Hamish McRae: Amid all the sound and the fury, the UK recovery is still on track

Economic Life: We are still spending five pounds for every four pounds of income and you don't need to look across the Irish Sea to know where that leads
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Yes, fine, but does all this stuff really derail the recovery? There is a huge amount of noise at the moment – about Ireland, the threat to the euro, US political gridlock, a new surge in commodity prices and so on – but then it would be astounding if there were not a sense of turmoil. There always is at this stage of the cycle. And given the serious and very much unresolved tensions within the eurozone there will be turmoil for some time to come. We are still in the very early years of this upswing and the next phase will be bumpy.

Uncertainty is bad for growth. It makes it harder to plan and discourages investment. In the UK we are coming out of recession without the usual jump in business investment. That may be to some extent because of a scarcity of finance: the phenomenon that loans are cheap but you can't get them. But I suspect it is more that people are not yet confident of sustained demand and are frightened of the impact of higher taxes, including VAT. This is not, popular wisdom proclaims, a good time to be in debt.

So there are headwinds, in the UK but also in just about the whole of the developed world. In that sense we are indeed all in it together. But to go on from there and declare that there will be barely any real growth for years to come and that will result in huge civil strife, seems to me to fly in the face of the evidence. There will be growth; the problem is that not much of that will be able to go into increasing living standards.

The best snapshot of how this cycle is developing for the British economy vis-à-vis previous cycles comes from the National Institute for Economic and Social Research and their most recent version is shown here. As you can see we are very close to the line of the 1980s recession. Actually after a really hairy downward ride on the roller-coaster we are a tiny bit above the 1980s line. Now it would be perfectly plausible for us to dip a bit below that line at some stage in the coming months, indeed I rather expect that to happen, but the broad picture would still be one where we will, some time during 2012, be back up to the previous peak in output.

This general picture is confirmed by other data out yesterday. Retail sales are up 2 per cent year on year in volume terms. The rise seems to have slackened off in the past couple of months, as the graph shows, but this conceals a decline in food sales and a rise in non-food items. I am not quite sure why we are eating less but spending more on other things – fears of obesity would hardly explain that – but this may just be a function of different price movements. Looking ahead, my guess is that this will be a good Christmas for sales but if the German experience when they put up VAT is anything to go by, that the first half of next year will be very dull. Eventually retail sales there recovered but it is a bit of a no-brainer to go out and buy any big-ticket items ahead of a rise that everyone knows is going to happen.

Meanwhile the big squeeze on public finances is yet to come. The other graph shows the way, month by month, the deficit is mounting at almost exactly the same rate as last year. The October borrowing requirement was seen as being slightly disappointing because it was a tiny bit higher than in the same month the previous year.

But the detail matters less than the big picture and that, I am afraid, is that for all the talk of the cuts, the harsh arithmetic shows that nothing much has happened yet. We are still spending five pounds for every four pounds of income and you don't need to look across the Irish Sea to know where that leads.

These will be the last public accounts before the Office for Budgetary Responsibility produces its new report on the economy and on public finances on 29 November. So we are now on the glide-path to the next set-piece event, the autumn statement on the economy. This, you may recall, was elevated by Gordon Brown into the pre-Budget report, and is now going back to its pre-1997 form – though now with the separate input from the independent OBR. It is useful to have official forecasts for the economy and for public finances twice a year as a reality check on the Government's thinking, a pause when we can all ponder whether these people are judging the risks and opportunities in a sensible way. It will also remind us of the mountain, the debt mountain, that has to be climbed.



And that leads to what seems to me to be the biggest question of all: to what extent does the debt hanging over not just the UK but the entire developed world change the profile of the recovery?

The conventional view, never to be dismissed, is that this will result in a slow and disjointed recovery in most of the developed world, in contrast to a vibrant one in the emerging economies. That is probably right and were that to be the case, the recovery would in any case merely carry on the same pattern of the past decade, when in both growth and recession, the emerging world outpaced the developed one.

But there are a number of smaller questions that we can hardly begin to answer. For example, does the rapid fiscal consolidation being forced on much of Europe really slow the Continent's overall growth? On that, the answers are wide open. It may well be that if all the weak eurozone countries are forced into austerity at the same time that will hold back the whole region. On the other hand it may equally turn out that Germany will revert, indeed has already reverted, to its role as Europe's locomotive, pulling the rest along behind.

Another question is whether ultra-cheap money is really boosting demand? The popular view is that tighter fiscal policies should be offset by still-loose monetary ones. That is the case behind any further quantitative easing plans. But the reaction of the markets to the last bout of QE in the US was to mark long-term interest rates up, not down. That is ominous. Maybe we are getting to the stage where ultra-loose monetary policy does more harm than good.

The UK will become a bit of a test-bed next year. The issue is the impact of tightening fiscal policy on demand. In the short-term it would be odd if there were not some loss of demand, particularly since part of the tightening directly affects consumer spending. But in the slightly longer term, there may be little effect at all, maybe even the reverse. Increased confidence that something is being done at last may more than offset the mechanical impact of consolidation.

Go back to the National Institute's graph. There is a natural tempo to the economic cycle. While the cycles are in detail rather different from each other you have to be profoundly pessimistic not to acknowledge that the recovery, so far, is looking OK.

hmcrae@independent.co.uk

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