BBC BLOGS - Stephanomics

Archives for March 2011

Which will crack first - wages or prices?

Stephanie Flanders | 15:43 UK time, Wednesday, 30 March 2011

Never mind the 1980s, you have to go back to the Labour government's income policies of 1977 to find a time when household incomes have been as squeezed as they have been in the past year.

Both the government and the Bank of England are implicitly assuming that households will continue to take their medicine, with wages rises falling far short of tax and price rises for at least another two years, and inflation obediently falling back to target in 2012. But you don't have to be an inflation hawk to wonder whether it is likely to happen now. After all, it's not what happened in the late 70s, the early 80s, or the early 1990s.

Believe it or not, many would argue that a prolonged squeeze in household incomes was the "best case" scenario, starting from where we are now, because it spreads the pain of adjusting to a more inhospitable global economy as widely as possible. If wages pick up, interest rates would have to rise further, sooner, to bring inflation under control. Unemployment would be higher, perhaps permanently; growth would be slower, and the costs of this adjustment would fall disproportionately on public sector workers (whose pay is frozen) and all those unemployed workers who find it even harder to find a job.

Those new GDP figures I mentioned yesterday showed real household disposable income falling by 0.8% in 2010. That's the first time this measure has fallen since 1981. As Graham Turner of GFC Economics has pointed out, it's also the largest annual decline since 1977, when phase two of the Labour government's incomes policy was capping incomes growth to combat inflation (see chart below).

Chart showing UK real disposable income

At that time, monetarists like Milton Friedman used to publicly lecture Labour ministers that they were making the situation worse: income and price controls only repressed inflation, they didn't get rid of it. And in that case, he was right. The income policy fell apart, collective bargaining resumed, and both nominal and real disposable incomes rose sharply in 1978 and 1979 to make up for lost ground.

Will we see the same kind of explosion in pay in 2011 or 2012? The monetarists would certainly not expect one, looking at the still weak state of lending and money growth. It's not easy to see in the wage data either. The latest survey from IDS (see chart below) shows wage settlements running well below inflation. The median deal reached between December and February was for a pay rise of 2.5% - very similar to last month.

There are some warning signs in the small print of this month's report. Pay rises in the private sector are running at 2.9%, and the IDS note that most of the April deals it has recorded, not yet included in the three-month rolling average, have been for wage rises of 3% or higher.

The MPC are likely to be poring over those April pay deals as they start to come in, setting the context for the great debate over rates at their meeting in May. The chances are that private sector wages will continue to creep up. But it is also the case that the public sector pay freeze will put downward pressure on average earnings for the whole economy. And as we know, inflation is only one part of the squeeze for households.

In the past I've highlighted the broader TPI measure of the cost of living, which includes not just price rises but tax changes as well. That rose by 5% in 2010, and now the latest figure, for February, shows a year on year increase in costs of 6%. Using that broader measure, even a 3.5% pay rise in 2011 would still represent a sharper fall in real incomes than in 2010.

For some, this squeeze in real incomes poses a bigger risk to confidence and the economic recovery this year than government budget cuts (although, of course, the decision to raise VAT has made its own contribution to the rise in prices). The doves on the MPC are betting that another year of economic hardship will be more than enough to bring down inflation next year.

But only Adam Posen is putting his money where his mouth is: in an interview earlier this week he said he expected inflation to go to 1.5% in the second of half of 2012, and he would not seek another term on the committee if he turned out to be wrong. In theory, we should all hope Posen's right about inflation. But then he might also be right about the grim state of the economy. I'm not sure if I want him to go or stay.

Why the government needs another Plan A

Stephanie Flanders | 14:40 UK time, Tuesday, 29 March 2011

The government doesn't need a Plan B - it needs an alternative Plan A. That is the conclusion I have come to, observing the economic and political debates of the past few weeks.

Just so we're clear, I'm not suggesting the government should change direction on the deficit. But ministers would be a lot happier if there were an alternative scenario out there for voters to compare and contrast with Mr Osborne's.

Take today's GDP figures - which are the third official take on what happened to the UK economy in the last three months of 2010. Once again, stripping away the impact of the snow, the ONS reckons that the economy was broadly flat in the fourth quarter, with household and government spending slightly weaker than first thought, and output in the production industries a little stronger.

Ed Balls blames the government for the slowdown in the economy, even though most of the coalition's spending cuts have yet to come in. His claim is that consumers and businesses have lost confidence and cut back spending, in expectation of the larger spending cuts and tax rises to come.

In its detailed economic assessment, published last week with the Budget, the Office for Budget Responsibility does not sign up to the Ed Balls version of history. But it cannot explicitly rule it out. The simple truth is that we will never know how the coalition's deficit strategy has affected the recovery - because we will never be able to see what would have happened under a different approach.

This, more than anything, is what drives Mr Osborne's advisers up the wall. They spent most of Budget day texting or e-mailing journalists, complaining that we were dwelling too long on the economic risks of the coalition approach - and not enough on what might have happened if the deficit had continued to rise.

You can see why they would be bothered. If the choice is between no cuts and these cuts, the public will take no cuts every time. But, as Mr Osborne will tell you until he is blue in the face, that is a false choice. He and most economists would say the real choice is much less appealing: we put up with these cuts, and run the risk of a slow recovery, or even a double dip, or we cut more slowly, and run the risk of a major debt crisis.

Reasonable people can differ on which is the better course. The majority of mainstream economic opinion is in Mr Osborne's camp. But the much smaller group of Balls sympathisers includes some extremely distinguished economists, including two Nobel prize winners and the FT commentator, Martin Wolf.

In any event, neither Mr Balls nor any of the people out marching last Saturday have any intention of offering up a worked-out alternative to Mr Osborne's strategy. Why would they? It makes much more sense politically to have all voters' eyes firmly on Mr Osborne's Plan A, so they can blame his cuts for bad economic news.

Which brings me back to my starting point: the government doesn't need a Plan B so much as an alternative Plan A. It needs a worked out scenario for what might have happened to the economy and to interest rates, if Alistair Darling's plans had been implemented, or (perhaps) if there had been no deficit cuts at all.

The natural candidates to draw up such a scenario would be the OBR. Of course, you'd need lots of heroic assumptions about how the Bank of England would have responded to a slower timetable for deficit cuts - let alone the bond market. But these would not be much more heroic than the assumptions already built into their central forecast, let alone the "alternative scenarios" which the OBR has worked through to test its public finance forecasts. The OBR has, for example, carefully calculated what would happen if inflation were to remain higher for longer, or if the eurozone economies turn out to be much weaker than expected over the next few years. (In case you're interested, it thinks the economy would be weaker with higher inflation, but the public finances would be stronger, whereas neither growth nor the public finances would be hugely affected by a weak eurozone, but the re-balancing of Britain's economy would be further delayed.)

You would think it would be a simple matter to ask the OBR to run a "Darling" scenario for the public finances - or a plan for no cuts at all. Naturally, this would hold political risks for Mr Osborne if it appeared to show the economy doing better, long term, under a less ambitious approach. But the chancellor honestly believes the long-term gains of getting on top of the deficit more than offset the short-term risks to the recovery. Presumably, he would expect the OBR to reach the same conclusion. It would certainly be a good way to shut up the opposition.

All of which makes it rather unfortunate that the legislation which created the OBR explicitly bars it from considering alternative policies to the ones being followed by the government. Alternative states of the world, yes. Alternative governments, no.

Independent budget watchdogs in other countries - such as the Dutch Central Planning Bureau - often do have the power to cost other parties' policies. But you can see why Mr Osborne would want to prevent the OBR from continually second-guessing his approach. It is not the OBR's job to show alternative paths that the country might have followed, only to make an independent judgment of the path we are actually on.

The decision to limit the OBR's role means that Mr Osborne is doomed to suffer the same frustration as all his predecessors - of having his policies compared with some ideal alternative, not any alternative that Britain might have got. However, ministers and their advisers should comfort themselves with the thought that unfair treatment is the price of electoral success. Ultimately, the only way to show people what would happen in your absence is to lose.

Micro trumps macro

Stephanie Flanders | 15:30 UK time, Wednesday, 23 March 2011

We'd forgotten what these kinds of Budgets were like. The last few Budget statements have produced plenty of satisfying macro headlines, with shock rises in borrowing, and/or shock spending cuts to pay for it.

But for most of the first decade of this century, this is what Budgets were like: the medium term borrowing numbers go up by around £10bn or so; the growth forecasts get revised (usually down); and the chancellor fills the rest of his speech with intricate "micro" measures to stimulate growth and/or achieve various other specific objectives that the Treasury has decided to endorse.

That is what we had from Gordon Brown, many many times. Perhaps surprisingly, that is also what we got from Mr Osborne today. There was even the obligatory cash-grab from an unpopular sector of the economy - in this case, big oil. Though, as befits a chancellor still in his first year in the job, there are some grand ambitions amidst the meddling.

As predicted, net borrowing will be £11bn higher in 2015-16 than had been forecast in November. Overall, the Treasury is borrowing £46bn more between 2011-12 and 2015-16. But the Office for Budget Responsibility (OBR) has decided that nearly all of the increase is cyclical. The structural current surplus, the target the chancellor has set himself, has been cut by just 0.2% of GDP in 2015-16. That measure of the Budget will still be in surplus a year ahead of schedule, in 2014-15, as Mr Osborne planned in his first Budget.

The extra borrowing is the inevitable consequence of higher inflation and slower growth, which the OBR expects to push up the cost of benefits and debt interest. There has also been a slight downward revision in the revenue forecasts. As I discussed on Tuesday, this is because the OBR does not expect workers to be compensated for higher prices - the OBR forecast for labour income over the next few years (and thus income tax revenues) has been pushed down.

The growth forecast for 2011, at 1.7%, is now more or less in line with the market consensus, which is for growth of 1.8% this year. The OBR's forecast for 2.5% growth in 2012 is still well above the consensus, which is now for 2.1% growth. However, the OBR is not far off the Bank of England's forecast of around 2.7%.

But all these changes are small beer. He's spent money here and there, and raised it in other places - the big picture is no change. In 2011-12, for example, he's spending an extra £635m in 2011-12, on balance, but raising an extra £625m to pay for it.

The action, such as it was, came in that headline-grabbing cut in fuel duty (brought to you courtesy of oil companies in the North Sea) and in all those micro-measures to spur enterprise and growth, the sheer number of which would have made Gordon Brown proud, though not necessarily the content.

I asked Chief Secretary to the Treasury, Danny Alexander, what would stop the oil companies passing on the cost of the extra tax onto consumers, at the pump. His answer, give or take, was that he didn't think they would, but they'd be looking out for it. Hmmm.

I also asked him, further to my earlier post this morning, why the government had chosen not to use the room for manoeuvre that it had to boost public investment, or to cut borrowing slightly more slowly. You will be shocked to hear that he did not accept the premise. I'm not sure I expected him to.

The chancellor has stepped back from merging the National Insurance and income tax systems altogether - Paul Johnson, the director of the IFS - said he wasn't surprised. But merging the administration of those two taxes, which he has now promised to do, will make a welcome difference to companies if they can iron out the many practical difficulties. I am intrigued to see how he can "preserve the contributory principle" for national insurance while making it substantially simpler for companies to manage.

There's plenty of tinkering in the much vaunted plan for growth. But the reform of the planning regime, taken alongside the localism Bill, will transform the way planning decisions are taken in the UK. Whether they will make a positive difference or a negative one, of course, will be hotly debated. But as with Mr Osborne's first Budget, you can't say it won't make any difference.

Boxed in (by own boxes)

Stephanie Flanders | 10:40 UK time, Wednesday, 23 March 2011

"Boxed in". That's how we describe the chancellor today as he approaches his second Budget. I used the same phrase myself, on last night's television news, and it's true: slow growth and a record-breaking deficit do seriously limit his room for manoeuvre.

But it's a reflection of how the chancellor has dominated this debate about fiscal austerity that we forget that the lack of wiggle room is self-imposed.

On paper, you might actually say that he did have some room to give some extra support to the economy. The Budget plans he laid out last year have him eliminating his target measure for borrowing - the structural current budget deficit - a year earlier than his own rules require. And that target measure itself excludes public investment. In theory, he could announce today that he was sharply raising his public investment plans for the next few years, to support the recovery, without loosening his fiscal strategy at all.

And yet, we're not talking about any of these things, and we don't think it's even a remote possibility. Why? Because he has made it central to his approach that there will be no change, no deviation - even if the deviation is actually consistent with his overall mandate.

Many economists would say this was a strength: you get your market credibility precisely by binding yourself to the mast, so you can be sure of resisting those siren calls when things get rough. If Mr Osborne had made it easy for himself to loosen the purse-strings, investors would not be so convinced that he would stay the course, and - he thinks - the government's cost of borrowing would now be higher.

That is why Mr Osborne has taken such a hard line against all talk of a Plan B - and, presumably, why he has allowed Ed Balls and other opponents to define "Plan B" as pretty much anything that was not in last year's Budget plans. It is also why even those sceptical of the chancellor's approach - like the FT - have said he has no alternative, now, but to press ahead. The financial markets would almost certainly take any deviation today as a sign that he was caving into pressure.

Depending on how you look at it, Mr Osborne's lack of flexibility is either his greatest asset - or his greatest weakness. Probably both. It makes it easier for him to hold the line against squealing backbenchers. But it does also make it more difficult for him to make even modest changes in response to economic events.

Lashing himself to the mast worked out well for Odysseus. He got to hear the sirens, the ropes held and the ship soon sailed on to safer waters. We all have to hope the same is true for the UK.

Mr Osborne's squeeze

Stephanie Flanders | 11:35 UK time, Tuesday, 22 March 2011

British households aren't the only ones being squeezed by rising inflation. Today's batch of public finance and inflation numbers remind us that the unusual combination of low growth and above target inflation are bad news for the chancellor as well.

CPI inflation jumped up again in February, to 4.4%. It is overstating it to call it a "shock" number, as some City commentators have. But it is somewhat above market expectations - and above the Bank of England's central projection in the Inflation Report forecast published only last month.

The numbers also break a number of records. For example, the 2.8% annual rise in clothing prices and the 3.4% rise in the "core" measure of inflation (excluding energy, food and alcohol and tobacco), are each the highest they have been since the series began in 1997. The broader RPI measure, at a stunning 5.5%, is the highest since summer 1991.

Events in the world economy - and mixed indications about the state of the UK's recovery - mean that many City forecasters are now talking down the possibility of a rate rise from the Bank of England in May. For what it's worth, the betting is now that it will come in the summer.

Will this number change that calculation? Perhaps. But there is still only limited evidence that this burst of higher prices is feeding through to wages. Consumer inflation expectations are creeping up - as you would expect. High inflation is not exactly a secret. But there is limited evidence that workers are actually negotiating higher wages to compensate.

If you look at earnings growth across the economy, it is higher than a year ago, but it's still well below the inflation rate and there's little sign of it taking off.

Taking a three-month average, regular pay was growing at an annual rate of 1.4% at the start of 2010. A year later, it's growing at annual rate of 2.2%, but it has been at roughly that level for many months. If you exclude the financial sector, the growth rate is lower.

So, the theory goes, inflation is high, but it's still not the kind of rate that is likely to get out of hand. That is good news for the Bank. Unfortunately, as the FT pointed out on the front page this morning, that means it's also the wrong kind of inflation to help the chancellor.

Usually, there's a great silver lining to high inflation for the Treasury: It makes it easier to bring down both the stock of debt and annual borrowing, relative to GDP, because it means that nominal GDP and tax revenues grow faster than either borrowing or spending. (Assuming that spending is fixed in nominal terms.)

The head of the Office for Budgetary Responsibility (OBR), Robert Chote, warned us at the start of the year that this would be less true of the current bout of inflation, precisely because earnings - and thus income tax revenues - were probably not going to keep pace with rising prices.

Make no mistake - it is still much, much better for the chancellor for nominal GDP to be rising at an annual rate of 5-6%, as it has been in the UK, than for it to be falling or flat, as it has been in some of the crisis economies in the eurozone. It helps slow the rise in the debt stock as a share of (nominal) GDP, and also reduces the real cost of servicing all that debt.

There are different views on whether it's harder or easier to cut spending when inflation is high. My own view is that it makes it easier. Because most people suffer from what economists rather rudely term "money illusion", it's easier to cut wages - or spending - in real terms, after inflation than to cut them in nominal terms, upfront.

We saw both of these effects, in reverse, at the start of the crisis. As I've discussed before, the big reason spending jumped so dramatically as a share of GDP was that nominal spending totals were not cut, as inflation fell, meaning that the same nominal budgets translated into a sharp rise in spending in real terms, which then accounted for a much larger share of a shrinking economy.

Others believe the rise in inflation will make it that much harder for Mr Osborne to achieve his spending targets - because they will now represent a much tighter real terms squeeze. Perhaps. But thanks to the OBR we do know that he cannot expect to benefit from the same "fiscal drag" that inflation usually affords, where tax revenues rise faster than the economy, or public spending.

Today's public finance figures show a sharp rise in borrowing, after the surprisingly good numbers we saw for January. This is more or less what the Treasury told us to expect when those January figures came out. But it has shrunk the wriggle room that Mr Osborne will have for extra spending when he delivers his Budget tomorrow. High inflation looks set to shrink his room for manoeuvre in future Budgets as well.

The shrinking pound in your pocket

Stephanie Flanders | 00:00 UK time, Monday, 21 March 2011

Nearly everyone's feeling squeezed these days, and for good reason. New research published today in association with the BBC shows that after tax, the real income of the median household in the UK, right in the middle of the income distribution, will be 1.6% lower in 2011 than it was in 2008. That's a loss of around £365. Usually, they could have expected their income to have risen by nearly £1140 over that period.

This represents the greatest 3-year squeeze in real living standards since the early 1980s. Looking at the likely prospects for the next few years, the IFS reckons that the real income of the median household will still be lower in 2013 than it was in 2008 - meaning the largest 5 year drop in living standards since the early 1970s.

As we all know, it's not just the recession that has hit household incomes - there's been a triple whammy of slow or no growth in the economy, above-target inflation and tax and benefit changes to cut government borrowing. In advance of the Budget, I asked the IFS to try to estimate exactly what had happened to real household incomes as a result of all these different factors - and which had done the greatest damage.

The result of that work is the research published today. Here's what I found most interesting in these figures.

First, for most households, low interest rates and high inflation have had a much greater impact on their real incomes than either unemployment or tax and benefit changes. If you break down that £365 loss in post-tax income for the median household, only £79 is directly attributable to loss of employment. About £203 has been lost as a result of earning less interest on savings, and another £203 has been lost as a result of their wages not keeping up with inflation.

You might wonder why those losses add up to more than the total loss of £365 a year. The answer is that changes in benefits and direct taxes over this period have actually raised the income of the median household between 2008 and 2011, by about £120. This includes the changes coming in April.

That's the second striking element of these findings. Only households in the top fifth of the income scale or the bottom tenth, on average, have lost out from changes in direct taxes and benefits over this period. Everyone else, on average, has gained.

How can this be true? One part of the answer is that the VAT rise is not included in this heading, because it is already included in that £203 loss of real earnings, due to inflation rising faster than wages.

If you think about the way we pay for that VAT rise, we pay for it in higher prices - and the increase in VAT is a large part of the reason why the target measure of inflation is now running at 4%. It would be double-counting to measure the impact of higher VAT directly as well as taking inflation into account.

These numbers don't take account of the benefit cuts that are coming after 2012, many of which, like the cuts in housing benefit, will cut the income of many households. Inevitably, the indirect effects of public service cuts are also excluded here. But we often forget that the government is also raising the personal tax allowance by £1000 from April. That will boost real incomes for a large part of the income distribution, even if the government will be taking it away in other ways.

That brings me to another point: These figures show that by far the tightest squeeze on incomes, in percentage and absolute terms, has been to the richest households. A family in the 95th percentile - right in the middle of the top tenth of households will be 3.8% worse off, in real terms, than they were in 2011. That's a fall in their annual income of around £2230. Nearly £600 of that is due to the loss of benefits or higher direct taxes, with around £815 due to lower interest on their financial assets or other savings.

I suspect few will shed tears for this group. There will be more concern that the household in the 5th percentile - in the middle of the bottom tenth of the income distribution - will have lost around £35 a year from tax and benefit changes, compared with a gain for the median household of around £120. (Although, as ever, the IFS would note that the bottom tenth contains a lot of students or self-employed people with highly variable income, whom we would not necessarily consider poor).

The other group that has lost relatively more than other groups has been pensioners. The median pensioner household will have seen their real annual income fall by 2.4% since 2008, or £456. In more normal times, the income of this "typical" pensioner household would have risen by nearly £960 over that period. Unlike most other groups, tax and benefit changes have also left pensioners slightly worse off - with a net loss for the median pensioner household of just under £13 a year.

That brings me to the final point to note: the relative importance of low interest rates in squeezing real household income. That is responsible for the lion's share of the loss in pensioner income - more than £350. But even the typical household with kids has lost about £77 a year as a result of lower interest income.

You might think it strange that the IFS has included the negative impact of low interest rates for savers - and not the direct benefit of lower borrowing costs for households with mortgages. The measure of household income they use is after taxes, but before housing costs. But, once again, the impact of lower rates is included in the RPI measure of inflation that they've used in calculating the change in real earnings.

If interest rates had not fallen so far, then the loss in savings income would have been smaller, but the loss of real earnings from employment would look a lot larger, because the RPI measure of inflation would have been even higher than it actually was. For that reason, the IFS believes it has fully taken into account the fall in mortgage rates.

As anyone with a mortgage will tell you, mortgage rates have not fallen nearly as far as the official base rate. There are households who were on tracker mortgages when rates were slashed, who have seen a massive boost to their net income, but they are not the majority. (And many of them will have had to re-negotiate their mortgage by now, because that particular deal has run out). By contrast, savings rates have generally fallen in line with official rates.

That is how loose monetary policy is 'supposed' to work after a financial crisis - low interest rates help banks rebuild their balance sheets by widening the gap between what they charge borrowers and what they pay to savers. That will be little compensation to families who feel they are being squeezed on all sides. For most, they would be right in their suspicion that the recovery has been more painful so far than the recession.

A health check for the UK

Stephanie Flanders | 15:41 UK time, Wednesday, 16 March 2011

Back in November, the OECD described the coalition's spending cuts as "substantial but necessary". Now its economists have spent more time poring through the plans, its economists have decided that they are "ambitious and necessary". For this, the OECD's director-general earned himself a joint press conference at the Treasury this afternoon with the chancellor.

I cannot speak for this report, but the tradition with these OECD member surveys, which the organisation carries out every 2-3 years, is that there is a lot of back and forth between the authors and the national authorities. The Treasury will almost certainly have seen and commented on numerous drafts of this report - and had plentiful chance to water down the bits they didn't like.

That is what happened in the Gordon Brown Treasury - which is one reason why the OECD's past criticisms were muted, to say the least. (The IMF was slightly better at standing up to Ed Balls.) But I doubt there was much that George Osborne's people wanted to tone down in this report. After all, new governments are always in favour of full disclosure when it comes to the challenges and problems that the previous government left behind.

You can imagine the dismay that Mr Osborne will not have felt, on reading that "despite sharply rising school spending per pupil during the last 10 years, improvements in schooling outcomes have been limited in the UK." Or the OECD's comment that the economic imbalances which built up under Labour "exacerbated the downturn during the global recession and contributed to a more pronounced fall in GDP, a larger fiscal deficit and higher inflation than in most of the OECD".

The assessment of the impact of spending cuts will also have raised few eyebrows at Number 11. "Although fiscal consolidation will slow growth in the short run as demand is withdrawn, it is unlikely to derail the recovery and indeed could support growth in the long run."

But there are some interesting nuggets in this report, some of which have direct relevance to the Budget. Here's one line that leapt out at me:

"Although the government has tried to focus public investment on projects with high economic returns, the large cuts in public investment are a risk to long-term growth. Channelling more resources to public investment would be warranted, as long as projects offer a viable rate of return. Efficiency-increasing fiscal measures should be in line with the existing profile of fiscal consolidation. (emphasis in original)"

Mr Osborne stuck broadly to the sharp cuts in public investment pencilled in by Alistair Darling, though there was a special "Challenge" team in Whitehall devoted to picking the most productive use of the funds. With the government still paying such a low interest rate on its borrowing - nearly zero, in real terms - and so much the government might fruitfully invest in, some economists have suggested that the chancellor could support growth by investing more in the next few years, without damaging his market credibility or putting his fiscal targets at risk. (Investment is excluded from the borrowing target that he has set himself.)

The OECD economists like the idea of more public investment - but don't like the idea of borrowing to pay for it. They only want higher public investment in exchange for greater cuts elsewhere. In particular, they'd like to see the NHS 'unprotected' from real cuts. Efficiency gains, they say, are the answer for the NHS, not higher spending in real terms. I wonder whether the Health Secretary, Andrew Lansley would agree.

But the report reserves its sharpest language for the state of the UK housing market - and the planning regime. Here the OECD is preaching to the converted, at least at the Treasury. The rest of the government might have more doubts. Here's the summary:

Current land use planning policy is excessively restrictive, making supply unresponsive to demand and contributing to creating housing shortages and reducing affordability.... A reform to replace top-down building targets with incentives for local communities to allow development is underway, but the outcomes are somewhat uncertain. Housing taxation is regressive and encourages excessive demand for housing. More effective taxation could help contain demand and stabilise the housing market.

I hope to discuss in a later blog how the government might seek to match the simple economic need for more houses and a freer panning regime with the very difficult local politics. As I suggested in my bulletin piece last night , business groups are excited by the prospect of root and branch reform in this area, but can't help being alarmed by the uncertainty that comes with it. They also want reassurance that the "localism" agenda isn't about to make the planning system even worse than it is now. That is one of many questions that Mr Osborne will need to answer next week.

Jobs for the boys - and the over 65s

Stephanie Flanders | 12:42 UK time, Wednesday, 16 March 2011

There's always plenty that the headline labour market figures leave out. This month I'm tempted to say they miss the story entirely. When you look at the big picture - it looks like not very much is happening to jobs in the UK. The broader measure of unemployment is moderately higher than a year ago, but so is employment. And the number of people claiming jobseekers allowance has actually fallen by 8% in the past year. But there is plenty going on behind those headline totals, with stark consequences for different parts of our society.

To put it bluntly - it's a good time to be a man, working in the private sector, and/or over 50. If you're under 25, or a woman, or working in the public sector, the labour market is a bleak place these days, and there's little sign that it's about to get better.

I flagged up a few weeks ago the sharp rise in the number of over 65 year-olds in work. This part of the workforce has again grown sharply in the latest quarter, by 56,000. There are now a record 900,000 people in this age group still in employment. The number of working 50-64 year olds is also on the rise, though only by 1.3% - roughly the same as for the population as a whole. Starting from a much lower base, employment in the over 65 category is an astonishing 17% up on the year.

Here's the stark reality: employment in the UK has risen by 296,000 since the start of 2010, and 75% of those jobs - or 222,000 - have gone to people over 50. Just under 44% of the jobs have gone to the 3% of workers over 65. For comparison, the number of 16-17 year olds in work has fallen by nearly 8% over the same period, while the number of working 18-24 year olds has been more or less flat.

The gender divide is even more striking. The number of women in work has risen by only 19,000 in the past year - or barely 0.1%. Put it another way: men account for fully 94% of the rise in the number of people in work. You'll find some of the explanation for that in the difference between the public and private sector. The figures here are less timely, but the number of private sector jobs rose by 428,000 in the year to December. Over that time, the public sector shed 132,000 jobs.

Sorry for all the numbers, but there are times when the figures tell the story better than words.

Anyone who remembers the 1980s and early 1990s recessions can only be struck by the contrast with today. Back then, partly as a result of the way corporate pensions were taxed, companies laid off older workers first, in the hundreds of thousands. Many of those people never found work again. Now we've interviewed a 70 year old accountant for today's news bulletins who did stop working a few years back, but so missed being part of the workforce he fought his way back last year, after applying to 50 firms. He doesn't want to ever retire.

As I said in that earlier post a few weeks back, long term it's excellent news for our economy - and the Treasury - that older people are staying in work. But we cannot afford for that to come at the expense of those who are just starting out. It cannot be good news for the Britain's inner cities that the unemployment rate among 16-24 year olds is now more than 20%.

The Search for Growth

Stephanie Flanders | 11:16 UK time, Tuesday, 15 March 2011

If he's like the rest of us, George Osborne is probably thinking about Japan today. But he's also supposed to be thinking about growth. Having spent his first months deciding how to shrink the deficit, the focus of next week's Budget, we're told, will be how to expand the economy.

He's not the only one. It feels like every day I get another invitation to a "high level seminar" or conference on the subject of growth. But where, exactly, does economic growth actually come from? And what, if anything, can governments do to help?

Those are the questions I've tried to answer in a two part series called "The Search for Growth", the first of which will be broadcast on Radio 4 today.

When it comes to growth, politicians have no trouble describing the goal - George Osborne and Business Secretary Vince Cable will each be once again describing their vision of a "new economic model for the UK" in the next few days.

The problem is, we're not starting from a blank sheet. Britain's been in the economic growth business for a long time - you could say we started it, with the industrial revolution from the end of the 18th Century. That is where modern growth, in terms of a fairly continual rate of growth in income per head, really began. Growth before that time had only been "extensive" growth, where growth comes solely through a rising population, and living standards remain broadly the same.

More than 200 years of intensive growth - growth in income per head - has made us one of the richest countries in the world (a fact it's sometimes easy to forget, amidst the gloom). But it's also given us bad habits, and now we have a financial crisis to shake off, and the tightest squeeze in government spending in at least a generation. Understandably, people worry that we will never get back to the growth path we were on.

One thing is clear. When it comes to growth, even small differences can make a big difference to our living standards over time. In the past 40 years our economy has grown by about 2.25% a year, on average. At that rate, living standards double every 30 years. If we grow by 1.25% year instead, it will take 60 years.

Is that what we can now expect? It is one possible path for the UK. But after making these programmes I don't think it's the only one. Around the country, you can find plenty of vibrant businesses, even in supposedly "dying" sectors like shipbuilding, and even in "deeply challenged" regions like the North East.

These firms are creating growth and jobs the same way that growth has always been created - through innovation. Making better stuff, and using fewer resources to do it.

It's true of "high-tech" companies like the British software company, Autonomy, and the high-end fashion label, Burberry, both of whom feature in the programme. But we also spoke to Bury Black Pudding, in an industrial estate in Greater Manchester. It doesn't have a big office in Silicon Valley, or a prime slot in London Fashion Week, but it's doing very nicely indeed.

Growth is happening. In many ways, it would take a very determined government to stop it entirely (though plenty of governments in the past have done their best). But even the success stories also help show why other parts of the economy are not taking part.

Alnmaritec, the boat company that I visited yesterday in Blyth, on the Northumbrian coast, has hired more than 100 people in the past year, most of them former steelworkers and shipbuilders. The company has gone from building £250,000 steel boats to £2m ones in just 3-4 years, and has vessels in its yard destined for China, Angola, and Australia. But it can't get so much as an overdraft from its bank, and it is recruiting naval architects from the rest of the EU because it can't find enough of them here in Britain.

As ever, the Search for Growth is a glass half full, glass half empty kind of story. But there's some pretty interesting stuff in the glass.

Measuring the economic aftershocks

Stephanie Flanders | 10:47 UK time, Monday, 14 March 2011

The Japanese will be counting the human cost of the earthquake for many years. But when the world's third largest economy suffers such a catastrophe, it's natural for economists to wonder about the economic impact - for Japan and for the world.

Like the implications for the nuclear industry, there is already a range of views about what those economic consequences will be.

In the short term, all agree that the disaster will hit Japan's output, conceivably tipping it formally into another recession. GDP shrank in the last three months of 2010. It is possible that output will now shrink in the first quarter of this year as well.

Everyone can also agree that the Bank of Japan will do all it can to prevent the Japanese currency rising in response to the crisis. Bonds fell after the Kobe earthquake in 1995, but the yen rose to a record high as the economy moved into deflation. The BoJ doesn't want that to happen this time.

We have already seen Japan's central bank inject an extra 15 trillion yen (£114bn;$183bn) into the economy this morning. It also offered to buy an additional 3 trillion yen of government bonds. This has helped to reverse the rally in the currency you saw in the early hours after the quake.

Finally, everyone agrees that the government will fund the vast majority of the reconstruction effort, almost certainly through some form of emergency stimulus programme, and that this is likely to boost GDP over the course of the next year or so. Chile's economy shrank by 1.3%, on a quarterly basis, when it had its earthquake a year ago. It grew by more than 4.5% the following quarter.

As I see it, there are two big imponderables on the economic front, which won't get resolved for some time.

First, will this ultimately, be deflationary for Japan, or inflationary? Some will consider it bad taste to raise the question. In years to come, few will want to say the disaster was good for Japan.

Nevertheless, as Robert Cookson and David Pilling point out in today's Financial Times, Japan has been trapped in its deflationary malaise for so long, officials have often talked in the past about the need for some kind of major economic shock to bring the country out of it. Even now, there are those who see this silver lining in the horrific events of the past few days.

Some say this misunderstands the economic impact of reconstruction. The national accounts don't show a fall in GDP when infrastructure is destroyed by a natural disaster - only the subsequent rise, when that infrastructure is replaced. In that sense, you can say the post-crisis rebound in GDP is a statistical artefact that "doesn't make anyone richer".

But, as the economist, John Maynard Keynes would have been the first to point out, there are times when digging up roads - or re-building them - can create more wealth than the earthquake destroyed. (In technical terms, when the fiscal multiplier is well over one.) That may well be true of Japan today.

The trouble is that the reconstruction effort must still be paid for, at a time when the government is already running a deficit of nearly 10% of GDP and the debt ratio is heading to 230% of national income. There was a lot more room for extra borrowing when Kobe was hit in 1995.

That brings me to the second question: does this raise the chances of a fiscal crisis in Japan? I am tempted to say yes - how could it not? But whether it increases them substantially depends on the broader macroeconomic impact.

As Robert Peston notes in his blog, global investors have been relaxed in the face of Japan's extraordinary funding needs, because the government doesn't need to rely on the global market to buy their bonds. The nation's desire to save is as large as the government's need to borrow (though household saving has also fallen since 1995).

Even another downgrade of Japan's bonds would not seriously endanger the government's ability to fund itself. But Japan is on uncharted ground. No developed country, in peacetime, has ever built up such a gargantuan debt to the future. In that sense, Japan is a test case and not a welcome one.

What does it all mean for the rest of the global economy? As I said at the start, this is all going to take time to play out.

It's a bad time for another surprise - either for the real economy or the financial markets. But if we're lucky, the long-term consequences at a global level will be more micro than macro, with certain sectors, such as the energy industry, affected more deeply than others. (I'm excluding here the possibility of a fundamental re-assessment of the costs and benefits of nuclear power, which would obviously have macro implications as well).

Short-term, global inflationary pressures will surely be a little stronger in 2011 than they would have been, due to the damage to Japan's energy supplies, and the short-term stimulus from reconstruction. Whether the long-term impact is deflationary or inflationary will depend, in large part, on the reaction of the Japanese people themselves.

A multi-track global economy

Stephanie Flanders | 17:30 UK time, Friday, 11 March 2011

We always talk about the economy in black and white - it's boom, or bust, or if we're really unlucky, a double dip.

But what if the future is simply grey? That's the question I was discussing with guests on the Bottom Line this week. I was interested to know whether a long period of slow growth might be more challenging, for some businesses, than a short, sharp shock.

The point was brought home to me lately when we interviewed an insolvency expert for the television bulletins. He reminded me of an astonishing fact - that the corporate insolvency rate in the UK is currently at a 30-year low. But, he said, the first couple of years of an economic recovery are often the worst for business failures, especially if growth is slow to pick up. The longer companies are forced to operate well below their usual capacity, the greater the chance they will eventually go bust - even after making it through the toughest recession in more than 20 years.

I've banged on about this before - it all goes back to the so-called "endogeneity" of our supply, and the worry that slow growth will become a self-fulfilling prophesy by destroying capacity and skills.

It all made me interested to hear what my studio guests would say about living with a slow growth. They were Rupert Soames, chief executive of mobile energy group, Aggreko; Neal Gandhi, chief executive of international business services company Quickstart Global and David Haines, chief executive of German bathroom fittings company Grohe.

Surprise surprise, they could barely comprehend the concept of a slow growth economy - all of their businesses are doing so well. (When's the last time you heard an interview with a chief executive talking about how bad his company was doing?!) But there was a good reason why they might all be thriving. None of them depended on the UK market for their growth.

Grohe has been doing well, even in the slow UK market, but where the bathroom business has taken off is, you guessed it, in the Bric countries. As so often in these conversations, all roads inevitably lead to China.

We also spoke about why the German economy is doing so well - and whether royals should get mixed up with promoting Britain's business interests. You might be surprised to hear that Prince Andrew got a big thumbs up from the guests. When the palace was looking for endorsements last week, it should have phoned them.

But most interesting, to me, was a theme that I have come across a lot in the last few weeks - the notion that the digital economy, combined with a more integrated global economy, has smashed all previous ideas about what a "global" firm looks like.

As Rupert Soames commented, in the old days they said you had to reach a certain critical size before you could even think about exporting, or opening offices abroad. Now you see tiny niche players, with customers from around the world. The fact that Germany's SMEs have always worked this way is, famously, a big part of the country's economic success.

Neal Gandhi's business helps UK companies set up outposts abroad, providing them with office space and staff in places such as India and China, so they don't have to cope with the time and expense of doing it themselves.

He's been working with an online gift recommendation service based in southern England. Just a few weeks after the business got started, a well-known TV personality in Argentina happened to stumble upon their service, and tweeted about it. Suddenly, Argentina was by far their biggest market. That's not something you can plan for. But, happily for them, Argentina grew by 7% last year.

Gaming the next rate rise at the Bank

Stephanie Flanders | 16:43 UK time, Thursday, 10 March 2011

These days the Bank of England is like the proverbial swan gliding on a lake. On the surface they haven't changed policy at all for over a year - and they've kept the base rate at 0.5% for two. But make no mistake, there's plenty of activity underneath.

The system for setting Britain's monetary policy is what economists would call a "repeated game". There's one target; one policy instrument (give or take a bit of quantitative easing); and one meeting every month. All of those variables are fixed. What can change from one meeting to the next is the external environment, the views of the nine men making the decision - and, of course, the stakes.

In the past I've always thought that it was silly to engage in a lot of kremlinology about who thinks what on the MPC: all those league tables showing how each member has voted, and where they sit on the spectrum between "arch dove" and "arch hawk". It rarely seemed that one vote here or there really mattered. But now all that's changed. Everyone is investing a lot of time in thinking about how the interest rate game might play out over the next few months, and that includes senior members of the MPC.

In recent posts I've written about the key votes to watch on the committee, and where the new member's vote might eventually go.

Today I want to talk about two 'games within a game' which senior people at the Bank are pondering almost as hard as the decision itself.

Question one: Does it matter, when the MPC does vote to raise interest rates for the first time in more than two years, whether the governor votes in favour?

Question two: Is it possible for the Bank to raise rates without the City assuming it's the first in a series of hikes?

Interestingly, in the intricate world which the MPC now inhabits, the answers to the two questions turn out to be related.

First things first - does it matter if Mervyn King votes for the first rate rise when it comes? Implicitly or explicitly, most of the City predictions - especially those forecasting a rise in May - seem to assume it doesn't. In general, the betting has been that Charlie Bean and Paul Tucker are most likely to change their vote, with Mervyn King and Adam Posen deemed the least likely to change their view. But for Bank insiders, the Governor's vote matters a great deal.

In more normal times, they think it's OK for the Governor to lose the odd vote - as he did in the summer of 2005, when the Bank voted to cut rates (a decision which many now consider a mistake). But these are not normal times.

Imagine the MPC did vote in May for the first rate rise in over two years, but the governor voted against. We wouldn't find out for two weeks, but the governor would have to lead an exceedingly interesting Inflation Report press conference in between. Mervyn King always insists that he speaks for the MPC in those appearances, not himself. But often you'd be forgiven for missing the distinction.

Things would be even more awkward once we knew for sure that he had not voted for a change. When the Bank makes a decision this important, you want the leader of the institution to be out there defending it, without caveats and complications.

I suspect the governor agrees with this. If so, the debate moves from when the swing voters will change their minds - to when those switchers will persuade the governor to switch too.

If that analysis is right, then 'they'll all go together when they go'; all of the senior Bank officials on the MPC will vote for a rate rise when it happens. (In theory you could have a change in policy with Charlie Bean, Paul Tucker, Mervyn King and Paul Fisher all on the losing side, but Adam Posen's position makes that unlikely, to say the least.)

But then think about question two, the debate over whether the first rate rise must shortly be followed by others. The received wisdom within the Bank - and outside - has been that you could not have one rate rise in isolation. But, as we heard at the ECB press conference last week, the ECB president does seem to think, in current conditions, that it would be possible to "send a signal" with a rate rise, without necessarily committing to many more.

With so much uncertainty hanging over the economy, and fears over the impact of the higher oil price, some at the Bank would like to have the same option open to the MPC. The last thing they want is a one point rise in the average fixed rate mortgage in response to a quarter point change from the Bank. Equally, for all the talk about 'taking it one month at a time', they don't really want to be cutting rates again, months after raising them.

I say some at the Bank might like to have the option. But the ground has not been laid for such an approach, in the City or among the broader public. Reasonably, on the basis of the Bank's past history, most observers assume that once rates go up once, they will rise fairly steadily thereafter.

If there had been any doubt about the matter, Mervyn King rather put an end to it with that line from Monty Python in the February press conference: There will be no "futile gestures", for which read "symbolic", one-off increases in rates.

So, you might think, that's another reason to expect the first rate rise to come later rather than sooner. But all this strategising does open an intriguing possibility.

If Mervyn King doesn't believe in one-off rate rises, then the City would be right to expect a series of increases after any rate rise the governor votes for. But equally, if the governor didn't vote for it, the City might well hesitate to assume that further rises were in the bag.

In that scenario, the MPC hawks could get their 'warning shot' against inflation without committing to a long campaign. If they could only get past the problem of the governor spending an hour and half defending a rate rise to journalists that he didn't support.

Time to worry about oil?

Stephanie Flanders | 14:01 UK time, Tuesday, 8 March 2011

Until recently, the received wisdom in the city was (a) that the steep rise in the oil price would be temporary, and (b) that it would only cause serious problems if it went to $150 a barrel. At least one of those two beliefs is now being tested. Possibly both.

After a brief period of treading water, the price of oil lurched up again yesterday, with Brent crude pushing back up toward the $120 mark. The last thing the Opec countries want is a market panic. That's why today you see talk of Saudi Arabia, Kuwait, the UAE and Nigeria all raising their production. But now the world is officially worried about the balance between oil demand and supply, I wonder how much long-term reassurance this can offer.

Consider, first, the question of how long the oil spike will last. I was struck by the Bank of England deputy governor, Charlie Bean's blunt answer to this in a speech at the end of last week:

"the bottom line is that while agricultural prices may fall back a little this year, oil (and also metals) prices are more likely to remain elevated. And there must be a risk that continued turmoil in the Middle East and North Africa results in a substantial oil price spike, present Opec spare capacity notwithstanding."

This chart of the oil price (below) over the past year or two shows how prices have leapt up in response to events in the Middle East. But you can also see how the oil price had previously been marching upwards, with no help from Colonel Gaddafy or anyone else.

Most economists were fairly relaxed about that earlier rise, because it was linked to rising demand from the emerging market economies, not disruptions in supply. But, as The Economist points out in its latest issue, a look back at history finds plenty of occasions when large increases in the oil price have been followed by recessions, when the root cause of the price spike was rising demand. All you need is for rising demand to collide with unresponsive supply.

The gap that's opened up between the US and global benchmark price of oil (WTI and Brent crude) shows how different supply conditions can have large consequences for the price. Prices are lower in the US because America has greater refining capacity - and it's recently tumbled on a lot of new supplies of natural gas, which US producers find hard to export.

Libya accounts for only about 1.5% of global production, or just over 1.5 million barrels per day. Reports suggest that production is now running at about a half or a third of that level. Somehow this has added nearly $20 to the cost of a barrel of oil.

Does the world have alternative sources to turn to, if Libyan production shuts down altogether - and/or the crisis hits production elsewhere? For decades the answer to the spare capacity question has always been Saudi Arabia. As long as supply was not disrupted there, the thinking was that everything would probably be OK.

As I said at the start, Saudi officials are doing everything they can to strengthen this belief. They have no interest in people losing confidence in the scale of their reserves. But there are plenty of long-time sceptics out there, who say the Saudis have been overstating how much oil they have left - and say now they're exaggerating their spare capacity as well. One Washington insider told me yesterday: "we're clear that the Saudi ability to make up for more than Libyan disruption is non-existent." Those doubts are helping to push up the price. No wonder they're rallying other Opec troops for the front page of today's FT.

Assume that roughly $120 per barrel oil is here to stay, with a strong chance that it will rise further. What does that mean for the global recovery? The answer is that no-one can know for sure.

Optimists point out that, historically, oil prices need to double in a year to cause serious bother. That's how you get that $150 threshold I mentioned at the start. Any number below $150, supposedly, the world is OK. Another point in our favour is that we are at the start of the economic cycle this time. Previously, higher oil prices have tended to push the world into recession when interest rates have been rising for a while and the recovery is fairly mature.

One estimate, from Fathom Consulting, suggests that a permanent 10% rise in the price of oil in the first three months of 2011 would not have much effect on global growth this year, but take about 0.2% off the growth rate next year. That's not nothing, but it's manageable. Whereas, in their model, $150 per barrel oil would cut growth next year by fully 1%. But as the authors admit, these things are rarely so clear-cut. And it matters a great deal where you are starting from.

Look around the world today, you see emerging market economies with an inflation problem, and rich countries who mostly have a growth problem. The worrying thing about an oil price hike is that makes both problems worse. It's especially worrying for the UK, which is in the unique position of battling slow growth and rising inflation.

That is why the past five global recessions have all been preceded by a sharp rise in the price of oil. They not only hit growth, they make it harder for policy makers to respond. Oil is the ultimate wild card for the global economy - and it's been a while since the UK was dealt a good hand.

From Goldman Sachs to the MPC

Stephanie Flanders | 13:30 UK time, Monday, 7 March 2011

I can reveal that the new member of the Monetary Policy Committee (MPC) will be Ben Broadbent, a senior economist at Goldman Sachs. He will replace the leading proponent of rate rises, Andrew Sentance, when he leaves the Bank of England's interest rate committee in May.

Mr Broadbent is a widely respected economist who spent some of his early career at the Treasury. In the past year or so, Goldman Sachs has tended to be more upbeat about the UK and global recovery than many in the city, and Mr Broadbent's own commentaries have been consistently supportive of the government's tough approach to the budget, arguing that the economic recovery was strong enough to withstand the effect of spending cuts. Only today, he and a colleague published a paper suggesting that households were less vulnerable to interest rate rises than generally thought.

Many will therefore expect Mr Broadbent to follow Mr Sentance in voting for higher interest rates when he joins the committee. Three voted for a higher rates at the February metting, with 6 against. There is another meeting this week, but most do not expect the balance to change until April or May, if then. Mr Broadbent's first MPC meeting will be in June.

However, Broadbent has also stressed in the past that a weak pound would be crucial to offsetting the impact of spending cuts, by pushing up exports. The pound could strengthen if interest rates rise faster in the UK than in other countries.

More recently, he and his team have also drawn attention to the impact of rising commodity prices on household incomes. I wrote about their research here a few weeks ago.

Today's report, which Broadbent co-authored, says only "the MPC is divided and there are respectable arguments both for, and against, higher rates. But the sensitivity of households' interest payments is not top of the list."

Critics will note that there are still no women on the nine person committee, which lost its only female member last summer. Officials say the post has gone to the stand-out candidate, whose reputation speaks for itself. They also say there were 27 applicants for the post, of whom only one was a woman.

More important, to some, than the gender imbalance will be the marked imbalance of outlook on the new MPC. When Mr Broadbent joins, all of the four external members of the MPC will have spent most of their career as macro-economists. In the past there has been a desire to mix in some micro-economists, or at least people, like Mr Sentance, with experience as industrial or business economists. Arguably, that is now a missing voice on the MPC. But neither that or the gender imbalance are likely to be resolved any time soon. The four external members of the MPC are all fairly recent appointees, who could each see their contracts renewed for another three-year term before another new face comes to the committee.

Update 1546: Famously, Rolling Stone magazine described Goldman Sachs as "a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money." I know for a fact that Ben Broadbent vigorously disagrees. But squid-watchers will note that he is the third Goldman Sachs man to join the MPC since its creation in 1997. Andrew Sentance actually replaced the last Goldman man, David Walton, who died suddenly in 2006. Sushil Wadhwani, a former Head of Equity Strategy at Goldman, served on the MPC between 1999 and 2002.

Less contentiously, readers of Stephanomics may remember that Ben Broadbent was one of the 'GDP sceptics', who thought the strength of the recovery was being understated by the ONS in the second half of 2009. This came to the fore in his response to the first estimate for GDP in the third quarter of 2009. This was widely expected to mark the end of the recession. When the ONS announced that output had shrunk by 0.4%, Mr Broadbent claimed the GDP figures were "literally unbelievable".

That figure has subsequently been revised up, but only by 0.1%. On the face of it, the ONS has come out ahead, though the Goldman Sachs team point out that the major revisions to the official GDP numbers tend to be years after the event.

I suspect Mr Broadbent will warn people not to confuse his views with those of his team - or to assume that he will take the same view on these issues in June that he takes now. But it's hard not to look for clues in his most recent research reports. I'm particularly struck by a note entitled "Three Questions for the UK Economy", published on January 7.

In that paper, which in this case is signed by Mr Broadbent, he asks three questions which go to the heart of the debate now raging at the MPC. First, can the economy absorb the effect of cuts? Second, will rising costs (of imports etc) push up wages? And third, will the MPC continue to ignore high headline inflation?

On the first question, he says there will be a hit to the economy, especially in the short run, but that this issue generally gets overdone, and people forget that fiscal policy has already tightened quite a lot. They also, in his view, forget the crucial role that private investment will play in the recovery. Similarly, he has long argued that the private sector can create more than enough jobs to offset losses in the public sector.

On the second question, he concludes that there must be a wage response to rising costs, even if it is now only partly visible in the headline pay data. (Incidentally, the Bank does too - the latest Inflation report forecast builds in some "second-round" effect on wages of above-target inflation.)

Third, and perhaps most interestingly, he has this to say about the Bank and its approach to rates:

"We doubt policymakers are deliberately aiming for high inflation. But their 'reaction function' certainly seems to have changed and it's possible that, in the face of deleveraging and uncertainty about the supply side, the MPC is running a de facto nominal GDP target. If so, then it will be hoping that, in the race between supply-side improvement and credibility impairment, the first is the winner."

He concludes:

"We continue to expect no rate hikes till the end of 2011. But, amid all the endless coverage of the fiscal tightening - which we, no doubt, will add to - it will be worth keeping an eye on trends in private-sector pay."

Remember this was written on January 7th 2011. The debate has probably moved on since that was written. And now, so has the author.

The 'separation principle' and the euro

Stephanie Flanders | 10:40 UK time, Friday, 4 March 2011

The European Central bank can afford to ignore the likes of Greece and the Republic of Ireland when it sets interest rates - for the same reason that the eurozone can afford to bail them out. They're small.

Between them, the crisis economies on the periphery account for about 18% of eurozone GDP. Germany alone accounts for 30%, and it grew by 3.6% in 2010.

Jean-Claude Trichet

Strong hints yesterday from Jean-Claude Trichet that the ECB would raise rates next month will not have gone down well in Portugal and Athens. They need higher interest rates like a hole in the head. But as these governments will have learned by now, that is how the eurozone works. One interest rate very rarely fits all.

For most of the single currency's first decade, the ECB's policy rate was probably too high for Germany - and too low for the booming periphery. Germany's domestic consumption grew by just 1% a year, on average, for the first eight years of the euro. Consumption growth in Spain, Portugal and the Irish Republic was many times that. And we all know what happened to house prices and the level of private debt.

Still digesting the enormous costs of unification, German workers saw their real wages squeezed in this period, as German companies slowly re-built their competitiveness, while the countries at the periphery had a ball.

Now, as any German politician will happily tell you, the shoe is on the other foot. Now it's Spain, Portugal and the others who must sacrifice short-term growth for long-term competitiveness. For them, even a record low interest rate is probably too high. For Germany it looks too low.

This, say the true believers in the euro, is how you would expect a single currency to work among such a diverse collection of states. When one group of countries is down, the other is up - and vice versa. Only gradually do they see-saw toward the same path.

A logical consequence of this dynamic is that interest rates will go up this year, even if several eurozone economies are still going down.

Except, these days it isn't really "one monetary policy fits all". Because the European Central Bank is still providing large amounts of exceptional support to eurozone banks. And most of that support is helping the periphery.

On the same day that Mr Trichet talked sternly about "strong vigilance" on inflation, the ECB was announcing that these refinancing operations would remain in place for at least the next three months. To the surprise of some market-watchers, there were not even any efforts to further limit funding for banks now "addicted" to ECB support.

The ECB president was keen to stress the "separation principle": there's monetary policy, and there's exceptional support for the banking system and woe betide anyone who confuses the two. The Greek, Portuguese and Irish governments will see less of a distinction, but they are very glad that the ECB does. Arguably, the ECB's refinancing operations for the banks are playing a much more important role in supporting their economies right now than the official interest rate.

Make no mistake: the separation principle is very important indeed to the ECB. In a messy time for the eurozone, it is a source of pride to the ECB that its interest rate policy has stayed "clean". You may not agree with its judgements, but even the critics will accept that interest rate policy has been set according to the economics, not the politics. Yesterday's press conference was a case in point. Happily for the periphery, the rest of the ECB's response to the crisis has been a lot messier.

The Bottom Line on timing

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Stephanie Flanders | 18:11 UK time, Thursday, 3 March 2011

They say the secret of great comedy is in the timing. Most chief executives would probably the same about business: whether you win or lose, timing always seems to have a lot to do with it. But, as your grandmother ought to have told you, there's a difference between doing something quickly and doing it well. When I hosted The Bottom Line this week, I asked my guests how they managed the tricky business of time. And what happened when they got it wrong.

Around the table were David Wild, the chief executive of Halfords, Mike Norris, the head of Computacenter, an IT services firm that does the "corporate plumbing" for big companies around the world and Chris Moore, chief executive of Domino's Pizza in UK and Ireland, which now sells a million pizzas a week in those two countries alone.

As you can imagine, timing means something different to Mr Moore than it does to the other two. Every Domino's Pizza customer is supposed to get their order within 30 minutes, and around 90% of them do. Mr Moore said the lesson of experience - here and in the US - was that "up to 30 minutes, the customer's hungry, after 30 minutes, they're angry". The single most important statistic in his business is the time between the customer putting down the phone and the pizza going out of the door of the shop. Every Domino's franchise has that "out-the-door" time monitored, down to the nearest second.

For Computacenter, timing is a more nuanced affair, with clients paying more, according to how fast they need their IT systems to be put in and, especially, how fast they need them to be fixed when they fail. Smaller companies might be willing to wait a day for the technicians to arrive. Foreign exchange traders in the city are apoplectic if the system is down for 30 seconds - let alone 30 minutes.

The boss of Halfords also had some interesting stories to tell about getting the timing right, and getting it wrong. They timed their anti-freeze supplies about right, for last winter's snow and ice. But this time last year they drastically underestimated how long Chinese migrant workers would stay at home after Chinese New Year. The result was a big shortage of bikes in UK stores in April and May. Another sign of the times. I bet Mr Wild's predecessors didn't have to worry about Chinese holidays and how it would affect the supply of children's bikes.

With the continuing turmoil in the Middle East, I also asked my guests whether they felt a responsibility to keep up with world events generally - and whether it really mattered, from a business standpoint, if they switched off. We had an interesting range of comments on that subject as well, including some intriguing observations from our UK pizza supremo, on the difference between Muammar Gaddafi and Cheryl Cole. For that and more, I'm afraid you'll have to tune in.

Older workers make their mark

Stephanie Flanders | 17:49 UK time, Wednesday, 2 March 2011

"You spent all the money - now you're taking our jobs." That is probably not how the Office for National Statistics would like younger workers to react to a press release they put out today, highlighting the rise in the number of over-65s who are still in work. But it's the conclusion that some unemployed school-leavers might draw.

In its release, the ONS trumpets the news that at the end of 2010 there were 870,000 people over 65 in formal employment in the UK. That number has more than doubled since 2001. This age group now makes up 3% of the workforce, up from 1.5% in 2001.

What the statisticians do not spell out is how many new jobs are going to these older workers. The latest figures show total employment in the UK rose by 218,000 over the course of 2010. Over that period, employment among the over-65s rose by 104,000. Put it another way, 3% of the workforce has hoovered up 48% of the new jobs.

We knew that nearly all of that recent job growth was part-time: as I have commented in the past, full-time employment has barely risen at all since the end of the recession. I have also noted the contrasting experience of men and women: men took the brunt of job losses during the downturn, but now they are gaining jobs at a much faster rate than women. But I must admit that I hadn't noticed, until looking through the figures earlier this week, that quite so many new jobs had been going to people over 65.

Some have suggested that this is because older workers are more willing to accept the part-time, lower wage work that is now available. That is probably part of the explanation - after all, many workers in this age group may have other sources of income to buttress their earnings. But the ONS paper shows that this is not the whole story.

Both full-time and part-time work in this age group have risen over the past three years. Some 83% of the over-65s now in work have been continuously employed for more than five years; two-thirds have been with their current employer for more than 10 years.

How should we feel about this phenomenon? I leave that for you to decide. Let me just highlight two possible implications - one positive, the other less so.

The positive lesson to draw is that British people are working later in life. In the long run, that is good news. Other things equal, the more active members of the labour force we have for longer, the faster we can grow, and the easier it will be to get our government borrowing under control.

As I've written in the past, extending our average working lives has a double benefit for the Treasury because it means there is more income tax revenue coming in, and less going out the door in benefits and pensions. Indeed, the fact that labour force participation has been rising among older workers, even at this difficult time, could suggest that the gloomier estimates of the UK's potential growth rate in the next few years could turn out to be wrong. (In case you're wondering, IFS and Barclays Wealth, that means you).

That's the positive news to take from these figures. The darker lesson is that politicians may have to worry, not only about the quantity of jobs created in the next few years, but which parts of the population are getting them.

Economists don't tend to go in for a lot of soul-searching about "McJobs". They usually say it's better for people to be in work than out of it - and leave judgements about the quality of those jobs to others. Nor do they spend much time worrying about the social consequences of young people being out of work (or not in their day job, at any rate). But economists do have to worry about the long-term quality of the UK's labour force - and they should care if young graduates and/or prime-age workers are locked out of the labour market for years at a time. That will reduce our potential growth rate as surely as rising labour force participation increases it.

Youth unemployment has been rising up the political agenda. No-one wants to get into weighing the social benefits of one more 66-year-old staying in work versus a 20-year-old getting his or her first step on the jobs ladder. Naturally, we want both - and if we can't have both, the economist in me says that employers are unlikely to give us a choice between the two.

But even if the economists can duck the issue, politicians may not be so lucky, especially if the contrast in the experience of young and old workers continues to be this stark.

A food price puzzle for the UK

Post categories:

Stephanie Flanders | 13:49 UK time, Tuesday, 1 March 2011

We all eat food. So we should all be interested in what's happened to British food prices in the past year or so. The members of the Monetary Policy Committee who appeared before the Treasury Select Committee this morning also have what you might call a professional interest in the subject. Along with other commodity prices, rising food prices have been a key piece of the British inflation puzzle that the Bank of England has been getting wrong.

There's a micro issue here, and a macro one. The "micro" puzzle, highlighted by recent research by UBS [160KB PDF], is whether and why UK food prices have been rising more quickly than in other countries. The "macro" puzzle, highlighted by deputy governor Charlie Bean in his answers to MPs, is why British companies - including food retailers - have been able to pass on higher input costs to consumers, despite the subdued state of domestic demand.

On the micro puzzle, these are the highlights of the UBS study:

"Clearly, all economies have had an increase in consumer food prices over the last year - the significant rise in commodity prices has generally offset or more than offset the modest declines in labour costs that have been experienced. The UK does, however, stand out as being somewhat anomalous in experiencing significantly more consumer food price inflation than elsewhere." (see chart below which is on page 7 of report)
"This pattern tends to hold when we break food down into its subcategories.Looking at the broad subcategories of food that are identified by Eurostat, the UK stands out as having the broadest range of food price increases. Politicians may well feel justified in asking 'if everyone faces the same commodity price increases, why does the UK have so much more food inflation?'"
Graph showing food price inflation in selected economies (food consumed at home)

There are some possible answers to that question. One very obvious one would be that the fall in the pound has pushed up food prices faster than in other countries. If you looked at a similar chart for CPI inflation overall, you'd get a similar picture: prices going up faster in the UK.

Is there anything that is happening to food inflation that can't be explained by the weak pound? The UBS researchers think so: they estimate what's actually happened to the cost of retailers' inputs, including import prices (so, taking account of sterling) and changes in industry wages. They then estimate how prices "ought" to have risen, in response to these cost changes, and compare that to what actually happened. The results are shown in this second chart (from page 11 of the report).

Graph showing UK processed food CPI compared to a cost-based pricing model

Their "killer" conclusion is that the cost of retailer inputs has risen by about 3.5% in the past year, while the average price of processed foods in the shops has risen by 6%. As the authors suggest, that is likely to cause some bother for the supermarkets, and probably renewed calls for politicians to "take action" against the supermarkets. (As ever, what that action might be is less clear).

However, there is another, equally interesting, conclusion to be drawn from this chart - which is that, until recently, there was a remarkably strong correlation between the cost of the inputs and the cost paid by the consumer. UBS says the correlation is 93%. That is what you would expect to see in a competitive market.

If the UBS model of costs is roughly right - and it very rough and ready - then there is a short-term UK food price puzzle, but long-term, retailers seem to have adjusted prices in line with their costs. Indeed, in the early noughties, the chart suggests they were actually raising prices more slowly than cost increases would have justified.

This is about the rate of change in prices. There has been a similar argument, in the past, about the level of UK food prices. In 2000, the Competition Commission found that food prices were 12-16% higher in the UK than in other similar European countries, but the difference could be explained by, among other things, different planning regulations in the UK which pushed up the cost of commercial land.

More recently, Eurostat found a similar price gap. The micro argument over these numbers, and what, if anything, they tell us about UK retailers will run and run. But for the Bank of England, the more urgent puzzle to solve is the macroeconomic one.

As Charlie Bean explained to the MPs on the committee, one of the reasons the Bank has got its inflation forecast wrong was that it underestimated how much "pass-through" there would be from a lower pound (and therefore higher import prices) to higher retail prices. In the 2006 speech that I cited a few weeks ago, he made much of the fact that a sharp rise in energy prices had not then translated into higher inflation. He believed this was due to tougher global competition:

"Exactly the same heightened competitive pressures in product markets that appear to have contributed to the flattening of the inflation/activity trade-off, may also have affected the way that businesses have responded to the increase in energy costs. Rather than immediately pass on in full such increases in higher prices, it appears that they may have instead looked to lower other costs, either by granting lower wage increases, or by putting downward pressure on the prices of intermediate inputs, or by raising efficiency. Our regional agents have also asked a sample of their business contacts how they have responded to the squeeze in profit margins occasioned by the rise in energy costs. The survey suggested that relatively few businesses expected to be able to raise prices and instead planned to raise efficiency, reduce employment or push down on wage and other costs. And some respondents felt they had little alternative but to accept the hit on their margins. That was especially the case in manufacturing, which is the sector that is most exposed to international competition."

British manufacturers are just as subject to global competition now as they were in the mid-noughties. When you consider the subdued state of the economy, you would think they would be even less able to pass on cost increases in 2010 than they were in 2006.

Instead, as the deputy governor noted in his testimony, we have seen the opposite: a higher degree of pass-through than before, and a much worse forecasting record for the Bank of England. That is one of many puzzles about the UK's inflation rate that the Bank now urgently needs to solve.

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