The trouble with economists is that sometimes they just make things worse. Unknown to themselves, they often operate so far behind the curve that they end up trying to deal with one stage in the economic cycle, just when the underlying forces that drive the economy are already having that effect. So they exaggerate the trend. This happened earlier this decade, when interest rates were allowed to fall far, far too low. And it could be happening again. It is just possible that they are in danger of throwing buckets of water on a drowning economy one moment, and then running scorching hot water on a raw burn the next.
Maybe the single biggest threat to the economy today is, economists.
Take as an example, an extraordinary dichotomy of opinions on where the economy is going that emerged yesterday.
On the one hand you have the National Institute of Economic and Social Research (NIESR) which revealed its latest forecast for the UK and global economy. Listening to their economists speak at the press conference, one could be forgiven for believing that all is fine. NIESR reckons the UK will expand by 1.5 per cent this year and 1.4 per cent next. Not especially good, but considering all the doom and gloom out there, a nigh on miraculous performance. On reading its report you might conclude: crisis, what crisis?
But the NIESR does have a concern. It is worried about inflation. It wants to see hikes in the rate of interest soon, to “nip” inflation “in the bud.” Ray Barrell, a senior economist at NIESR said, “The Bank of England needs to send a sharp signal to the economy that they are still focused on inflation.”
NIESR is fretting about inflation expectations too, and fears that if these lead to wage increases, then it will be “too late.”
Contrast this with the findings of a Reuters survey. Economists polled said they believe there is a 40 per cent chance the UK will hit recession next year. Bear in mind, it was just over a year ago that Alan Greenspan started talking about US recession, and every time he spoke he seemed to state more bearish odds. If you believe the UK runs around 12 to 18 months behind the US, then expect a similar shortening of odds throughout the rest of this year.
Then contrast the NIESR warning with the latest musings from Capital Economics. You may recall, the head honcho at Capital Economics is Roger Bootle who penned the book The Death of Inflation, so it does have a somewhat doveish agenda. But then again, with the latest data from the British Banking Association, out earlier this week, revealing yet another fall in mortgage approvals to yet another all-time low, there are real fears growing that not only are would-be home buyers being squeezed of cash, but that things are now spreading to business too. With this in mind Vicki Redwood at Capital Economics recently said: “We think that about £65bn in extra capital is needed in order to compensate for the credit crunch and to keep lending at recent levels.” She added ominously: “and banks are already showing signs of contracting. Just for their balance sheets just to stagnate, UK banks may have to raise £35bn.”
So, on the one hand, we have NIESR worrying about inflation; on the other, we have a growing queue, maybe not yet from Threadneedle Street to Timbuktu, but a growing queue nevertheless, of economists saying recession is about to bite.
The truth is, it seems unlikely that wage inflation will take off. Most of us are far too worried about our jobs to start giving our employers a hard time. Only where jobs are ‘safe,’ in the public services, will unions think they get away with pushing for wage rises. And, frankly, a rise in interest rates will do nothing to change this.
Unions are more likely to be influenced by how soft they think the government is. How vulnerable they think the government is. How willing it is to change with the wind. How willing it is to change its fiscal rules.
Right now, interest rates as a government policy instrument are almost meaningless. What good is a cut in rates when hardly anyone can raise finance?
If you believe inflation is always a monetary phenomenon, then you will believe the current surge in prices, especially in oil, was caused by too much money floating around earlier this decade. The Bank of International Settlements reckons the mistake policy makers made was in setting inflation targets that were too easy. They should have aimed for zero inflation.
Maybe another mistake was made. Earlier this decade we were told deflation was the big worry. Yet falling prices are only a bad thing if they are accompanied by falling wages. Earlier this decade it was not like that. Prices were falling because things were getting cheaper, thanks to improved productivity both at home and abroad. Job markets were buoyant.
Central banks fought an enemy that wasn’t there. In the process, they created the current economic crisis.
Perhaps central banks put too much emphasis on surface tensions. Inflation is what happens when our spending is greater than supply, and one way to judge whether spending is too high, is through looking at our savings. Earlier this decade, our savings were too low; this is what created the pressures which led to soaring asset and commodity prices.
The economy has become so used to our frivolous ways that any return to a normal savings to borrowing ratio will hurt.
In current circumstances, it is no longer possible to solve the problem of saving being too low. Most of us have enough problems getting through the month, without saving too.
The credit crunch means there is less money sloshing around, shoring up inflationary pressures.
Now is the time to worry about deflation. Yet, some central bankers are at once against, just like they did earlier this decade, fighting a new enemy that doesn’t exist. They are fighting the spectre of inflation – just when deflation could be building.
Remember, previous periods of growth-sapping deflation followed crashes in asset prices. Remember this too. The crash in shares is not a new phenomenon. Both the FTSE 100 and Dow are lower than their pre-dotcom boom peaks. This has all the hallmarks of a beginning of a deflationary downward spiral.
Data available is, frankly, not fit for purpose. Central banks and economists who base their judgements on data are basing their judgements on flawed material.
Now is the time to see things for what they are. There is certainly no slack out there right now, yet slack is what is required for inflation to take off.
You don’t need a Ph.D. in economics to understand this. You don’t need a Masters from the University of Life. You just need a degree of common sense.
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