More questions than answers in economic policy

4 April 2011

You don’t have to look far before you find someone who claims to have lost out thanks to the economy’s performance so far in 2011.

Many home owners are concerned that the value of their property is dropping, wages are failing to keep pace with inflation and tenants are facing high rental costs as tight mortgage lending criteria push up demand in the private rental sector.

On top of all this, the year began with the surprising news that the economy shrank in Q4 2010 spending cuts and tax increases had begun to bite.

It would seem the tough year promised by the government has become a reality.

Consumer Prices Index inflation is running at 4.4% and Retail Prices Index inflation is at 5.5%.

This is effectively an admission by the Bank of England that the target inflation rate is temporarily deemed irrelevant in the pursuit of growth.

But the strategy is risky. The Monetary Policy Committee’s present approach could ultimately consign the UK to higher rates further down the line as the Bank eventually tries to restore inflation to target.

While the last quarter was defined by rising prices, whether these come under control will define Q1

Of course, low rates mean more affordable mortgages, especially for those on a variable rate.

This will continue to limit the number of repossessions, which fell consistently through the end of 2010.

With the looming, although unlikely, possibility that the economy may again be in recession, the relief that lower mortgage payments provide to household finances will have bolstered consumer demand and helped mitigate the impact of the rise of unemployment - but by how much?

By cutting deeply into public sector spending the government expects 170,000 individuals will be made redundant.

The government’s argument is that a growing private sector will be perfectly placed to sweep up those who leave the public sector into jobs.

But this ignores an important and possibly damaging structural problem.

Many of the former public sector workers who make up the 8% of the economically active population currently unemployed will have to retrain before they can work in the private sector.

How many people this applies to is a critical question. Regardless of how much growth there is, the excess supply of labour must be appropriately trained.

To this extent, the country’s employment policy is running up a blind alley with unemployment.

Q1 2011 has so far posed more questions than it has answered and we will probably not have a firm hold on the success of the government’s austerity package for another six months.

High inflation and increasing unemployment have created cause for concern since the new year, but house prices and mortgage lending have so far proved resilient.

While the past three months have been defined by increasing prices, it will be whether these come under control that will define the next quarter.

If commodity prices fall and inflation consequently returns to target naturally, an extended period of growth will become far more likely.

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