The writer is a former deputy governor for financial stability at the Bank of England
Instead of focusing on whether Kwasi Kwarteng’s “mini” Budget will lead to the growth he desires, attention has rapidly and rightly shifted to financial stability. This should have been uppermost in the chancellor’s mind before he delivered his statement to the House of Commons on September 23, because without stability there will be no sustainable growth.
As deputy governor at the Bank of England in the years leading up to the 2007-09 global financial crisis, I worried about rising debt levels for the simple reason that history has shown that debt is at the root of all financial crises.
The reasons for my concerns then were twofold. First, stability demands that there should be a consensus that debts are sustainable. In other words, that debt can be serviced and repaid when due. Second, the consensus is always based on trust, and trust can evaporate rapidly and cannot be taken for granted.
In the lead-up to the crisis the worry was that debts within the financial system would reach a level where sustainability could become an issue; and that as the levels of debt rose, one day a shock or spark could ignite massive sales of debt instruments, triggering instability in the markets. We did not know what might light the spark but we worried that complacency would lead to the danger being ignored.
As a result, I took a hawkish stance on interest rates and was chastised by colleagues on the Monetary Policy Committee who told me that debt was of no consequence for monetary policymaking. My protestation that one day that same debt could lead to instability fell on deaf ears.
The financial crisis and its aftermath serve as a warning that sparks can appear unexpectedly, and that amassing debt without regard to mounting dangers is risky. Now once again the UK is in a perilous position. But this time the debt is not caused by overpaid bankers, but by the sovereign government itself. The spark has been the “mini” Budget.
It is extraordinary that more thought had not been given to the stability implications for trust and the impact on confidence in the markets of mounting levels of debt. How did it come to this? I see three underlying factors.
First, complacency about the implications of excessive debt has built up in the years since the crisis, when interest rates have been at or close to zero and the cost of debt has been low. Not only was this dangerous, it has also fed rising inequality as asset owners have been rewarded for little effort, with seemingly no impact on growth, and those without have felt left behind.
Second, we in the UK have been arrogant in forgetting that to a large extent our sovereign debts are provided by foreigners. They need to be convinced that government policies will make sense or they will flee. And third, the ideological approach taken by successive governments has rejected the advice of “experts”.
There is now a real risk that, after a long period of ignoring the implications of debt, we are in danger of moving from a gradual questioning — perhaps illustrated by the steady decline in the value of sterling up to the “mini” Budget — to a situation where there is a real and sudden loss of trust.
What is to be done? The Bank of England was right to take the calming measures announced last week. But it now faces the challenge of avoiding the calamitous outcome of monetary financing, where the central bank prints money to pay the government’s bills. In addition it will need to adjust rates, perhaps brutally, both to restore confidence further and control inflation.
But it is ultimately up to the government to take action to restore trust and avoid yet worse outcomes. The BoE cannot do more than calm the waters and buy time. For the good of the UK and its citizens I hope the government will remember that debt matters.
