The EU have agreed to a bailout for the Greece economy. The UK will not be involved.

The EU have hinted at a stricter implementation of fiscal rules. The EU used to have the Growth and Stability Pact, which limited government borrowing to 3% of GDP. But, countries have routinely ignored this. (Greek borrowing hit 12% of GDP)

However, a strict implementation of the growth and stability pact could have damaging consequences for countries who don't have their own monetary policy.

The bailout doesn't mean the end of the problems for the Greek economy

Drastic Economic Measures

Readers Question: The Daily Mail of March 5th says the Government is borrowing £600,000,000 a day ? That is 25 million an hour or £416,000 a minute. At present we have a Budget Deficit of £178 Billion which will be increasing by 4.2 Billion a week. When I read it I thought it was a mis-print Is this figure correct ? Am I right to be worried ? I just don't understand how the UK Economy will ever be OK ?

Annual government borrowing is expected to be around £178 billion (or 12.6% of GDP). This is being added to the total national debt (accumulated over many years) of £848.5 billion.

Reasons To Be Worried over UK Economy

• The annual deficit is a record level for peace time. (We have had higher annual deficits, but, only in wartime)
• In past few weeks, political uncertainty - prospect of hung parliament have made markets worry we don't have a concrete plan for reducing debt after election. This market uncertainty has caused the pound to have a rough weak.
• Sluggish nature of economic recovery suggests tax receipts will be slow to rise. Reducing deficit too quickly could push economy back into recession.

Reasons Not To Be Worried.

• We've Borrowed much more in the past.

See also: UK National Debt

• The UK has had periods of much higher national debt in the past. Government borrowing was over triple current levels in 1950. In the late 1940s we set up the NHS, welfare state and laid foundation of longest economic periods of expansion on records. Debt doesn't have to be a constraint on growth. (Though debt certainly doesn't guarantee growth - just look at Japan since 1990s)
  
• Political uncertainty is somewhat misplaced. There is no guarantee of a hung parliament. And even with a coalition I think parties may be able to find consensus on reducing deficit.
• British debt levels started from a lower level. Other countries have much higher debt levels such as Italy and Greece over 100% of GDP. see: list of national debt by country.
• If the economy does recover, then annual borrowing will fall. The return of bank profits and bank bonuses may seem unfair - but, it is actually good news for the fiscal position because we will get more income tax. True there is still a structural deficit. But, it is good economic sense to allow borrowing to increase during a recession - see: Should we worry about national debt?
  
• Interest rates are low. Interest rates are low in the UK, meaning the cost of financing national debt is low. The rate on long term gilts (30 years) is 4.1% (and it's fallen since the start of 2010) This means we spend a relatively small percentage of GDP on debt financing.
• Debt maturity. The average UK debt maturity is 17 years. This is a much longer time period than other countries and means we have to refinance a small % of debt than before.

The level of government borrowing is a serious concern. But, it is not unmanageable. We still have a triple A credit rating and debt financing costs are low. As long as reasonable attempts are made to reduce the structural deficit and this doesn't cause another recession, the UK should be able to ride out this challenge to the nation's finances.

Related

• Historical National Debt
• How is National Debt Financed?
• Who Owns Government Debt?
  

One of the difficult things in economics is measuring the impact of a policy. For example, you could argue, the UK's recession was one of the deepest in Europe, therefore, this shows the failure of our fiscal policy and Monetary policy which included Quantitative Easing.

However, such as a simplistic conclusion is likely to be misleading. There were several factors that made the recession very deep, and it could have been deeper and more prolonged without the unorthodox policies and unprecedented intervention.

A report by Capital Economics suggests that Quantitative Easing has boosted GDP by 2-3%. That's not much considering it involved £200bn of asset purchases. But, without it the economy would still have been in recession. (link Telegraph)

This indicates that since quantitative easing began last March, banks have hardly been in a rush to increase lending. But, it also means the scale of quantitative easing has created little if any inflationary pressure as some feared.

It would be interesting to see a report on the impact of a record expansionary fiscal policy (budget deficit of 12% of GDP). I would hazard a guess, the budget deficit has had a similar impact on GDP of + 2-3%.

Related

• Quantitative Easing Explained

As we mentioned earlier, leaving the Euro is not a realistic policy. So how does Greece deal with its economic crisis? How does it cut its debt and return the economy back to strong economic growth?

The immediate answer which springs to mind - is with great difficulty.

Unfortunately, Greece has no recourse to any real loosening of monetary policy. They can't devalue the exchange rate, they can't pursue an independent policy of quantitative easing, they can't leave the Euro.

Yet, at the same time, bond market pressure is forcing them to cut their budget deficit - just at a time when the economy needs fiscal policy to provide a boost in aggregate demand not a tightening.

One solution that springs to mind, is to cut public sector wages, and cut the bloated Greek civil service. This spending cuts would provide the markets with clear evidence of sincere efforts to tackle the budget deficit. But, if (and it is a big if - given political situation) the Greeks were able to cut wages there would be negative impact on output and spending.

Certainly the cut in government borrowing is desirable, if not necessary from a fiscal point of view. But, the cut in wages and rise in unemployment would reduce Aggregate Demand and worsen the recession. Greek GDP fell 1.5% in 2009. There is a danger this could be much worse this year.

It is one thing to cut public sector employment, but, it is hard to see job creation in private sector.

Greece along with Spain are suffering from a lack of competitiveness - indicated by size of current account deficit. To boost competitiveness would require a prolonged set of measures to tackle wage inflation, boost competitiveness, encourage innovation, more flexible labour markets e.t.c. It's easy to talk about 'increasing competitiveness' but in the real world to actually achieve improvements in competitiveness requires significant time, effort and political will.

I certainly wouldn't like the job of Greek finance minister. There is an element of having to grin and bear it. Hoping that despite austerity measures, the economy will somehow bounce back and return to positive growth. It will be interesting to see how the Irish economy fares. So far they have been relatively successful in tackling the budget deficit. Hopefully, they may provide a model for an economy cutting the deficit and being able to return to positive growth.

There is no quick or easy fix. I would suggest that borrowing from IMF or EU would be a good step for Greece. It would help to minimise the impact of deflationary fiscal policies at a time when they have very few alternatives.

Related

• Problems with Greece Economy

A while back, I looked at the case for placing less emphasis on an inflation target of 2%.

Axel Weber, a leading contender to succeed Jean-Claude Trichet as the next president of the European Central Bank has criticised Olivier Blanchard, chief economist at the International Monetary Fund, for his suggestion inflation targets should be raised to 4 per cent to help in fighting the economic crisis. Weber states raising the inflation target to 4% is not just “playing with fire”, but is “reckless and deeply damaging”. This highlights the predominance, the ECB, give to low inflation at all cost. via ( Telegraph)

The ECB have a very strict attitude to keeping inflation low. This model of low inflation has generally served the German economy well. The post war period has been an era of prolonged expansion, against a backdrop of low inflation. After the trauma of the hyperinflation in Germany in the 20s and hyperinflation in countries like Austria and Hungary in 1945, 46, it is at least understandable that the, Bundesbank dominated, ECB want to keep a low inflation target. The problem is that there is a difference in targeting 2% inflation for German economy and targeting 2% inflation for Eurozone.

The Case for 2% Inflation Target

Having a low inflation target has reduced inflation expectations. It would be a real shame to throw away these hard won gains. If an inflation target is revised upwards, people may no longer take the inflation target seriously. Once you lose these low inflation expectations, it may be difficult to keep inflation under control. It may require a situation of permanently higher interest rates.

Criticisms of ECB View

The problem with sticking to a 2% inflation target is that:

• Inflation increasingly volatile. The UK has been experiencing swings in the headline inflation rate. Often spikes in inflation are temporary events which don't reflect the underlying situation of excess demand. If you target inflation at 2% there is a risk of ignoring a wider economic picture.
• True, high inflation has costs. But, it is not at all clear that inflation of 3% of 4% is really as damaging as some Central Banks make out.
• By targeting low inflation of 2%, it means that some areas in the Eurozone - especially those suffering from a lack of competitiveness i.e. Greece and Spain face the risk of deflation. Whilst the costs of moderately higher inflation are uncertain, the costs of deflation should be crystal clear. Deflation raises the prospect of prolonged downturn and creating a deflationary debt cycle. Exactly the last thing, economies in the south of Europe need.If I sound repetitive repeating the dangers of deflation it is only because deflation could be catastrophic and the powers that be in the ECB seem too quick to dismiss it.
• Liquidity Trap. - We are still effectively in a liquidity trap with interest rates close to zero; but, some economies remain sluggish and stuck in recession. Higher inflation and higher nominal interest rates would be a good thing not a bad thing.
  

A higher inflation rate would give monetary policy more flexibility and enable it to be more pro-growth. It would lead to a weaker Euro. But, at the moment, a weaker Euro is no bad thing. The EU need to realise the biggest problem facing the Eurozone is not some absurdly remote threat of inflation, but, the real potential of deflation and continued mass unemployment.

Related

• ECB and Bank of England

The economic situation in some of the peripheral EURO economies like Greece, Italy and Spain is pretty grim - with a prolonged recession, prospect of deflation, uncompetitive exports, rising unemployment, and current account deficits. In the case of Greece it is compounded by record levels of government debt.

A textbook solution to the above problems, is to allow a devaluation of the exchange rate and pursue a more expansionary monetary policy.

But, being in the Euro, it would be very problematic to do it. Exchange Rates are permanently fixed, and the ECB show no signs of deviating from its religious devotion to low inflation whatever the costs.

One question is can an economy actually leave the Euro and go back to it's original currency? Could Greece leave the Euro and readopt their own currency?

Problems of Leaving the Euro

Firstly, there are grave political problems, the fallout could affect the economies reputation and lead to less confidence and less investment e.t.c in the long term.

Transaction Costs. Switching from one currency to another is a significant cost. Not only do you have to re-introduce a currency, but, also change over bank machines, and any coin operated machine. This is not insurmountable. After all, it was achieved in switching over to the Euro. But, the difference is that in 1999 there was an enthusiasm and willingness to pay for the transaction costs - it was sold as a one off. The cost and inconvenience of making the transition in an economic crisis is much harder to gain public support - let alone enthusiasm.

Euro Savings and Mortgages Need to be Converted. A more significant problem is that Greeks would need to not just convert currency but also all financial contracts currently in Euros. Savings in banks, mortgages all would need converting at a pre-arranged level.

The difficulty is agreeing an exchange rate to make the conversion to.
If markets thought the level was too high, and the currency likely to depreciate there would be an outflow of savings from Greece to other Euro countries where savers can guarantee the level of their savings. If people expected the Greek currency to devalue significantly against the Euro (quite a likelihood, they would want to deposit abroad.) It could lead to a run on Greek bank deposits.

It would be even more difficult to get people to buy Greek bonds because no one would want to hold a bond with likelihood of devaluing currency.

Wage Contracts. In a country like Greece, it would be difficult to re-negotiate wage contracts. Powerful trades unions, may demand a large nominal wage increase to compensate for the devaluation in the Greek currency. If unions were successful in gaining large wage increases, this may offset the gains in competitiveness due to devaluation.


Leaving the Euro

If the ECB decided to tackle deflation and print money (about as likely as the US forming a single currency with Cuba and Mexico). A country like Germany may get fed up with the devaluation of the Euro and general decline in competitiveness. They could leave the Euro, without the risk of a run on bank deposits. In fact the opposite could happen, The new D Mark would be very strong compared to the Euro, and it would be much easier for Germany or a strong economy to leave the Euro. Interestingly, I see David Blanchflower raising the theoretical possibility of Germany leaving Euro to re-form the D-Mark (Germany jettison Euro). The D-Mark would appreciate helping struggling Euro members to regain competitiveness.

Obviously, I can't see this happening, but, theoretically it would be much easier for Germany to leave than Greece.

• more on Leaving Euro
• Why UK will never join the Euro.

The 1990s began with a severe recession, and a humiliating exit from the ERM.

The mirage of the 1980s bubble had exploded. Inflation, once thought to be defeated once again had reared its ugly head. All the hard won gains of the 1980s seemed to be lost.

Belatedly, the government sought to tackle the bubble inflation indirectly through the Exchange Rate Mechanism - a semi fixed exchange rate. This required exceptionally high interest rates which made a mild recession into a much deeper recession, - unemployment soared. More detail - ERM Crisis 1992

The worst hit area of the economy was the housing market. After enjoying the heady days of the late 80s with 30% annual growth in house prices, the housing market slumped as people simply couldn't afford the record mortgage interest payments. House prices began falling in 1990, and were still falling in 1995. Adjusted for inflation, the real house price fall was even more dramatic.

As the economy recovered, the primary objective of economic policy was geared towards avoiding future booms and busts, which the UK economy seemed particularly prone to.

Rather than target indirectly through money supply or exchange rate, the Bank of England were given a specific inflation target of RPI 2.5% +/-1

By, 1997, the Bank of England were made independent, giving them control of setting interest rates. It was hoped, an independent Bank would not be vulnerable to the political cycle of creating a convenient economic boom before an election. It was felt the Bank of England would have the willingness to make unpopular decision in keeping inflation under check and avoid the boom and bust which had weighed down the UK economy. Importantly, it was hoped, that people would have confidence in the Bank of England and this would help permanently reduce inflation expectations.

On a narrow judgement, this has been remarkably successful. Inflation, remained low throughout the 1990s and into the 2000s, since the end of the Lawson boom, UK inflation has been close to the government's target of 2%, apart from the odd temporary deviations. It is certainly nothing like the inflation problems of the 1970s and 1980s.

By, the end of the 1990s, the economy seemed to be doing well, and quietly there was growing optimism. Already people were talking of the end of boom and bust, the new buzzword was the period of great stability.

It seemed that this new policy of inflation targeting had solved all the major economic problems at a stroke. This new found optimism was perhaps summed up by a quote by Paul Krugman in 1997. Quote

“If you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: it will be what [Alan] Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God.”

After the 1992 recession, a flexible labour market helped unemployment fall quickly (much more quickly than after the 1980s recession)

Economic growth was positive, unemployment falling rapidly and towards the end of the decade, the government even recorded a budget surplus.... Surely nothing could go wrong now?

Related

• UK economy in 1980s - The Thatcher Revolution
• Modern Economic History of UK
• Economics of the Naughties
  

Hi, I would like to ask if China went into a recession, would that make the economies in other countries that are currently in recession better off? In other words, would it improve relatively the state of the economy in other countries considering the standard of the market has fell?

If China went into a recession, it would adversely affect other economies.

China's economy is primarily based on exports. But, as one of the largest economy it is still a significant importer, especially of raw materials. If China went into a recession, global commodity prices and demand for commodities would probably fall. This would be bad for economies like Australia and Canada which produce significant amounts of raw materials.

If China went into recession, there would be an adverse effect on world trade. China would buy less imports and this would lead to a slowdown in global trade. It could also have a significant effect on global confidence, causing sluggish global growth.

I was interested to recently learn that the UK exports twice as much to Spain as it does to China. Therefore, we might expect a recession in China to have limited effect on UK economy. But, the Chinese economy is such an important influence on global economy that the UK would be effected indirectly.

There are also a few uncertain outcomes. For example, in a recession, would China still have a large current account surplus? (you would expect the surplus to remain). In that case, China may continue to buy dollar assets and it would have an incentive to try and keep its exchange rate low.

• It depends why a recession in China occured? - was it due to a collapse in external demand or due to a tightening of Chinese Monetary policy.
• Would the recession affect other Asian countries as well?
• A recession may well heighten trade tensions and could lead to a rise in protectionist sentiments.

Impact of Chinese Recession in China

The biggest concern over a recession in China would be the impact on China itself. The transition from a rural economy to an urban economy has been so swift that it has been estimated that China needs a growth rate of 7.2% to prevent a rise in unemployment. [1] Negative growth could have a devastating effect on Chinese society - where there is little if any unemployment insurance.

Chinese Economy vs US Economy

If Chinese GDP fell, the US may gain a bigger share of world GDP; therefore it may be doing relatively better than China. But, a recession in China would damage the absolute living standards in the rest of the world.

How Likely is a Chinese economic Collapse?

I can't see it in the short term. But, a significant downturn is quite possible. This question would need more analysis though

Related

• Impact of Recession in China
• Problems of Chinese Economy
• Chinese Economic Bubble

If the 1970s, ended with a feeling of powerlessness, who else could have taken power but Margaret Thatcher? Before her election, few would have realised her conviction and rigid adherence to a new market based ideology. Few, if any could have predicted how she took the economy and reshaped it in her own image.

Whatever, you might say about Thatcher, the period is certainly interesting for economic historians.

The late 70s left two major economic problems - high inflation and industrial unrest. With her chancellor, Geoffrey Howe, she took to tackling inflation with a gusto and intensity rarely matched. The government pursued a new set of Monetarist policies - jettisoning the post war Keynesian consensus. Tax were raised, spending cut, interest rates increased, the pound appreciated, the money supply was controlled. All this reduced inflation.

Money Supply targets (an intrinsic part of Monetarism) proved to be more or less useless. But, the deflationary fiscal and deflationary monetary policy did succeed in achieving a reduction in inflation. Thatcher had achieved her first goal, but, unfortunately, that was only part of the story. The unprecedented reduction in aggregate demand led to one of the deepest recessions since the 1930s. Manufacturing output plummeted and unemployment shot up to 3 million. (see: 1981 Recession) In inner cities, youth unemployment reached over 50% leading to a wave of inner city violence from Brixton to Toxteth. It seemed the great Thatcher revolution was ushering in a new social revolution. At the height of the recession, 365 economists wrote to the Times saying Mrs Thatcher must change her economic policies. Yet, if the country didn't know by now - this Lady was not for turning. She persisted with her policies and unemployment remained at 3 million until the mid 1980s. If Britain had been the first industrial nation, it was also becoming the first nation to 'de-industrialise'

There was certainly a need to tackle inflation in the late 70s. It would have been hard to do that without some fall in output. But, the extent of the recession was far greater than necessary. - I can only give the analogy of solving a painful toe, by cutting off a leg. The recession of 1981 really didn't need to be so severe. - Ideology did triumph over common sense.

Thatcher may have been an ideologue, but, she did have luck.

• The Falklands war was perfectly timed to give her an unexpected landslide in the 1983 election. The public finances also received a huge boost from:
• Oil revenues - 10% of Tax revenues were coming from oil in early 1980s. Something kept strangely quiet.
  
• Sale of Council houses
• Proceeds from privatisation.

This enabled a wave of tax cuts - mostly on income tax for high earners.

The Miners Strike

1984, was Thatcher's next war, and this time it was 'the enemy within'. - She wasn't talking about members of her cabinet - that would be later. This time the enemy was the high priest of the Union movement - Marxist and firebrand Arthur Scargill. If the miners had won in 1973, Thatcher was not going to share the same weakness as Heath. Thatcher prepared for war and after a bitter, bloody and damaging strike, the miners finally trudged back to work, outmanoeuvred and defeated after 12 months of strike action. It was perhaps a 'pyrrhic victory. A fight where the victor emerged with little credit. But, it did break the back of the militant union movement. Combined with strict anti-union legislation. The threat of a 3 day weak would never be repeated.

Lawson Boom.

As the economy recovered, the government were keen to promote the idea of a 'supply side miracle'. After all the government had all but defeated the unions, it had implemented new supply side policies like privatisation. Britain no longer appeared the 'sick man of Europe' but, it appeared Britain was leading the world with its groundbreaking policies of privatisation and market deregulation.

In particular, the finance sector boomed as layers of regulation were removed at a stroke. The good times were back - especially for the young professionals in the south. It was the age of the Yuppie. A wave of consumerism and materialism gripped part of the nations. House prices and share prices rocketed. Even the likes of 'Sid' could benefit from this new share owning, property owning democracy. By the late 1980s, memories of the Winter of Discontent were like a bad dream as the UK economy raced away - outstripping the growth even of Germany and Japan.

It seemed there was nothing could stop the economies momentum - Mrs Thatcher may have made political enemies with the poll tax, but, the economy looked rosy. It seemed too good to be true - but, unfortunately - 'too good to be true' characterised the Lawson boom perfectly. There had been no supply side miracle. Growth of 5% was simply unsustainable. Inflation reared its ugly head. By the time, it reached 10% it was too late. Belatedly the government sought to control inflation - through entry into ERM and higher interest rates. Thatcher may have disliked the political impact of ERM, but, it was the economic costs of ERM which was the biggest problem. Reminiscent of the 1968 devaluation crisis. The government was committed to maintaining a rate of the pound the markets though ridiculous. The government, almost comically raised interest rates to 15% - in the middle of a recession - in the hope they could maintain the value of the Pound. The Markets ignored the desperate move and continued selling the Pound. After ignoring the inevitable for so long, the chancellor (now Norman Lamont) finally on Black Wednesday, left the ERM and devalued the pound. Finally interest rates could fall and the UK could start to recover from another needlessly severe recession. See: (ERM Crisis)

- It was a classic boom and bust - but surely we would learn our mistake of the 1980s boom and bust - we wouldn't allow that to happen again.... (to be Continued...)

• Modern Economic History of Britain

See previous decade - 1960s.

The 1970s was not just an era of dayglow trousers, lava lamps and the emergence of punk rock. It was a traumatic economic decade of stagflation, a three day week and the return of unemployment.

Things got off to a bad start, with a combination of inflation and strikes. To deal with growing inflation, the Heath government tried capping wages. This was fuel for industrial unrest, leading to frequent and widespread strikes. In 1973, the miners went on strike and were also joined by sympathetic trades unionists- led by, amongst others, the young and infectiously strident Arthur Scargill. Growing up in Thatcher's Britain, it is hard to remember how powerful trades unions actually were at the time. During Heath's government 9 million working days were lost to strike action - plus more to practises such as 'working to rule'. Flying pickets successfully blocked coal and coke factories, which at the time produced the majority of the nation's power. Suddenly the life source of Britain's energy was being blocked.

Britain might have survived the miners strike, if it had not been for another unexpected economic shock.

Oil Prices in 1970s

• blue line - nominal oil prices
• Yellow line - Real oil prices, adjusted for inflation

Since oil had become an intrinsic part of the economy, we had taken it for granted that oil could be bought cheaply. But, the 1973 oil crisis, changed all that. Suddenly the price of oil more than doubled and the UK faced an energy crisis to go along with a spike in inflation. The government seemed powerless as Britain was put on a three day week and TV was turned off at 10.30pm. Emergency speed limits were introduced to conserve petrol.

If in 1957, we had never had it so good, by 1973, it seemed we had never had it so bad. It was a return to the 1940s austerity; but with no obvious enemy, the public were less forgiving of this inconvenience.

1974, also saw an unwelcome return of a real recession. In the post war period, we had booms and busts, but, the bust were relatively mild, with only very minor declines in output. But, in '74, output fell 3.4% causing a return of high unemployment.

Inflation in the 1970s

The Winter of Discontent

The late 70s, inflation had continued to be a problem; with a combination of rising oil prices and rising nominal wages. Again the government sought to control the wage inflation by imposing wage caps. But, again the unions were in no mood for stiff wage settlements. Strike action broke out across the country, extending from the industrial heartlands to the public sector. Public servants from dustbin men to grave diggers in Liverpool went on strike. Unburied coffins in Liverpool piled up, and in cities across the UK, garbage went uncollected. Not for nothing, was that period of strike action called the 'Winter of Discontent'. It seemed the government was unable to control either inflation or the strike action. A feeling of powerlessness pervaded the country.

In some regards, the economic situation of the 1970s was not quite as bad as the dramatic Winter of Discontent suggested. Certainly the three day week was a radical event. But, it was relatively short lived. The 1970s was a period of rising living standards. Nor is the 1970s a vindication of monetarism and proof of the failure of Keynesian ism. See: How Really bad was the 1970s?

Yet, the UK economy had fundamental problems, and it needed a radical shake up. But, no-one could have predicted quite how radical the Thatcher revolution would be... (to be continued - see: economy of 1980s)

• Modern Economic History of the UK

The end of the 1950s was a period of rising living standards, summed up by Harold MacMillan's 'you've never had it so good'

Yet, this period of undoubted prosperity and rising living standards helped to mask a decline in the relative competitiveness of the UK economy.

Whilst our competitors like Germany, Japan and US roared ahead, Britain lagged behind. Our productivity growth was inhibited by both stuffy 'old school tie' managers unwilling to innovate and bring in change, and unions increasingly confrontational and belligerent. Industrial relations resembled more a war zone than anything meaningful and productive. Whilst Japanese workers sang company songs with zest and loyalty, British workers were more likely to be working to rule or plotting the next strike. Industrial relations certainly weren't a one way problem. But, the break down in industrial relations threatened the future competitiveness of UK industry.

It was left to the Socialist Barbara Castle (an MP I admire) to take on the unions. Her white paper 'In Place of Strife' was positively moderate in comparison to the later Thatcherite era. But, even the hint of attacking union power was too much. The unions stood firm and pushed Wilson and Castle to drop their plans. It was a missed opportunity that would impact the government later.

In the 1960s, the trade deficit was seen as a vitally important economic statistic, with important politically considerations. Unfortunately, for the Harold Wilson government of the 1960s, the UK trade deficit was embarrassingly large - a result of the decline in competitiveness and a wish to retain a strong pound. Campaigns like 'Buy British' were surprisingly prominent, but, ultimately failed to make any real dent in the trade deficit. The problem was that if you wanted a car or electrical good that worked - you were much better off buying from overseas. If we made jokes about Skodas and Ladas in the 1980s, British Leyland was the butt of many jokes during 60s and 70s.

Forced To Devalue

If you look at the economic history of Britain. There have been several occasions when a government has politically committed to keeping a strong Pound, - even when this didn't make economic sense. Yet, despite all the government's boasts that they would never devalue - the markets invariably have destroyed the government's vain hopes - leading to a devaluation. Invariably the devaluation was a political embarrassment, but, beneficial for the economy. 1968, was no exception. Harold Wilson was forced to devalue. The devaluation did no harm. The whole experience was later repeated in 1992, when the markets again forced the government to devalue against its wishes.

But, the experience did seem to sum up the 1960s. - not bad - but, could have done better - and we certainly weren't as good as everyone else. It is also interesting to remember how reliant Britain still was on loans from the United States. Britain was slowly lowering its debt. But, even after two decades of growth, national debt was uncomfortably high. Undoubtedly, had it not been for the necessity of borrowing from the US, Harold Wilson would have been freer to be more critical of the Vietnam War - as he told his cabinet on why he would not criticise the war - 'You can't afford to kick your main creditor in the balls' - or words to that effect

But, ff the late 1960s were difficult, the 1970s proved to be one of the most difficult economic decades since the 1930s. It was an era of industrial confrontation, rampant inflation, an unexpected oil shock and an unwelcome return of mass unemployment. The economic power of the UK was exposed for what it had become.... (to be continued)

• Previous 1940s and 1950s
• Modern Economic History of Britain
  

Yesterday, the ONS reported that CPI inflation jumped to 3.5% in Jan. This record jump was partly influenced by the impact of rising VAT from 15% to 17.5%.

But, stripping away temporary factors, is an inflation rate of 3% good news or bad news? A little inflation is much better than the threat of deflation

Around the world, Central Banks have an inflation target of 2%. But, the costs of having an inflation rate of 3% are only marginally higher. A higher inflation rate would enable higher nominal interest rates and thus give Central Banks more manoeuvrability in cutting interest rates in the case of a slump we witnessed recently.

More analysis at - Optimal Inflation Rate

Related

• The Twin threat of Inflation and Deflation

Pre War - It is worth remembering how bad the economic situation was before the war. Mass unemployment started in the 1920s. There was deflation, and falling wages which precipitated the great national strike of 1926. The Great Depression only exacerbated the problem of unemployment and poverty. As writers such as George Orwell memorably depicted in The Road To Wigan Pier - The 1930s was also a bad time to be unemployed - unemployment insurance was meagre, means tested and inadequate. Basically, in the 1930s, there was no welfare state, no universal health care - just mass unemployment, especially in the north.

It was this grim period of the 1930s, that raised so much hopes that after the war things would really be better. A key element for this new hope was The Beveridge report which laid the foundation for the modern welfare state and the abolishment of poverty. Beveridge was not a socialist, but, a liberal. Yet, his vision of a universal welfare state laid the foundation of post war Britain and defined the post war Labour government.

Britain in 1945.

In 1945, Britain was triumphant in defeating the axis powers. At conferences like Yalta, we appeared to be one of the Big Three powers. But, the reality was - we were completely broke. The war had exhausted our financial reserves. It is fashionable to worry about the UK national debt (currently 60% of GDP). But, in the 1940s, this had reached over 200% of GDP.


This scale of debt, was the over-riding feature of our post war economy which hung like a shadow over the UK economy and UK politics.

In 1946, towards the end of his life, we sent the great economist - Lord Keynes to Washington to help argue for an £8bn loan. People say that despite his ailing health, this was one of Keynes' greatest hours - passionately and brilliantly explaining why Britain needed a loan. The American's politely listened - only to refuse. It was only the heightening of cold war tensions that America became motivated to bailout Britain and the rest of Europe. But, whatever the motive, it is certain the America loans were vital to keep the UK economy afloat - especially in that awful winter of Britain in 1947, where secret government records show they drew up contingency plans for mass starvation.

Against a backdrop of record debt, and a reluctant profession of private doctors, any government may have been forgiven for dropping an ambitious plan to introduce a universal national health care service. But, somehow, Nye Bevan succeeded in introducing a universal health care service free at the point of use. True, the number of treatments were more limited in the 1940s, but, the basics of the health service have remained in place ever since. It was a great achievement given the fiscal state of the country. But, it certainly couldn't have been done without a loan from the US.

The 1940s and 1950s, were an age of austerity (rationing only ended in 1954). But, it was an era of full employment. And after the horrors of the Great Depression, this was no small thing. With the end of rationing, and the booming of global trade, living standards rose rapidly. We entered a new era of consumption - labour saving devices like vacuums and washing machines became the norm rather than the exception. In 1957, Harold Macmillan proclaimed in a speech that 'people have never had it so good' - A sentiment that seemed to express the improvement in living standards of the 50s and early 60s. Yet, despite the improvements in living standards. Britain was quietly slipping behind our competitors. And this period of prosperity would soon be challenged.

• Next - the 1960s economy

Related

• Modern Economic History of Britain

Some 350 economists (including Joseph Stiglitz) have signed a letter proposing a modest 'tobin tax' on speculative dealings on shares and currency movements. The tax would amount to 0.05% of transactions.

"This tax is an idea that has come of age. The financial crisis has shown us the dangers of unregulated finance, and the link between the financial sector and society has been broken. It is time to fix this link and for the financial sector to give something back to society.

"This money is urgently needed. The crises of poverty and of climate change require an historic transfer of billions of dollars from the rich world to the poor world, and this tax would offer a clear way to help fund this." (from Independent)

More on advantages and disadvantages of a Tobin Tax

I've been enjoying watching Andrew Marr's BBC programme- A History of Modern Britain - from rationing to punk rock - from Enoch Powell to Arthur Scargill - modern Britain had everything (and at times, surprisingly violent into the bargain). You also realise how much economics influenced, life, living standards, politics and society. Looking back over the turbulent past few decades also puts the current economic crisis into perspective.

This week I will be writing a brief and potted Economic history of Modern Britain.

• Economics of the 1920s - a legacy of war debt, deflation and life under the gold standard
  
• Economics of the Great Depression 1930s - the economics of mass unemployment.

This week:

• Economics of the 1940s and 1950s - Austerity, rationing, war debt, but full employment, new welfare state and rising living standards.
• 1960s - The 'You've never had it so good era' starts to unwind.
• 1970s - The Era of Discontent. Strikes, 3 day weeks, inflation, boom and bust. The 70s had everything except stability
• 1980s - The Thatcher era gave us two deep recessions, an experiment with monetarism mass unemployment, broke the power of trades and one of the most memorable booms of post war Britain.
• 1990s - Recession and then the great stability
• The economics of the 2000s