David Blanchflower: Has Treasury realised at last it's time to act?

Economic Outlook: The IMF report "explodes what is left of the credibility of the analysis behind fiscal strategy"
  • @D_Blanchflower

Of particular note last week was an interview with our floundering Prime Minister David Cameron in the Daily Telegraph in which he appeared to accept that his economic policy had failed, warning that austerity would have to last until 2020, plus that there were more spending cuts to come. He appears to now be merely (mis-)managing decline, and has absolutely no clue how to turn the economy around; more of the same won't do.

The data over the last week were dominated by bad news but did have a couple of positive signs on the economy, including an unexpectedly large drop in CPI inflation, which now stands at 2.4 per cent in June, down from 2.8 per cent in May. This is the third month in a row that the annual rate has fallen. It is now at its lowest since November 2009, when it was 1.9 per cent. I have every expectation it will be below the MPC's 2% target within three months or so.

There was also a small drop in unemployment of 65,000 on the rolling quarter, although this was dominated by a fall in London of 50,000. It does look like the puzzle over why the labour market has held up so well is explained by the fact that around 100,000 people have been hired over the last couple of months into temporary Olympics-related jobs. Once they are over, expect unemployment to rise again.

But the bad news was pretty awful. The reports from the Bank of England's agents suggested that private-sector employers do not expect to increase hiring over the next six months. The Bank of England's Trends in Lending Survey showed that the annual rate of growth in the stock of lending to UK businesses was negative in the three months to May. The stock of lending to small and medium-sized enterprises also contracted.

Wage growth continues to fall; weekly earnings grew by only 1.5%, which still implies continuing falls in real earnings, and that is likely to keep consumer confidence at its current low levels. It was unsurprising then to find that data on retail sales were, to say the least, disappointing, rising by a meagre 0.1% in June –, a much smaller increase than was expected by the consensus (0.5%).

The government's deficit was again larger than expected in June. A deficit of £14.5 billion compared with £13.9 billion in June of last year means spending so far this tax year is some 11.7% higher than for the same period last year, against the government's target of reducing the deficit by 4.6% this year. Chris Williamson of Markit noted that "the risk that is materialising here is that implementing austerity in a period of weak domestic and overseas economic growth is having the opposite to the desired effect on deficit reduction in the short term". It's hard to argue with that.

Then the IMF made two interventions – both of which were terrible news for Slasher Osborne, who has on numerous occasions claimed that the IMF supported everything he did, no matter what it was, and his Plan A was the best plan designed by anybody, ever, even though it wasn't. First, in its latest World Economic Outlook, the IMF reduced its growth forecast for the UK by more than any other G8 country in 2012 with a rise in GDP of just 0.2%, compared with a previous forecast of 0.8% and 1.4% in 2013 – a 0.6 percentage point cut from its previous 2% forecast. In contrast, it raised its forecast for growth in Spain by 0.4% for 2012.

Then on Friday, it produced its latest mid-term report on the state of the UK economy, and it was devastating. Its key points were that recovery has stalled and post-crisis repair is likely to be more prolonged than initially envisaged. The IMF argued there was room for more expansionary demand policies, as well as additional monetary stimulus via quantitative easing and "possibly cutting the policy rate as well as better targeting of transfers to those most in need".

Fiscal easing measures in such a scenario, it argued, should focus on higher infrastructure spending and temporary tax cuts that are targeted (for example, to lower-income households) so as to boost their multipliers, as these measures they suggested are more credibly temporary than increases in current spending. This has given Ed Balls lots of ammunition to fire.

As my old friend Jonathan Portes noted in his must read blog (http://notthetreasuryview.blogspot.co.uk), paragraph 43, page 38 of the IMF report was of particular importance as it "explodes whatever is left of the credibility of the analysis underlying the government's fiscal strategy".

Indeed it does. This is the relevant part: "Further slowing consolidation would likely entail the government reneging on its net debt mandate. Would this trigger an adverse market reaction? Such hypotheticals are impossible to answer definitively, but there is little evidence that it would.

"In particular, fiscal indicators such as deficit and debt levels appear to be weakly related to government bond yields for advanced economies with monetary independence. Though such simple relationships are only suggestive, they indicate that a moderate increase in the UK's debt-to-GDP ratio may have small effects on UK sovereign risk premia… Bond yields in the US and UK during the Great Recession have also correlated positively with equity price movements, indicating that bond yields have been driven more by growth expectations than fears of a sovereign crisis."

As Portes notes, the IMF agrees that the reason gilt yields are low is weak growth, as I have argued on numerous occasions, not confidence as Slasher has tried to claim, saying that he could "loosen policy with minimal risk and probable benefit". He should of course, and now.

The IMF did not say when the government should act, as politically it is hard for it to tell one of its paymasters what to do, but pressure is mounting to act to get growth going. That pressure will become almost impossible to resist on Wednesday if the first estimate of gross domestic product growth published by the Office for National Statistics for the second quarter of 2012 comes in negative as I suspect it will.

Capital Economics, for example, which I trust, is forecasting –0.5%, which seems credible. That would mean three quarters of negative growth in a row and five of the last seven. I gather that panic has set in at the Treasury on the need to do something fast. About bloody time.