Changing How the World Thinks

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Recession is the threat, not inflation

Now is not the time to raise interest rates


The current narrative about the economy is that price rises are a worrying sign. Long-term price inflation devalues people’s savings, discourages investment, and can create shortages. The textbook remedy is for central banks to raise interest rates, essentially making money more expensive, driving prices back down. But according to a new study, there are powerful signs that the US economy is going into recession, something that will likely impact the UK and other economies around the world. If that’s the case, raising interest rates should be the last thing central banks should be doing now, argue ex-Bank of England advisor, David Blanchflower and Alex Bryson.


All is not quite as it seems in the world economy.  Whilst the worst of the COVID pandemic may be over in developed economies its effects continue to reverberate both here and on the other side of the Pond.  Indeed, in a paper we have just released we argue that the US economy is going into recession about now. You might not think so, judging by the markets and by labour market statistics which seem quite buoyant.  But if you focus on consumer and producer expectations about the near future you get quite a different picture – one which is eerily familiar to those who remember the recession of 2008.  Strikingly, these indices gave early warning to all six of the prior US recessions since 1979.

Those consumer and producer expectations indices tell us how economic actors are feeling about the future – the future of the economy, of unemployment and their own household finances.  They are important because, as we have shown in a series of papers, they are predictive of what happens in the economy some 6-18 months later. Back in 2007 they were pointing to economic downturn but few paid attention until it was too late.  The same is true today.  These indices have dropped in the last six months at a rate that is comparable to what happened during the recession of 2007/2008.

Data from across the eight biggest states in the US showed a sharp decline in consumer expectations in the spring of 2021, just as they did in 2007.  There are some similar signs of worsening consumer confidence in the UK.  The YouGov Consumer Confidence Index fell n October and the Institute of Director’s Economic Confidence Index “fell off a cliff” in September.

The numbers tell a story: we are witnessing a dramatic slowing down of the US economy.

Commercial and industrial loans have also fallen to the lowest as a proportion of total assets on U.S. banks balance sheets, indicating that businesses and people are reluctant to get into debt at this point in time.  Auto parts production is down 14% from last year. Median weekly earnings of the US's 115.3 million full-time wage and salary workers were $1,001 in the third quarter of 2021 (not seasonally adjusted), only 0.7 percent higher than a year earlier, according to the U.S. Bureau of Labor Statistics. The numbers tell a story: we are witnessing a dramatic slowing down of the US economy. Growth in the second quarter of 2020 was 10.4%; in the third it was 8.2%; in the fourth 5.1%. In the first quarter of 2021 growth was 3.3%; and in the second quarter of 2021 growth was negative, -1.2%.

In part the slowing in the US is driven by fears of COVID from returning to work with the Delta variant spreading, especially among women.  A recent survey by The Conference Board, released on 31 August 2021, indicates that 42% of workers are worried about returning to the workplace for fear of contracting COVID-19, a substantial increase from June 2021 when only 24% expressed this concern. Of note is that 48% of women and 37% for men said this.  As a result, young women are leaving the US labour force; the participation rate of women ages 25-34 fell from 76.5% to 75.9% whereas for women 35-44 it fell from 74.8% to 74.0% in September 2020.  Older women are retiring.

In the UK a new survey from CV-Library found that a third of UK workers would consider leaving their job, rather than work with an unvaccinated colleague.This is important because, especially now, COVID means standard labour market indices – wage growth and employment growth – are particularly unreliable.  Unlike in prior recessions as the unemployment rate rose and wage growth fell, the opposite occurred this time: wages and unemployment rates went up together.  There are 700,000 more benefit claimants than there are reported as the unemployment count based on definition set out by the International Labour Organization (ILO).  The economy has been impacted by the furlough scheme and we have little clue what proportion will lose their jobs now the payments have stopped.  These gliches in official statistics will sort themselves soon but,

in the meantime, the most reliable reading for the economies of the United States and Europe are those we get from consumer and producer expectations.  And they are looking bad.  The US seems headed to recession.The reason this matters in the UK is that contrary to what Mervyn King used to tell us when he was Governor at the Bank of England, the US and UK economies have not decoupled. When America sneezes – and it is – the UK catches a cold.  It usually takes 4-6 months before we feel the effects over here.  That gives us until early in the New Year to steel ourselves against potential recession.

The markets seem to have got ahead of themselves in thinking interest rate rises are coming.

That’s why this is not the time to be thinking about raising interest rates in the UK. Remember, we have already seen the end of the furlough scheme, reductions in Universal Credit payments, and we have a tough Budget coming up where the Chancellor will be looking for ways to raise taxes and limit spending commitments. If you add a tightening of monetary policy to that, it’s going to increase the probability that we will import the recession that, we think, has already started in the United States.

It seems the Bank’s Governor Andrew Bailey has not learned the lessons of the recent past.  The European Central Bank raised rates in 2011 when coming out of the Great Recession. Turns out it was a big mistake. The Fed in the US raised rates over the period of 2015-2018.  That tightening of monetary policy is now generally recognized to have also been a big mistake, choking off full recovery after the recession. Chair of the Federal Bank, Jerome Powell, has admitted this was an error.  Andrew Bailey, the current governor of the Bank of England, seems ignorant of those past lessons, and looks like he is committing a major error by talking up the prospects of a rate rise.

The current level of inflation is transitory, that is what the data is showing. Failing to understand that and trying to mitigate inflation by raising interest rates will almost certainly push the UK into a recession.

 In the minutes of the September 2021 Monetary Policy Committee (MPC) meeting there was a 9-0 vote to keep rates at their current level of 0.1% noting that "The Committee’s central expectation continues to be that current elevated global cost pressures will prove transitory."  It’s hard to understand what happened over the following month to change that prudent judgement. Inflation ticked up to 3.2%, but that was entirely predictable and there was nothing unusual about it.  If the Bank of England does pull the trigger next month and raise interest rates, it probably won’t be a unanimous decision.

The markets seem to have got ahead of themselves in thinking rate rises are coming. In the last week retail sales and consumer confidence have fallen and the CPI fell back. The best analogy to our current state of inflation is to think what happens when a hurricane hits an island.  The power goes out; stores lose the contents of their fridges and the price of food rises.  It is a bonanza time for roofers and electricians whose wages rise dramatically for a while and inflation goes up temporarily.  But eventually, after a few months, things get back to normal and there is no impact at all on inflation in a year’s time. None at all.  That is what transitory means.  Inflation reached a peak in the summer of 2008 and collapsed soon after, as the oil shock then was transitory, just as now.

The current level of inflation is transitory, that is what the data is showing. Failing to understand that and trying to mitigate inflation by raising interest rates (the textbook remedy) will almost certainly push the UK into a recession.  In uncertain times it is better to wait and watch the data unfold before taking drastic action that could well be regretted.

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