Renewed Interest: The role of monetary policy in crisis and beyond

Published on Public Finances and the Economy

Interest rates are at an all-time low. The Bank of England’s base rate is about to enter its eighth year at 0.5 per cent – the lowest level in its history and its longest period of non-movement since the Second World War. Yet still UK inflation remains well below its 2 per cent target, bumping along around zero for much of 2015.

This report considers the potential scale of lost headroom facing the Bank of England and some of the prospects for dealing with a new lower rate environment. We set out a number of illustrative examples which highlight the importance of conventional monetary policy after 2008, the extent to which it looks to have been blunted and the probability that policymakers will run out of road over the next decade.

  • Monetary loosening undoubtedly played a vital role in supporting the UK economy following the onset of the global financial crisis in 2008. Yet it has been a sometimes uncomfortable experience. Having crashed into the zero lower bound, the Bank had to embark on a largely untested programme of QE – with the ultimate effects of that policy still not being fully understood.
  • In this report we have shown that there is a very real chance that the Bank will face the zero lower bound again in the future – quite possible within the next five years. When it does, it may find that conventional rate movements generate much smaller effects than was the case in 2008-09.
  • With much clearer sight of the problem this time round, there is an opportunity to prepare by considering just what non-rate based mechanisms central banks can turn to. There are no easy answers – new tools will be, by definition, unconventional – but the question at least needs to be asked.