–Estimates UK Spare Capacity At 4% to 6.5% of GDP
–Probably Room For UK Economy To Grow 4% to 6%
–Would Be Right For MPC To Do What It Can To Stimulate Economy
–Worried About Impact On Inflation Expectations Of More Stimulus

LONDON (MNI) – The UK economy appears to have a substantial margin
of spare capacity, but with inflation a full percentage point above
target there has to be concern over the impact of providing further
stimulus on inflationary expectations, Bank of England Monetary Policy
Committee member Martin Weale said.

Weale looked at the impact of the financial crisis on the UK’s
trend rate of growth, and concluded the evidence suggests the economy
could now enjoy rapid, non-inflationary growth given the size of
the output gap. In theory, the MPC should provide further policy
stimulus in these circumstances – but with inflation currently above
target, Weale said the majority on the MPC saw no compelling case for
easing or tightening policy.

“The Monetary Policy Committee has to chart a course between the
Charybdis of recession and deflation and the Scylla of excess inflation.
At the present time a majority of the Committee does not see a
compelling case either for slackening or for tightening policy,” Weale
said.

“In the light of the information that we have and the knowledge we
have as economists for interpreting that information, we think, at least
for the time being, that the right course is to leave policy
unchanged,” Weale said.

The majority of Weale’s speech focussed on estimating the impact of
the financial crisis and its aftermath on the potential level of output
of the economy and on trend growth.

Weale said, before taking account of the impact of the rebalancing
of the economy, the reduction in capacity is in a range of 2.5 to 5% of
GDP.

Looking at this in light of the Bank of England’s latest growth
projections, in the November Inflation Report, Weale said the
implication was “there is spare capacity of the order of 4-6.5% of
current GDP.”

With such a large margin of spare capacity, in theory the economy
has scope for rapid, non inflationary growth.

“My own best estimate is that there is probably room for the
economy to expand by 4 to 6% as a cyclical economic recovery. But that
estimate is highly uncertain,” he said.

The Inflation Report growth forecast shows that over the next three
years, the output gap will only be partially closed.

“At the end of 2013 the most likely outcome is that real GDP will
remain about 6% below its pre-crisis trend, although one also has to
remember that trend growth has probably fallen a little,” Weale says.

The economy, in theory, has scope to expand faster than the BOE is
forecasting and “in such circumstances, it would be right for the
Monetary Policy Committee to do what it could to stimulate the economy
further, provided that such a stimulus were consistent with meeting the
inflation target.”

In echoes of fellow MPC member Adam Posen’s speech in favour of
providing more stimulus, Weale said “We should never forget that spare
capacity amounts to a waste of resources and that the associated
unemployment is a source of misery. Furthermore, the more rapidly the
gap is closed the lower is the productivity loss arising from sustained
unemployment.”

Unlike Posen, however, he does not advocate launching another round
of quantitative easing at present, citing uncertainty over estimates of
spare capacity and concerns over inflation expectations.

“The MPC cannot be sure that there is as much spare capacity as my
calculations imply, and has to be sensitive to the fact that inflation
in September was more than one percentage point above its target,” Weale
said.

“Indeed, inflation over the next few months may well rise further,
even if a subsequent decline is expected. I certainly worry about the
effect on inflationary expectations of introducing additional monetary
stimulus in such circumstances,” he added.

He warned of repeating the errors of the 1970s if policymakers
focus on maintaining demand and pay insufficient attention to the impact
of nominal demand on inflation.

–London bureau: +4420 7862 7491; email: drobinson@marketnews.com

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