July 19, 2016    4 minute read

Why The Bank Of England Cannot Help The Economy

Looking For Alternative Solutions    July 19, 2016    4 minute read

Why The Bank Of England Cannot Help The Economy

What can one learn from Brexit and how it be applied to the economy? Everyone had different reasons for voting ‘in’ or voting ‘out’ in the recent referendum. The main arguments that came through from people who voted to leave the EU were not immigration or “£350m more to the NHS a week”. It was more a way of saying that they were extremely unhappy with how the system works and that they do not understand how laws are passed, and decisions are made through the EU. Effectively, the result was more a revolt than anything else: people are angry at how everything is run, and so they take it out on their representatives, the politicians. So, how can this possibly help with the running of the economy?

The Current State

The current level of inflation in the UK is 0.3%, which is significantly below the 2% target rate set by the Bank of England (BoE). The UK saw a 0.4% growth in Q1, and will likely register a decrease in growth rate in Q2 as Brexit will have had time to impact the economy. As one can see from these figures, the economy is not necessarily in a good place, and it definitely will not see large growth soon.

The Current Solutions

The BoE has a few ‘weapons’ in its arsenal to increase the rate of inflation, lending and subsequently affect GDP. These instruments are quantitative easing (QE), which is just pumping money into the economy, and adjusting interest rates.

QE is currently being used in the UK – in fact, the Monetary Policy Committee voted unanimously to maintain the stock of purchased assets financed by the issuance of central bank reserves at £375bn. Interest rates are currently at 0.5%. In other words, there are a few ways for the BoE to use those instruments in order to maximise growth. They can pump more money into the economy but, as seen with the ECB, it does not really work, so it is not a real solution. They can reduce interest rates further, to potentially 0%, and again, as was the case with the ECB, it does not change anything. Lastly, they could do both – reduce interest rates and increase QE. These are all theoretical solutions – the instruments were created by economists, for economists. The impact of reducing interest rates and increasing QE can only be understood by those who have a minimum apprehension of economics. Not everyone can understand how the economy works and how reducing the interest rates will allow banks to loan money at a cheaper rate. This, in turn, should mean cheaper money for the consumer, which should (in theory) increase spending, and consequently, affect the aggregate demand curve.

Alternative Solutions

Having seen the result of the referendum, and by trying to understand the reasons behind the population voting as they did, the two solutions above are completely useless in solving the current economic problems. This is simply due to people not seeing a difference. As established above, the main reason for the pro-Brexit vote was to make a point, show that people were angry with politicians, and the way the EU is run. People voted Leave to make a difference, and have some impact on the UK, and they did. Consequently, people need to see the change. Reducing interest rates and increasing QE does not make a difference for the majority of the population because most of the time it is not obvious and this is why these instruments are not working.

What are the alternative solutions? Simple, really. First, reducing income tax (this is something the government should take control of, as the BoE cannot help). By reducing income tax, people will see an increase in their real pay. They will see that the number on their pay slip has increased. That is how one makes a difference and people need to see it in order to act differently. People will have more disposable income, and that money will be spent, as this is the age of consumerism.

Second, reducing VAT. People will be encouraged to spend more, and in the aggregate demand formula consumer expenditure accounts for over 60% of GDP. Growing is easier through consumer rather than government spending. By reducing VAT, the consumers will again see that ‘difference’ in prices and the sentiment will change.

In conclusion, people need concrete solutions, and not theoretical instruments, that work on paper. They do not work in the current state of the world.

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