Opinion: Latest Bank of England liquidity policies not an effective substitute for government action

With every turn of the wheel which drives the Eurozone deeper into crisis, the uncertainty which clouds the UK’s economic prospects grows more pronounced. As events in Spain and Greece, in particular, consign the Eurozone to a state of paralysis, UK consumers, banks and businesses can but bide their time and await the final fallout.

In those circumstances, measures which help to create certainty and boost economic confidence should be welcomed.
But the measures announced by the Bank of England on Thursday, will not achieve their purpose to any significant extent, and should not be treated as a substitute for real policy action by the government to boost confidence.

The Bank’s proposals are designed to increase the amount of money that retail banks can borrow from the Bank of England, and in turn increase the amount these banks can lend to consumers. However, those same retail banks are currently in a state of semi-paralysis as they wait to see how much of a hit they face on loans they’ve made which are secured against Eurozone assets.

At the same time, new national and international regulations concerning the levels of capital banks are required to hold are coming into force. In practice this means that banks will “write down” the value of the assets they hold in the Eurozone and use the liquidity mechanisms of the Bank of England to access the extra capital they require to comply with the new regulations.

The positive to emerge from this scenario is that it should help prevent a further systemic banking crisis in the UK. This is a form of monetary musical chairs — moving liquidity around to fix the holes in the roof, it will have a minor impact on confidence in the banking system, but not, as intended on the wider economy.

Even if the retails banks’ capacity and willingness to lend is increased by the new measures, for consumers and small businesses — submerging beneath a daily wave of economic data and uncertain that their current level of spending can be maintained — borrowing for new economic activity is not likely to hold that much appeal.

Businesses, meanwhile, aware that the Eurozone is contracting, and aware that consumers have been repaying old debt faster than they have been borrowing anew, are not likely, to any significant extent, to wish to take on new borrowing, to try to creat more activity.

The Coalition’s economic strategy has always been based on trying to attain the maximum levels of certainty. Before the ink was dry on the Coalition Agreement, both parties confirmed that they would honour Alistair Darling’s pre-election promise to “cut faster and deeper than Thatcher”. But by announcing all of the cuts in the first year, a level of certainty would be achieved, they argued, which could not be by Labour’s “drip drip” of announcements.

The Coalition’s policy of major infrastructure spending in the latter half of the parliament will have a real impact on confidence, as market participants will have adjusted their behaviour for the impact of cuts which were announced years ago, while real money spent in the economy will generate real economic activity, boosting confidence more than increasing the capacity for people to borrow money to spend in shrinking markets ever will.

Its a sign of how much the economic orthodoxy has shifted in recent years that the idea of leaving everything to monetary policy, the staple of Reagan, Thatcher et al has been superceded by a Tory Chancellor in a Coalition Government using Keynesian stimulus to repair the economy.

The Bank of England is nescessarily independent of government, but the Coalition must be wary at all times of the impact which the Bank’s policies will have on the wider measures been undertaken by the government.

* David Thorpe was the Liberal Democrat Prospective Parliamentary Candidate for East Ham in the 2015 General Election

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4 Comments

  • This piece is a welcome one and it starts off well. But I think it rather lost its way towards the end

    “The Coalition’s policy of major infrastructure spending in the latter half of the parliament will have a real impact on confidence, as market participants will have adjusted their behaviour for the impact of cuts which were announced years ago, while real money spent in the economy will generate real economic activity, boosting confidence more than increasing the capacity for people to borrow money to spend in shrinking markets ever will.”

    The paragraph before this said this was an argument, but here it becomes a fact. But even if this rather optimistic logic holds (the adjustment in behaviour obviously has secondary effects) I don’t really get the logic – why won’t ‘market participants’ (which means who? everyone?) have adjusted their behaviour for the impact of the announced infrastructure spending? Either things have an immediate effect or an effect when they’re implemented or a bit of both – not sometimes one and sometimes the other?

    Finally, what does the last paragraph mean?

  • david thorpe 17th Jun '12 - 1:53pm

    @ matthew,

    Tghe article which I submitted did not call ti an argument, whether any of it is fact is of course contentious, but its an opinion piece and those are my arguments!
    The l;ast paragraph is intended to show that the bank of englands policies may actually act counter to the governments, which is a dillema posed by indepedence for the bank ofe ngaldn

  • Richard Dean 17th Jun '12 - 3:26pm

    I am a bit confused about this bit:- “banks will … use the liquidity mechanisms of the Bank of England to access the extra capital they require to comply with the new regulations”. Can a bank really use a loan as if it were capital in this way?

  • toryboysnevergrowup 18th Jun '12 - 5:04pm

    Much as I would like to see a policy of major infrastucture spending in the latter half of this Parliament (one in the first half would have been better) I’m afraid I see little evidence of this in last Budget Report. And it should also be remembered that if infrastucture projects are to be properly planned there will have to be a lag before the real cash spending takes place – so I very much doubt that there will be much benefit in this Parliament.

    I do share David’s pessimism that much will come from the new lending facilities to the banks, and I do think he has got a little confused between liquidity and capital. That said injecting a little liquidity into the banks at the moment is probably no bad thing.

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