Bank of England November 2009 Inflation Report - Treasury Contents


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 optimistic.

  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.

ISSUES FOR THE COMMITTEE TO CONSIDER

  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





 
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