Blanchflower: VAT hike first double-dip casualty?
Updated on 06 August 2010
As the Bank of England's Monetary Policy Committee yesterday decided to hold interest rates at 0.5 per cent for the 18th month running, former member of the committee David Blanchflower tells Channel 4 News this is no time to raise rates because a double-dip recession is likely.
The MPC yesterday, quite rightly in my view sat on its hands and left interest rates at 0.5 per cent. They also left unchanged the stock of asset purchases financed by the issuance of central bank reserves at £200 billion.
There has been some discussion in the media regarding the fact that with high levels of inflation and the strong GDP growth number for 2010Q2 that now was the time to start increasing rates.
That was the view expressed by the external MPC member Andrew Sentance in his testimony before the Treasury Select Committee last week. He and I rarely agree on anything. Sentance has voted for increases of 0.25 per cent over the last couple of meetings and it is very likely he did so again at yesterday's meeting.
In his testimony he argued that he voted for increasing rates because of the strong growth in the world economy, positive news from business surveys and the high level of inflation currently existing.
Fortunately the other members to this point have taken a different and more credible view. David Miles and Mervyn King took a much more dovish tone in their testimony to the TSC, essentially arguing that it is time to wait and watch and ready to act if necessary.
This is a very similar position to the one taken by the Federal Reserve in the United States. Other members of the MPC including Adam Posen and Spencer Dale have expressed dovish views also so once again I expect Sentance will have been in a minority of one. Thank goodness.
Let's consider the various arguments against a rate increase.
First, the coalition government is misguidedly planning to slash public spending and increase taxes which will lower output and destroy well over a million jobs. So if fiscal policy is tightening you need to keep monetary policy loose.
So Sentance is Osborne's worst nightmare as the last thing Osborne needs is a tightening in monetary policy, which would inevitably push the UK into a recession. And if the news on the economy is bad then the most obvious plan B available, other than reversing a chunk of Osborne's austerity measures, which would be a devastating blow to the coalition government, is to do more quantitative easing.
But this is quite slow acting. There is no room to cut interest rates. I completely disagree also with my old friend Sir John Gieve who this week suggested that rates would have to rise to 2.5 per cent by this time next year.
No way no how, sorry John. I share Roger Bootle's view, that interest rates in the UK will have to remain at 1 per cent or lower, at least through 2015.
Second, inflation is no threat. The problem is deflation which is already being experienced in Ireland, Latvia, Portugal, and Japan and is a growing concern in the Euro area where the inflation rate is 1.4 per cent and falling.
Indeed some members of the Fed, including James Bullard, president of the St Louis Fed, seem to be getting increasingly worried that the US is headed into a deflationary trap.
Where the US goes the UK follows a few months later, especially now that the exchange rate has strengthened quite sharply over the last few weeks, which reduces inflationary pressures. Most of the recent increase in CPI inflation is due to tax increases anyway.
Third, contrary to what Sentance claimed, there is growing evidence that the world economy is slowing.
Initial jobless claims in the US have risen again and consumer confidence there is falling, raising the fear that consumer spending will drop.
Japan and China are also slowing. In the UK consumer confidence among individuals has recently showed alarming declines. There has also been a worrying increase in people's expectations of what will happen to unemployment, which showed its second biggest increase ever in July. Consumer spending looks like it is going to drop soon, as people worry about rising joblessness.
Fourth, business activity looks to be slowing. A weighted average of the Markit/CIPS PMI surveys of firms in construction, manufacturing and services show the July readings were the weakest since September 2009.
The fifth successive monthly fall in the services PMI Business activity Index, which sat at a 13 month low in July, is consistent with a slowing of services GDP through the rest of this year.
Fifth, business confidence in the UK is plunging. PMI indices tracking companies' expectations about activity levels in the coming year, according to Markit, "showed record falls in June, and failed to bounce back in July". The one bright spot has been manufacturing which has benefited from the weak pound, but worryingly also was the fact that the manufacturing New Export Orders Index has also collapsed from showing strong growth in Q2 to near stagnation in July.
In its most recent data release Markit found that growth of new orders received by producers of investment goods, which act as a useful indicator of business investment, has fallen dramatically over the last three months.
We're in a 'very bad place'
So where does that leave us? Actually in a very bad place.
The likelihood is that the economy is about to return back to recession and the latest growth data is as good as it gets. I still think it is very plausible that we will see one or more negative quarters of growth this year.
This is the much talked about double-dip. Inflation is the least of our worries and in the medium term is no threat at all so this is no time to raise rates.
The financial markets are not calling for draconian cuts in spending and the government can borrow at very low rates. The UK is demonstrably not Greece despite David Cameron's claims to the contrary.
I fully expect the economic data to continue to worsen. This will mean the government is going to find it very difficult to implement its planned cuts later this year.
I suspect the first casualty will be the proposed increase in VAT planned for January. Osborne's economic policies are a disaster in the making for the British people.
David Blanchflower is professor of economics at Dartmouth College and the University of Stirling and writes the economics column for the New Statesman. He is also a columnist at Bloomberg.