By almost any measure we are in a boom. We are indubitably in a financial boom, for shares everywhere are at or close to their all-time highs – the Footsie hit its all-time high on Friday, and the Dow has raced past 20,000 and is now closing in on 21,000. But for the US and UK at least it is also something of an economic boom. To be sure, what is happening does not tick all the boom boxes, but it ticks quite a few of them.
Both economies are pretty much running at full capacity. If you take unemployment as a crude measure of that, in the UK it is at 4.7 per cent, which is equal to the lowest since 1975. In the US the rate is the same, 4.7 per cent, which half a percentage point or so away from the troughs it reached prior to the financial crash of 2008 or the level of the boom of the late 1990s. But to see US unemployment materially lower than now you have to go back to the 1960s.
It is possible that the unemployment rate can be pushed down to an even lower level without leading to unacceptably high consumer inflation. It would be good news for all sorts of reasons, social as well as economic, if that were true. There is a debate among economists as to just how much spare capacity there really is, both here and in the US. But there can’t be that much spare capacity, as price increases – a sort of pressure gauge of demand – are starting to come through. In the US consumer prices are up 2.7 per cent on the year, the highest rate for five years, and here they look like nudging above two per cent, the centre point of the Bank of England target range, on Tuesday.
These are not red alarm levels. But they are flashing amber, and the US Fed has responded. It made another rate increase last week. We haven’t moved, though Kristin Forbes, the American academic who is on the monetary policy committee, was the lone voice voting for an increase. I personally think she is right and the rest of the committee wrong, and I think in a year or so she will be vindicated. But several members of the committee do seem, from the minutes, to be inclining towards some tightening of policy, and I’m pretty sure that were it not for the whole Brexit thing we would have had an increase in rates by now.
Instead, what we have had has been a sudden loosening of monetary policy as a result of the fall in the exchange rate. The Bank of England used to have a rule of thumb, whereby a four percentage point change in the exchange rate was equivalent in its impact on demand to a one percentage point change in interest rates. We have had a 15 per cent fall in sterling over the past year, so you could say we have had the equivalent of a four per cent fall in rates. Actually the sums don’t work as well as they used to, partly because rates are so low and partly because manufacturing is a smaller proportion of the economy. But there is no doubt that the fall of the pound has given a sizeable boost. It has helped stoke the boom.
The trouble is, this does not feel like a boom. Why?
There are several answers to that. One is that booms rarely feel unsustainable when you are in one. Think back to the run up to financial crash in 2008. Things seemed to be going all right and the Treasury at least forecast they would go on doing all right. Or in the late 1990s? Again growth seemed secure – though the dot com share boom did not.
Another answer is that real wages haven’t risen, or at least not by much. But that may not have anything to do with the cycle. It may be because of long-term structural changes in the global economy, including the impact of technology. In any case, it may be that real wages have risen as a result of the rise of social media and the app economy, but we have not measured correctly the impact of both on living standards.
As for real wages, the huge problem in the UK is housing costs, and that is at least partly a result of the ultra-cheap money policies of the central banks. Relative to earnings UK house prices are the highest they have ever been: more than seven times average earnings. If that is not a signal we are in a boom, what on earth is?
So what is to be done? Well, classic central banking theory says that monetary policy should lean against booms by, among other things, increasing interest rates. Or as William McChesney Martin, chair of the Federal Reserve between 1951 and 1970, put it, the job of the Fed was: “to take away the punch bowl just as the party gets going”.
Prepare for a sharper rise in rates, certainly in the US but also in the UK, than people currently expect.