Economy may shrink 4.3% in 2009

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The Independent Online

The economy will shrink 4.3 percent this year, its sharpest decline since the aftermath of World War II, before staging a moderate export-driven recovery in 2010, a leading academic thinktank forecast today.

The National Institute of Economic and Social Research said the quarterly growth forecast was gloomier than its last one in February because slumping global trade made the earlier estimate of 2.7 per cent contraction too optimistic.

But recovery should start in the last three months of this year, as consumers purchase big-ticket items before value-added tax rises in 2010, and then be sustained by overseas demand from fiscal stimulus programmes in the United States and Europe.

"We expect the worst to be behind us with Q1," said Simon Kirby, a research fellow at NIESR, which expects the economy to expand by 0.9 per cent in 2010 contingent on stronger exports.

"If exports don't recover we could easily see a second year of contraction," Kirby said.

Unemployment was likely to keep on rising long after the recession was officially over, hitting a peak of 9.6 per cent of the labour force or 3.1 million people on internationally comparable measures in 2011. Only further wage restraint would stop unemployment increasing further.

NIESR said the economic pain was more comparable to that felt in the teeth of the depression in 1931, when the economy shrank by 4.6 per cent, than after World War II when figures showed a sharper contraction as the economy retooled for peacetime needs.

The Bank of England will be unable to claim much credit for the recovery if it maintains its current quantitative easing policy, which is too focussed on buying government debt at the expense of loans to companies, NIESR said.

Though the Bank does include corporate bonds and commercial paper in its asset purchase facility, the overwhelming focus of the initial £75bn in purchases is on gilts.

"It's impact is likely to be like the VAT reduction. You won't be able to see any clear effect ... and it runs the risk of becoming a policy failure," said NIESR's director, Martin Weale.

Weale said that in 1985 the Bank held £15bn of 'bills of exchange', a sum of bank credit to firms equivalent to £75bn worth in today's money, and that it should put more effort into doing something similar now.

"If the BoE says it's all too difficult, then it's not too surprising banks and businesses don't really try," Weale said.

The sharp downturn this year and slow recovery thereafter give an even grimmer outlook for public finances than that in Chancellor Alistair Darling's annual Budget last month, which was based on a 3.5 per cent contraction in output.

NIESR said Britain's total public debt was likely to rise to 94.5 per cent of GDP by 2013/14 - well above Darling's projection of 76.2 per cent - and that reducing it to a more prudent 40 per cent would be painful.

Even with a generous deadline of achieving this by the 2023, the government would have to cut public spending by 10 per cent, raise the basic rate of income tax by 15 percentage points or increase the retirement age by five years, NIESR said.

"The (fiscal) disaster is on the scale of a major war," said NIESR researcher Ray Barrell.