Is Osborne being squeezed from all sides?

Vincent Cable. Photograph: David Levene

The FT reports that “cabinet ministers”  - it’s Vince Cable, everybody knows it’s Vince! – are looking into completely nationalising RBS and setting it to work directly lending to firms in an effort to boost growth. It would cost £5bn to buy the remainder of RBS and the betting I expect is that this would be paid for several times over if the purchase leads to even a modest increase in growth. Yet, this is the same Vince Cable who asked “What tools does the Government have?” and responded:

The first is continued use of monetary policy, and stronger communication of the policy aim it is meant to achieve – robust recovery in money spending and GDP.

This is what has confused me. Taking over RBS seems to be a losing proposition because were RBS – or the newly formed national investment bank – to boost lending it would eventually lead to firms expanding production and hitting bottle necks. Those bottle necks would cause price increase and those price increases would lead to tightening from the Bank of England. The action would be entirely self defeating.

There seems to be only a couple of ways to explain Vince’s economic policy in view of his previous comments. One is that there is a supply side problem in the banking system. The banking system is currently in a stable equilibrium where no banks are lending much and it doesn’t make commercial sense for any bank to break ranks because unless others join and encourage growth it will fail. The government is there to overcome this and move the banking industry to a high lending equilibrium. Overcoming this problem would actually lend a deflationary pressure to the economy by improving productivity and encourage more stimulus from the Bank of England.

The second justification for Vince’s policy is that no longer doesn’t believe that changing the Bank of England’s mandate to target nominal GDP is enough. Given Vince’s past comments I don’t think either explanation for this policy is really convincing. Vince has always emphasised the Chuck Norris effects of a NGDP target for the Bank: communication is the tool, not the banking channel. I then got reminiscing and thought…where had I heard of combining a nominal GDP target with directed lending to firms…why its good-egg of the liberal blogosphere and coalition apparatchik Giles Wilkes’  Centre Forum paper “Credit Where it’s Due” of course!

It looks like what is being discussed is the second plank of Giles’ prefer policy:

The Bank should start by targeting a high level of nominal growth until the economy is performing at its potential. This will reassure the private sector that liquidity won’t dry up in the near future, and so encourage more investment now. The second step should be for ‘credit easing’ to replace ‘quantitative easing’.

But why start with the second, less potent policy? Politics.

Then it occurred to me. George Osborne is facing as much pressure  to change course from within the Cabinet as from without.

It looks like a rearguard action is being fought within the Government to upset Osborne’s deficit cutting and investment cutting first policy platform. This is unsurprising, the coalition is presided over a lost decade in progress and that does terrible things for your reelection chances, especially for the Lib Dems.

As I’ve pointed, ad nauseum, the Chancellor can change the Bank of England’s mandate to adopt NGDP level targeting at any time, but there are political risks to doing anything unconventional and Osborne seems loathe to deviate from the script. Osborne is very much a part-time Chancellor but he is a full-time political operator.

Perhaps there is a worry in Government that changing the Bank mandate alone will be insufficiently convincing for firms and markets, it may be that this policy is a supporting plank of one that will be much more effective. And perhaps, more importantly, there is a worry in parts of government that they will not be able to convince another part of government change the Bank’s mandate unless the groundwork has been laid to make it politically acceptable.

So although the nationalisation of RBS may prove good policy in the end, it may be that its political power is more important than its economic significance. Although it doesn’t strike me as necessarily the best way run a bank, given that we’re already screwed and convincing expansionary monetary policy is our only hope, I’ll see how this one plays out.

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One thought on “Is Osborne being squeezed from all sides?

  1. Interesting post.

    The view on the banking sector as a supply-side constraint is an interesting one, that seems to be the Posen view and one perhaps shared more widely in the Bank – in the July minutes there is a reference to the “Funding for Lending” scheme having a possible affect on aggregate supply as well as demand.

    But I guess I’d say we should resist the temptation find “structural issues” to explain weak demand. Weak demand is weak demand. The banking sector was totally fucked in March 2009 and demand stimulus worked then.

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