This week’s disappointing GDP figures, which saw Britain’s economy shrink by 0.5% in the last quarter of 2010, raises fresh concerns about the prospect of a double dip recession. MBS experts give their view.
“A fiasco requires a pivotal event that dramatises the government's defeat. And what Cameron and Osborne now face is not that kind of climactic defeat but the insidious drip, drip of bad news on the economic policy front”
This week's economic figures are much worse than expected, a full 1% lower than most experts forecast and if repeated next quarter will send us into double dip recession territory. This will be very hard for the Coalition to brush off as "the wrong sort of weather", as the worst impact of public spending cuts has yet to even hit. When these kick in next quarter (April-June), alongside the impact of the VAT rise, this is now a definite possibility.
"It would not be surprising if the risk premiums demanded by financial markets from the UK sovereign bonds will be soon based on policy measures against rising inflation rather than the size of fiscal deficit."
David Cameron and George Osborne have been very foolish to say that they had "secured the recovery" recently, when they clearly haven't. What is more, the global economy is doing better than expected, so our performance is doubly disappointing. This will add to the Coalition's woes at the May local elections.
The UK government's priority is to cut the fiscal deficit to appease the financial markets and then gamble with the Bank of England's quantitative easing policy- lowering interest rates through pumping liquidity into the financial system- to stimulate economic growth. This is a simplistic rigid economic policy in an increasingly unpredictable international economic environment where commodity and food prices generate inflationary waves in global economy, currency wars in foreign exchange markets cause high volatility in global capital flows, and sovereign debt crisis in the EU put the bond markets in almost permanent turmoil. The government's economic policy is not flexible enough to adjust to these unfolding major trends in a global economy. The assumption that the UK's severe austerity measures to reduce the fiscal deficit will definitely have positive impact in financial markets is not realistic to say the least.
"The quantitative easing by the Bank of England is more likely to help financial markets to generate profits by taking positions in currency and bond markets rather than to stimulate bank lending to the private sector for investments."
Financial markets today react to the global economic developments on a daily basis and, as the euro-zone politicians have recently discovered, tend to be inconsistent in their policy demands from the sovereigns. It would not be surprising if the risk premiums demanded by financial markets from the UK sovereign bonds will be soon based on policy measures against rising inflation rather than the size of fiscal deficit. Financial markets have already started to take positions on the value of sterling based on inflationary news in the UK and the interest rate differentials between sterling and other currencies.
Consequently the quantitative easing by the Bank of England is more likely to help financial markets to generate profits by taking positions in currency and bond markets rather than to stimulate bank lending to the private sector for investments. We have already seen how the small and medium sized companies are deprived of loans and financial support from the UK banks and investments in the private sector are not happening. Our government believes that the private sector will fill the gap in economic growth and job creation that is created by severe cuts in public spending. This is not happening and is not likely to happen on the scale that the government expects. The private sector sees significant uncertainty in the economic environment due to inflationary pressures, falling demand after the public spending cuts and the turmoil in currency markets. Added to this is the unsolved banking problem. Two of the largest banks in the UK, Lloyds-HBOS and Royal Bank of Scotland, are still in government ownership in varying degrees. There is uncertainty about how the government is going to exit from the ownership of these two banks and whether the banks will be broken into smaller units along functional lines.
"A fiasco requires a pivotal event that dramatises the government's defeat. And what Cameron and Osborne now face is not that kind of climactic defeat but the insidious drip, drip of bad news on the economic policy front."
The UK needs a flexible short-term programme to carefully and imaginatively chart through the current uncertainties in global economy and a coordinated medium- to long-term strategy to make the UK a competitive and innovative economy in the first half of this century. This means identifying the right and relevant levers in the economy that are not limited to sovereign debt management and monetary policy.
Politics is about telling plausible stories and appearing to b e in charge of events. A disappointing GDP figure dents the credibility of the coalition and their chancellor George Osborne because it raises questions about whether public expenditure cuts have been pressed too far and whether quantitative easing is doing anything except providing cheap feed stock for the financial markets. With a bruiser like Ed Balls shadowing the Chancellor, the next few months are not going to be easy for Osborne.
But, with a bit of luck, maybe the Coalition can avoid a classic fiasco like the IMF loan or the winter of discontent in the 1970s; or like Black Wednesday in 1992, when the pound left the ERM. A fiasco requires a pivotal event that dramatises the government's defeat. And what Cameron and Osborne now face is not that kind of climactic defeat but the insidious drip, drip of bad news on the economic policy front even before their Maoist approach to health reform starts to create new problems.
All good news for Labour (and disastrous for the Lib Dems) but don't let that Punch and Judy stuff distract you from the point that blaming the government for cutting too fast is not the same as having an economic policy on the key issues. We have a political discourse about rebalancing the economy which is buyer's remorse because nobody knows how to prop up the ex-industrial regions without large scale health and education expenditure which we can no longer afford.
Ismail Ertürk is a senior lecturer in banking at MBS.
Colin Talbot is professor of public policy and management at Manchester Business School.
Karel Williams is Professor of Accounting and Political Economy and director of the ESRC Centre for Research on Socio Cultural Change at Manchester Business School.