Britain ‘further ahead’ in race for recovery

Gary Duncan, Economics Editor

Britain has moved ahead of other leading economies in the race to restore the stability of its banking system and pave the way for economic recovery, the newest member of the Bank of England’s rate-setting committee said today.

Professor Adam Posen said that more decisive and “forthright” action by the Government had left Britain further forward in putting the banking system on a more normal footing than some of its leading competitors.

“The UK seems to be well ahead of the US and most euro area governments in this area of providing banks capital and disclosing their real situation,” Professor Posen, who joined the Bank’s Monetary Policy Committee as an external member from the beginning of this month, told MPs.

He said that the West’s leading economies faced a race to “beat the clock” so that banks’ operations returned to relative normality before extraordinary stimulus measures to shore-up growth ran out.

“If you do not fix the banking system by the time your stimulus runs out, then private demand will not pick up when the stimulus runs out,” he told the Commons Treasury Committee. “That’s what we saw in Japan in 1997, and that is what we saw in Japan in 1999-2000. So we have a clock ticking here in the UK as in the US and the euro area.”

But the professor said Britain was now among the best placed of leading economies, contrasting this with the situation in his native United States where he feared further problems from the banking sector.

“I think in all honesty the UK is closer to beating the clock than the US or Germany,” he said.

“I am more concerned about the bank issues coming back to the fore in the US than in the UK. I think there’s still a lot of unfinished business.”

Professor Posen, one of America’s most respected academic economists, backed other members of the MPC, including Mervyn King, the Bank’s Governor in expressing optimism that the recession is set to end this year, but echoed their warnings over an uncertain and slow recovery.

“Looking ahead to the UK I think… we’re looking at a firming of conditions and I would be surprised if we did not get back to growth by early 2010, possibly earlier,” he said.

But he cautioned that the recovery was likely to follow a “sawtooth” pattern, with a revival coupled with intermittent setbacks.

He warned that renewed growth was likely to be relatively weak, with any return to a pace of growth above the economy’s long-term speed limit or trend rate “unlikely”.

“There is a possibility of above-trend growth, one has to hope for that. But I don’t foresee the UK or any other major economy getting a smooth above-trend path for the next couple of years,” he said.

In comments likely to fuel City expectations that Professor Posen will prove doveish over interest rates, and over any early winding up of the Bank’s controversial quantitative easing scheme to pump newly-printed money into the economy, he told MPs that he saw deflation as a greater danger than inflation at present. He added that he regarded an undershooting of the Bank’s 2 per cent inflation target as potentially a bigger problem than an overshoot.

“The risks right now certainly are more about deflation than inflation in the short-term,” he said. “What Japan has demonstrated is that once you fall into a really deflationary situation, it’s very hard to get out. It’s very sticky,” he said.

He added: “There remains reason to think that undershooting a 2 per cent inflation target has somewhat greater costs and risks to real economic output and employment than overshooting it by the same amount.”

After the pound’s sharp plunge over the past year, the professor predicted that it would recover some ground over the coming months.

“I see stronger sterling against the euro in the medium-term,” he said. “In the very immediate term, the potential that slower action on policy from the [European Central Bank] will lead to an interest rate gap that could temporarily push up the euro.” (Gary Duncan, The Times).

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