Business

What can the UK do to kick start the recovery?

Women cranking up her car in 1916
Image caption What will it take to get the economy going again?

The UK's life signs are worrying.

Consumer and business confidence has slumped, unemployment is rising again and consumer spending and manufacturing output are falling.

The Bank of England and the Treasury are being forced into awkward U-turns.

While in the spring, the Bank's Monetary Policy Committee had been leaning towards a rate rise, now the talk is of pumping more cash into the economy.

Meanwhile, it appears that the government is privately questioning whether its unwavering "Plan A" for austerity may after all need some kind of tinkering to soften the blow to economic growth.

But what are the policy options available to the UK if the slump deepens?

Printing money

With short-term interest rates already at a minimal 0.5%, the Bank of England's remaining policy options primarily involve creating and distributing more money.

There is no limit to how much cash the Bank can print, but what does it spend it on?

So far, the focus has been on government debt.

The idea is that this pushes asset values up and longer-term interest rates down, which makes borrowing cheaper and encourages investment.

The Bank could be more aggressive in its strategy, for instance by lending the money directly to those who most need it, such as small businesses.

But with consumer spending so weak, banks, investors and businesses may be too pessimistic to put their money to work in the economy, preferring to sit on the newly-created cash, even if it earns no interest.

This problem - named the "liquidity trap" by Depression-era economist John Maynard Keynes - reduces the Bank's money printing to an exercise in futility, like pushing on a string.

Stoking inflation

Some economists suggest that in such circumstances, a central bank should give people who hoard cash something bigger to fear - inflation.

Rising prices might encourage them to do something more useful with their money.

Moreover, when prices and - crucially - wages and property values all rise in tandem, it steadily makes debts more affordable, encouraging people with big mortgages to start spending again.

But, even assuming a bit of inflation would help - and many economists dispute this - achieving it is a different matter.

The Bank needs to be seen as capable of delivering on any promise to push up prices.

And with unemployment so high, it is hard to see how wages can rise more quickly, unless the government and the unions co-ordinated this across the economy.

Cutting red tape

There are plenty of calls from industry for simpler regulation.

The British Chambers of Commerce wants employment laws softened.

Banks warn that if the government does not slow down the introduction of the ringfencing of their retail banking operations and tougher capital requirements, then it will crimp their ability to lend.

Meanwhile, the government is simplifying the rules for planning applications, and has actively sought ways to cut the burden of red tape, all in the name of growth.

But while there is certainly scope to encourage business spending, surveys suggest that what holds firms back most is weak demand.

Why invest in new factory capacity or building new homes, if nobody wants to buy what you are offering?

Indeed, banks claim that the main reason lending is not rising is because businesses do not want to borrow.

Cutting taxes

Tax cuts can run into much the same problem as the Bank of England faces.

It puts more money into people's hands, but are they actually going to spend it?

As mentioned above, businesses are in no hurry to spend.

However, it may make sense to target small businesses, many of whom complain they are short of cash and cannot borrow.

Small businesses also typically employ a lot more people relative to their turnover than big firms do.

For similar reasons, it may make sense to target income tax cuts at the poor, as high income earners typically save a larger share of what they earn.

However, even low earners may not spend all of the extra income, choosing instead to prioritise repaying their debts.

Borrowing and spending

The Keynesians say that in a liquidity trap - if that is what the UK is in - if nobody else will spend, then government must do so instead.

That boosts demand directly, and also puts money into the hands of the people and businesses employed, who can than spend more themselves, magnifying the overall effect on demand.

And by raising expectations about future demand, it encourages banks to lend, and businesses to borrow and invest, pushing the economy back into a virtuous circle of rising spending and incomes.

The government can currently borrow at almost the lowest interest rates in its history - a reflection of how muted market expectations for medium-term growth and inflation are.

Chancellor George Osborne has argued that the UK's low borrowing cost is because austerity has turned the UK into an international safe haven for investors - the implication being that a spending splurge risks the UK experiencing the same fate as Greece.

However, some economists argue that the real difference between the UK and eurozone countries is that Britain controls its own currency and therefore cannot run out of money to repay its debts.

That means Spain - which has lower debts than the UK - faces much higher borrowing costs because it poses a real risk of default, whereas for the UK the "risk" would be runaway inflation.

There is moreover an important distinction between short-term and long-term policies.

Insolvency (which can manifest itself in runaway inflation) is more a question of managing long-term spending commitments, for example by raising the state retirement age.

But addressing the current slump requires a short-term rise in spending.

An obvious candidate - and the one apparently being actively looked at by Whitehall - is infrastructure.

It helps the construction sector, which has been worst affected by the slump and therefore has the most spare capacity.

It should also increase the productivity of the UK economy, meaning that it ultimately pays for itself through higher tax revenue.

The government is said to be considering accelerating infrastructure spending equivalent to 0.35% of annual economic output.

However, there is a problem with infrastructure - it takes time, particularly if there are no "shovel-ready" projects available.