Effectiveness of monetary policy will be limited in next recession, say ex-BoE officials

The government will need to cut taxes or boost spending when the next economic downturn arrives, according to two former Bank of England officials who said the central bank was low on firepower.

The former deputy governors Rachel Lomax and Sir Charles Bean warned ministers they will be unable to rely on monetary policy to combat the next recession now that interest rates are at historically low levels.

They said a stimulus package based on a cut in the Bank’s base rate from 0.75% would only have a limited effect on borrowing costs and leave the Treasury with no option but to use its own finances to boost the economy.

The comments came a week after the Bank of England’s governor, Mark Carney, said a disorderly exit from the European Union could plunge the UK into a deeper recession than any seen over the last 100 years.

Carney said the scenario mapped out by Threadneedle Street to illustrate the worst possible outcome from a no-deal Brexit would push up unemployment and inflation while also hitting house prices.

Speaking at a monetary policy forum organised by Fathom Consulting, Bean, who is the chief forecaster at the Office for Budget Responsibility, said: “I do think we need to start thinking again about using fiscal policy more actively than we have in recent years.”

In a broader attack, Lomax said governments would need to adopt extra spending to aid the recovery and not follow the austerity programme of the last 10 years.

“It is a major puzzle to me that the reaction to the financial crisis on fiscal policy was the way it was,” she said, adding: “Governments have got scared of fiscal policy responses and if ever there was a case for it, it was then.”

Bean also said that if ministers were reluctant to borrow more, they could boost the economy in a downturn with public investment backed by tax increases, which would stimulate growth more than other measures.

Over the longer term, Bean and Lomax said, governments should consider taxing wealth, and property in particular, to reduce the need for higher government borrowing.

Bean said: “A wealth tax could target property, though there is now a serious debate about taxing land.”

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Lomax said her work at the Treasury during the 1970s involved drawing up a wealth tax green paper for the then Labour government that was shelved. A critic of George Osborne’s austerity policies, she said the government and the central bank needed to have a more “joined-up approach” to tackling the next financial crisis or risk a long period of stagnation akin to the last 10 years.

“Monetary policy has become siloed since central bank independence in the 1990s,” she said. “There needs to be an examination of the winners and losers from various policies: a political economy approach rather than one where fiscal and monetary policy are separate.

“It’s true that there is some character from the Treasury is sitting listening to the [monetary policy committee], but I don’t see any evidence that leads to joined-up thinking.”