Hiking interest rates no answer to UK Brexit woe

The US economy is clearly slowing. On Friday we saw the unemployment rate rise by 0.3 percentage points from 3.4% to 3.7% and a big decline in employment on one of the two employment measures. My work with Alex Bryson (Blanchflower D.G. and A.J. Bryson, ‘The economics of walking about and predicting unemployment in the USA‘, National Institute Economic Review, August 19, 2022) suggests a monthly rise of this magnitude is the best indicator of the start of a US recession, as called by the NBER Business Cycle Dating Group.

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Consistent with this slowing, US credit card delinquency rates are back to 2008 levels. Office vacancy rates are rising: in New York it is 48%. Restaurant demand is slowing. Cellphone activity is down in the majority of major cities - downtown San Francisco it is 31% of pre-pandemic levels while in Chicago it is 50%.

It may surprise people to know that markets are pricing in eight rate cuts by the Federal Reserve by December 2024 from the current 500-525bp (basis points) to 300-325bp with cuts starting in 2024. Inflation in the US has also been declining fast and may go negative by 2024 as it did in 2009.

There are two patterns in the data: declining goods inflation and rising services inflation. During the pandemic people bought goods and now that spending spree has stopped. Plus, consumer durable demand is down as most people use financing and interest rate costs are up. Auto loan interest rates are now 7.5% versus 4.5% a year ago and auto loan delinquencies are a problem. Alongside this there is rising services inflation as people are doing what they couldn’t do in the pandemic - going on cruises and to theatres. The number of people going to Broadway shows and theatres is now back to 2019 levels.

Inflation in the US is currently 5% and I expect it to drop below 4% over the next two months as large base effect increases from 12 months ago - of 0.9% in June and 1.2% in July - drop out of the calculations. If we use the average monthly change observed over the last six months, of 0.3% a month, I expect inflation to be 4.4% in June and 3.5% in July.

Other European countries last week also saw surprisingly large drops in inflation. Spanish inflation dropped to 3.2% - its lowest level for two years. The drop in German annual inflation from 7.6% in April to 6.3% in May reflected a sharp slowdown in energy prices as well as lower inflation for food, other goods and services. Economists polled by Reuters had forecast a figure of 6.8%. French inflation fell to 6% in May, down from 6.9%. CPI inflation in the UK, in contrast, is a disappointing 8.7% after eight of the last ten months in double digits. Despite 12 successive rate increases and asset sales by the MPC which appear to know not what they do.

Sadly, these rate rises have hardly had any impact at all on inflation - which was caused by supply chain issues after the pandemic, the Ukraine war and Brexit. Brexit and its devastating impact on supply chains, especially for food, is what sets the UK apart from every other country. This can't be fixed by rate rises.

Unsurprisingly, in their own survey, confidence in the Bank of England is at record lows. Then Chancellor Jeremy Hunt said it would be just fine to create a recession? Really? I don't think so. We know that inflation hurts but purging it comes at a cost which turns out to be worse.

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Slowing the economy means a rise in joblessness. Recent work (El-Jahel, L., R. MacCulloch, and Shafiee, H. (2022), ‘How does monetary policy affect welfare? Some new estimates using data on life evaluation and emotional well-being', Journal of Money Credit and Banking) has looked at wellbeing and found that a one percentage point rise in the unemployment rate has a six times higher impact than inflation on life satisfaction, is four times higher for smiling; enjoyment five times, nine times for sadness and thirteen times for pain. Thirteen!

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But two dissenting members of the MPC Swati Dhingra and Silvana Tenreyro, who care about ordinary people, know what is going on. At the last meeting they voted against a rate rise arguing that they expected inflation to plummet soon plus all the rate rises hadn’t actually had time to work yet. This is what they sensibly said (the rest are in Gagaland): "The lags in the effects of monetary policy meant that sizeable impacts from past rate increases were still to come through. That implied the current setting of Bank Rate would be likely to reduce inflation to well below target in the medium term. As the policy setting had become increasingly restrictive, this would bring forward the point at which recent rate increases would need to be reversed.” Exactly.

Larry Summers in a BBC Radio 4 interview this week got it spot on. Brexit, he noted, is an “historic economic error” that damaged the UK economy and drove up inflation. The problem for the MPC is that 12 rate rises have lowered the CPI by around a percentage point – rate rises can't compensate for inability to import cheap food and materials. The treatment isn't working but it seems more of the same is planned - why? To get CPI to the 2% target or so, following the MPC's logic could well require rates to go beyond 25% with the same (pathetic) success rate. UK borrowing costs are back to where they were under Truss as the markets have once again lost confidence in UK PLC. The moron premium is back. Where is that lettuce?

Danny Blanchflower, Bruce V. Rauner ’78 Professor of Economics, Dartmouth College, and University of Glasgow