The Bank of England is “dangerously ill-equipped” to avert the next recession and remains mired fighting the last downturn, according to a report calling for the introduction of radical new policy tools.
According to the Institute for Public Policy Research (IPPR), the odds of a recession once every 10 to 15 years mean Threadneedle Street needs additional firepower for when the economy next begins to falter.
As the Bank considers raising interest rates above 0.5% from next month for the first time since the last recession almost a decade ago, the report suggests monetary policy would still be unable to fulfil its normal function should the economy falter. It found interest rates of 5% would be the minimum required to allow for sufficient cuts to combat the next downturn - a level that was unlikely to be achieved before the next recession.
In all three of the last recessions dating back to the early 1980s, interest rates were cut by 4.5%-5% in order to sustain economic demand. In the downturn following the financial crisis, the Bank had to go a step further with additional stimulus from quantitative easing, opting to pump £445bn into the economy by buyinggovernment bonds from the financial industry to help consumers and companies keep on spending.
The IPPR said an interest rate cut of that size would not be available any time soon given the current historically low level of rates. Meanwhile, quantitative easing would be unreliable because it boosted the wealth of homeowners and shareholders at the expense of pensioners and young people renting homes.
Alfie Stirling, author of the report, said: “Current macroeconomic policy is dangerously ill-equipped to tackle the next recession, whenever it comes.”
“Interest rates will already be too low to allow for the cut that will be needed to stimulate demand. We are heading for a car crash if nothing is changed.”
Alternatives to keep the economy running could include a new national investment bank, which would be similar to a policy put forward by Labour and used in countries such as Germany, France and China. However, the IPPR suggested such an organisation could have a mandate for borrowing to finance economically and socially productive lending during downturns.
Another option could be to order the Bank to target lower levels of unemployment or economic growth alongside its normal mandate of steering inflation towards 2%.
Finally, the report said higher government spending or tax cuts could help drive forward economic growth – which has been lacking as successive Conservative-led governments have focused on cutting spending to reduce the budget deficit, despite the damaging impact of worse income growth and living standards.
The IPPR said greater levels of government borrowing to finance investment during the last recession could have helped stimulate the economy, potentially getting the deficit down more quickly.
Michael Jacobs, director of the IPPR commission on economic justice, said: “Pursuing austerity in an attempt to achieve a balanced budget has given us nearly a decade of slow growth, and the Bank of England has run out of tools to compensate. We badly need a new approach.”