Walking the tightrope

Both the Government and the Bank of England are walking a tightrope in terms of economic policy at the present time. The Bank is (quite properly) a relatively secretive institution, even if much more transparent than it was in the past and I am not claiming to have any special inside knowledge.

However, there are concerns by observers of the Old Lady that inflation has got baked into the cake. Electricity prices are expected to go up by 10 per cent in the summer and gas prices by 15 per cent, the latter driven by liquified natural gas demand from Japan.

It could be argued that increasing interest rates would actually do very little to drive down inflation and would impact on consumers by pushing up mortgage rates. The Bank does consider, however, that inflation will eventually diminish because there will be no further VAT rise; no further fall in sterling; and (hopefully) no big rise in energy prices.

Exports have been largely driven by sterling depreciation. It is particularly a matter of concern that imports by businesses resoponding to Bank surveys have not been affected at all despite a 20 per cent rise in their cost. Imports are predominantly intermediate ones suggesting that no domestic substitution is occurring. However, it is possible that the rate of growth in imports may have been slowed down.

The consequences of an unprecedented fiscal contraction in the UK economy have yet to be seen. However, big corporates do have tons of cash they could spend. Employment intentions are picking up, but a lot of it is part-time and self-employed.

There have been substantial differences on the Monetary Policy Committee (MPC), although these will diminish with the departure of ultra inflation hawk Andrew Sentance who even seemed to question the Bank's forecasts. Sentance's argument is in essence that it is really all about global imbalances rather than UK domestic conditions and the former will persist.

More generally, the differences on the MPC reflect considerable uncertainty about risks. Some members of the MPC are concerned about the credibility gap in terms of constant overshooting of the inflation target. People are arguably more concerned about growth and employment than inflation.

At the moment there is an unprecedented monetary expansion and at some point this will have to stop. However, there is believed to be some concern in Bank circles about the fragility of the economy and downside risks.

The Bank has in effect admitted that the output gap (slack in the economy) is smaller than thought and this means that any expansion may see limited productivity gains and create inflationary pressures. It is unfortunate that the output gap is one area in which data is less reliable, but it is evident that some physical capacity has been destroyed for ever. There are also some signs of skill shortages appearing, especially in engineering.

One uncertainty is the sterling exchange rate. Bank thinking is to prefer the current rate, but a mild appreciation seems likely. In any event it cannot be managed.

Growth has been driven by larger firms, but business has never been better at the company owned by one of my children and her husband. New workers have been taken on and the order book is full. However, they were not receptive to the idea of a chat with the Bank's regional agent.

Labour still lacks new growth model

Labour still lacked a new growth model argued Professor Colin Hay at an End of New Labour? workshop at the University of Warwick last Friday. This would involve the channelling of credit out of the housing market to targeted export oriented sectors of the economy. An alternative account to the crisis of debt in terms of a crisis of growth could just about be detected.

It was difficult to see how a model of privatised Keynesianism (reliant on debt to fuel growth) could be resuscitated. High levels of private debt had increased the sensitivity of demand in the economy to interest rate variations.

There was a large interest rate spread between the LIBOR wholesale rate and mortgage and commercial lending. This functioned as a form of bank recapitalisation and was a drain on consumer demand and investment.

A manufacturing rebalancing of the economy would be very difficult to achieve. There was a need for downward pressure on the actual cost of borrowing. One could politicise the spread of credit, shaming banks. The Bank of England should be made responsible not only for base rate but for monetary policy more generally. Mortgage holders were likely to respond positively to such a strategy, but it was not sufficient.

Andrew Gamble asked how, given the extent of financialisation and individualisation, could this be reversed politically? How could the state change the supply of credit, what capacity would it need?

Peter Burnham raised the question of whether government needed a growth model. Jim Bulpott would have argued that it need it politically, but not economically. As far as manufacturing was concerned, the value chain was broken and three-quarters of what was left was in workshops employing small numbers of workers. One could not impose rates on any bank.

In summary the discussion suggested that there was no easy route out of the current crisis.

Growth higher than expected

Growth was at the upper range of expected outcomes in the third quarter at 0.8 per cent: Growth

This does not fit well with the forecasts of those who have been predicting a double dip recession. However, I always thought this was largely a question of semantics. There isn't that much difference between a negative growth rate and a positive one if the latter is not robust enough to generate enough private sector jobs to replace those lost in the public sector.

Consumer confidence as revealed by retail sales is not strong and one test for policy will be when the 20 per cent VAT rate is introduced in the new year. The public sector job cuts will, of course, not happen all at once and some of them will take the form of retirement from the labour force. But when they start to cut in, policy will be tested.