Osborne’s assertion that high debt slows growth has been wrong from the start

The volatility caused by discussing withdrawing monetary stimulus has made it more likely for it to be increased in the UK


I have held the view for some time that pretty much all of the growth we have observed is attributable to the monetary stimulus both in the UK and the US.

In the US the areas that have seen strongest growth have been housing and car sales, both of which have benefited from low interest rates. Those who argue that monetary stimulus hasn’t worked do not understand the counterfactual – what the world would have looked like without the stimulus. Ben Bernanke argued that in the US unemployment would have been 25 per cent without the stimulus and in a much-misquoted assessment, I argued similarly for the UK.

In September 2009 I said as follows. “If spending cuts are made too early and the monetary and fiscal stimuli are withdrawn, unemployment could easily reach four million. If large numbers of public sector workers, perhaps as many as a million, are made redundant and there are substantial cuts in public spending in 2010, as proposed by some in the Conservative Party, five million unemployed or more is not inconceivable.” IF, IF, IF, IF and more IF!

I am getting utterly sick of the Tory trolls, as well as some biased commentators (including Dominic Lawson in this newspaper last week), who should know better, suggesting this was a prediction, which of course it was not. It appears they are simply trying to create mischief by changing the subject because of the abject failure of the Coalition’s reckless austerity policy or are just too stupid to understand what a conditional statement is. Two can play that game.

I was simply trying to understand the extent of the counterfactual and what unemployment would have been, if and only if, the stimulus was withdrawn, which it indubitably hasn’t been. Of course it is rather rich given I don’t run a formal forecasting model of the economy and the OBR, which is funded by public money that George Osborne created does, plus the MPC, which also swallows oodles of public cash, has been totally hopeless. Recall in June 2010 in its Budget forecast, OBR predicted cumulative growth in 2011 and 2012 of over 5 per cent and we got 1.3 per cent, which is less than in either France or Ireland. I wonder when our downgraded Chancellor will be heading to Paris to ask President Hollande for advice on how to generate growth?

As an aside, recent evidence by Miles Kimball and Yichuan Wang does not augur well for Osborne’s ability to get the deficit down, noting of course that the deficit rose last year. They find no evidence that high debt slows growth. Quite the reverse.

They claim “there is not a shred of evidence for a negative effect of government debt on growth”. What they find is that causation runs in the opposite direction from growth to debt rather than the reverse that Osborne has so frequently asserted. So low growth as has occurred in the UK, Kimball and Wang find has a strong positive effect on debt because tax revenues go down and spending goes up in a recession.

Supporting evidence for my view that monetary stimulus is doing most of the economic growth work came in the US when Bernanke at his most recent press conference suggested the possibility that QE might end – if and when the unemployment rate hit 7 per cent, with rate rises conditional on unemployment hitting 6.5 per cent. Of course he also said that QE might rise if unemployment was to rise further.

Even the mention of monetary stimulus potentially ending was enough to send the markets into a tail-spin, even though there was essentially no news in what Bernanke said. The latest labour market release from the Bureau of Labor Statistics by my old friend Erica Groshen, now the BLS Commissioner, added to market volatility and showed that non-farm payrolls increased by 195,000, but the unemployment rate remained unchanged, while the participation rate rose from 63.4 to 63.5. This caused the dollar to strengthen and 10 year bond yields to rise above 2.7 per cent. The sharp rise in bond yields recently has caused a number of Fed officials to warn that this is an overreaction.

The other big news last week on a similar theme was the MPC’s statement, which came as a surprise as it was only the third time a statement was released when there was no policy action. One sentence pushed the equity markets up by over 3 per cent, weakened the pound and lowered bond yields. This was it. “The significant upward movement in market interest rates would, however, weigh on that outlook; in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy.”

That suggests that at the August MPC meeting there would likely be further QE to get the yield curve down from two years out, as well as forward guidance, presumably linked to declines in the unemployment rate, say to around 6.5 per cent. The ECB also looks likely to be venturing into the world of forward guidance. The volatility caused by even discussing the possibility of withdrawing monetary stimulus has made the chances of it being increased in the UK even greater. No time to even contemplate a rate rise as advocated by Andrew Sentance and others, which would inflict immeasurable harm.

Several factors add to the prospects that the MPC will do further stimulus at its next meeting. First such signs of recovery as there are, including June’s positive CIPS/Markit surveys, as Capital Economics points out need to be tempered by the fact that the recovery appears to have been driven by some unsustainable sources, including a drop in household saving. Second, the peak in inflation may be close, given that the BRC’s measure of non-food price inflation suggests that core inflation fell in June. Plus recent falls in global food prices “suggest that the next big move in food inflation will be down” while the fall in producer price inflation will also push down on the CPI. I agree there is spare capacity in the economy so there will be little wage push on inflation.

It really is quite clear that IF monetary and fiscal stimulus were removed unemployment would rise perhaps as far as… hang on, I am not going there. But more stimulus should be introduced at least until unemployment hits 6.5 per cent or even lower if wages aren’t rising! By the way how is Osborne’s prediction doing on keeping the AAA credit rating?

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