After the report of UK GDP in the second quarter of 2012 of -0.7% and the revision by the Bank of England of its GDP forecasts in its quarterly inflation report today to around 0% for the full year 2012, compared to 0.8% estimated by the Bank in May 2012), the Bank of England and the government are still looking for the causes of the continuing lack of growth and improvement in the UK economy, and unfortunately seeing it mainly in developments in the eurozone, citing demand for UK exports is down and that investment demand is down as well.
In response to the continuing weakness in the UK economy, the Bank of England has announced an increase its asset purchase programme by £50bn at the 4-5 July 2012 meeting of the Monetary Policy Committee (bringing the total to £375bn) and has implemented a £80bn 'funding for lending scheme' effective 1 August 2012 whereby the Bank of England effectively lends cheap funds to banks for on-lending to the private sector.
Bank of England Governor Sir Mervyn King stated today his press conference of 8 August 2012 following the inflation report that the eurozone continues to adversely affect the UK economy and the central bank has sought create money in the economy to reduce funding costs for banks via the two schemes above in the hope that the banks will 'pass on' (some or all?) the reduced funding costs to customers in the form of lower borrowing rates.
All well and good, but as the current weakness in the economy is caused by a lack of demand in the economy, what good will these 'supply side' measures really have if they do not address the basic weakness of consumer and investment demand in the economy?
So instead of the government spending money to stimulate the economy, the classic cure to a recession in macroeconomics, the Bank of England is printing money and conducting a quasi fiscal policy in 'spending this money' by making it available to the banks.
Is this really preferable? Weren't the banks part of the problem, and still not in great shape? Why rely upon them to make sure funds reach the real economy? In the first case, the government deficit is increased, necessitating increased borrowing from the markets and, yes, increasing the liabilities on the government balance sheet. In the second case, the liabilities of the Bank of England are increased. In either event there is an increase in total liabilities. The difference between the two is that direct government spending is assured of getting into the real economy whilst the Bank of England scheme depends upon the willingness or ability of banks to lend.
Any loans made by the banks to companies under the scheme will be on the books of the banks and the banks will ultimately be responsible for these credits. So, unless the Bank of England is asking or requiring banks to lower their credit standards, and to relieve the banks of the increased capital they will need to hold against any loans made under the scheme, it is difficult to see that the scheme will result in any dramatic increase in lending. In addition, the scheme makes a big assumption that there is unmet demand for loans from creditworthy borrowers. King himself in today's press conference said he cannot say with this scheme will be successful or not. This is a surprising admission - if the effectiveness of the scheme is in question, then why adopt it?
Because of this, it is hard not to conclude that this scheme is more about politics and about appearing to take action to appease financial markets than it is about taking credible action to improve the economy. Because of this scheme, the government can maintain its austerity credentials and does not have to admit that 'plan A' is not working whilst indeed implicitly acknowledging that the government's economic programme is doing nothing to foment growth and job creation in the economy.
So the government can maintain its mantra that it is doing everything it can to improve economic conditions and conceiving 'innovative' ways to do so. In fact, as we have seen above, there is nothing innovative about the scheme - it is just a weak and ineffective substitute for stimulative fiscal policy. We all know the remedy; however, the government refuses to acknowledge what is needed because it would call into question its political worldview - that government is too big and needs to be reduced. This is the real objective of austerity - the economic conditions are perfect to allow the government to hide this in the name of fiscal responsibility.
Even the IMF recently have asked the UK government to relax austerity; however, the Bank of England remains resolute in backing its political soulmates at HM Treasury, complicit in allowing the government to maintain its 'plan A'. As mentioned by Paul Mason of BBC2's Newsnight at the Bank's press conference of 8 August, the Bank needs to push the government to take fiscal policy actions to improve conditions, there is only so much that monetary policy can do. The central bank governor, therefore, is making it easier for the government to avoid facing the facts and remain in its ideological prison - the classic definition of an enabler.