The United States and Great Britain share a history, a language and many of the same indignities dealt out by the global credit crisis. Yet when it comes to some of the toughest economic decisions that lie ahead, the issue of inflation looms as an Atlantic Ocean of difference between them, says a prominent British economist.
Mark Berrisford-Smith, senior economist at London-based banking giant HSBC Bank PLC, said in an interview with The Globe and Mail that while the growing dangers of deflation have dominated the economic dialogue in the United States over the past few months, Britons face the opposite problem. It's inflation that now looms as the mounting threat to the British recovery - and the key challenge to monetary policy.
The HSBC economist, visiting Canada for the first time to address a financial conference this week in downtown Toronto, fears that Britain's central bank, the Bank of England, is losing its focus on the inflation front by holding off on interest-rate hikes and playing down the inflationary threat as it tiptoes through the country's fragile recovery.
"The inflation rate in Britain is 3.1 per cent, which is against a [Bank of England policy]target of 2 per cent and a ceiling of 3. If that inflation target is serious, if they want to retain their credibility as an independent, inflation-fighting central bank, then ultimately you have to react if inflation is persistently above the target. You can say until you're blue in the face that inflation will trend lower over time … but if it doesn't trend lower, at some point you have to do something about it," he said.
The danger, he argued, is if the central bank persists in keeping rates low despite above-target inflation. It might choose to do so to stimulate the economy, as the new British government unveils deep and sweeping budget cuts to reverse the stimulus-fuelled spending excesses of the past two years.
"Especially when governments are reducing deficits as well, it's tempting to leave the monetary stimulus in. But you still have to keep a watchful eye on inflation. If you've got inflation targets, then they're only credible if you take the actions that will mean that you'll stick to them. That would certainly be my worry about the U.K. at the moment," he said. "It's not what they say that ultimately counts, it's what they do."
He questioned whether the rock-bottom interest rates that Western central banks adopted during the financial crisis were really the best way to manage the problem.
"I have some doubts over whether, even at the height of the financial crisis, we should have cut rates quite as far as we have," he said. "Once you get to near zero, monetary policy loses its impact, and as we now find, people are starting to dream up all kinds of crazy new tools [like quantitative easing]that haven't been in the toolbox before.
"The thing is, you've got no experience as to whether they work," he said. "It's like pumping drugs into a sick patient that haven't gone through the trialing process. We don't know what this stuff does."
Mr. Berrisford-Smith said that the sovereign debt crisis gripping several southern European countries has faded, and the danger of defaults has pretty much passed, removing one of the big threats to the European economy. However, he said that countries like Greece still must wrestle with long-term questions about how to manage or restructure their debts, and face years of government spending cuts.
In addition, he said, the global economy still hasn't dealt with a risk that could ultimately dwarf the sovereign debt crisis - what he calls the "dollar debt crisis."
"We mustn't get carried away with this notion that the only potential debt crisis in the world is lying in Europe. The potentially much bigger debt crisis is closer to home - in the United States," he said. "We have an American administration that has a $1.5-trillion [U.S.]annual deficit … equivalent to more than 10 per cent of GDP.
"It's tempting to think that because the dollar is the world's reserve currency, that you can keep on running fairly large deficits," he said. "But ultimately, the deficit still has to be financed to a considerable extent by people outside the United States. And those people have to be prepared to hold dollars.
"There may come a point when they're not prepared to hold those dollars. And then, what happened in Europe will be on a rather smaller scale than what might happen [in]the States."
David Parkinson