By Michael Baxter 5 Mar 2010 [0 Comments | 574 views]
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Yesterday, the Bank of England didn’t surprise anyone and stood pat.
Interest rates remained at their record, rock bottom low. Not only is the UK rate of interest half a per cent, it has been at that level for a year now.
Warning, warning… some boasting is about to follow. This column predicted zero, or near zero interest rates, when central banks across the world had only just begun to reduce rates. We are not aware of any publication or economist who made a similar prediction so early on. see Could interest rates fall to zero?
As for the future, rates are probably going to stay low for some time.
We still hold to the view that deflation, and not inflation, is the big enemy, which could mean low interest rates for years.
The big danger lies in a possible crash in sterling, or if markets decide the UK government is too big a credit risk. Then rates may have to go up.
But what is quite interesting is that Capital Economics has said that it was thanks to the Bank of England’s quantitative easing that the UK has lifted out of recession. They reckon the programme has boosted GDP by between 2 and 3 per cent.
They are probably right. But then again, there is another point here.
Economists may have got too clever for our good. Alan Greenspan, and his chums at the Bank of England, may have perfected the art of playing with interest rates to smooth out the economic cycle. But maybe that’s the problem, the real underlying problem.
Economists seem to see the economy as a bit like a car journey down the motorway. The car should drive at 70 miles per hour. If you hit a traffic jam and don’t move at all for 15 minutes, and then restart and hit the speed limit straight away, then that means your journey will take 15 minutes longer.
The economy, they say, should grow at between 2 and 3 per cent a year.
If one year it stops growing, then they say there has been a permanent loss of output of between 2 and 3 per cent.
And for decades they used the ideas of Keynes to try and manipulate the cycle: deflating demand during the boom; inflating during the downturn. Alan Greenspan appeared to master the trick, and deliberately slowed the US economy down during the mid 1990s.
Apparently his move was pretty controversial at the time, and according to his book, The Age of Turbulence, the Clinton government was none too happy. But Greenspan reckons he stopped the boom going too far, and as a result avoided recession the following year.
Alan Greenspan and Gordon Brown are friends. The man the press named the maestro, waxed lyrical about our Gordon in his book.
You will of course recall, Gordon Brown had a similar idea to Greenspan. He used to talk about “no more boom and bust”. And since he presided over the longest ever run of sustainable economic growth, it did appear he had pulled the trick off, at least for a while.
The idea of controlling the economic cycle, of smoothing it out and eliminating recession, is something of a holy grail for economists.
But is it possible that the dream of controlling the economic cycle is actually flawed? Maybe we need the odd recession from time to time, in order to purge the economy of the bad ideas and to create space for new businesses to grow into it.
Economists see it as wasteful if resources are not being used. So it is essential to prop up businesses in the bad times, otherwise resource is going to waste. This is the argument for protecting industry.
But on the other hand, if we are all working for the government, as civil servants shuffling paper around, we don’t have an incentive to go looking for another job that may be more productive.
Entrepreneurs are often born in times of austerity. They create a business with its independent revenue stream because they can’t get a decent job.
Maybe recessions are essential for kicking new dynamism into the economy.
At the other end of the economic debate, the market fundamentalists blame Keynes for all our ills. The trouble is, modern day economists use the ideas of Keynes to fix problems that Keynes knew nothing about. His theories were developed during the Great Depression. He outlined a series of remedies as to what to do if such times returned.
But during that period when Gordon Brown and Alan Greenspan were playing with the economic cycle, there wasn’t even a hint of depression. Keynes said nothing about smoothing out the economic cycle. Yet modern day Keynesians used his ideas to do precisely that.
This column has argued before that maybe the UK should have had a recession at around the turn of the millennium, at the time of the dotcom bust. By throwing low interest rates, government borrowing and the kitchen sink at the economy during this period, the UK was one of the few economies to avoid recession. In the US, thanks to Greenspan working his magic, the US recession was mild.
But maybe if, instead, the cycle had been allowed to take its natural course, things would be a lot easier today.
David Cameron criticises Gordon Brown for not fixing the roof when the sun was shining. He was right to criticise Brown. But maybe his reasoning was faulty. Maybe the reason why the sun was shining is precisely because Gordon Brown kept spending up.
But that does not necessarily justify Gordon’s spending.
Sometimes there is a price we pay for growth today, and the price is less growth tomorrow.
There is nothing permanent about a fall in growth. Rather, it creates space and enables a spurt of new dynamism.
But all these arguments do not mean that measures currently being taken by central banks and government to reduce the effect of the recession are doomed to fail. For the first time since Keynes penned his General Theory back in the mid 1930s, we are seeing an economic backdrop that has frightening similarities with the 1930s.
Just because Keynesian economics is arguably the cause of the current economic difficulties, it does not mean Keynesian economics can’t help us now.
