Yesterday Nick Thornsby and I were lucky enough to get letters printed in the Financial Times. Nick wrote a letter on the 50p tax rate that was published in the UK print edition. He argued that abolishing the 50p tax rate should surely not be anything like the Chancellor’s top priority. There are many better ways to improve the tax system:
For a start, he could think about early implementation of the coalition’s plans to raise the personal allowance to £10,000, helping those earning the minimum wage, who are not only feeling the effect of the squeeze on living standards, but who often pay the highest marginal tax rates in the first place. As the Financial Times has previously argued, both property and carbon are under-taxed relative to income in the UK, so these are two areas the chancellor can look to to raise the necessary revenue for such a move.
My letter was printed in the European edition and was a response to Tim Congdon et al’s letter defending quantitative easing (QE). As I pointed out, Congdon’s own argument relies on banks to act as the transmission mechanism between the Bank of England and the economy – a tranmission mechanism that is distinctly subpar at the moment:
Sir, Tim Congdon et al are quite right to stress that broad money supply (M4 in the UK) is more economically significant than central bank money (Letters, September 1). But, contrary to their opinion, this is an argument against using quantitative easing to boost the faltering economic recovery.
Since the Bank of England announced its programme of QE in March 2009 annual growth of M4 (excluding intermediate financial institutions) has actually fallen from about 4 per cent in the beginning of 2009 to 2 per cent now.
The responsibility for this lies with the commercial banks: their reserves at the Bank of England are now more than three times larger than before QE was announced. In other words, of the £200bn created through asset purchases, £87bn has been hoarded.*
Expecting further QE to revive the economy would be like trying to inflate a bouncy castle through a leaky tube: it will never get very bouncy.
There is also little evidence that the impact of QE on the financial markets has stimulated investment or consumption. Most of the liquidity created by QE seems to have ended up invested in government bonds and gold, rather than equities. When UK companies are not even investing their surplus cash the fact that long-term interest rates have fallen is surely irrelevant to their investment decisions.
Waiting for QE to stimulate the real economy seems to be like waiting for Godot. QE will not produce economic growth until the broken transmission mechanism is fixed. Banks are paralysed by fears of further credit losses and sovereign debt crises, and companies see few profitable investment opportunities. Policymakers should address these problems before they fiddle with the money supply.
*Source: Bank of England statistics. Bank reserves from series
LPMBL22: February 2009: £39,467 million; July 2011: £127,196 million.