The eurozone crisis has provided a scary backdrop to every column I have written here over the past 12 months, as has the ongoing and rather sterile debate about whether the government should stick to its “Plan A” or opt for a “Plan B”.
The answer to that, of course, is that in a ideal world the government would not only have a Plan B, but Plans C, D, E and F as well. But this is not an ideal world. Far from it.
To add some more letters to the alphabet soup, Britain’s AAA rating is hanging by a thread and, as we saw in the autumn statement, George Osborne is struggling to meet his self-imposed fiscal rules. I can predict with confidence and some trepidation that the Plan A/Plan B debate will go on in 2012. The question of whether Britain clings on to that AAA rating will be a live one.
But the big theme of 2011 was one of disappointment. An economic recovery that started very well slowed markedly. As I always say, we should treat the Office for National Statistics’ (ONS) first guesses about gross domestic product with some caution. The figures will be revised.
The picture we have now, however, taking the ONS’s latest numbers, is of an economy that grew by 3% in its first 12 months of recovery – from the third quarter of 2009 to the third quarter of 2010 – but slowed to just 0.5% in the latest 12 months, up to the third quarter of 2011.
A better way of looking at it, perhaps, is by reference to calendar years. In 2010, Britain grew by a respectable 2.1%, the ONS now says. A year ago my expectation, and that of most independent forecasters, was that we would see something similar, that is growth of about 2%, in 2011.
This time last year the Treasury’s monthly compilation of independent forecasts showed an average expectation for 2011 growth of 1.9%, with the newest forecasts slightly more upbeat at 2%. One or two forecasters were positively glowing with optimism, predicting that the year’s growth rate would be 3% or more.
The disappointment is reflected in the latest assessment by independent forecasters, taken from the Treasury’s latest compilation published a few days ago. Now the assessment is that the economy grew by just 0.9% in 2011, less than half the 2010 rate, and half what was predicted by the consensus a year ago.
How worried should we be by this? It is not hard to think of reasons why we should be concerned. The eurozone crisis, of which more next week as I look forward, has hit confidence, particularly among businesses, as well as exports, and is far from resolved.
The issue of weak bank lending – the practical impact of the hangover from the banking crisis – remains with us. Despite the chancellor’s imaginative plan to launch credit easing, lending to small and medium-sized firms has been falling on an annual basis since early 2009 and continues to do so.
Some of the one-offs of 2011, such as the Japanese earthquake and tsunami and its impact on manufacturing supply chains worldwide, will one hopes not be repeated. But there will be other shocks, and there will be other repeat factors like additional bank holidays to celebrate royal milestones.
When an economy is strong enough it tends to shrug off such special factors. The fact that there was a response this time – latest figures show the economy did not grow at all in the second quarter – shows an underlying fragility.
The government’s fiscal tightening – its Plan A – clearly had an impact on growth during 2011. The Treasury would point out that there was also such a tightening during 2010 and so this alone does not account for the growth disappointment.
It is a fair point, though perhaps the nature of 2011’s changes, the Vat hike at the start of the year to a new high of 20% and April’s increases in national insurance contributions, brought home to people the fact that we are all in this together when it comes to cutting the deficit.
The big explanation for 2011’s growth disappointment, however, was the squeeze on real incomes – and to a certain extent business margins – from high inflation. Some of that was due to the Vat hike. Most was not.
A year ago, when we knew about the Vat hike, the consensus among forecasters was that consumer price inflation in the fourth quarter of 2011 would average 2.8%. In the event it has been roughly two percentage points higher.
That makes the difference between a mild squeeze on real household incomes and a savage one. The Office for Budget Responsibility says 2011’s drop in real incomes was the biggest in the post-war era. It made the single biggest difference to economic growth, turning the prospect of a dull but respectable recovery year into a disappointing one.
Without high inflation, growth of 2% would easily have been in reach in 2011. As it is, consumer spending has never been so depressed at this stage of a recovery.
Could anything have been done about it? I started the year thinking the Bank of England would have been wrong to accede to pressure for higher interest rates, given that the die for 2011 was already cast.
But Andrew Sentance, before he left the monetary policy committee (MPC), made a persuasive case that some of the factors that appeared to be beyond the Bank’s control could be influenced. In particular, to the extent we were suffering from high imported inflation, the Bank’s actions – by bearing down on the pound – exacerbated the problem.
So for a time we appeared to be moving towards a rate hike. Three MPC members voted for it and others seemed ready to join them. By the end we had gone full circle, with the Bank opting to resume quantitative easing.
Though I was rather uneasy about that, the proof of the pudding will be whether it is seen to be supportive of growth during the next few months and whether, as the MPC believes, inflation will fall very sharply in the coming months. That, as I shall discuss next week, has to be the hope.
My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.
This post originally appeared at David Smith’s EconomicsUK and is posted with permission.
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