Writing in the Daily Telegraph on Monday 19th October 2015 Dr Fox said …..
Eight years after the start of the economic crash and six years into our period of the lowest interest rates in 300 years, a number of questions are being asked. Among them are whether or not quantitative easing (QE) has worked and what the current policy approach tells us about the relationship of our central banks to government. Recently, there has been a chorus questioning whether QE has brought benefits to the real economy.
A growing number of bankers and economists have openly begun to question whether having lower, long-term government interest rates feeds through to some of the necessary parts of the economy, especially small businesses. Large companies are able to borrow easily in the bond market but small companies, on whom long-term economic viability depends, can face cripplingly high borrowing costs. Critics also point to research by the Bank of England which suggests that QE has boosted asset prices and household financial wealth, which is “heavily skewed with the top 5 per cent of households holding 40 per cent of these assets”.
This has brought a renewed focus on how central banks and governments relate to one another – and rightly so. When state policy is assumed to have such large economic and distributional consequences, what is surprising is that central bank actions are not scrutinised more closely. The Government has a major say in the appointment of bank officials and the regulatory environment. Since governments, especially those who are spending far more than they raise, have an interest in low borrowing costs, there is an added incentive for the central bank to keep interest rates down. In essence, central banks have become the government’s lender of first resort and, however independent they are on the surface, will always keep their obligation to ensure the government is adequately financed at the top of their agenda. It is not just that facilitating public finance is a key task of central banks, but history suggests that it is always the pre-eminent concern.
Supposedly, the lender of last resort is defined as “the discretionary provision of liquidity to a financial institution, or the market as a whole, by the central bank in reaction to an adverse shock which causes an abnormal increase in demand for liquidity which cannot be met by an alternative source”. Many would argue that classical doctrine would suggest that this concept should be applied only to single distressed financial institutions, only if they are solvent and then at penal rates of interest on first-class security. Yet increasingly, central banks have been bailing out huge parts of the financial system, even elements that are clearly insolvent, and at below market interest rates against the flimsiest collateral.
We have long been fixated on the concept of GDP growth as the determinant of economic wellbeing, particularly in the political arena. Yet, there is a difference between GDP and wealth creation and it is the latter that ultimately determines our national prosperity. We create wealth when we turn an individual’s idea into a good or a service for someone else to buy. Consider the Keynesian idea of burying £5 notes in bottles in mineshafts and having the private sector dig them up, or Krugman’s proposal to stage a fake alien invasion to boost anti-alien defence spending. Both would boost GDP, but neither would add to worthwhile economic activity. There are better ways to measure whether policies are conducive to wealth creation. If we take total government expenditure out of GDP calculations, then the resulting measure, Gross Private Product (GPP), gives us a much better idea of worthwhile economic activity.
Looking at the relationship between GPP and GDP the pattern is largely predictable. If we construct a ratio between the annual percentage growth of GDP and GPP for the past 35 years, then it becomes easy to identify who was running the economy. Since 1979, the Conservative Party has been in office for 23 years. Despite steering Britain through two recessions and inheriting the 2008 crash, under Tory management GPP grew at a faster rate than GDP for 19 of those 23 years. By contrast, of the 13 years that Labour was in power between 1997 and 2010, 11 of them are characterised either by stagnation or contraction in the percentage of growth that originated in the private sector.
In other words, Labour achieved their growth rates by pumping public money into the economy, with the net effect of crowding out private sector wealth generation. We can also see the alternative – how the private sector is able to grow when it is given the space. The only surprise is that anyone would be surprised at all.