Following the UK’s vote to leave the European Union a decade ago, the Bank of England moved swiftly to support the economy, lowering the base rate to a historic low of 0.25% at its August Monetary Policy Committee meeting. The decision came after an unprecedented seven-year period in which interest rates had been held at 0.5%, underlining just how dependent the post-financial crisis economy had become on ultra-loose monetary policy.
The post-crisis policy mix
In the years following the Global Financial Crisis, very tight fiscal policy was offset by exceptionally accommodative monetary policy. In simple terms, policymakers had one foot on the fiscal brake and the other on the monetary accelerator.
Governments, companies and households were all retrenching at the same time, which weighed on the real economy. Yet financial markets were supported by low discount rates, which helped raise valuations, and by quantitative easing, which encouraged portfolio flows into risk assets.
The unintended consequences of ultra-low rates
One of the ironies of this policy combination is that, while it may have helped stabilise economies and markets, it also widened the divide between those who owned assets and those who did not. Rising asset prices benefited the asset-rich, while savers and those without meaningful investments saw little direct benefit. This growing sense of inequality may well have contributed to the political environment that produced the Brexit vote.
Criticism of zero interest rates and quantitative easing has therefore continued to build. Beyond its impact on wealth inequality, ultra-loose policy has distorted risk-taking, placed pressure on pension fund solvency and accelerated the closure of defined benefit pension schemes. It has also allowed some weaker companies to survive despite poor profitability and stretched balance sheets, something that may have weighed on productivity growth across the wider economy.
The challenge for central banks
The difficulty is that the policy options available to central banks remain constrained. With government indebtedness still elevated, the next recession is likely to prompt calls for another monetary response, even if many of the side effects of previous interventions are now well understood.
For central banks, this creates something akin to the Hotel California problem: they can check out of extraordinary policy settings, but they may never fully be able to leave. The challenge will be finding a way to support economies in periods of stress without further entrenching distortions in markets, pensions and broader wealth distribution.
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