There was a good discussion on the Bank of England’s interest rate rise on the World at One yesterday. (It’s here at around 34 minutes in.)
Duncan Weldon explained that the interest rate rise was driven by pessimism, not optimism. The Bank has taken its foot off the pedal not because the economy is speeding ahead but because, even at the slow speed it is chugging along at, it is already starting to shake. Jajit Chadha also used a car analogy, explaining that the Bank can only use the brake and the accelerator but can’t do much about the problems with the engine.
The Bank of England was already on board with the motoring explainer, declaring that the economy’s speed limit is now GDP growth of 1.5 percent per year, way below its pre-crisis trend. The Bank believes that there is very little spare capacity in the economy.
The clapped out engine, of course, is the economy’s chronic productivity problem. This, says the Bank, is due to low investment and the inefficient use of labour and capital.
The contrast with the pre recession period is sharp. At the moment, all that is increasing is employment. The UK’s output is only rising because more of us are working and so the number of hours worked has gone up. What we manage to produce per hour hasn’t changed. As a country, we are working harder but not smarter. In previous decades, output increased because we became more efficient. Nowadays, like Rick’s Sandwich Bar, we are growing the business simply by throwing more and more low-paid people into the fray.
The Bank’s outlook is gloomy:
Taken together, these factors are consistent with productivity growth remaining subdued in coming years. Alongside modest labour supply growth, that will weigh on growth in the
United Kingdom’s overall potential supply capacity, which in turn will limit the speed at which output can grow before it leads to domestic inflationary pressure.
As Duncan says, this is actually more important news than the rate rise.
This is NEWS. If the Bank thinks potential growth is circa 1.5% then that is properly grim.
— Duncan Weldon (@DuncanWeldon) November 2, 2017
The Bank of England has drawn similar conclusions to the Office for Budget Responsibility; the UK economy’s problems are deep-rooted. The productivity stagnation and low growth isn’t simply a hangover from the recession, it is something that looks to be set in, at least for the next few years.
If growth of around 1.5 percent per year really is as good as it’s going to get for the rest of the decade, it will mark a significant shift from what most of us have been used to for most of our working lives. The economy used to trundle on at around two-and-a-half percent and most of us took it for granted. When there were recessions we made up the ground afterwards. Not any more. We have now had ten years of stagnating wages and what little growth there has been has simply been the result of putting more hours in. The Bank of England and the OBR have, effectively, written off growth prospects for the rest of the 2010s. Those people who warned of a lost decade when the financial crisis hit may turn out to have been optimistic.