Kick-starting the economy - what can the government do?

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Wednesday 13th August 2008

by Bob Bardsley
Know Your Money Editor

The government is facing criticism on a number of different issues at the moment, ranging from the credit crunch to stamp duty. But with inflation still rampant, the Bank of England's monetary policy committee seems hesitant to take action in order to ease consumers' affordability concerns. So what is left for the government to do that could both relax some of the restraints on spending and borrowing, while improving public sentiment towards policymakers?

Below are three of the main issues Britons are facing, along with industry practitioners' opinions of what caused the problems to arise in the first place and how they may be overcome. However, some people may note that part of the predicament for the government itself is that some of the obstacles oppose one another - such as the need to cut interest rates in order to ease mortgage affordability, while wishing to maintain the base rate at a sufficient level to constrain consumer spending and therefore reduce inflation from its relatively high figure.

Inflation - when will the bubble burst?

Inflation has been making the headlines this week with the revelation that the current consumer price index - which is based on the amount being paid by the public for a typical shopping basket of goods - is up by 4.4 per cent. Many media sources have reported this as being twice the target rate, although it may be worth bearing in mind that the Bank of England's target is actually anywhere in the range of one to three per cent.

Responding to the publication of the latest inflation report by the Bank, the centre for economics and business research (cebr) suggests that the surface problem may be linked not to the tightening of conditions at present, but to lenient pricing a year ago - the point with which today's prices are compared when calculating inflation. Economist with cebr Charles Davis says: "What we are looking at now is probably the effects of interest rates we had a year or more so ago. Perhaps the whole problem might have been that interest rates have been too low in the UK, probably a year or so ago."

But with the Bank facing a "headwind" of tightened conditions elsewhere in the economy, Mr Davis asserts that policymakers may be forced to "sit on their hands" on the issue of inflation. He adds that economic growth is increasingly unlikely over the remaining months of 2008.

Credit crunched consumers

In contrast with the relatively high rate of inflation, the so-called "credit crunch" has become a household phrase over the past year. On August 9th 2007, the European Central Bank (ECB) put almost €95 billion (£75 billion) into the continent's money markets - now widely considered to be the unofficial "birthday" of the crisis. The Observer's Heather Stewart notes that, a little over 12 months later, British homeowners are now bearing the brunt of tightened credit conditions.

She contends that prime minister Gordon Brown's refusal to nationalise Northern Rock during its own liquidity problems around the turn of the year - instead favouring a private-sector takeover of the sub-prime lender - now smacks of being "an ideological hang-up about avoiding nationalisation". She expresses the opinion that nationalisation may in fact provide the protection that consumers need against "predatory businesses" which aim to exploit them for a profit. This contrasts with the government's reliance over the past ten years on the discipline of the market itself in determining the limitations of executive earnings and other issues, she notes.

Stamp duty - putting the foot down

Perhaps the area where the government has received the most criticism in recent days, however, is over the issue of stamp duty. The property tax has already been accused in recent months of being archaic in not tracking market prices upwards and, as a result, now being imposed on a larger proportion of properties than was originally the case. Financial services provider Halifax was calling for an index-linked approach to stamp duty as long ago as December 2006, before the credit crunch was even a twinkle in the ECB's eye.

Now, inflation has driven up the cost of running a household by almost five per cent in the space of a year and, while the base rate stands at three-quarters of a percentage point below its figure in August 2007, many lenders have been accused of not passing that reduction on to their mortgage customers. Meanwhile, figures from the Royal Institution of Chartered Surveyors indicate that house prices have begun to drop, posing the risk of negative equity to recent buyers. With the institution also reporting sales statistics at a record low level, the rumours that the government might be implementing a suspension of stamp duty to kick-start the market may have been welcome relief to some looking to buy their first home in the current market.

However, the Prime Minister's Spokesman this week refused to comment on the issue, saying only that 10 Downing Street works in close collaboration with HM Treasury on such topics. Liberal Democrat shadow chancellor Vince Cable today expressed his objection to the "clumsy mishandling of stamp duty" from the government. "Given how fragile confidence is, the one thing we should expect of ministers is that they behave carefully," he stated. But with no official announcement forthcoming from the prime minister or his spokespeople, consumers may yet wonder what action their representatives will ultimately take to tackle the market conditions. ADNFCR-8000200-ID-18730302-ADNFCR ©