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'Green shoots' debate misleads policymakers Samuel Brittan Financial Times 26/06/09 Those with short memories have forgotten that "green shoots" became notorious in the UK when Norman Lamont, then British chancellor of the exchequer, proclaimed the beginning of the end of the 1990-92 recession. Lord Lamont later argued that he was not all that wrong in the light of subsequent statistics. We need not enter this historical debate. The point is that his political opponents and many in the financial markets did not believe him and used "green shoots" as an ironic taunt. Yet the same people, or their successors, now talk about green shoots with a straight face, oblivious of historic connotations. There are many reasons for not going to town on present talk. The clearest is the stock cycle which first magnifies and then damps the underlying output movement. Another is that much of the discussion emanates from the financial markets, especially equities and commodities. This is not to deny that stock market movements can initiate as well as signal changes in the wider economy. The problem is their inherent volatility. The US economist Paul Samuelson once remarked that Wall Street predicted eight of the last five recessions; the same might be said of recoveries. World output cannot go on falling at turn-of-the-year rates without the international economy winding down. Jean-Claude Trichet, president of the European Central Bank, has said that output is now falling "at a decreasing rate". It is highly likely that we will have before long a quarter or two of stable output - probably first in the US and last in the eurozone, with the UK in between. The interesting question is where we go from there. The accompanying chart makes no predictions but illustrates some alternative scenarios, which have different policy implications. The steadily rising line shows an underlying growth trend normally taken to be somewhere between 2 and 3½ per cent a year in advanced industrial countries. It does not, of course, show what the economy is physically capable of, for example under the stress of wartime pressures. It shows rather what can be sustainably achieved under normal conditions. The curved line first falling below it and then rising above it is the kind of business cycle behind most official macroeconomic models. On this view booms and slumps are fluctuations around a given trend and any monetary or fiscal stimulus in the downturn must be reversed in the upturn, for example by a budget surplus or a monetary slowdown. The point marked "green shoots" shows a resting place where we might soon be. The lower dotted line illustrates how we can lapse from there into a double dip recession. Even a treble dip one is possible, as for instance in the 1930s, when the US upswing following the New Deal was terminated by a premature monetary and fiscal tightening in 1937. Now, orthodox policymakers, such as those in Germany, may be relying too much on exports to rising emerging world markets to prevent it happening again. The middle dotted line is there just as a warning that continuing growth of any kind cannot be taken for granted and that external shocks or policy mistakes can induce long-term stagnation. The most interesting of the lines is the top dotted one, which I have labelled, perhaps tendentiously, "growth recession". It takes seriously the conclusion of Christopher Dow, the late British economist, that "major recessions" lead not merely to a downward dip in output below trend but to a downward displacement in the trend itself. The UK Treasury in its 2009 Budget has assumed, with many cautions and qualifications, a one-off downward displacement in the level of trend gross domestic product of 5 per cent of GDP, after which growth can resume at a trend rate of about 2¾ per cent a year. Everything depends, however, on the reasons for this downward shift. The Treasury cites factors such as a reduction in the capital to output ratio as a result of higher risk premiums in capital markets, and the likely reduction in the size of the UK financial sector, which has shown above average productivity growth. John Maynard Keynes suggested a different approach in his 1936 General Theory. He remarked: "I doubt if we have had any recent [peacetime] experience of a boom so strong that it led to full employment." He saw a long-term state in which the propensity to save outran the propensity to invest, thus making full employment impossible without major policy changes. He never quite faced up to the challenge of making budget deficits respectable; but he envisaged a combination of backdoor measures to encourage public and private investment, plus fiscal redistribution to the less well off and permanently low interest rates to encourage consumption. This is the opposite of the belt-tightening measures called for by the economic bien pensants. I am not arguing that Keynes's vision applies to the very long term, when we will have to cope with unfavourable demographic pressures. But it could apply for quite a few years. We should not rush too soon to base policy on an assumption that trend output has shifted downwards.
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