Central banks becoming hooked on stimulus, Mervyn King says

The spectre of a post-pandemic burst of inflation has been raised by the former Bank of England governor Mervyn King, as he warned central banks and finance ministries were in effect becoming hooked on stimulus.

In a thinly veiled attack on the $1.9tn package of measures announced by Joe Biden, King said policymakers provided extra support in the bad times but were reluctant to withdraw it in the good times.

King, who left Threadneedle Street in 2013, said the case for record low interest rates and fresh government support was rapidly diminishing as Covid-19 lockdown measures were relaxed.

His comments on the risks of inflation are at odds with most members of the Bank’s nine-strong monetary policy committee, though in tune with the thoughts of its chief economist, Andy Haldane, who has also warned of cost-of-living pressures as pandemic measures are eased.

The International Monetary Fund last week revised up its forecast for US growth this year to 6.4%, partly in response to Biden’s Covid relief package, but King said there ought to be “no argument for a dramatic set of expansionary policies” coming out of the crisis.

“Given that central banks have already introduced expansionary monetary policies last year, and are going further, what on earth is the case for a further fiscal expansion?”

King’s comments come after the former US Treasury secretary Larry Summers, who was also a top adviser to Barack Obama, said he felt Washington was deploying the “least responsible” tax and spending policy in four decades, which could lead to the economy overheating and wasted resources.

Speaking at the Royal Economic Society’s annual conference, the Bank’s former governor said there was growing evidence that the productive capacity of the UK economy had been maintained during the Covid pandemic, which would help to kickstart growth after restrictions were relaxed.

“Once you’ve decided to relax restrictions and let the economy come back to normal, that is the time when you want demand to pick up. Everything we see around us suggests it will pick up quite rapidly,” he said.

While some economists are concerned about rising inflation as lockdown measures are relaxed, others fear there will be long-term scarring to the economy and greater risks from withdrawing emergency support too soon.

However, King said he believed governments should focus on providing targeted assistance for workers and businesses that have suffered most during the crisis using the tax and benefits system rather than stoking overall demand by pumping billions into fresh stimulus programmes.

He said keeping interest rates at rock-bottom levels could prove counterproductive, and suggested governments and central banks appeared incapable of stepping back from providing emergency support.

Threadneedle Street cut interest rates to 0.1% last spring, the lowest level in its 327-year history, attempting to support households and businesses with lower borrowing costs as the crisis spread.

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“What we’re confronted with now is a world in which policymakers seem to behave as if whenever there’s a bit of bad news, we inject a lot more money into the economy, we have more fiscal stimulus, but when things return to normal we don’t withdraw it,” King said.

“This ratcheting up of central bank balance sheets and government balance sheets, I think, is a real problem for the future.”

King said “zombie companies” were being supported by low borrowing costs and needed to be “allowed to fail” to help a more efficient allocation of resources as the economy adapted to a post-pandemic world.

“People have failed to recognise that the problem is one that can’t just be solved by even lower interest rates or even more fiscal stimulus,” he said.