The most interesting bit about George Osborne’s autumn statement this year wasn’t all the stuff on how long weak growth will go on for, or how bad Britain’s public finances are.
We knew all that already. Economies can’t grow when they’re suffering the deflationary effects of a banking crisis, the inflationary effects of a poorly supported currency and the deadening effects of a vast state. It doesn’t matter how much fiddling you do, transferring bits of money from one special interest group to another, unless you take radical action to get rid of one of your problems (deflation, inflation or the government), all you can do is thank your lucky stars if your economy isn’t actually shrinking.
I imagine that’s what George Osborne does in private, while simultaneously praying for global bond markets to continue to be fooled by his spurious claims of austerity even as he increases the national debt by 60% in his first parliament alone.
So, to the interesting bit: the admission by the Office for Budget Responsibility (OBR) that Britain’s potential output is smaller than it was pre-crisis. A proper credit bubble followed by a real banking crisis permanently damages an economy. Capital is misallocated and low rates allow capacity that should never have been created to be created. All of a sudden, demand disappears as do all loans and access to working capital. Businesses that go bust under these circumstances represent permanently destroyed productive potential.
Take a restaurant launched on a pile of money secured against the rising price of a domestic house in 2007. It goes bust in 2008. Its front is boarded up. Given that there is no longer any lender daft enough to make a similar loan to the next middle manager who wants to get out of the rat-race by opening his own place, we know it won’t open again (until the next credit bubble rolls round).
So it isn’t part of the output gap. Same goes for all activities that were originally based solely on the existence of mispriced credit. This recognition by the OBR matters. Why? It reinforces the point about us having lower growth for longer. But also because the big excuse for claiming that quantitative easing isn’t inflationary is that the output gap prevents it from being so. But if there is not much of an output gap, that argument no longer entirely holds.
The lack of an output gap isn’t just an issue for Britain. Halkin’s Peter Warburton has been drawing attention to the supply side nature of global inflation for some time. Last week he got back from a three-week trip to Asia, more worried than ever. The global credit boom diverted money away from infrastructure investment, he says, and the bust has now raised the cost of capital for it. That squeeze will soon feed through into the prices of everything from food to transport. Add that to the shift to global QE and you can see why Warburton is still an inflationist.