Cheap government credit isn’t the magic bullet for our future growth
SOMETIMES life sucks. Sometimes, one day we are active athletic people, running and playing squash, and the next we experience a bad back injury and cannot run fast or twist any more.
When such things happen, it is tempting to believe that there must be a solution, some magic bullet that will restore us quickly to our former state. We ask the doctor what pill we should take or what surgery there is. If no such therapy works we could try other routes – maybe Chinese or chiropractic medicine. Next we might get desperate, checking out homeopathy, Reiki, or faith healers. We don’t want to accept that our back is bust, we are fortunate to be able to walk at all, and if we exercise vigorously again it will only be after a slow, challenging process of rehabilitation. Sometimes there really is no magic bullet, and sometimes a wise and helpful doctor should tell us that hard truth – even if we initially angrily reject her counsel.
As with back injuries, so with an economy. Sometimes economies experience serious shocks and things must change. People don’t want to accept this. They feel policymakers ought to be able to pull some mystery lever, fire some magic bullet, and all will be well again. A policymaker that told us that there was nothing more to do but grapple with rehabilitation would find his or her counsel rejected as angrily as a doctor without a cure.
The British government’s latest wheeze – its latest putative magic bullet – is “funding for lending”. The idea is that the Bank of England will lend money, on easy terms, to banks, provided those banks can credibly guarantee that money will be lent out to businesses.
At one level, this is terribly ironic, because so much of policy the past four years has reduced the capacity and willingness of the banking sector to lend. That is most obvious in the case of the huge increases there have been since 2008 in liquidity and capital requirements. The more capital firms must keep idle, in one sense or another, the less they will have to lend.
But it is also the case that the whole process of bailing out bust banks has impeded credit growth. If banks had gone bust, there would have been multiple new banks that entered or arose to take the place of the bust old banks; and old banks that had not gone bust would have also expanded to serve the unmet demand. Because these new and surviving players would be healthy banks, they would be eager to lend and to gain new customers. By contrast, bust banks do not have market-driven incentives to expand – quite the reverse. To make bust banks expand their lending, policymakers have attempted all kinds of regulatory inducement and instruction (e.g. Project Merlin). Such measures chase the problem – it is policy, in the form of increased capital and liquidity requirements and in the form of bailouts to keep zombie banks going, that has been an important driver of limiting credit growth.
Of course, when I say “credit growth” I mean growth of credit to firms with viable investment projects. Even under ideal circumstances, one would expect total credit in the economy to shrink – particularly as households (not firms) cut back. Politicians may not like it, but the truth is that UK households are horribly over-indebted and should be cutting their debts faster, not slower, so total credit should be shrinking, not growing.
In reality, claims by the government to the contrary notwithstanding, the new funding-for-lending announcements, together with their catchily titled “Extended Collateral Term Repo Facility” bank liquidity-enhancing brother, are intended by the government to respond to the risk of another credit crunch if (as is seeming increasingly inevitable) there is a widespread financial collapse in the Eurozone. But in truth, a Eurozone collapse would set off such a dramatic series of events that the Mansion House measures would be overwhelmed and irrelevant. No magic bullet can end the euro crisis, and no magic bullet can prevent Britain being caught in the fallout of it.
Andrew Lilico is chairman of Europe Economics.