The Bank of England should be given the power to cut interest rates into negative territory and take steps towards a higher inflation target to help future-proof the nation’s finances in the event of further crises, according to a report.
The Resolution Foundation said the economic crises over the past 15 years have already seen the UK’s debt to GDP ratio soar from 36% in 2007 to around 100% – the largest peace-time rise in more than 300 years.
It is warning that higher interest rates are also cranking up the nation’s debt bill, with each one percentage point rise in rates adding around £15 billion to government borrowing in five years’ time.
The Bank of England needs greater monetary firepower, secured by enabling slightly negative interest rates and taking steps to move to a 3% inflation target if we return to an ultra-low interest rate world— James Smith, the Resolution Foundation
The think tank’s report, called Built To Last, predicts that the UK is heading for debt to rise to around 140% of economic output over the next 50 years, if rates stay higher for longer and following current fiscal policy plans.
It cautions that the cost of servicing this debt could reach 5% of GDP, which would be its highest sustained level in more than 70 years and more than the combined departmental budgets for energy, defence and transport.
If rates slump back down in the event of lower growth, the pressures on debt could be even greater, according to the report.
The Resolution Foundation’s research – the 46th report from The Economy 2030 Inquiry, funded by the Nuffield Foundation – is recommending a “reset” of monetary and fiscal policy to give monetary policy more scope to act in the event of a downturn and ease the pressure on the Government to support the economy through fiscal support.
It believes policymakers at the Bank of England should be allowed to cut rates into negative territory, by up to minus 1%, in the event of a downturn and to increase the inflation target to 3%.
But the inflation target should only be upped once the current 2% goal has been reached and if the UK returns to a low interest rate world, according to the report.
It added that governments must also develop fiscal policy tools to allow targeted support in the case of an economic crisis, rather than more expensive universal support.
James Smith, research director at the Resolution Foundation, said: “We need to reset the UK’s approach to macroeconomic policy.
“The Bank of England needs greater monetary firepower, secured by enabling slightly negative interest rates and taking steps to move to a 3% inflation target if we return to an ultra-low interest rate world.
“The Government should plan now to be able to provide more targeted support in future recessions, having overspent by £35 billion on poorly targeted schemes in the recent past.
“This reset would ensure we can support the economy in bad times and fix the fiscal roof when the sun eventually arrives.”
