For once, I agree with Osborne

Chancellor George Osborne's testimony to the Treasury select committee indicates that he believes mo

I became an interviewer on live TV in the United States this month and found out why Jeremy Paxman is paid so well. He deserves every penny, honestly. I didn't realise how hard it is to sit on the other side of the table. You have no idea what those interviewees are going to say. Rest assured, I am not giving up my day job. Paxman is safe.

I was invited to be a guest host on CNBC's Squawk Box, the must-watch financial markets show that goes out on weekday mornings across the US. It was rather disconcerting that, on introducing me, the producers played clips from a couple of Austin Powers movies. Later they showed bits of Monty Python and the Holy Grail, which was more to my taste. To give you a sense of what a big deal the show is, a couple of years ago my missus told me that I would really have made it if I ever got invited on to Squawk. At least Carol thinks I have arrived.

Alistair Darling agreed to join me on the programme from Westminster as one of my guests. Of particular interest was the former chancellor's comment that the Bank of England's Monetary Policy Committee (MPC) was late to cut rates in 2008, despite my pleading as a member of the committee at the time. "It's probably fair to say that central banks - well, the two in Europe - I don't think really appreciated how much the storm was gathering," he said. "I think if interest rates had come down slightly earlier, then that would have helped."

I asked him how close we were to global financial meltdown in the autumn of 2008. He revealed that "we came within hours of a collapse of the banking system. RBS was one of the big­gest banks in the world and we had a situation where it was going to struggle to get through a day, so we had to take action." Failing to do so would have been catastrophic.

All Squawk

While Squawk was on air, US producer prices were released. They had dropped by 0.5 per cent in June, more than the market expected. The following day, the labour department announced that US consumer prices also fell last month, by 0.1 per cent, dragged down by a decline in energy prices. Concerns about de­flation are growing. On top of this, the publi­cation of the Thomson Reuters/University of Michigan survey of consumer sentiment sent shockwaves through the markets. The index plummeted to 66.5 this month, down from 76 in June. This closely followed the news of a sharp drop in the Conference Board's consumer confidence index, from 62.7 in May to 52.9 in June. The board's expectations index was also downbeat, declining to 71.2 from 84.6.

Alongside all these data releases came the minutes of the June meeting of the Federal ­Reserve's Federal Open Market Committee (FOMC), which suggested that risks had shifted again to the downside. The FOMC's members noted that "the committee would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably. Given the slightly softer cast of recent data and the shift to less ­accommodative financial conditions, members agreed that some changes to the statement's characterisation of the economic and financial situation were necessary. Nearly all members judged that it was appropriate to reiterate the expectation that economic conditions . . . were likely to warrant exceptionally low levels of the federal funds rate for an extended period."

Since the FOMC's meeting at the end of last month, the figures have shown a further weakening of the economy. The Fed gets it.

This set me thinking about the similarities between the situations in the US and in the UK, not least because consumer confidence is on the decline here, too. The Nationwide consumer confidence index slumped further in June, driven principally by falls in the expectations index. There was a marked increase - from 46 per cent to 53 per cent - in the proportion of respondents who said they expected there to be fewer jobs in six months' time. Producer prices were also down on the month, falling by 0.3 per cent between May and June.

Inflation in the UK poses zero threat, given the huge amount of spare capacity that exists. As measured by the consumer prices index (CPI), inflation is being pushed up primarily by the Labour government's VAT increase from 15 to 17.5 per cent. If indirect taxes are excluded from the measure (the CPIY, rather than the CPI), inflation has in fact fallen to 1.6 per cent. Inflation expectations are flat. Deflation is a growing worry here, as it is in the US.

In a speech to the Bristol Business Forum on 16 July, the MPC member David Miles argued that now is not the time to tighten monetary policy, distinguishing himself from his committee colleague Andrew Sentance, who has been advocating and voting for rate increases.

I recall that on 24 September 2008, nine days after the fall of Lehman Brothers and six months after the UK entered the worst recession in living memory, Sentance argued: "The current prospect for the UK economy is very different to the major recessions we have previously seen in the mid-1970s, early 1980s and early 1990s. In these episodes, economic activity fell sharply for one to two years. In my view, the current outlook is for a much milder period of weak economic activity on this occasion." Wrong then, wrong now.

Reserve powers

It is clear from listening to Chancellor George Osborne's testimony to the Treasury select committee on 15 July that he believes monetary policy should remain loose, and I agree with him on that. Rates must remain, as the FOMC put it, at "exceptionally low levels for an extended period". Plan B would mean further quantitative easing and lots of it.

In the unlikely event that Sentance is able to persuade a majority of the MPC to vote for a rate increase, I wouldn't be surprised if the Chancellor used Section 19 of the Bank of England Act 1998 to reverse that decision for the good of the country. And he should. These reserve powers allow the Treasury, after consultation with the Bank's governor, to "give the Bank directions with respect to monetary policy if they are satisfied that the directions are required in the public interest and by extreme economic circumstances".

A vote by the nine-member MPC to raise rates could well result in an increase in the unemployment figures of at least five.

David Blanchflower is a labour economist and a professor at Dartmouth College, New Hampshire, and the University of Stirling.

NOTE: The printed version of David Blanchflower's column said inflation was being pushed up by "the new government's VAT increase from 17.5 to 20 per cent". It should have read "the Labour government's VAT increase from 15 to 17.5 per cent", as corrected above. This error was not the professor's, but introduced in the editing process.