A death Sentance for the economy
Andrew Sentance, of the Bank of England’s Monetary Policy Committee, thinks the UK should start rais
I wrote last week of the likely impact of cuts on scientific research and warned that there would be many such stories over the coming months. The warning turned out to be rather prescient; the only surprise was its source. I refer to that astonishing leaked letter from the Defence Secretary, Liam Fox, to David Cameron in which he warned that spending cuts on the scale proposed would compromise the armed forces' capacity to defend the nation.
Dr Fox warned that the cuts would limit the UK's ability to deploy forces in high-threat areas and remove long-range search and rescue. The cuts would cause "some risk to civil contingent capability, including but not limited to foot-and-mouth, firefighting risks, fuel shortages, flu pandemics, Mumbai-style attacks and the 2012 Summer Olympics".
The leak caused huge embarrassment to the government. The leaker was probably some upstanding public servant who is unhappy that the government is about to fire 700,000 of his or her colleagues. I am sympathetic, and see no reason why public-sector workers should make it easy for governments to fire them.
Then we had that IMF mission report on the UK economy, which George Osborne claimed as a "very welcome endorsement" of his strategy. But this paragraph from the report was probably not so welcome:
. . . downside risks are also sizeable, given the continued fragility of confidence, still-strained balance sheets among households and banks, signs of renewed housing market weakness, and the possibility that headwinds from fiscal consolidation could turn out to be more powerful than expected . . . an adverse scenario where major new shocks – arising from either external forces or domestic ones – trigger another extended contraction in output cannot be ruled out.
Worryingly, the data suggests it may be time to rule in the possibility of an extended contraction. An L-shaped recovery, with many years of slow growth, looks increasingly on the cards. The latest figures from the Office for National Statistics suggest that the hugely important service sector declined by 0.2 per cent in July. And the latest data from the monthly EU survey showed a large jolt downwards in consumer confidence in September (see the graph below). According to the latest Markit/Chartered Institute of Purchasing and Supply survey, UK manufacturing activity has fallen to a ten-month low. New export orders declined for the first time since July 2009. This suggests that the rate of growth in the UK in the third quarter will be well below that in the second.
The Monetary Policy Committee member Andrew Sentance, in an extraordinarily out-of-touch comment piece in the Times, argued that it was time to tighten monetary policy because the economy is starting to warm up and is "now recovering at home and abroad". The tightening was needed "to avoid a future jolt to business and consumer confidence that might indeed derail the recovery". You mean like the drop in confidence that has occurred over the past three or four months, as shown in the graph? Presumably Sentance hasn't been looking at the data that we have been examining in this column over many weeks and months.
The comments would presumably not have made comforting reading for Osborne. The last thing he needs is for interest rates to rise just as he is about to slash public spending and raise taxes. It's worth repeating that Sentance has had a poor Great Recession. In February 2008, he stated that "an outright recession – in which economic activity falls year-on-year – is a remote risk for the UK economy at present". On 24 September 2008, days after the collapse of Lehman Brothers, he argued that there would be no recession: "But 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."
Oh dear. There's more. Sentance claimed a year ago that the financial crisis was over, arguing that, "over the last six months, the financial storm which swept around the world just over a year ago has abated". Try telling that to the Irish. He was wrong then and is wrong now.
Must-read for Miliband
The timing of a very important speech by another MPC member, Adam Posen, was not an accident. On 28 September, Posen took dead aim at Sentance's claims that inflation is a problem. In fact, he said, "further easing should be undertaken". And right away. He continued:
In every major country, actual output has fallen so much versus where trend growth would have put us, and trend growth has not been above potential for long enough as yet, that there remains a significant gap between what the economy could be producing at full employment and what it currently produces. Thus, policymakers should not settle for weak growth out of misplaced fear of inflation. If price stability is at risk over the medium term, meaning over the two- to three-year time-horizon for [MPC] decisions, it is on the downside.
I couldn't have put it better myself. The speech is a must-read for Ed Miliband especially. The next MPC meeting, taking place as we go to press, seems to be heading for a three-way split, with Sentance voting for another rise in interest rates, Posen voting for more quantitative easing (QE), and the rest voting for "no change" on both counts. However, there is a chance that Posen might be able to secure a majority to vote with him on QE. But more likely is that the MPC will agree to an additional £50bn worth of asset purchases at its November meeting, when it will produce its latest forecast.
I have a sneaking suspicion that when Sentance's second term on the MPC is up, on 31 May 2011, the Chancellor, whoever that is, will not rush to reappoint him. Mervyn King will be pleased to hear that I am unavailable.
David Blanchflower is a labour economist and a professor at Dartmouth College, New Hampshire, and the University of Stirling
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