[ccebook.cn]The World in 2010

interrupted recoveries, largely because of employment arrangements that stretch out job losses over many
years.) On the rare occasions when British recoveries have aborted, the reason was clear: interest rates were
drastically increased, to ward off inflation or to “defend” sterling.
Which leads to the next question: what policies will Britain see in 2010? On the monetary side, the Bank of
England has made its intentions unusually clear. Interest rates will be kept at exceptionally low levels, not just
until economic growth is firmly re-established but until there is significant shrinkage in the very large “output
gap”. This is a measure of spare capacity and unemployment—and hence of potential deflationary pressures—
favoured by many central banks. Since no big reduction of the output gap is likely until 2011, interest rates
will remain very low into 2011 and probably beyond.
The main damage done by the crisis, the collapse of government finances, is ironically another reason why
British interest rates will remain at rock-bottom levels much longer than businesses and homeowners generally
expect. If the new government has the courage to attack the deficit, it will expect low interest rates as a quid
pro quo—and the Bank of England will be happy to oblige, since its internal models suggest monetary stimulus
really will be needed to offset the deflationary effects of serious budget cuts. Moreover, such is the size of the
hole in government finances that many years of fiscal retrenchment will be required. Thus a combination of
ever-tighter fiscal policy with surprisingly low interest rates will dominate British macroeconomic policy until
the middle of the new decade.
The imperative of long-term fiscal retrenchment raises the final, and most interesting, question about Britain’s
prospects: will politicians dare to undertake the fiscal tightening needed to stabilise public debt at a
reasonable level? The retrenchment required can appear impossibly daunting. But the British government
remains one of the world’s most creditworthy borrowers, so it has the luxury of tackling its budgetary
problems over several years. If the directors of any private company sent their department heads an
instruction to cut costs by 2% a year without sacrificing customer service, this would hardly be considered a
managerial nightmare. Any leader who could instil private-sector attitudes towards productivity growth and
cost control into the management of the public sector would be hailed as the saviour of the British economy.
Anatole Kaletsky: partner, GaveKal Research; editor at large, the Times. Author of “Capitalism 4.0: How the Global Economy Evolves
Through Crises” (to be published by Bloomsbury/Public Affairs in 2010)
Copyright © 2009 The Economist Newspaper and The Economist Group. All rights reserved.
-119-