With only
a couple of weeks to go before I undertake my BSc Economics degree at the
London School of Economics (LSE,) I thought it was about time that I posted
something on my rather neglected blog! Here is an article I wrote recently for
a school magazine about risk and uncertainty in the UK economy. I hope it
provides some insight into a topic that I spent a long time researching last
year (more to follow in a later post.)
"Aside
from Mervyn King and George Osborne, risk and uncertainty are the biggest
players in the UK economy as they impact the stock market, investment and
consumption among many other factors. When markets are buoyant, uncertainty is
low, so households and firms are more confident and are likely to hold stocks
and shares, refinance property to increase consumption and borrow from banks
for investment purposes.
However,
following the 2008 credit crunch, uncertainty over the economy’s growth
prospects has been high, so domestic absorption has been weak. Therefore, the
encouragement of risk taking has become a crucial factor in stimulating the UK
recovery. With banks, firms and consumers deleveraging (paying down debt)
rather than spending, and reducing the risk on their balance sheets, growth
prospects in the UK remain weak. Historically, a period of private sector debt reduction
has been coupled with an expansion of government debt, but with the chancellor
extending fiscal austerity until 2018, the UK economy is being held back from
returning to growth, as the public and private sectors are being cut back at
the same time.
It has
therefore been left to Mervyn King and from July, Mark Carney, the George
Clooney of economics (google him, it will be worthwhile) at the Bank of England
to manage this uncertainty by stimulating the UK’s economic recovery and
reducing perceived risk using monetary policy, taking some focus away from
their primary mandate of maintaining inflation at its 2% target. One of the
policies implemented by the Bank is Quantitative Easing (the asset purchase
programme), which aims to reduce the cost of borrowing for firms in order to
increase investment. Although QE has had the desired effect on government
borrowing costs, with gilt yields falling quite significantly, it has not had
the same impact on the borrowing costs for firms as banks are unwilling to take
the risk of investing in private bonds.
In order
to improve the effectiveness of QE and encourage banks to take the necessary
risk of lending to businesses in order to fuel the UK’s economic recovery, one
policy that the Bank could enforce is a negative operational standing deposit
facility rate. This means that banks are charged to hold excess reserves at the
Bank of England, rather than receiving an interest rate of 0.5%, encouraging
them to invest in private assets, which although may be higher risk, generate
higher yields. This should mean that QE actually has its desired impact.
The Bank
of England has also implemented the Funding for Lending Scheme, which enables
banks to borrow at a lower cost if they maintain or increase new net lending to
any household or corporation. Banks can also refinance up to 5% of their
existing loans, which should translate into lower mortgage costs for consumers
and lower borrowing costs for firms. Although mortgage costs have fallen
following the implementation of the scheme, funding has not increased to small
and medium sized enterprises, which make up 99% of all businesses in the UK,
and therefore a large proportion of total employment.
A
potential policy measure to address this concern could be a reduction in the cost
for banks if they take the risk of increasing new net lending to small and
medium sized firms, which make up a large proportion of UK employment. Additionally,
if firms could refinance up to 10% rather than 5% of their existing loans,
mortgage costs for existing customers could be reduced, which would free up
money, resulting in higher consumer expenditure.
It may
seem counter-intuitive to encourage greater risk taking at a time when this is
being touted as a fundamental cause for creating our current economic mess.
However, in order to set the economy back on track, it seems necessary to
pursue bold policy measures which may increase confidence in the prospects for
the UK economy and raise the level of risk everyone is willing to take, helping
to aid the recovery. Risk taking needs to be managed throughout an economic
cycle, and should be reined in at a time when everyone is prospering, and
encouraged when the economy has flat-lined and is struggling to pick up."
I think my next blog post shall be explaining the
policies I mentioned above in greater detail, which hopefully will come before
the turn of the next century!