Unit 4 Macro: Returning to Growth - Lessons from the 1930s and 1980s

If fiscal consolidation continues and radical changes to monetary policy are ruled out, it is mainly ‘supply-side’ reform that can restart UK growth without doing longer-term damage to the economy. Among other things, that means repairing infrastructure, improving education, reforming taxation and tackling the restrictive planning system. But one area that could deliver both short-term stimulus and long-term efficiency is private house-building – as happened in the 1930s recovery from recession. Today’s planning restrictions mean that the stock of houses is three million below and real prices are 35% above what they would be if market forces operated freely.These are among the conclusions of Professor Nick Crafts on what policy-makers can learn from the 1930s and 1980s, when the UK economy made strong recoveries from severe recessions very similar to the current one. Despite fiscal consolidation, both the 1930-32 and 1979-81 recessions were followed by strong recoveries.Delivering the Royal Economic Society (RES) annual policy lecture in London on Wednesday 17 October 2012, Professor Crafts summarised the policy lessons from those decades that are relevant to kick-starting recovery now:

* MONETARY POLICY: although it is not possible to cut nominal interest rates when, as now, they are at the lower bound, it is possible to deliver monetary stimulus by reducing real interest rates if – as in the 1930s – the authorities are willing and able to commit to higher inflation. But the inflation targeting regime in place since the 1990s would have to be revised.

* FISCAL STIMULUS: although there are reasons to think the fiscal multiplier may be relatively large when interest rates are at the lower bound, history says that this claim needs to be treated with caution, especially when public debt to GDP ratios are large.

* PRIVATE SPENDING: a key component of policies to stimulate recovery during an episode of fiscal consolidation is an ability to ‘crowd in’ private sector spending. Private housing investment aided recovery in the 1930s and consumer spending did so in the 1980s.

* INDUSTRIAL STRATEGY AND COMPETITION: if politicians wish to devise more interventionist industrial policies, it is essential that they are designed with a view to minimising the adverse impacts on competition.

Professor Crafts noted that, broadly speaking, the policies potentially available to promote recovery are fiscal stimulus, monetary stimulus or supply-side reforms that ‘crowd in’ private sector consumption or investment spending:

* THE GOOD NEWS: in the likely absence of more short-term stimulus measures, it is supply-side factors that must drive growth. The ‘good news’ is that there are plenty of evidence-based reforms that can strengthen the UK’s growth performance by improving ‘horizontal’ industrial policies.

* SUPPLY-SIDE POLICIES: these include repairing a serious infrastructure shortfall; institutional reforms to deliver higher quality schooling and improve cognitive skills; reforming taxation to reduce corporate taxes and expand the VAT base; and addressing the massive distortions created by the land-use planning system, which undermine the potential productivity gains from successful agglomerations.

* THE BAD NEWS: the ‘bad news’ is that these policy choices are very much exposed to ‘government failure’; they are subject to implementation lags; and they have their effects in the medium and long term.

* RELAXING PLANNING RESTRICTIONS: the potential benefits from some relaxation of the UK’s draconian planning regulations are huge and the employment implications of steadily addressing the housing shortfall could be considerable. Building 200,000 extra houses each year might employ 800,000 people.

* PROMOTING HOUSE BUILDING: this would require addressing issues of housing finance and giving incentives to local communities to want development because they can benefit from it – and builders to believe that delaying construction would not be profitable.