Yesterday, I observed the Bank of England become the centre of a debate and the Brexit Diary today addresses this controversy.
The Bank of England (BoE) has been caught in a criticism crossfire as it meets with financial institutions and discusses its monetary tools. By nature, the BoE is a pessimistic institution with its key role based on stability. Think of it this way, if the economy booms central bankers and regulators don’t get plaudits or bonuses, however, when the economy busts they get the blame and often lose their jobs. Politicians may lose their jobs on the downside, but they can usually count on re-election on the upside. This creates tension, but it is an important mechanism for economic management. The BoE would certainly look foolish if it took out its monetary tool kit, in simple terms, trying to encourage economic activity, too late. The BoE is trying to deliver a message that it is ready to act and therefore allay fears it will be late. I found it odd that the BoE should be criticised for this communication and preparedness, particularly in light of the 2007-8 downturn when the BoE was seen as acting too slowly.
But do the BoE’s tools have value in our current situation? The BoE’s toolkit is technical but ultimately it is only two things: providing funding and influencing interest rates. While lowering short and long term interest rates might make them more in line with interest rates of other slow growth countries, I find it hard to see how this would stimulate further borrowing and investment from today’s already low rates. The Sterling would likely decline further in value but the benefits to some would likely be cancelled by harm to others; if the pound’s drop from $1.50 to $1.32 hasn’t helped enough, another few cents won’t make a difference. Yet, lowering interest rates further will have material harm on the domestic banking and long-term investment sectors. Making money on basic lending becomes more difficult, corporate and state pension liabilities will be revalued upwards with risk to corporations and insurers, investors will find it more difficult to understand return possibilities….more of what we have now.
The immediate challenges to UK business surround confidence, with reduced certainty (the future might be better or worse) businesses and individuals will find it harder to make investment and employment decisions and generally want to wait. Imagine your employer has recently planned a new investment or hire, but since Brexit has said ‘we’re not sure about making this investment, we’re less certain of its success, let’s wait and see’. Such news can easily translate into ‘let’s wait and see before buying a new house, car, taking a holiday’ and those decisions quickly put others out of their jobs. We’re in that situation now and I’m certainly hoping it doesn’t last long. However, uncertainty has many forms. I write as a participant in university sector management, a business model that few would think of as beyond a bit boring. On the positive side cheaper pounds could attract more foreign students but on the negative side the students may find it harder to get student visas….so which should I plan for? I might not have an answer for a year or more. Would lower interest rates influence my decision to build a new building for students? More on risk next week.
Dr Peter Hahn is the Henry Grunfeld Professor of Banking at ifs. You can read his entire series on Brexit and it's implications here.