Memorandum submitted by Ms Bridget Rosewell,
Volterra Consulting
Rates are on the rise again . . .
On 6th November the Monetary Policy Committee
raised bank base rate for the first time in four years. Their
worries about indebtedness of consumers and continued house price
inflation have outweighed considerations of whether recovery is
fragile and the state of manufacturing. Are they right? And how
many more rises are we likely to get?
We can start by looking at what kind of recovery
we have. The downturn started in the wake of the dot com crash
and deepened further post 9/11. However, it has not been a very
serious dip, as the chart of US growth shows. On a quarterly basis,
it was only just a recession, with only two quarters of falling
output on a year on year basis. For the last 7 quarters output
has been growing again, with a bit of setback during the war with
Iraq. As far as the US is concerned, this is now a well developed
recovery.
What of the UK, however? So far, it is the only
country to raise rates of interest and indeed they never fell
so far here as in the US or even the Eurozone. Admittedly, the
Eurozone remains in the doldrums, with little economic growth
either occurring or in prospect.
. . . PERHAPS BECAUSE
THE LAST
CUT IS
NOW REGRETTED
In the UK, we have not actually experienced
a recession. A comparison with the US shows a downturn emerging
at the same time as in the US, but is did not go as deep, bottoming
out one quarter later than in the US, but with growth never much
below 1.5% year on year. Since then, it has been pretty stable
at 2%. Moreover, the overall position of the economy is stronger
than was previously thought—all because of the introduction
of a new technique.
The chart below compares the old and new measures
for the main indicator of output—GDP. The statisticians
have introduced a new method of calculation which makes more rapid
adjustment to the weights applied to those parts of the economy
which are growing. The chart shows how this has made the boom
up to 2000 stronger, while the downturn is about the same as before.
As a result, the Monetary Policy Committee are almost certainly
worried that there is less room for expansion in the economy than
they thought and that their last rate cut was misconceived. (Incidentally
they also unwound the effects of an import VAT scam which had
been so successful that it had significantly increased the apparent
value of imports. This correction has also improved the growth
rate!)
At present therefore the economy appears to
be pretty stable at slightly below the underlying growth rate.
The rate rise we have had (probably) corrects what now looks like
a mistake. There seems little reason on the basis of the real
economy to do more. The new figures show that growth has been
somewhat faster and that therefore capacity utilisation is at
a rather higher level than previously thought. However, the Bank's
analysis suggests that they are not too concerned and still think
that utilisation is below normal, giving room for growth. In addition,
their look at the labour market also provides some evidence that
further increases in participation are possible (p 27). This would
be worth probing. I agree that the capacity utilisation figures
as generally presented may not be worth very much. But they are
used quite widely in Treasury.
THE ISSUES
The fear is about personal indebtedness. Directly
this is not the Bank's concern. But over extension leading to
a house price crash and a reduction in spending would be. They
are trying to use interest rates to curb our desire to borrow
without scaring us. Doing this will help moderate house prices
and borrowing without bringing it to a halt. It is noteworthy
that the Inflation report is quite agnostic on Mortgage Equity
Withdrawal and whether this is being used to finance consumption.
Indeed on balance I would conclude that it may well not be. Moreover,
the report points out that arrears and repossessions are at extremely
low levels, suggesting that households are managing their debt
successfully. Though personal bankruptcies are at a high level,
the numbers involved are very small.
The other main issue which is not addressed
in sufficient detail is that of the contribution of the public
sector. Public sector wage inflation is running well ahead of
the private sector. The real consumption wage is falling as a
result of tax increases (p 31). Both of these features put upward
pressure on inflation.
In both the demand and output sections, the
Report is coy about what is happening to government consumption
in real terms. It points to the difficulty of measuring productivity
in government services, but do not address the issue in enough
detail. This should be challenged. A recent report in "Economic
Trends" from the ONS suggests that prices are rising faster
in public services than elsewhere and productivity is falling.
This has implications for the government's fiscal policy and for
the MPC too. What view is the MPC taking of public sector inflation
and what assumptions is it making about the future of fiscal policy?
19 November 2003
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