In the pantheon of economic forecasters it seems reasonable to assume economists at Merrill Lynch and members of the Bank of England Monetary Policy committee stand near the top. Yet the last few days have seen predictions of real woe from both camps, perhaps the most negative yet from any respected economic quarter.
David Blanchflower, MPC arch dove, and famous for his more gloomy thoughts on the economy, reckons the UK is heading for recession – unless interest rates are dropped fast.
“I think we are going into recession and we are probably in one right now,” the dove told the Guardian. “We will probably have three or four quarters of negative growth, but the risks are to the downside.”
He added, “It’s not too late to stop it, but we have to act right now. Monetary policy has been far too tight for too long. We can’t just sit and do nothing as we have done for too long.”
He went on to talk about how we are likely to go down the same path as the US, but that unlike the US we will not be getting a big tax stimulus. As for inflation, he is more worried about prices falling too slowly. “The economy is now slowing so fast that we run the risk of writing a letter on the low side in the medium-term,” he said.
So if the UK could mirror the US economy, how are things Stateside?
Yesterday, Merrill Lynch produced a report so nightmarish in its projections that it should have come with an “X” certificate.
New York-based economists Sheryl King and Drew Matus who penned the report said, “Just like consumers, who are insulating their windows and making fewer trips to the malls, we are adjusting our economic forecasts to the new high-oil-price reality, not to mention the latest round of trauma in the mortgage markets.”
They went on to predict a 2.5 per cent contraction in the US economy in the final quarter of this year. Let’s run that past you again. A 2.5 per cent contraction. They are saying the economy will be 2.5 per cent smaller at the end of this year than at the end of 2007.
They also predict a similarly bad performance in the first quarter of next year, and expect the US economy to contract by 0.5 per cent in 2009.
The Merrill report was in sharp contrast to last week’s report from the IMF predicting US growth of 0.8 per cent next year. The IMF actually upped its projections for global growth this year and next, and even upped its projections for the US for 2008.
But not everyone was impressed. Writing in the Telegraph, Ambrose Evans-Pritchard, surely the most bearish reporter in broadsheet land, said, “Plainly, the IMF cannot or will not offer any useful insights.”
The IMF bases its model on what it calls mean reversion. But there seems to be a failure to realise how serious any kind of mean reversions will be. For years the US and UK have been propelled forward on debt. Debt encouraged by interest rates that were far too low. US debt has in turn provided the main impetus to global economic growth. If these two countries now just start repaying their debt, save more, and spend less, then the implication for the global economy could be very serious indeed.
Despite some comments on our blog to the contrary, it is not as simple as just cutting our cloth for a few years and living within our means. As Mr Evans-Pritchard said, “True ‘mean-reversion’ would imply debt deflation on such a scale that would, if abrupt, threaten democracy.”
This is why the current crisis is more serious than many forecasters would have you believe.
This is why the solution requires a great deal of creative thinking.
But, those who urge cuts in interest rates as the key way to bring normality miss the point. As Keynes pointed out 70 years ago, cutting rates at a time of high debt is akin to pushing on string. This crisis can not be ended simply by cutting rates so that we can borrow our way out of trouble.
Neither can it be ended simply by the US and UK buying less and selling more abroad. The big changes this would prompt in the global economy would be catastrophic.
The only solution lies in tax cuts. Big tax cuts – targeted especially at poorer earners. Not only will this make impoverished Anglo Saxon consumers feel more confident, it will, in the case of the UK, incentivise the longer-term unemployed to find work. Work that is sure to be created as Polish workers realize there is not much point in staying in the UK.
The real hope is that somehow these tax cuts will not encourage greater borrowing, instead at least some of the proceeds will be used to repay debt. In some ways then the credit crunch would be no bad thing as it would stop further borrowing.
UK government borrowing may be too high, but net debt remains modest. Government borrowing can be reduced by cutting unemployment, through providing greater incentives to the unemployed via taxation. This will reduce benefit payments. The government should accompany this with a gradual scaling down in various means tested benefits. If it wants to give more to the poor and take from the rich, it should instead up personal allowances, but, if necessary, up percentage income tax too.
The government needs to act fast too. It has grossly underestimated how serious this crisis is. It can no longer afford to remain asleep at the wheel. It can no longer react to events after they have happened.
