Economists employed by PLCs aren't much cop on the whole. If they aren’t getting wheeled out at corporate shindigs to warm up for the CEO or regional sales team, they’re doing their damndest to get their employer’s name in the press by vomiting screeds of guff surveys typically bought off the shelf from someone else who actually has a degree of methodological competence. So it was with some interest that I read “Monetary Policy and the Current Recession”, a speech given by Andrew Sentance at the Institute of Economic Affairs (IEA) on Feb the 24th.
Dr Sentance is a member of the Bank of England’s monetary policy committee and as such a big cheese. He’s also been an economist at the CBI and British Airways so is as big a PLC economist as it’s possible to get in Britain. The IEA by the way was Thatcherism’s think-tank, a body founded (and voluntarily funded) to promote free-markets as the solution to all the world’s socio-economic ills, give or take the credit crunch free markets caused. So when Dr Sentance went to the IEA you might think it was a match made in heaven (1). Alternatively, after reading the speech you might think “aye right”.
Dr Sentance you see is the self-appointed voice of economic reason - “The fact that we have to look back nearly two decades to find the last recession and three decades or more for its two predecessors inevitably makes it harder to put the experience of the current recession in perspective. That, in turn, may account for some of the more apocalyptic and hyperbolic views of the current conjuncture.”
He goes on – “I have argued that while the downturn is being driven by a financial crisis of a type we have not seen in post-war economic history, our experience of the current recession in the UK is not – so far – out of kilter with earlier post-war recessions” i.e. if what I’m saying turns out to be bollocks saying “so far” makes for a sweet get out clause.
Anyway, that’s the guff, what about the meat? Well there isn’t much really. There’s a big-up for himself as a forecaster when he was at the CBI and for its business surveys to an extent thats cringeworthy compared to the measured tones usually associated with the Bank of England. Then, there’s a dire account of the British economy in the 1970s just in case we’d forgotten his former employer’s raison d’etre is representing the interests of employers first and foremost. For Dr Sentance, in the 70s “British industry was then being held back by a set of problems which became known as the “British disease” – low productivity, bad industrial relations and lack of non-price competitiveness”.
Err right. Lets not bother comparing the history of industrial relations here with continental Europe and the uniquely positive contribution oil revenues have made to the British economy since the end of the 70s. We’d also best ignore the repeated exchange rate crises and fiscal policy induced booms followed by busts also seen in the past and just don’t talk to me about supply-side shocks of a kind we simply aren't seeing right now!
Or is that unfair? He does make one interesting point about GDP, which is that the magnitude of recent trends looks more like the recessions of the early 70s and early 80s than the early 90s and while that’s as maybe we got through those in due course. Plus there are some nifty runs of data that provide some benchmarks and guidance as to how long things might take to sort themselves out (remember this is at the IEA so no government intervention, no government intervention!).
The problem with using historical experience like this though is straightforward; things change or as Mark Twain put it “History doesn't repeat itself - at best it sometimes rhymes”. Picking through the resultant differences in turn provides a straightforward challenge to Dr Sentance’s perspective.
He says “growth in the UK economy should receive additional support over the course of this year from a competitive pound”, which is a fair point given devaluation and cheaper credit was fundamental to recovery in the 1990s. But, growth of what exactly?
In this regard Dr Sentance is clear “a competitive pound puts British manufacturing in a much better position to win new markets at home and abroad - mitigating the negative impact of the recent sharp downturn in global demand”.
Bollocks. Maybe it does maybe it doesn’t, the fact is the manufacturing industries he describes trade on the basis of technological advantages and high value add, which conveys a high degree of insulation from exchange rate movements.
Ahh, says Dr Sentance, but manufacturing today is less affected by the British disease of the 70s so is better placed to respond. Err, right. First off, lets humour the guy by ignoring the accuracy of his historical analysis and the point already made about British manufacturing exports not being especially sensitive to exchange rates. Lets also ignore how despite the “British disease” being presumably cured we’ve still moved into recession. Then lets pretend manufacturing hasn’t been in long-term, relative decline for decades and finally lets also ignore Dr Sentance’s own point about the “highly synchronised contraction in demand and output across the global economy” i.e. cheap pound or no no-one will be buying British anytime soon.
Instead, lets just point out that with manufacturing now accounting for under 15% of GVA (a lot like GDP) judging by the weightings in the official statistics, it’s a far smaller part of the economy than it ever was to the extent that a meaningful, manufacturing led recovery predicated on a competitive exchange rate is a stupid idea. Ooops, almost forgot, a cheap pound can also push up inflation by making imports more expensive, unless Dr Sentance is pretending deindustrialisation didn’t happen and that we’re all about to start buying our flat screen TVs from British TV factories that don't exist? And anyway even if manufacturing does recover, it’ll have to go some to counter-balance the restructuring (i.e. hacking back) of the much larger business services and finance sector that drove British economic growth from 2000 until the credit crunch.
So if Dr Sentance sounds like he’s talking pants (though beautifully presented I’m sure), is the apocalyptic hyperbolic alternative justified given his own criteria of things being “not yet clearly worse than the mid-1970s and early 1980s downturns in output”?
Well lets have a broader perspective than just GDP for a start, I mean theres house prices for instance where judging by the (I’m guessing nominal) Nationwide quarterly house price index, the current downturn is only the second time since 1955 i.e. before the 70s and early 80s recessions quoted by Dr Sentance, that annual house price growth has turned negative. Not only that, the rate of the decline seen in Q4 last year was the worst on record, something that also applies to commercial property values. So by two measures things are already worse now than in the 70s and 80s.
Then there are official interest rates, which are now at their lowest level in 300 years. Here let me repeat that 300 YEARS i.e. before the 70s and 80s. Alongside this the Bank of England is about to take the UNPRECEDENTED step of implementing a quantitative easing policy due to what Dr Sentance rightly describes as a “financial crisis of a type we have not seen in post-war economic history” i.e. even if we include the 70s and 80s.
The reason for pulling rates down to crisis levels and introducing quantititative easing is because banks are in schtuck and the supply of credit to the economy has fallen significantly or to quote the Bank of England's own Feb 09 Inflation "major UK banks have, on average, also been reducing lending". This isn’t something Dr Sentance is keen to talk about, which is a shame because it’s what caused the mess in the first place and has so far seen government take the UNPRECEDENTED step of nationalising and part-nationalising high street banks.
Moreover, if rapid lending growth contributed to pre 2008 economic growth, then the constraints now being permanently placed on the banks' use of wholesale funding and securitisation to finance their retail and coporate lending makes for a permanent, step-change in the availability of credit likely to constrain i.e. drag out, any recovery.
On the other hand while business insolvencies jumped a frightening 52% in Q4 2008 compared with Q4 2007, enough to push the 2008 total up 24%. Looking at the official data going back to 1961 we’ve seen worse than this, but, with far more insolvencies on the way may I suggest the jury is still out on this one?
Or is this is too reasonable given Dr Sentance also said “there is now much more evidence that firms and households are seeing lower borrowing costs”. Really? Right lets bring some reality into play here cos things really are getting a bit silly. With the hack back in high street LTVs from well over 85% to under 60% in some instances, to get the best mortgage deals buyers – going by December 08’s average house purchase price data – are having to find something like an extra £30 grand or so for their deposit (the shift from an 85% LTV to 60%). So sure, mortgage rates have fallen, but at these LTVs who has got the savings to buy regardless of what the rate is? Or to put it another way with credit being aggresively rationed by policy as well as price (i.e. interest rates), to focus on one and ignore the other is to miss the point.
In my view then some of the more apocalyptic commentary does appear warranted. Sure the GDP downturn and increase in insolvencies are only as bad as say the 70s and 80s, but we're only 2 quarters into the recession. Plus, key asset values are already falling at unprecedented rates. Speaking of unprecedented we're also now seeing a range of unprecedented measures being taken in response to arguably the worst financial crisis since the Great Depression. And of course this is just the British experience; the IMF is already bailing out economies across the world.
All in all then Dr Sentance hasn’t provided A particularly convincing response and that’s despite having had two, I’m guessing, very bright young things helping him with his research. In fact, the quality of the analysis compared to what MPC members usually produce does leave you wondering what he's doing on the committee; a sop to his former employers perhaps? As for a more meaningful response to what's currently being labelled a recession for me its deficit financed social housing and public works, not that that would win me any friends at the IEA right enough.
(1)Alternatively you could ask what was an impartial MPC member doing at an institution that has helped provide/promote many of the theoretical underpinnings of right-wing politics. In the interests of balance will Mervyn King be speaking at the next Association of Radical Economists annual conference I wonder?