UK: New-Style ‘Corsets’ Face Old-Style Problems

Unaccustomed as I am to delving into the subject of what used to be called ladies’ foundation garments the time has come to to talk about the corset.

The corset, to avoid any misunderstandings or hot flushes, was the nickname given to a Bank of England scheme of the 1970s, intended to control bank lending. Under the supplementary special deposits scheme, banks were required to operate within limits specified by the authorities, and faced penalties for not doing so.

It lasted from 1973 to 1980, in three phases, and was not the only mechanism for controlling credit. Hire purchase controls, scrapped in 1982, set the proportion of the purchase price people had to put up before buying on instalment.

Mortgage lending was controlled by the simple expedient of rationing. Until banks were allowed to enter the mortgage market in the early 1980s prospective borrowers queued. I was once told by a building society – now a bank – I would have to wait two years for a loan.

The point of reviving these memories now is that they were all examples of what we now call financial policy. There is very little new under the sun, and there is nothing new about seeking to restrict lending growth by direct means.

Indeed, given the Labour party’s current shift towards direct interventions to tackle the “cost of living crisis” – though shop prices and petrol were 0.6% lower last month than a year earlier – maybe we should all be studying the 1970s.

The history of the corset was not a glorious one. It coincided with one of the most turbulent periods, until the recent crisis, in Britain’s modern economic history. It ran alongside very high interest rates. It did what you would expect any system of direct controls to do, encouraging lending growth to shift into other, non-controlled channels.

When it was abolished in 1980, provoking a row which meant Margaret Thatcher never really trusted the Bank again – it failed to warn her of the one-off boost to her precious money supply – that seemed to be that for such policies.

The corset was rendered redundant because lending could then as easily flow into Britain from foreign banks, or overseas subsidiaries of British banks. The Bank’s own assessment, in 1982, was that the corset “exemplifies the difficulties of relying excessively on direct controls on the banking system as a means of influencing monetary developments”.

I raise it now because there is a danger of repeating past errors. The Bank is once more concerned about lending excesses in the housing market. Its financial policy committee(FPC) will meet on June 17, and is set to announce measures to seek to cool housing lending.

The FPC’s next scheduled meeting after that, September 26, means those measures will be given a little time to take effect, after which there could be more. Its final quarterly meeting of the year is on December 8.

In some ways it is odd that the FPC is considering action to restrain mortgage lending. Its own figures show net mortgage lending in the year to March was up only 1.1%. A decade ago this lending measure was rising 15% a year.

I accept it is concerned about new lending, so gross lending may be more important, and it was up 31% in March on a year earlier. After a long period of mortgage famine, however, this only took it to £16.8bn, half its pre-crisis peak of more than £32bn in June 2007.

Will such measures cool the London housing market? Foreign buyers, cash-rich buy-to-let landlords and people getting hold of their pension pots to put into property mean the main effect of curbing mortgage availability would be to further limit the chances of genuine owner-occupiers. Reducing the scope of Help to Buy would be in irrelevance in London.

The prospect of success looks more remote than in the case of the corset in the 1970s. The market may slow, but not mainly as a result of FPC actions.

The Bank probably knows this but that will not stop it trying and the dangers are twofold. The first is that it will disappoint on house prices. Rising house prices have effects that go beyond financial stability. They have social consequences and may ultimately be inflationary.

The second danger, and this is the biggest, is that financial policy – direct measures – comes to be seen as a substitute for monetary policy; higher interest rates.

Charlie Bean, the Bank’s deputy governor, is hard to characterise as either a hawk or a dove on interest rates, but he is the wisest owl on the monetary policy committee. He is also on the FPC.

In a speech at the London School of Economics ahead of his retirement at the end of next month, he set out both the role of direct measures, so called “macroprudential” policy, and the limitations.

As he put it: “Compared to the impact of changes in interest rates, we have relatively little experience of deploying macroprudential instruments. And there will often be scope for those affected to work out ways to circumvent them, including by moving activities outside the regulatory perimeter.”

The latter, of course, was what happened under the corset in the 1970s. “There may well be times when moentary policy is the only game in town,” he added, so that even at a time of below-target inflation – with no inflationary danger in sight – the Bank should “lean against the wind” by raising rates.

We may be moving towards that point. The minutes of this month’s MPC meeting, released last week, showed the first stirrings of discussion about hiking rates, with some members arguing that the decision was becoming “more balanced” and others arguing that raising rates early could be the best of ensuring that they do not need to rise too much.

The minutes, coming on the day when official figures showed the volume of retail sales last month nearly 7% up on a year earlier reignited the debate on rates, it having been kicked into the long grass by Carney a few days earlier. But with the MPC about to undergo a big shake-up of its membership, we do not know whether this month’s stirrings will turn out to be a false signal.

The Bank does not need to be precipitate. There is a case for waiting until the economy is back above pre-crisis levels and real wage growth is more firmly established. That does not mean a hike now, but should mean the process starts next year, ahead of the May election.

The risk is that the Bank leaves it too long, in to hope that financial policy takes care of it. Experience suggests it will not. Corsets, I gather, can be uncomfortable. But they rarely deal with the underlying problem.

This piece is cross-posted from EconomicsUK with permission.