Maintaining Stable Macroeconomic Conditions

Executive Summary The UK economy faces more than usually uncertain times. Outside the European Union, and in an increasingly challenging global environment characterised by ageing populations, climate change, populism, protectionism, and more, the country needs to chart a new course. This may well require policymakers to consider unconventional approaches to monetary and fiscal policy and, at the very least argues for important modifications of the current policy regime, including the autonomous mandate of the Bank of England. At some point, there will be a major slowdown in economic activity. Yet the Bank of England has very little leeway to respond by cutting interest rates, and it has already adopted an armoury of unorthodox tools that may be decreasing in effectiveness. More radical monetary approaches would be likely to be politically controversial; and are not without risks. In these circumstances it would be a mistake to rely solely, or even largely, on monetary policy to maintain demand. It would be better to conduct monetary and fiscal policy in tandem, and for discretionary fiscal policy to be required to play a much more active role in demand management than hitherto. This would, for example, imply major extension of the automatic stabilisers and efforts better to calibrate discretionary initiatives with the business cycle. But given the long-term pressures on the public finances, more fundamental changes in the structure of spending and taxation are needed, along with a redrawing of fiscal rules and targets, under independent budgetary oversight. The current, historically low, share in GDP of public spending is itself unsustainable in light of the demand for services of an ageing population; plans should be made to raise it closer to the European average. In the most extreme circumstances it might become necessary to waive the fiscal rules entirely and for the Bank of England directly to underwrite fiscal stimulus in order to sustain aggregate demand. It would be wise for the authorities to consider the options in detail now, while the environment is still relatively stable.