Classic mid-cycle pause holds dangers for Clarke
Tuesday 31 October 1995
Since the beginning of 1993, it has been slow, quick, slow: we had one year of steady growth, one of sizzling growth, and we are now into the third year of rather slower growth. Since just about every forecaster underestimated the rate of growth last year, and just about everyone over- estimated it this year, no one feels overly confident now.
Last year people under-estimated overall growth largely because they did not spot the growth of exports, particularly to continental Europe; this year they have over-estimated mainly because they did not see the extent to which consumers would trim their spending in the face of increased taxation.
You can see the way in which consumption has not benefited fully from the expansion in the economy by looking at the chart. (The forecasts shown here come from Charterhouse, chosen because it is rather more cautious about growth this year, and more optimistic next than the consensus.) In 1993 consumption ran ahead of growth of GDP, leading the economy out of recession, but last year and this it has been running well behind. Maybe you can explain some of this in terms of the new insecurity that everyone, in jobs or out, seems to feel. But you can equally explain it simply by pointing to the way taxpayers have been hit over the head.
This raises an important question for next year. We know that there will not be any tax increases in the Budget. The reasonable working assumption is that there will be some modest net tax cuts (of which more in a moment). It is, therefore, quite plausible that consumption will rise reasonably briskly next year. A recovery started by consumers, and then subsequently sustained by exports, will then be supported again by consumers.
You can embellish this story a little by expecting a recovery in exports next year, with the US still growing strongly, some recovery from weak growth on the Continent, at last some growth from Japan, and continued rapid growth (though from a small base) in many of the variety of "emerging" economies. Investment will probably be quite good (Charterhouse thinks it will be very strong).
The main cloud is in stockbuilding, or rather the continued running down of stocks. This has been happening very sharply in continental Europe this year as manufacturers over-estimated the growth of demand last year and have had to slice back. But all in all, you can make a very good case for expecting good growth next year.
Conclusion? We are in the classic mid-cycle pause. This is not what many industrialists feel, for they are quite worried by the soft demand they see for their products and services. It is not what politicians feel, for they are beset by worried people in their constituencies. And it is not, to judge by their behaviour, what most consumers feel for they are still very cautious in their spending habits. But it is probably right.
If it is, what are the implications for the Chancellor? There has been an undercurrent of concern during the last month or so, which has surfaced to some extent in the newspapers, that the Chancellor will "give away" too much: that he is about to make a fiscal error by stoking up consumption at just the moment that it was going to bounce back anyway. I really think that is wrong. I think he is in serious danger of making an error, but a different one.
Let's assume that there are indeed pounds 2bn of net tax cuts, maybe a little more. That really is not a big enough number to matter. Take the PSBR down by pounds 10bn - the reduction that actually occurred between 1993/94 and 1994/95 - and people feel it. But a couple of billion is too small a number to have any real impact. True, it is possible to manipulate public spending so that one or other interest group can be made to feel better. Perhaps, too, a budget can affect the mood of people and influence their behaviour that way. But unless the Chancellor heads right outside the span of expected measures, there will be no fiscal mistake next month.
There might, on the other hand, be a monetary mistake. The lags in monetary policy are very long. The Chancellor appears to have got away with his resistance to that rise in base rates that the Bank of England wanted, because world interest rates came off shortly afterwards. The Bank has subsequently dropped the pressure for an early rise. It is quite possible, assuming that the Budget is reasonably well-regarded by the markets, that, come the spring, it will even be possible to engineer one small cut in base rates. The inflation story will appear quite good. The retail price index, both at a headline level and at the underlying rate, will be flattered by electricity price rebates, while wage pressures have been curbed (at least in the private sector) by the slowing of growth this year. And of course lower interest rates would give specific help to the housing sector, something that particularly concerns the present government.
But against this should be set two dangers. One is that consumers will indeed become much more confident next year - that the pause now will be reflected in a sharper jump come the spring. The other is that monetary policy may now be more loose than, say, the housing market or yesterday's money figures suggest - the weak sterling is signalling amber.
The foreign exchanges think that the Chancellor is about to make a mistake, and while they are a deeply unreliable witness, they are worth attention none the less.
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