According to Bank of England Governor Mark Carney, central banks might not be able to stop a sharp economic downturn as ever since the global financial crisis, they have used up much of their usual monetary policy arsenal.
“It’s generally true that there’s much less ammunition for all the major central banks than they previously had and I’m of the opinion that this situation will persist for some time,” Carney told the Financial Times in an interview published recently.
“If there were to be a deeper downturn, (that requires) more stimulus than a conventional recession, then it’s not clear that monetary policy would have sufficient space.”
The outgoing governor warned that the global economy is heading towards a liquidity trap, which occurs on the rare occasions when monetary policy loses its effectiveness to manage economic swings and looser policy does not encourage additional spending.
To avoid this scenario, Carney said there was a need to look at supplements to monetary tools, ranging from interest rate cuts and quantitative easing to guidance on future interest rates.
Avoiding the possibility of a downturn
Carney’s opinion that government’s should consider fiscal policy tools such as tax cuts or public spending increases when tackling a downturn are shared by other central bankers including European Central Bank’s Mario Draghi and his successor, Christine Lagarde.
Then again, he said monetary policy was not yet a spent force internationally, with the US and Eurozone interest rate cuts last year encouraging borrowing and spending. “We’re starting to see that stimulus flow to the global economy.”
As for what options would be left for his successor Andrew Bailey, Carney said that they’d still be tools in the armoury. For example, the BoE could still cut interest rates from 0.75 per cent to close to zero and “supplement monetary policy with macroprudential tools” by relaxing the capital requirements of banks to enable them to lend more.
What does it mean for the UK’s post-Brexit economy?
In spite of concerns about the possibility of a downturn, Carney believes that the City should be optimistic about its prospects after Brexit. He also noted that there was no point in London, as one of the world’s major financial centres, being a rule taker from Brussels.
He urged the UK government to avoid aligning its financial regulations with those in the EU for better trade terms after Brexit.
“It is not desirable at all to align our approaches, to tie our hands and to outsource regulation and effectively supervision of the world’s leading complex financial system to another jurisdiction,” he said.
Another area where the City of London could profit from Brexit would be helping to finance and accelerate action to mitigate global warming. Carney described this as a “huge commercial opportunity,” as the City could finance the transition to a low-carbon economy in place of some EU activity.
However, he recognised that the financial sector was not a substitute for effective policies at the national and international level.