This blog was first published in The Herald newspaper on 4 August 2021.
By Graeme Roy, Professor of Economics at the Adam Smith Business School, University of Glasgow
It is interesting how sentiment on the economy can quickly turn from one extreme to another. Just a few months ago, the talk was of a UK economy in the doldrums, with a long road to recovery. Unemployment was forecast to rise to over 10% and many were predicting that the Bank of England might embark on negative interest rates for the first time in its history. Today, the talk in some quarters is of inflation and parts of the economy at risk of overheating.
So, what do we know about the path for recovery?
The first, and most important point, is that there remains huge uncertainty about the outlook. Whilst the latest predictions are undoubtedly more positive than earlier in the year, significant uncertainties remain. This is not just because of ongoing concerns about the spread of the virus and new variants, but also huge unknowns about how business and consumers will react as COVID financial support is lifted.
However, as social distancing restrictions have eased, there has been a sharp rise in activity across the economy. UK GDP jumped by over 6% between January and May. A further sharp rise is expected over the summer following the latest lifting of restrictions. The number of jobs furloughed has fallen from over nine million at the peak of the crisis to just under two million – including a fall of over half a million in June alone. Last week the IMF upgraded the UK’s growth forecast for 2021 to 7%, the joint fastest of any country in the G7.
UK inflation has risen to 2.5%, with the Bank of England’s former Chief Economist Andy Haldane predicting it could reach 4% this year. The respected National Institute of Economic and Social Research believe that there is a 1 in 10 chance that inflation could exceed 5%. These would be rates not seen in around a decade.
Were this to occur, there would be pressure on the Bank to tighten monetary policy sooner rather than later. Indeed, two members of its interest rate setting committee have already expressed the view that – whilst interest rate hikes might not be on the immediate horizon – the time for easing off on its Quantitative Easing programme is fast approaching.
Others have warned against tightening policy too soon, pointing out the risk to an economy recovering from a sharp recession. Given the significant levels of uncertainty that exist, these decisions will be close judgment calls for monetary policymakers. Judgements not just about the pace of recovery, but how much of the recent rise in prices is temporary and how much of it is a more persistent shift in the underlying dynamics of the economy.
For the time being, most of the recent growth in inflation has been driven by rising prices amongst goods and services – such as transport, eating out and fuel – that have bounced back from lockdown. In these areas, current levels of inflation are likely to slip back. Inflation expectations have also yet to shift significantly. But there are signs of concern. Supply chains remain in flux, putting pressure on prices that may be longer lasting. There are also signs of emerging wage pressures too. There were over 860,000 vacancies in the UK in the three-month period to June, nearly 10% more than pre-pandemic – fuelling concerns of a ‘wage-war’ for talent.
However, despite recent growth, the UK economy remains some 3% below pre-pandemic levels with other challenges, most notably the ongoing adjustment to post-Brexit trading arrangements, still weighing heavily on growth. Given this, and such high levels of uncertainty, the correct course of action must be for policymakers to wait for more sustained evidence of recovery before easing off too quickly on stimulus measures.
Doing so will also provide space for the Chancellor to put in place policies that shift the focus away from emergency lockdown measures to economic recovery. This will have to include support for those businesses hit hardest by lockdown, measures to address youth unemployment, and proposals to tackle rising poverty. A U-turn on plans to remove the temporary £20-boost to Universal Credit announced during lockdown would be a start.
At the same time, any debate on the future direction of UK economic policy cannot ignore the wider global context or our international responsibilities.
There is a growing divide between a more positive economic outlook for high-income economies like the UK, and a weaker outlook for middle and low-income economies. A key reason are the huge inequalities in vaccination rates. Recent data show that whilst close to 40 percent of the population in high-income economies have been vaccinated, it is less than half that in middle-income countries. In many low-income countries, less than one per cent has received one dose.
Vaccine access divides the global recovery: countries looking forward to greater normalisation of activity in the near future (most high-income economies) vs. countries still contending with prospects of resurgent infections and rising death tolls (many middle and low-income economies).
The fear is that for many lower income countries, economic recovery in Europe and North America will not only widen global inequalities but expose them to new devasting waves of the virus. Many do not have the fiscal buffers or resilience in their corporate balance sheets to cope with further lockdowns. A tightening of monetary policy in Europe and the US will only exacerbate fears of financial stress.
We cannot see our own economic recovery as anything but intertwined with that of the rest of the world. The virus does not recognise international borders, and if we are to have a sustainable recovery, domestically and internationally, countries must work together. Delivering on commitments for vaccinations across the globe is crucial. But it will also require a wider global economic response, with increased financial support for low- and middle-income countries.
In this light, the scaling back of the UK foreign aid budget this year is just as much a bad economic policy as it is a dereliction of our global responsibilities. It will be difficult for countries like the UK to build a consensus on global challenges, such as the transition to net zero, without showing leadership on the economic recovery from COVID.
Much of the focus and commentary on the path to recovery for the UK economy is dominated by daily signals on the outlook for inflation or the twists and turns of the latest economic statistic or survey. But it is the longer term, and global, challenges that will shape the future path of our economy as we emerge from the pandemic and where policy will have the greatest impact. Seen in this light, our priorities must align just as much with the needs of tomorrow and the coming decades as the worries of today.
Image credit: Sybille Reuter | iStockphoto