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Inaction is now the biggest economic risk

The long-term cost of high unemployment to individuals and to society is huge.

The long-term cost of high unemployment to individuals and to society is huge.

Not surprisingly, NIESR's latest forecast, published today, has led to predictable headlines focusing on our prediction of a "return to technical recession." But this misses the point. We are forecasting that the economy will contract slightly in the first half of this year; some other forecasters agree, others don't. But the differences are within the margin of error; we could well be wrong. The point is that almost everyone expects, even assuming an eventual successful resolution of the eurozone crisis, that growth will be slow at best.

So what should be done? The UK economy currently suffers from deficient demand; the current stance of fiscal policy is contributing to this deficiency. A temporary easing of fiscal policy in the near term would boost the economy. The credible commitment to a sustainable fiscal policy over the longer term provides the government with the flexibility to provide a clearly defined and temporary boost to near-term demand. For example, an increase in government investment would not have a significant impact either on long-run sustainability or - given the way they are defined - the likelihood of the government meeting its fiscal targets.

It is important to be clear that this is not about averting a recession in the short-term. It doesn't matter very much, either to the economy as whole or to individuals, whether economic growth is 0.2 per cent or -0.1 per cent. This is about minimising the long term social and economic damage. On current forecasts - both ours, and that of the Office of Budget Responsibility (OBR) we are set for an extended period where growth will not be enough to reduce unemployment to the levels we saw before the recession. We expect unemployment to rise to about 9 percent - 3 million - this year and to remain high. Even in 2014, it will still be over 7 per cent. This compares to the OBR's estimate that the structural unemployment rate is about 5.25 per cent.

That difference - the "unemployment gap", shown in the chart below, is a measure of the how much extra (or less) unemployment there is as a result of macroeconomic conditions - i.e. cyclical unemployment resulting from labour demand, or lack of it (more explanation here). In other words, if macroeconomic policy is broadly on track, the unemployment gap should be small; it is a measure of the number of people who are not working because macroeconomic policy isn't either.

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The chart shows that the unemployment gap in the aftermath of the 2008 recession will be larger and longer than any recession since 1970 (which certainly means any recession since the war) including the early 1980s, although there is probably some uncertainty about the 1980s estimates. It says that - on the official view and the official forecast - the unemployment gap is a million now, rising, and will be higher in 2013 than now; and that even by 2015, fully seven years after the recession began, it will be over 2 percent of the labour force, about 650,000 people. Unemployment at this elevated level for such a long period is likely to do permanent damage to the supply side of the economy, with large long-run economic costs.

The argument about fiscal policy is often presented as "Yes, fiscal stimulus might do some good, but are you willing to take the risk?" In my view the risks are hugely exaggerated, as I wrote in this magazine. But people talk much less about the downside of inaction. If we do not do something to boost labour demand now, we are not just taking a risk, we are accepting the likelihood of continuing high levels of unemployment that will damage both many individuals and society as a whole. In 1925 Winston Churchill expressed his dismay that policymakers seemed to be "perfectly happy with at the spectacle of Britain possessing the finest credit in the world simultaneously with a million and a quarter unemployed." As Martin Wolf puts it, "How masochistic does one need to be?".

Jonathan Portes is Director of the National Institute of Economic and Social Research. His blog is http://notthetreasuryview.blogspot.com