The latest economic package won't provide durable stimulus
Image: UK Parliament
The UK government’s latest package to stimulate the economy is unlikely to bring durable relief because it does not address weak economic demand.
The economy is sinking because people don’t have enough money to spend.
The Bank of England has reduced the interest rate from 0.5 per cent to record low of 0.25 per cent. This is accompanied by extension of quantitative easing (we used to call it printing money) from £375bn to £435bn by buying £60bn worth of government bonds plus another £10bn to buy corporate bonds.
Another £100bn is to be given to banks to prop up the dip in their profits caused by the interest rate cut, in the hope that the banks will pass on the full benefit of 0.25 per cent cut to their customers.
The above package does little to increase the purchasing power of ordinary people and will also have numerous contradictory effects.
The interest rate cut may generate a monthly saving of £25 on a mortgage of £120,000 for about 1.5 million people on tracker mortgages which follow the changes in the base rate. There will be no immediate gains for those on fixed rate mortgages and none for millions living in rented accommodation.
The interest rate reduction is bad news for savers, especially those relying on interest rates to boost their income, as the return on their savings will plunge. So savers’ spending power will be eroded.
Around 50 per cent of UK adults do not have any savings and are unlikely to be tempted by low interest rates to something away for a rainy day.
The interest rate cut would lower the yields on Treasury Bills and Corporate bonds, key part of pension scheme portfolios, and increase the deficits on defined benefits (DB) pension schemes.
Many employers will be unwilling to provide additional funds to reduce the deficit and will instead seek to reduce the pension rights of employees. So employees and retirees will suffer. The persistence of a smaller pension pot and low returns will force many to postpone retirement.
The government has aversion to borrowing but encouragement of personal debt is a key part of its economic strategy. Currently, at £1.479 trillion, the UK has one of the highest personal debts per capita in the world and it is expected to rise to £2.5 trillion by 2020.
The latest interest rate cut will exacerbate personal indebtness. With the rise in working poor, it is doubtful that millions will be in a position to repay the debts, stoking fears of a repeat of the 2007-08 banking crash.
A rationale for reduction in the interest rate is that a lower cost of borrowing will persuade companies to invest more in productive assets. This is highly problematic because FTSE100 companies alone are already sitting on a gross cash pile of £166 billion.
Companies are not investing, possibly due to uncertainties arising from the Brexit vote and may simply want to hang on to cash for a rainy day. It is more likely that companies are unwilling to invest because of the fear that they will not be able to sell the resulting goods and services.
Various economic indicators show that people’s purchasing power is exhausted and government will not be able to reinvigorate the economy without addressing this.
The data published by the Office for National Statistics show that at the end of 2015 workers’ share of gross domestic product (GDP) in the form of wages, salaries and other payments sank to 49.7 per cent (see Table D on page 44, downloadable here), compared to 65.1 per cent of GDP in 1976.
This is the biggest rate of decline in any western economy. Between 2007 and 2015, real wages in the UK fell by 10.4 per cent. As bankers and other elites have maintained their bonuses and remuneration levels, the real rate of reduction for many is likely to be higher.
Despite increase in the number of people in employment, there is an increase in the working poor. Around 11.6 million people live below the minimum income standards. Some 3.9 million children are now in families struggling to make ends meet. Some 554,000 people rely on food banks and charity to make ends meet.
Government could have stimulated the economy by writing off the debts of the poor and thus increasing their purchasing power. It could have mailed cheques to people living below the minimum income standard, those using food banks, or the less well-off experiencing difficulty in repaying bank loans.
It could have helped small businesses by writing off their business rates. It could have offered people generous scrappage proceeds for replacement of old boilers, cars, cookers, beds or anything else that could have stimulated sale of new products.
It could have reduced the rate of VAT on selected items. It could have used the money to fill potholes, raise state pension, or write-off student loans thus ensuring that some will have more in their pockets.
It could have used the money to build new roads, bridges and infrastructure projects, but the government has shunned all such methods for boosting the general purchasing power of a large section of society.
It is unlikely to usher in some new stable era of economic management.
Prem Sikka is Professor of Accounting at Essex Business School’s Centre for Global Accountability
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