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Central bankers do it their way Samuel Brittan: Financial Times 08/11/02 It is as well that central bank actions are not co-ordinated. The US Federal Reserve has a clear bias towards stimulus and preventive action, as its half-point cut in interest rates this week shows. The European Central Bank has a bias towards caution and delay. The Bank of England is in between. The averaging out of such biases is more likely to produce a beneficial result than any world secretariat. Despite all the pessimistic talk, both the US and the UK have returned to trend growth rates in the first three quarters of 2002 after last year's mild US recession and modest UK slowdown. The difference is that a, probably slight, majority on the UK monetary policy committee sees such growth continuing, but in lopsided fashion on the back of a still-continuing property-based consumer boom, with most of the stimulus from Gordon Brown's spending plans to come. It rightly decided not to follow the US cut. The consumer-property price bias is present across the Atlantic; but the Fed was influenced by spot indicators of a more feeble fourth quarter, and even more by weak confidence surveys from business and consumers. The euro area is again different, as it is growing below trend. But an overcautious ECB is not its main problem. Much time is wasted in trying to date recessions in terms of the US definition of two or more quarters of falling output. When the normal growth rate for developed market economies is 2½to 3 per cent a year, anything below this is a sign of depressed conditions. And little importance attaches to whether it is on one or other side of the zero mark. What is happening in the euro area, and is feared in the US, is best described by the American term "growth recession". There was nothing catastrophic about the 2001 US setback. At the peak of the boom the year before, capacity utilisation and employment rates were well above normal levels; and a period of below-trend growth was required to put the US on a sustainable path. In the UK, in contrast to the US, the growth slowdown was not accompanied by a rise in unemployment. While encouraging for Labour's job aspirations, it means the productivity drive has hit the buffers. In previous periods of feared slow growth, cries of "deflation" and calls for "cheap money and plenty of it" have tended to come from radical economists and the political left. How does one account for similar cries that now emanate from business and financial circles? The clue is that the recent world slowdown resembles the business cycles before 1914. In other words, it has been, especially in the US, due to the termination of an unsustainable boom, which has left excess capacity in its trail. Not surprisingly, the associated equity bubble has burst. The US Datastream Index is more than 40 per cent below its 2000 peak and the telecommunications, media and technology sector is more than 70 per cent down. US corporations are hesitant about new investment, a hesitation aggravated by uncertainties over the Middle East and terrorism. The stock exchange shakeout has so far been offset in the US and the UK by the continued buoyancy of real estate values. Central bankers worry about imbalances. Growth in both the US and the UK is consumption-led and has involved near-record current account deficits. No one knows for how long and on what terms world financial markets will continue to finance them. But their biggest worry is that consumer debt will stop rising and undermine the output recovery. The other worry that surfaces in so many financial market analyses is that governments and central banks will soon run out of ammunition if further stimulus is required. Japanese nominal interest rates are effectively zero; and with Federal Funds rates at 1? per cent, there is not much more, it is said, that the Fed can do for growth. One fear that does not keep me awake at night is deflation. As the October review of the National Institute for Economic and Social Research states, falling prices need not be associated with poor real growth. In Britain between 1880 and 1890, output grew at 2.2 per cent a year while prices fell by 0.6 per cent. Much more recently in 1998-99, UK producer prices fell but output grew normally. The effect of mild deflation of, say, 1 per cent a year "is much less than the change from expected inflation of 10 per cent", which prevailed some years ago, "to the current UK target of 2½ per cent". What might keep me awake is the prospect not of deflation but of stagflation, due to a Middle East-based oil price explosion that simultaneously boosted world price indices while reducing world demand. We have been there before. As for the authorities running out of ammunition, this will only be true if they run out of imagination. It has been supposed that the achievement of a low but positive inflation rate by independent central banks would itself stabilise economies, and that this would be accomplished solely by variations in short-term interest rates. A new model may be required.
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