IPPR is calling on the Chancellor to introduce active fiscal policy to boost demand and compensate for reduced business investment in view of exit from the European Union.

Chancellor should remove public investment from deficit targets and aim to reduce debt over a longer time horizon. Government should intervene to stimulate demand, and increased spending should take the form of investment to improve long term productivity. On Thursday, the Bank of England announced a further cut in interest rates but this will not be enough to arrest the effects of Brexit – and neither is simply more of the same quantitative easing (QE). 

The Bank’s decision will come after poor PMI data published last week showed reduced activity across the UK economy in July. With interest rates already so close to what economists describe as the effective zero lower bound – the point beyond which further cuts provide little additional stimulus – the Bank is unable to provide a sufficient response through conventional policy alone. Alfie Stirling, IPPR Research Fellow in economic policy, said: “At this stage, further cuts in interest rates can only get us so far before they fail to boost the economy at all and even start to cause harm. Relying on monetary policy alone to keep the economy on track after Brexit is like trying to stay afloat in a storm with one hand tied behind your back. The Chancellor has already hinted he will ‘reset’ government spending policy – but he must be prepared to do this properly. It is not enough to wait for the economy to stall, and then simply borrow more to cover the costs of increased welfare and reduced tax receipts. We need to use government spending as a preventative measure, like interest rates, to keep the economy moving.”

Given interest rates are already so low, the Bank could respond by announcing further QE – buying up more government debt to pump money into the financial markets, effectively lowering interest rates indirectly. But standard QE can prove poorly targeted, while it also relies on market mechanisms that work less predictably during economic stagnation or recession. The cost of UK government debt has fallen since Brexit as safe assets such as Treasury bonds have become increasingly attractive to investors. This means the cost of public borrowing is low, with interest rates on ten year bonds falling to below 1 cent since the referendum. 

IPPR is calling on the Treasury to take this opportunity to actively support the Bank of England:

• If the OBR confirms the UK economy has experienced a shock, the Chancellor should set out plans to remove public investment from deficit targets and target debt reduction over a longer time horizon.
• Increased public investment should be focused on improving productivity over the longer term by spending on physical and digital infrastructure, such as housing, transport and improved broadband connectivity.
• The government should launch a review to explore the best way of accounting for investment in human capital. Those areas of expenditure – such as some elements within education, skills, employment programmes and health – that pass a tight set of criteria such that they can be shown to boost the productivity of our workforce should be treated as a form of investment spending.

The Treasury can also do more beyond increasing investment:

• Instead of ruling out tax rises, as the Prime Minister has suggested, the Chancellor should set out a review of the UK tax base.
• Revenue streams from wealth should be expanded, and inefficient tax reliefs – such as those on buy-to-let mortgages, some elements of capital gains and pension contributions for high earners – should be revisited to avoid further cuts.
• Where appropriate, the Treasury should also consider new mandates for the Bank of England that allow for more innovative forms of QE that find their way quickly into the real economy.