UK economy can't get out of the blocks
Following the distraction of the London Olympics it's back to the drawing board for UK policymakers, who have very little fiscal or monetary ammunition left in order to stimulate their shrinking economy.
As the tinsel is swept up from the Olympic stadium and the various barricades that held back the spectators from the athletes are dismantled and life returns to normal, those policymakers are confronting an economic situation in the UK that on many measures is as severe as the performance of the UK in the 1930s Great Depression.
The dire position of the UK economy shows up most clearly in the recent GDP data. They show that GDP fell 0.7 per cent in the June quarter, the third quarterly decline in a row. Overall GDP is now 4.6 per cent below the level of early 2008. For the UK, this is a weaker GDP performance than during the early 1930s Great Depression which, despite the downturn being deeper than now, was shorter in duration and the "lost” output was recovered within four years.
The problems of what to do about this crippling economic performance have the background of the BoE already setting the policy interest rate near zero (0.5 per cent) and it has implemented a staggeringly large £375 billion (around $560 billion) of bond purchases. With the policy interest rate unable to be cut further, at least according to BoE Governor Mervyn King, any additional monetary policy response will inevitably be focused on more bond purchases. The aim of this is to keep bond interest rates near 300 year lows which is turn will keep borrowing costs for the corporate sector lower than they would otherwise be. In the circumstances, this injection of liquidity is obviously desirable, but it means there will be a further debasement of the British pound which is already floundering some 30 per cent below its pre-global financial crisis level.
A big worry is that even with another £50 billion or £100 billion or more of bond buying from the BoE, there is no guarantee the economy will recover. The banking sector remains zombie-like and is floundering from scandal to scandal. The UK does not have a globally competitive and large-scale sector that can take a lead and drive a recovery – unlike say mining in Australia or Canada, manufacturing in Germany or China or technology and finance in the US. The recovery will need to be built on a yet to be identified part of the economy.
Impotent monetary policy is poison for an economy. The last two decades in Japan shows how bad things can get when monetary policy can’t and doesn’t work.
In these circumstances, you might think fiscal policy would be set with a view to support economic growth. That is, the government could be expected to implement some Keynesian measures aimed at stimulating growth and employment.
In the UK, that is not the case. The Cameron government has chosen fiscal austerity over fiscal stimulus. At face value, this is understandable. The credit ratings agencies are threatening credit downgrades for the UK if the budget position remains unchanged. The government is saddled with net government debt of more than £1 trillion ($1.49 trillion) or close to 86 per cent of GDP (net government debt is 9 per cent in Australia). Even with the austerity measures and what look to be optimistic forecasts, the UK will only just balance its budget in 2016-17.
The problem with the current stance of fiscal policy, like in many other countries with government debt problems, is that a mix of higher taxes and cuts to spending and payments is pulling cash out of an already weak economy. The ability of any sector to get and then maintain traction is limited. It is little wonder then that GDP is continuing to fall.
In 2005, the unemployment rate in the UK was below 5 per cent. Now it’s above 8 per cent and no one seriously expects it to fall within the next year.
It is a sad situation for the UK which in the 1950s accounted for about 7 per cent of world GDP. Currently it accounts for about 3 per cent of world GDP and it’s on track to fall to just 2 per cent of world GDP over the next decade or so.
Team GB obviously did well at the London Olympics and good luck to them on that score. But the UK economy remains weak, seemingly incapable of revival. If only the policymakers could pull out a gold medal performance and get the economy back on track. This seems unlikely. More probably is a situation where the economy stumbles at every hurdle.