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Economics: New deal

The start of 2009 brought confusion rather than clarity to the economic
outlook. There has been bad news in abundance: most retailers reported a tough
Christmas, unemployment is moving inexorably upwards and the housing market
continues its long southwards slide. To counter the pessimism, there was yet
another Bank Rate cut to 1.5% ­ the lowest since the Bank of England was founded
314 years ago ­ and yet more government initiatives announced to support jobs
and spending.

Still, there is no clear consensus among the so-called experts on the length
and depth of recession. Each month, HM Treasury publishes a comparison of
independent forecasts from 40 organisations (24 financial and 16 others, such as
the Confederation of British Industry, International Monetary Fund and the OECD)
for a range of indicators. Although all predicted in December’s edition that GDP
would shrink in 2009, the extent of the decline ranged from a mild -0.1% to a
much more severe -2.6%. This would make it the largest UK decline in any
calendar year since 1945 (the record is currently 2.5% in 1980). As a
consequence, the views on the key components of spending were equally mixed,
although all predictions showed consumer spending and investment in the
doldrums. Government spending is the only area likely to show positive growth.

All this shows is that any forecast from any economist at any time comes with
a health warning, but in the current climate, the health warning is in bold type
and capital letters. The uncertainties are even greater than usual. What can be
said with a reasonable degree of confidence is that the recession will end,
because recessions always end. Since 1945, there have been three major downturns
(apart from the very short dips in activity in 1956 and 1961, which both lasted
just two quarters with output falling by only 0.6% and 0.8% respectively).

On average, the recessions of 1973-75, 1979-81 and 1990-92 each lasted around
two years, although there were quarters of flat or even ‘W’ shaped, slightly
increasing growth. In terms of consecutive quarters of falling output, 1973-75
was the shortest, measured by the peak-trough fall in output, 1990-92 was
mildest, while the longest recovery period was from the 1979-81 recession. The
three recessions were all characterised to varying degrees by sharp rises in
unemployment (usually lagged) and government spending and borrowing, an eventual
easing of inflationary pressures and an improvement in the UK’s trade position.

Using the past as a guide to the future, the authorities have pulled all the
traditional levers very decisively to try to minimise the economy’s fall. Not
only have interest rates been cut, but taxation has been eased, government
spending increased and sterling has weakened. All the initiatives that were
successfully used by the Major government after the ERM exit in September 1992
have been tried again, but more decisively and even earlier in the cycle.

If they do not work as intended it is because there is something different
about this recession: the turbulence in banking. Seeing events unfold in the
final quarter of 2008 was like watching a train crash in slow motion.

There were two intercity locomotives on the same track heading towards each
other, the economy (which was slowing) and the credit crunch (which was
tightening). The belief now is that the government has built a detour line that
will take the credit crunch away from the economy, thus avoiding a head-on crash
(that is a major institutional failure). But there will be collateral damage,
which is likely to slow the pace of recovery.

For many businesses, it is access to credit, rather than price, that is the
issue. There is little point in cutting Bank Rate if there is no money
available. And, of course, cutting interest rates could well reduce the supply
of funds further, as savers, unimpressed by rates on offer from banks, withdraw
their money and seek alternative investment opportunities. This is why
quantitative easing now appears to be on the agenda for the policymakers, in
effect pumping money into the system.

The best guess at the moment is that growth stops shrinking in Q4 this year,
marking the end of recession.

But the UK needs annual growth in the region of 2.5% to absorb the new labour
coming on to the market, to generate the tax revenues the government needs and
so on. This notion of trend growth approximates to a quarterly rate of increase
in GDP of 0.6% to 0.7%. An end to the technical recession this year does not
imply a quick return to trend. Getting there may stretch beyond 2010.

This is the problem after next for the authorities, but a crucial one.
Assuming that, as a country, the UK does not want or cannot go back to the
reliance it has had in recent years on retailing, financial services and
property and construction to generate growth and jobs, something else has to
fill the gap. The question of how Britain pays its way in a global economy in
the 21st century may be even more difficult to answer than how to persuade
people to start spending again in 2009.

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