High debt heralds new rate policy: UK shadow chancellor

Britain's high levels of government debt will force a change in the way in which monetary policy is conducted, the UK's shadow chancellor of the exchequer, has said.

George Osborne, who has been shadow chancellor since 2005 and - if polls are to be believed - is set to replace Alistair Darling in May, said Britain's mountain of debt had risen to dangerous levels. He quoted a study by Carmen Reinhart and Kenneth Rogoff showing that once a national debt reached 90% of GDP an imminent risk of a debt trap emerged. Britain's was above that level already if various off-balance-sheet liabilities were included, he said, and was rising.

As a result, the debt would impact all facets of economic policymaking. "The long term implications for our economic policy framework of the crucial role of rapid debt accumulation in causing economic instability are profound," he said. "It forces a fundamental reassessment of the way we conduct both monetary and fiscal policy."

On monetary policy, Osborne pledged to keep the 2% inflation target if elected. But the shadow chancellor warned that he would talk with the Bank of England about including housing costs in the measure, which at present accounts only for consumer prices. For Osborne, the Bank had concentrated excessively on its inflation target, and this narrow focus proved insufficient. He urged much more attention be paid to credit flows, citing arguments of Jacques de Larosière who has said, most recently in an article in Central Banking journal, that central banks should pay more attention to growth of money and credit.

After monetary policy, he turned his focus to the regulatory framework. The current structure, for Osborne, guaranteed a poor outcome. Nobody was responsible for ensuring the monetary policy transmission mechanism was in working order, he argued, saying it was, therefore, essential that the Bank was responsible for micro-regulation of banks in order for it to take control: "Who can pretend that micro-regulation of huge banks like Barclays and HSBC does not have big system wide effects?" As chancellor, he would look at adjustable capital and liquidity ratios, he said. There would be a levy on banks. And he offered his support for the Volcker Rule, saying he would seek international agreement on structural reforms to prevent retail banks to engage in proprietary trading.

Osborne said he would also set up a fiscal council under Sir Alan Budd, a founding member of the Bank of England's Monetary Policy Committee, to provide an independent annual assessment of the UK's fiscal situation and prospects, and make recommendations to the government on tax policy, such as how much net tightening or loosening is needed. This would also prepare for the first time a fully transparent national balance sheet showing all government liabilities, including unfunded public-sector pensions.

He would also reform the public sector and listed a range of specific measures, including introducing a budget within 50 days of taking power to take immediate action to start curbing the deficit. It was too risky to wait, he argued, because investors might force action, raising interest rates, which are already rising at the long end, and prompting damaging panic action. He put maintaining Britain's credit in international markets at the top of his list of priorities.

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