- The Bank of England risks a policy misstep in its response to the new UK budget, according to Paul Krugman.
- That's because the bank has failed to act appropriately in the past, resulting in runaway inflation and two currency crises.
The British pound could plummet even further if the Bank of England wavers on raising interest rates, according to Nobel economist Paul Krugman.
The top economist pointed to Britain's new mini budget, unveiled last week, which involves cutting taxes on the highest earners and doing away with planned corporate tax hikes. The plan led the pound to plunge to a 37-year-low on Friday and fall another 2% on Monday, after the Bank of England said that it would continue to monitor the market for volatility but declined to commit to new economic tightening measures.
The decline in the pound is a sign investors have lost confidence in the UK economy, with top economist Mohamed El-Erian urging the Bank of England to issue a super-size 100-point rate hike to keep inflation under control.
But the central bank could neglect to raise rates aggressively enough to lessen the threat of further inflation, Krugman warned, which could lead to more pain for the pound and the economy.
"These doubts were reinforced on Monday, when the bank disappointed investors hoping for an emergency rate hike to stabilize the pound, limiting itself instead to a rather vague statement that it 'would not hesitate' to raise rates if necessary to limit inflation," Krugman said in an op-ed for the New York Times on Tuesday, pointing to the currency crises of 1976 and 1992, when the central bank hesitated to raise interest rates in the facing of soaring inflation and debt.
That was largely because policymakers feared rate hikes would set off high unemployment and send mortgage rates skyrocketing – which would be disastrous for UK households, given that most homes are financed with floating rate mortgages. Rate hikes then would have caused its population "direct financial pain," Krugman said, adding that this could be a reason why the Bank of England may hesitate to tighten enough today.
Krugman and other economists have been vocal critics of the new tax plan, with Krugman previously calling it a "zombie" economic idea. Referring to comments from one economist in the City of London, Krugman noted the UK is paying a premium for its "moronic" handling of the economy.
"It's still too soon to write Britain off; it's a rich country with a lot of freedom of maneuver," Krugman said. "On the other hand, if British monetary policy is really constrained in this way, going all in for zombie fiscal policy is even more irresponsible than it would be otherwise."