If Brexit means Brexit, we are not doing what we need on macro policy to make the best of it

Budget day.    Article 50 is about to be invoked.  From here until actual EU exit, there is a sizeable risk of a sharp reduction in growth, or even a recession, as information emerges about the likely terms of trade with the EU post Brexit, and in particular, the chance of existing on WTO terms only.

The Bank have in the past frequently opined to the effect that they ‘have the tools’ to pursue their mandate of inflation and employment stability.  But at present, their tools are mightily constrained.  Central bank interest rates are at their effective floor, and have been since March 2009.   QE purchases currently at £435bn.  No-one is going to go for negative interest rates nor helicopter money in a hurry, and, in my view, rightly so.

The job of stabilising the economy is therefore going to fall to the Treasury.  Relying on the automatic stabilisers [the tendency for tax revenues to fall, and transfers to rise] won’t be enough.  So discretionary changes in either taxes or spending, or both, will be needed.  If the past is anything to go by, the government is likely to be slow to respond.  A better position to be in would have been to pre-empt these risks with a stimulus, forcing the BoE to respond [raising rates] and create room for itself to provide the marginal stimulus if needed.

In addition, the Government should have been to put in place a modest, conditional delegation of at least advice over discretionary stimulus in the event that the BoE deems that its own instruments can’t do enough.  This falls short of the full fiscal council suggestions others like Simon Wren Lewis and Jonathan Portes have recommended.  But it would help.  And to recap it would comprise something like the following:  BoE advises HMT on missing stimulus in units of interest rate changes.  HMT reflects.  Either rejects and explains why.  Or agrees and devises fiscal response, including plans for an unwind, reviewed by the OBR for consistency with long term plans.

In the face of uncertainty and policy tools that are constrained in one direction, the BoE ought also to be giving thought to engineering a conscious overshoot of the inflation target on their most likely outcome for the economy.  That is the way to ensure that the target is hit in expectation.  We don’t hear them talking about this at all.  And this is coherent with the previously voiced ‘we have the tools’ view.

If Brexit means Brexit, we are not doing what we need on macro policy to make the best of it.

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