Two pieces of economic data have emerged on the British economy over the past week, and while they paint a somewhat contrasting picture of the economic climate, the main picture which emerges is that the Coalition’s strategy is broadly correct.
The latest inflation statistics show that the Consumer Price Index (CPI) is now about 5%, significantly higher than the Bank of England’s target of 2%. It seems to me that the Coalition’s single greatest error on the economy since coming to power has been to underestimate the rate of inflation.
But in this they have not been alone. The received wisdom has been that inflation would be kept low by public sector spending cuts putting the brakes on demand.
As I pointed out on Lib Dem Voice here, inflation is caused by many factors other than demand. Sterling has lost 25% of its value in the past two years, making imports more expensive, which in turn has raised the rate of inflation, and would do so whatever the rate of growth.
One of the reasons the currency has weakened is largely due to the rate of borrowing. One of the few things Gordon Brown got right about the economy was his decision to follow the great Liberal economist JM Keynes by using a stimulus to ignite demand in the economy towards the end of Labour’s term in office. To ignite this demand, he was required to run massive deficits, again as per Keynes’ teaching. This demand led to the growth experienced in the first six months of the Coalition’s time in power.
However, if you run a deficit and use debt to pay for it, the result is just as Keynes acknowledged: inflation and the challenge of keeping inflation down and re-paying the debt. The very fact that we have inflation at this point in the economic cycle indicates that the Coalition’s broad analysis of where on the cycle the UK economy currently is is the correct one. The fact that Labour are also committed to cuts indicates a general consensus on this point.
That inflation is even higher at this stage than it should normally be is perhaps also due to demand-side factors, not in Britain, but in the rest of the world. As countries such as Brazil, India and China have developed, demand in those nations for raw materials and for oil has meant that world demand is not stagnant.
The second crucial set of economic statistics which have emerged recently are those relating to consumer spending, which have shown a considerable rise both in terms of the month-on-month numbers and the year-on-year numbers.
The month-by-month stats show an increase in consumer spending of 0.6% which more than cancels out the previous month’s decline of O.4%. Its interesting that the considerable number of people who sneered when ‘seasonal factors’ were blamed for the decline, are now quick to say ‘seasonal factors’ are responsible for the rise.
This is why the year-on-year comparison is relevant: the September 2011 consumer data shows a considerable increase on September 2010. Even if there is a seasonal bounce to the 2011 figure (due to the previous month’s poor weather meaning people purchased more in September), then demand is at worst consistent, with people spending rather than hoarding their income.
Perhaps the most relevant part of the statistics is that while high street spending has declined, spending online has shown an increase of more than 10% in the past year. This helps to put into context the closure or poor profits of many high street stores, and indicates that while demand in the economy is not expanding rapidly, neither is it declining at any alarming rate.
As I said at the start of this article, the government have, I believe, got their broad strategy correct, rightly trying to tackle the inflation which is inevitably and necessarily caused by the earlier stimulus.
For theses cuts to be “too far, too fast,” (the Labour mantra) consumer demand would now be declining, not rising slowly, and this would be having the effect of pushing inflation down because such poor demand would be cancelling out the supply-side inflationary pressures caused by the increased rate of borrowing. We would see inflation still happening, but at a lower rate and with demand falling drastically, and unemployment much higher. David Blanchflower, an ardent critic of the coalition, forecast that unemployment would hit three million in 2011, while inflation would be low. Neither point has been proved to be correct, or even nearly correct.
The Coalition outlined in its plans for inflation to fall and growth to be sluggish until mid-2013, when the inflationary pressure declines, increasing consumer purchasing power, and this causes growth to rise. The Government underestimated just how high inflation would go, and this has seen growth lower than anticipated, resulting in a lot of the economic legroom being taken away from the Coalition on the demand-side.
The tightrope any government would be walking at this point has just gotten that bit thinner, but the knots keeping it in place at either end are not coming loose, as they are in the Eurozone countries. France and Germany are growing at a slower rate than the UK, while Ireland, which has cut hard, starts to sprout the green shoots of recovery and is projected to grow at a rate faster than the EU average this year.
The current Eurozone situation will put more pressure on the world economic demand, and in time this may require some tinkering around the edges of the UK’s macroeconomic strategy (and the Coalition has indicated that this is a possibility that is being considered).
This why the cuts are necessary. Labour argued that the cuts should happen at a slower rate and begin later in the cycle. This is a view which had some merit until the Greek sovereign debt crisis. This impacted sharply on Britian because it meant that those who lend to countries would have less faith in the system, and thus demand higher rates of interest than previously. By endorsing a more rigid cuts policy, Britain has overcome the doubts of our lenders to the extent that the country is borrowing money at the cheapest rate in its history. This mean’s our deficit is smaller as the interest component is reduced.
But while the confidence of the international markets has been secured and is vital, the true test of where the economy is was always going to come on the domestic front, and thus far the Coalition’s policies are passing that test.
* David Thorpe is a Lib Dem member in Hammersmith and Fulham.
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13 Comments
I think it is wrong to jump to conclusions based on one month’s figures. Currently inflation is outstripping average wage increases and benefit levels, so if there really is a trend towards greater consumer spending then logically this would surely be an indicator that personal debt is also increasing. Other surveys show that consumer confidence is low and in that context it would be very interesting to understand why consumer spending would increase in circumstances when normally it would go down.
It is all very well saying that Blanchflower was wrong about unemployement, but the government has also seriously overestimated growth figures and are hardly in a position to claim they have been proved right. Indeed if growth goes negative in the next quarter, what then? Another stimulus or more cuts? Osborne opposed the last stimulus whilst we supported it.
Er, really? It devalued in 2008, but that was three years ago. Or are you talking real terms or something?
I agree with some of what you are saying, but:
a) Sterling has been broadly flat since 2008, despite massive fiscal deficits. It is weird to say that fiscal deficits have led to a Sterling depreciation.
b) You should not confuse retail sales with consumption/household demand; retail sales are only 10% of GDP whereas household consumption is 60% of GDP, IIRC. Growth in (nominal) household consumption expenditure has been absolutely pathetic over the last year, compared to historic trends.
c) Don’t buy Osborne’s stupid argument about record-low interest rates being “good” for any sovereign borrowing in their domestic currency. It is a completely insane straw man. That long-term gilt yields at a record low means only one thing: investors’ hopes for long-term growth in the UK economy are at a record low. That is a hugely, massively, negative signal. If you pretend it is not, you are simply lying.
Australia can borrow for ten years at 4.54%, the UK can borrow for 2.5%; Japan can borrow for 1%.
That people would crow about us becoming more like Japan, rather than more like Australia, is either ignorant or very misguided.
Last year you told us that the growth figures vindicated the Coalition’s economic strategy and predicted that we were entering a period of robust growth. We have had zero growth since then and we may well be heading for a contraction. Have I missed the article where you acknowledge you were completely wrong? Can we expect another article next year telling us why the economic data – whatever it is – vindicates the coalition’s strategy?
@geoffrey
i have written at least three times on this site about the fact that te government re getting the strategy broadly right…..and each time its been said Im only using onemontt hs figures!
I try to use as braod a base fr articles as possible, hence quoting david blanchflower, my own pst articles, and various statistics, in the space I am permitted here I cannot go further into it.
of course your right that the government got its growth forecasts wrong, thats beause it got its inflastione xpectations wrong, I mention that in the article, though I would say the middle east crisis has contributed somewhat to the fel component of high inflation.
“andrew R
Last year I wrote that the robust growth showed that the stimulus had had its effect and tthis showed that the coalition were right in their judgement that the cycle was now ready for the cuts phase, its the same poiint I am making now, Im not predicting robust growth there won be till post 2015, though I would hope its gets beetr from mid twenty thirteen.
“justanother voter, yes Im speaking more inr eal terms aout the value of the currecy, as quoted in the times by Ina King, on monday last. The reason retail sales are important is that they measure more closely discretionary spending, as my link above shows a huge amount of the increase was in items like computers and gadgets, which are discretionary, if people have the confidence to buy those, and the discretionary income to so do, thats a positive sign.
Then your argument simplifies down to inflation being caused by a real-terms devaluation. That is a ‘not even wrong’ argument; it is circular.
A nominal devaluation can result in import price movements. There has not been one since ’08. Deficits have not moved Sterling. QE2 did not even devalue – Sterling has strengthened since the announcement.
This is all guff masquerading as macroeconomics. There are good arguments for cutting the deficit but none are made here.
I am afraid this is a load of codswallop.
a) Inflation is high because of temporary factors, mostly the VAT increase, the depreciation and the oil price shock. It is about to plummet and there is a significant chance it will go to deflation. Note how much lower it would be if house prices were in there as they should be.
b) Retail sales volumes are actually down by 0.2% 3mth on 3mth – values are up because of inflation. Consumer confidence is collapsing as are the latest business confidence date for the retail sector. I guess you didn’t spot that the latest CBI Distributive trades survey out yesterday found that “Retail sales fell in the year to October, at a similar pace to August and September, according to the latest CBI Monthly Distributive Trades Survey. A quarter (24%) of companies saw sales volumes rise on a year ago, while 36% reported a fall, giving a rounded balance of -11%. This was broadly the same as last month (a balance of -15%). The volume of sales was poor for the time of the year (-34%), and was the lowest since May 2009 (-36%).
c) Bond yields are low because the economy is tanking and there is zero prospect the MPC will raise rates. Note that most other countries with their own central bank and exchange rate have lower bond yields than the UK – Canada, Denmark, Sweden, Japan and the US are examples. Bond yields were also low under Labour.
d) The country was never bankrupt or comparable to Greece or Botswana. The coalition leaders have talked down Keynes’ animal spirits and must take full responsibility for the collapse in confidence. Would the CEO of a FTSE 100 company ever claim it was bankrupt I think not. He or she would be fired on the spot as the share price fell..
Carry on applauding the fine job the coalition is doing as unemployment rises, growth has halted, consumer and business confidence has collapsed and the consumer is running scared and banks aren’t lending. Employment fell by 178,000 over the next quarter. I dread to think what it would have done if the coalition’s policies weren’t passing the test
If the coalition has done so well how come the value of the country’s investment in RBS and Lloyds has halved since they too office.
Stop deluding yourself.
Danny Blanchflower
@ danny blanchflower.
your comments re; animal spirits, Im afraid that high inflstion is one of the things which conributes to the low leel of onfidence, or animal spirit, another round of stimulus, would only depen inflaion and therefore damage tehanispirits furher. by taking decisive action the government are able to offer the markets a degree of certainty, which helps with our borrowing position, labours cut but later and lesser means the uncertainy remains, and the ‘animal spirits’ dont iike uncertainty. the eurozone crisis and probably the unexpected events in the middle east have however contributed a degree of uncertainty which has somewhat taken the edge off the governments attempts to bring certainty.
this temporary bout of inflation is a hell of an unwanted guest, its saying a long time, for something so temporary., it wil recede as a number of things come into play, and as it recedes so will the leel ofpurchasing power increase.
You very correctly highlight the low level of consumer cofdence, and its strange that the consumer figures which I have highlighted show such a high level of discretionar spending in such a climate.
Are you the david blanchflower i refer to in my article?
I only ask because you sign yourself ‘Danny” which I thought was just a nickname which the media bestowed upon you because of your surname being the same as an x footballer.
If you are then thanks for the reply, even If I dont agree with all of it, I am very much in the leaners chair when it coms to economics and would never claim to be an expert and I admre your writings, as much now as when you were a critic of the brown overnment
@Danny Blanchflower
Thanks for the welcome outbreak of sanity and reason.
“c) Bond yields are low because the economy is tanking”
Quite.
It was interesting to hear the German Ambassador on Newsnight last night describe the ECB (and therefore I presume all central banks) as an ‘Inflation Machine’.
That is exactly the problem we are up against.
As Mr Blanchflower may be hinting, Central Banks are actually operating as ‘Deflation Machines’ at the moment. And the elected politicians who should take responsibility for monetary policy are complicit, from Tokyo, to Frankfurt, to London, to Washington. Like lemmings they are following the Japanese path where the Central Bank is effectively aiming for zero inflation … and succeeding. Zero inflation and zero growth.
It is a dereliction of responsibility for our elected politicians to devolve monetary policy to the unelected central bank which should be serving its Parliament.
What would be wrong with 5% inflation at this point in the economy? If the long term trend growth for the UK is 2.5% then the real effects of 5% inflation would actually be 2.5% At the moment real incomes must be falling by something like that, so we are getting that downside already.
The choice is therefore continuing 2.5% declines year after year, or some monetary stimulus that gets growth back on track.
I think maybe, paradoxically, the Governor of the Bank of England gets this (more than the Coalition, actually). I think he is targeting NGDP at 5%, in the expectation that, as inflation declines over the next 12 months, RGDP expands.
How would David Thorpe react to 5% inflation in 2013/14 of which 2.5% is the increase is RGDP?
I for one would grab that.
But you don’t get that by obsessing about inflation – continuing to destroy money – and suffocating growth.
in the link I highlight in my article to a previous article I wrote about inflation the comments section contains a link from me to an article in which vince cable says the inflation is temporary, and that was a long time ago.
I highlight that to show that Im not blindly embracing everything the lib dems say on the subject as the oracle…..and indeed it shows how much the government have underestimated the threat of inflation…..some of the temporary factors will start to wash out of the ecoomy, like the oil price, in the near future…..
“danny blanchflower
britain and greece’s economy and level of idebtedness are not the same, but they exist in the same world, and the animal spirits which greece can contribute to the forming of in the world economy affect britian, therefore britain just react to them because t soveriegn debt makrte and the leves of demand for our exports will react to them….
I am that David Blanchflower nicknamed Danny since I was ten!
Inflation is hurting people but a huge part of it is because of the mistaken increase in VAT which accounts for about 1.5pp of the 5.2% we now have. Confidence collapsed because Osborne, Cameron and Clegg said the economy was bankrupt when it wasn’t.
The govt is not giving certainty at all as growth has collapsed and they just look incompetent and intransigent – Vince Cable clearly agrees. Q3 is likely to be bad on Tuesday and Q4 likely to be negative as MPC members Fisher and Weale have noted.
It was foolish to implement austerity when one of our major markets was slowing as I repeatedly warned in 2010. NOne of this is a surprise. There is also no precedent for an ‘expansionary fiscal contraction’ without big loosening of monetary policy and a booming export market.
Osborne and Cameron I am afraid have shown no understanding of basic economics as Mervyn King said in his leaked wikileaks interview with the US ambassador
The economic data was always going to be a problem for Osborne’s Plan A
Hence the calls this weekend for a plan B. Where are all the letter writers now saying how great a job Osborne is doing
DGB
I do wish people would stop comparing the debt position within Greece to that of the UK. This propaganda used by the right wing and sadly echoed by the author of the blog is dishonest. The dept position of Greece is a million miles away from that of the UK. The total debt in Greece is way higher than the UK and it is in a currency that it does not control. Its level of maturity is also vastly different as it requires constant re-financing unlike in the UK which has some of the longest debt maturity. The UK can also create money to but its own debt as it has its own central bank and sovereign currency. That currency has depreciated to reflect the a range of economic indicators but this allows the potential to export more cheaply and encourages inflows of credit. Yields on British debt are low as they have been over recent years and debt sales have almost always been oversubscribed, this is not a new phenomenon and was the same under labour. The high yields in Greece actually reflect the hopelessness of the economy there, just how will Greece recover when they are having to impose such huge reductions in government expenditure. The cuts in Greece will actually make it harder to repay the debt not easier and this is reflected in the price of the debt. You cannot cut your way out of this situation you must grow out of it and a little inflation will help this along as it erodes the value of the debt over time. The idea that the UK is at risk of a Greek style tragedy is only a realistic prospect because of the actions of the government who have sucked the life out of the economy. The bad news is only just beginning.
“growth lower than anticipated”
That’s an understatement. The government forecast growth of 2.3% this year – the reality is that the economy has flat-lined. This government, like most before it, simply hasn’t a clue what it’s doing with the economy.
In other economic news, some Halloween data from the Office for National Statistics will make pretty horrific reading for those Lib Dems who have been trying desperately for the past 18 months to kid themselves that VAT is not regressive :-
http://www.bbc.co.uk/news/business-15519727