David Smith - Economic truths: Britain tames the bulls and bears - Monetary and fiscal policy have been conducted in a highly responsible way for some time. The UK has a stable economy. Can it last?

David Smith - Economic truths: Britain tames the bulls and bears - Monetary and fiscal policy have been conducted in a highly responsible way for some time. The UK has a stable economy. Can it last? - In its latest assessment, the Organisation for Economi

by DAVID SMITH
Last Updated: 31 Aug 2010

In its latest assessment, the Organisation for Economic Co-operation and Development gave it to us straight. Britain now had a 'less cyclothymic' economy, and that is a good thing.

Before you reach for your dictionary, let me say I did not know what it meant either. Cyclothymia, it seems, is 'a temperament inclined to alternation of high and low spirits'. The fact that we have become less cyclothymic means we are less subject to those wild economic mood-swings, one moment raging bulls, the next growling bears.

It means - and I must remind Tony Blair and Gordon Brown that I hold the original copyright on this phrase - no more boom and bust. An economy once noted for its volatility has become remarkably stable.

I thought it worth examining Britain's stability and trying to answer the question on everybody's lips: can it last?

First, some facts. The economy did not suddenly become stable on 1 May 1997. The most impressive piece of economic policymaking in Britain in modern times was in the autumn of 1992 when, out of the wreckage of the country's involuntary exit from the European exchange rate mechanism, a new policy framework was constructed.

Thus, the Bank of England was given an enhanced role, both of monitoring and forecasting inflation and of openly advising the chancellor on interest rate decisions. And, for the first time, inflation was explicitly targeted, rather than anything else.

Sadly for Norman Lamont, the then chancellor, the 'Norman and Eddie show' never really got going; Kenneth Clarke took over just as the new framework was bedding in, and we should take the period since then as our measure of the new stability.

Over that time, Britain has achieved the longest unbroken phase of economic growth since quarterly records began in the mid-1950s. This has averaged 2.8% and - most impressive of all - been higher than inflation, which has averaged 2.7%. Employment has grown to record levels, pushing unemployment below 4% on a claimant basis. After a disastrous start, the 1990s turned into a golden age, which, it appears, is continuing.

I have not mentioned Bank of England operational independence, Brown's boldest act. It would be churlish to deny that it has strengthened and given greater credibility to the Ken-and-Eddie framework. With politicians out of the way, people and businesses are entitled to believe that low (2.5%) inflation, with occasional hiccups, will stretch into the future.

Nor have I mentioned the extraordinary health of Britain's public finances.

Again, the roots of this are in the past, in particular the two big tax-raising budgets of 1993, one Lamont's, the other Clarke's. These set the public finances on a rapidly improving course. When Brown took over in 1997 he was encouraged, not least by the Treasury, to believe the budget deficit of the early 1990s needed more tightening. As we can see from the current embarrassment of exchequer riches, he need not have done so.

What we have had in Britain, then, has been unusual. Monetary and fiscal policy have, over a long period, been conducted in a highly responsible manner. It has worked out well, so why didn't we think of it before?

The glib answer is that conditions have been so benign, particularly in terms of global inflation, that it has been easy to run a good policy.

Yet there have been plenty of times in the past when British governments have messed things up without assistance from the outside world.

The real point is that, since 1992-93, macroeconomic policy has been run in an ideology-free way. It is easy to forget that, however impressive the microeconomic achievements of the Thatcher government, they were accompanied by a flawed and badly conducted monetarist experiment.

Ideology also got in the way of good macro policy in the 1970s under both Labour (Denis Healey's Keynesian expansion during the world oil crisis) and the Tories. When the present framework for policy was hit on in the autumn of 1992, almost everything else had been tried, usually with poor results.

Can it last? The moment people start declaring golden ages for the economy is the time to shift your money to Switzerland. One risk is that Brown will disperse the proceeds of past prudence too quickly.

I am confident, however, that the longer the current framework delivers low inflation, the more it will be able to do so indefinitely. Even the most cyclothymic among us will accept that things have changed.

The real worry is that the economic stability of the past seven years or so has been achieved alongside instability in another important area, that of the exchange rate. Would Britain's economy have been so stable without the pound's fall and rise of recent years? Probably not. Could it be so stable in the absence of sterling volatility, which has acted as a safety valve for the economy? Perhaps not.

A stable exchange rate could, paradoxically, give us an unstable economy.

That, however, is another story.

Visit David Smith's web site: www.economicsUK.com

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