UK government needs to play its part to lift the economy

The government and the Bank of England should be working in tandem but one is taking a free ride

A good partnership is crucial in many aspects of life.  Take the UK economy for example - it is vital that the government and the central bank work in harmony if they are to provide support for the stumbling recovery.  Both seem to share a common view of the task in hand, painting a gloomy picture of the economy.  Yet, to borrow an analogy from the recent Winter Olympics, the combination is more like an ice skating duo that not only can’t stay in synch but where one is sabotaging the efforts of the other.

Working from same play sheet

The starting point of the government and the Bank of England is the same.  Economic data coming out of the UK shows that the country is performing better than most – GDP was up by 1.9% in 2013 with unemployment down to 7.2% in the three months through December.  Yet, if an economic upswing is on its way, neither the government nor the central bank wants anyone to know.  “Neither balanced nor sustainable” is how Mark Carney, the head of the Bank of England, described the UK economic recovery.  The Chancellor, George Osborne, claims that the “recovery is not yet secure”.  A more pessimistic outlook on the UK economy is actually closer to reality.  GDP in the UK is still lower than before the onset of the global financial crisis.

Despite some signs the economy is picking itself up, a fully-fledged return to form is still some way off.  Key drivers of growth are still frozen with UK businesses neither investing nor finding much business in overseas markets.  The economy also scores poorly in terms of long-term prospects with low levels of investment translating into few gains in productivity as well as stagnating wages.

Are you pulling my leg?

The UK central bank is the more diligent of the pair.  It has been working hard to convince people that interest rates will not be rising anytime soon.  The hope is that businesses and households can be convinced to borrow if they feel secure that interest rates will remain at their current low levels.  Mark Carney has tried to use forward guidance to this end but the policy fell flat (as outlined in a previous post).  Downbeat comments on the state of the UK economy are another avenue for soothing concerns over interest rate hikes.

George Osborne seems to be skating off in a different direction.  His remarks on the economy are part of a routine designed to push his austerity program promoted as painful but necessary due to the high levels of government debt.  Austerity did seem to have its merits amid the Eurozone crisis when investors with cold feet were pulling their money out from indebted countries.  Worries about debt levels have eased but the UK government is still sticking with its harsh spending cuts.

Doing more harm than good

The austerity measures are proving harmful in two ways.  Firstly, there is a shortfall in demand in the UK economy which is exacerbated by lower government spending.  The ideal response to weak demand is a fiscal stimulus with the actual benefit to the economy larger than the actual increase in government spending.  Yet, despite the negative effects, the UK government has chosen to do the opposite due to an ideological dislike of large government.

The other negative is that the Bank of England has been left solely in charge of generating an economic recovery.  It is bad enough that the duet has turned into a solo performance but the austerity measures act as a further handicap.  The one-man act has proven tough even for someone with the stellar reputation of Mark Carney but this situation also creates its own problems.

Loose monetary policy has been a factor behind increased asset prices showing up in the property valuations and the stock market.  This has helped to push up consumer spending as households with property or stocks feel wealthier.  Yet only a small portion of the population are benefitting.  Monetary policy by itself is not the route to a balanced or sustainable recovery (as argued in a previous blog).  A change in direction by the government is needed to give more balance or the economic ice may prove thin indeed.