I'm even more gloomy about the economy

by Ed Bowsher on 24 August 2010  |  12 comments
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There's lots of gloomy economic news out there......

There’s lots of gloomy economic commentary out there today and I agree with much of it.

I’ll start with Dr Martin Weale, the newest member of the Bank of England’s Monetary Policy Committee. Apparently he thinks it would be ‘foolish’ to rule out another recession. He’s particularly worried about the risk of another banking crisis. This could be sparked by an increase in the number of bad loans thanks to falling property prices or by a sovereign debt crisis where a country has to default on its loans. I think he’s right. You can’t rule out another banking crisis.

Then Gavyn Davies weighs in with a gloomy take on the outlook for the US economy. (You’ll have to register on the FT to read his post.)

Here’s the nub of his piece:

“No-one yet makes a double dip the most likely course of events in the US. But this is not very surprising, since economic forecasters almost never acknowledge the start of a recession until some months after it has actually taken place. Instead, they talk about ‘increased risks of recession.’ It is interesting to note that both JP Morgan and Goldman Sachs now say that a double dip recession is about 25-30 per cent probable, which is what forecasters generally say when they are becoming really concerned that such an outcome could easily occur.”

That’s fair enough too. News of a 27 per cent slump in US home sales only strengthens Davies's argument.

Then there’s comments from Andrew Lilico, a right-wing economist. He’s being widely quoted for suggesting that the Bank of England’s base rate could reach 8 per cent in 2012. You can read his original paper here. In the paper he argues that if the government continues to cut spending and interest rates remain low, we’ll see strong economic growth in 2011.

Now I admit, that doesn’t sound too gloomy, but hang on....on the downside, he fears that inflation could rise to something like 10 per cent in 2012 and the base rate will be jacked up in response – perhaps to 8 per cent. In fact, he thinks inflation could rise as high as 20 per cent if the Bank of England doesn’t raise interest rates fast enough.

That’s plausible. Inflation can pick up speed remarkably quickly and policymakers can ‘lose control of events’ for a while.

But double-digit inflation isn’t Lilico’s only scenario. The press reports don’t tell you that he isn’t ruling out a bout of deflation in 2011 and 2012 either. Although I don’t agree with all the points in Lilico’s paper, I think he’s right to highlight the risk of deflation as well as inflation. As far as I’m concerned, deflation is the really scary outcome. I’d rather have a year or so of double-digit inflation than a decade of deflation or very low inflation.

It’s very hard to call this right as we’re not in a conventional economic cycle. There’s not much history to look at when we wonder where to set interest rates. That lack of precedent means that there’s a strong chance that central bankers and politicians will get it wrong which is the most depressing point of all.