Growth is back. The mood of gloom has turned to boom. Forecasts, it seems, are being positively revised with every passing week.
But, of course, any government can raise output by spending £100 billion more than it takes in tax, and by showering the economy with cheap credit. As Ted Heath discovered, stimulus economics isn’t necessarily the same as sustainable growth.
In my paper on monetary policy, After Osbrown: Mending Monetary Policy, published this week by Politeia, I suggest that we can already see clear signs that this is yet another credit-induced boom. We are more dependent on consumer spending than before. The UK current account deficit – a good indication of excessive demand – is widening. House prices rose by over 8 per cent last year.
When it comes to monetary policy, the Coalition has picked up where Gordon Brown left off. QE has been expanded. The promise of record low interest rates extended. Programmes devised by the Treasury under the last administration to subsidise credit have been rolled out.
Far from solving our underlying economic problems, monetary policy today is, I fear, sowing the seeds of yet another downturn. Over the past 40 years, Britain has experienced four significant downturns. On each occasion, the downturn was preceded by the same thing: a surge in the money supply. Monetary policy today is creating something similar.
‘Nonsense!” says orthodox opinion. “M4 and those other measures of money are not rising like they did before.’ Indeed M4 is not. But by the time M4 does so, it will be too late. Other monetary indicators, such as the divisia index, for example, should be considered As my paper indicates, they suggest we are repeating that same credit boom/bust cycle again.
The trouble is not so much that we Conservatives are aping Gordon Brown. We are adhering to establishment orthodoxy. And we are doing so because we have lacked a coherent idea of what a free market base monetary policy ought to look like. And we’ve not had one for almost 30 years. What can we done?
Gordon Brown economics is not the answer. Neither, I suggest, is reheated monetarism. Nor should one ever seek to game monetary policy around the demands of the electoral cycle. Ask Anthony Barber, Ted Heath’s Chancellor. Neither the economics nor the politics ended well.
My paper proposes three changes in monetary policy:
- Tighter monetary policy: Of course raising interest rates flies in the face of conventional wisdom. But it was the conventional wisdom, which believed that low interest rates make you rich, that got us where we are.
- Raising rates would increase savings and dampen down excess demand. But most important, higher rates would unwind the mal investment, which like cholesterol in our economic arteries explains our sluggish economic performance (See exports and productivity).
- Real bank reform: Why have we had runaway credit bubbles over the past four decades? Part of the problem has been misjudgement on the part of monetary authorities. But part of the problem stems from the ability of banks to conjure credit from thin air.
- How much banks lend needs to be a function of their deposits, as well as their willingness to lend and borrowers’ willingness to borrow. In my paper I outline a free-market proposal to ensure that a bank’s lending is curbed by the actions of its depositors.
- Break up the banking cartel: We cannot be certain if being a cartel makes UK banks more prone to extend credit recklessly. But the cartel has undoubtedly behaved recklessly. Starting with RBS, the banks need to be broken up. Perhaps the regulators also need to make it easier for non-traditional banks, such as PayPal or Google or O2, to begin to offer de facto banking services, too?
There is no silver bullet and my paper does not offer a comprehensive solution. But it makes some suggestions of what a free-market monetary policy might look like. I reckon we are going to need one.
*Douglas Carswell is MP for Clacton and the author of Politeia’s After Osbrown: Mending Monetary Policy, published this week.