Chancellor and Governor

Later in term we will spend some time thinking about monetary and fiscal policy; these are the two ways in which governments attempt to influence economic activity, wisely or otherwise.  Both are currently in the news regularly; fiscal policy because the Coalition is running a very tight fiscal policy in order to bring down the government deficit, and monetary policy because interest rates remain essentially at zero yet inflation is high.

The current monetary policy arrangements have the Bank of England commissioned by the government to set interest rates to achieve an inflation target of 1-3%.  However, for 20 of the last 30 months, that target range has been missed by the Bank.  Every time the target is missed, the Governor of the Bank of England, Mervyn King, must write a letter to the Chancellor explaining why the Bank has failed in its duty.  The Chancellor usually responds, and these letters, in the interests of openness, are published on the internet.  Here is George Osborne's recent response to King.

The interesting aspect of this letter is that Osborne suggests that by staying the course of the government's very tight fiscal policy, this will help monetary policy to be more effectively conducted because without it, inflation would surely happen.  Of course, there are plenty of counter arguments to this assertion, not least that given inflation is generally imported inflation currently (cost push), then it will not necessarily fall due to domestic actions by governments (unless they can increase the exchange rate).  Furthermore, such a contractionary fiscal policy could yet see the UK returning to a recession (we saw negative growth in the last quarter), in which case again if inflation is imported, there seems little reason why this would make the Bank's job any easier: Inflation will still be high, and the economy in a recession.

Furthermore, whatever the government does with fiscal policy, the Bank can always counteract with monetary policy: Assuming their efficacy, if fiscal policy was loose, then tight monetary policy would suffice to keep economic activity reasonably constant, and equivalently a tight fiscal policy could be counter-balanced with a loose monetary policy (so QE2 and more).

GDP Growth Announcement

Every three months or so, the Office for National Statistics releases the numbers for Gross Domestic Product (GDP) for the previous quarter (three month period). Today it released its first estimate of what GDP was for the UK in 2010Q3 (the third quarter of 2010) which is based on about a quarter of all the information available to them.

Next term we'll talk quite a bit about GDP but the BBC's economics section has quite a nice description of it if you're not familiar.

In 2010Q2 the UK economy grew by 1.2% which was surprisingly high, but it is often the case that as an economy starts to emerge from a recession that it grows strongly. Growth in 2010Q3 was expected to be much slower with many pundits expecting about 0.4%. Today though that number came in at 0.8%. It means that for 2010 as a whole, growth is likely to be just shy of 2%.

Does this mean the economy is up and running and all is well? As the BBC article makes clear however, there are other reasons to be a little bit pessimistic about future growth: Retail sales fell in September, and house prices are falling (these are seen as a barometer of economic activity). Furthermore, the impact of the Coalition government's steep spending cuts will start to take effect soon, something else that is likely to depress future growth.

Policy Uncertainty

One thing we'll talk about second term is the impact uncertainty can have on economic outcomes.  In other words, if people are uncertain, they do less: They don't take big decisions.  In particular, they don't make investment decisions.

A big thing in the US currently is the impact of uncertainty over government policy, and its impact on the economy.  Tyler Cowen at Marginal Revolution (a blog well worth subscribing to for both terms of your econ101 experience) has this post about it.  Some people suggest that uncertainty over policy is the reason why the US economy is not recovering strongly.  These people are generally Republicans responding to the fact they are out of power and trying to lay all the blame at the foot of the in-power Democrats.

As Cowen points out though, there's much more at stake - not least the restructuring that's going on in the US economy.

The main point I think is: Don't trust anyone who tries to tell you there's a single cause for why the economy is in the mess it's in, either this side of the Atlantic or the other.  There's many, many causes, and a huge number of alternative solutions out there that may or may not work.  The economy is a complicated beast, and far too complicated for single-cause explanations...