David Blanchflower: With central banks so passive, there's plenty of reasons to be bearish

Economic Outlook: Inflation is set to fall sharply, especially given the rapid decline in the oil price

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The Independent Online

The week started for me with a rather ominous sign. I was making coffee and looked out of my dining-room window and there was a large black bear sitting at my bird feeder (pictured). I watched it chomp away at the sunflower seeds for a good 15 minutes or so. My 125lb Bernese Mountain Dog was stultified into inactivity and didn't even bark. Eventually I went outside and yelled at the bear and it ran away. Oh if only economics was that easy! My fear is that this presages a bear market. Hopefully not, but if it is, the right response would also be to scare it away as quickly as possible. No sign, though, of policymakers doing that despite the evidence from the 1930s that action is better than inaction.

The early part of June is a time of change in the small New Hampshire town where I work. It is the time of the passing-out parade that we call "Commencement". After four years on the idyllic banks of the Connecticut River that separates Vermont from New Hampshire, Dartmouth's graduating class of 2012 will head off into one of the toughest labour markets for a long time. This month's US jobs report showed that unemployment in the United States had risen again to 8.2 per cent, while the unemployment rate of new graduates is at scarily high levels.

The level of the unemployment rate is going to be a major issue in the November presidential election. The Republican Mitt Romney will try to claim that Barack Obama's policies have failed, while the President will note that he inherited an economy that was in freefall and that over the last year employment has risen by around 2.5 million.

The big question is how Mr Obama is going to get more Americans back to work, with the Republicans trying to block any effective measures for their own political advantage. The Federal Reserve chairman, Ben Bernanke, in testimony before Congress last week gave little sign that action was coming any time soon, although he was speaking for himself rather than for the whole committee.

Inaction was also the order of the day first by the European Central Bank on Wednesday and then the Monetary Policy Committee on Thursday. In contrast, the Chinese central bank cut rates for the first time since 2008. It cut its one-year lending rate by a quarter of one percentage point, to 6.31 per cent. Chinese banks will also pay less interest on deposits, with the deposit rate dropping from 3.5 per cent to 3.25 per cent. Recent reports from both India and Brazil added to the fear that the world economy is slowing once again.

I really have no idea what the incompetents at the do-nothing ECB are doing given the ongoing mess in the euro area. The main policy rate is still 1 per cent and should have been cut. The ECBreally is fiddling while Athens and Madrid burn and other capital cities are smouldering. Even German industrial output is falling. Fitch downgraded Spain a further three notches from A to BBB, which is just above junk status, and said mistakes at a European level that had allowed the debt crisis to escalate were in part to blame for its decision. Fears are also growing that Cyprus, after Spain, will be next to fall. But still nothing from those ECB clowns. At the subsequent press conference ECB president Mario Draghi wittered on about inflation fears, and concerns over whether expectations are anchored to the target. Blah, blah blah. Inflation is clearly not the problem. Oh dear.

Then our hopeless MPC did nothing once again, even though they produced a forecast in May that showed inflation below the target at the end of the forecast horizon and since then the risks to the downside have been gathering. Even the International Monetary Fund told them to get busy and do more quantitative easing. I actually had predicted they would move, so it was a surprise to me that they didn't. Not least because the data continues to suggest no growth at best this year and a contracting economy at worst. It really is hard to see why they didn't act now.

The latest PMI business surveys signalled a slowing in private-sector growth to a six-month low in May as domestic and overseas demand waned, adding to recent concerns about the health of the UK economy. The All Sector PMI – a weighted average of the output/activity balances from the three PMI surveys covering construction, manufacturing and services – fell to a six-month low of 52.3 in May.

Inflation is set to fall sharply, especially given the rapid decline in the oil price, which has fallen sharply over the last couple of weeks (see chart). Brent crude is now under $100 a barrel, having been over $125 in March. The latest producer price data showed that between April and May the output index for home sales of manufactured products fell 0.2 per cent, compared with a rise of 0.6 per cent between March and April. Between April and May the total input price index fell 2.5 per cent, compared with a fall of 1.4 per cent between March and April. This is the largest monthly fall since December 2008.

The latest Bank of England Inflation Attitudes Survey did show a slight pick-up in households' average expectation for the rate of inflation over the coming year, from 3.5 per cent in February to 3.7 per cent in May. But Sam Tombs from Capital Economics has noted that there are three reasons to be unconcerned by this rise, which I share. First, other surveys revealed that inflation expectations fell in May. Second, households' inflation expectations have been a poor guide to the future path of inflation in the past. Third, the considerable slack in the labour market suggests that, even if inflation expectations have edged up, they will not lead to higher earnings growth.

The lessons we should learn from the 1930s and from 2008 and 2009 is that it is better to get ahead of the curve than trying to play catch-up. The risks just about everywhere are clearly to the downside. There is big trouble ahead. No wonder the bears are on the prowl.