The economy is not looking great. CPI inflation at 3.8%, well above the 2% target, unemployment rising, GDP growth stagnant, the pounds losing value and to top it all off the unions are threatening strike action. What can we do about all this? We've seen this before in the 1970's when inflation and unemployment increased simultaneously, it's called stagflation, so how can we tackle it?
Well although Gordon Brown will be keen to be seen doing all he can, what he should be doing is leaving the Bank of England to do its own thing. The Bank needs to get inflation back down to target in order to stabilise the economy. This will mean rising interest rates which many argue will cause the economy to worsen, however whether the bank increases interest rates or not the economy does not look great. If the bank were to raise interest rates the money supply would be reduced, i.e. less money will be available in the economy meaning prices will fall.
If Gordon Brown is serious about economic stability then he should not give in to union demands for a 6% increase in public sector pay. This has warning signs all over it as there's a danger of a wage-price spiral. It's simple, if people get higher wages, they spend more and prices will go up further. And even if they do go on strike they won't last for long. I find it ironic when I watch the news when I see the strikers talking about how they're struggling with money and prices; if they're struggling that much how can they afford to lose 2 days pay by going on strike? As long as they're on strike they'll lose money and eventually they'll realise they'd be better off doing there work and earning some money than losing money by striking for a wishful pay rise.
And so what of unemployment? Many economist will be familiar with monetarism and Milton Friedman. He argued any attempt by government to reduce unemployment will lead to higher inflation. Not good. This is because increasing government spending will cause the money supply to increase, which means interest rates will go even higher than if the government did nothing about it. The government should simply leave businesses alone. If businesses are left alone by the government to do business, they will in time solve the rising unemployment.
Oil prices are another big problem at the moment. People are not happy about the price they're paying for petrol. This is not an easy problem to solve and I'm afraid long term the only way the price of petrol is heading is up. Its obvious as demand for oil is higher than 10 years ago due to the BRIC (Brazil, Russia, India and China) economies growing rapidly. And demand will continue to increase as their economies will continue to grow. In fact by 2050 the BRIC economies along with the USA will be the 5 largest economies on the world, ahead of Britain, France, Germany and Canada. Also the supply of oil will continue decreasing as our thirst for oil will mean stocks will diminish over time.
So long term petrol will continue getting more expensive. So what should the government do? Again I would say nothing. Just leave fuel duty at the level it already is and the market will correct itself. Eventually petrol prices will reach such a level that consumers will seek more fuel efficient cars or use alternative cheaper fuels such as hydrogen powered cars. The environmental benefits of this are tremendous and it's all because of market forces. I must point out this would not be deliberate in the pursuit of saving the environment, it is an inevitability.
After all these economic woes people are worried about the one they fear most is falling house prices. So they should be as it is the biggest asset that most people own. However this credit crunch should be seen as a blessing in disguise. Since the collapse of Northern Rock and many American banks, banks are lending less rashly. At least now we can be more assured that there will be more stability in the market as banks aren't lending to people who they know will default on their payments. In the mean time although people may be struggling to pay their mortgages they must realise this, that in the long term house prices will rise. There are always periods where house prices fall, most recently this was in the early 1990's, but give it 2 or 3 years they will start rising again.
So the big economic question looming at the moment is will there be a recession? Personally I don't think so although growth will be sluggish. There is still signs in the economy that the economy still has strength. I would simply say that the economy is cooling off after over a decade of strong growth.
And to sum this all up I will declare what I feel should be done at the moment to get us through this economic slowdown. Firstly leave the Bank of England to sort out inflation. Secondly keep the restraint on public sector pay. Thirdly leave businesses alone to do there thing. Fourthly leave fuel duty at its current level. Lastly leave the housing market to take its own path, it will recover in time.
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