Growth must be the focus as the world economy slows

Andrew Sentance has a list of questions for Mervyn King. Here are my answers.

Andrew Sentance on his website has posed ten questions that he wants answered by Mervyn King. So I decided to answer them myself.

1. The Monetary Policy Committee (MPC) resisted arguments for a rise in interest rates in the second half of 2010 and earlier this year. And yet it has moved very quickly to mobilise more quantitative easing (QE) based on short-term worries about economic growth, despite the fact that inflation is now over 5 per cent. Is this not evidence that the MPC is targeting growth, not inflation?

I guess you never did realise that monetary policy can only impact inflation 18 months to two years ahead. As it is being driven by temporary factors and they are about to drop out, inflation is going to be below target at the forecast horizon. This would be even more obvious if the CPI included falling house prices. In any case, behavioural economics shows that people care much more about unemployment than they do about inflation.

2. The Bank's analysis of the original round of QE showed that it raised inflation. How can a new round of QE be justified when inflation is at 5.2 per cent, the highest rate we have seen since the early 1990s?

The Bank's analysis showed that it raised inflation, which was a good thing, because we were headed to deflation. A new round of QE is justified, because the economic data in the UK and especially in the eurozone is slowing. Perhaps you didn't notice.

3. MPC forecasts have seriously underestimated inflation since the onset of the financial crisis. How can the committee be so confident that inflation is set to fall below target when its previous forecasts have been so inaccurate?

You mean the forecasts that you signed up to? The MPC also was too optimistic about growth. All forecasts are based upon the data that there is to hand. If another shock comes along in either direction than all bets are off. How could the MPC be expected to forecast, say, a hurricane that disrupts oil production and then pushes up both oil prices and inflation?

4. The MPC has taken a decision to reactivate QE without the support of a quarterly forecast. How can the committee then assert so confidently that inflation will fall below the 2 per cent target without a further injection of QE, when it has not carried out a forecast exercise to support this judgement?

The shock to output is so large that they had to move. Contrary to what you claimed in a number of your speeches, growth was revised downwards, not up, which meant it was obvious that inflation was going to be well below the target. The Greek referendum means that risks are even greater to the downside. Every time, you have called it wrong, so you have no credibility, sorry.

5. Some economists have argued that QE will depress sterling and add to inflation directly through that route. Given that the weakness of sterling and rising import prices have added to UK inflation in the past 2/3 years, is this not a very legitimate concern?

You know very well that depreciation of the currency helps to increase stimulus in the economy, not least because it raises the cost of imported goods and thus encourages import substitution. This has been rather slow to happen to this point, because of the mistaken austerity programme that cuts too deep and too fast. What you're not acknowledging is that the alternative was for the economy to go over the cliff, which would create very high levels of unemployment. Economists have to consider the outcome for people across society.

6. The MPC minutes suggest that the committee believes that QE will be as effective in the current environment as in 2009. Yet a key channel of influence for QE is the downward impact on long-term interest rates, which are now much lower than in 2009. Does this not suggest MPC will now be less effective?

The MPC has performed its own Operation Twist with its new form of QE, which emphasises the long end of the curve. In contrast to the stock of data, a third of the purchases will be of 25 years duration and over compared with 11 per cent of the stock. The economy needs stimulus.

7. The first round of QE in 2009 probably boosted business and consumer confidence because the Bank of England appeared to be "pulling out all the stops" to stabilise the economy. Is there any evidence that the confidence effect of this current round of QE will be so positive, particularly when there are major worries about high inflation at present?

Maybe not, but that simply is an argument for doing a lot more QE, rather than less. Hence some economists' expectations that QE will move to at least £500bn. Doing nothing, as you seem to be proposing, would push the economy over the cliff.

8. If QE is effective, it brings forward future growth into the present. But that means growth may be weaker in the future -- and the governor acknowledged this problem in his Liverpool speech. Why does the Bank/MPC think that we will be better placed to cope with weaker growth in the future than now?

There is no evidence from anywhere that more growth now means less growth later -- look at China. In the case of Japan, less growth now means less growth later. The economy is subject to severe headwinds and if action hadn't been taken, inflation would be below the target and perhaps even negative

9. A big concern for the public and business is pensions. By depressing long-term investment returns, QE makes the pension funding problem more difficult. Has the MPC taken this into account in its decision on QE and how does it respond to these criticisms?

As Mervyn King said, raising rates now to help savers is nonsensical, as it would drive up unemployment and lower growth.

10. The broader public will find it hard to understand why the MPC has not taken any steps to counter high inflation and yet seems very ready to inject more stimulus, which might add to inflation over the longer term. Surely the actions of the MPC are undermining confidence in price stability and the inflation target?

I am afraid it is you that has confused the public, by claiming that interest rates should have been raised in the depths of a recession. Just think what would have happened to the economy if you had had your way -- mortgage payments would have risen, consumer spending and house prices would have fallen and unemployment would have risen and growth fallen. It is quite clear now that what you were arguing for was totally mistaken.

You failed to call the recession and wrongly suggested that the risk to the economy was inflation. The danger remains of deflation, not inflation. Note the statement made by the MPC when it moved to doing more QE.

The pace of global expansion has slackened, especially in the United Kingdom's main export markets. Vulnerabilities associated with the indebtedness of some euro-area sovereigns and banks have resulted in severe strains in bank funding markets and financial markets more generally. These tensions in the world economy threaten the UK recovery.

Note the scary word "threaten". Growth must be the focus right now, as the world economy slows.

David Blanchflower is economics editor of the New Statesman and professor of economics at Dartmouth College, New Hampshire

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Q&A: What are tax credits and how do they work?

All you need to know about the government's plan to cut tax credits.

What are tax credits?

Tax credits are payments made regularly by the state into bank accounts to support families with children, or those who are in low-paid jobs. There are two types of tax credit: the working tax credit and the child tax credit.

What are they for?

To redistribute income to those less able to get by, or to provide for their children, on what they earn.

Are they similar to tax relief?

No. They don’t have much to do with tax. They’re more of a welfare thing. You don’t need to be a taxpayer to receive tax credits. It’s just that, unlike other benefits, they are based on the tax year and paid via the tax office.

Who is eligible?

Anyone aged over 16 (for child tax credits) and over 25 (for working tax credits) who normally lives in the UK can apply for them, depending on their income, the hours they work, whether they have a disability, and whether they pay for childcare.

What are their circumstances?

The more you earn, the less you are likely to receive. Single claimants must work at least 16 hours a week. Let’s take a full-time worker: if you work at least 30 hours a week, you are generally eligible for working tax credits if you earn less than £13,253 a year (if you’re single and don’t have children), or less than £18,023 (jointly as part of a couple without children but working at least 30 hours a week).

And for families?

A family with children and an income below about £32,200 can claim child tax credit. It used to be that the more children you have, the more you are eligible to receive – but George Osborne in his most recent Budget has limited child tax credit to two children.

How much money do you receive?

Again, this depends on your circumstances. The basic payment for a single claimant, or a joint claim by a couple, of working tax credits is £1,940 for the tax year. You can then receive extra, depending on your circumstances. For example, single parents can receive up to an additional £2,010, on top of the basic £1,940 payment; people who work more than 30 hours a week can receive up to an extra £810; and disabled workers up to £2,970. The average award of tax credit is £6,340 per year. Child tax credit claimants get £545 per year as a flat payment, plus £2,780 per child.

How many people claim tax credits?

About 4.5m people – the vast majority of these people (around 4m) have children.

How much does it cost the taxpayer?

The estimation is that they will cost the government £30bn in April 2015/16. That’s around 14 per cent of the £220bn welfare budget, which the Tories have pledged to cut by £12bn.

Who introduced this system?

New Labour. Gordon Brown, when he was Chancellor, developed tax credits in his first term. The system as we know it was established in April 2003.

Why did they do this?

To lift working people out of poverty, and to remove the disincentives to work believed to have been inculcated by welfare. The tax credit system made it more attractive for people depending on benefits to work, and gave those in low-paid jobs a helping hand.

Did it work?

Yes. Tax credits’ biggest achievement was lifting a record number of children out of poverty since the war. The proportion of children living below the poverty line fell from 35 per cent in 1998/9 to 19 per cent in 2012/13.

So what’s the problem?

Well, it’s a bit of a weird system in that it lets companies pay wages that are too low to live on without the state supplementing them. Many also criticise tax credits for allowing the minimum wage – also brought in by New Labour – to stagnate (ie. not keep up with the rate of inflation). David Cameron has called the system of taxing low earners and then handing them some money back via tax credits a “ridiculous merry-go-round”.

Then it’s a good thing to scrap them?

It would be fine if all those low earners and families struggling to get by would be given support in place of tax credits – a living wage, for example.

And that’s why the Tories are introducing a living wage...

That’s what they call it. But it’s not. The Chancellor announced in his most recent Budget a new minimum wage of £7.20 an hour for over-25s, rising to £9 by 2020. He called this the “national living wage” – it’s not, because the current living wage (which is calculated by the Living Wage Foundation, and currently non-compulsory) is already £9.15 in London and £7.85 in the rest of the country.

Will people be better off?

No. Quite the reverse. The IFS has said this slightly higher national minimum wage will not compensate working families who will be subjected to tax credit cuts; it is arithmetically impossible. The IFS director, Paul Johnson, commented: “Unequivocally, tax credit recipients in work will be made worse off by the measures in the Budget on average.” It has been calculated that 3.2m low-paid workers will have their pay packets cut by an average of £1,350 a year.

Could the government change its policy to avoid this?

The Prime Minister and his frontbenchers have been pretty stubborn about pushing on with the plan. In spite of criticism from all angles – the IFS, campaigners, Labour, The Sun – Cameron has ruled out a review of the policy in the Autumn Statement, which is on 25 November. But there is an alternative. The chair of parliament’s Work & Pensions Select Committee and Labour MP Frank Field has proposed what he calls a “cost neutral” tweak to the tax credit cuts.

How would this alternative work?

Currently, if your income is less than £6,420, you will receive the maximum amount of tax credits. That threshold is called the gross income threshold. Field wants to introduce a second gross income threshold of £13,100 (what you earn if you work 35 hours a week on minimum wage). Those earning a salary between those two thresholds would have their tax credits reduced at a slower rate on whatever they earn above £6,420 up to £13,100. The percentage of what you earn above the basic threshold that is deducted from your tax credits is called the taper rate, and it is currently at 41 per cent. In contrast to this plan, the Tories want to halve the income threshold to £3,850 a year and increase the taper rate to 48 per cent once you hit that threshold, which basically means you lose more tax credits, faster, the more you earn.

When will the tax credit cuts come in?

They will be imposed from April next year, barring a u-turn.

Anoosh Chakelian is deputy web editor at the New Statesman.