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Rachel Reeves was in full Iron Lady mode when she delivered her Mansion House speech to the City’s finest this week. Regulation was acting like “a boot on the neck” of business, choking off enterprise and innovation. Cutting red tape would have a “ripple effect” on the whole economy. Regulators should not give way to the temptation of “excessive caution” but instead boldly regulate for growth. It could have been any Tory chancellor since Nigel Lawson speaking.
If Reeves seriously believes this stuff she is heading for a rude awakening. Chancellors don’t need a crystal ball to tell them where financial deregulation leads; they can read the many books detailing what happened last time this was tried. The global financial crisis of 2008 came about because policymakers bowed to the pressure from big finance to sweep away “burdensome” regulations, pledging that more funds could be channelled into productive investment as a consequence.
Instead of providing backing for startup businesses, easy money led to ever more reckless speculation and a giant credit bubble. The inevitable crash led to a deep recession, the bailout of the banks and – in a textbook example of shutting the stable door after the horse has bolted – a tightening of regulations.
By that point it was clear the Thatcherite experiment had failed. Britain’s manufacturing sector struggled while finance became an end in itself, abandoning what should have been its prime function: providing long-term capital for businesses. In their haste to liberate the economy, Thatcher and her supporters had ignored the warning delivered by Keynes in the 1930s. “Speculators may do no harm as bubbles on a steady stream of enterprise,” Keynes said. “But the position is serious when enterprise becomes the bubble on a whirlpool of speculation.”
It is possible that Reeves is softening up the City with some deregulation now before walloping its high rollers with higher taxes on wealth in the autumn budget. If so, she could justifiably argue that the better-off were the main beneficiaries of rising share and house prices as a result of the £900bn pumped into the economy by the Bank of England through its money creation programme. The FTSE 100 rose above 9,000 points for the first time this week.
But while it would be nice to think the Mansion House speech was part of a cunning plan to squeeze the rich, it doesn’t feel that way. A more likely explanation for her deregulatory zeal is that the chancellor fears the economy is becoming stuck in a doom loop and in those circumstances any growth is better than no growth.
Reeves is right to be worried because the economy is not in a good place. Activity as measured by gross domestic product contracted in both April and May, while inflation picked up to 3.6% in June.
The increase in employers’ national insurance contributions has made businesses reluctant to hire and the public finances are in a bad state. Borrowing is high and the U-turns on the winter fuel allowance and welfare payments, coupled with weak growth, mean Reeves is on course to break her self-imposed fiscal rule.
To avoid doing so will require tax increases – and over the next few months there will be endless speculation as to how much will be raised and who is going to pay it. This is a rerun of last year, when the prospect of higher taxes hit both business and consumer confidence, slowing the economy in the process. There is an obvious risk that higher taxes stall the economy, adding to pressure for further austerity measures. Hence the doom loop.
Borrowing more so that tax increases can be avoided might sound attractive but is fraught with risk. The bond markets have been keeping a close eye on the UK ever since Liz Truss’s disastrous premiership three years ago, and if Reeves did decide to break her fiscal rules the government would almost certainly end up paying more – and possibly a lot more – in debt interest. Historically, Labour governments have been at their most vulnerable to a financial crisis in their second and third years.
So, it’s not hard to see why stronger growth is a more attractive option for the chancellor and there are ways of getting it. For a start, the Bank of England needs to sharpen up its act. With the economy on the brink of recession, the Bank’s monetary policy committee should be cutting borrowing costs by more than 0.25 percentage points each quarter.
Threadneedle Street is also making life more difficult for Reeves by gradually selling back the bonds it bought under its quantitative easing programme in the 2010s and early 2020s. This is leading to lower bond prices and higher government debt interest costs than would otherwise be the case. This process – known as quantitative tightening (QT) – should be halted.
It is also absurd for the government to be proposing cuts in welfare while the commercial banks are being paid interest at 4.25% on their risk-free reserves being held at the Bank of England. In 2023, NatWest, Barclays, Lloyds and Santander received more than £9bn between them – a rise of 135% on the previous year. There are far better uses for this money.
Reeves could order the Bank to halt QT and she could stop the payouts to the commercial banks. Judging by her Mansion House speech she would rather rely on the financial sector to dig her out of a hole. Good luck with that, chancellor.
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Larry Elliott is a Guardian columnist
