We could be re-entering post-war Britain, not the 1970s
Capital Economics note looks at parallels between the middle of the twentieth century and now, and draws on implications for interest rates.
Queues at petrol stations and the spectre of inflation – coupled with low growth – have triggered concerns that the UK is in the midst of returning to the dark days of the 1970s. But is this the right historical comparison?
Not according to Neil Shearling of Capital Economics, a research outfit. In a note published earlier this week, Shearling said the situation was more akin to that seen in the decades following the Second World War.
If he’s right, then it’d make little sense for policymakers to react to the situation we have right now by removing fiscal and monetary support — even if, as the Bank of England expects, inflation is likely to rise to around double its 2 per cent target by the end of this year.
Shearling draws three parallels between today’s economic climate and that seen post-1945. The first is labour market frictions:
In the first 18 months after the war, seven million people were “demobbed”. But labour market frictions made it difficult to match this new supply of workers to available jobs. As a result, several sectors, including coal mining and agriculture, faced acute labour shortages while at the same time the overall number of unemployed workers increased.
The second: a rise in public debt and private savings.
By the end of the war, the UK was running a budget deficit equivalent to 22% of GDP. Last year it was 15.5%. In both periods, there was a large jump in public debt. Between 1939 and 1945 public debt increased from 153% to 242% of GDP. Today it is on track to rise to around 105% of GDP this year, up from 80% of GDP before the pandemic.
In both periods the expansion of budget deficits came alongside a large rise in private savings. And in both cases, this increase in private savings was the consequence of government intervention in the economy. During the pandemic, lockdowns prevented consumers from spending income, causing savings to accumulate. During the war, rationing performed a similar role.
Finally, there’s the boom in consumer demand — coupled with supply shortages — leading to a surge in inflation:
The output of steel in the UK was curtailed by a shortage of fuel, which in turn was held back by a shortage of labour. Finally, to make matters worse, the rise in inflation was exacerbated by a sharp increase in global commodity prices as the world economy rebounded. Between 1945 and 1950 the price of oil rose by 70%. All told, in the six years after the war the overall consumer price level in the UK increased by 35%.
All of which leads Shearling to conclude that we’ll see something akin to “financial repression”, when central bank policy kept debt repayments under control by keeping real interest rates (the nominal interest rate minus the inflation rate) negative, in the coming years:
Between 1945 and 1955 the real yield on 10-year UK government bonds averaged around -2%. These ultra-low borrowing costs helped the public debt burden to be brought down gradually over time. The institutional backdrop is very different today. But a decade of quantitative easing has blurred the lines between fiscal and monetary policy.
We think that’s about right. The BoE will no doubt raise rates, but in historical terms, they’ll remain low.
Disagree? Comments in the usual place.
