Analysis: The Bank of England and the CSR

The Black Country speech by the Bank of England governor yesterday gave the strongest hint yet that Britain will continue to rebalance its economy away from government spending to exports, despite the failure of the strategy since the financial crisis.

Mervyn King said the economy would need to push more than half a million jobs would need to be created in the export sector to make up for lower job creation in the service sector and government cuts such as those to be announced in the Comprehensive Spending Review (CSR) today.

“To achieve a rebalancing we need to sell more to, and buy less from, economies overseas. To close the gap between exports and imports, more than half a million jobs will probably need to be created in businesses producing to sell overseas – compensating for fewer employment opportunities serving UK consumers or the public sector,” he said.

The government is due to announce job cuts of half a million in the CSR. King’s statement implies authorities would ideally like to see workers re-housed in the export sector.

However, exports do not seem to be leading the recovery in Britain, despite a large dip in the value of sterling, which makes British exports cheaper and more competitive.

The British trade deficit reached a record high of £4.9 billion in July, with imports rising and exports falling from the previous month. (article continues below)

If the Bank of England embarks on a second round of quantitative easing to stimulate the economy, this could make sterling weaken further as the supply of the currency increases.

Some of the money may also be sold off if it leaves Britain for faster-growing investment destinations, such as emerging markets, which would then theoretically have higher currencies with stronger buying power and more money to spend on developed-world exports.

However, economists such as Charles Dumas at Lombard Street Research have warned a second round of quantitative easing could destabilise certain emerging markets, which could create uncertainty regarding their orders of exports from developing economies such as Britain.

The Bank also appears split on easing monetary policy further. Although Adam Posen, a member of the Bank’s Monetary Policy Committee (MPC), has voted for further easing, Andrew Sentence, another member, has favoured tightening and the other seven members are unconvinced of the need for drastic action either way.

King was also concerned uncoordinated monetary policy could prove disastrous for the world economy.

“What is needed now is a ’grand bargain’ among the major players in the world economy”

“The need to act in the collective interest has yet to be recognised, and, unless it is, it will be only a matter of time before one or more countries resort to trade protectionism as the only domestic instrument to support a necessary rebalancing. That could, as it did in the 1930s, lead to a disastrous collapse in activity around the world. Every country would suffer ruinous consequences – including our own,” he said.

“Let me suggest two principles for the way ahead. First, focus discussion on the underlying disagreement about the right speed of adjustment to the real pattern of spending. Without agreement on this, policies will inevitably conflict. Once broad agreement is reached, it should be easier to agree on the instruments of policy.

“Second, in terms of policy instruments, put on the table many potential policy measures – not just the single issue of exchange rates. That should include, in addition to exchange rates, rules of the game for controlling capital inflows, plans to raise saving in the deficit countries, structural reforms to boost demand in the surplus countries, and even the role and governance of the international financial institutions.

What is needed now is a “grand bargain” among the major players in the world economy.”

Neither King’s speech nor advance information on the CSR mentioned the potential for fiscal policy to make up for cuts, as opposed to using coordinated monetary means.

James Dowey, the chief economist at Neptune Investment Management, has come out in favour of tax write-offs on returns from new investments in the British economy. Unlike quantitative easing, whose printed stimulus money can leave Britain for other economies, tax write-offs on new investment could unlock mounting corporate cash piles, whose returns earn the government little in the way of tax.

American politicians are also debating tax cuts as a means of stimulating the economy as Congressional elections approach at the start of next month.