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Credibility Deficits

Coalition economic credibility undermined. Labour still has work to do.

We may be facing the worst financial crisis ever, the Bank of England governor told us last week. Unfortunately, we have a government whose policy seems to be ‘rein in spending, hold on, and hope for the best’. At this point, with credibility in Tory-Lib Dem economic policy fast eroding, Labour must take further steps along the road to restore its own economic credibility.

The European sovereign debt crisis is also a banking crisis. Eurozone leaders have finally recognised that their banks need more capital to withstand sovereign debt losses. There are few signs that they recognise the scale of the solutions required. It may be that they do indeed know what they need to do, but to convince their citizens they need to demonstrate they are exploring every other alternative and not directing taxpayers’ money to failing banks and failing states with abandon. Yet time is running out.

Last week also saw the publication of revised UK GDP data. This showed that the economy grew only 0.1 per cent in the quarter to the end of June (down from 0.2 per cent previously estimated). Moreover, the previous quarter’s growth rate was revised down from 0.5 per cent to 0.4 per cent, which means that the economy took longer to recover from the snow-affected last three months of 2010, let alone return to growth.

More interesting, however, were the revisions to earlier figures. It had been thought that GDP fell 6.4 per cent in the recession. The latest figures show the fall was a stunning -7.1 per cent, but that the rebound was more rapid with recovery beginning in the third quarter of 2009 rather than the fourth. That all ties in with the way the recession began; there was a sudden drop in confidence across the economy after Lehmans. It also suggests the economy had a much bigger shock than we thought.

Financial crises are often also existential crises. The threatened collapse of a system which relies on confidence, or rather, on faith, naturally raises all sorts of questions about what life is really all about and what really matters. Mervyn King seemed to be saying that the turmoil in Europe could lead to something worse than the fallout from the collapse of Lehman Brothers in 2008. That could lead to all sorts of questions about what sort of society we want, but with very little time or freedom to come up with answers.

In such a situation governments have to exercise leadership and be proactive. Anything less (as practised by our current Chancellor of the Exchequer) risks economic policy being overwhelmed by events. However, the time for short-term fixes is probably over. Temporary tax cuts and the odd gimmick will have limited impact and risk wasting money (because what matters are jobs and investment). In the same way that austerity measures attract most support when a traditional economic cycle is in operation (providing hope of future spending increases), so temporary stimulus measures may not amount to much if we are going to see a period of lower or little growth. The answer is to limit austerity while credibly cutting public sector debt, and while taking measures to increase business and consumer confidence in the future.

Labour cannot just sit back; we have to be proactive too. Labour is launching a jobs and growth campaign, centred on its five point plan for growth. That’s a good start and certainly contrasts with the intellectual vacuum expanding in the Treasury, but we have to do more nuts and bolts work to make sure that a Labour government won’t scare anxious investors or understandably cautious and worried voters.

This article was first published on the Progress website on 11 October 2011.

My Fabian Society pamphlet, Credibility Deficit - How to rebuild Labour's economic reputation, can be downloaded here.
Progress, 11 October 2011, 11/10/2011

Not an easy task given uncertainties, especially if energy and commodity prices do fall later in the year. Ultimately, radical economic reform required.
Central banks are struggling to head off general inflation while dealing with price shocks that will be negative for growth. They waited too long, which has made their tasks more difficult.
The Bank of England has raised interest rates, but that does not mean it has been most effectively managing inflation risks.
The Bank should signal it will act if higher prices look likely to translate to higher inflation rate.
The IMF's Fiscal Monitor is actually quite radical.
Spare a thought for finance ministers, and the opposition counterparts who aspire to replace them. The conventional wisdom was that they should at least make an attempt to follow fiscal rules. Now, there are no rules.
My letter in the Financial Times on the need for a framework for economic policy decision-making.
Responding to Brian Griffiths' article in The Article on the risks of inflation.