The UK government and BoE is in trouble. The growth is lumpy, and the government is hoping that the -0.5% Q4 result was due to the snow (I liked the snow! Few more years like this, and Brits may finally start to recognize that there’s something to having some insulation in the house… )
At the same time, the inflation is high. Not sky-high, but uncomfortably high. It’s been over the official target for 23 months now, and Mr. King probably now has a template for the letter he has to send every quarter or so.
Yet, rates are still in the ZIRP territory, to offset the financial tightening (a.k.a cuts) and make sure the millions of Brits who believed that property prices can go only up don’t go down (the drain).
The problem is, that with the high inflation (and especially the price increases in energy, food and similar, which makes for a significant part of spending – more so for the poorer) and stagnant wages, the spending power is being eroded faster than the ZIRP policy can help. After all, the interest cost of a mortgage is a fixed cost in your budget – but the inflation is a compounding cost (I’ve done some numbers on it, and it can look pretty bad. Maybe material for some future post).
Rising the rates shoots mortgage owners (and then banks, and then small businesses, etc. etc.). Not rising it shoots BoE credibility, and more importantly, all households that don’t manage to get a rise. More slowly, but result is the same.
Damned if you do, damned if you don’t. Quandary if I ever saw one.
Yet there’s something that can help all the parties. It’s actually pretty simple. It’s Keynesian (for purists – not really Keynesian, but Keynesian in how the word is mostly interpereted now) and austere at the same time (depending on your definition of time). It lets you to have your cake, and eat your cake.
Hard to believe? Here it is.
First, the good old Keynesian part. Govt should invest heavily. Especially into the infrastructure, which I doubt has seen much investment since the Germans made Brits to do it wholesale. That could keep the construction industry going for a bit, and may even help the other businesses in the UK (note: don’t shovel money into PFIs though, nor indiscriminately spend them on civil services. That would be just a re-run of a bad late-90s movie).
Where’s the austerity I hear you crying? Surely, that is pure unadulterated Keynesianism leading to increased deficit, higher interest rates cost and all that!
So here’s the second part of my proposal.
At the same time, the government legislates that the UK debt issuance will massively switch to inflation-linkers, starting say in five years time. Let’s say (finger in the air numbers warning), that they will increase it by 10% every five years from now until it hits 50% of all the debt (replacing retiring fixed-rate debt with linkers). SALE! Preferential terms to the holders of freshly minted, relatively low-interest fixed coupon instruments issued to finance the infrastructure, and that will automatically switch to linkers 5 years from now!
Talk about tying your own hands! This would surely persuade even the most ardent bond vigilante that the government will care about inflation in not so far future. And if not, well, you have a linker, so it’s not your problem anymore, is it? Pension companies would love this, as they consistently struggle with sourcing enough inflation to pay their liabilities. So it even helps pensioners.
So, eat your cake today, and you still may have one in the future to give to somene else – if you promise to build a bakery.