He fears that we will eventually see an “exit from cash” that’ll initially raise GDP but swiftly raise prices too. This raises some issues.
The first is: do people have – or are they likely to have – excess cash which they want to dispose of by buying either financial assets or good and services. Mr Lilico is correct that the money stock is now growing, having stagnated in much of 2009-11; the Bank of England’s preferred measure rose 4.5 per cent in the year to July. But it’s harder to say that cash balances are excessive. The money stock is now equivalent to 25.1 per cent of the financial wealth of households and non-financial companies. This is only slightly above its average since records began in 1997 of 24.7 per cent.
You might think that with real interest rates negative, consumers and business will want to unburden themselves of an under-performing asset. This is not obvious. The same slow trend growth of which Mr Lilico complains is a reason to hold onto cash. Why reduce your liquid assets if your future incomes – and by implication returns on real assets – will be low?
Let’s, though, assume Mr Lilico is right and that we do see a desire to get out of cash. Is this something to fear? The Bank of England thinks not. The precise point of quantitative easing is to get people spending. The prospect of an exit from cash isn’t a bug of policy, but the central feature.
The key question is: would such an exit, and higher spending, lead to sustained real GDP growth as the Bank hopes, or to inflation? In other words, do we have the capacity to increase supply without raising prices.
Here, I have some sympathy for Mr Lilico’s pessimism. Weak capital spending and stagnant labour productivity – problems which, it must be emphasized, predate the crisis to some degree – do hint at an impairment of our productive potential.
But there are tentative signs of this problem receding. In Q2, total hours worked rose only 0.3 per cent whilst GDP grew 0.7 per cent. Productivity, then, has begun to recover. Granted, this is only one quarter so it’s inconclusive. But it’s consistent with the view of supply optimists such as the TUC’s Duncan Weldon, that weak productivity has been the symptom of weak demand, rather than a disease in itself.
For me, though, the biggest doubt about Mr Lilico’s story is his claim that inflation will trigger “rapid pay rises.” I suspect it won’t, simply because there is a huge excess supply of labour. This doesn’t just consist of the 2.5 million people who are officially unemployed. There are also 1.4 million part-timers who want a full-time job and 2.26 million people out of the workforce who’d like to work. And the latter is not a mere idle preference; in Q2, 433,000 “economically inactive” people found work. And then there’s the possibility of labour demand being met by increased immigration.
I just can’t see wages being a threat to inflation any time soon.
However, this doesn’t mean we should entirely rule out a pick-up in inflation. There’s always the possibility of a fall in sterling raising import prices. And we must be sceptical of the economist’s tendency to think of the macroeconomy as producing only a single good. It doesn’t. If demand rises for businesses which don’t have much spare capacity, we could get inflation, whereas we won’t if it rises for those with spare capacity. The fact the economy is heterogenous makes any forecasts uncertain.
