Poor recession figures will keep interest rates down

Anatole Kaletsky: Commentary

The modest fall in Britain’s GDP in the third quarter will cause some big gains and losses among currency and bond traders, but it does not change economic reality in any significant way. While economists may define the “end of recession” as the quarter when GDP starts to grow, no matter how feebly, this is not how ordinary people and businesses see things.

Suppose GDP had risen marginally instead of falling, most people would still have believed that Britain was in recession — and rightly so. Even if the economy had started crawling out of the hole into which it stumbled after Lehman, the hole would remain very deep and the top hardly in sight. The German GDP, for example, expanded slightly in the second quarter, yet Germany is still in a deeper hole than Britain — 6.7 per cent below its peak GDP peak, compared with 5.9 per cent here and 3.8 per cent in the US.

What matters is not whether GDP moves up or down a little in one quarter or another. It is when economic activity recovers with growth strong enough to reverse unemployment and restore wealth, production and consumer spending to their pre-recession peak levels.

How long might this take? In Britain’s last deep recession, it took two years after the resumption of growth in mid-1981 for output to return to its previous peak. And the middle of 1983 was, in fact, about the time that Britain’s economic confidence increased and the Thatcher Government’s popularity recovered. To restore the economy by early 2012 to its peak level of output would require not just a marginal resumption of growth, but a rapid recovery with growth rates above 0.7 per cent per quarter.

Is such a strong “V-shaped” recovery possible given the debt burdens on consumers, the credit crunch and the pressures to cut public borrowing? Nobody knows, but the weak GDP figures may paradoxically have made a V-shaped recovery more likely. Because of these figures the Bank of England will probably increase its monetary expansion and will certainly keep interest rates near zero for the foreseeable future.

As homeowners, businesses and consumers realise that ultra-low rates are not just temporary but are here to stay for years ahead, house prices and shares should keep rising and the pound should remain weak. This monetary stimulus should eventually feed back into exports and consumption — and could generate a surge in economic activity. If and when this happens, the Bank will be in no hurry to damp it down, as there will be little inflation risk until the economy returns to its peak output. Nobody knows when that might happen — but we can now be confident that interest rates will remain near zero until 2012 or beyond. (Anatole Kaletsky, The Times) http://business.timesonline.co.uk/tol/business/economics/article6888261.ece

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