The time for action on macroeconomic policy is nowby James Smith / November 26, 2019 / Leave a comment
Okay, fair enough, there’s a lot going on right now. With a fraught election campaign in full flow, and our future relationship with the EU still up in the air, you can be forgiven for taking your eye off preparations for the next recession. But boom and bust hasn’t gone away. So while the sun isn’t exactly shining, our political leaders shouldn’t forget about fixing the roof.
Recessions are a time of severe economic hardship, so being ready for the next one matters a lot. In an average recession, the economy shrinks by around four per cent. That might not sound a lot but it is the equivalent of around £3,000 for every household in the UK. On top of that the number of unemployed people increases by one million on average. And what makes all this worse is that the brunt of recessions is normally felt by those on lower incomes.
Policy plays a crucial role in limiting the damage. For instance, in the aftermath of the financial crisis, the Bank of England’s Monetary Policy Committee (MPC) slashed its short-term policy rate, and started buying government debt on an industrial scale in an effort to reduce longer-term interest rates too (so-called Quantitative Easing, or QE). The fiscal floodgates were also opened, with the deficit rising to its highest level since the war. Without all this support from macroeconomic policy, with the bulk of the boost coming from monetary policy, estimates suggest GDP could have been 12 per cent lower. So while the financial crisis was certainly very bad, it could have been a lot worse.
Unfortunately the same trick won’t work next time we have a recession. When it arrives—and it will, possibly sooner than we might hope given evidence of slowing growth at home and abroad—conventional monetary policy won’t be much help. The key reason for this is the long-term decline in interest rates we’ve seen across the world. This has seen around $13 trillion dollars’ worth of sovereign debt trading at interest rates of less than zero, which essentially means financial markets are paying for the privilege of funding governments. The world’s central banks have thus found it difficult to raise rates since the crisis. The Bank of England is…