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The Coalition’s Economic Policy of Fiscal Austerity and Monetary Experimentation by the Bank of England

Nicholas Sowels
p. 165-188


The Coalition government came to power in the midst of the Great Recession. The economic problems it has had to face have been substantial, given that the UK and the rest of the industrialised world are gripped in the worst economic downturn since the 1930s. The government’s policy response has been remarkably conservative, in all senses of the word. Far from questioning the Thatcher legacy of holding down public spending and reducing the size of government, the Coalition has broadly pursued a conventional policy of fiscal austerity within a wider agenda of reducing the size of the state. In contrast, the Bank of England has been obliged to implement various forms of unconventional monetary policy to prevent the economy from collapsing. What exactly the consequences of these policies are remains unclear : they are experimental. What this holds for the future is uncertain. But there must be serious doubts about whether the neoliberal paradigm, which is widely seen to have brought prosperity to the UK between the early 1990s and the financial crisis in 2007-08, can continue to function, albeit topped up loose money.

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1At the time of writing, the UK economy appeared to be returning to some form of growth. GDP in 2013 rose by nearly 2 %, with household consumption accounting for slightly more than half of this growth (Financial Times, 18/12/2013). In the United States too, the closing days of 2013 indicated more vigorous household spending, supporting the notion that the US economy was on a stronger growth path and hence allowing the Federal Reserve to begin tentatively to wind down its massive quantitative easing programme.

2Still, profound doubts about the sustainability of growth remain. These are based on the very simple observation that household income growth is weak, largely because wage growth is poor. Neoliberal economics has affected a significant reduction in wages as a share of national income, since the 1970s. To make ends meet, households in Britain (and the United States in particular) have resorted to borrowing to buy homes and consumer goods. The limits of such an approach to personal finance and as a national macroeconomic strategy have been shown by the financial crisis, which burst in 2007 and 2008. Yet neither governments nor central banks have not addressed these underlying issues.

3On the contrary, as we shall see here, the UK Coalition government has achieved little in redressing the fundamental imbalances of the British economy. The upturn at the end of 2013 was driven by the same factors that drove growth prior to the financial crisis : cheap money which is partly making its way into higher house prices and renewed borrowing to fuel consumption. By other measures of its economic performance, such as the expansion of manufacturing output and an improved trade performance, the British economy appears to be going down exactly the same road which it has been since the Mrs Thatcher and the “New Right” came to power in 1979.

4This paper examines the Coalition government’s approach to macroeconomic policy. The first section begins by reviewing Britain’s economic outlook before examining fiscal policy. Section 2 then turns to monetary policy. It is largely in the hands of the “operationally independent” Bank of England and is taking the strain of trying to stimulate the economy. The last section of this paper returns to the issues just discussed, and attempts to summarise some of the main questions that will shape the future of the British economy in the medium term.

The Economic Outlook and Coalition Fiscal Policy

5The Coalition government entered office in a period of intense economic crisis. While the immediate prospects of a meltdown of the global economy had receded (indeed 2010 was a year of relative calm in the on-going Great Recession), crisis conditions prevailed both in the UK and internationally.

6In terms of growth, the UK economy was very badly hit by the crisis which began in 2007-2008. The Table shows that growth slumped particularly strongly in 2009. More significantly, despite the rise in growth in 2013, GDP going into 2014 was still less than its peak in 2007 ! This constitutes an unprecedented recession cum slowdown of the economy in recent history : Alistair Darling’s warning in late August 2008 that Britain’s economic times were “arguably the worst they've been in 60 years”, has turned out to be horribly accurate (Guardian, 29/08/2008).

Table: Trends in the United Kingdom’s Key Economic Indicators



















Real GDP*









Consumer price inflation*


















General govt. balances**









Govt. gross financial liabilities (gross debt)**









Current account balance**









* annual percentage change, and rate for unemployment, ** percentage of GDP.

Source : OECD, Economic Outlook, No 94, November 2013, various Annex Tables.

# Figure taken from The Financial Times, Chris Giles, 18/12/2013.

The Great Recession and the collapse of public finances

7The impact on public finances of the Great Recession has been accordingly spectacular. Up until the present crisis, Britain’s public finances had been in comparatively healthy shape, albeit erring on the profligate side according to the so-called “Golden Rule” set out by New Labour in its 1997 manifesto. According to this Rule, “ over the economic cycle the Government [would] only borrow to invest and not to fund current expenditure”. As part of its big-push for economic credibility, New Labour in its early days did much to hold down government spending, and actually recorded public spending surpluses entering the new decade. These were followed, after its re-election in 2001, by a fairly substantial increase in spending on services like health, education and transport, as well as income support for poor families aimed at getting households on welfare back into work, and fighting child poverty.

8As Gordon Brown’s early prudence as Chancellor gave way to profligacy, much ink was spilled in the mid-2000s about when and to what extent he was breaking his own Golden Rule. The upshot of analysis at the time was that “yes” the Golden Rule was being broken, that efforts should be made to improve the structural nature of the balance of public spending, but that the consequences of such profligacy were not dramatic (see Sowels for a discussion about New Labour’s public spending policy in the 2000s).

9However, as the UK economy was powering along during the NICE (i.e. Non-Inflationary Continuous Expansion) decade, Gordon Brown as Chancellor and then as Prime Minister remained pretty sanguine concerning government deficits. It should be added, that while the spending taps were gushing with cash, Britain’s national debt to GDP ratio was comfortably in line with, or even below, that of the other major industrialised economies.

10The crisis and the Great Recession have of course changed everything ! Within a few years, Britain’s public finances became engulfed in vast quantities of red ink. It is possible to point to three key factors which are responsible for this. First, immediate capital injections for banks and guarantees in the wake of the crisis were staggering : according to the National Audit Office, peak support for the banking system ran to £ 1.2 trillion at the height of the crisis, though this was overwhelmingly in the form of guarantees (£ 1,029 billion), with a much smaller, though still substantial, amount in cash outlays (£ 133 billion). By March 2013, the outstanding government guarantees had fallen to a mere £ 26 billion, but cash outlays remained notably higher at £ 115 billion (NAO, 2013). Second, the New Labour government adopted a number of measures to stimulate economic activity, such as the cut in VAT to 15 % in 2009, or bringing forward £ 3 billion in capital spending (HM Treasury, 2008). Lastly, and highly significantly, slower economic growth entails falls in government revenues from tax. This is especially the case for economic slowdowns resulting from financial crises. As early as 2009, two American economists (Carmen Reinhart and Kenneth Rogoff) published a cross-country study of financial crises, over time. They clearly noted the way recessions after financial or banking crises last longer than usual downturns : two years compared to one year after a “normal” recession. Furthermore, their cross-country study also indicates that public finances deteriorate substantially following such recessions, not so much because of greater public spending to support growth, but above all because of falls in tax receipts (Reinhart and Rogoff).

11As we shall see below, further work by C. Reinhart and K. Rogoff on the relationship between public debt and growth subsequently had a major impact on fiscal policy in the industrialised countries, especially in Europe and the United Kingdom. Significantly, after pulling out all the stops – fiscal and monetary – to prevent the world economy from collapsing in the immediate aftermath of the financial crisis, governments began reviewing their public spending policies in 2010. The Coalition government was not alone in this, and immediately following its election it adopted a far more restrictive policy of fiscal austerity.

The launching of the Coalition’s austerity policy

12The policy change was announced in the Emergency Budget the Coalition introduced shortly after coming to office. Thus on 22 June 2010, the new Chancellor of the Exchequer George Osborne announced the Coalition’s intention to cut the public deficit from 10.1 % of GDP in the financial year for 2010/11, down to 1.1 % of GDP in 2015-16. The rationale for such a steep reduction in government deficits was based on the argument that without strong remedial action, public deficits of over 5 % of GDP would continue for more than six consecutive years (from 2009), which would be “unprecedented in the post-war period” (HM Treasury, 2010a : p1).

13After setting out its policy in June, the Coalition put forward a more precise outline of its expenditure planning in the Spending Review, it presented to Parliament in October 2010. The overall objective of the Review was that spending across all departments – apart from health and overseas aid – should be cut by 19 percent ! In aggregate, the planned cuts to expenditure by 2014-15 ran to £ 81 billion (HM Treasury, 2010b).

14The government justified this policy by asserting notably that “economic evidence [...] suggests that fiscal consolidation efforts that rely largely on spending restraint are more likely to promote growth and stabilise debt” (ibid, p 15). The evidence in question was the UK Article IV Consultation by the IMF in May 2009, the OECD Economic Outlook No 81, June 2007, and a study by two Italian economists, Alberto Alesina and Roberto Perotti. The latter had published a paper in 1996, under the auspices of the renowned US National Bureau of Economic Research. According to their empirical findings, rather than closing deficits by raising taxes, governments were advised to cut spending, especially spending on welfare and public sector pay, which have an innate tendency to rise, in order to return to growth. In contrast, Alesina and Perotti found that deficit reduction through greater taxation tended to fail (Alesina and Perotti).

15This overall deficit reduction strategy was accompanied by forecasts for growth formulated by the newly created Office of Budget Responsibility (OBR). The OBR was set up by the Coalition government as an independent watchdog to provide economic forecasts to government and to assess actual fiscal policy and its outcomes against the government’s stated objectives. In the event, the OBR’s initial forecasts for growth at levels which would have clearly supported the Coalition’s policy of fiscal consolidation turned out to be woefully over-optimistic : 1.2 % 2010, 2.3 % in 2011, followed by 2.8 percent in 2012 and 2.9 per cent in 2013. Thereafter, growth was forecast to expand by 2.7 percent in 2014 and in 2015 : i.e. just slightly less than the 2 ¾ trend in growth that was the officially recognised potential rate of growth of the UK economy before the crisis.

16Austerity and the persisting recession

17This divergence between these early forecasts and Britain’s actual economic performance has been a significant part of the Coalition’s economic problems. Britain is not alone in this. Indeed, most of the OECD countries have been grappling increasingly with the fiscal dilemma of dealing with deficits at a time of low or flat growth. In many cases, the logic of fiscal austerity seems to be failing – badly – as it compounds downward pressure on growth. Moreover, policy advice on these issues is highly contradictory and the economics profession seems far from reaching a consensus on what to do.

  • 1 See for example Paul Krugman’s op-ed blog, “The Arithmetic of Fantasy Fiscal Policy”, The New York (...)

18Put in its simplest terms, these policy controversies centre on whether governments – in this case the UK government – should pursue fiscal policies to support growth in a fairly Keynesian way, or tackle government deficits in order to restore confidence in the private sector which will then spend and invest, and hence generate growth. Emblematic progressives – or Liberals in US parlance – like Paul Krugman have repeatedly come out favouring more fiscal stimulus to sustain growth.1 The argument here is that until growth has returned to a health and sustained level, governments should support activity using fiscal policy : World War II is sometimes even evoked as having finally seen off the Great Depression (in the United States), thanks to the massive government stimulus of the private sector it entailed.

  • 2 Nick Fyfe and Andrew Threadgould, teachers at Dulwich College, have written a very competent summar (...)

19In contrast, arguments based on austerity stress so-called “Ricardian equivalence” effects, namely that when governments run deficits, consumers and firms anticipate that future taxation will rise to pay for such deficits. As a result, they – private sector – agents save more and spend less, so that the expansionary effect of fiscal policy is blunted by retrenchment in the private sector (Fyfe and Threadgould).2 This approach is in fact a broader restatement of the critique of Keynesianism which reshaped government policy in 1970s, arguing that agents cannot be fooled by public policy-makers and will always discount government efforts to manipulate economic activity beyond its “natural rate”.

  • 3 Their findings are set out briefly in “Debt and Growth Revisited”, VOX, 11/08/2010: retrieved 29/12 (...)

20Moreover, an important aspect of the current debate not only hinges on deficits, but more generally the accumulation of public sector debt. A further empirical study by Carmen Reinhart and Kenneth Rogoff (subsequent to their work on the consequences of financial crises cited above) has provided policy-makers in Europe in particular with a strong argument favouring austerity. Again, using cross-country data over time, they examined the impact of government debt on growth. Their essential finding was that no clear link existed between debt and growth, up until a debt/GDP ratio of 90 %. At this point, Reinhart and Rogoff’s empirical analysis found that debt did indeed lead to a median fall in the growth rate of 1 %, and a far-larger average fall (Reinhart and Rogoff, 2010).3 As the financial crisis had led to the explosion of public debt in nearly all industrialised countries, whether previously “virtuous” like Spain of the UK or more profligate like the US and France, the 90 % ceiling has sent alarm bells ringing throughout many countries.

21However, this apparently wide-ranging conclusion has not been the end of the debate. On the one hand, the Reinhart and Rogoff study has been criticised for containing calculation errors, and including some exceptional situations which affected their overall conclusions. Far from debt levels above 90 % of GDP leading to strong falls, or even a collapse in growth, they may indeed hamper activity under abnormal circumstances. The Great Recession is unusual, so that policy prescriptions relating to normal circumstances are less relevant (see Robert Pollin and Michael Ash in The Financial Times, 17/04/2013).

22Furthermore, more recent work by Olivier Blanchard (Chief Economist) and Daniel Leigh of the IMF suggests that fiscal retrenchment during the Great Recession may well have compounded the crisis in several countries. Again, the argument here is that the crisis is very far from being a normal situation, in particular as interest rates are very low. As a result, Blanchard and Leigh conclude – along with others – that the fiscal multiplier (i.e., the ratio by which changes in fiscal policy affect total output) is very likely to have been greater than 1 : in other words, a £ 1 or € 1 cut in government spending reduces GDP by more than £ 1 or € 1. Clearly, if this is still true for Britain – or, say, Greece – it has very significant consequences for the kind of fiscal consolidation pursued by the Coalition government.

23Indeed, in April 2013, Mr Blanchard warned that the government’s austerity policy put growth at risk. However, in the face of stronger growth since the summer of 2013, the Fund reassessed its position in October 2013. Indeed, there has been a shift across the political spectrum in the UK (including Labour) which now favours fiscal consolidation until 2017-18, or well into the next Parliament (Financial Times, 8/10/2013).

24If Britain’s growth does now return to a higher, relatively healthy rate of 2 % or more, then the Coalition government will surely feel itself vindicated in the conduct of fiscal policy. Much will of course depend on developments within the world economy. But much will also depend on the UK economy itself, because at the end of 2013 Britain’s renewed growth appeared to be based on many of the imbalances which had preceded the crisis. Significant doubts therefore still remain, and are discussed at greater length in Section 3. But these doubts, and indeed the structural weaknesses of the UK economy are also manifestations of the way monetary policy has been conducted since the onset of the Great Recession, which we shall turn to now.

Experiments in Monetary Policy

25While the fiscal policy of the Coalition government has been highly orthodox – striving to balance budgets – the monetary policy of the Bank of England has been not just expansionary but unconventional. This reflects the new-found flexibility, even inventiveness, in the monetary policy pursued by many central banks, notably the Federal Reserve of the United States, and in similar but different ways by the European Central Bank and the Bank of Japan. As we shall see below, since the explosion of the financial crisis in the autumn of 2008 (following the collapse of Lehman Brothers on 15 September), central banks around the world have been obliged to adopt new policies which contrast with the so-called “Jackson Hole consensus” that had prevailed prior to the crisis.

26This expression refers to the way monetary policy had converged around a new consensus during the 1990s and early 2000s, following the strong conflicts over macroeconomic policy which waged in the 1970s and early 1980s. It is called the “Jackson Hole consensus” as monetary policy is discussed each year in late August in the mountain resort of Jackson Hole (Wyoming) by central bankers and leading monetary policy specialists from around the world. According to Charles Bean (Deputy Governor of the Bank of England responsible for monetary policy) and other Bank officials, for example, this consensus was based on a series of policy principles which became generally accepted by central bankers. In a paper they presented at Jackson Hole itself in August 2010, Bean et al. summarised these principles as follows :

  1. Automatic stabilisers aside [i.e., the automatic tendency for fiscal policy to be counter-cyclical over the business cycle thus smoothing out demand], fiscal policy was unsuitable as an instrument of macroeconomic demand management […]

  2. Monetary policy was therefore assigned the primary role in short-term aggregate demand management, with policy conducted through the manipulation of a suitable short-run interest rate.

  3. The monetary transmission mechanism operated mainly through longer term interest rates, asset prices and expectations of future inflation. Expectations of future policy rates were therefore central and credibility was key.

  4. The conduct of monetary policy was best delegated to an independent central bank, free of short-term political considerations [...].

  5. Intermediate monetary targets were not useful, because of their unstable link with the ultimate objectives of policy (though that did not preclude them being helpful at times as indicators of future demand and inflation). For jurisdictions with floating exchange rates, monetary policy should instead be focused on the only thing it could reliably determine in the long run, namely the price level […].

  6. Asset markets were thought to be efficient at distributing and pricing risk and financial innovations were normally welfare enhancing. While asset prices might be subject to bouts of “exuberance” on the part of investors, there was little that monetary policy could do about them. The best monetary policy could do was to limit the fallout when sentiment turned.

  7. Systemic financial crises were seen only in history books and emerging markets ; they were unlikely to happen in advanced economies with their developed and wellregulated financial markets. Moreover, price stability and financial stability were natural bedfellows, the successful achievement of one facilitating the attainment of the other. (Bean et al.).

27What has been specific to the UK case (though the fiscal and monetary “policy mix” in the euro area has been almost identical) is that the orthodoxy of fiscal policy means that monetary policy has indeed become by far the dominant instrument of policy in fighting the Great Recession. There are, however, some paradoxes surrounding this overall configuration of policy. To be sure, it corresponds to the primacy of monetary policy in macroeconomic policy which emerged progressively with the eclipse of Keynesian policies by monetarist policies in the late 1970s and early 1980s, as noted by Charles Bean (see above). However, the primacy of monetary policy not just in maintaining monetary stability but in stimulating output and growth continues the process of placing immense powers in the hands of central bankers, who are nominated officials and who are only indirectly responsible to electorates throughout the world : usually via their obligations to testify regularly about policy before legislative committees. This constitutes a further and major step in the “depoliticisation” of economic policy which goes back to the “monetarist revolution” of the 1970s, and in the UK to the election of the Conservatives led by Margaret Thatcher in 1979. Even supposing that central bankers are at all times acting in good faith – a supposition that is open to challenge – there are risks that such an organisation of policy may well end up being limited in its approach, given the bluntness of monetary policy (see below). Also, while central bank independence may facilitate ensuring monetary stability under “normal” circumstances, it must be asked to what extent it is justified when central banks become overwhelmingly responsible for macroeconomic policy.

28This question is especially relevant as this primacy of monetary policy may not be particularly effective (see below). As has already been seen above, research published by the IMF in 2013 indicates that fiscal policy may have a more potent role to play in exceptional circumstances, and notably when interest rates are very low. If this is really the case, then today’s world has arguably come full circle, with monetary policy being “like pushing on a string”, to quote the well-known quote popularised by Keynes.

Rock-bottom interest rates

29The most immediate, and in some ways most visible aspect of the Bank of England’s policy has been to set ultra-low interest rates since the beginning of the financial crisis. In the 4th quarter of 2008, the Monetary Policy Committee (MPC) of the Bank cut interest rates by 3 percentage points, and then by a further 1½ percentage points in early 2009. This brought the Bank Rate down to ½ percent, where it has remained since.

30Significantly, the Bank of England has kept interest rates low, even though inflation in the UK has actually been quite a bit higher than in other EU members or other industrialised countries. Moreover, the Consumer Price Index (CPI) grew above its target rate of 2 % (±1 %), and the Governor of the Bank found himself systematically writing “open letters” to the Chancellor of the Exchequer. In line with the monetary regime that evolved during the 1990s and which was completed and formalised by Gordon Brown in 1998 with the Bank of England Act, the Governor of the Bank is obliged to explain MPC policy publicly to the government, to set out its views on when it thinks inflation will return to target, and to indicate what steps the MPC is taking to return CPI inflation to target (range).

31Most of the time, these “open letters” have thus entailed the Governor of the Bank, speaking on behalf of the MPC, and explaining why the MPC believed that the exceptionally weak state of the UK economy called for continued, low interest rates, even if inflation was higher than its target range.

Massive market intervention

32During the near-meltdown of the international financial system, the Bank of England along with other central banks intervened massively in the markets to ensure that the banking system and finance would continue to operate. The aim was to prevent the collapse of finance turning into a collapse of economic activity in general.

33Thus while the (Labour) government acted to take institutions like the Royal Bank of Scotland into public ownership, the Bank of England took on functions of the interbank markets, lending to banks short term, for them to be able to continue operating. Under normal conditions, banks permanently go to the interbank markets to refinance their portfolios and businesses. As most of these transactions are short-term, interest rates are low and banks lend to each other easily. At the height of the financial crisis in the autumn of 2008, however, these interbank markets ceased up, essentially because banks were no longer able to trust each other, given that no one knew which institutions were holding sub-prime and other toxic securities. To prevent banks from collapsing domino-style, the Bank of England and other central banks took over responsibility for such financing.

34The same thing even occurred in the so-called “commercial paper” markets. These are markets for short term debt instruments issued by (large) companies, and used to finance their on-going operations. Again, the commercial paper markets dried up during the in the midst of the financial crisis. And again, the central banks were obliged to take over the functions of these markets, in order to prevent large businesses from failing.

35By and large, such exceptional intervention by the Bank of England (and others) ended relatively quickly. In conventional terms, they largely exceeded the usual operating practices of central banks, and perhaps even central banks’ mandates. At the same time, such exceptional intervention – such exceptional provision of liquidity – did follow Walter Bagehot’s long-established banking principle, namely that in times of crisis the central bank should lend freely to solvent banks, but at rates that would discourage unnecessary borrowing.

Quantitative easing

36Quantitative easing on the other hand is in quite a different category. It is a policy which the Bank of England launched in early 2009 with the aim of injecting money into the economy in order to boost nominal spending and achieve the inflation target. This was and is done by the Bank buying up public and private assets. These assets have in fact mainly been gilts (i.e., British government bonds). Thus, between March 2009 and January 2010, the Bank of England purchased £ 200 billion in mostly medium- and long-dated gilts, equivalent to about 30 percent of gilts held by the private sector at the time, and 14 % of GDP (Joyce, et al.).

37When this policy was initiated, it was a bit of an unknown, though the Bank of Japan had already had experience in quantitative easing to prevent deflation, as of 2001. The Bank of England’s belief however was that it would act in a similar way to cutting interest rates, namely that QE would stimulate activity and support prices, an important goal in itself due to the dangers of deflation which may weigh strongly on growth, notably because deflation raises the real value of debt. There are various “transmission channels” by which QE was and is believed to be able to do this.

38Overall, by buying up assets, the Bank of England raises their price and in so doing automatically pushes down the percentage rate of return on those assets : i.e., the effective rate of interest they pay out in any one period, even if the absolute value of the payments (the “coupons”) remain unchanged. Sellers of the assets will then be holding more money, which they may then want to invest in other assets, so that lower interest rates spread to these assets too, and so on. Other things being equal, lower (medium and long-term) interest rates should encourage borrowing and investment (in production or in real estate), and this should boost activity. Higher asset prices might also stimulate extra spending by agents (households) which feel they are richer : the so-called wealth effects.

39There are other channels through which quantitative easing is believed to operate, including : policy signalling, support for liquidity, and confidence in the economy. In short order, signalling effects function by the way their persuade agents that the Bank of England would do everything it could to prevent deflation. As we shall see below, the notion of providing markets with a stable vision of the future later became the basis of so-called “forward guidance”. Support for liquidity involves the central bank intervening to ensure that markets continue to operate : i.e., that buyers and sellers can enter and exit the market and find counterparties with whom to trade. Confidence effects arise from the way central bank intervention through asset purchases contributes to encouraging agents more generally to consume, and invest (ibid., Joyce et al.).

40The impact of such massive quantitative easing, which by the end of 2013 had run to £ 375 billion, has on the whole been rather mixed. Mainstream economists discussing the experience in the United States as well as in the United Kingdom tend to argue that it has played an important role in heading off deflation and a far more substantial collapse in output. Thus, Gavyn Davies, a former partner of Goldman Sachs and supporter of the Labour Party, writing in The Financial Times in February 2012 stated that “real GDP in the UK may have been boosted by about 1.5 per cent” (Davies). A broadly similar assessment about QE (and forward guidance in the US, see below) was given in a speech in March 2012 by Janet Yellan, who became Chair of the US Federal Reserve in February 2014.

41More circumspect and critical views concerning quantitative guidance also exist however. Thus John Kay, a reflective yet broadly mainstream economist and well-known columnist for The Financial Times, has called quantitative easing a “leaky bucket”. In particular, writing in July 2013, he asserts that QE has not been very effective in boosting growth, but that it has favoured those persons and households owning assets, such as shares, but notably housing. They are benefitting from QE, which is impacting on the distribution of income and wealth in the British economy. More generally, he argues that QE is above all helping the financial services sector (Kay).

42In a similar vein, Mark Blyth, for example, a professor of international political economy at Brown University, was already highly critical of QE in the US, in August 2012 : i.e., before the Fed announced its third, open-ended round of QE in September 2012 (QE3). He returns to the Keynesian critique that flooding markets with money in an economic situation in which agents have little confidence and see little reason to invest is like “pushing a string”.

  • 4 WSWS or World Socialist Website is published by the International Committee of the Fourth Internati (...)

43A more radical critique as given, say, by Nick Beams on the World Socialist Web Site ( the way QE has provided trillions of dollars virtually free of charge to the major banks and financial institutions. Far from leading to strong growth – either in the US or elsewhere – such cheap money is feeding speculation in stocks and other risky financial assets. Globally, QE is also associated not with real investment, but instead with companies building up huge cash mountains, running to an estimated $ 4 trillion (Beams). These both compound and react to weak growth throughout the industrialised world. “Rather than employing profits to finance expansion of production, companies are increasingly using their cash holdings to finance share buybacks in order to boost equity values, thereby providing financial profits to the hedge funds, banks and investment houses which are the major shareholders of large corporations” (Beams).

Forward guidance

44The last and most recent component of the Bank of England’s new approach to monetary policy concerns “forward guidance”. This policy was announced in August 2013 and reflects a new impetus in Bank of England’s thinking and policy since the appointment of Mark Carney as Governor, at the beginning of July 2013. Mr Carney was lured to London very specifically by George Osborne, Chancellor of the Exchequer of the Coalition government. He came from the Bank of Canada, with a reputation as having played a key role in guiding Canada’s banking system during the crisis, hence ensuring that it did not collapse in the same way as the UK, or US, banking systems. The skills attributed to him as a result explain the generous total compensation package he was offered to cross the Atlantic, and which runs to about £ 624,000 (BBC).

45This policy is based on a commitment by the Bank of England to maintain the Bank Rate at 0.5 percent until the unemployment has fallen below 7percent, provided that this does not pose risks to inflation of financial stability. Similarly the Bank stated that it would not reverse QE (i.e., sell back assets to private agents) until the unemployment target had been met. The rationale for this policy is that by setting out a clear target related to employment and by implication growth, the Bank helps strengthen agents’ confidence and hence encourages agents to invest, thus consolidating the nascent recovery (Bank of England website).

46There are some provisos to this policy, which the Bank has called “knock-outs”. The first is that consumer price inflation over an 18- to 24-month horizon should not be forecast to rise by more than 2.4 percent. Next, people’s expectations of future inflation must remain at around 2 percent. Lastly, forward guidance will be halted, if the Bank’s newly created Financial Policy Committee, which overseas banking and finance regulation and stability, “judges that the stance of monetary policy poses a significant threat to financial stability that cannot be contained by the tools and policies of the regulatory authorities” (ibid.).

47There are a number of things which can be said about this policy. In some ways, it is a logical extension of monetary authorities seeking to make policy predictable and hence credible in the eyes of agents. This has been an important part of monetary policy, stretching right back to the Medium Term Financial Strategy (MTFS) devised by Nigel Lawson in the early 1980s, whose aim was to guide agents’ expectations about the government’s policy at the time, and so facilitate the downward movement of inflationary expectations. Indeed, with the “knock-outs” we find the very central position of expectations about inflation in Bank policy. Agents’ expectations about future inflation are indeed seen to be a key determinant of actual inflation.

48At the same time, the introduction of an unemployment target into monetary policy seems positively amazing when viewed in the historical context of policy in the UK. It was precisely the abandonment of unemployment on the high alter of fighting inflation during the early 1980s which was the cornerstone of Mrs Thatcher’s first government’s move away from the post-war consensus on achieving a “high and stable rate of employment”. From this point of view, that an explicit unemployment target has entered the Bank of England’s calculations in setting interest rates seems truly remarkable.

49In fact, it arguably suggests that the Bank’s mode of operation is aligning itself (for the moment at least) with that of the Federal Reserve in the United States. The Fed has always had a dual responsibility for maintaining price stability and supporting growth. More recently, it too has interpreted this twofold objective in terms of establishing forward guidance. Following the outbreak of the crisis in late 2008, the Fed used forward guidance as a way of encouraging long term interest rates in the markets to shift downwards. More recently – September 2012 – the Fed linked its low interest rate policy and its asset purchases under QE to unemployment falling below 6½ percent, provided that inflation forecasts remained within ½ percent of the Fed’s long term target of 2 percent (ibid., Yellan). The policy announced by the Bank of England in August 2013 does indeed seem very similar to this, thus constituting another example of how British policy-makers look across the Atlantic for inspiration.

50Since the Bank’s August decision, the economy has picked up. This is surely due largely to other factors than just the announcement of forward guidance itself. There were already some indications of activity finally strengthening, again due to the very easy credit conditions in certain parts of the UK economy and in particular the upturn in the housing market, which we shall return to below. Accordingly, there has been a fair amount of speculation about whether the Bank would not start raising interest rates far earlier than it originally suggested when forward guidance was adopted (i.e., 2015). However, statements by members of the MPC made at the end of 2013 indicate that monetary policy is likely to be fairly accommodative for some time still. Thus, in a speech given in December 2013, Spencer Dale (Executive Director, Monetary Policy and Chief Economist of the Bank) announced very clearly that :

[...] our guidance is rooted in the recognition that it’s a long way back to the economy being fully recovered. The damage and losses associated with the financial crisis and the years of frustration and disappointment that followed won’t be reversed simply by one or two quarters of strong growth. Our guidance makes clear that we intend to maintain the current exceptionally stimulative stance of monetary policy until we’ve seen a sustained period of strong growth [...]

51It is of course too early to tell what the exact impact of forward guidance will be. According to Martin Weale (an external member of the MPC), theory suggests that forward guidance may indeed be very powerful, especially in the short term, in raising output, provided that guidance leads to lower expectations concerning the future path of interest rates. But, this has not taken place in the UK : in the wake of the policy being announced, future expectations of interest rates did not change much. This may be because the Bank of England’s policy had been widely expected. There does however seem to have been a decline in uncertainty and this has probably provided some (small) stimulus to the economy (Weale).

The Return to Growth and Britain’s Unbalanced Neoliberalism

52The better-than-expected growth achieved during the second half of 2013 has confounded some of the Coalition’s critics, not least economists at the IMF (see above). At the end of 2013, the UK seemed to be on a higher growth path – again ! – when compared to the eurozone as a whole, and France in particular. But, there were/are a series of important qualifiers to Britain’s faster growth.

The persistence of unbalanced growth

53Taken as a whole, these stem from the fact that the return to growth is not the result of a rebalancing of the UK economy, an objective which the Coalition had clearly stated it would strive for, when it came to power in June 2010. Growth is not being pulled by exports nor investment in industry. Instead, in late 2013 growth seemed once again to be driven by household consumption and the housing market, both in turn being supported by rising household indebtedness.

54This should perhaps come as no surprise. In December 2013, Stephen King (Chief economist at HSBC) noted quite clearly in an op-ed article in The Financial Times that : “QE is a blunt instrument. To suggest that economies can be ‘fine-tuned’ in favour of either export-led or consumer-led growth is a triumph of wishful thinking. Even if it helps improve economic conditions, there is no guarantee that, on its own, QE will deliver the ‘right’ outcome. Supplementary drugs may also be needed”. Mr King went on to note that significantly for all the shaking out of finance and falls in output, Britain’s current account deficit in goods and services has “simply got bigger and bigger” (King).

55Indeed, there is some indication that countries are reacting to the crisis in different ways, in accordance with their own “behaviour patterns” and institutional organisations. This is perhaps not surprising. The literature on “varieties of capitalism” is now vast, taking its name from the seminal study directed by Peter Hall and David Soskice, and published in 2001 (Hall & Soskice et al.). Generally speaking, this research points to the fact that capitalisms do exist in various manifestations, and in particular that the English-speaking countries or “Anglo-Saxon” countries constitute a fairly coherent group of “liberal market economies”. In an updated look at the question in 2007, Peter Hall noted that while there has been a general trend towards greater liberalism throughout the developed world, the evolution of national economies still continues to be “path dependent”, reflecting national economic histories and institutions.

56For the UK, this of course raises questions about the sustainability of its present return to growth. Assuming, that the international environment remains clement for the foreseeable future, questions still remain as to what extent the UK will be able to plough on by basing its growth on debt-fed consumption and house-price inflation. In a very dark assessment of Britain’s economic future published in 2012, Larry Elliot (economics editor of The Guardian) and Dan Atkinson (of economics editor of The Mail on Sunday) argued that Britain is becoming increasingly like a developing country (Elliot and Atkinson : Going South). More specifically, given the way the UK economy is shaped by finance, which is pushing households into debt while again generating huge returns for the financial services sector, it is characterised more and more by economic “dualism”. In other words, Britain is very much moving towards an economy and society in which some actors are well-integrated into the global economy and are hugely wealth, whereas much of the population is suffering from economic stagnation if not poverty. Moreover, the successful, competitive parts of the economy – whether in industry or finance – are often owned by foreign investors, frequently capitalising on Britain’s low labour costs and low-tax regime.

The sustainability of neoliberalism

57More generally, it may be asked whether Britain’s neoliberal model which has emerged since the late 1970s is in fact sustainable. The recourse to debt and especially rising debt levels – be it private sector debt held by households or even by governments – may not be sustainable forever. Forecasting under normal circumstances is always hazardous, and the capacity to build up debt is difficult to fathom. With interest rates at rock-bottom, debt servicing is easier today than during other periods in the past. The capacities of both the private and public sectors to take on debt is therefore in many ways quite elastic. Indeed, authors like Larry Elliot and Dan Atkinson were already seriously cautioning about debt in their book Fantasy Island, published just before the financial crisis (2007). So too was Philippe Auclair, a French journalist living in the UK, in his Le royaume enchanté de Tony Blair (2006). In this book Mr Auclair, at one point referring to his rural roots in Normandy, repeatedly makes plain his amazement over the build-up of debt in the UK both by government and private individuals. Other countries too have exceedingly high debt levels, such as Japan, which appear financeable for the time being. So accumulating debt can go on for a long time. But the situation could change markedly were interest rates to rise or were sustainable growth to remain elusive.

58Of particular importance to this must surely be the question of wages. Neoliberalism throughout the world has seen the share of wages in GDP fall : the OECD estimates that overall labour income has fallen as a share of GDP from 66 % in the early 1990s to 62 % in the 2000s (Economist, 2/11/2013). Middle-income households, to say nothing of low-income households, are being squeezed everywhere, and as a result are turning to debt to live : to buy homes and to finance their consumer lifestyles. The situation may be somewhat less pronounced in the UK, where the OECD estimates the labour share fell from 73.1 percent of GDP in 1990, to 69.0 percent in 2008 (OECD).

59This combination of household borrowing and consumption behaviour pattern has followed as a direct result of neoliberalism. On the one hand, competitive pressure has borne down on incomes. On the other hand, the deregulation of finance has made it easy to borrow. It must be asked to what extent these fundamental traits of neoliberalism can carry on – indefinitely – in the UK and elsewhere.

60This is not the place to build scenarios. However, the neoliberal accumulation regime, to draw on the language of Regulation theory, does seem to be exhibiting profound signs of dysfunction, in as far as the basis for sustained household consumption – namely rising wages – appears increasingly fragile. To put it in more overtly Marxist terms, neoliberalism is driving down wages and average household income, leading to and maintaining economic crisis conditions. This has been a strong and clear trend in the United States since the late 1990s as median income has fallen. It has been less the case in the UK, as median income only really retreated with the Great Recession : according to the Office of National Statistics, median household income in real terms fell by 3.8 % between 2007/8 and 2011/12 (ONS). As a result, growth has been propped up by rising indebtedness. It must be asked whether this economic organisation can go on, even if the limits to debt are extendable. Moreover, the excessively loose monetary policy pursued by the Bank of England (and other central banks) may well be preparing the way for further financial crises as asset prices (stocks, bonds and more recently prime real estate) are rising strongly.


61The Coalition government came to power in the midst of the worst crisis faced by the industrialised countries – and more generally the capitalist economic system – since the 1930s. Its response to this situation has been highly orthodox in terms of fiscal policy, with the government essentially striving to bring down massive deficits through spending cuts. Although this policy probably contributed to lengthening the Great Recession in the United Kingdom, by the end of 2013 growth was picking up, and the government felt itself vindicated in the face of its critics.

62The return to growth therefore appears to have been largely stimulated by monetary policy. In contrast to fiscal policy, it has been highly unorthodox, experimental and inventive. Not only has the Bank of England held down interest rates at historically low levels for more than five years, but the Bank has been obliged to devise new policies to further stimulate the economy, in the form of quantitative easing and forward guidance.

63However, the return to growth which was underway at the end of 2013 appears to be characterised precisely the same imbalances which were manifest in the British economy before the crisis, most notably the reliance on rising household debt to finance house purchases and consumption, while other aspects of the “real” economy continued to show signs of malfunctioning : as borne out notably by weak income growth and large current account deficits.

64This raises serious issues about the sustainability of the return to growth and more generally the sustainability of the neoliberal accumulation regime which has emerged since the late 1970s.

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1 See for example Paul Krugman’s op-ed blog, “The Arithmetic of Fantasy Fiscal Policy”, The New York Times, 31 August 2013: retrieved 29 December 2013, <>.

2 Nick Fyfe and Andrew Threadgould, teachers at Dulwich College, have written a very competent summary of The UK Economic Policy 2003-2013. It not only presents the main outlines of policy in numerous areas, but sets out many of the underlying theories in a succinct and readable manner;

3 Their findings are set out briefly in “Debt and Growth Revisited”, VOX, 11/08/2010: retrieved 29/12/2013, <>.

4 WSWS or World Socialist Website is published by the International Committee of the Fourth International.

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Nicholas Sowels, « The Coalition’s Economic Policy of Fiscal Austerity and Monetary Experimentation by the Bank of England », Observatoire de la société britannique, 15 | 2014, 165-188.

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Nicholas Sowels, « The Coalition’s Economic Policy of Fiscal Austerity and Monetary Experimentation by the Bank of England », Observatoire de la société britannique [En ligne], 15 | 2014, mis en ligne le 01 novembre 2014, consulté le 22 septembre 2020. URL : ; DOI :

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Nicholas Sowels

Maître de conferences à l'Université Paris 1

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