Thursday, 3 July 2008

The bad ideas show

Last night, the BBC’s Newsnight discussed Marks and Spencer’s profit warning. The program produced an MP, a businessman and an advertiser, who were all shook up by M&S sudden recognition that things were not well in the high street. There was a collective sense of surprise that the retailer had a hard time shifting its overpriced ready meals and style-deficient clothing.

Once the shock about M&S had worn off, the panel turned their attention to what the UK needed to avoid a serious downturn. The panel concluded that there was a danger that we could “talk ourselves into a recession.” It forcefully argued that the economy needed a series of “confidence building” measures to keep our spirits up.

The panel focused on three ideas; all of them deficient.

Housing needs a cut in stamp duty

To be fair, the panel did not suffer from any illusions about the crisis in the housing market. Prices are falling dramatically, and something needed to be done to avoid overpriced housing from taking the economy down with it. The panel had an answer. It felt that a reduction in stamp duty would stabilize prices, and allow first time buyers to reenter the market. Once the FTB’s returned back, confidence would be restored and everything would be fine.

The panel were understandably vague about how lower stamp duty would encourage more mortgage approvals. The housing crash started when banks woke up and realized that the household sector is now holding huge amounts of debt. Banks understood that any further growth in personal sector debt presented unacceptable risks. To be sure, banks realized this growing threat far too late; and as such, many banks are in deep trouble. Nevertheless, the banks are at last beginning to understand their predicament. UK banks will not suddenly go on a mad dash to lend just because the government knocks off a few percentage points off stamp duty.

Reduce taxation on oil

The panel recognized that the UK now had a series inflation problem. However, the problem was characterized as just a nasty external shock arising from the sudden rise in the price of oil. Since about 70 percent of the price of a liter of petrol comprised of tax, the problem had an obvious solution – cut fuel duty.

If it were so easy, government would have already cut fuel duty. Brown and Darling understand they would be replacing one problem with an even bigger one. It would take a sizable cut in duty to have a significant impact on inflation, yet even a modest duty cut would have an enormous effect on tax revenues. Cutting fuel duty is not worth it.

Cut interest rats now

Finally, the panel argued that UK needs a modest cut in rates. The reduction would only be symbolic, designed primarily to signal the future path of rates, rather than to make a series dent in borrowing costs. The panel felt that Bank of England “should risk” a little higher inflation in order to avoid a recession.

In fact, this is what the Bank of England has been doing. Since 2006, the MPC has tolerated above-target inflation in return for keeping the growth rate high. For a time, the strategy worked. Growth in 2006-7 has been strong, and it is only in the last six months that growth started to weaken. Any further attempt to trade off a higher growth rate with a little more inflation would threaten to push the CPI inflation rate several percentage points above the target.

There is a counter-argument that suggests that a rate cut would not result in a significant increase in credit. The credit crunch would ensure that the inflationary threat would be contained. Therefore, would help homebuyers but it would not generate a new surge in lending.

This argument is only half-right; the credit crunch would ensure that a cut would do little to revive consumer expenditure or reflate housing. It would keep inflation on the boil. Lowe rates would further weaken sterling and amplify the external shocks that are driving inflation upwards. It would also serve to further destabilize price expectations and run the risk of a dangerous wage-price spiral. A modest rate cut would do nothing to help growth and worsen the inflation dynamics.

Bad ideas

Brown, Darling and the MPC need to focus those problems that they can resolve and face the consequences of those problems that they can not. Lets start with those difficulties that need no policy response. The housing market is dead, and nothing can save it. The banks have drastically reduced lending. The price of oil is rising, it may continue to go up, or it may not. Its future path will be determined elsewhere.

The government and bank of England can affect future inflation expectations. A long overdue rate increase would convince wage setters that a wage-price spiral would not be tolerated. Better control over public expenditure would reduce aggregate demand and support the bank of England in its fight against inflation.

There are no easy ways out of the economy’s current predicament. There are plenty of ways of making things worse. Last night’s Newsnight showcased some of the worst ideas currently in circulation.


CWS said...

We aren't short of bad ideas.

Anonymous said...

Alice, you right on all points.

The government is 'bottling it' on the need for a sufficiently stringent base rate, allowing inflation. And while failing to manage the currency properly they point the finger at reasonable complaint about wages being held down after the fact as inflationary.

B. in C.

gobsmacked said...

typical goernment broardcasting. keep the debate off the real subject.

i saw the programme and was amazed at how out of touch they all were.

dont these people read any blogs?

tv news is out of date, way behind the blogs. i found this out a while back. if ican find this out everyone will soon be turning off the tv news.

i thought you would post on this when i watched it!

I disagree about raising rates though. we are in for deflation, demand destruction as falls property so falls demand. jobs will go. oil is a bubble all bubbles are the same, all bubbles burst.

rich010273 said...

House prices will fall to around 3.5 x salary average price. There's no way round it as people can't get the mortgages. It can't be saved unless banks suddenly lower their lending standards.

Oil price is due to Bernanke. Lopping the interest rate in the US has caused this oil price bubble as investors leave Treasury Bonds and the Dollar and leap into commodities.

Interest Rates are set to try and balance growth and inflation. This is not the remit of he BOE and as the Treasury Select Committee said "you are not employed to write letters to the Chancellor, you are employed to target inflation". About time Brown defined what his "economic stability" criteria is for the BOE.

Stagflation, Recession, Depression, get used to it as our economy will really benefit from sorting the "wheat from the chaff".

BTW, credit crunch. Exactly where do people think all this money has "gone" from the banks? The numbers don't add up for the amount of "lost" funds to the amount of bankruptcies and IVA's. So are the banks just getting handouts from the BOE to inflate the pound? Makes the poor poorer and the rich richer doesn't it?

sobers said...

What the UK needs is someone to tell the general population the truth - namely that a large proportion of them have been living beyond their means, as have the govt on all our behalf. The consequences of this will be painful for all - higher taxes and lower govt spending to repair the public finances, and reduced availability of debt for private consumption. We will all have to accept a lower standard of living, get used to repairing stuff instead of buying new, of only buying something when we have the CASH to do so. And also go back to actually making things in this country instead of imagining that an economy can sustain itself on services alone.

What are the odds of any politico saying that? More chance of Osama Bin Laden showing up on Any Questions!

electro-kevin said...

So the economic 'miracle' was largely based on the inflated value of housing stock ?

Brought about by lending gimmickery and overcrowding perhaps ?

A heavy fall is now both necessary and innevitable and the only sensible thing this government can do is to cut welfare, the NHS and excessive government. A withdrawal from Iraq and Afghanistan would help too.

The tax burden carried by the private sector must be reduced whatever it takes.

While this is being done the focus must be on restoring and maintaining law and order in our damaged country.

Anonymous said...

If the base rate is not raised to 6%, then cheap loans to the big banks are just a taxpayer subsidy.

The Bank of England passes to the Treasury those operating profits not kept in the reserves. Keeping the base rate artificially low hurts the public purse.

Why should the taxpayer subsidise the banks and save the government's reputation (the Chancellor is a nice man who won't let the Bank of England raise the base rate), while the banks relend at 7% or more and make hay off the taxpayer?

B. in C.

Anonymous said...


The central premise of "how can we avoid a recession" is the wrong on. We desperately need a recession to correct all of the imbalances in the economy. Fortunately, a recession is exactly what we've got.

I didn't watch the debate. At any point did they suggest the government or the consumer should stop spending money they don't have?

Or was it the usual Keynesian counter-cyclical clapttrap?


powerman said...
This comment has been removed by the author.
powerman said...

There are two solutions, one requiring a bit more personal responsibility than the other, but more sustainable productive in the long run. See if you can guess which is which:-

i) Govt spending is cut sufficiently to allow both taxation and borrowing to be reduced. Interest rates are allowed to rise to encourage capital accumulation rather than consumptive borrowing and boost the pound as a bulwark against inflation. The reduction in taxation providing the financial breathing room to allow households to afford this without going broke.

ii) Politicians just watch prices continue to inflate as the pound weakens and investors continue to avoid the debt and equity markets (i.e. the markets where money for new private investment in future wealth generation comes from). Unions get angrier and angrier and eventually force wages up in an attempt to keep up with inflation (who can blame them?). Politicians and blue-chip directors call for wage restraint whilst being booed and ignored for showing no restraint in the remuneration they've awarded themselves over the last decade. The unions eventually win by threats of massively disruptive industrial action, with some politicians and business leaders coming around to supporting them, because it's popular and wage inflation seems like a shortcut to re-establishing saner debt-to-income ratios.

We better choose wisely here. The hard part is that the wrong choice will seem good for a few years, then things will be worse. Much worse.

Anonymous said...

Alice, good point about the BofE already risking rate cuts in order to stimulate growth, never occured to me whilst watching the debate.

I became quite angry whilst watching those three blabbering on about the 'danger of talking ourselves into a recession' as well as Mc Fool attempting to not answer the total % of tax placed on fuel.

I was also peeved at the way the Beeb portrayed the government's recent 'uturns' as negative implying that Crash Gordon should stay strong in our hour need and not listen to the low paid, workers etc and their whinging about increased taxation.

All in all in was a poor showing from the Beeb however I expect nothing less from this sham of a 'non-biased' media outlet.


Woody Finch said...

Alice, just found your site and think its great. Been looking for something like this for a while.
I agree with the general analysis but not with the prescription for a rate rise. Effective rates for UK consumers are now 6-7% minimum anyway, because of the crunch. With the nominal growth rate a maximum of 5.5%, that's already going to be reining in growth.

Anonymous said...

Here's an ominous sign:

1. The Labour party nowhas no money except what the trade unions give it
2. Union members are whining about inflation and demand special treatment
3. Union leadership is saying "make it easier for us to strike or we don't pay you"

(all those have already happened, the rest is a prediction

4. Labour rolls over and rushes through badly designed laws
5. Unions immediately strike
6. Labour thrown out of power like its 1979 all over again.
7. Landslide Tory victory and they smash the unions like its 1984, with full support of everyone who isn't in a union.