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Project Fear was nothing more than a colossal Treasury blunder

By Roger Bootle - Telegraph / 6 August 2017

Renowned Brexiteer Roger Bootle has written several books on economic issues and writes regular newspaper columns.

“Highest Stock Market EVER, best economic numbers in years.” 

By claiming credit for America’s economic performance with this tweet, President Trump tried to deflect attention from the chaos in the White House. The US economy is doing well but the idea that this is due to President Trump is preposterous. Congress has prevented him from doing anything. In any case, the time lag between policy measures and their effects on the economy is much longer than the mere six months that President Trump has been in office.

The UK economy is actually doing quite well, too. Admittedly, according to the official figures released last week, growth in the second quarter of the year was only marginally up on the first quarter, and it was well down from the strong rates registered in the third and fourth quarters of last year. But to have grown over the last year by about 1.7pc is no mean performance. Again, this is not due to government actions. Nor is it in accordance with earlier forecasts.

Under the previous Chancellor, George Osborne, the Treasury forecast that, in the event of a Brexit vote, by now the economy would have contracted by about 0.4pc. And if the shock of the Brexit vote turned out to be really dire, then GDP would have fallen by some 2.2pc. The robust performance of the economy needs to be trumpeted by our leaders, not downplayed.

Granted, given the usual time lags, I suppose that Brexit uncertainty could yet hit the economy hard. But this does not look likely. The much-vaunted squeeze on consumers’ real incomes, partly as a result of the rise in inflation caused by the Brexit-related fall of the pound, is not far from its peak. By early next year, consumer price inflation should be falling back and, a little later, real incomes should be rising again.

Pessimists can say that the balance of trade has not shown any improvement as a result of the lower pound. But again time lags hold the key. It takes two or three years for the full effects of a lower exchange rate to be felt. Forward-looking surveys of export orders currently suggest that by the end of this year, exports will be rising by about 10pc. What’s more, against this backdrop, corporate investment will probably pick up as well.

Despite all this, many ministers and senior officials, including the Governor of the Bank of England, sound pessimistic about British prospects – unless we manage to secure a free trade agreement with the EU and/or some sort of transitional agreement. “Crashing out” and “falling off a cliff-edge” are the key catchphrases in vogue. This is nothing new. The British establishment has traditionally been inherently pessimistic about Britain’s economic performance. Interestingly, it has nevertheless been keen to continue with the same old economic policy. Funny, that. The Project Fear episode looks like one of the greatest Treasury blunders of all time – apart from all the others. Trying to keep the pound on the Gold Standard in the 1930s ranks as a real corker. It was market pressure that forced us off in 1931. More recently, the Treasury failed to recognise excessive growth of demand in the late 1980s, and failed to foresee the fragility of the financial system before the financial crisis of 2007/09.

Most strikingly, the Treasury’s abject failure over the implications of the Brexit vote is reminiscent of another occasion almost 25 years ago. In 1992, the UK was struggling to remain in the European Exchange Rate Mechanism (ERM), which obliged the British authorities to keep the pound above a specified minimum level against the Deutschmark. This forced the authorities to maintain interest rates cripplingly high even though the economy was flat on its back.

To a few economists at the time – and I am proud to say that I was one of them – this strategy seemed to be peculiarly ill-judged. I argued that if we came out of the ERM and the pound was allowed to fall substantially then, in the circumstances of the time, inflation would not pick up, and interest rates could come down, thereby helping to engender economic recovery.

The Treasury poured scorn on this view. It argued that if the pound came out of the ERM then inflation and interest rates would both rise, thereby condemning the economy to prolonged recession. In the end, the markets forced the pound out of the ERM on September 16, 1992 accompanied by much wailing and gnashing of teeth in Whitehall. The economic establishment went into a collective funk. We had “crashed out”. Or, if you like, we had fallen off “a cliff-edge”. What happened afterwards bears repeating.

Far from being forced to increase interest rates as the Treasury had suggested, the Chancellor was able to cut them. Inflation did not pick up but rather fell back. Most importantly, the economy staged an impressive recovery. And this experience led, in stages, to the independence of the Bank of England and a radically reformed policy regime that underpinned sustained growth. This path was not initially chosen by the Treasury but forced upon it by the markets. Similarly, the economic establishment would never have chosen Brexit as being in Britain’s best interests. Instead, the Treasury had Brexit thrust upon it by the electorate. But, unlike the 1992 experience, they can still seek to wriggle out of it by favouring various sorts of delays, transition deals and “soft” arrangements, as peddled by the Chancellor.

Is it not remarkable that after the appalling Project Fear blunder, so many of the key individuals who spread its gloomy message still think that they are in a position to warn the rest of us of ghastly economic times ahead? And, perhaps even more remarkably, they are listened to.

Imagine a leading surgeon with an unfortunate habit of amputating the wrong leg. Everyone says to him: “Never mind, Mr Snodgrass. Better luck next time.”

ROGER BOOTLE
Managing Director of Capital Economics and author