Play economy blame game then move on

I have not felt as depressed about the domestic and global economic outlook for many a long year. Discussion is now turning to the vexed question of who is to blame.

I have not felt as depressed about the domestic and global economic outlook for many a long year. Discussion is now turning to the vexed question of who is to blame.

The electorate may have decided that Mr G Brown of Number 10 Downing Street is a suitable fall guy, but can we really blame chancellors past and present and Bank of England governors for the credit crunch, the US (near) recession, the ballooning of oil, commodity and food prices and the impact of this combined miscellany on the UK outlook? Not all their fault, I would argue.

Every new piece of data adds to the evidence of slowdown. That applies to consumers and business. Land Registry data show house transactions down 40% year-on-year. British Bankers' Association data show a 56% decline in mortgage approvals from last summer to this spring. Taken together that must imply that a sharp decline in house prices, across at least most of the UK, lies ahead. The only questions look to be: how far prices will fall and how long the downturn will last.

The housing market affects actual and perceived wealth - which in turn influence spending. Another influence comes from disposable income trends. Disposable incomes increased by less than 1% in the year to March 2008; and given (relatively) high and rising inflation alongside (relatively) low and stable increases in average earnings, the income squeeze must have intensified. Given these adverse figures, consumer spending must be set to slow sharply.

On the output front, the monthly PMI for manufacturing was dire. The index for June fell to 45.8. Any figure less than 50 shows a decline in output and this was the lowest figure since December 2001. Given that new orders have fallen faster and further than output, the worst of this sector's output decline is probably still to come.

The services PMI was equally appalling, down at 47.1, with outstanding business a depressing 43.4 and business expectations at a series low. This all suggests rapid growth deceleration and possible GDP decline ahead.

The word "stagflation" comes to mind more and more. This was a risk I addressed directly at the turn of the year - hoping to be proved a prophet of doom. Oh dear, doom looks to be closer at hand.

So, who do we blame? The combination of factors causing the present state of play makes this a very complex question.

The international environment has been a major factor in our downturn - through the implications of both the US slowdown and that credit crunch. The Federal Reserve took remarkably strong action to stimulate its economy when slowdown beckoned. It took major risks with inflation, and the inflation chickens are now coming home to roost, constraining monetary policy at least this year.

In fact, the imbalances within the US economy, and in relation to China et al, meant that short-term interest rate moves were about as effective as sticking plaster when surgery was required. This failure to deal with imbalances smacked of a short-term fix and meant that trauma at some stage was inevitable.

The credit crunch emerged from the US financial sector, spread globally at pace and again looks to have been due to an excess belief in the almost infallible stability of the system that had served us so well since the early 1990s. Risks were understated while regulation was probably inadequate. The consequences have been huge.

The rise in inflation has been another external phenomenon. Nobody agrees why oil prices have shot so far. Some lay the blame on supply constraints. But could the Organisation of the Petroleum Exporting Countries and company really solve the problem in the short or even medium term by turning a few taps? I doubt it.

The fact that various newer economies are growing so fast means that oil demand is accelerating away.

At the same time, the continuing political tensions across oil producing areas - and their neighbours - inevitably place a further risk premium on prices already heightened by the demand/supply imbalance.

Again, we face a long-term problem - with or without global warming - regarding energy policy in an oil-scarce world.

Closer to home, the Bank of England Monetary Policy Committee did ease rates in an attempt to limit the downturn, but now the spectre of excessive inflation becoming embedded in price and wage decision-making certainly constrains monetary policy here - understandably given the single and simple MPC target of CPI inflation control. Again the problem is rooted in the past. Now might be the time for tight monetary policy and a looser fiscal stance. But fiscal policy was, most would argue, far too lax in recent years and hence further loosening now is not feasible within any criteria for fiscal prudence.

The MPC may have been a touch relaxed on interest rates during the period that fiscal policy was unduly loose. Perhaps, but the evidence from the eurozone is that the same stagflation risks are emerging there, despite a very strict approach to monetary policy by the European Central Bank.

So the blame lies in the approach to policies over the medium term past rather than the past few months. We had an extended and incredible period of stability and success across the UK, the US and the eurozone. Decision makers may have relaxed too much, believing the incredible could endure.

Our policy and regulatory instruments have not yet proved adequate to deal with the complex nexus of forces at play. We look to be in for tough times for an extended period before we return to sweetness and light - also known as growth around trend and low and stable inflation.

Every decade or so there comes a time to seriously revisit macro management in the evolving domestic and international environment. That time is upon us now.