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.
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.