The Government's austerity programme risks becoming "self-defeating", the Chancellor has been warned by Kate Barker, the most senior economist yet to intervene in the debate over growth.
By Philip Aldrick
Ms Barker, a former Bank of England rate-setter who is spoken of as a potential Governor, said George Osborne had left himself no "room for manoeuvre" to combat the recession by insisting that he can not budge from his debt and deficit reduction targets.
"There is a risk that the fiscal mandate, rather than a useful discipline, will become a straitjacket," she added.
In an explosive report for the think-tank CentreForum, Ms Barker also called for changes to the Bank's inflation target, raised questions about the effectiveness of more quantitative easing (QE), and said the Treasury's reforms to financial regulation were "flawed" and would overburden the Bank.
Mr Osborne is already under pressure from economists and business leaders to relax his spending cuts and tax rises to boost growth. Yesterday, Adam Posen, an outgoing member of the Bank's rate-setting Monetary Policy Committee (MPC), joined the Chancellor's critics by calling on him to use Britain's record low borrowing costs to increase targeted spending.
"As long as interest rates are as low as they are in the UK, it doesn't make any sense to sit on the money," he said.
In her report, Ms Barker, who is also a non-executive at the Government's independent forecasting body the Office for Budget Responsibility (OBR), wrote: "The insistence by the Chancellor that there should be no deviation from the fiscal plan may be making it more difficult to announce adequate responses to unexpected economic events."
"There is a danger of self-defeating austerity, if some room for manoeuvre cannot be developed," she said.
The shock rise in government borrowing has already been seized as evidence that austerity is undermining Mr Osborne's deficit reduction plan. The Treasury has responded by arguing that taking on even more debt is not the solution and would jeopardise the recovery.
Piling more pressure on the Chancellor to act, Ms Barker added that the Bank is nearly out of policy "bullets" to fight off the downturn. Although QE was a "powerful support" at the start of the crisis, buying more gilts - beyond the £375bn already announced - could lead to "diminishing returns", she said. "There is concern that more QE will not prove sufficient."
Ms Barker also conceded in her report, Macroeconomic Policy: too much autonomy and too little co-ordination, that the Bank may have been partly to blame for the crisis. "The MPC's failure to take sufficient account of the rapid rise in credit may well have exacerbated the UK's recession," she said, adding that interest rates could have been higher in the "mid-2000s" to choke off the debt boom.
Ms Barker was on the MPC from 2001 to 2010, but said she had raised concerns about household debt levels.
She recommended changing the Bank's inflation target from 2pc to a range from 1pc-3pc to help rate-setters take a "longer term view of risks [and] a more strategic approach to monetary policy".
Turning to financial regulation, she warned that plans to hand over powers for financial stability had "delegated too much to the Bank", and that the arrangements with regard to the Financial Policy Committee (FPC) were "flawed".
The FPC's macro-prudential powers, to stamp out risky or excessive lending, "should be taken by the Chancellor on the basis of advice from a group on which the Bank is strongly represented" Ms Barker said. "It would ... enable better policy coordination."
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