Blanchflower, Brown, Japan & Recovery
Danny Blanchflower’s article in the New Statesman is a must read.
The former MPC member writers that:
The risk of a long-lasting economic depression is not over. There have been some positive signs recently, and the worst may be behind us – but we should not get too carried away. Retail sales have risen a little and there are some positive signals from the housing market. There was even some evidence of positive GDP growth in France and Germany. Nonetheless, in the United Kingdom, money supply growth remains weak, banks are still not lending and mortgages are hard to come by. The latest surveys for construction and manufacturing still show contraction. Negative equity is on the rise, as are mortgage defaults. Unemployment is climbing fast and a million jobless young people under the age of 25 are in danger of becoming a lost generation.
One year on from the financial crash and the ensuing recession, the question remains: how did we get into this mess in the first place? In my view, and as I have consistently argued over the past two years, the economy would have been in much better shape today had the Bank of England’s Monetary Policy Committee (MPC) – on which I sat as an external member for three years until 31 May – not kept interest rates so high, especially from the beginning of 2008. House prices had peaked by the end of 2007 and business and consumer confidence surveys had collapsed. By the second quarter of 2008, based on both output and employment, the UK economy had moved into recession. But my colleagues on the MPC did not join me in voting for rate cuts until October 2008.
And he lays much of the blame at the feat of Governor Mervyn King.
In fact, it was in late 2007 that I became convinced there was much more slack in the economy than others on the MPC believed. Starting that October, at monthly meetings of the committee, I started voting for rate cuts, something that continued through every meeting in 2008. The collapse of Northern Rock had shocked me, and in January 2008, I warned in a Guardian interview that my MPC colleagues were “fiddling while Rome burns”.
In the summer of 2008, I warned the Commons Treasury select committee that “something horrible” was going to happen. I was becoming even more worried about recession, and in September I voted alone, as ever, for a cut of 50 basis points (bps) – or 0.5 per cent – to the Bank’s base rate. At my September appearance before the select committee, King, who was sitting two seats from me at the time, was asked by the MP Andy Love: “On unemployment there have been some suggestions, and Mr Blanchflower has said – and I think there are quite a lot of people out there who would agree with them – that it may go up faster than the projections in the Inflation Report. Is that a worry to you?”King replied: “At least the Almighty has not vouchsafed to me the path of unemployment data over the next year. He may have done to Danny, but he has not done to me.” To say the least, I was rather surprised.
He also makes strong criticisms of the Bank. An attack that the Tories should take very seriously indeed given their plans to give the BOE more power.
Throughout this crisis the MPC needed the advice of experienced bankers, lawyers, businessmen and market-watchers. Unfortunately, practical folk who knew how to spot and cope with banking crises were in short supply at the Bank of England. There were too few regulators on the staff. Instead, the Bank was stocked full of mathematical modellers who had never seen the inside of a commercial bank or a hedge fund – and the models they used failed to pick up on the greatest financial crisis in a century. Yet, in my view, it was clear from roughly six months before the Lehman’s crash in September 2008 that a financial tsunami was heading our way from the United States.
He does end on a more positive note:
In recent months, however, there has been a sudden transformation at the top of the Bank of England. Mervyn King’s support for a bigger boost to QE shows he now understands what has to be done to tackle this crisis. This makes a pleasant change for me, as I have spent the past three years criticising his decisions.
Danny got things right from 2007, and was sadly ignored. One year on from Lehman’s and people now seem convinced that we have a ‘recovery’. That we can start ‘cutting’ public spending. Japan’s lost decade, the peril we aim to avoid, is instructive.
It wasn’t a sudden crash followed by a return to growth.
(Hat tip Alphaville)
The most ridiculous aspect of this situation is that we have a historical example at hand of what can happen should fiscal policy be retrenched too early. As it happens, it is better to err on the side of incaution following a large explosion of an asset price bubble. That example? Japan in the 1990s and early 2000s.
“There are few things as dangerous as premature attempts at fiscal consolidation during a [balance sheet] recession.”
A balance sheet recession is characterised by a major decline in demand for debt following the bursting of an asset-price bubble. The credit crunch had the potential to become such a recession and would have done had not a strong mix of monetary and fiscal stimulus been undertaken. And it could still happen.
How do we know? Well, fearing a ballooning Japanese deficit – a consequence of the bursting of share and property bubbles in the early 1990s – the Hashimoto administration decided to retrench Japanese government spending in 1997. What happened? The economy plummeted into the worst post-war meltdown and a credit crunch was precipitated. Tax revenues collapsed and the budget deficit soared – so much for fiscal consolidation.
Just to make sure we received an absolutely clear message should our own economy be beset by similar issues, the Japanese government tried the trick again in 2001 under Prime Minister Koizumi (who saw himself as a kind of Japanese Ronald Reagan/ Margaret Thatcher hybrid.) He placed a cap on the deficit.
The result? Tax receipts shrank, the budget deficit increased, and the target was dropped at risk of crippling the economy once more.
“We are doing the right thing to make sure that for the future as we move into a full recovery we will invest and grow within sustainable public finances – cutting costs where we can, ensuring efficiency where it’s needed, agreeing realistic public sector pay settlements throughout, selling off the unproductive assets we don’t need to pay for the services we do need.”
In the wide-ranging 35-minute speech on the economy he also said he would be “demanding that internationally we look at setting limits on city bonuses”.
He said, “when the recovery comes” a Labour government would “continue to raise the minimum wage every year” and got a round of applause from union delegates when he said he would be “arguing that we should implement a blacklist on uncooperative tax havens”.
He said: “The choice is between Labour who will not put the recovery at risk, protect and improve your front line services first and make the right choices for low and middle income families in the country.
“And a Conservative Party which would reduce public services at the very time they are needed most, make across-the-board public spending cuts to pay for tax cuts for the wealthiest few, and make different choices about public services because they have different values.
“These would be the wrong choices at the wrong time for the wrong reasons because they have the wrong priorities for Britain.”
I’d be happier if we spoke of tax rises as well as spending cuts.
But the message is becoming clearer. The Governor of the Bank of England seems to (belatedly) ‘get it’. Gordon Brown ‘gets it’. The biggest risk to any recovery now is an ideologically driven Tory programme of cuts.