Ireland’s storm is blowing our way
The Irish banks need more capital and quickly. Fiscal austerity has failed.
With each passing week, the situation in Ireland deteriorates. The problems in the Irish economy and their spiralling debt payments may all too quickly spill over to affect the UK, not just because of the exposure of banks such as RBS and Lloyds, but because Ireland is a more important market for UK exports than China. The Irish banks need more capital and quickly. Fiscal austerity has failed in Ireland.
I was home for only a week from my trip to Asia and then it was time to return to the UK once more. While I was over, I took a day trip to a snowy Stockholm to attend a conference on the labour market, organised by the Swedish Ministry of Finance. Our new Nobel laureate in economics, Chris Pissarides of the London School of Economics, was also there, trying to avoid a scrum of journalists hoping to interview him. They mostly wanted his views on the Chancellor George Osborne's austerity package, which, as Pissarides has already made clear, he thinks is a mistake.
The opening address was given by the impressive Swedish finance minister, Anders Borg, who understands the need to maintain stimulus in a recession. Sweden has suffered a bigger fall in output than the UK, but employment in the country has risen. It took a while, though, to get past his earring and ponytail! Fortunately for the Swedish people, in every respect, he is no Slasher.
Sitting on its hands
On 11 November, the "do nothing" Bank of England published its latest inflation report. The Monetary Policy Committee's overly optimistic forecast suggested that more quantitative easing (QE) is required - inflation is forecast to be well below the target of 2 per cent in two years' time, and to prevent that the economy is likely to need more stimulus - but they sat on their hands as usual. As a result, the pound has risen by around 3 per cent in trade-weighted terms, reducing the level of stimulus to the economy as well as the economy's growth prospects and dampening inflation. The US Federal Reserve announced $600bn more QE on Wednesday 10 November, and the MPC should have responded with more, not least to prevent the currency appreciating.
George Osborne's recent intervention, at the Treasury Select Committee on 4 November, suggesting that the MPC should do more QE seems to have had the opposite effect. Various high-ranking Tories have explained to me that their plan has always been to "co-ordinate" monetary and fiscal policy. Such an intervention by the Chancellor would be seen by many MPC members as a threat to the independence of the Bank of England. It was equally unwise for the Bank's governor, Mervyn King, to make comments on fiscal policy, especially now it has been widely reported that his views seem not to be shared by other members of the MPC.
The MPC's forecast implies that this will be the fastest recovery from a recession of this magnitude in almost a century and that the level of output at the start of the recession in the second quarter of 2008 will be restored by the middle of 2011, which is unlikely to say the least. Interestingly, nobody else much believes this forecast for growth either. A Reuters poll of other forecasters suggested that they think output will be much lower than the MPC projects. With all this uncertainty, why exactly should firms invest and hire in the UK when there are much better opportunities in Brazil, India and China? There is, too, the pressing prospect that workers from eastern Europe will arrive to take what jobs are available.
The chart below shows the MPC's forecast for output, based on the market's expectations of interest rates over the next few years (the MPC does not forecast interest rates itself). Astonishingly, the MPC believes there is little chance that growth will be zero or negative in any quarter between now and 2013. And it assigns a higher probability that it will be as much as 5 per cent annualised in every quarter. That makes no sense, given that the risks to output are hugely to the downside, consumer and business confidence is collapsing and house prices are falling again.
The preliminary data on GDP growth for the third quarter of 2010, at 0.8 per cent, was higher than the markets expected. A big driver of growth in the last two quarters was the construction industry. However, at the beginning of November, Markit's UK Purchasing Managers' Index for construction showed the sector slowing fast. The reading in October, the lowest for eight months, showed a "solid reduction of employment in the UK construction sector". On 9 November, the Construction Trade Survey had similar findings - that output had fallen, not risen in the quarter. Orders books fell across the industry.
Commenting on the survey, Julia Evans, chief executive of the National Federation of Builders, said: "Despite official figures showing impressive industry growth, the industry's own figures point to a fall in output, falling prices and fewer enquiries. This all points to a depressing Christmas for the industry." Not least because the public sector accounts for more than one-third of total construction output.
The ONS revised downwards the output growth in the construction sector on 12 November for the second quarter of 2010, from 9.6 per cent to 6.8 per cent and the first quarter from -0.8 to -1.2. I expect overall growth for all three quarters of 2010 to be revised down. Growth in the fourth quarter may receive an artificial boost because consumers are likely to bring forward their spending ahead of the VAT rise in January. My concern, then, is that growth will be negative in the first quarter of 2011.
Meanwhile, the Nationwide Consumer Confidence Index fell again in October. The expectations index is at its lowest level for 18 months. Business and consumer confidence are collapsing. In Seoul for the G20 meeting, Osborne said of the UK economy: "If you look at the economic data, it has generally been on the optimistic side in recent weeks and that should give us some confidence." Really?
David Blanchflower is a labour economist and a professor at Dartmouth College, New Hampshire, and the University of Stirling
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