HISTORICALLY low interest rates have delayed the rebalancing of the economy by keeping troubled firms afloat, the Bank of England’s chief economist warned last night.
In an unusual warning of the downside risks of ultra-loose monetary policy by a Bank official, Spencer Dale said Threadneedle Street’s stance could have “slowed the reallocation of capital and labour to more productive uses”.
He said: “[The] loosening also served to blunt some of the incentives driving the rebalancing of our economy… Likewise the lower level of borrowing costs and support for demand may have allowed inefficient firms to remain in business for longer.”
He added: “Rather than prompting households to save more, the low level of interest rates encourages people to spend more and save less.”
Dale also revealed that he is less dovish than his Bank colleagues on the Monetary Policy Committee.
“I think inflation is just as likely to be above as below the inflation target in the medium term,” he warned.
Nonetheless Dale, who was addressing a group of students at Aberystwyth University, insisted that the Bank is right to hold rates at historic lows and to expand its quantitative easing programme (QE).
“I’ve no doubt that had monetary policy not responded quickly and aggressively to the financial crisis, our economy would be in a far worse state today,” he said.
“But there is a limit to what monetary policy can achieve when real adjustments are required. The forces driving the adjustment need to be allowed to operate.”
The Bank’s Monetary Policy Committee, which Dale has sat on since the summer of 2008, has kept interest rates at 0.5 per cent for three years. The Bank is taking its total asset purchases to £325bn.
Consumer price inflation has been above the Bank’s two per cent target rate since November 2009, coming in at 3.4 per cent last month.
Dale said that the Bank is tasked with a “delicate balancing act between providing short-term support without stifling long-term change”.
“In this context, loose monetary policy can in part be thought of as a form of forbearance: putting off difficult changes and adjustments to a later day.”
The rebalancing of the UK economy requires greater exports and a reduced reliance on cheap credit, he said, as well as a higher savings ratio.
Dale foresees the end of the era of cheap money, and told the assembled academics that businesses will need to adapt.
“If it turns out – as I suspect it will – that the cost of credit enjoyed by many companies prior to the financial crisis was unsustainably low, then our industrial structure will need to adjust to a higher cost,” he said.
Calls for a move towards a stronger manufacturing sector are overly simplistic, Dale also argued.
“The traditional distinction between manufacturing and services is simply not meaningful in many successful companies today,” he said, citing Apple as an example of a consumer services firm, manufacturer and high tech designer all in one.