Comment: Time for some new thinking from Osborne

FISCAL policy or monetary policy – that is the question? Chancellor Osborne did his best to answer it during his speech at the Lord Mayor’s annual Mansion House dinner.

Unsurprisingly, he rejected fiscal expansion. The country is in double-dip recession despite a budget deficit worth a whopping 8 per cent of GDP. If you believe the output gap – the difference between unused capacity and demand – is small, then borrowing more will have minimum impact. Or to use Osborne’s words, the fiscal multiplier is tiny, suggesting that cutting VAT, as recommended by Labour’s Ed Balls, would add little to growth.

Instead, in a bid to steady the markets ahead of the Greek elections tomorrow, the Chancellor and his sidekick, Sir Mervyn King, proffered a fresh round of monetary stimulus. More than £100 billion of extra liquidity is to be pumped into the UK banking system. Will it work? I’m dubious.

For a start, £100bn sounds a lot, but it’s not. According to the Bank of England, to hit the UK’s 2.5 per cent trend rate of GDP growth you need the money supply (i.e. bank lending) to increase by 9 per cent per annum. But money supply is growing at half that rate, and that’s after the Bank’s latest round of quantitative easing (printing money). Since last October, the Bank’s QE programme has pumped some £125bn into the financial system yet money supply growth remains sluggish.

The Chancellor would reply that his Mansion house plan is different from QE, which focuses on buying bonds (the Bank now “owns” a third of the National Debt). Some £80bn in Treasury cash will be offered directly to high street banks at below market rates, provided they lend it to small businesses. But with the economy in the doldrums, which small businesses are going to borrow this cash?

True, bank shares surged yesterday on the news but expect that to be temporary. Besides, this Treasury wheeze could have unexpected outcomes. Lloyds might benefit, as its liquidity position is the weakest of the high street banks. But the competitive position of HSBC could be undermined as it has lots of spare liquidity, allowing it to win market share.

To make a serious difference the Bank of England needs a new QE programme that puts something like £500bn in fresh liquidity into the banking system. Rather than let this new cash sit as idle bank reserves, or be used to buy government bonds, it should be put to productive use in the real economy.

One way of doing this would be for the Bank of England to buy a broader range of assets than the government’s own securities; eg. bundles of mortgage loans packaged and securitised. That would boost house building instantly.

Football hogs euro news but for how long?

THANK heavens for small mercies. Punch “euro” into Google this week and you get football results rather than forecasts of economic disintegration. The respite won’t last. Sunday sees Greece go to the polls in an election that is too close to call. On Monday, the result – effectively, in or out of the euro - will dominate discussions at the G20 summit in Mexico.

Meanwhile, the EU is preparing contingency plans for a Greek exit-cum-default. There is talk in Brussels of limiting cash withdrawals from ATMS, imposing emergency capital controls, and even suspending the Schengen agreement, which allows visa-free travel across most of the EU. However, I doubt if millions of Greeks will be packing suitcases stuffed with euros on Monday morning and heading for Germany. Euro crises usually end in fudges rather than meltdowns.

My betting is that overnight on Sunday, Mario Draghi, the Italian head of the European Central Bank, will launch a major intervention to protect bank solvency and stabilise sovereign debt markets across Europe.

Yesterday he was making pointed statements about Europe’s weak economy coinciding with moderate inflation – a sure sign he is going to print money. Remember, Draghi comes from southern Europe and knows the economic stakes facing Greece, Italy and Spain.

Then on Monday, the G20 leaders will gang up on German chancellor Angela Merkel and extract some compromise deal to moderate Germany’s short-sighted insistence on austerity. A Marshall Plan for southern Europe, perhaps?