David Blanchflower: What took central banks so long to do more stimulus?

Why didn't they lower rates in February given there was no risk of inflation?
  • @D_Blanchflower

As I boarded a flight, which has wifi, to Seattle for a friend's daughter's wedding, news came through that the People's Bank of China had cut rates, for the second time in a month, by 0.31 per cent. Interesting number. I can't say I ever thought of voting for anything that was not divisible by 25 when I was on the Bank of England's Monetary Policy Committee, but why not? External MPC member Willem Buiter, much to the market's surprise, voted for a rate cut of 40 basis points in May 1999 for some reason. Then the unsurprising news came in that the MPC had increased its asset purchase programme, by £50bn. Finally, just as the plane was about to leave, the announcement came through that the ECB had at long last finally cut rates by 0.25 per cent to a record low of 0.75 per cent, though still well above the rates in the US and the UK.

Three central banks easing monetary policy together does suggest that the global economy is slowing once again and we should take note. I have every expectation the Federal Reserve will also act soon if the employment data continues to worsen, as it did on Friday when non-farm payroll growth continued to disappoint.

The ECB decision is the most astonishing. And not because they did it, but because it took them so long. Why didn't they lower rates in June, May, April, March, February, etc, given that there has been no risk of inflation for the last five years? Presumably the fact that euro area unemployment this week hit 11.1 per cent with youth unemployment at 22.6 per cent was a bit of a wake-up call. Spain is about to enact a further €30bn of fiscal tightening, including spending cuts and increases in VAT, in order to reduce the deficit, despite the fact that it will inevitably increase it further. Up is down; the lunatics have taken over the asylum.

At the press conference, the ECB's president, Mario Draghi, said: "Economic growth continues to remain weak with heightened uncertainty weighing on confidence." He added that: "The risks surrounding the economic outlook for the euro area continue to be on the downside". Eurozone growth has been killed off by overly tight monetary and fiscal policy, and very little has changed for a long time. Raising rates, twice, in 2011 was an act of economic suicide, just as it was in 2008 when the euro area economy was collapsing.

And so to the MPC, which restarted its programme of quantitative easing, something it obviously should have done in both May and June, and probably earlier. There was an inevitability about it given Sir Mervyn King's apocalyptic language over the last week or so on the parlous state of the UK economy. Sir Mervyn, of course, was in the minority of four out of nine at the previous meeting voting for more stimulus. This couldn't go on for long if he was to retain what little of his credibility he has left, so he was inevitably going to put pressure on his minions to remove this embarrassment.

The MPC's central forecast for inflation in its May Inflation Report suggested inflation would be below its 2 per cent target, so it should have acted then. Once again the MPC has been caught with its pants down; monetary policy tends to work best when it is proactive rather than reactive.

The MPC is coming under increasing pressure to broaden the range of assets it purchases given that the economy still seems to be slowing and credit availability remains limited, especially to SMEs. It remains unclear why it hasn't, as advocated by Adam Posen. In his letter to the committee agreeing to increase the ceiling, the Chancellor, George Osborne, made it clear eligible assets include not only gilts but also private-sector assets, for which a £10bn facility remains on the books.

The MPC's May growth forecast for 2012 still looks overly optimistic at 1 per cent. Capital Economics still believes that growth will be minus 0.5 per cent, and I agree with them. In part this is because provisional figures reporting that household spending rose by 0.1 per cent quarter on quarter in the first three months of this year were recently revised down and spending is now estimated to have dropped by 0.1 per cent. There is every expectation, based on business surveys and low levels of consumer confidence, that second quarter growth will also be negative, making three quarters of negative growth in a row.

And then to that inquiry that the Chancellor had hoped would be solely focused on the manipulation of Libor and be headed by Andrew Tyrie, who insisted it had to have cross-party support. Mr Osborne seems to have badly underestimated the public mood and left the suspicion the Tories have something to hide. During the Commons debate, the shadow Chancellor Ed Balls demanded Mr Osborne "put up or shut up" over an allegation in a magazine interview, where the Chancellor said Labour was "clearly involved" in manipulating the interbank lending rate four years earlier. Slasher, as ever, failed to deliver. What a mess. The incompetent Mr Osborne has to go for the good of the country.