Economics update from John Birchall
The inflation numbers are moving upwards and most economists can’t see them coming down for quite a while.
The keeping of the CPI within the Maastricht agreement of 2% +/- 1% seems a distant hope – or is it – more later.
Within the Euro zone any price suppression now seems to be over as the figures below show.
Euro Zone HIPC Inflation – May 2010.
So, was it expected – well yes, you can’t run huge deficits designed to reduce the impact of a recession and not know that prices will rise, but if that is an accepted part of economics what can be done about it?
The unemployment rate has begun to move upwards and that may eventually put a downward force on price rises.
However, the main monetary reaction, that of increasing interest rates seems a risky strategy as economies struggle to really move beyond 0% growth.
The 16 Euro Zone countries and they account for 75% of EU trade are struggling to move back to where they were in 1996!
Euro Zone GDP growth rates – April 2010.
Tax rises are forecast in many countries but that too may cause the move out of recession to stumble. The state of most public finances also puts a restraint on any increases on state spending.
The % of Government deficit measured against GDP for the 16 Euro Zone economies.
As is well known the level of government debt is already causing concerns of a possible failure to pay amongst some of the EU’s economies.
Government Debt as a % of GDP – Euro Zone countries
So, in the normal teaching of economics the following are looking a little shaky:
• Put up interest rates to reduce consumption – it’s not that high as it is
• Put up taxes, again to reduce consumption – this may yet be the case in UK and some other EU countries where VAT rates maybe increased – fears over the consequences on the fragile recovery
• Let governments spend more, so boosting both demand and hopefully supply – most unlikely
Let’s be brave and design a PAU strategy!
• Don’t lose credibility on inflation and put up interest rates – as advised by the OECD. But spending was expected to rise as quantitative easing caused consumer spending to remain steady – so may be that won’t be part of our strategy!
• But is inflation really that large a problem? If we strip out known tax changes and fuel price increases the real level of price increases was 1.4% and that is below the Growth and Stability Pact level we have been tracking
• Labour rates are holding firm and many negotiations are bringing in freezes.
• We are not in the Euro, so we can use a cheap currency to boost exports
• So, keep calm, gradually increase interest rates in real terms, raise taxes – much depends on political strength of the coalition – Mr. Laws story just breaking – could be bad news
But here the good news stops! We all know that the old trick of 1970’s and 80’s was a con, (i.e. letting the £ slip) you have to boost productivity and that is something the UK is not good at. We may have to spend less at home, to keep prices down, so as exports continue to appear cheap – let’s not address quality just yet. However, put in simple economics textbook language the UK has to become a price taker and accept that it is no longer a price maker – the balance of power is shifting and our days as a major industrial influence are probably over. China now determines the price of the five major commodities needed for industrial production, now that is power!
May be we needed not worry too much about inflation but productivity and competitiveness – both price and non-price are going to become more and more important. So, it’s a touch of demand-side policies, some painful e.g. VAT increase and more to supply-side policies – they take time to have an impact and the large de-industrialisation was carried out nearly 30 years ago.
It will be interesting to watch and see if the PAU school of economics is accurate.