UK economic prospects look absolutely awful: Commercial development activity has collapsed, unemployment is rising and business confidence is plummeting.
On top of all that, the OECD (Organisation for Economic Co-Operation and Development) index on UK consumer confidence is at its lowest level since records began in 1974.
The malaise has sent politicians of all parties scrambling for air time. The most surprising comment was from Ed Balls who, as Brown's economic adviser and co-author of the lofty tome "Reforming Britain's Economic and Financial Policy Towards Greater Economic Stability" (H M Treasury 2002), was an architect of the Prime Minister's new order that supposedly banished boom and bust.
Balls said "this is a financial crisis more extreme and more serious than that of the 1930s". Downing Street endorsed Balls' remarks by confirming they were in-line with previous statements by the Prime Minister and Chancellor. So, we are in recession, the data is awful and even the politicians agree.
Perhaps this is an appropriate time to look at two factors that accentuate the effect of any recession, the "accelerator" and the "multiplier".
The "accelerator" refers to capital spending). Output/production requires capital. This is intuitive - cars cannot be built without factories and machines to put them together. If we assume there is a ratio/co-efficient between capital investment and output, then we can estimate how much capital investment will be made for any given increase in GDP. For example, assume the capital/output ratio was 5, ie. 5 units of capital investment produced 1 unit of output. If demand is rising, and GDP is growing, then capital investment will be equivalent to five times the real increase in GDP. As capital investment cannot be made immediately businesses try to anticipate demand. This means that companies will respond to expected rises in demand and increase capital expenditure, thus boosting the economy - it is something of a self-fulfilling prophecy. Conversely, if demand is expected to fall, capital investment declines or falls to zero. So the capital investment "accelerator" has the effect of speeding up falls in the economy.
The "multiplier" is similar and is based on the theory that jobs lost in one sector of the economy will result in a reduced demand for goods and services in other sectors of the economy. As the "accelerator" and the "multiplier" tend to work together, they are cited as one of the main reasons that we experience economic cycles.
As jobs are being shed in many sectors the "multiplier" is working through the economy to worsen the recession. Similarly, with business expectations and consumer confidence indices reaching record lows, demand is anticipated to decline, so investment spending is cut and the "accelerator" is also contributing to the recession.
As the "accelerator" and "multiplier" are embodied in classical economic theory, and are very good explanations for cycles, it is simply ridiculous for any politician to claim that they have ended "boom and bust". Whilst the "accelerator" and "multiplier" contribute to the downturn, they also speed the upturn. Eventually, capital items will need replacing (machinery, plant and motor vehicles do not last forever) and as this happens, jobs are created which boost demand through the "multiplier" effect.
As this takes place, capital expenditure rises to meet anticipated growth in demand and so the "accelerator" cuts in. It seems that this government, having ignored the "multiplier" and "accelerator" in a down cycle, are similarly ignoring their effects for the up cycle.
Gary Reynolds is director and chief investment officer at CourtiersIFAonline
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