Hearing clearly amidst the noise
Thursday 22 October 1998
At a time like this, the thing to do is to try to distinguish the clear signals from the background noise. Let's try to do so.
The first source of noise to filter out is the political one - not the sounds made by the main parties, but rather the attempt by interest groups to push their preferred policies.
Because borrowers are a more effective lobby than savers there will always be a political bias towards low interest rates. Borrowers tend to be large companies and younger people. Both know how to make a noise. Savers not only tend to be older people; they are often less well off than the borrowers. Their voice is inevitably more muted.
The second source of noise to filter out comes from dodgy data. Economic data frequently turns out to be wrong. Not only are the initial figures often so radically revised that they turn out to have been worse than useless; whole new series of data are published which give a different picture of what has happened.
There have been three important examples of this misinformation this year. One is shown in the chart, which demonstrates that earnings were much lower in the early part of this year than the earlier series suggested, and that after a peak in late spring, they have been tending to go down. Since earnings trends are one of the key variables taken into account by the Bank of England Monetary Policy Committee (MPC), you can see the obvious scope for a misjudgement.
The two other bits of data are the output of the economy as a whole and the balance of payments. If earnings growth this year has been "better" than expected (the inverted commas because if you can sustain higher wages, that is surely better than underpaying your workforce) so too have both economic growth and the current account.
People keep talking and writing as though there was already a recession. However, not only does the economy still seem to be growing, but growth in recent years has been markedly higher than the original figures suggested. It seems to be growing still. As for the current account, instead of going into a yawning deficit it has more or less remained in balance. The latest figures, for the second quarter, showed it in surplus.
The possibility that fears of recession have been much exaggerated has been aired by Professor Tim Congdon, of Lombard Street Research. He points out that there were recession-mongers as far back as the middle of 1997 warning of the possibility of a fall in output this year. So far they have been wrong. He believes they may be equally wrong next year, because there is no need for a recession.
It is an interesting way of looking at recessions: things that are both necessary and deliberately created. The last three recessions were all associated with high inflation, which policy-makers had to combat by cutting demand. At present there is no inflationary problem, or at least not one of any magnitude. So there is no need for a period of falling output.
He believes that "policy-makers would be incompetent if they allowed a recession to develop". But that, he argues, is not necessarily a call for big cuts in interest rates. Sterling has weakened against the mark, but the fall was disproportionate to the cut in interest rates. If rates were cut to 5 to 6 per cent the pound might fall too far and inflation rise above the target level.
I would add that since sterling seems to be almost a dollar proxy, we may find that if the dollar does come further down the pound will become even more competitive against the European currencies. What we cannot know, however, is how sterling will behave once the euro is launched. Will it continue to track the dollar, or will it start to converge on the euro? Or will it remain a "safe haven"? All we can say is that the background noise will be very loud for the next several months.
So where are the clear signals?
I'm not sure about the clarity of the data, but there seems to me to be several areas where we need to listen.
The most obvious is employment. If job creation is continuing - and according to the Labour Force Survey it grew by 70,000 in the three months to end July - then we should set that growth against the high-profile job losses by large employers. The problem is that the data takes a while to filter through, but at least employment (unlike unemployment) is a forward-looking indicator. Companies do not take people on if they see that demand is falling.
The next area is corporate profits. Company profits are real figures, not estimates or polls. If profits hold up, two things happen. Companiescarry on investing and growing; and the share markets are better able to recover their nerve. The analysts are busy cutting their estimates for next year, but it is still possible to expect some profits growth, even if it is very little.
A third area is tax receipts. Again, these are hard figures, lagged a bit to be sure, but actual money collected. If the economy is still growing, tax revenues will grow. If it stops, tax revenues will slide.
And how might the Bank of England react to developments in these areas? The key thing to understand is that the MPC is not only divided into hawks and doves, but hares and tortoises. The hares want to move fast - push rates up, whip 'em down - while the tortoises want to move slowly. If the economy were to head down, watch for the hares, for their moment might come.
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