Martin Weale's commentary on the economic policy framework in the last National Institute Economic Review is well worth reading. He starts by stating bluntly that, 'It is abundantly clear from the chaos of the past few weeks that [the 1997 policy framework] has failed.'
Weale is, of course, suddenly back in fashion because his Cassandra like prophecies of doom entitle him to say 'I told you so', particularly in relation to the National Institute's forecasts which are more pessimistic than those of the Treasury.
He does qualify this by saying that the monetary arm of the framework has been its most successful component. But this is now being politicised with strong hints from the Chancellor to the Bank to cut interest rates sooner rather than later. The inflation objective thus effectively disappears, whilst cutting rates will do little for demand when there is so little liquidity and the base rates and mortgage rates have increasingly become decoupled. As Weale notes, the belief that interest rate changes can play a major role in easing the current crisis is probably mistaken.
Some of his main criticisms are:
1. The regulatory framework for the financial services sector. In particular the FSA was not equipped to prevent or at least dampen asset bubbles. Regulation of the financial sector was not regarded as a macroeconomic issue, but was given an equivalent importance to the regulation of utilities or commercial television.
2. The Treasury's method for measuring the economic cycle, 'giving rise to an inevitable perception that it was subject to political manipulation' to ensure that the fiscal rule could be met.
3. The treatment of the surge in tax revenues around 2000 as a permanent increase in revenue rather than a temporary or poorly explained surge. This led to fiscal policy errors.
He forecasts a current account deficit of 3.7 per cent of GDP in 2010 with a national debt as a proportion of 55 per cent by 2010. In other words, any new government would inherit a poisoned chalice. As Weale points out, a shift to a budget surplus is needed, but explaining that to a public which has been used to deficits is going to be difficult.
Weale anticipates that the UK will be the most affected of the advanced countries by the recession as it has very high private sector debt levels and a large financial sector. However, he expects a recession similar to that of 1990-92 rather than 1920-22 or 1929-32.
John Major was able to ride that out politically, but he was a relatively new face, whilst Gordon Brown was Chancellor and hence directly involved in the policy errors that were made. Of course, everyone makes mistakes, but some have more serious consequences than others.
I will deal with Weale's remedies, which I find less convincing than his analysis, in a subsequent post.