The Bank of England should be set a 3% inflation target and given powers to crash borrowing costs below zero in response to future economic shocks, a leading thinktank has said.
The Resolution Foundation said Britain required a big overhaul of its economic toolkit to avoid decades of rising debt or austerity, and called for reforms at the Bank and the Treasury to get a “bigger bang for each buck”.
The report said the Bank’s inflation target set by the government should be increased from 2% to 3%, although only once the existing remit had been met to ensure inflation was brought under control.
Suggesting that Threadneedle Street lacked capacity to respond to future economic downturns, it also called on ministers to sanction the use of negative interest rates of up to -1%. This would mean charging commercial banks to deposit money with the central bank, instead of paying interest, in a policy designed to encourage lending and discourage saving.
In changes that would mark the most radical shakeup since Gordon Brown handed the Bank independence for managing inflation in 1997, the thinktank said Threadneedle Street had found itself boxed in for much of the past 15 years during a period of ultra-low interest rates.
Although inflation has soared to the highest level in decades after the Covid pandemic and Russian invasion of Ukraine, Resolution said there was a danger that future economic shocks would require a sharp cut in borrowing costs. Should inflation have a starting point closer to 3%, and with the ability to use negative rates, the Bank would have more capacity to respond.
The report also said a steady ratcheting up for government debt could limit options to respond to future downturns. If the UK stayed in a new higher interest rate environment over the long-term, with only debt reduced gently between recessions, the thinktank said the country’s ratio of debt to gross domestic product could rise to about 140% over the next half century.
It called for the Treasury to target a primary budget surplus - excluding debt interest costs – of about 1% of GDP to prevent the UK debt ratio from rising over time in the face of inevitable shocks.
The report said governments should also use “smarter” tax and spending policies in downturns to avoid driving up the national debt, suggesting that targeted, rather than blanket support schemes, could have saved £35bn during the response to the pandemic and cost of living crisis.
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James Smith, the research director at the Resolution Foundation, said a “reset” for policymaking was required. “This reset would ensure we can support the economy in bad times and fix the fiscal roof when the sun eventually arrives.”