Readers of this site will know I have long been advocating that the Bank of England cuts interest rates and concentrates on fighting recession. Inflation will fall next year anyway. This has proved contentious with some of my readers. I ask them, how much more evidence do you need of slowdown, how much bigger a fall in property prices, how much more of a squeeze on incomes and lending before you accept that conditions are disinflationary, even recessionary?
Yesterday I was delighted and amazed to read the words of David Blanchflower, Monetary Policy Committee member. He delivered an extraordinary broadside against his own Committee. He accused the Bank of relying on “wishful thinking†in its forecasts, and condemned the whole monetary policy as “misguidedâ€. He agrees that next year inflation will fall, and states “18 months down the road and inflation is going to plummet like a rockâ€. In a now famous remark he said “ To sit and worry about inflation expectations and what is going to happen to those, rather than worry about the fact that the economy is going to go into recession seems to be misguidedâ€.
Of course, under the requirements set down by the government to the MPC, they are required just to worry about inflation expectations. Their remit prevents them from considering the impact of their actions on the real economy, unless that has an impact on inflation. For years we have been fed the soundbite that the UK has an independent Central Bank and that is a guarantee of economic stability. The truth is we do not have an independent Bank, and the actions of the MPC have helped destabilise the economy. They kept money too loose allowing a credit binge, and they are now keeping money too tight, assisting a Credit Crunch. They have been aided in this by pro cyclical regulation of the banks – too loose on the way up, too tight on the way down – and by a government which does not seem to understand money markets.
We will now see many of those who have spent the last few years praising the mythical independent Bank demanding a change in its government remit. The truth is that in a democracy if any institution or group of actors gets things wrong and inflicts economic misery on the public, their roles, jobs and remit will be debated and changed. No quango or Bank stays “independent†for long if its actions do not please. The politicians have to respond to the popular anger about failure or mistakes. The government will have to look at adding a requirement to the MPC to consider its impact on the real economy, just as the Fed has to in the USA. In the last quarter the USA produced annualised growth of 3.3% (where are all those pundits who told us the US is in recession now?) whilst the UK slowed to a standstill and Euroland fell. The USA has a Central Bank that has to work with the government to influence the level of economic activity as well as prices. Euroland and the UK have central banks which just concentrate on inflation, and manage to get that wrong.
Perhaps the most important thing David Blanchflower said was “We need to actually get ahead of the game and it appears that we are now behindâ€. Exactly. It is as if all those clever economists have forgotten one of the basic things they teach their students – there are leads and lags in economic policy. Changing interest rates has a delayed effect, as it takes time for all rates to adjust and for banks and borrowers to adjust their behaviours to the new levels. Many people have protection from higher mortgage rates for a period. Larger companies can use interest rate futures to protect themselves for months ahead. Many people and companies have a bit of money for a rainy day, but not enough for a rainy year.
The present high inflation reflects mistakes of the MPC and others a year or two ago. There is nothing the MPC can do in the short term about that. The issue is what are conditions going to be like a year or two ahead? Most commentators agree they will reflect the current squeeze. It is difficult to see inflation staying high against such a background, and strange to see a government and a Bank so keen to intensify the squeeze by most of their actions. The rest of the MPC need to join David Blanchflower, by trying to project themselves into the future. Most of them seem to be at best living in the present, if not stuck in the past. Applying a second load of bolts to the stable door after the horse has bolted won’t bring it back. The issue is how we get a new horse into the stable in times of slowdown or worse.
I remain strongly of the view that the US has got its policy response right to the Credit Crunch, and the UK is still getting it wrong. It will not be easy for the US authorities to chart a successful course, given the magnitude of the mistakes made on the way up. They still have to contend with a very weak banking sector, with more bad news still to come, and with a very weak property market, which adds to the banking weakness. So much lending is secured against property, so falling property prices undermines old loans and puts people off making new ones. The Fed’s slashing of interest rates helped, but it cannot get all the market rates down in line with its rates, because the banks are short of cash and reluctant to lend. There will be some excitement about a change of President, and the two main candidates seem to be lining up to continue fiscal stimulus to assist low interest rates, with the emphasis on tax cuts to alleviate the squeeze on personal incomes. All that means the US is better placed than Europe.
Meanwhile Euroland remains mesmerised by inflation despite the obvious evidence that the slowdown has now hit Germany as well as Italy and Iberia. Destocking is adding to the woes of companies, as they fight to become more liquid against a backdrop of declining turnover. The UK is going for a huge fiscal stimulus based on increased public spending with revenues falling from the downturn. The fact that the government sector is as overborrowed as the private sector before entering the downturn leaves it in a weak position, at the mercy of the markets. The pound is now falling against the dollar, having devalued against the Euro, increasing the cut in living standards.
(Previous blogs on this topic on www.johnredwood.com include
“Halve interest rates and cut wasteful spending” 18.7.8
“The lies about the EU economy” 14.8.8
“The Bank of England is fighting the wrong dragon ” 9.8.8
“An inflationary or inflammatory letter?” 17.6.8
“Why have the government and the Bank of England failed us on inflation?” 17.5.8)
August 29, 2008
"This has proved contentious with some of my readers."
Yes. Why didn't you protest when the MPC, with its remit, was set up?
"I ask them, how much more evidence do you need of slowdown…"
No one is denying the slowdown. The argument is over what is the best solution. Do you follow the works of Mises, Hayek, and Friedman or the Keynesian economists? I would side with the latter but I'm not a politician. 😉
Instead of artificially inflating the economy politicians should be concentrating on lowering trade barriers, taxes, and regulations.
reply: I have been a consistent critic of the Bank of England policy of this government.I have set out my proposals to bring about a recovery in these blogs.
August 29, 2008
I've already heard a lot of people in the property sector putting pressure on the BofE and there is no doubt that the government will crack soon with a subtle press release to get the ball rolling.
http://lettersfromatory.wordpress.com
August 29, 2008
I am not surprised that you have taken this opportunity to use David Blanchflower's outburst to support your position of dismissing the threat of inflation and demanding interest rate cuts from the Bank of England. Like you I shall ignore the fact that another member of the MPC voted for an increase in rates at the last meeting and the rest decided to leave them at the current level. Your argument is based on the need for the MPC "projecting into the future", which I would have thought that it already did, and that: "The present high inflation reflects mistakes of the MPC and others a year or two ago. There is nothing the MPC can do in the short term about that." With these thoughts in mind, would you please refresh my memory as to when you and David Blanchflower warned the MPC and the public, in such strident terms, that their interest rate policy of a year or two ago would create today's inflation? This would help us in deciding if your current recommendations should be given more credence, by coming from those with proven greater foresight, than the majority of the MPC.
Reply: I regularly said money policy was too loose – the published version is the Economic Competitiveness Report.
August 29, 2008
As one of the readers who previously thought cutting interest rates would merely provide an artificial stimulus I will admit you were probably right. Apart from the fact that you can quote impressive support is the fact that oil prices, rather than rising to $200 as so many Cassandras predicted are already falling. I thought there would be a long term fall but not this fast, which proves that it was indeed a bubble rather than a structural change of direction. If so the "recession" itself is a crisis of confidence rather than something fundamental & should not be fed by fiscal policy.
I don't change my mind that if we want a successful economy in the long term it will need real microeconomic reform. Cutting government spending, cutting corporation tax & other business taxes, cutting regulation, allowing the market to build new competitive power stations, allowing the mass production of houses, cutting the bureaucracy & regulations that meran public works cost up to 13 times what they used to even allowing for inflation, even technology X-Prizes. If we were to do all that I have no doubt we could match China's growth rate.
August 29, 2008
There are numerous commentators expressing serious doubts about that 3.3% figure for US GDP – see for example the nakedcapitalism blog.
August 29, 2008
Hello John!
You ask “Where are all those pundits who told us the US is in recession?â€
I don’t know about them but I happened to see some financial expert today who said! (roughly!)
“It’s fair to say that when an economy is experiencing growth it’s hard to say that economy is in recession but America is set to show slowing consumer spending in July, the 3.3 gain will full to 1% in the next quarter & anyhow! when you strip out the necessary factors that should be factored in, the 3.3 gain only really works out to two tenthsâ€!!
Was he wrong?
If you also factor in that some American companies are looking to lay people off as they tighten their belts, house repossessions are still rising, the tax rebate Americans got has all but faded away & the cheap brand supermarkets are about the only big companies seeing some sort of sensible rise in their share price, you have to wonder where to draw the line between thinking you are or aren’t in recession!
This is also hoping things like the weather don’t cause pipe lines to burst or oil rigs to fall over causing more price rises!
Many experts I have seen lately & over the last few months have said that the world is going into recession & point to things like India seeing their economy grow at its slowest rate in years, it seems impossible to find a happy side to what is slowly starting to envelope the world’s business structure at the moment!
I heard some financial experts say on a programme I was watching the other week that “at the moment the public are in denial, soon they will be desperateâ€
!! I KNOW!
It seems to me that our elders who said things like “save your money for what you want†& “it’s unhealthy to get in debt†are proving to be sound words, even our banks don’t trust each other at the moment & it seems the banks who will survive are the ones with some pennies saved for a rainy day, lesson to be learnt there!
August 29, 2008
This is all getting too complicated for me, so I will just refer to the following over at the Oracle. Notice the last para' in Nadeem's piece, where he suggests Gordo's next election winning idea for home owners.
Today a bunch of MPs are calling for local councils and RSLs to be able to do a negative equity swap with distressed mortgage voters. Naturally, these will be "securitised" as taxpayer backed, trade-able (junk) bonds. These will find there way back to the BoE, where they will burn out the recently fitted turbo-chargers, on its pound note printing press.
You will remember that the US Fed stopped calculating M3 – broad money supply – back in 2006. The number was getting embarrassingly high. So when the BoE stops calculating our version – M4 – you will know we are really in the s***. http://www.marketoracle.co.uk/Article4360.html
August 29, 2008
You haven't mentioned the Trades Unions who are getting restive now and who more or less fund the bankrupt (morally and financially) fund raisers of the Labour party . They are doing a 1970s reprise.
You haven't mentioned the £1,000,000,000,000 which (Jeff Randall), according to the Telegraph today is the amount that public servants' pensions now cost. This fact alone seems to me to be enough to keep the ridiculously high taxes ridiculously high.
Then, as mentioned in the business section of last week's Spectator, there is the distress of the major banks. One large bank (name removed -ed) is apparently, in real difficulties. The sum of a further £50,000,000,000 is mentioned to prop up the crumbling and impotent Northern Rock. The other High Street Banks, too, are all in difficulties, apparently. Hence their inability to lend whatever the lending rate may be.
Broke government with no means of doing anything much, everyone, who can, getting into the Public Sector quick in one way or another, and a stronger TU could point to stagflation, actually – as in the 1970s.
August 29, 2008
Unlike you John, I have never believed that the Bank of England is independent of the Government. I still think that this Government could never relinquish control of anything they got their fingers in. The BOE is independent in name only.
Reply: I have been the one politician saying throughout the last 11 years that the Bank is not independent!
August 30, 2008
THE UK SITS ON A PILE OF SAND.
Alistair Darling finally looked as if the penny has dropped when he said people are "P'd off". No doubt many will find this a very perculiar choice of phrase for any government minister to use however although it accurately describes public feeling ( eventually ), he doesn't actually provide a remedy so what is the point of him saying it ?
He says it's imperative to tackle the problems to get the "zeal" back into Labour if they want to win another term in office !! – Obviously the penny hasn't dropped far enough on that one then since Labour have no chance at all in gaining power again I doubt unless some lucky star were to land on Labour HQ sometime in the next 100 years !!
There are things we can do to put this crisis right and I'm sure there's a myriad of ideas out there, but patently none in government where it's needed.
UK housing stocks are a complete mess and totally out of control to the detriment of ordinary people who need to make a home. They simply can't afford to buy a home because prices have been inflated by speculators in the But To Let market buying houses off plan and using unlimited amounts of borrowing to fund their speculation.
It must be stopped if housing is to return to provide the needs of our society rather than the needs of greedy speculators without a social conscience.
Councils should quite rightly buy up loose housing stock but this should be done through an exchange for public shares and not with taxpayers money. Councils could quite easily raise the revenues needed for this and inject a lot of rental and shared ownership properties back into the market to give ordinary families a chance to get on the ladder, which will promotes home ownership, balance house prices, rid the market of speculators and still maintain the ability for private individuals and firms to produce wealth.
Secondly, the government should hit home on easy credit by putting a stop to credit card companies permitting transactions for non-essentials. Online gambling comes to mind as an example, and people should be encouraged to save and invest. The above housing scheme could carry tax free shares much like the current ISA's but purely in local government housing stocks.
Revenue could also be generated by releasing shares in housing association stocks in much the same way.
Stamp duty should be switched to the seller and it should have a flat rate of 5%.
First time buyers should qualify for a reintroduced MIRAS scheme which would run for no longer than 10 years, and it should not extend to second homes or subsequent purchases.
Banks and building societies should be compelled to provide 5 year, 10 year, 15 year, 20 year and a 25 year fixed rated products for home purchase amongst their ordinary schemes to give stability to people who buy.
Secondary home improvement loans should be regulated only through banks and building societies which fund our housing market, and secured loans through any other source for home improvements or ownership should be banned.
Payment protection insurance should be mandatory for home purchase and no mortgage should be granted without it. It should be included in the ordinary buildings insurance scheme and validated as being in force each year by the lender as is the case now with building insurance.
I have to say this country is in a right mess now because of rampant spending, a culture of easy credit, a complete lack of any social conscience or proper control by government and a rackless attitude by government to carry on deceiving itself and the public that things are "fine", when clearly our economy is built on debt.
The UK sits on a pile of sand !
August 30, 2008
[…] that Britain may, after all, be Going To The Dogs. But he has cause to feel vindicated: at every step, his economic analysis has proved superior to the Monetary Policy Committee’s – let alone […]
August 30, 2008
If only we could follow the example set by the US and cut interest rates sharply in response to the current crisis. The problem however is that it is not only the people of this country who have realised that this government in general and Gordon Brown in particular have ruined the economy here, the world's financial markets have too. As a result the pound is heading south and the further it goes the worse inflation will become and the harder it will be to bring it under control. Higher not lower interest rates in the coming months may well be the price we all have to pay therefore.
September 4, 2008
John,
You can't have it both ways:
"They kept money too loose allowing a credit binge, and they are now keeping money too tight, assisting a Credit Crunch."
Asset prices are only down 10% so if money policy was too loose this is now a correction back to an equilibrium price. Alternatively if prices are too low now, then previous monetary was not too loose. Once asset prices are down another 15% or look for sure as though they are heading that way, I would agree with you, but at the moment your judgement is premature.
Reply: Not so – the squeeze is too tough, as people are going to find out to their cost.