Recruit Bond Markets to Reset U.K. Fiscal Policy
If Chancellor of the Exchequer Philip Hammond is serious in his pledge to “reset” fiscal policy, here’s a suggestion: Co-opt the bond market to fund a much-needed revival of infrastructure investment.
Public investment in the U.K. has dropped markedly since the free-spending days of the 1960s and 1970s, and has been stuck at about 4 percent of gross domestic product for most of this decade. This chart, compiled by economics writer Chris Dillow, illustrates how the gap between public and private spending has grown as austerity took hold in recent years:
In the wake of the decision to leave the European Union, however, that rise in business investment may be reversed. The British Chambers of Commerce said earlier this week that its members are reporting “muted business investment intentions.” The lobby group said “final and irrevocable decisions on infrastructure projects, both big and small,” would boost business confidence.
In many ways, the U.K. was the poster child for economic austerity. Despite a succession of restrictive, cost-cutting budgets under the previous governments, the economy seemed to be humming along just fine. But the change of government and the uncertainty unleashed by Brexit now puts Britain at the forefront of a global debate about whether increased government spending can stimulate growth when monetary policy has run out of steam.
Hammond has given himself elbow room to invest in infrastructure by abandoning a pledge to erase the country’s budget deficit by 2020. Now there's an opportunity to create a new class of government debt -- infrastructure bonds -- specifically to pay for those investments.
In return for providing long-term funds, investors could be rewarded with higher interest rates on infrastructure bonds than they can currently get on existing U.K. government securities. The government might also structure the securities so that there’s a tax break available for retail investors willing to participate in the program.
Martin Gilbert (no relation), founder of the $390 billion investment firm Aberdeen Asset Management, told me last month that he’d expect yield-starved money managers to be enthusiastic buyers of infrastructure bonds. With 10-year U.K. government debt yielding just 1 percent and even 30-year gilts offering less than 1.8 percent, it wouldn’t take much of a premium to seduce buyers while still borrowing cheaply:
That borrowing environment should prove irresistible to the government, which has hinted strongly that a fiscal reboot is coming. Soon after becoming prime minister, Theresa May referred in a speech to the need for “more Treasury-backed project bonds for new infrastructure projects.”
When May talks of investing “in the things that matter, the things with a long-term return,” she’s referring to projects such as the planned high-speed rail links in the north of the country that won’t just create jobs during their construction, but will also help to rebalance the country’s economy by fostering business development outside of the southeast.
Stephen King, senior economic adviser at HSBC, sees a way of addressing the unequal way the benefits of quantitative easing have been distributed across the country. In a piece for the Financial Times on Tuesday, he recommended a “gilt purchase fund” at the Bank of England, with the proceeds to be used by the government “to stimulate spending directly” by cutting taxes or investing in infrastructure:
The BOE would still enjoy monetary ‘dominance’ over the fiscal authority -- there would be no open cheque book -- but its gilt purchases would have a more effective immediate impact on economic activity. And, by having a say in the ‘distribution’ of monetary stimulus, the government could claim to have made monetary policy both fairer and more effective.
The recent collapse in the British pound will stoke inflation, inhibiting the Bank of England’s scope to cut interest rates further. That increases the pressure on Hammond, who is scheduled to make a statement on his economic agenda on Nov. 23. He should spend at least part of the next six weeks canvassing the investment community. As he noted last week, spending on economic infrastructure could have a positive impact on productivity performance, where the U.K. is a laggard. The Chancellor shouldn’t waste the opportunity.
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