# Mervyn King on Brexit, crisis supervision, economic rebalancing and reforming the IMF

The former Bank of England governor discusses Brexit, radical regulatory reform, the difficulties rebalancing the European and global economies and an overhaul of the International Monetary Fund

What do you make of the 'surprise' UK referendum decision for the UK to leave the European Union?

I deliberately stayed out of the campaign, as I did not want to make life difficult for my successor, and nor am I prepared to say much after the event. But the way the government conducted the campaign turned out to be counterproductive. As I travelled the country, the word that came up most frequently was 'scaremongering'. They could see it on both sides. People wanted to be given arguments and facts in a calm, measured way so they could make up their own minds. But they were not treated like that. Much of the campaign was insulting to the intelligence of the voter. The bewilderment and disbelief by those who voted to remain [in the EU] reflect how out of touch they have been for a long time with many people around the country, especially outside London. That's a lesson that needs to be learned. It was a real contrast from the dignified, honourable and straightforward statement from [then prime minister] David Cameron on the Friday morning [June 24] in which he resigned. He said: "We have the result. We must make it work." That's the only sensible reaction to this.

Does Britain's exit from the EU – or 'Brexit' – provide an opportunity for the UK economy to be rebalanced?

The UK economy has to be rebalanced one way or another, 'Remain' or 'Leave'. We need a level of the exchange rate of sterling much closer to the level we had in the middle of 2013. The fall in sterling we've seen since the vote has merely brought the effective exchange rate of sterling back to its level in mid-2013. That rose by over 16% between the middle of 2013 and late 2015, and was very unfortunate in terms of our ability to rebalance the economy. We are now in a better position to rebalance the UK economy.

What would be the main priorities of the UK's negotiation with the EU?

There are four areas where it would be sensible to have in separate baskets. One is trade negotiations relating to trade in goods and services. Second is a separate basket on financial services. That's going to be a highly politically sensitive area. The third is agriculture because we will have an opportunity now to recast the way in which we construct subsidies for agriculture. There is no reason why we should stick with the EU-type subsidies, even though vested interests will argue for it. The fourth area is Northern Ireland, something that received far too little attention in the campaign. People in Dublin are nervous about what Brexit means for the broader UK, as we will now have a land frontier with the EU. We need to think through very carefully what this means for a whole range of policies – not just security and border control, but also tariffs in general and addressing electricity pricing. This is an opportunity to have a greater collaboration between north and south.

What did you think of the Bank of England's (BoE) immediate response to Brexit?

The Bank approached it in the right way, which was to make a short statement – these are not occasions for lengthy press conferences – to reassure everyone that there is no threat to the financial system, and I don't think there is a threat. Then it is a question of business as usual. Monetary policy carries on, and that's the right thing. An unfortunate aspect of the campaign were government forecasts of what the consequences of Brexit might be, which inevitably were highly speculative – in particular for the long run. The problem is that the long run judgement then feeds back to the short-run forecast because it was assumed that people would anticipate the long run. The only honest answer about the long run consequences is we don't really know. If businesses are transacting with each other now, buying and selling from each other, they'll want to do it today as they did last week. There's no immediate change in this. I do think it is possible to find a way in which most trade carries on. Businesses want to do it, and it would be very difficult to stop them doing it. You can't rule out that Brexit is going to have an impact on the level or growth rate of UK GDP, but it isn't a certainty or a fact. Nor in the long run is it very plausible. The mistake of the 'Remain' campaign was to portray these extreme outcomes in the future almost as inevitable, rather than what they were, which were highly speculative forecasts.

People in Dublin are nervous about what Brexit means for the broader UK, as we will now have a land frontier with the EU. We need to think through carefully what this means for a whole range of policies

What should members of the BoE's monetary policy committee be thinking at a time when people are looking towards them to do something to calm markets?

I'm not sure that they should be looking at them to calm markets. The Bank has already done that. It would be a mistake is to jump up and down and say: "Don't worry, we're in charge" – and create a sense of excitement that's not appropriate. The Bank has made it clear that it is monitoring what's going on very carefully, and stated that the banking system is more stable than it was before the financial crisis. The markets are being driven very much by politics – after all, the political events were wholly unprecedented and quite remarkable. At a time when the country needed senior politicians to work together, the last thing you wanted was for them to be utterly absorbed in intra-party fighting. The Bank will try to show it is business as usual and set monetary policy in light of the judgement about the risks in the future.

Major central banks have cut rates (with some now negative), deployed quantitative easing (QE) and there is now talk of 'helicopter money', which you appear to believe is the combination of tax break plus QE. They all seem to have diminishing returns. Should they give up on these policies?

No, they shouldn't give up on them, and I don't think they are. But people must come to the realisation that these policies will not be sufficient to generate a sustainable recovery.

[US economist] Larry Summers has a nice phrase when talking about the US: "We got into this crisis through too much spending, too much borrowing; and the only way to get out of it now is even more spending and even more borrowing." What he means is that the correct short-term response was to be willing to use monetary and fiscal policy to stimulate the economy, and that was absolutely right. It's what countries did in 2009 and 2010. At that point, it became pretty clear that there were other considerations. The phrase that Larry uses is another way of saying there may be an argument for taking one step back to take two steps forwards, but it is a step backwards. It's going in the wrong direction. Ultimately, other policies are required to ensure that you can go forwards. We can't keep taking steps backwards.

The reason easy monetary policy is not generating a sustainable recovery is because we're not facing temporary headwinds in the economy. We're facing the need for a significant, permanent rebalancing of our economy. That requires a much wider configuration of policies. It would be wrong for central banks to say: "This isn't producing a recovery, so we'll raise interest rates". You need other policy measures to be taken so that central banks then feel it's natural to raise interest rates. That's what needs to be done. Just relying on easy monetary policy won't get us there.

Mervyn King is the former governor of the Bank of England and chairman of its Monetary Policy Committee from 2003 to 2013. From 2011, he was also chairman of the Global Economy Meeting and the Economic Consultative Committee hosted by the Bank for International Settlements. In 1991, he was made the UK central bank's chief economist and executive director, before being promoted to deputy governor in 1998, a role he held until 2003.

King received a first-class degree in economics in 1969 from King's College, Cambridge, and an MA from St John's College, Cambridge, and Harvard (as a Kennedy Scholar). King now lectures at New York University's Stern School of Business and School of Law as a visiting professor and is a school professor at the London School of Economics.

He was appointed a life peer by Queen Elizabeth II, taking the title Baron King of Lothbury in 2013, and a Knight of the Garter in 2014. King is the author of The end of alchemy: money, banking and the future of the global economy (2016), which details his reflections on banking and money garnered from his near 50-year career.

Have central banks hit their monetary policy limits?

They are approaching the limits, and I'm not sure that much more easing will achieve very much. It might achieve a little bit, but it simply is not going to provide the ultimate solution. It's another step backwards. At this point, central banks probably need – even more strongly than they have been doing – to say: "We're not the only game in town. We can't be the answer to this. What monetary policy does is to buy time to enable you to put right what was wrong." The trouble is central banks have bought almost eight years, but nothing else has really happened. In part, this is because the models used by monetary economists and central banks may be useful in certain circumstances, but I don't think they're helpful now.

Why are the models not helping?

The models assume the shocks that hit the economy are temporary in nature, that they will eventually go away. These headwinds will disappear. But we're not facing temporary headwinds. I became less and less satisfied with the assumption of the simple models we used, whether it was in monetary theory or in terms of the econometric models the people at central banks were using. There were assumptions built into those models that were driving the results, and actually they were not useful models for the problems at hand. Models ought to be regarded as tools in a toolbox. No good workman carrying a toolbox around to go to people's houses to solve problems would ever dream of entering, saying: "Well I've only got one tool here, so let me find something in this kitchen that I can use the tool on." You have a whole box of tools, and you say: "There's the problem. What's the right tool for that?" That's the approach that needs to be adopted. It got turned on its head, with economists becoming infatuated with particular models and then insisting that the world had to be fitted into the model. That has been very damaging, and it is part of the reason why a lot of people still think the problem facing central banks today are headwinds and, by assumption, these headwinds are temporary. There's no reason to justify that assumption, and it is stopping people from seeing what is really going on.

The crisis revealed that many people had been spending more than they could justifiably spend, given their expectations about long-run income. They have lowered their level of spending with the realisation that the period of stability we had before the crisis wasn't sustainable. We confused stability and sustainability – perfectly understandably, in some ways. After the volatility of the 1970s and 1980s and the period of high inflation, we had achieved what looked like a highly successful macroeconomic outcome. It was stable, but it wasn't sustainable. The financial crisis revealed that clearly to people, so a lot of them lowered spending. In those parts of the world where spending could and should have risen – countries such as Germany, the Netherlands, China, some other Asian economies – domestic demand was suppressed by strategies of export-led growth. Although countries such as China, for example, said they had a clear plan to rebalance their economies and rely less on exports and more on domestic spending, in practice, hardly any resources have switched from the export sector to produce goods and services for domestic consumption. These changes will have to come at some point. Monetary policy is not sufficient. Obviously, monetary policy has been necessary, but it hasn't been sufficient.

But has loose monetary policy been necessary?

We would have had even weaker demand and output otherwise, even though we are now at a point where monetary policy has diminishing returns and is not going to achieve much more. There is a debate about the use of fiscal policy, and the appropriateness of its use depends on the individual country. It's fascinating to hear talk about helicopter money, because some people seem to believe it is possible to create an asset without a liability. There's only one natural law in economics. That's the law of double-entry book-keeping. You can't abolish that.

Do you think the regulatory reform, Basel III in particular, has value?

A lot of good, well-intentioned people are working hard to try and make it operate. But I was struck by two things after the crisis. The first was that the Basel framework in place before the crisis was flawed – not because of any incompetence on the part of the people responsible for it but because a crisis almost by definition occurs when something unexpected happens. The risk weights and the other regulatory details are not able to anticipate that. So a system that depends on getting that detail right doesn't make much sense. You need something much more robust. That's why I favour a simple leverage ratio – not so much as a backup, but actually as the main method of deciding how much equity finance banks should issue. We should not worry too much about what happens when banks are not actually at risk of failure. Regulators should worry about them only when there's a risk of failure.

Having a sufficiently large equity cushion will lower that risk of failure. The second thing that struck me was that many of the important financial centres decided that the whole complicated, bureaucratic, and inevitably slow, exercise of getting agreement across a large number of countries was not well suited for them. They would deviate from the minimum capital requirements from Basel and impose their own higher ones. This was something that no one had really anticipated before. The idea was that Basel would set a level playing field – it all started due to the concern that Japanese banks were able to operate with lower capital requirements and hence expand their business abroad.

This was completely turned on its head after the crisis, when countries like the US, the UK, Sweden and especially Switzerland, decided it was in their own self-interest to have higher and tougher capital requirements than the Basel minima. It was good for their banking system to be seen as safer, and made it easier for the banking system to attract funding and to get customers. With better access to funding, they were more able to lend to the real economy. This is likely to continue. You also see a wave, particularly in the US, towards the 'subsidiarisation' of foreign banks, so there is no reliance on overseas regulation.