The UK and the US – different responses to stagflation

What a difference a year makes. In May 2007, the professionals completing the RICS estate agents’ and surveyors’ survey of the residential property market were bullish on past property price rises and the prospects of more to come. That May survey showed a positive balance of 21 for past prices UK-wide, and a big 56 positive balance for London. New-buyer enquiries were in balance. The latest figures in 2008 show a negative balance of 95 on past prices UK-wide and a negative 94 on London. The business has never been more pessimistic, with practically every agent reporting prices down and expecting more of the same. New-buyer enquiries have reached early 1990s levels, at minus 68. Even the Housing Minister has to go to cabinet with a pessimistic forecast for house prices, and kindly lets the rest of us read what we already know from the public surveys.

This week also brought the expected bad inflation figures. Energy and food prices have boosted CPI and RPI inflation, with the government’s alcohol duty increases and VAT on petrol and diesel offering the extra boost to the rise. Readers of this blog will not be surprised by either development, following pieces on the coming drop in house prices and the short-term up-tick in inflation. Shop-price inflation is still much less than factory-gate inflation, which is far below the inflation in metals and energy used by the factories. Everyone is having to absorb higher prices to some extent. The consumer is unable to protect himself or herself through sufficiently large wage increases, so spending power is falling.

The UK is now paying the price of government and regulatory excess in recent years. The government sector has inflated its costs and borrowed too much. As a result, the UK government had to increase taxes at exactly the point in the cycle where it should be cutting them. The Bank of England is having to keep interest rates much higher than our leading first-world competitors, because the inflation here is exacerbated by tax increases and the sloppy credit conditions of recent years. The nationalisation of Northern Rock has left the government short of cash to improve the liquidity of money markets, when its US counterparts are being much freer with the extra cash.
It was against this background that Gordon Brown carried out his tax con, cutting the basic rate of tax to 20p, while removing the 10p band. People noticed this was a disguised tax increase for many, and that it affected those on low incomes disproportionately. It led to the forced U-turn this week, as Labour backbenchers reported accurately the mood on the doorsteps, and demanded a rebate.

In the US, a positive recession-busting strategy has been followed vigorously. Interest rates have been slashed from 5.25% to just 2%, cutting everyone’s cost of borrowing. Substantial sums have been made available to money markets to ease the liquidity crunch. Mortgage regulation has been eased. Consumers have been given a boost with a tax cut, helping those on lower and middle incomes.

The UK is unable to cut interest rates as much, because of its persistent inflation problem. The UK authorities have not made so much money available, because they foolishly spent far too much on Northern Rock, instead of heading off that problem with sensible monetary easing before the run. Northern Rock, in public ownership, is now increasing the credit squeeze by having to cut back on its lending. The UK government has been putting taxes up instead of easing pressures on consumers, because of the big appetite of the government sector to spend more. Yesterday, for one year only, we were offered a modest tax reduction through the gritted teeth of a government held to ransom by its backbenchers and afraid of the voters of Crewe and Nantwich. The UK is talking of intensifying regulation, rather than easing it, while there is no danger of over-lax lending. We are told there will be more and tougher banking controls in the draft Queen’s speech – the usual sound of bolting the stable door after the horse has gone, making it impossible to get the horse back in.

The US should get by without the savage recession some have already called and others have forecast, because they have been so determined to see off the downturn as quickly as possible. The UK will have longer to struggle, with its twin large deficits – an over-borrowed government sector, and a heavily indebted consumer one. While the tax rebate this week makes a small but welcome contribution to the consumer, it is achieved at the expense of an even worse public sector deficit. This will act as a further constraint on the government achieving a better economic performance. The Chancellor yesterday should have offered reductions in wasteful or needless spending, or, at the very least, postponed some of the expensive computer and consultancy schemes during the year when he intends to give some money back to taxpayers.

We have more months ahead of mortgage famine, falling house prices, and price rises squeezing us more. The government’s tax increases on fuel, alcohol and others have made it more difficult to get inflation down and to reassure people that their real incomes will not fall too much. Meanwhile, the Asia Pacific region continues to outgrow us, and the pound is now falling against the dollar as well as against the strong currencies of the fast-growth countries.


  1. mikestallard
    May 14, 2008

    The chickens are coming home to roost even if the horse cannot get back into the stable!

  2. Tony Makara
    May 14, 2008

    Faced with a recession or inflation I would prefer to see a recession, because I know that will be easier to resolve in the long-run. That may seem Lamontesque but inflation devalues everything, including our nations status. The US will have to deal with inflation eventually, agressively cutting rates at a time when the dollar is falling and while energy and food prices are soaring is a recipe for disaster. Price stability provides a measure of value and must be maintained, all else must be built around that. In the UK consumers and government have lived on credit for the last decade, its now time for a painful correction and people have to accept that. We need to cut rates but we can't, because if we do we will be opening the door to currency devaluation and inflation, which will be made all the worse because of our dependence on imports. Stability is the key. I don't want to see a recession but putting off a correction today will only mean having to face a more torturous economic realignment tomorrow.

  3. Matthew Reynolds
    May 14, 2008

    I think that all QUANGO's brought in since 1997 should via a single Act of Parliament have a sunsetting clause meaning that without being renewed by a Parliamentry vote a QUANGO would cease to function in four years time .

    All government red tape introduced since 1997 should as with QUANGO's be subject to a sunsetting clause via a single Act of Parliament meaning that if not renewed via Parliamentry statute it expires after two years. So within two years of a Tory general election victory Labour's red tape madness could be ended.

    Conservative ministers would not want to go before Parliament trying to revive Labour QUANGO's & regulation so thanks to two simple pieces of Parliamentry Legislation government can be made much smaller very soon. All new regulations & QUANGO's should be subject to a sunsetting clause meaning that they too will expire within a four years without being renewed via a vote in Parliament.

    As with Eire the UK can secure lower levels of public expenditure as a share of GDP & a lighter regulatory burden and Parliament can be used to force the next Conservative government to move powers away from QUANGO's towards either elected Ministers or local government. This means cuts in the public debt paving the way for tax cuts !

    This plan is good for the economy & democracy . Excess red tape & a bloated state sector have got us into this malaise – time for the opposite policies to get the UK en-route to prosperity.

  4. Jonathan Robson
    May 14, 2008

    It is obvious to any thinking person that New Labour are now so desperate to cling on that they will promise anything – but are the promises what they seem?

    "Critics say Mr Brown's decision to preview the government's programme diminishes the role of the monarch and the relevance of the State Opening of Parliament in November.

    But the government says it is appropriate to announce proposed measures earlier to allow consultation over the summer, resulting in a more concrete Queen's Speech. "

    Skipping over the obvious "republican" tendancies of Labour – notice that these are not policies but "consultaions" – and we know what consultations are in the hands of labour – just ask a few friends what they think and hey presto consulation done.

    New Labour have had thousands of consultations – but guess what – no one has ever asked for my opinion, strange.

    One other thing on another but related topic – Why is the BBCs website all about Labour? Do the BBc never ask for comments from the most popular party in England? (49% at the last opinion poll).

    I can imagine if the Conservatives had just pulled out a 2.7 billion pound tax cut, it would be wall to wall criticsm and sneering from the BBC.

  5. anthony scholefield
    May 15, 2008

    I dont understand thgis post which reads as though any recession is bad and should be dealt with by 'recession busting'.
    Worse the current recessions in the US and the UK have been caused by slack monetary policies.
    The idea that the solution to problems caused by slack monetary policies is… more slack monetary policy quite wrong.
    The system needs to be purged.factors reallocated to more profitable activities not the smoke and mirrors of profit increases and asset writedowns of the city institutions

    Reply: Yes, the problem was caused by slack money policies. The danger now, however, is different – the credit tightening will go too far unless the authorities take action. In the UK a lot of the problem has been caused by wasteful and excessive state spending, which needs tackling in the ways described on this website.

  6. Tears for Tier 1
    May 15, 2008

    The worst thing about the "leaked"/ telephoto cabinet briefing document was that:
    1. The government believes that house prices will drop by 5% to 10% this year alone.
    2. The government believes that first time buyers should be encouraged to buy now.

    I can't imagine what would be said of any investment company advocating such a policy.

  7. Robert
    May 15, 2008

    John, sadly I feel that Anthony has a point as I have argued before. Bottom-line there is no easy way out – we have to take the pain and yes, it could get alot worse than one would like if you believe Ambrose Evans-Pritchard, not that I agree with him. We have to make sure that inflation does not get into the system, and Mervyn King I believe is on the right track. We need a period of sensible and 'conservative' monetary policy. Stagflation, a term I used over 9 months ago is becoming more of an accepted potential outcome, though I know not by you. I disagree with you and Roger Bootle as I believe that this period of inflationary pressure will last longer than you both think. I feel that more economists, usuallly poor forecasters mind you, are coming around to the idea that stagflation may well be a potential outcome now, amusing to a number of us who were ridiculed for this view at the end of last year. As always time will tell, but as the previous post stated we need to purge the system and bring financial discipline back. House prices falling will be good for first time buyers, they will have to save for smaller absolute deposits (I assume 15%, => 85% LTV)and potentially borrow less and have a much better risk reward. If they fall by 30% over the next two years that would I believe, on 3.5x av. incomes and 5% wage inflation, reconnect the market to be based on fundamentals again.

    Reply: I agree that we will approach stag, especially if the Bank means what it says this time and keeps rates up (Remember their pledge not to bail out banks?). Inflation will spike soon, and then the Credit Crunch effect will be seen infalling inflation.

  8. Neil Craig
    May 15, 2008

    Given the options of recession or inflation I would go for more inflation. Inflation is merely a discontinuity in the way we count wealth (ie money) whereas recession is a cut in real wealth.

    However neither is either necessary or useful in solving the problem. What is needed is a cut in government spending/waste, regulation & the % of GNP spent by the state. A recession which does not cut the state sector or inflation which merely hides the extent of government borrowing would be counterproductive. We atre beyond the stage at which merely sharing the fruits of growth, when it comes, with those who produce it will do.

  9. Tears for Tier 1
    May 15, 2008

    Neil Craig said
    "Inflation is merely a discontinuity in the way we count wealth (ie money) whereas recession is a cut in real wealth"

    That just plane wrong.
    Inflation is a highly inefficient "tax" that transfers wealth from savers to borrowers (frankly its more like a legalised process of theft).
    Its inefficient because its both highly insidious and it discourages almost all forms of beneficial economic activity.

    Inflation is the worst form of moral hazard and is strongly associated with the ending of most of the great civilizations in history.
    It should be oposed by all conservative minded thinkers.

  10. Tears for Tier 1
    May 15, 2008

    Neil Craig said
    “Inflation is merely a discontinuity in the way we count wealth (ie money) whereas recession is a cut in real wealth”

    That just plain wrong.
    Inflation is a highly inefficient “tax” that transfers wealth from savers to borrowers (frankly its more like a legalised process of theft).
    Its inefficient because its both highly insidious and it discourages almost all forms of beneficial economic activity.

    Inflation is the worst form of moral hazard and is strongly associated with the ending of most of the great civilizations in history.
    Policies that may encourage inflation are always well-meaning in the short term but they should be opposed by all conservative minded thinkers.

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