Jobless figures show demise of the slump may be exaggerated

• Figures conflict with King and Bernanke's remarks
• Britain's jobless still rising after stimulus packages

Comments (15
Ashley Seager
The Guardian, Monday 21 September 2009

It's a conundrum: central bank chiefs such as the Bank of England's Mervyn King and the US Federal Reserve's Ben Bernanke say the recession is over, yet unemployment on both sides of the Atlantic continues to rise rapidly, with Britain's jobless rate hitting a 13-year high of almost 2.5 million last week.

So what is going on? We have no proof yet that recession – commonly defined as two consecutive quarters of contraction in the economy – is over, although all the signs are that many major economies will return to growth in this quarter. In Britain's case, that will end a run of five quarters of shrinkage.

But, as King made clear last week, that is far from the end of the story – it certainly isn't time to plan a party, except possibly in some banks where the bonuses are flowing again.

The key thing to remember is that in this recession Britain has seen its total output of goods and services slump by more than 5%. So just because we may grow by, say, 0.4% in the July to September period, it doesn't mean normality has returned. It will take many quarters of that kind of growth to make up for all the lost output, hence it will be a long time before joblessness stops rising, let alone begins to fall.

There were, however, encouraging signs in last week's labour market data. The number of new redundancies each month has levelled out and the number of job vacancies has stopped falling although unemployment is likely to top 3 million next year.

So if the recession is over, what's to worry about? Plenty, and King was right last week when he said the pace of any recovery was "highly uncertain". His Bank monetary policy committee colleague David Miles said on Friday: "This is going to be a protracted period of a return to a more normal level of activity." He believes we may remain in recession for another six to nine months.

The latest lending trends report from Threadneedle Street, published last Friday, also made for alarming reading. It showed a record fall in bank lending to British firms in July. In spite of the taxpayer bailouts, banks are not keeping to their word that they would support a recovery. There have been huge efforts by the government and Bank of England to get banks lending again, but it simply isn't happening – making a sustainable economic recovery almost impossible.

Retail sales figures last week were also very subdued, suggesting people remain cautious about spending if they are worried about losing their jobs. Even those in secure jobs are preferring to pay off their debts. All these factors can weigh on the economy for several years, especially if whichever party wins the next election tightens fiscal policy too much and too quickly, as the Tories look likely to do. This is where the danger of a so-called double-dip recession comes from.

The recovery that we are seeing is dependent to a huge extent on the support from fiscal policy, ultra-low interest rates and the Bank's quantitative easing. The question is to what extent the economy can generate its own, self-sustaining growth.

Tim Drayson, at Legal & General Investment Management, has produced an excellent paper arguing that the world economy in general, and Britain and the United States in particular, are going to post fairly decent growth over the next couple of quarters thanks to the US fiscal stimulus, which is having its maximum impact now, and the so-called "inventory effect".

The latter occurs when firms that have shut down production lines in the early stages of a downturn in a bid to clear stocks of unsold goods, or inventories, start up production again at the first sign of an upturn. The combined effect of many companies doing that can be quite powerful and has been the motor driving the FTSE 100 and other stockmarkets. Investors know companies have shed labour and surplus stock over the past year so are now in a position to generate healthy profits and dividends.

But this may be as good as it gets for the FTSE because the inventory cycle, and government spending stimulus, are one-off events, not permanent changes.

Drayson and his LGIM colleagues think there is scope, once those effects have worn off, for 2010 to be quite disappointing, although he stops short of predicting the "double dip" that some gloomsters expect.

He says: "Once the initial effects of government stimulus wear off, the US and UK economies may suffer a relapse in growth." He also points out that with the large amounts of spare capacity existing in most major economies as a result of the big falls in output outlined above, there is little reason to worry about inflation. LGIM expects consumer prices index inflation in Britain to stay below the Bank's 2% for several years.

There are, of course, siren voices that warn about the inflationary dangers of all the interest rate cuts and quantitative easing from central banks and fiscal stimuli from governments. Presumably they would have preferred to do nothing to prevent a massive depression with millions more thrown out of work?

Or perhaps their predictions have more to do with sour grapes at not having seen the recession coming and having urged central banks through the summer of 2008 to raise interest rates to prevent high oil prices feeding through into higher wage inflation this year. It never did, by the way – virtually every month sees a new record low in wage inflation. It was the dog that didn't bark.

Which brings us on to interest rates and their likely future path. The markets are expecting central banks to start raising rates as soon as the turn of the year. But the markets have been wrong about rates all the way through this recession and are almost certainly wrong now.

Tightening

LGIM's Drayson says interest rates could stay at their record lows in many countries through next year and possibly 2011 as well. Certainly, King and Bernanke are very conscious of the dangers of withdrawing their respective stimuli too early. But on top of that are the big fiscal tightenings that are coming everywhere over the next decade. These measures will restrict economic growth as they suck money out of the economy. That means interest rates will have to stay low to prevent inflation turning into deflation.

In Britain, interest rates were higher than they otherwise would have been for several years because the Labour government was running loose fiscal policy whereby spending was advancing faster than tax receipts, thus boosting the economy. The next decade will see fiscal policy going into reverse as whichever party is in power will seek to pay off our collective overdraft. That means rates could stay below, say, 3% for years and years.

That may sound daft for a country used to rates either side of their long-run average of 5%. But after what we've been through in the past couple of years, we are now in a different world.

ashley.seager@guardian.co.uk

guardian.co.uk/business/economics

http://www.guardian.co.uk/business/2009 ... xaggerated