Some commentators claim that the UK’s current economic recovery is illusory. They say that the recovery is based on an artificial boom fuelled by loose money and will eventually come crashing down to earth.
I think it is very likely that this view is wrong, for at least two reasons. One, the UK does not have loose money that would fuel a credit boom. Two, the best tool we have for telling if the recovery is ‘real’ or not is the market. And the market is telling us that it sees things as looking good.
The idea that we have loose money is extremely common. It is based on the assumption that a Bank of England base rate of 0.5%, historically very low, must mean that money is loose. This is what Milton Friedman referred to as the ‘interest rate fallacy’. It is a fallacy because it fails to ask the key question: ‘compared to what?’
That ‘what’ is, or ought to be, the ‘neutral rate of interest’ – the interest rate where, in David Beckworth’s words, “monetary policy is neither too simulative nor too contractionary and is pushing the economy toward its full potential.” The tightness of money is determined by the central bank rate relative to the neutral rate. If the neutral rate of interest is lower than the base rate, then money is tight.
Is the neutral rate of interest in the UK currently above or below 0.5%? It’s hard to say. Milton Friedman pointed out that usually low rates were a sign of tight, not easy money. This is because low rates almost always coincide with very low inflation, nominal GDP growth and money growth—which Friedman pointed out were much better ways of assessing the stance of policy.
It’s possible to infer from things like NGDP growth (well-below trend until recently) that money has been unusually tight. NGDP growth seems to be returning to the trend rate, if not the trend level, that it was before the crisis. People calling ‘easy money’ may disagree, but if they are simply pointing to low interest rates without trying to compare them to the neutral rate, they’re not proving anything at all.
But even if it’s not down to easy money, maybe the recovery really does sit upon a throne of lies that will inevitably collapse. How could we tell?
Since the world is very, very complex, it is unlikely that one individual expert or panel of experts will be able to possess all the information they would need to make reliable predictions about the future.
Where possible, we should prefer the ‘wisdom of crowds’. And we have something that can do so very effectively: the market. And the market seems pretty optimistic: the FTSE 100 is growing strongly; firms are taking on new staff; gilt yields are extremely low.
Second-guessing the market is particularly unusual for people on the right of the political spectrum. As Josh Barro put it recently, “A conservative is somebody who thinks every market is efficient — except the Treasury bond market.” (A point worth remembering next time you read about the UK’s “looming debt crisis”.)
Of course markets can get things wrong. There is a high degree of uncertainty involved in all predictions like this. But, given a choice between the aggregated judgement of millions of market participants, all bringing their local knowledge to bear, and the judgment of a few experts, I’ll go with the market.
In summary, there’s no reason to think that either we have excessively loose money or that the recovery is illusory. Note that mine is an entirely negative argument – I am not claiming that money is too tight, or just right, nor am I claiming that markets are correct. I’m saying that, given the information we have available to us, we should resist the urge to doomsay. In short: don’t worry, be happy.