A bit of a slowdown, then back to normal? It won't be that easy
It is possible that we will go back to trend growth after the millennium ... but the risks remain on the downside
Thursday 11 February 1999
More about the recession threat in a moment. First, have a look at the top graph, showing producer price inflation through the 1990s in the UK, the G7 minus the UK, and the euro area. Back in the early 1990s Britain had a significant inflation problem. In absolute terms inflation was not at all high by comparison with the levels of the 1970s or early 1980s, but it was high by comparison with the other large developed countries. Since then, and most dramatically in the last year, inflation has plunged. But it has not only plunged. It has harmonised. The price at which companies can sell their goods is sharply negative everywhere.
Inflation on the conventional measure of the retail price index does continue in the UK: the middle part of the Bank projections put it spot on 2.5 per cent. But that is partly the result of the way we calculate our RPI. If we were to use the standard method of calculation of the EU it would be half that, and even that method does not allow for quality increases, or the fact that people change their habits, shopping around for discounted deals.
Where there is inflation is in asset prices: house prices still seem to be climbing, particularly in London and the South-east, and share and (particularly) bond prices are higher than they were a year ago. Asset price inflation does not enter into the normal considerations of central bankers: they worry about it, to be sure, but it is not in their official target ranges.
THIS LEADS to a really big question which will, I suggest, preoccupy people in the next decade. Why is there asset price inflation in a world where there is no inflation, or virtually none, in goods and services?
Monetarists would say that it is because too much money is being printed. You do not need to believe that there is a direct mechanistic relationship between the supply of money and the supply of goods and services to accept that there ought to be some sort of relationship between the two. Through the 1980s, real money supply (the broad M4 measure) was consistently higher than the growth of GDP, as the lower graph shows. So except in the early 1980s and early 1990s squeezes, monetary policy accommodated some rise in prices.
But now there is little or no rise in prices and money supply is still growing faster than the economy as a whole. Talk to anyone involved in financial markets and the word that keeps cropping up is "liquidity" - there is a lot of money chasing a limited supply of securities. So share prices have stayed high and bond prices have soared away.
You could even say that, while there was current inflation, rising prices of goods and services were available to absorb excess monetary growth. Now the money is not mopped up in that way and goes into holding up share prices. This is by no means only a British phenomenon. In fact the excess liquidity argument is even stronger in the US. Share prices are at a 40- year high relative to company earnings.
But this is not sustainable. Asset prices cannot go up relative to current prices for ever, any more than house prices can rise faster than earnings. At some stage a new equilibrium has to be reached: there is either a plateau - or maybe a slump.
This brings us to the new Bank forecasts for the UK economy. It expects a pause in the first half of the year, a recovery in the second, and a resumption of trend growth next year. This is more or less what the market expects, and presumably what the Treasury will also forecast when it brings out its new numbers at the time of the Budget, now less than four weeks away.
It is very hard to disagree when there is such a high degree of consensus about something, particularly since most of the factual evidence seems to support the conventional view. (The main bit that does not is the employment figures, which have been strong, but this may be the result of lags.) Talking to business people with activities right across the country, I catch the impression that there is still very solid demand. Provided the price is right, people will still buy. Volumes, in general, are fine. The problem is getting the price to a level where people feel they are getting good value. As the year moves on, demand will be further stoked by the millennium: the negative aspects of the millennium bug, which costs money to fix, and the more positive "party-time" spending expected in the second half.
AND THEN WHAT? Back to trend growth? Well, it is certainly possible. It may transpire that the majority is right after all, and it is a plausible notion that the pause in UK growth this year will have allowed some modest rebalancing of the economy so that it can resume trend growth after a longish period of out-performance. But is not a period of below-trend growth really just as likely?
Because of the separate publication of the Inflation Report people no longer pay much attention to the parent publication, the Bank's Quarterly Bulletin. This is a pity because it is dealing with a problem that, unlike current inflation, still exists: the threat of global recession. No, it is not saying that this will happen, but its commentary on events since the publication of the last edition, in November, has a consistently cautious tone.
Japan is still in the deepest recession since 1955, when GDP data was first collected. The US had very strong growth in the final quarter of last year, but the headline figures masked a slowdown in final demand, and manufacturing weakened sharply in the second half of last year. The euro zone had a good third quarter and consumer confidence has remained high, but business sentiment has weakened. Growth forecasts for Germany and France are being shaded down. And outside of the developed world, uncertainties remain in Brazil and China.
ASK THIS QUESTION: what will be the booming economies of the year 2000? The US? Not if it has to pull the whole of the world economy along with it, and certainly not if the long-awaited market correction takes place. The euro zone? It may do all right, but it needs to do better. Japan? Well, maybe there will be some sort of recovery, but it can hardly be a vigorous one. The rest of east Asia? Yes, there may be some recovery at last, but it will at best be patchy. The rest of the world? There will be pockets of decent growth - outer Europe may well be one - but these will not be large enough to act as engines for the world.
To say all this is not to forecast a global recession. But it is to acknowledge that the risks for the world economy remain on the downside. The IMF published a special interim assessment of the world economy at the end of last year, in which it pointed out that the industrial production of the world economy is now growing more slowly than at any time since the beginning of the 1990s.
The pattern of growth is differently distributed, for then the US, Canada and western Europe were in actual recession, while Asia was growing at more than 5 per cent a year. By the end of last year there were patchy signs of recovery in Asia, but looked at in aggregate, the rest of the world was only inching forward. Estimates for world trade growth this year are being correspondingly downgraded. Sure, the services sector continues to run more strongly than the industrial one, and that may keep the world out of absolute recession. But the margin between a slowly growing world economy and one that is not growing at all is quite fine.
Maybe we do not yet need a Recession Report, after all. The balance of probability is that there will be some sort of global growth through next year, even if it is pretty muted. But the idea that there is a bit of a slowdown then everything returns to trend and we can all relax is too easy. I remain more concerned about next year than about this one.
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