August 8, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Prepare to groan – bad joke coming up. The IMF used to have trouble making up its mind; now it is just not sure.

Three weeks ago, this influential and much respected financial institution, upgraded its projections for economic growth for the UK. Well, that was July. Clearly, things must look very different in August, because now it has changed its projections again, this time, downgrading them, and by quite a bit too.

It now expects the UK to grow by 1.4 per cent this year. This contrasts with its previous projection of 1.8 per cent, and the projection before that of 1.6 per cent. So far this year the UK has expanded by 0.4 per cent in Q1, and 0.2 per cent in Q2, so if the IMF is right, the second half of the year will be slightly worse than the first half.

As for 2009, it now expects growth of 1.1 per cent. This compares with its previous projection of 1.7 per cent, and prior to that it projected 1.6 per cent.

All in all, then, the latest IMF forecasts are by far the worst to date. In fact, actually, a growth of 1.1 per cent for 2009 is barely above recession pace. Remember, a recession is defined as two successive quarters of negative growth – which could easily be contained within a 1.1 per cent annual growth rate.

Also of interest from the latest IMF report, it turned its attention on inflation and the fiscal deficit.

It said: “Inflation rose to 3.8 per cent in June, on account of food and fuel price developments. And while there is scant evidence of second-round effects, as wages remain subdued, indicators of long-run inflation expectations have risen further.”

On the fiscal deficit it said it recommended: “… that the net public debt ceiling of 40 per cent of GDP be retained. Should it be breached,” the IMF said, “concrete and frontloaded plans” should be introduced “to bring debt back below the ceiling.”

Its comments about inflation seem to be about right. There are good reasons to expect inflation to fall, but, unfortunately, the UK public don’t seem to agree; they expect inflation to stay up. How serious this is depends on your point of view. If you believe inflation is determined by expectations, then the high level of expectations in the UK is worrying. On the other hand, economic theory often seems to assume we are a lot cleverer than we really are. Quite frankly, most of us tend to assume the next few quarters will be like the ones just past. So, inflation rose yesterday, and is still up today; we assume it will be high tomorrow.

And in a way, that aspect of human nature says a lot about why we have economic cycles. Most people refused to believe house prices could ever crash, because they assumed the economic conditions would not change. They said: “Look at how low interest rates are, and how plentiful credit is.” They did not factor in the fact that both these variables could change. That is just one example; go back through economic history and you will see this aspect of human nature behind many of the booms and busts.

It often seems economic theory is quite flawed in the way it assumes some kind of all-knowing aspect to human nature.

The reality is that since our expectations are determined by the recent past, our expectations for inflation will always be behind the curve. Actually, if you look beneath the surface, there are good reasons for thinking inflation will reduce quite sharply, and may even go negative towards the end of next year. It seems unlikely many of us have factored the deep forces at work when we are asked our expectations.

As for the IMF’s comments on public debt – it is worth noting the IMF has a thing about low public debt. It always wants countries to cut this. In 1997, it practically forced reductions in debt in the economies of East Asia – and in 1998 it did the same with Russia. In both cases, the result was a very nasty and avoidable recession.

The UK can not possibly keep net debt below 40 per cent of GDP; to attempt to do that right now would be tantamount to forcing a recession. As we have argued before, the government should in fact allow its net debt to rise, and spend some of the proceeds on tax cuts, especially aimed at the lower end of the income scale, and in the process increase incentives to work over claiming benefit.

July 25, 2008 | posted by Michael Baxter in UK economy | comments (0) |

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.

June 11, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Growth in the UK economy slowed to a snail’s pace in May, suggests the latest estimates from the National Institute of Economic and Social Research.

In its latest estimates, out yesterday, it had quarterly growth in the three months to May of just 0.2 per cent.

This contrasts with 0.4 per cent growth in the three months to April.

So, does this spell recession?

The NIESR said: “Although the May figure is very low and output growth could slow further, the time profile for growth late last year still makes it unlikely that taking the year as a whole, output will be lower in 2008 than in 2007.”

Then again, with growing expectations that the next change in the interest rate will be up, the prognosis for the UK seems to be getting worse.

Remember that many forecasters, including, recently, the OECD, have predicted that 2009 will be worse than this year.    If you believe the UK economy runs between 12 and 18 months behind the US, then it certainly seems probable 2009 will be the year the economic cycle hits bottom.  So, if growth is just 0.2 per cent a quarter now, the omens for 2009 are not good.

Quarterly growth and estimated quarterly growth – NIESR

Jan-07   Feb-07   Mar-07   Apr-07   May-07   Jun-07   Jul-07   Aug-07   Sep-07
0.80%    0.70%     0.70%     0.70%     1%            0.80%    0.80%   0.60%     0.60%

Oct-07   Nov-07   Dec-07   Jan-08   Feb-08   Mar-08   Apr-08   May-08
0.70%    0.60%     0.60%    0.50%     0.60%     0.40%     0.40%     0.20%

April 7, 2008 | posted by Michael Baxter in UK economy | comments (0) |

Cast your mind back to four weeks ago tomorrow. It was Budget day, and Alistair Darling tried to reassure us.

Our chancellor said the UK will grow by between 1.75 per cent and 2.25 per cent in 2008, well clear of recession levels.  Then, Mr Darling reckons the economy will pick up, and grow around the level of the long-term average of between 2.25 per cent to 2.75 per cent.

Based on those assumptions, he went on to say Government debt levels are forecast to be 38.5, 39.4, 39.8, 39.7 and 39.3 per cent of GDP by 2012/13.

Now that was quite interesting, because, as you may recall, he is supposed to follow two rules – the famous Golden rule, and the not-so-famous Sustainable Investment rule – which is supposed to restrict public net debt to 40 per cent of GDP.  But by Mr Darling’s own estimates, in the year after next, net debt will be just 0.2 percentage points of breaking his Sustainable Investment rule – leaving a tiny amount of room for error.

And here is the worry, in making these projections, he assumed 2009 will see a pick up – whereas most expect next year to be worse than this.

Now, the Treasury Select Committee has entered the debate, and it is bad news for Mr Darling.

“The Treasury’s optimism is based on its contention that the UK economy is better placed than other OECD economies in the face of market turmoil,” said the Committee, and, “We remain concerned that some of the economy’s characteristics that have proven beneficial during past crises might prove to be conduits through which the current problems in global financial markets are transmitted to the UK real economy.”

John McFall, chair of the Committee, says: “The Treasury’s forecast of economic growth in the next two years is more optimistic than the consensus view… There are significant downside risks to the economy and therefore potentially to tax receipts.”

The Select Committee is right.     The current economic crisis relates to debt – and countries that see high levels of consumer debt are most vulnerable, and the UK is near the top of the list.

Recall comments made by the IMF last week: “Particularly at risk [is] the UK housing market, where the financial crisis is exacerbating issues of affordability and general economic gloom”– it seems absurd to claim that the UK is better placed than other OECD economies.