THE UK economy is now accelerating strongly and, if the traditional correlations with business surveys continue to hold, growth could be 3 per cent or more next year. Furthermore, if unemployment continues to decline as fast as the claimant count has fallen in the past four months, the 7 per cent unemployment threshold set out in the Bank of England’s forward guidance policy will be hit in March next year.
Forward guidance hasn’t failed. But given that, when it was introduced last August, unemployment was expected to hit 7 per cent roughly three years from the announcement, it arguably hasn’t provided much guidance or certainty. Meanwhile, the Bank’s existing policy of inflation targeting is scarcely credible. Other than for a few months in 2007 and in 2009, inflation has now been above the Bank’s 2 per cent target for the past eight years.
But how do we fix this, and what is the current policy framework missing? In short, we need a monetary policy regime that takes into account the impact of globalisation on the UK economy. Despite recent troubles, emerging economies are still super-competitive and are using huge quantities of primary resources, thus squeezing our growth while adding to inflation.
In these circumstances, the concept of Money GDP targets becomes increasingly attractive. The idea was promoted initially by two Nobel Laureates James Meade and James Tobin, and enthusiastically supported in the UK by the eminent economic commentator Sir Samuel Brittan. Money GDP refers to the nominal value of the goods and services output of the economy (not accounting for inflation), and a Money GDP target would task the Bank to ensuring a steady rate of nominal GDP growth.
Setting the Monetary Policy Committee (MPC) a Money GDP target, rather than an inflation target, would allow some flexibility to cope with a globalised world in which, for a country like the UK, there are upward pressures on inflation and downward pressures on the growth trend.
I would set the target rate of Money GDP growth at 5 per cent GDP of growth in cash terms, with a margin of 1 per cent either way. If I am right that the UK’s current trend rate of growth is probably somewhere a bit below 2 per cent, this implies an inflation trend slightly above 3 per cent. Neither number is satisfactory, but this may be the best that we can do given the unfortunate hand of cards that we have been dealt. As the West adjusts to the new circumstances created by growth in the East, and particularly our weakness in exporting to fast-growing markets, our underlying economic performance is bound to be unsatisfactory.
The Institute of Chartered Accountants in England and Wales (ICAEW)/Grant Thornton business survey, which my organisation devised and analyses, implies GDP growth of 1.3 per cent in the fourth quarter of 2013. Even without this kick forward, UK GDP growth would be the fastest in the Western world in 2014. We are moving into the sort of territory where there is a significant risk that the upturn may get derailed by the balance of payments, as UK exports grow much more slowly than imports and put downward pressure on the pound. While some devaluation is probably necessary as part of the adjustment to the new global economy, it is easy to have too much of a good thing.
A credible monetary regime would help prevent the pound from falling out of bed and enable the upturn to be sustained, even if at a slower rate than might happen otherwise. It would also set the framework for getting interest rates back to a more normal level than the present 0.5 per cent Bank Rate.
There are weaknesses inherent to using Money GDP as a target. Most importantly, it is susceptible to revision of the GDP numbers. This is a genuine problem, but the alternatives are worse, and I would not use this operational difficulty as a reason for not changing the policy regime. Indeed, I suspect that the MPC has been covertly using something like a Money GDP target for some time, one of the reasons why it felt that forward guidance was necessary.
If a Money GDP target is applied, we might see an early rise in interest rates. Indeed, if growth continues to accelerate, we could even see a small rate rise when the Bank of England next updates its forecasts, which will be in advance of the February MPC meeting.
Douglas McWilliams is executive chairman of the Centre for Economic and Business Research, and the Mercers’ School memorial Gresham professor of commerce. He will give a fuller discussion of this issue in his lecture “Should the UK adopt Money GDP Targets”, held at 6pm tomorrow in the Museum of London. Seating is on a first come first serve basis. www.gresham.ac.uk/lectures-and-events/should-the-uk-adopt-money-gdp-targets