Policy Research in Macroeconomics

Vicious loop: rising private debt merging with falling wages, productivity & inflation

The Bank of England’s Andy Haldane is a fine economist. He occupies an ideology-free zone. This is highly unusual in central bank circles. He has just made a particularly skilful, and nuanced speech. Many gushed over it. Gillian Tett of the Financial Times suggested that it was good enough to qualify Haldane as a journalist.

But Haldane is not a journalist. He is a central banker. And that makes his ‘Twin Peaks’ speech particularly ominous. For while he bows to his political masters in the Treasury by acknowledging the growth in UK employment, his speech tilts definitively towards gloom. Let’s analyse it more carefully than I was able to do in a brief BBC Newsnight interview (eleven minutes into the show).

First, as part of his positive ‘Peak’, Haldane notes that “consumer price inflation, at 1.2%” has reduced “the squeeze on households’ real disposable incomes”. That is questionable, given the ongoing squeeze on household incomes. [Later in the speech he gives it to us straight: “average weekly earnings growth adjusted for consumer price inflation – is currently running at close to minus 1%” (My emphasis).]

He then goes on to make a remarkable “positive” statement. “According to financial markets inflation is expected to return and stay close to target over the medium term.” That is in my view a highly unlikely trajectory. And Haldane appears to agree, because later, in his conclusion he makes a tortured reference to disinflation as “the weak pipeline of inflationary pressures” – weak because of falling wages and commodity prices. So the financial markets are likely to be wrong again. And all the while deflationary pressures intensify.

Note that he, a policy-maker at the Bank of England is not telling us what the Bank considers the future direction of inflation to be. Instead he implies that the future direction of inflation is in the hands of markets, and not the central bank. That is depressing, but right of course, because the Bank of England, like the Federal Reserve has done almost all that can be done to manage inflation, given that the committee of men and women who decide on policy, have only one, not very effective weapon or policy tool: the central bank rate of interest. The current rate cannot reasonably fall much lower. Indeed the Bank can only maintain a 0% nominal rate – or as it is known, a Zero interest-rate policy (ZIRP).

What Haldane is saying here quite pointedly is this: the Bank of England can do no more. The clear implication is that now its over to the UK’s coalition government and in particular the Treasury to act – as the downward spiral of wages, commodity prices intensifies and debt-deflation threatens. The Treasury may still turn a deaf ear. Treasury ministers have since 2010 effectively sat on their hands when it came to dealing with the grave and ongoing debt crisis of 2007-9. Both Lib Dem and Conservative Treasury ministers have airily consigned responsibility for fixing the private finance system to ‘the market’. They place on the private sector the responsibility to “fix” both the UK and the global financial system and in particular to manage, re-structure or de-leverage excessive private debt levels. Ministers have instead concentrated, somewhat obsessively, on dismantling the state and cutting public sector jobs, spending and investment. These policies have in turn led to falls in UK wages. The result, as yesterday’s public debt and deficit numbers confirmed, is a predictable deterioration in the public finances – one we warned of in PRIME’s The Economic Consequences of Mr. Osborne.

So while the government is failing to achieve its target of cutting public debt, and instead has applied policies that have worsened the public finances, the market has singularly failed to address and manage the vast overhang of private debt. The UK’s private debt stands at 186% of GDP – more than double that of government debt – according to the recent 16th Geneva Report on the global economy: Deleveraging? What Deleveraging?   And as both private and public sector wages and incomes continue to fall, much of that private debt is unlikely to be repaid, further weakening the already shaky private banking sector.

Only a week ago, the UK Chancellor acknowledged that trouble is on the horizon – but slipped in a quick defence by blaming it on the Eurozone. “This is a critical moment for the British economy” he is quoted as saying. “The eurozone risks slipping back into crisis. Britain cannot be immune from that. It’s already having an impact on our manufacturing and our exports,” (9 October, 2014). So Haldane’s “reasons to be fearful” are shared by the Chancellor.

But Haldane the central banker is more direct than the politician. He takes great care to stress how positively awful is the fall in real wages. “Growth in real wages has been negative for all bar three of the past 74 months. The cumulative fall in real wages since their pre-recession peak is around 10%. As best we can tell, the length and depth of this fall is unprecedented since at least the mid 1800s.” Note also that Haldane made this speech on the eve of the TUC’s “Britain needs a Pay Rise” demonstration. That cannot have been a coincidence, and in itself sends a clear message that wage falls are becoming intolerable – both for workers, for society, but also for the economy as a whole.

Haldane then tackles the thorny issue of productivity and concludes “that at 15% below its pre-crisis trend level…(it) has not flatlined for that long in any period since the 1880s….” It is our view here at PRIME that the UK government has made what it considers to be a politically convenient trade-off between productivity and wages. The Coalition has a preference for low, and falling wages (as do many corporate bosses) and has been prepared to trade off low wages against productivity. If the government had preferred higher levels of productivity, it would have stimulated the creation of high-skilled employment via public investment in e.g. green technology and sustainable transport, which would have in turn encouraged private investment and the creation of higher-skilled, higher-paid jobs in manufacturing and other skilled sectors. Instead the Treasury has sat on its hands, and watched as wages and productivity have fallen precipitously.

As the recent cautiously drafted Geneva Report notes, and as the OBR confirmed in its 2014 Budget forecast, the savings rate of the UK’s household sector will continue to fall, while household debts are set to rise at a much faster rates. This ongoing rise in private debt, at both national but also at global level, is “interacting in a vicious loop” with “a poisonous combination” of falling incomes and weak productivity. Policy-makers in both Britain and the Eurozone are idly sitting on their hands and twiddling their thumbs as this vicious downward spiral intensifies. Worse: they are cheering on austerity policies which repress incomes and weaken productivity and output further, while doing nothing about dangerously high levels of private debt.

So Andy Haldane is right to be gloomy. Given the excessive caution of central bank speeches, we can go further and interpret his speech as sounding the alarm, and warning government that the monetary authorities have no more effective policy tools in their locker. Government must act – before it is too late, and the economy is plunged into another destructive, financial crisis.

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