The Bank of England should act aggressively because the economy faces serious risks from the coronavirus, a top policymaker has warned.
“It is safer to err on the side of easing somewhat too much, and then if necessary tighten as capacity pressures eventually build, rather than ease too little and find the economy gets stuck in a low inflation rut with increased hysteresis costs,” said the member of the Monetary Policy Committee, referring to the risk of people losing their jobs and being stuck out of work for years to come.
He said that it is possible the economy will recover more quickly than in a "usual" recession because unemployment was low at the start of the year, debts have not grown excessively, and the crash has been caused by a pandemic rather than economic factors.
However, he warned there was a serious risk of a slow recovery that could “scar” the economy and the workforce for some time to come, pushing him towards a looser monetary policy.
“The more that uncertainty and caution weigh on spending, the greater the likely extent of persistent scarring on potential GDP through high unemployment and business failures. In turn, the greater the loss of potential GDP, the greater the likelihood that consumers and businesses downgrade expectations for future income gains and hence cut spending,” he said.
“If unchecked, there are risks of a vicious circle, whereby the economy gets stuck in a self-feeding loop of weak activity, pessimistic expectations and low investment.”
As a result, “risk management considerations favour a relatively prompt and aggressive response to downside risks”.
Similarly he said there appeared to be very little risk of inflation taking off, given oil prices were so low and the large number of workers on furlough or with reduced hours meant there was much slack in the economy.
Mr Saunders said that more quantitative easing may not have a huge impact on interest rates in financial markets, but it was still worth voting for £200bn of QE in May’s meeting.
“There would still be advantages in further asset purchases in terms of keeping gilt yields low and avoiding an undesirable tightening in financial conditions which otherwise could hinder growth,” he said on a webcast.
The lower band to which interest rates could be cut was regularly under review, Mr Saunders added. “Negative rates are a tool that requires careful assessment. I wouldn’t rule it out, but that doesn’t necessarily mean I would rule it in either.”