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Moody’s blues, private-sector grief and another letter from Mervyn

The credit rating agency’s decision to put the UK on negative watch is a big embarrassment to the Ch

The biggest news on the economy recently was the decision by the credit rating agency Moody's to place the UK on "negative outlook", which means that the country's rating is at risk of a downgrade. The reasons? The "increased uncertainty regarding the pace of fiscal consolidation in the UK, due to materially weaker growth prospects over the next few years, with risks skewed to the downside", and the high risk of further shocks (economic, financial or political) from the euro area.

This presents a considerable embarrassment to the Chancellor, who used to claim that his austerity measures had taken the UK off a negative watch that he had inherited when he took office. George Osborne's response was to claim that it is "a reality check for anyone who thinks Britain can duck confronting its debts". For those on the right who think Moody's was spooked by the UK's debt burden, think again. The biggest concern is that the UK economy is heading back to recession. And maintaining a AAA rating may well not be worth the pain: since France lost its AAA, the country's ten-year bond yield has fallen. The reality is that there is still no growth plan or any credit easing. Rabbits in headlights come to mind.

Crisis of confidence

Then, on 15 February, there was the latest labour-market data. The unemployment rate rose to 8.4 per cent, driven primarily by an increase of 27,000 in the number of unemployed 18-to-24-year-olds. The rise was not surprising: a survey released on 13 February by the Chartered Institute of Personnel and Development (CIPD) suggested that the first three months of 2012 will be the most difficult quarter for the jobs market since the recession, as the number of private-sector firms surveyed planning to make redundancies increases. The worsening prospects, the CIPD found, are almost entirely accounted for by a drop in confidence in the private sector. Your response, George?

Heading for a fall

The Consumer Prices Index (CPI) measure of inflation at long last plummeted, as I and the Monetary Policy Committee had been predicting for a while. It's expected to drop like a stone over the next few months. Most people, including some economic commentators, have no idea how the CPI is calculated. It is the rate of change in prices, so if the oil price rises from £100 to £110 a barrel today and stays there for five years, the increase in the first year is recorded in the CPI, but the next year the change in prices is zero and the CPI doesn't move. This month, the impact of the VAT increase introduced at the beginning of last year dropped out of the calculations.

I set out below the official data to illustrate how inflation is likely to drop sharply. The new estimate of 3.6 per cent is obtained by dividing 121.1, the price level in January 2012, by 116.9, the level in January 2011, and taking a percentage, which gives the annual change in prices. The difference between the two numbers, 4.2, is just the sum of the 12 monthly changes. This month's drop of 0.6 was predictable, given that -0.6 is the average price fall for the month of January between 2000 and 2005, before the latest inflation burst. We knew which number was being dropped from the calculation. Going forward, if I impose the averages for 2000-2005 on top of the latest 12 months of data we have - not an implausible proposition - inflation will be 1.1 per cent by the end of this year. So, rather than write a letter because inflation is too high, Mervyn King will likely have to write a letter because inflation is below the target.

Misplaced faith

I have been having an ongoing spat with David Smith of the Sunday Times about what I consider to be his one-sided reporting on the economy. It's perfectly possible - excusable - that all of this has passed you by but it strikes me that as the data moves against his increasingly untenable positions, Smith clutches at ever thinner straws. In his 12 February column, he claimed that I believed "that all the economy's woes [my emphasis] are due to the government's fiscal tightening". Not so. I have always said that our economic woes were exacerbated by fiscal tightening that was too deep and too fast at a time when the economy was being hit by severe headwinds (including from the euro area), a lack of bank lending and senior government ministers talking down the economy.

But I have never, and would never, claim that Britain's economic problems are uni-causal. Serious economists know better. As I am on a roll, I thought I should also present some research to counter Smith's suggestion that GDP is invariably revised upwards and so we need not worry about initial, gloomy data releases. Look at the definitive source on revisions to GDP growth data, "Understanding the Quality of Early Estimates of Gross Domestic Product" by Gary Brown et al, from November 2009. This concluded: "Revisions are not sufficiently large, regular or predictable to be able to support any procedure of incorporating bias adjustments into early estimates." Or how about a 2007 Bank of England study, which found that historically there is some evidence of bias in early estimates of GDP - certainly in the 1980s and early 1990s - but that it is far from clear "this has persisted into more recent periods"? It looked at revisions between 1999 and 2005 and concluded that, compared to initial growth estimates, revisions were "not significantly different from zero".

Then, on 14 February, Smith downplayed the Moody's negative watch for the UK, claiming that "today's real news" was "a drop in inflation". Really?Feels like more spin to me.

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

This article first appeared in the 20 February 2012 issue of the New Statesman, How do we stop Iran getting the bomb?

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A simple U-Turn may not be enough to get the Conservatives out of their tax credit mess

The Tories are in a mess over cuts to tax credits. But a mere U-Turn may not be enough to fix the problem. 

A spectre is haunting the Conservative party - the spectre of tax credit cuts. £4.4bn worth of cuts to the in-work benefits - which act as a top-up for lower-paid workers - will come into force in April 2016, the start of the next tax year - meaning around three million families will be £1,000 worse off. For most dual-earner families affected, that will be the equivalent of a one partner going without pay for an entire month.

The politics are obviously fairly toxic: as one Conservative MP remarked to me before the election, "show me 1,000 people in my constituency who would happily take a £1,000 pay cut, then we'll cut welfare". Small wonder that Boris Johnson is already making loud noises about the coming cuts, making his opposition to them a central plank of his speech to Tory party conference.

Tory nerves were already jittery enough when the cuts were passed through the Commons - George Osborne had to personally reassure Conservative MPs that the cuts wouldn't result in the nightmarish picture being painted by Labour and the trades unions. Now that Johnson - and the Sun - have joined in the chorus of complaints.

There are a variety of ways the government could reverse or soften the cuts. The first is a straightforward U-Turn: but that would be politically embarrassing for Osborne, so it's highly unlikely. They could push back the implementation date - as one Conservative remarked - "whole industries have arranged their operations around tax credits now - we should give the care and hospitality sectors more time to prepare". Or they could adjust the taper rates - the point in your income  at which you start losing tax credits, taking away less from families. But the real problem for the Conservatives is that a mere U-Turn won't be enough to get them out of the mire. 

Why? Well, to offset the loss, Osborne announced the creation of a "national living wage", to be introduced at the same time as the cuts - of £7.20 an hour, up 50p from the current minimum wage.  In doing so, he effectively disbanded the Low Pay Commission -  the independent body that has been responsible for setting the national minimum wage since it was introduced by Tony Blair's government in 1998.  The LPC's board is made up of academics, trade unionists and employers - and their remit is to set a minimum wage that provides both a reasonable floor for workers without costing too many jobs.

Osborne's "living wage" fails at both counts. It is some way short of a genuine living wage - it is 70p short of where the living wage is today, and will likely be further off the pace by April 2016. But, as both business-owners and trade unionists increasingly fear, it is too high to operate as a legal minimum. (Remember that the campaign for a real Living Wage itself doesn't believe that the living wage should be the legal wage.) Trade union organisers from Usdaw - the shopworkers' union - and the GMB - which has a sizable presence in the hospitality sector -  both fear that the consequence of the wage hike will be reductions in jobs and hours as employers struggle to meet the new cost. Large shops and hotel chains will simply take the hit to their profit margins or raise prices a little. But smaller hotels and shops will cut back on hours and jobs. That will hit particularly hard in places like Cornwall, Devon, and Britain's coastal areas - all of which are, at the moment, overwhelmingly represented by Conservative MPs. 

The problem for the Conservatives is this: it's easy to work out a way of reversing the cuts to tax credits. It's not easy to see how Osborne could find a non-embarrassing way out of his erzatz living wage, which fails both as a market-friendly minimum and as a genuine living wage. A mere U-Turn may not be enough.

Stephen Bush is editor of the Staggers, the New Statesman’s political blog.