Written evidence submitted by Professor
Anton Muscatelli, University of Glasgow
1. The key feature of the November Inflation
Report by the Bank of England is the improvement in the short-term
outlook for GDP growth relative to the August Inflation Report.
The Bank's view is that the economic recovery will be fed both
from the major domestic monetary policy stimulus (with a total
of £200 billion of asset purchases by the Bank), and external
demand as the fall in Sterling begins to feed through on net exports.
2. In this short report I highlight some
of the issues with this revised forecast. My main concern about
the forecast in the Inflation Report, which to some extent echoes
some of my earlier written evidence to the Committee, is that
the Bank's expectations for the economic recovery still look too
3. In my view, there is still a strong possibility
that the path for GDP growth in the next two quarters will still
be weak, and that it is only when, and if, we observe a pick up
in growth in the developed as well as the emerging economies,
that the UK recovery will gather pace.
4. The Bank's outlook for GDP looks too
optimistic, with a rapid bounce-back in growth from 2009 Q4 and
the level of output recovering by the beginning of 2011 (pp 2-3).
My view is that UK output growth will still be weak in 2009 Q4.
Leading indicators show a recovery in industrial production in
September, as well as confidence indicators, but it seems unlikely
that GDP growth could recover as fast as shown in the report.
A best case estimate for 2009 Q4 is quarterly growth of 0.3-0.4%
The NIESR estimates of GDP growth to October still estimate a
quarterly output fall of -0.4%.
5. In other deep recessions (eg 1979-1983,
it took up to four years for GDP levels to recover its original
level. A recovery in three years, as is indicated by the Bank
at present, would make the current slow-down more akin to the
1990-93 recession. Again, this seems unlikely given the nature
of the current slowdown, and its roots in a major financial and
public finance crisis.
6. It would be interesting to ask the Bank
to outline how its current forecasting model operates given the
switch from interest rate policy to quantitative easing. How reliable
are current forecasting techniques which the bank uses to project
the impact on growth of quantitative easing measures?
7. A key issue for the UK economy, as I
have noted in recent written briefings for the Committee, is the
extent to which domestic consumption and investment expenditure
might respond positively to clear signals from the Government
and the Opposition that steps will be taken to stabilise the public
finances from Budget 2010 onwards. These "Ricardian"
effects, whereby consumer and investment spending might actually
react positively to reductions in public spending and fiscal stabilisation,
cannot be ruled out at a time when the general public is so concerned
about the public finances and the extent of future tax liabilities.
8. In this context, it might be of interest
whether the Bank is looking at how future fiscal policy announcements
might impact on their projections for GDP growth. Understanding
consumer spending responses to fiscal stimuli will be crucial
for the Bank to understand how it should conduct monetary policy
over the next year.
9. One reason for recent optimism for UK
GDP growth, and this has been factored into the Bank's projections,
is the amazing turnaround in growth in the Asian economies, particularly
China and Japan. To some extent, however, the impact of the economic
recovery in Asia may be less robust than is thought. The emerging
economies of India and China have started to recover, and some
of that was expected (see for instance the projections of various
agencies like the IMF from early 2009). However, Japan's recovery
is in part a reversal of the inventory cycle, and we have seen
similar bounce-backs in other industrialised economies in recent
months. The key issue is whether this is sustained. A pure re-stocking
cycle will not be sustained unless world demand continues to grow.
Unless domestic expenditure in the emerging economies begins to
act as a pull on the rest of the world economy, there are dangers
that the current world economic recovery will not last, and/or
may exacerbate current account imbalances in the world economy
which were part of the cause of the original crisis.
18 November 2009