Foreward: Rip it up and Start Again

The British economy’s relative decline has been highlighted by a sequence of events that will be seen as historically important. The financial crisis laid to rest our notion that it was sufficient to build a national plan on a burgeoning City of London. The referendum on Brexit told us that openness to European trade and migration alone did not allow our economic structures to deliver sustained increases in prosperity across the country. Life under the pandemic has further exposed the need to redevelop our public provision of health, social care and transport infrastructure, as well as a reconsideration of the revenues to finance that. While it is not the duty of the state to replace private sector activity and impinge on its plans unduly with taxes, the state (local and national) does have the obligation to support and enable the private sector to generate jobs and prosperity across the nation, as well as provide public goods. In those obligations it has repeatedly failed. As we reach the end of 2021, we are emerging from the Covid-19 cloud, albeit gingerly. However, it is by no means certain that we will avoid returning to some restrictions on our mobility; certainly, the threat that we might do so will continue to affect household and business confidence. Economic activity is facing a persistent negative supply shock, which means that we cannot produce all the goods and services we would want at prevailing prices. Alongside that, there is much pent-up demand as signalled by the stock of household savings. Two fundamental judgements in the short run are how quickly these disruptions to domestic and global supply sort themselves out and how quickly households return to their more normal propensities to save. If we think the disruptions will iron out by Christmas and consumers will quickly run down their savings, we might well think that our problems are behind us. However, if we think that disruptions will persist and firms and households will continue to act with caution, we may be faced with economic stagnation. As this Outlook makes clear, we believe that short run supply problems faced by the UK will persist and are likely to be exacerbated by Brexit. This is because our exit from the European Union has acted to reduce the pool of labour, contributed to lower levels of firm investment than might otherwise have been the case, and led to some contraction in the size of our traded sector. Of course the squeeze on less well-off households is now well over a decade old long, predating Brexit, and has primarily resulted from an inability to address our productivity shortfall, which is our long term supply constraint. In this sense demand and supply are meet each other at the same point where low skills and low wages are associated with low levels of demand and constrained supply. Our problems are not insurmountable but prompt and consistent interventions by the state to support training, labour mobility, house building may act to alleviate some of the costs of adjustment to that high wage-high skill economy for which we yearn. Structurally, we think there are large shortfalls in the capital stock – human, physical and otherwise – in many parts of Britain. The government needs to address these with a prolonged period of regional regeneration that asks hard questions of our local government system and domestic finance. The National Infrastructure Bank should help establish address these shortfalls and fill the gap left by the European Investment Bank. However, it is early days, and the scale of its ambition may not match that of the task in hand. The supply shortfalls can only be offset by years of investment in public services with a sustained fiscal intervention. However, when placed alongside negative real interest rates, there is at the same time now a serious inflation risk that requires tighter monetary policy. Inflation nearing 5 per cent will surely risk of escalating inflation and wage expectations, particularly as firms seek to mark-up after the Covid-19 crisis. Failure to act soon may lead market participants to conclude that the Bank of England’s preferences for output growth have trumped those for price stability, which is its primary goal. Alternatively, to conclude that the Asset Purchase Facility’s balance sheet may not be able to bear considerably higher policy rates. We have proposed a way of unwinding quantitative easing without exposing the facility to large losses and potentially dislocating gilt markets with large scale and lumpy redemptions. We hope that the Monetary Policy Committee will take note. It is becoming clear that over the past ten years, we adopted the wrong mix of monetary and fiscal policies. The latter being too tight and the former too loose. It is time to rip up our sheet music. Fiscal policy should promote public investment and the build-up of national assets; monetary policy should concentrate on restoring interest rates that will provide more incentives for firms and banks to deploy their capital productivity. Start again.