Memo to Vince Cable: lack of credit demand, not supply holds back UK economy

Memo to Vince Cable: lack of credit demand, not supply holds back UK economy: time for a cut in VAT and increase in quantitative easing

Talking about the risk of a double-dip in the UK economy, Vince Cable argued in yesterday’s Sunday Times that the top economic priority now is making banks lend again. His prescription is based on a completely wrong diagnosis of the current economic problem.

 It is clear there has been a significant loss of economic momentum not just in the UK but globally. This suggests global causes – not UK banks’ lending practices – are at work. I would highlight two problems.

First, high oil and food prices. These have squeezed households’ spending power and companies’ profit margins, resulting in weaker domestic demand across developed economies (in the UK, retail sales have been flat for the last year). As a result, manufacturers have seen orders fall and they are now cutting production in response.

Second, the withdrawal of fiscal stimulus – either actually (as in the UK with the VAT hike and cuts in public spending) or in prospect (as in the US). This is taking demand out of some economies and creating uncertainty about future demand which makes companies reluctant to recruit new staff and to expand their investment plans. It is likely, therefore, that the banks are right when they say that the problem is not their willingness to lend, but the willingness of households and companies to borrow.

 What are required therefore are measures to support demand.

Governments have limited room for manoeuvre on fiscal policy, but that does not mean they have none at all. Bond yields in the UK are at record low levels and the economy has grown by just 0.2% over the last three quarters.

In these extreme circumstances, the Coalition should ease the pace of fiscal tightening through tax cuts. A cut in VAT is appealing because it could be implemented very quickly – and the evidence from 2009 is that it would support demand. Alternatively, a cut in income tax targeted at the less well off, who are likely to spend most of the proceeds, would be more effective in boosting demand, though it would take longer to implement and feed through to the economy.

The Monetary Policy Committee also needs to do its bit. Last week it passed up on the opportunity to increase the scale of quantitative easing (QE) from its current level of £200 billion. There are grounds for doubting the effectiveness of additional QE on its own when consumer and business confidence are slumping, but combined with tax cuts it could help to support demand and growth in the economy.

These measures – a tax cut and an increase in QE – would not, on their own, guarantee the UK avoids a double-dip recession. That will also depend on the oil price, the verdict of the credit rating agencies on US sovereign debt and whether speculators are successful in widening their attack on Europe debt markets to encompass Italy, or even France. These global headwinds are outside our control. But policymakers here should use what room for manoeuvre they have in a coordinated attempt to counter them.

12 Responses to “Memo to Vince Cable: lack of credit demand, not supply holds back UK economy”

  1. CAROLE JONES

    Memo to Vince Cable: lack of credit demand, not supply holds back UK economy: http://t.co/StZXEbh :

  2. Michael

    LMemo to Vince Cable: lack of credit demand, not supply holds back UK economy l Left Foot Forward – http://bit.ly/nlOR6W

  3. Knut Cayce

    Memo to Vince Cable: lack of credit demand, not supply holds back UK economy: http://bit.ly/nGqJUh : writes @IPPR 's Tony Dolphin

  4. salardeen

    LMemo to Vince Cable: lack of credit demand, not supply holds back UK economy l Left Foot Forward – http://bit.ly/nlOR6W

  5. mike cobley

    No, not tax cuts but tax increases on high earners and corporations. And increasing staff numbers at HMRC with the specific aim of going after tax evasion/fraud. And renegotiating the criminally extortionate PFI contracts. And regulating currency speculation, and speculation on commodities like food and oil. Job done.

  6. Niklas Smith

    I think your diagnosis of the problem is better than Vince’s (and Chris Dillow is saying much the same thing as you). However, I doubt a VAT cut would do much to increase credit demand and investment – the likely impact is mainly to move consumption forward. Generally, people will not change their long-term spending and investment plans on the basis of a temporary tax cut because they know it’s temporary.

    I think the awkward truth is there is not much that policy can achieve at the moment, beyond messing things up (e.g. the miserable compromises of the Eurozone’s response to the sovereign debt crisis, or the farcical debt ceiling “debate” in the USA).

  7. Martin Johnston

    Memo to Vince Cable: lack of credit demand, not supply holds back UK economy: http://bit.ly/nGqJUh : writes @IPPR 's Tony Dolphin

  8. kirkland

    http://bit.ly/3aZh05 Memo to Vince Cable: lack of credit demand, not supply holds back UK economy http://bit.ly/nKAanS

  9. Will Straw

    Making banks lend more money is not the priority argues @IPPR's Tony Dolphin: http://t.co/NhOo9AY

  10. Peter Deaves

    Making banks lend more money is not the priority argues @IPPR's Tony Dolphin: http://t.co/NhOo9AY

  11. Stuart Bruce

    Disagree. The ability to borrow is directly related to the ability to do new things – i.e. grow businesses, recruit people, buy new property, buy things for it etc. Often in order to make money you need to borrow money to kick start it. It is hard work to create a business plan/application to borrow money off the banks and most small businesses aren’t inclined to put in the effort at the moment when they think there is such a small likelihood of success.

  12. Roger Bone

    An alternative aproach to measures such as VAT reductions and other stimulants to consumption is to expand public investment in infrastructure since this will genuinely increase national productivity. Chosen carefully (projects not inducing imports of plant and equipment, not having long lead times but in sectors where there is spare UK capacity) this should not be damaging to UK’s long term health.

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