King’s BOE Should Print Money, Change Mindset, Fathom Says

By Svenja O’Donnell

Feb. 10 (Bloomberg) -- Bank of England Governor Mervyn King should print money now and abandon economic assumptions that have failed to save the U.K. from its worst recession since World War II, a group of former central bank economists said.

King and his colleagues are too reliant on an economic model that doesn’t pay enough attention to credit and housing bubbles, said Danny Gabay, director of Fathom Financial Consulting and a former author of the bank’s quarterly inflation report. Ignoring these key drivers of the downturn bears “some responsibility for the current malaise,” he said.

The Bank of England has so far stopped short of increasing the supply of money even after cutting its benchmark rate to a record low of 1 percent this month. Officials should now cast off the mindset of “the Threadneedle Street establishment” in favor of faster action and “bold, fresh thinking,” Fathom says, referring to the central bank’s address.

“The bank should be printing money by now, and should have started doing it some time ago,” said Gabay, who will present an alternative approach to the crisis in London today. “The framework at the Bank of England is based on an economic nirvana. If you assume, as we feel they did, that it represents reality, you end up in the kind of mess we’re in now.”

Buying homes on the verge of repossession to add money to the economy may prove an effective tool to fight the recession, Fathom says. U.K. economic prospects may be even “bleaker” than those released in the Bank of England’s quarterly inflation report tomorrow, it forecasts.

Cracks

The Bank of England’s inflation-targeting approach, which King helped draw up in the 1990s, is showing cracks after successfully helping policy makers keep consumer prices under control for most of the past decade. Inflation breached the Bank of England’s upper 3 percent limit last year after a surge in oil prices. The credit crisis has now sparked fears among policy makers that inflation will turn negative in coming months.

“The Bank of England’s analytical framework worked well in terms of anchoring inflation between 1997 and 2007 but its inability to respond to the housing bubble and the subsequent crisis of the last 18 months has exposed its shortcomings,” said Gabay.

U.K. gross domestic product will drop 2.8 percent this year, the most since 1946 and more than any other industrialized country, the International Monetary Fund said on Jan. 28. The Bank of England said last week there’s a “substantial risk” inflation will undershoot its central 2 percent target.

Home Purchases

Purchases of homes by the Bank of England would help put a bottom on the decline in the housing market and help fight deflation by pumping money into the financial system, Fathom says. Housing sales in Britain dropped to the lowest level since at least 1978 in the quarter through January, the Royal Institution of Chartered Surveyors said today.

“The underlying problem in the economy lies in falling asset prices, notably housing,” Fathom said in the report. “The government should buy houses directly and instruct the Bank of England to print the money to pay for them.”

The Bank of England on Feb. 5 cut the benchmark rate to 1 percent, the lowest level since the bank was founded in 1693. The Treasury last month granted it unprecedented powers to buy assets, as rates head towards zero, forcing the bank to adopt less conventional monetary policy tools.

“The framework at the Bank of England assumes markets clear, markets are efficient, consumers are rational and housing markets are not prone to bubbles,” Gabay said. “Over-reliance on this has contributed to the economic mess that the U.K. now finds itself in.”

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net.