Bill Jamieson: The buck passes back to government

Negative interest rates? You mean the bank stops paying us interest and instead charges us for putting our money on deposit with them? You heard broadly right. It’s the latest idea being pondered at the Bank of England to kick-start lending. It would be, in the admission of Bank deputy governor Paul Tucker flying this kite, “an extraordinary thing to do”.

But then, we are in extraordinary times. Never before has Britain’s central bank had to reach for such extreme solutions. Never before have we faced such a seizure in lending markets and a failure of the economy to respond to conventional stimulus.

Government spending boosts are constrained by the highest debt and deficit levels since the 1930s. Ultra-low interest rates have not worked in the textbook manner expected. Massive amounts of money pumped into the economy – £375 billion so far in the form of “quantitative easing” – has now reached 22 per cent of GDP, higher than in the US (13 per cent) or the eurozone (4 per cent). Bank Governor Sir Mervyn King believes yet more is needed (he opted for more QE in the monetary policy committee meeting this month, but was outvoted).

Why has QE not worked? The more money the central bank sought to pump into the economy via the commercial banking system, the more the commercial banks simply took the money and returned it to the vaults of the Bank of England – earning interest by doing nothing.

The most recent experiment has been a £70bn Funding for Lending Scheme (FLS) launched last summer. Under this, banks were offered cheap money from the central bank on condition that it was on-lent to businesses and individuals.

Results thus far have been mixed. While the scheme has helped spur higher lending for mortgages and may have helped nudge loan rates lower elsewhere, only £4.4bn of FLS money was taken up in the first two months – and this by just four lenders.

This is the background to the Bank’s “negative interest rates” proposal. It would stop paying interest on money deposited with it by the commercial banks and, instead, charge them a fee to encourage them to step up lending.

Retail deposits at high street banks would not be so penalised, but savers would be hit all the same. The effect would be to oblige banks to cut savings rates and raise current account charges. Thus the gain of extra lending by the banks would need to take into account losses suffered by savers and the potential hit to bank profits.

Savers would have every reason to feel they are being punished time and again by a desperate central bank. It is bad enough that the Bank has failed to meet the 2 per cent inflation target for 38 successive months and admitted it would be unlikely to do so for the foreseeable future. By this route, the real value of savings is relentlessly eroded.

The problem of discouraging savings is that it runs against the grain of real-life common sense. In times of economic uncertainty, when job security cannot be counted on, it is natural that households should seek to put something by in the event of future setback.

In any event, barely a week passes without admonitions from government agencies and independent advisers that we are not saving nearly enough for retirement. Under this bombardment of conflicting signals, what are individuals and households supposed to do?

The return on fixed interest savings has already been slashed to derisory levels. Even before resort to negative interest rates, the Bank’s money printing has already imposed a stealth tax on savers: an estimated £65bn a year in interest foregone.

The Keynesian solution is to encourage people to draw down savings and go out spending – thus sending a demand stimulus through the economy. But this can only work if individuals and households have the confidence to spend – and that confidence is dependent on households feeling that previous debt and borrowing levels are back under control.

And it is the same problem of confidence, or the lack of it, that accounts for the muted effect of QE on the economy (other than driving up asset prices) and the sluggish response to the Funding for Lending Scheme. The pace of business investment in the UK, far from rising, showed signs of slowing in the October-December quarter, as businesses invested £400 million less compared with the preceding three months.

Companies are reluctant to take on more borrowing while the economy is flat-lining and when the banks, incapacitated by billions of pounds of non-performing loans on their books, are now ultra-cautious about new lending proposals – particularly from those sectors most deeply troubled: commercial property, construction and high street retail businesses.

If all this sounds depressingly circular, it’s because it is: a central bank pushing out next-to-free money to banks to on-lend to companies that don’t want to borrow with the result that the Bank’s cheap money comes back to its vaults.

What happens if negative interest rates don’t work? We are brought to the last stop on this line: distributing a cash bonus to every person in the country, whether we save it or spend it: a device better known as “helicopter money”.

And if that smacks of the gambler’s last throw, that’s because it is. Would this really boost confidence? Or fuel a growing suspicion that the authorities have lost control of events?

We are learning the hard way that there are limits to what monetary policy can do, and that monetary stimulus cannot do the work of structural reform. Central bankers, not only here but across the advanced economies, now feel that – short of surrendering their independence and becoming full adjuncts of government – they have run out of means to set growth back on a sustained and healthy uptrend.

Tellingly the MPC last year dismissed possible monetary instruments (such as altering the interest paid on commercial banks’ reserves at the central bank), concluding that “it seemed possible broad-based monetary stimulus would on its own be insufficient to transform the outlook for growth”. It passed the buck back to the government to undertake “more targeted interventions to boost demand and the supply capacity of the economy, and to facilitate rebalancing”.

That was as good as saying the central bank has done all that it can. It is up to the government and the Chancellor to re-energise the economy by reforms to accelerate bank deleveraging, removing regulatory hurdles for small business, easing the tax burden on enterprise and rebalancing the economy out of the City of London and the south-east of England.

Better, surely, sharply lower or even negative business taxes for Scotland and the north-east of England than negative interest rates on bank deposits. A cut in VAT on home improvements would be an obvious first step, boosting house building another. It is time for such bullets to be bitten and action taken. Savers have suffered enough.