Riding the mini-cycles

Has the economy entered a new era of mini-cycles, in which growth occurs in a series of short bursts, followed by significant setbacks - a nightmare for both economists and politicians? This suggestion was put to me last week by Graham Cox, the astute senior economist at Sun Life.

The idea that we might have embarked on an era of mini-cycles is supported by recent experience in the United States. The recession there ended early in 1991, since when there has been a continuous recovery. But while the upswing has been continuous, it has certainly not been steady. The graph shows the recent behaviour of the purchasing managers' index, the best of the business surveys in the US. The crucial level in this survey is 50, with readings above this figure indicating an expanding manufacturing sector and those below a contracting one.

On three occasions since the American upswing started there have been serious fears that it was running into the sand. Two of these episodes ended happily, with the economy embarking on a renewed burst of strong growth just when the markets were beginning to talk about slump. The third started just after last November's election, and is only now showing a few signs (such as last Friday's strong employment data) of ending.

A similar pattern has developed in the UK. Although the purchasing managers' survey has been collected here for only a couple of years, the graph shows that signs of recovery in the autumn of 1991 and in the spring of 1992 quickly faded, and there are fears that the same might be happening again. The purchasing managers' index fell slightly in May, and there were also declines in the Halifax house price index, and in the rate of growth of M0 (by far the best monetary indicator of activity in the economy). Despite strong car sales in May, the upsurge in consumer demand in the early part of 1993 seems to have faded since the announcement of tax increases in the Budget.

This stop-start pattern has been observed in the early stages of past recoveries, but this time it has been more pronounced. Why, then, is it happening? There seems to be a tug- of-war under way, in the US and in Britain, between two opposing influences on consumer behaviour and these are essentially taking it in turns to gain the upper hand.

A rum affair

The first influence, which is still undermining consumer sentiment, is the continuing very high ratio of debt to income, which - despite all efforts - has not been reduced one jot since 1989. This has largely eliminated the willingness of consumers to borrow from the banks, which are in any case reluctant to lend except on the most gilt-edged of security. (In fact, this applies literally, since the banks are increasingly holding gilts rather than making loans to the private sector).

A consumer recovery without additional borrowing is a very rum affair. It depends to a considerable extent on the willingness of people to dip into their savings to finance purchases of consumer durables. This is inherently liable to setback.

Luckily, though, there is an offsetting force at work. While the ratio of outstanding debt to income has remained at about twice the level of any previous recovery, it has become far easier to service this debt as base rates have come down. The 'hole' taken out of personal income by mortgage payments has therefore decreased dramatically, leaving room for consumers to finance other purchases. From time to time, this extra money has forced its way out of people's pockets, and they have rather sheepishly trooped off to the shops to spend.

Confidence has been gradually repaired, but not yet enough to make this spending a continuous process. Consumers still need to be persuaded they are getting a bargain. Therefore spending has come in sudden bursts during sales or special promotions by the retailers. But as soon as businesses try to push prices back to 'normal' the flow of spending completely dries up. This cat-and-mouse game between consumers and retailers results in mini-cycles that are extremely difficult to forecast or control.

Furthermore, the mini-cycles are increased in amplitude by the fact that retailers and manufacturers are trying to keep stocks as low as possible. This means that a sudden burst of demand flows quickly through to increased production, with no buffer from inventories. The mini-upswing therefore gathers momentum. But just as producers are beginning to feel confident enough to hold stocks, demand dries up and a mini-downswing starts.

Political pressure

If this is an accurate analysis of what is going on in the economy, there are some obvious consequences. First, it will be almost impossible to produce any serious upward pressure on inflation, since demand will dry up as soon as prices begin to rise. Second, it will be extremely difficult to set monetary policy with any long-term objectives in view. Instead, there will from time to time be intense political pressure to reduce base rates - from whatever level they have by then reached - each time a mini-downswing is in progress. This will rapidly be followed by fears that base rates have been cut too much.

Probably the right thing for the new Chancellor to do in these circumstances is to try his utmost to ignore relatively minor fluctuations in growth as they occur, and to set monetary policy according to his best guess of the needs of the economy in the longer run - rather as the chairman of the Federal Reserve has done so successfully in the US in the past year or two. Whether this will prove politically feasible, of course, depends on the length and extent of the mini-downswings - and on the nerve of Kenneth Clarke.

But this raises the most difficult question of all - what actually is the right level of base rates for the long- term needs of the economy? In America, by common consent, this has proved to be around the 3 per cent mark, which the Fed has targeted for some time. But in Britain there is no such consensus.

A few economists continue to argue for base rates around 4 per cent - and I would tend to agree with them, though only in the context of a significant further tightening in budgetary policy. Others, some of them in the Treasury, see 6 per cent base rates as dangerously low, and probably incompatible with the inflation target of 1-4 per cent. These are issues on which Mr Clarke will need to ponder long and hard.

And there is one more complication, currently only minor though growing quite fast. More than half of all the new mortgages now being taken out in the UK are characterised by fixed interest rates, often of more than three years in duration. Within a couple of years, a large chunk of the house-owning population will in effect have declared themselves independent of short- term fluctuations in base rates, and will instead be influenced by longer- term changes in bond yields.

This will 'Europeanise' the British economy more efficiently than membership of the exchange rate mechanism ever did. And as base rates become less potent, it will leave tax changes as the main way of managing fluctuations in economic activity.

(Graph omitted)

Start your day with The Independent, sign up for daily news emails
ebooks
ebooksA special investigation by Andy McSmith
  • Get to the point
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Ashdown Group: Treasury Assistant - Accounts Assistant - London, Old Street

£24000 - £26000 per annum + benefits : Ashdown Group: A highly successful, glo...

Ashdown Group: Business Analyst - Financial Services - City, London

£50000 - £55000 per annum: Ashdown Group: Business Analyst - Financial Service...

SThree: Trainee Recruitment Consultant

£18000 - £23000 per annum + OTE £45K: SThree: At SThree, we like to be differe...

SThree: Trainee Recruitment Consultant

£20000 - £25000 per annum + competitive: SThree: Did you know? SThree is the o...

Day In a Page

General Election 2015: Chuka Umunna on the benefits of immigration, humility – and his leader Ed Miliband

Chuka Umunna: A virus of racism runs through Ukip

The shadow business secretary on the benefits of immigration, humility – and his leader Ed Miliband
Yemen crisis: This exotic war will soon become Europe's problem

Yemen's exotic war will soon affect Europe

Terrorism and boatloads of desperate migrants will be the outcome of the Saudi air campaign, says Patrick Cockburn
Marginal Streets project aims to document voters in the run-up to the General Election

Marginal Streets project documents voters

Independent photographers Joseph Fox and Orlando Gili are uploading two portraits of constituents to their website for each day of the campaign
Game of Thrones: Visit the real-life kingdom of Westeros to see where violent history ends and telly tourism begins

The real-life kingdom of Westeros

Is there something a little uncomfortable about Game of Thrones shooting in Northern Ireland?
How to survive a social-media mauling, by the tough women of Twitter

How to survive a Twitter mauling

Mary Beard, Caroline Criado-Perez, Louise Mensch, Bunny La Roche and Courtney Barrasford reveal how to trounce the trolls
Gallipoli centenary: At dawn, the young remember the young who perished in one of the First World War's bloodiest battles

At dawn, the young remember the young

A century ago, soldiers of the Empire – many no more than boys – spilt on to Gallipoli’s beaches. On this 100th Anzac Day, there are personal, poetic tributes to their sacrifice
Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves

Follow the money as never before

Dissent is slowly building against the billions spent on presidential campaigns – even among politicians themselves, reports Rupert Cornwell
Samuel West interview: The actor and director on austerity, unionisation, and not mentioning his famous parents

Samuel West interview

The actor and director on austerity, unionisation, and not mentioning his famous parents
General Election 2015: Imagine if the leading political parties were fashion labels

Imagine if the leading political parties were fashion labels

Fashion editor, Alexander Fury, on what the leaders' appearances tell us about them
Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

Phumzile Mlambo-Ngcuka: Home can be the unsafest place for women

The architect of the HeForShe movement and head of UN Women on the world's failure to combat domestic violence
Public relations as 'art'? Surely not

Confessions of a former PR man

The 'art' of public relations is being celebrated by the V&A museum, triggering some happy memories for DJ Taylor
Bill Granger recipes: Our chef succumbs to his sugar cravings with super-luxurious sweet treats

Bill Granger's luxurious sweet treats

Our chef loves to stop for 30 minutes to catch up on the day's gossip, while nibbling on something sweet
London Marathon 2015: Paula Radcliffe and the mother of all goodbyes

The mother of all goodbyes

Paula Radcliffe's farewell to the London Marathon will be a family affair
Everton vs Manchester United: Steven Naismith demands 'better' if Toffees are to upset the odds against United

Steven Naismith: 'We know we must do better'

The Everton forward explains the reasons behind club's decline this season
Arsenal vs Chelsea: Praise to Arsene Wenger for having the courage of his convictions

Michael Calvin's Last Word

Praise to Wenger for having the courage of his convictions