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How Irene, Ben and Christine are blowing all forecasts off course

As well as the hurricane, the recent speeches by the heads of the Fed and the IMF could have a huge

The United States is recovering from the effects of three severe headwinds, courtesy of Irene, Ben and Christine: a tropical storm and two speeches. All three have implications for the US economy - and for ours.

First, Irene. The devastation that the hurricane caused to the east coast of the country may not have been as severe as feared but is likely to have resulted in billions of dollars of damage. Almost six million homes and businesses lost electricity, flooding was widespread (eight inches fell in 24 hours where I live) and more than 13,000 flights were cancelled. It will be a while before normal service is resumed. A pal of mine, due to fly back to Boston from Chicago, was faced with a five-day wait for the next available flight. He chose instead to rent a car and set off on a 950-mile road trip.

Hurricane Irene could provide a downward shock to US GDP growth, as a result of the disruption to commerce. (Peter Morici of Maryland University estimates that the final cost of the storm could be as high as $45bn, once loss of economic activity is factored in.) As with the tsunami that struck Japan in March this year, economic policymakers have to be ready for these sorts of "negative surprises", which make accurate forecasting almost impossible.

Easing does it

The effects of Hurricane Irene were preceded by two shocks of a different kind. On Friday 26 August, Ben Bernanke, chairman of the board of governors of the Federal Reserve, the US central bank, made a speech in Jackson Hole, Wyoming, entitled "The Near and Long-Term Prospects for the US Economy". Bernanke argued that he remained optimistic about the "longer-run" prospects for the country's economy, because "The growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years."

However, he did note that the US economy had slowed more than expected, so the recession was "even deeper and the recovery even weaker than we had thought".

Earlier that day, GDP growth in the US for the second quarter of 2011 was revised downwards, from 1.3 per cent to 1.0 per cent. In addition, we discovered that consumer confidence, as measured by the Thomson Reuters/Univer­sity of Michigan index, fell from 63.7 in July to 55.7 in August. The US economy, like the UK economy, appears to be slowing again.

Of particular significance was Bernanke's announcement that the meeting of the Federal Open Market Committee, originally scheduled for one day, has now been extended to two days, allowing for fuller discussion. Why the extension? This indicates that the committee - which, like the Monetary Policy Committee (MPC) of the Bank of England, has the power to set interest rates - is about to act. There is no guarantee of consensus among committee members, but poor economic data, along with the disruption caused by Hurricane Irene, suggests that the next meeting presages a further bout of quantitative easing (QE) in the US.

During his speech, Bernanke insisted that "fiscal policymakers should not . . . disregard the fragility of the current economic recovery. Fortunately, the two goals of achieving fiscal sustainability - which is the result of responsible policies set in place for the longer term - and avoiding the creation of fiscal headwinds for the current recovery are not incompatible. Acting now to put in place a credible plan for reducing future deficits over the longer term, while being attentive to the implications of fiscal choices for the recovery in the near term, can help serve both objectives." Bernanke could easily have been addressing his comments to our coalition government.

The final headwind came from Christine Lagarde, managing director of the International Monetary Fund (IMF). Her Jackson Hole speech, like Bernanke's, would not have pleased the British coalition government. Lagarde called for a recapitalisation of European banks to prevent another financial crisis and echoed Bernanke's argument that the pace of deficit reduction should be slowed when growth is being compromised, as is occurring in the UK.

“Put simply," she told her audience, "while fiscal consolidation remains an imperative, macroeconomic policies must support growth [my italics]. Fiscal policy must navigate between the twin perils of losing credibility and undercutting recovery."

March madness

Lagarde's intervention will be particularly painful for the Chancellor, George Osborne, given his frequent claims that the IMF supports his austerity programme. Meanwhile, because he supported Lagarde's candidacy over that of Gordon Brown, the criticism will stick.

In his Budget speech on 23 March 2011, Osborne said: "We are able to set off on the route from rescue to reform and reform to recovery . . . because of the difficult decisions we've already taken. Those decisions have brought economic stability." He added: "We have put fuel into the tank of the British economy" - and that his plan for growth was for "a Britain carried aloft by the march of the makers". I'm reminded of George W Bush's "Mission Accomplished" speech on the deck of the aircraft carrier USS Abraham Lincoln in May 2003. Years later, Bush admitted his mistake. One suspects Osborne will have to do the same.

Contrary to Osborne's claims, there is increasing evidence of economic instability in the UK and, as a result, growing international support for him to perform a policy volte-face. It is vital that both fiscal and monetary policies operate together to aid growth in the UK. Comments from members of the MPC such as Ben Broadbent and Martin Weale suggest that the Bank of England - which is, once again, playing catch-up - will restart QE sooner rather than later. That would be a welcome move.

It is high time that the coalition loosened fiscal policy to boost growth, investment and jobs by increasing spending on infrastructure, lowering payroll taxes, especially on the young, and providing significant tax incentives for firms to hire and invest.

This is exactly the type of package that President Obama is likely to announce in his major speech on jobs on 8 September. The coalition needs to act quickly to prevent a march of the makers becoming a march of the unemployed ex-makers.

David Blanchflower is the NS economics editor and a professor at Dartmouth College, New Hampshire, and the University of Stirling

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

This article first appeared in the 05 September 2011 issue of the New Statesman, 9/11