UK will get QE2 – but may need fiscal help too
The odds are moving rapidly towards a launch of QE2 in the UK. A second bout of quantitative easing – printing money – would be controversial. But a fragile economy needs extreme treatment – monetarily, and probably fiscally, too.
Britain’s substantial home-grown problems are being exacerbated by crisis in the euro zone. UK unemployment crossed 2.5 million in the three months to July. Activity in services, the bulk of the economy, almost contracted in August. Wages, up just 1.7 percent in the past year, are falling fast in real terms, impoverishing consumers and threatening deflation. And exports are stalling: the euro zone is the UK’s main trade partner.
Inflation, 4.5 percent now and likely to go higher in September, is the obvious obstacle to still looser money. But in January it should drop to about 3.5 percent as this year’s sales-tax increase drops out of the equation. In any case, it is not inflation but the threat of renewed recession that is now the Bank of England’s foremost terror. GDP growth may already be negative.
Policymakers will have to do more. Adam Posen, the BoE’s chief dove, has suggested a new public bank. This quick and unfashionable Fannie Mae-like step seems unlikely. QE2, probably to the tune of about 50 billion pounds, is the obvious emergency remedy.
But there are big doubts over how much money printing can achieve. It may bolster bank confidence, and could drive 10-year gilt yields well below 2 percent. But whether it will stimulate mortgage or business lending is questionable – especially if banks continue to struggle with the euro zone crisis. The BoE risks pushing on a string, as the economist Keynes warned.
That leaves fiscal policy. The UK has been right to focus on reducing an intolerable deficit. But a fiscal rejig, as Barack Obama is pursuing in the United States, may also be necessary. The government could stick to departmental spending cuts while also cutting taxes for the low-paid to stimulate spending, and investing in infrastructure and social housing to spur employment.
Europe’s negative forces are strong. Counteracting them is likely to necessitate more policy activism.