Figures suggest Scotland stands on the cusp of economic recovery, but let’s just be wary of what we wish for, writes Bill Jamieson
Thanks a million, Mark Carney. With the new Bank of England Governor’s bold pronouncement yesterday on “forward guidance” he has put Scotland within a hair’s-breadth of “escape velocity” on economic recovery.
He revealed that the Bank will not consider raising interest rates until the jobless rate has fallen to 7 per cent or below. Currently, the UK unemployment rate stands at 7.8 per cent. But in Scotland it is 7.1 per cent.
We’re almost there. So it’s good news, then? Well, not quite. Put another way, were all of Alex Salmond’s dreams to come true and an independent Scotland were to have its separate central bank, Carney’s forward guidance would suggest the recovery from economic emergency in Scotland was almost complete. But be careful of what you wish for. The corollary of this is that interest rates would now be free to rise.
That would be a huge relief for Scottish savers. But ask any Scottish business leader or economist whether our recovery is really so advanced as to put us on the edge of higher interest rates, and the answer would be an emphatic “no”.
To give an idea of how far the UK economy as a whole has to catch up, Mr Carney has calculated that a fall in unemployment to 7 per cent would require the creation of about 750,000 jobs and could take three years.
The immediate implication of this “forward guidance” – the new device of Mr Carney’s by which he aims to give households and businesses a clearer idea of the Bank’s thinking on interest rates to help confidence and investment – is that Bank’s £375 billion asset purchase programme known as “quantitative easing” will not be cut back and interest rates are going to stay at their ultra-low level of 0.5 per cent for a considerable while yet.
But surely that really is good news? Here again, not quite. For while businesses and mortgage borrowers would love to know what level interest rates are likely to be for the forseeable future, it is a venture fraught with hazard and one that could jeopardise the very recovery Mr Carney is seeking to engineer.
The dangers are both practical and conceptual. On practical grounds the decision to set interest rate policy by reference to a set level of unemployed may prove to be a major error. It raises all manner of questions about the composition and accuracy of the unemployment numbers.
Take, for example, the current controversy over “zero hours” contracts. Thousands of people on such contracts may currently be working all hours, but they are not counted as being in work for the purposes of employment statistics.
Conversely, and more controversially, the problem that has dogged job stimulus programmes for decades is that we have a substantial core of long-term unemployed, a considerable percentage of whom – possibly up a third on some estimates – may be considered unemployable, no matter the adjustments made to the tax and benefits system. However sensitive this may be for politicians – and central bankers – to discuss, other than in the most oblique and general terms, the problem is that the reduction in unemployment can never be linear: it becomes progressively harder to reduce the jobless numbers to a genuine “core” level.
Another problem opened up is that it risks putting job creation ahead of labour productivity, leading to a loss of competitiveness – and a higher level of inflation – that may in due course generate further unemployment.
And it is not just the level of interest rates that determines employment. All manner of forces and factors influence the employment numbers, from labour market regulation through skills levels to the ease of labour mobility.
However, the problem with forward guidance as a monetary policy guide is altogether deeper. No matter how well intentioned, the search for certainty on longer term movements in the cost of money has forever been the pursuit of central bankers and economists. Such prediction is invariably at the mercy of external forces or events – a hike in oil and energy costs, or exchange rate volatility or political instability or a growth slowdown across the world’s leading economies. For all the brainpower of the Bank of England and the Monetary Policy Committee – and that of highly paid investment bankers and fund managers – applied to this task, such forecasting will at all times be vulnerable. The future cannot be reduced to statistical projection or mathematical models. Were this not so, and reliable “forward guidance” really was achievable, our economy would be permanently in the sunny uplands and we would all be seriously rich.
What the Bank has now created in its guidance of interest rates lower for longer is a potential conflict between sticking to this guidance over the coming period or disregarding the forecast and responding promptly to changes in inflation. And history shows us how stubborn inflation can be once allowed to take hold. Back in 1988 chancellor Nigel Lawson was convinced inflation was “just a blip”. But within two years mortgage rates had shot from an average 10.9 per cent to 14.9 per cent and did not fall back to single percentage figures until 1993.
As matters now stand, we may in fact be nearer “escape velocity” and sustainable recovery than Mr Carney’s implied three-year haul would suggest. You do not need to don rose-tinted spectacles to view the latest indicators as highly encouraging. In recent days we have had sharply better figures on manufacturing output, car sales, retail sales, consumer confidence and house prices.
Particularly notable was the rebound in manufacturing output, up by 1.9 per cent in June to score its best annual gain for two years. In addition, the CBI reported increasing orders and production expectations in July. The Society of Motor Manufacturers has reported a 17th successive month of year-on-year gains, with private car sales leading the way with a 16.4 per cent year-on-year gain.
And in case we suspected that this spending upturn was confined to cars, the British Retail Consortium has just reported a 3.9 per cent year-on-year gain in overall retail sales, the best July performance since 2006. Taken together with Purchasing Managers Index surveys pointing to upturns in overall services, and construction output at its highest since 1998, it reinforces the view that the economy seems well placed to surpass the 0.6 per cent quarter-on-quarter GDP growth achieved in the second quarter.
Those who dismissed “expansionary fiscal contraction” as an oxymoron now have to address an uncomfortable truth that a recovery story is unfolding without resort to Keynesian fiscal stimulus (more borrowing, more debt). Indeed, a major concern now is that the Chancellor’s help for first-time house buyers may trigger another price bubble, requiring higher interest rates to dampen the flames.
No rate hike for three years? This foray into “forward guidance” may be reassuring for now. But the downside is a false sense of security, with all the attendant dangers that false prophecy can bring.