Belfast Telegraph

Wednesday 27 August 2014

High inflation, low growth and economic uncertainty. Is it a case of deja vu?

Has the global economy stepped back in time 3 years to autumn 2008? Two of our finest economists ponder the question

Yes/No

Richard Ramsey, Chief economist at Ulster Bank

Parallels have abounded in the financial media of late between current events and those of autumn 2008, when there was a collapse in world trade, financial market mayhem, and co-ordinated and unprecedented policy action by the world’s central banks and governments. So, is 2008 happening all over again? In the true spirit of economics, I think it is fair to say that, on the one hand, there are strong similarities – yet on the other hand, there are clear differences.

In terms of differences, the emphasis has shifted somewhat from the US to the eurozone. In 2008, George W Bush’s Treasury secretary Hank Paulson knelt before the House speaker and appealed for her support in passing the $700bn bailout package, and President Bush profoundly stated that “if money isn’t loosened up, this sucker could go down”. Today, it is eurozone governments that have been pleading with their respective parliaments to back and enhance the European Financial Stability Facility (EFSF) – aka the European bailout fund – to ensure that Greece would not go down.

China’s role is a similarity and difference. Back in 2008, China embarked upon an infrastructure splurge to keep its economy, and to a lesser extent the global economy, growing. Once again, China is being asked to save capitalism by investing in the EFSF. But, notwithstanding current strong rates of economic growth in China, there are growing concerns over aspects of its banking system that funded the huge growth in infrastructure spending. The system will be unable to repeat the capital investment boost of 2008. Furthermore, many commentators are anticipating the bursting of the Chinese property bubble.

Like 2008, bank recapitalisations are currently all the rage, only this time it is in the eurozone rather than the UK and Ireland. Meanwhile, the faces behind these actions have changed. Brown and Darling have been replaced by Cameron and Osborne. Brian Cowen and the late Brian Lenihan by Enda Kenny and Michael Noonan. The ECB’s Jean-Claude Trichet has also been replaced with ‘Super’ Mario Draghi, who will experience a baptism of fire. Further changes in the leadership of Spain and Italy are anticipated.

In Northern Ireland, by contrast, continuity has been the order of the day, with Sammy Wilson and Arlene Foster remaining in their respective finance and enterprise departments. However, the forthcoming Programme for Government needs to be markedly different from the last one. The sacred cows that protect the status quo have to be dealt with, otherwise the history books and the next generation will not look too kindly.

A major difference in Northern Ireland between 2008 and today is the view that Northern Ireland doesn’t do recessions. In 2008, talk of recession was viewed with significant scepticism, even when Sir Mervyn King announced that the UK economy was facing “the most serious banking crisis since the outbreak of the First World War”. To our cost, we have learned that we have consistently underestimated the length and depth of the recession and overestimated the recovery. While the local economy is not contracting at the break-neck speed of late-2008/2009, Northern Ireland is still expected to contract in 2011, as in 2008.

Other similarities in the Northern Ireland economy include the fact that house prices and construction output are still falling. In terms of unemployment, the dole queue breached the 30,000 mark in the autumn of 2008; it has already passed 60,000 today. The key difference between autumn

2008 and autumn 2011 is the sheer scale of the collateral damage inflicted on the private sector. Meanwhile, households, through inflation and falling incomes, are feeling the full force of the deferred pain from the recession that was absent in 2008. This explains why consumer sensitive sectors, such as retail, prospered in 2008 but are suffering now. Similarly, the public sector provided insulation for the economy in 2008. Now, however, our overexposure to the public sector will be a source of economic weakness.

Inflation is a common theme. The latest UK CPI figures hit 5.2% y/y, the same record high posted three years ago. Back then, CPI inflation plunged to 1.1% the following year. A further sharp fall in inflation is expected in 2012 but the UK economy will not have the temporary reduction in VAT to help drive inflation down. It should also be remembered that whilst the annual rate of inflation is the same as September 2008, the price level is not. CPI is almost 10% higher over the past three years, whilst the price of food and petrol are 12% and 20% higher respectively. Inflationary fears are arguably greater now than they were in 2008 with gold prices – an inflation hedge – having more than doubled. Meanwhile, equity markets, such as the UK FTSE 100, have posted a rather less impressive 30% gain.

As in 2008, Sir Mervyn has tempered expectations, last month warning in the media that the world was facing its worst financial crisis in history. He was also quick to pour cold water on the recent eurozone bailout package, stating that “the plan as it stands would buy no more than one to two years’ breathing space”.

So whilst there are a number of differences between today and 2008, like three years ago a meaningful recovery seems a long way off.

No/Yes

Alan Birdle, Head of economics and market analysis at Bank of Ireland UK

The shades of economic and financial gloom that have descended in recent weeks have inevitably drawn comparisons with the dark days of the autumn of 2008 after the spectacular demise of Lehman Brothers, the near collapse of other seemingly impregnable institutions and crises in banking systems.

Three years on and the global economy seems perched between fresh concerns about recovery and the potential for a relapse into crisis.

While the stage is familiar, some of the actors are playing lesser roles in this latest drama. The banking spotlight, for example, is now much less upon the UK and Ireland and more on Germany and France where direct exposure to euro-area sovereign debt issues is far greater.

Notwithstanding, the prevailing mood is again one of heightened uncertainty and a feeling of deja vu. Fear has again gripped both the markets and the high street prompting investors to scramble for havens of low risk, consumers to keep their hands in their pockets and businesses to defer expansion plans. We are in a so-called negative feedback loop when our horizons inevitably become very short-term and bad news seems to carry greater currency.

As in the autumn of 2008, the rate of inflation is again north of 5%. The impact has been palpable with an intense squeeze on real living standards compounding the negative wealth effect of the decline in asset values, higher direct and indirect taxation and all at a time of private-sector deleveraging and household balance sheet repair from the elevated levels of debt.

If we rewind to 2008, it was not uncommon in NI to hear the refrain: “Recession, what recession?” Even in the dark days of the global financial crisis, the early phase of the downturn had an asymmetric impact on businesses and households in NI.

All things property-related and some manufacturing was certainly feeling the chill but, overall, incomes and welfare benefits were still growing, public expenditure was still rising strongly and even as parts of the construction industry struggled with the steep decline in new housing, infrastructure spending was underpinning other activity. For retailers, footfall was steady and some locations enjoyed a boost from cross-border trade.

As we come into the present, the overwhelming difference from 2008 is that the recession has now well and truly landed on the dinner table across the region and taken its toll. Since 2008, the private sector has contracted overall by around 15%, an additional 30,000 claimants have been added to the register and around 1,000 businesses have entered voluntary or compulsory liquidation.

From a UK perspective, the recession has had an asymmetric impact across the regions with, for example, unemployment rising by 25% in the east Midlands compared with 75% in NI.

Undoubtedly some of the gloom in the region comes from a feeling that we are helpless to influence the big picture. But we should not be without hope of seeing small and gradual improvements over time.

A resolution to the eurozone crisis would, in time, help restore confidence in our key dependency economies, the UK and Ireland, while — in a potential re-run of 2008-09 — inflation is very likely to fall during 2012, easing pressures on household budgets.

Pound sterling is likely to remain at competitive levels boosted by policies of expanded money supply and a period of unchanged interest rates extending potentially into 2013.

Locally, I wonder if it is time to change the narrative of public discourse. In truth, for a region accustomed to quite generous spending allocations, any reversal was always going to be a formidable challenge. However, the cuts in Northern Ireland are modest relative to other regions and the Republic of Ireland. Public expenditure per head is still more than 20% above the UK average and we enjoy a level of public services that is not funded from local taxation. In cash terms Stormont’s revenue budget is relatively flat over the next four years at almost £11bn pa and after the recent decisions on water-charging and tuition fees we can only assume that the books can be balanced without raising the household tax burden closer to UK levels.

Public-sector job insecurity is running at elevated levels but the scale of potential job losses is likely to have been exaggerated. By 2014, it may be that more than 90% of those employed in public service today will still be in post.

However, we should remember that job and pay protection in the public sector comes with a price tag and opportunity cost in terms of reduced capital budgets which would have potentially greater positive multiplier effects on the economy.

Ultimately, we do ourselves a disservice if we fail to recognise empirical evidence that financial crises typically amplify recessions by lasting longer and going deeper. Elevated levels of debt and the imbalances created are growth-sapping and must be addressed. Calls for another Keynesian-type “jump-start” are seductive but not persuasive — as the 2009-10 experience has demonstrated, any boost is temporary. I expect the present UK government to stick broadly to its tight fiscal/easy monetary position for at least a couple of years.

These thoughts I believe should govern our expectations of recovery both in nature and timescale and inform our business and personal strategies.

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