries of the UK to an even more dangerous tipping point.

A second referendum only really makes sense when framed between leaving with no deal, and extending Article 50 and staying in: leaving with no deal with its resulting economic and social damage, in that case could well come into ‘new destiny’ territory.  If the majority voted for no deal at least they would be doing so with their eyes wide open, taking, perhaps, the heroic assumption that the consequences of the choices are communicated clearly and transparently the second time round.

But, as argued above, defaulting to ‘no deal’ option should be avoided by a responsible government and opposition.

Can Parliament agree on a ‘least bad’ option?

It is both possible and mutually desirable for both the EU and UK  to negotiate a withdrawal treaty and accompanying political declaration exit that could be conceivably be accepted by the UK Parliament.

The UK would accept an equivalent CU and connected continuing harmonization to EU rules concerning goods infinitely after its formal exit from the EU, at least until alternative trading arrangements are thrashed out and finalised.

Such a Mark 2 Chequers agreement would resolve the NI backstop for the foreseeable future and preserve the continuing vital not-to-be-lost benefit of frictionless trade in goods to both parties.

From the EU standpoint, it would provide comfort that the UK would continue to align and conform to EU rules.  In return for the UK jettisoning the unworkable FCA, the EU could offer some wriggle space to the UK on FOM.  It could also allow the UK’s to progress FTAs concerning goods to the point where they could come into operation when the UK finally leaves the interim equivalent but still bespoke CU. In the meantime the UK could negotiate and enter into new service agreements with the ROW.

The prime minister could thus offer this the as the ‘pragmatic’ and ‘principled’ best available deal that will allow the UK to actually leave the EU at minimum net economic cost, while providing scope within a realistic timescale for Britain to progressively to identify and to reap the most advantage from its altered future relationship with Europe.

The ERG and other hard-Brexiteers, of course, would indict that to stay in the CU and SM indefinitely would make the UK a ‘vassal-state’ that will prevent it venturing out onto a world stage again as a buccaneering and proud free trading nation winning new trade deals on its own account. Their bawl that this would constitute a grass betrayal of the June 2016 democratic decision to leave the EU can already be heard.  They are going to continue to shout that whatever happens, short of securing their desired no deal exit. That outcome – like the continuing CU and partial SM membership arrangement proposed here, was not on the 2016 ballot paper, when 52% of those who voted, simply expressed to leave the EU in preference to remaining.

The sensible majority in Parliament – across the parties –  should simply rely on the facts to demolish the deluded and national interest-damaging hard-Brexit position. The actual prospect of independent deals – at least of the  significance and scale needed to offset the loss of frictionless trade with our nearest and main partner, the EU, is to put it kindly, dim and distant, whose horizon has always extended way beyond January 2021.

Paul Krugman analysis on why existing customs union is better than relying on alternative free trade deals, provides a concise expert summary of that common-sense reality. It already is reflected in the government’s own economic analyses of the expected impact of different Brexit alternatives. Other studies have highlighted the particular adverse impact on jobs and incomes across areas most dependent on manufacturing industry, often located in either Labour-voting or marginal constituencies,  most notably in the North-east, as described in more detail in previous posts, such as http://www.asocialdemocraticfuture.org/time-labour-protect-national-interest-voting-cu/.

Of course, for Parliament to exercise its collective wisdom, the Labour leadership would need to be prepared at least to refrain from impose a three-line whip against such a Chequers Mark 2 withdrawal deal.

This it might do insofar that the government will have saved them the trouble of negotiating a deal with the EU that could and would not differ materially very much from what Labour could negotiate with Brussels. Voting it down to precipitate an election that would inevitably be dominated  by ‘what next for Brexit’ would very likely come across as self-serving; and rejecting a CU that would accord with current Labour party policy, which the majority of Labour MP’s are united in supporting – a unity that could shatter if attention shifted to the single market.

Other similar political calculations could also come into play.  Tory hard-Brexiteers  might well be joined by some ‘Lexiteer’ Labour MP’s; perhaps  some hard-Remain Labour MP’s committed to nothing short of a cancellation of Brexit or at least a second referendum could even join them in the ‘noes’ lobby, providing a potential silver lining to both Mrs May and Jeremy Corbyn, by isolating their respective hard-Brexit and Remainer detractors and plotters.

The prime minister could claim that she had delivered Brexit in accordance with the referendum mandate, while Labour could claim that they have secured a result far more worker and jobs-friendly than otherwise would have been the case.  Both leaderships would be served the national interest, while avoiding an election that risked the future break-up of their respective parties.

The balance of political risk would remain with Mrs May and her party. She would still have to withstand the venomous and destabilising attacks of the thwarted hard-Brexiteers who no doubt would strive to incite a rightwards-drifting rump membership to exert pressure on their MPs to ditch the prime minister.

If, on the other hand, she allowed the negotiations to drift to a point where a ‘no deal’ exit beckoned, the pressure for a second referendum to be called in time for such an outcome to be avoided, could become unstoppable.

 

 

 

The process and impact of Quantitative Easing (QE).

by

The Bank of England (BoE) statutory monetary policy remit or mandate since 1998 has been to secure price stability in a way that supports the government’s economic policy objectives. The Chancellor’s November 2017 annual letter to BoE Governor  defined that as the achievement of ‘strong, sustainable and balanced growth’. The same letter, however, underscored the government’s ‘absolute’ continuing commitment to price stability. That BoE mandate is operationalized by a forward-looking ‘medium-term’ inflation target of two per cent, as measured by the Consumer Price Index (CPI).

The primary monetary policy instrument open to the BoE to achieve that target is through influencing short-term interest rates by changing the rate – the Bank Base Rate (BR) –  that it levies for the near-term use of its own funds. But, BR, has been close or at its effective lower bound (ELB) – where reducing it further is expected to have little or insufficient impact on domestic real economic activity – for nearly ten years.

BR was reduced to a historic low of 0.5% in March 2009. It was then that the introduction of QE was also announced, in effect, to give a second string to the BoE monetary policy bow, in recognition that conventional monetary policy – changing BR – in the wake of the Great Financial Crash (GFC) had been rendered too weak to be effective on its own.

QE involves the BoE creating new money electronically and expanding its balance sheet massively in order to purchase financial assets, predominately longer-dated (5-25 years) government bonds (gilts), mainly from insurance and asset management companies, pension funds, and other non-bank institutions, https://www.bankofengland.co.uk/monetary-policy/quantitative-easing.  £375bn of such assets were purchased between March 2009 and July 2012, across three phases:

  1. £200bn between March 2009 and January 2010 (QE1);
  2. £125bn between October 2011 and May 2012 (QE2);
  3. £50bn extension announced in July 2012 (QE3).

There was then a lull until August 2016, when in response to Brexit uncertainty, the MPC announced, on top of a further cut in Bank Rate to 0.25%, another £70bn of asset purchases including a limited tranche of £10bn corporate debt (QE4).

For purposes of simplicity, post-GFC UK monetary policy (MP) can be defined as MP = BR+QE, with both acting in concert.  The acronym, MP, in this post, is used in accord with that meaning. References to monetary policy relate to its more general non-time-bound meaning.

The impacts of MP, in practice, over time, have been and are affected by the complementing or offsetting impact(s) of fiscal policy (FP), as well by a raft of other macro-economic factors, some endogenous (internal) to the economy, such as productivity, others exogenous, such as changes in internationally-set energy prices impacting upon the domestic inflation rate.

Since 2010, with interest rates remaining at their ELB, and with discretionary fiscal policy contractionary in impact, and thus acting in an opposite direction to that of MP, QE has provided the primary, if not the sole, active policy mechanism or instrument to inject additional discretionary demand into the economy to sustain output and employment.

The Chancellor’s November 2017 letter confirmed that the QE asset purchase facility would remain in place during 2018-19. The BoE had still not sold back into the financial system any of the £435bn worth of the bonds that it has purchased under QE since March 2009. Maturing bonds are replaced or rolled-over. Such sales would take liquidity out of the financial system, tending to push up short-term interest rates, thus acting as a drag on expansion within the economy, all other things being equal.

The BoE jealously protects, however, its flexibility to reverse QE in the future, if its Monetary Policy Committee (MPC) considers that would be consistent with its primary price stability remit. The post-GDC QE programme remains very much unfinished business.

How QE works in theory 

The honest answer is that even the central bankers don’t really know for certain (see Table 1, https://www.bankofengland.co.uk/working-paper/2016/qe-the-story-so-far ). The main identified transmission mechanism assumes that asset-holders, following changes in longer-term interest rates induced by QE, switch from lower-yielding and safe assets into higher risk  asset classes more associated with increased real economic activity: the ‘portfolio re-balancing’ effect.

In that light, a Speech by Deputy Governor of BoE in 2012 suggested that as an immediate effect, QE1 had lowered long-term gilt yields by around 1% (100 basis points) between March 2009 and January 2010, and a 20% increase in their price. Investment-grade corporate bond yields, in turn, were lowered by about 0.7% (70 basis points), and high-yield corporate bonds somewhat more, by 150 basis points. Later QE rounds appeared to have been more muted in their impact on gilt yields, but this may have been due to other influences within the wider macro-economic environment, such as the intensification of the Eurozone crisis.

BoE-financed asset purchases increase the demand for longer-dated government gilts and other securities (5-25years); other things being equal, this should push up their price and reduce their yields (interest as proportion of price). The financial institutions selling such bonds to the BoE can then use the resulting receipts to acquire equities and corporate bonds. That they should do so rests upon impact of the QE process suppressing safe-haven bond yields, thus improving the relative the risk-adjusted returns of equities and corporate bonds, as an asset class.  Such portfolio rebalancing should lower the cost of capital for firms issuing new equity or bonds by increasing their price or value while lowering their prospective yield (increasing potential receipts at point of sale and reducing their interest cost over time), so encouraging business investment. The BoE back in 2012 noted that given that both UK new equity and bond corporate net issuance rose sharply in 2009 compared to the preceding 2003-2008 period, that this provided some evidence that this may have happened, not only as response to the cuts in BR (which made equities relatively attractive as an income-earning asset), but also because of the immediate effect of QE1 on raising the demand for equities relative to gilts through the portfolio balancing effect.

Rising equity and property asset values that makes their holders, whether they are Middle England homeowners, or owners of substantial equity holdings, or firms with such assets, feel richer and ‘confident’ than they would otherwise be, and so more inclined to borrow, to invest, and to consume more, can provide a related but indirect ‘wealth effect’ transmission mechanism into real economic activity.

The injection of liquidity into the financial system by QE should also increase commercial bank deposits. Financial institutions selling bonds under QE will tend to deposit their receipts with their banks and/or use them to purchase higher risk assets that, in turn, generate receipts for the selling counterparty to deposit with their banks. This increase in the short-dated liabilities of the banks should encourage them to expand their direct lending to firms and to individuals to secure a return exceeding the interest payable to depositors –  the ‘bank lending channel’.  Little evidence is reported, however, that this happened, or was even expected. Banks preferred in the wake of the GFC to increase their reserves to cushion future anticipated asset write-downs of bad debts, even if that impacted adversely on their profitability.

Bank lending to households and firms can, of course, in any case, be used to fund the purchase of existing assets for speculative capital appreciation purposes, rather than on new productive assets that can generate future additional output and income.  As noted above, rising asset values can impact on real economic activity, largely indirectly, through the wealth effect.

The aggregate and distributional impact(s) of monetary policy (MP), as reported by the BoE

That very tendency of post-GFC MP generally, and of QE especially, to increase the prices of equities and property assets, has given rise to concerns about its distributional consequences and their possible impacts) on widening both class and generational inequality, with Conservative Cabinet Ministers expressing concerns about MP policy decisions made by unelected technocrats that reward the already-rich.

A growing sensitivity of the BoE to such claims is clearly discernible in recent speeches by senior staff and within its research output. A, March 2018, Staff Working Paper No. 270,  modelled both the aggregate macro-economic and the distributional household income and age cumulative impacts of the reduction of BR from 5.5% to 0.5% between February 2008 and March 2009 with the introduction of QE1-3, claiming to be the first UK study to investigate the impact of monetary policy in such detail at the household level.

The methodology it applied, involved, first, modelling the aggregate impacts of MP on gdp, employment, wages, consumer prices, house and equity prices, using the main BoE macro-economic forecasting model. The counterfactual of what would happened if monetary policy had remained unchanged in response to the GFC was applied.   Then the estimated macro aggregate impacts it generated were then mapped to the micro balance sheets of individual households. This was done comparing data from the government’s Wealth and Asset Survey (WAS) for 2012-2014 and the Family Resources Survey for household incomes to earlier surveys, covering household:

  • interest payments and receipts;
  • employment income;
  • financial, housing and pension wealth; and on the:
  • effect of prices induced by MP on household real savings and debt levels, fixed in nominal terms.

The impact of MP on different households was then further mapped, according to:

  • tenure status;
  • whether members were in or out of work;
  • age cohort.

Andy Haldane, the BoE’s current Chief Economist, summarised in his April 2018 speech, How Monetary Policy Affects your GDP,  the results of that cumulatively across the 2008-14 period, graphically displayed across 24 charts.  The headline results reported included that without MP, the:

  • unemployment rate would have been four per cent higher, gdp eight per cent lower, and consumer prices 20% lower;
  • overall impacts of MP income and wealth terms on different cohorts of society since the GFC proved positive and significant in overall; the average mean income household benefited by an estimated £1,500 a year, and £9,000, (charts 7, 8 and 9);
  • overall distribution of income and of wealth, as reported by the 2012-2014 WAS, between the end of 2007 and 2014 remained broadly the same: in a nutshell, the UK’s unequal income and wealth distribution appeared to have remained largely unchanged by the combined impact of MP (see Charts 5 and 6).

Drilling-down on the distributional impact of MP:

  • half of the total income gains in real cash terms was concentrated to the benefit of the top two income deciles; but, in percentage gain terms, Haldane advised, they were ‘reasonably evenly spread out, despite being slightly lower for lower-income households and negative for the lowest income decile’ (see chart 10 and 11, respectively);
  • the young gained proportionately more from the positive modelled impact of MP on inducing lower unemployment and higher wages – an outcome related to the relative greater pro-cyclical propensity of the young to participate in the labour market compared to older age groups if provided with the opportunity, (see charts 14 and 15);
  • households around retirement age, however, gained the most from the modelled impacts of MP on their total wealth (see chart 16);
  • higher income decile households secured higher additions to their utility (welfare) than did lower-income deciles (chart 22), but the welfare benefits of having a job, and its associated job-satisfaction and self-esteem benefits, were concentrated in favour of the young (chart 23).

Haldane offered some additions. Notably, the social welfare benefit of enjoying improved levels of subjective satisfaction or happiness (utility) as result of having a job and/or improved job security, as well as from higher levels of income and wealth, was computed. Regression analysis was used to translate WAS-reported changes levels in household happiness into a notional-income equivalent. Reduced unemployment and arrears were found to have an especially statistically significant impact in explaining survey-reported changes in household happiness. Strikingly, a reduced probability of being unemployed was associated with a notionally deduced income-equivalent effect on household well-being of £7,300, compared to an actual reported average household income of £32,500.

Disentangling and quantifying the particular effects of QE must have presented an even more challenging task to the researchers.  Charlie Bean, the deputy governor of the BoE the time, in the speech referenced above, noted that equity prices did rise substantially during both the periods covered by QE1 and 2. This was no doubt related to multiple reasons, including the continuing impact(s) of BR being cut to 0.5% that by reducing bond yields tended to make financial investment in equities relatively more attractive.  His tentative conclusion was that equity prices probably rose by about 20% and 10%, as a direct consequence (my italics) of QE and Q2, respectively. This was on the back of the broad empirical fact that the introduction of Q1 and Q2 coincided with equity prices switching from a decline to growth trend, as well as on more analytic BoE econometric studies conducted at the time. The 2018-reported findings also stated that QE had the most modelled wealth impact on equities. Instructionally, lower income or younger households tend not to own equities  (as they don’t tend to own housing wealth): the Bank of England quarterly-bulletin,2012, Q3, noted the richest 5% of households owned 40% of financial wealth held outside pension funds.

Only one chart (21) out of 24 in the latest 2018 BoE published research, reported QE-specific results. That painted a rather rosy picture, denoting that the overall impact of QE across the income distribution was positive, with all ten decile household cohorts enjoying an estimated c.20% average cumulative rise since 2007 in average real net income. There was some variation; the second to fourth deciles benefited from slightly under 20% gains, while the top decile enjoyed 30%. In that regard, the health warning that the direction of a modelled impact, rather than its precise estimated quantification, is more instructive, remains relevant. The translation of higher levels of household income and wealth attributable to MP to additions to their social welfare was appropriately captured by the near-logarithmic (constant percentage increase) across the distribution deciles that the survey reported, Haldane concluded,  in preference to average cash increases per decile, invoking the diminishing the classical marginal utility of income principle that a unit increase in income is worth less to a rich person in marginal utility or social welfare terms than a poor one.

WAS is collected only from private households, excluding people living in publicly provided housing.  As the authors of the working paper recognised, using the household as the unit of measurement hides inequalities within households; for example, young adults living with their parents while saving to purchase their own home were not be separately identified in the results. This is relevant as although MP does appear – according to the research –  to have particularly benefited some groups, such as the established homeowners; other groups, including, tenants, or, indeed, the increased number of young people having to still live in the parental home (and not separately recorded) due to unaffordable housing entry costs, were likely to be disbenefited by the impact of MP on the house prices and rents.   For members of Generation Rent, such effects, could be very significant, indeed.

Putting on one side survey sampling issues and the sensitivity of the regression results to different assumptions and specifications, the specifications and assumptions of the BoE model, or any other model for that matter, may or may not have captured the interaction of MP with other macro-economic and other quite possibly unidentified influence and their (temporal) distribution over time. As the FT economics editor, Chris Giles, has pointed out with respect to the economic modelling of different Brexit options, economic modelling depends on a lot on things that we don’t know. The BoE model patently failed, to take a notable example, to forecast the GFC as its specification failed to capture the actual behavior and impact of the financial sector.

Nor should sight be lost that the BoE is evaluating its own conduct of MP. Take one possible instance of that: its Chief Economist chose to introduce (no doubt an important and welcome dimension to macro-economic analysis) the impact on individual social welfare of MP in his analysis of the distributional impact of MP, highlighting that these were positive, as reported above; but these welfare gains only partially offset and compensated for what must have been much larger losses in welfare that followed the GFC that could have, in part, been made worse by the prior pursuit of monetary policy combined with failings in financial system regulation.

That said, all policies will involve winners and losers, who, in theory at least, could be compensated. And, after all, the remit of the BoE is not to secure some desired abstract distributional result, but, rather, to secure a medium-term inflation target consistent with future sustainable non-inflationary growth.

When measured against that benchmark, how effective has MP been?

Understanding the wider picture

It is important not to lose sight that any modelled positive changes in aggregate macro-economic outcomes and in micro household circumstances that may be attributable to QE, at best helped to ameliorate – and not to reverse or to overcome – the deflating cumulative impacts of the GFC and the following Great Recession. A state of stagnation now shrouds the UK economy. Many individuals and households are worse-off than they were in 2007: an unprecedented post-war outcome.

That interest rates remain at their ELB nearly a decade later, reflects the empirical reality that the UK has still not had a proper recovery yet, nearly 10 years on from the GFC. Its muted,  uneven, and incomplete nature was spelt out in Speech by Andy Haldane, May 2016, Whose Recovery?  in some evidential detail. He catalogued that actual real per capita gdp has barely moved since 2007, while net national income (after taking account of remittances of income and profits to foreign countries) fell, and net disposable household income flat-lined. Real earnings remained five per cent below their 2009 peak in 2016, and, although the incomes of the poorest income deciles did rise, this was largely because of the redistributive impact of pensions and benefits.

Increases in income and in wealth over the course of the decade have been largely captured by higher income and older households; while the real disposable incomes of pensioner households rose by 9%, the incomes of working age adult households fell by 3%. The median income household enjoyed little benefit, mirroring a similar long-term trend in the US. Consistent with that, Haldane postulates that half of all UK households have seen no recovery in their real inflation-adjusted income since 2005 (although he was reporting in 2016 using BoE analysis of data available then, the economy subsequently has not showed signs of a material recovery, rather, if anything regressing further). Regional inequality – measured by gdp per head – also widened.

The real actual income of younger people fell further and recovered more slowly from the GFC than did older age groups. Although MP impacts on their employment income especially, as was reported and considered in the preceding section, may have helped them, in the sense that their economic position in its absence would have been even worse otherwise, that countervailing influence was not enough to prevent the economic position of that group worsening, when considered and measured over the course of the last decade.  The growth of self-employment, part-time-working, and zero hours contracts within the labour market, no doubt, was connected to that outcome. Total employment levels recovering to record new levels conjoined with downward pressure on wages and job security.

The different presentational slants of these two speeches by the BoE Chief Economist are marked, no doubt related to the different purpose and target audience of both. They are not necessarily contradictory, but it takes quite an effort to reconcile them. The connecting thread between them is that MP served to prevent the economic fall-out of the GFC from being substantively worse than it proved, on ‘an umbrella doesn’t stop but protects from the rain’ basis.  Economic conditions were maintained that allowed many to either return or to enter the labour market and so secure better incomes and enjoy welfare levels higher than would otherwise been the case in the absence of MP. What MP has not done is to put the economy on a recovered sustainable growth path.

Even more seriously that sin of omission is linked to one of commission or agency. Where liquidity created by QE flowed into the purchase of existing land, housing, and equity assets, combined with the impact of low interest rates, it will have tended to pushup such asset values, along with the corporate profits of companies in the property and financial sectors. Many middle-income deciles saw their wealth rise, even while their incomes stagnated. The entry of the young into owner-occupation became much more difficult – at least without a contribution from the Bank of Mum and Dad. The richest households benefited disproportionately from rises in equity values. Leaving aside the broad distributional tendency for MP in general and QE in particular to maintain the status-quo of the wealthy staying wealthy, the poor remaining poor, and those in the middle, and the young in particular, having to run faster to maintain their position, comes the rub.

The palliative process and effect of MP risks creating conditions conducive to another asset bubble-induced recession, which are particularly prolonged and damaging, rather than helping to build the foundations and providing the wellsprings of future sustainable and balanced growth in line with the stated macro-economic objective of the current government.

Conclusion: a problem of political economy

Intuitively it seems safe and fair to conclude that QE acting in concert within the wider MP response may well have helped to prevent the GFC from turning into another Great Depression.  Not an unimportant outcome, of course: at least, when taken on its own terms. On the other hand, its immediate effect in helping to stabilise an economy in systemic crisis may have initially served to obscure that BR+QE can be inherently inadequate to secure sustainable recovery when interest rates remain at their ELB for a prolonged period. The UK economy appears to be in a near-comatose state, where fitful recovery alternates with stagnation. MP appears to have become the economy’s ‘life-support’, which, if reversed, could tip it back into prolonged recession or worse.

This lends support to the growing body of informed opinion that the current macro-economic policy framework has been overtaken by events, and that it requires strategic reform if the economy is to provide the future growth, incomes and public resources that its population expects and will demand.

The centre-left leaning think-tank, the Institute of Public Policy Research (IPPR) in March published Just About Managing Demand.  This proposed comprehensive reform to the BoE mandate, including raising the inflation target by up to two per cent to allow the economy to ‘adjust permanently to a higher rate of inflation’, which would then allow interest rates to settle at a higher resting point, giving greater space for a rate cut to be made in response to a future recession. The fiscal rules would also be changed allowing fiscal policy to be used as primary activist policy lever in place of the ‘uncertain and unreliable QE’ to restore and protect levels of aggregate demand when interest rates are at their ELB, and where ‘government fiscal policy is believed to be overly restrictive’.  The independent remit of the BoE would be further extended to allow the MPC measured against its medium-term inflation mandate to decide when such a stimulus was necessary and its quantification. The BoE would also gain an added power to ‘delegate’ that economic stimulus to a new National Investment Bank (NIB) in effect, linking it the introduction of a more interventionist industrial policy.

Other more market-oriented economists, including ex-members of the Monetary Policy Committee (MPC), such as Andrew Sentance, argue that weaning the economy off the addictive, artificial and harmful prop of abnormal and ultra-low interest rates, requires that they should rise and QE be unwound. Capital could then gravitate and be allocated to where it could secure the best return; the historical process of ‘creative destruction’ could then re-exert itself. Zombie companies, such as many high street retailers, would exit the market, releasing resources to the growth sectors of the future, capable of  creating the new sustainable jobs that could replace the zombie ones extinquished.

The BoE faces a MP policy double bind, where interest rates need to rise to provide it with some reserve power to respond to a future recession or shock, but given the reliance of the UK economy on debt-financed consumption and high and rising house prices – at least in London and the South-East –  and the current context of Brexit uncertainty, such rises could risk precipitating a downturn turning stagnation into actual recession that may or may not be followed by either depression or by a new process of creative destruction and rejuvenation; or rather, by much the same. Who knows?

The macro-economic framework is in a state of limbo, therefore, where the BoE is unable to achieve its remit in an economically, socially, and, thus over time, a politically acceptable way, but alternatives are stillborn.  Something sooner or later will need to give.

Reforming the Current Macro-Economic Policy Framework

by

Since the mid-nineties, the prevailing macro-economic policy framework – or ‘consignment’ as it sometimes called – has relied upon monetary policy to smooth the business cycle at a sustainable level of output and employment. In the UK, in 1997, it was given institutional backing, when the Bank of England (BoE) was given an independent mandate to achieve a medium-term set primary inflation target. The role of fiscal policy, in macro-economic terms, was relegated rather to the management of public deficits and debt.

This framework seemed to work during a period, often called the Great Moderation, when nearly all the advanced industrial economies, including the UK, enjoyed an unbroken period of steady sustained growth and low inflation. The business cycle appeared to have been all but neutered, if not banished.

That illusion was popped abruptly by the Great Financial Crash (GFC). The BoE in response reduced the base rate it charged for the use of its own funds from 5.5% in February 2008 to 0.5% in March 2009, when it also introduced the first phase of what has become known as the quantitative easing (QE) programme. £200bn of new money was electronically created and added to the BoE balance sheet to purchase long-dated government debt (gilts). This was in recognition that its main conventional monetary policy lever of base rate management had been rendered ineffective by short-term interest rates reaching their effective lower bound (ELB) – the point where reducing them further has little or no, and insufficient, effect on economic activity.

Rates remain at their ELB, reflecting the empirical reality that the UK has not had a proper recovery yet, nearly a decade on. Real gdp per head and average household income are barely above the level that they reached in 2007. The needed recovery in both growth and productivity is not currently on the horizon.

The macro-economic framework conceived during the Great Moderation – its application based on economic models that ignored the potential of liberalised financial markets to leverage debt – contributed to the GFC. It has been beached by the subsequent stagnation. In short, in its existing form, whether in design or operation, or both, it appears to be incapable of shifting the UK economy out of stagnation. It is thus unsurprising that policy attention is rotating back to the definition and ordering of the first-order principles of macro-economic policy, and to whether the BoE’s independent mandate should change.

The IPPR reform framework
A spring 2018 paper by Alfie Stirling, Just About Managing Demand, takes up that challenge. Produced as part of the centre-left Institute of Public Policy and Research (IPPR), Commission on Economic Justice , it reflects the view of the author, but follows the research and policy tramlines furrowed by the Commission; and no doubt will inform its final report.

Since 2010 monetary and fiscal policy has effectively pulled in opposite directions; monetary interventions injected demand into, while fiscal policy took it out of, the economy. The tendency of governments, with their short-term electoral horizons, to exhibit deficit bias, Stirling argues, has been supplemented by surplus bias: discretionary fiscal contraction or consolidation (fiscal austerity) is ostensibly used to reduce the deficit as a matter of economic necessity, but is effectively applied as a smokescreen to ‘shrink the state’ largely for ideological and political reasons.

The paper’s centrepiece proposal to overcome surplus bias, when interest rates are at their ELB, is to provide the BoE’s Monetary Policy Committee (MPC) with added independent powers to decide whether fiscal policy is ‘overly restrictive’ and in that event to set and quantify a rectification stimulus sufficient to substitute for the cut(s) in base rate cuts that the MPC would have otherwise made.

The operational implementation of that surrogate stimulus would then be delegated to National Investment Bank (NIB) – an institution presumably based on Labour Party proposals to establish a new National Investment Bank . The MPC to achieve its primary inflation target (as may be amended, as discussed below) would, in effect, align monetary and fiscal policy in default of the government.

A reformed and comprehensive set of fiscal rules, echoing and extending Labour’s Fiscal Credibility Rule, is also set out. The separation of current and investment public expenditure for control purposes (as New Labour’s Golden Rule did) would be reinstated. Five year rolling targets would be set for a zero-current balance, and for an operational debt target linked to a longer-term target level for debt.

Public investment (which supports long-term growth) would also be provided with a separate dedicated target, expressed as a minimum percentage of gdp over the same five-year rolling period. This minimum investment rule, however, would be subject to the proposed debt target; however when interest rates reach and remain at their ELB the zero-current balance and debt rules would be suspended, leaving the investment rule in place and operative.

The long-term debt target (which could be higher, lower, or the same, compared to a set baseline level) would no longer require the debt/gdp ratio to be lower at the end of each five-year Parliament. Rather it would be based on an assessment of the UK’s fiscal space – that is the scope available for increased public spending and/or lower taxes without threatening long-term fiscal sustainability and market confidence.

That assessment would be undertaken by the Office of Budget Responsibility (OBR) as a complement to its existing UK’s Fiscal Council (independent bodies set up by governments to evaluate fiscal policy),  remit. It would involve, a macro-economic ‘cost benefit analysis (comparing) lower levels of debt against higher taxes or lower levels of spending’. The OBR would also be given the independent authority to assess the long-term impacts of different investment projects on gdp in line with methodologies agreed with government and independent economists at different levels of debt.

It would also be mandated to conduct a review of accountancy classifications of investment, identifying areas where revenue spend on human capital, on software, or other sources of innovation and growth, in addition to capital expenditure on physical assets, should be counted as investment for expenditure control purposes. Borrowing that adds to future productive capacity of the economy or provides a revenue stream would not be subject to the zero-current balance rule. Borrowing by ‘independent’ public corporations – as defined internationally – for investment purposes would no longer be scored as government borrowing or debt.

Stirling highlights that recessions tend to recur on average every 10-15 years, with the next one expected before long. To prepare for that inevitable – although time-uncertain – eventuality, Stirling moots some more radical revisions to the BoE independent mandate.

The BoE’s primary inflation target could be increased by up to two per cent. This would be to allow the economy to ‘adjust permanently to a higher rate of inflation consistent with interest rates settling at a higher resting point above their ELB’. Unemployment and nominal (money) gdp targets, acting alongside, or as intermediate guides to, that target, could also be put in place.
These revisions would serve dual but related aims: pushing up interest rates above their ELB would enable the MPC once again to use interest rates management as an effective policy instrument to prevent or forestall a future recession; they could also prevent monetary policy being prematurely over-tightened during a period of above-target inflation, driven, say, by an external price shock, such as an oil price hike induced by international political instability.

In sum, changes to the BoE mandate could involve the toleration of higher future actual and expected inflation levels to get interest rates above their ELB and hence to provide reserve monetary firepower to counteract the next recession; but if they remain or reach their ELB, an activist fiscal policy of a path and magnitude determined by the MPC could then be deployed to overcome government surplus bias, as a more effective fiscal alternative to QE. Changes to the fiscal rule framework and to the classification of expenditures for deficit accounting and control purposes, if implemented in their entirety, could institutionally prevent the cutting of economically productive expenditures during a recession, while providing a target for their expansion across the economic cycle, subject to a long-term debt target, which, however would only apply when interest rates are above their ELB. Borrowing for investment by public corporations defined as independent in any case would not count against the deficit or debt total.

Political timing and feasibility
The package covers a lot of policy reform ground. It does come across a bit as a future strategic policy primer for the Shadow Chancellor, John McDonnell and his team; providing, perhaps, both its strength and weakness.

The next government would need to wrestle with the impact of Brexit on the economy and the public finances. Where not already ceded by the May government, fiscal demands on the current budget on ever-rising health and social care demands, local education quality and effectiveness, on training and apprenticeships, and manifesto commitments would have to be faced.
An incoming Corbyn administration would raise borrowing to finance its re-nationalisation, affordable housing, and industrial policy programmes, including the establishment of the NIB, where not shuffled off-balance-sheet. The political context can only be expected to be febrile in the first place – whether related to a Brexit-related hiatus and/or a media-hyping of the first ‘marxist’ Labour government – however unfair and politically-motivated that charge may be.

Making substantive changes to the BoE inflation, to the OBR fiscal mandates, and to the fiscal rules, all in parallel, could risk political over-load. And, to work and to stick, substantive changes to certainly the BoE and OBR remits could not simply be foisted on, but rather would require extensive consultation with, and the support of, the key institutional stakeholders involved. That would take time; as would the establishment of the NIB.

Although a Brexit-hiatus could precipitate a general election before 2022, it remains the due date. A freestanding NIB that relied upon the election of a Labour government in 2022 would be hard pressed to be operationally ready to expand lending on a scale sufficient to counteract any future recession much before 2025; that is unless the present Conservative minority administration decided to develop its own prototype, which it should, but probably won’t.

Changing the fiscal rules – and changing the BoE mandate even more so, as discussed below – would in themselves be political acts. The 1997 new Labour reforms to the fiscal rules and its establishment of BoE independence and were made on back of an already emerging strong technocratic and political consensus in their favour and were introduced within a supporting economic environment. The new economic settlement it represented – along with Gordon Brown’s self- denying ordinance to keep within Conservative spending limits – a tilt towards the centre ground and the assumption of the mantle of economic competence.

This time round, one can almost already hear the crescendo din already that would envelop the new government; that it only wants to change the fiscal rules to pass on the consequent debt burden to its successors for its own political purposes etc. Although is unlikely that Labour would be elected in the first place without a compelling economic and political narrative that underscored the necessity and desirability of substantially increased levels of public productive investment to spearhead the economy’s escape from stagnation, it is far from certain, however, that narrative would be sufficient to persuade the OBR to sign-off the government’s spending plans, whether in terms of the ‘fiscal space’ available for increased investment or their long-term fiscal sustainability.

Economically beneficial public investment also not only needs to be sufficient in volume, but efficient in selection, in composition, and in execution. Varying public investment levels for counter-cyclical stabilisation purposes could, however, risk a return to fluctuating famine and feast conditions, unconducive to such efficiency. http://www.asocialdemocraticfuture.org/investing-productive-infrastructure/ in that regard it proposes remedial reforms to the public expenditure and planning system that are designed to better reflect the long-term economic benefit of efficiently selected and executed infrastructural investment.

They include providing the National Infrastructure Commission (NIC) with a statutory remit to assist each government department to publish an annual Departmental Investment Plan (DIP). Each DIP should prioritise projects, according to their estimated economic and social return, incorporating auditable information on the methodology that it has applied to rank projects with reference to their expected economic return.

Such reforms could tie-in with changes to the fiscal rule framework that provide the OBR an added remit to assess the fiscal space available for increased public borrowing and debt. Splitting the function of assessing the micro-efficiency of individual projects from the more macro-task of assessing the overall fiscal space available for increased borrowing appears to align better with the respective roles and remits of the NIC and the OBR.

The point and sequencing of the proposed fiscal reforms referenced to likely future political and economic scenarios is not wholly clear. If Labour came to power in the aftermath of a Brexit hiatus it is almost certain that the economy would be in such a state that interest rates remained at their ELB. In that case, the new government could simply rescind the existing rules, and proceed to inject a fiscal stimulus financed by borrowing and begin to implement its industrial policy, including the establishment of the NIB. The OBR-brokered interaction between the investment and long-term debt rule in terms of assessing available fiscal space would come into play only when interest rates escape their ELB again.

The government would be able to call upon some substantive technocratic support to use fiscal policy as its primary instrument to escape recession. Prominent New Keynesian economists, such as Paul Krugman in the US, and Simon Wren Lewis in the UK, consistently made the case that monetary policy (MP) should have been complemented post-GFC, at the very least, by a fiscal stimulus, not contraction – a position that many mainstream other economists and organisations, including the IMF and the OECD have subsequently endorsed.

It could also point to empirical experience: the results of the Coalition’s conjoint reliance upon QE and fiscal austerity support the case that QE should have been, at the very least, combined instead with a conventional Keynesian fiscal expansion in public investment. Such an expansion where it utilised and safeguarded unused capacity within the economy could have protected and extended its future productive capacity, helping to lift the economic drag of falling and stagnant productivity.

A new Chancellor could also loosen fiscal policy in tune with the government’s own assessment of economic circumstances and requirements, without recourse to the MPC, as he could change the fiscal rules. In any case it would be unlikely that a newly-established NIB would be ready to spearhead the counter-cyclical response through expanding its ‘lending for business growth, housing, innovation, and social and physical infrastructure’ on sufficient scale to bring the economy back to a sustainable growth path.

For a new Labour Chancellor to press for a change in the BoE mandate, providing the MPC a power to initiate a fiscal stimulus, even though the BoE on number of occasions has disclaimed any wish to intervene in the direction and composition of fiscal policy, appears superfluous, save that it could provide an obstacle to future surplus bias if exhibited by a future government; that same government could then change the mandate again, however. Such a yo-ho would do little to bolster the credibility and purpose of an independent mandate.

Designing policy architecture to better prepare for the ‘next recession’ rather than escaping systemic stagnation now or, even worse, the prospect a Brexit-induced recession could therefore possibly put the cart before the horse. Without a period of economic expansion accompanied by rising pressure on wages and competition for loanable fund, neither interest rates nor inflation are likely to rise above their ELB to a point where rate reductions could be made to respond to a recession. The immediate policy reform priority is to escape stagnation in a sustainable way.

How necessary is (are) a BoE mandate change(s)?
A 2022 election could offer at least a time window for macro-economic framework reform to be considered and anchored to some semblance of a supporting cross-cutting and over-lapping political and technical consensus. On that score, the proposed reforms to the BoE’s mandate appear a rather tentative shopping list or one of possibilities. Many of the issues attached to raising the inflation target rate and/or providing it with a greater output and employment focus are not evidentially justified or explored – more attention is given to the proposal to empower the MPC to specify and delegate a fiscal stimulus to a newly-established NIB, as discussed above. The references, however, do provide a starting point.

With respect to raising the inflation target, the MPC has so far has recoiled from raising base bate above 0.5% This is despite headline inflation even exceeding three per cent – more than one per cent above its medium-term target – thus triggering the requirement for the BoE Governor to write an explanatory letter to the Chancellor. The majority assessment of its members has been that above target-inflation is mainly owed to conditions or factors external or outside (exogenous) to the domestic labour market, including rising oil prices and sterling depreciation linked to Brexit.

The BoE’s May 2017 Inflation report, in line with that, highlighted that the post-2015 fall in sterling was likely to keep domestic inflation above the two per cent target throughout the next three years, (author italics), further noting that where inflation settles once that upward pressure fades will depend on domestic (wage-related) price pressures, concluding that these were expected to build by 2020.

The MPC hitherto has been careful to apply its constrained policy discretion in accordance with its current mandate, focused on the medium-term not the short-term headline CPI inflation figure, so as not to chock-off any nascent or uncertain recovery, at least while spare capacity exists within the economy.

Given that institutional monetary policy context, what would be the economic point of modifying the primary inflation target to accommodate higher inflation and/or giving employment and output a greater weight within the BoE mandate? A slightly different answer to that of simply an interest rate buffer to counteract the next recession, which Stirling emphasises.

The underlying key problem is that the UK economy has failed to recover its pre-GFC secular real productivity and growth trend of annual average c2.3%-2.5% growth. The result: an unrecoverable massive 15-20% loss of potential GDP calibrated to the level it would have reached if that historic trend had been interrupted and thrown off-course by the GFC, the Great Recession, and then counter-cyclical fiscal austerity.

That lost stock of output and income foregone will rise further inexorably, if growth and productivity remain stuck in stagnation mode. In technical economic jargon the economy has suffered hysteresis (a change – in this case on UK gdp, whose initial effects persist, even when its proximate causes or source no longer exist).

A fiscal expansion combined with falling immigration that causing the labour market to further tighten and thus trigger wage inflation, but without it accelerating, could usher-in a new expansionary economic environment that could allow the economy to break out of that circle. How and by what mechanism(s)?

As labour inputs become relatively more expensive, investment in the upskilling of the indigenous labour force, as well as on additional and improved physical capital stock, should be encouraged, in turn, inducing an associated shift in the employment structure towards the formal and away from the insecure gig economy, pushing-up both overall (total factor) and labour (per unit period) productivity.

Infrastructural investment should also increase both the capacity of the economy and its total factor productivity; for example, improved connectivity should lower costs and expand the pool of labour that is available to work in higher productivity and thus higher paid jobs.

But if the MPC references the likelihood of rising domestic wage pressure to the current supply side-capacity of the economy, it risks taking the current compressed productive potential of the economy (for the purposes of MP) as an immutable given. The associated output gap (the difference between aggregate demand and the capacity of the domestic economy to meet it without inducing above-target inflation), has been significantly revised downwards since the GFC by the OBR.

The latest May 2018 BoE Inflation report appears to fall into that stagnation trap. Striking a more hawkish tone than its predecessor a year earlier, it notes that ‘labour demand growth remains robust with a very limited degree of slack left in the economy’ with productivity growth remaining muted, limiting ‘the pace at which output can grow without generating inflationary pressures is likely to be modest’, before diagnosing that ‘ongoing tightening of monetary policy (up to 2020-21) would be appropriate’ albeit that any future increases in Bank Rate are likely to be ‘at a gradual pace and to a limited extent’.

It is not altogether clear what that could mean in practice. It does suggest, on one hand, however, that the BoE does not intend to raise interest rates at a speed and magnitude sufficient for the MPC to draw upon a four to five per cent interest rate buffer to counteract the next recession, assuming that a Brexit-related one is avoided. On the other hand, even modest and slow rate increases could impede or even reverse the productivity-enhancing economic expansion outlined above.

In that case desired increases in personal and household income and improvements in public services will not be possible. Given the existing linkage between consumption and confidence to house prices in the UK, if rates were raised more substantively, such increases could even precipitate a home-grown recession, especially in a post-Brexit environment, which can only be anticipated to be uncertain at best.

Is increasing the inflation target to, say, four per cent, the answer, then? Raising the inflation target by up to two per cent could allow the economy in Paul Krugman’s words to ‘adjust permanently to a higher rate of inflation’, offering space for rate cuts to be made in response to a future recession. The ghost of accelerating inflation continues to lurk in the background, however. Economic actors might well take a supposedly one-off increase in the medium-term inflation target to be the thin end of a wedge that they should grab while they have the chance, resulting in insufficient passage of time for any productivity-enhancing adjustments to take root before pressures to tighten to retard insipient accelerating inflation become difficult to resist. It would also entail a quite marked discontinuity in the BoE mandate that could suggest instability and further changes, undermining its credibility.

What is not open to doubt is that allowing inflation to rest at a higher level would require – if international competitiveness is to be maintained – a commensurate increase in productivity across the tradeable sections of the UK economy; relying on sterling to depreciate in compensation instead, itself would add to domestic inflationary pressures.

Also, the Chancellor, facing higher public-sector nominal wage claims from health and other public-sector workers could well be forced to resort to fiscal drag and/or additional taxes to protect the current budget balance, dampening the translation of real wage into real disposable income growth in the process. Such dampening might well be desirable in terms of securing a shift in resources within the economy towards investment, but such suppression of real wage growth by stealth taxes cannot be expected to hold for any extended period.

An alternative might be to suspend inflation target temporarily while the economy escapes stagnation. It cannot be expected that the BoE would instigate such a change itself. But if imposed by the Chancellor, the effect would be nearly akin to abolishing the independent mandate of the BoE altogether.

Yet another variant could include raising the inflation target explicitly only for a temporary or time-limited period, on the basis that the retention of two per cent medium term target would conserve continuity. The aim would be to influence wage-bargaining behaviour so that real wage inflation tracks productivity, rather than inducing beggar-my-neighbour escalating, rises. That desirable outcome would tend to depend on, however, not only on the credibility of the new temporary, and necessarily, contingent target rule, but also on other emergent factors that may affect the labour market and wider economy. Perfect alignment of real wage inflation and productivity remains a heroic assumption.

Besides the existing inflation target is a medium-term one, although its precise time-span can be open to definition. The same desired end-result of a productivity-enhancing expansion could therefore possibly be engineered by more informal and less disruptive institutional means. The annual Chancellor’s letter to the Governor could be used to adjust the weight balance accorded to price stability and real economic activity, for instance. The MPC could continue to operate within its existing 1997-set medium-term two per cent target but with reference to a political tilt for it to be administered it in future with greater regard to employment and output considerations, as new economic conditions and times require.

An imperfect analogy might be a judge instructing the jury to decide a case on the balance of probabilities rather than beyond reasonable doubt. The underlying and overarching importance accorded to price stability would necessarily be diluted, however, with attendant possible implications for the credibility and certainty of the target. That said, a case can be made that the advantages of price stability was overstated within the existing framework and that events have tended to suggest that in some conditions its strict adoption can retard rather than induce strong and sustainable growth.

In that regard, tilting the MPC mandate towards output and employment considerations could also be achieved by moving to a nominal annual gdp target of, say, five per cent. This would combine or mix real output and inflation into a single target; it could be achieved by various permutations of both: for example, two per cent real growth and three per cent inflation, and vice versa. Such variability could gnaw at its overall credibility and certainty, however.

Or the target could be split equally, 2.5% for each; reducing uncertainty but at the same time also the flexibility that may be needed to allow the economy to recover its historic secular growth and productivity path. When taken in the round, as a 2013 Deputy Governor Speech on nominal income targets, pointed out, insofar that the existing mandate does take cognizance of output and employment objectives, many proposed alternatives can appear more different than they are actually are.

The issue really boils down to the relative weight that should be accorded to employment and output relative to medium-term price stability, for what period, and in what circumstances. Incremental evidence-driven change in emphasis subject to continual review might ultimately prove the best friend of radical reform.

%d bloggers like this: