What will the economy look like over the next ten years?
To the extent that part of the success in achieving stable growth and low and stable
inflation over the last decade and a half was due to the new way of conducting monetary
policy, the outlook is favourable.
The experience from 1992 until 2007 appeared to be positive one but there are clearly
lessons that need to be learned from the 2008-2009 recession. And, if stability
can be once again achieved and maintained over a prolonged period, that will allow
the authorities to concentrate on further supply side improvements to boost productivity.
But other factors also contributed to the benign 1990s and, to the extent that some
of these have now run their course, policy making will become a more difficult job.
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The 1990s started with a substantial amount of spare capacity as a result of the
earlier recession.
This allowed the authorities a degree of leeway when conducting policy up until
the middle of that decade. Thereafter, there was a greater resolve needed to keep
economic activity as close to its potential rate of growth as possible.
During the decade and a half of growth, the policy makers benefited from an expanding
labour force which allowed the economy to grow faster for a given rate of inflation.
Partly this was the result of a series of supply side reforms from the 1980s onwards
which have introduced a greater degree of flexibility into the labour market and
placed an increasing onus on individuals to seek work while providing greater support
in finding it.
Partly too it has stemmed from an upward shift in labour force participation – more
individuals deciding that they wish to be part of the workforce.
More recently, there has been a huge influx of labour from Eastern European countries.
The Bank of England has estimated that in the period from May 2004 to early 2007,
the labour force might have grown by around 215,000 workers as a result of immigration
from these countries.
Some of these factors may have further to run but it is unlikely that the labour
force will grow as rapidly over the next decade as it has over the last.
In early 2007, the Bank of England submission to a Treasury Committee enquiry into
the Monetary Policy Committee’s first ten years, noted that “many of the benefits
of globalisation have already worked through, and the adverse impact on commodity
prices of the development of China and India is now being felt”.
The improvement in the terms of trade had the effect of increasing the real value
of disposable income, allowing consumer spending to grow at above trend rates without
pushing up the rate of inflation.
Over the medium term, then, the probable pattern is that at a macro level the economy
will look largely like it has over the last decade, in terms of growth and inflation.
But with the authorities having to work harder to keep GDP growth close to trend,
variability in growth rates and in inflation rates may be greater than in the 1990s.
And the path to growth will need to change, which is a micro economic issue.
Whilst the direction of policy is likely to be the same, some questions arising
from the current recession about the detail of policy are worth raising. In particular:
- Should the official inflation target still exclude some measure of house prices?
- If so, how should asset price bubbles be managed – mortgage quotas, controls on
lenders, etc?
- Since much of the 2007 inflation was imported (food and energy), should the inflation
target be variable according to global economic conditions?
