Frances Coppola discusses a remarkable recession
After over a year-and-a-half of chaos, it’s little wonder there are so many views on where the economy might be headed.
A few weeks ago we ran our interview with Jennifer Arcuri, Boris Johnson’s former mistress, who gave some pretty scary predictions which you can read here.
This week we’ve got the view of respected British economist, Frances Coppola. Frances worked in banking for over 17 years, but is now a financial writer and has featured in Financial Times, The Economist, The Guardian, and many more publications.
So we hand over to her expertise…
N.B. everything below is Frances’ own opinion and and doesn’t necessarily represent the views of Jasmine or the MoneyMagpie team. None of it should be taken as financial advice. Read on and make up your own mind.
A remarkable recession…by Frances Coppola
The 2020-21 recession is remarkable. GDP fell by nearly 10% between February 2020 and February 2021. By comparison, the financial crisis of 2008-9 caused annual GDP to fall by only 4%. Even in the Great Depression of 1930-34, the largest GDP fall was less than 8%. Not since the Great Frost of 1709 has GDP fallen so much in one year.
Now, the speed at which the economy is recovering is equally remarkable. Between April and June 2021, as coronavirus restrictions were eased, GDP increased by 4.8%. The UK hasn’t seen a quarterly growth rate that high in living memory. The economy is still smaller than it was in 2019, but it’s catching up fast, though growth is expected to slow over the rest of the year. The Bank of England estimates that the economy will be back to where it was before the pandemic by the end of 2021.
Perhaps the most remarkable thing about this recession, however, is its cause. Never before in history have governments the world over deliberately shut down their economies to prevent the spread of a virus. There have been global pandemics before, of course. The Spanish flu of 1921 is one such, and although there was no government-mandated shutdown, its economic effects in the UK were very nearly as severe as those of Covid-19: GDP fell by 9.7% in 1921. If governments hadn’t shut down their economies in 2020, would there have been such a severe recession? The lesson of the Spanish flu suggests that yes, there would.
But in one respect, this recession is completely different from any recession in recorded history. Governments have provided unprecedented amounts of support to the economy across all sectors. In the UK, the furlough scheme and business support schemes have kept businesses afloat and people in jobs, while the self-employed support scheme and extension to Universal Credit has limited cutbacks in consumption spending. Without these measure, the GDP fall would have been much larger, and the recovery might be much slower.
The Bank of England has also provided unprecedented monetary support to the economy and, perhaps more importantly, to the government. Without the Bank of England intervening to keep gilt markets functioning properly, the government might at times have struggled to give the economy the fiscal support that was so badly needed.
In the United States, the government has poured money into the economy and given out helicopter money to households, all of it effectively financed by the Fed’s enormous QE programme. In Europe, governments have turned on the fiscal taps to support their economies, extraordinarily supported by the ECB. Even Greece, which has been shut out of the ECB’s QE programmes, received ECB pandemic support. Central banks might not have intended to embark on “people’s QE,” but that was the effect of their interventions.
There have been gaps in government support, of course, particularly in retail, hospitality and the arts. Some people have not qualified for government support schemes, and some businesses have been unable to survive prolonged government-mandated closures. In the UK, the same sectors were also affected by new trade and employment restrictions when Britain left the EU’s single market in January 2021. It may take them a long time to recover from these twin shocks – if, indeed, they ever do.
More worryingly, it is already evident that young people will suffer long-term scarring because of disrupted education and job losses early in their careers. The children of the pandemic, like the children of the financial crisis before them, have paid a heavy price to protect their elders. At some point, there will be a reckoning.
But there’s another reckoning on the horizon, and one that we have seen before. In an important respect, this recession is no different from that of 2008-9. The government has poured money into the economy, and as a result its finances are an absolute mess. In 2010, the economy was rebounding from the financial crisis: GDP rose by 2.1%. But a deficit of 10% of GDP and debt/GDP of some 75% frightened the country into electing an austerity-minded government that cut back hard on government spending and imposed higher consumption taxes, notably on energy, just as world oil and food prices were rising. That knocked the stuffing out of the nascent recovery.
Now, the government deficit is 14.5% of GDP, and debt is 106% of GDP. Already, the Chancellor is signalling an intention to be tough about government finances, though it’s fair to say the Prime Minister appears rather less enthusiastic. But will the Chancellor be able to bear down on the deficit and debt as the Coalition government of 2010-15 did – and what would be the effect on the economy?
The Prime Minister has said there will be no return to “austerity” of the post-financial crisis years, by which he seems to means spending cuts. So fiscal consolidation, when it comes, is likely to mean tax rises. The Government has already signalled an intention to raise corporation tax significantly, in effect reversing the cuts of the last decade, and there might also be changes to capital gains tax and property taxes. Whether it will also break its manifesto commitment to maintain the triple lock on state pensions and not to raise income tax or National Insurance rates is as yet uncertain. But it has already broken its manifesto pledge to maintain foreign aid at 0.7% of GDP. If one pledge can be broken, so can others.
However, as we discovered in 2010, anything that drains money from the private sector risks inhibiting economic recovery. That includes both government spending cuts and tax rises. So the timing of the coming fiscal consolidation is as important as its nature. The recovery must be robust and well-established before any attempt is made to reduce the deficit. Otherwise, we risk replaying the 2010 disaster on a much larger scale.
Over at the Bank of England, there’s another risk too. Inflation is already above the Bank’s target, at 2.5%, and the Bank forecasts that it will rise further, peaking at about 4% towards the end of 2021 before falling back to target in 2022. The principal cause of this inflation is rises in energy and goods prices due to supply shortages and disruptions, so it should unwind itself as supply chains get back to normal and oil producers increase output. It’s worth remembering that in 2011, oil price rises increased inflation all over Europe: the ECB’s decision to raise interest rates in response to this supply-driven inflation contributed to the sovereign debt crisis of 2012. The Bank of England won’t want to precipitate a similar crisis for the UK by prematurely raising interest rates in response to supply shocks.
However, if inflation remains substantially above target for longer than the Bank currently forecasts, or it sees evidence that wage rises are starting to feed into price rises, the Bank might raise interest rates. Doing so would depress GDP growth and inhibit the rate at which the government’s deficit reduces, putting pressure on the government to cut spending and/or raise taxes.
The strong recovery and elevated inflation are also putting the Bank under pressure to call a halt to QE. In May, Andy Haldane, the outgoing Chief Economist and member of the Monetary Policy Committee, voted against continuing QE. And in July, the House of Lords’ Economic Affairs Committee produced a report sceptical of the benefit of QE and concerned about its unfortunate distributional effects. The Lords’ report sparked a flurry of opinion pieces in the press calling for an immediate end to QE. The Bank ignored these, but in August, the Monetary Policy Committee remained split over the benefits of continuing with QE. It seems possible that QE will end sooner than the Bank has previously signalled.
In summary, although the Covid-19 recession is remarkable in many ways, the risks to the recovery are the same as they were after the financial crisis. The unprecedented support that the government and the Bank of England have provided in this crisis have enabled the deepest recession for 300 years to be not only short-lived, but followed by the fastest recovery in living memory. The danger now is that policymakers, scared of elevated inflation and large government deficits, prematurely tighten both fiscal and monetary policy, causing another long-drawn-out slump. Tolerating higher inflation and large deficits for longer is surely preferable to another decade of gloom.