The recovery has been engineered - things can only get worse

No one will admit it, but we are in the middle of a pre-election boom. And we all know what follows...

The European Central Bank’s huge quantitative easing plan will buy some time for the eurozone. Today, the focus switches to Greece, with some kind of renegotiation of its debts inevitable whatever the election result. And then what?

Well, the next big issue, as far as financial markets are concerned, looks like being the contrast between the Anglosphere and the rest of the developed world. We don’t have the figures yet but it is likely that last year no major English-speaking economy grew by less than 2.25 per cent, while no major non-English speaking one in the developed world grew by more than 1.5 per cent. This will drive monetary policy, for the prospect now is for interest rates in the former to rise, probably with the United States leading the pack, while rates in Europe and Japan will stay on the floor. We cannot yet know how effective the ECB bond-buying plan will be, though it must help at the margin. But the fact that it is happening at all underlines the need to crank up growth in Europe.

Beware, however, anyone who crows about our superior economic performance. For the coalition has managed to do what governments have so often sought to do ahead of a general election, though they always deny it: puff up a pre-election boom.

A lot has been said about the way that inflation at 0.5 per cent and earnings up 1.7 per cent mean that at last people are getting a real pay increase. If inflation falls further, and it is conceivable that it will be negative by the time of the election, real wages could be climbing by more than 2 per cent a year. They are already rising at their fastest rate since 2008. The issue now is not whether people are getting richer. Most are. It is whether they will go on getting richer after 7 May.

Consider these two statistics. One is retail sales. In the final three months of 2014, they were up 5 per cent year-on-year in real terms. That is the fastest increase since 2002, and it is not sustainable, though with falling inflation this boom can run for many months yet. The other is the current account deficit. The most recent figures, for the third-quarter of last year, show it was 6 per cent of GDP. That is consistent with the boom in retail spending, because one of the characteristics of Britons is that when they have some cash they spend it, much of it on foreign stuff. But a current account deficit of that size, the largest I can find anywhere in the world, is not sustainable either, though again this can run on for quite a while.

The idea that we are in a pre-election boom is not part of the political narrative. It would not suit the coalition for obvious reasons. But it does not suit the opposition either because it runs counter to the case that Labour has argued so far – the cost of living crisis and so on. If you look beyond politics and beyond the election, though, the question is how and when this boom will end. There is a best case and a worst case, with, as usual, the outcome likely to be in between.

The best case would be for investment and export growth to replace domestic growth. If the eurozone economy makes a modest recovery, then we could still have some rise in consumption coupled with a gradual decline in the current-account deficit. Exports to Europe are key. It may be, too, that the current account isn’t quite as bad as billed because the numbers may well be revised. Right now, they look implausibly bad to me.

There is a further element to the best-case scenario. It is that we can get unemployment down a lot more and get participation rates up, so that strong growth can continue without labour costs rising sharply. The more capacity there is in the labour market, the longer this strong growth can continue. We are down to 5.8 per cent, only one percentage point higher than what seemed to be the floor in the early 2000s. But maybe, thanks to our flexible labour market and to better training, unemployment could go lower – say to 4 per cent or even below. That would be really good news.

Unfortunately, there is a worst-case scenario, too. It would be that, next year, inflation snaps up suddenly, requiring a faster-than-expected rise in interest rates and a fall in asset prices, including property. The consumer boom would end anyway, but it would come to a sharper end. We would be back into the long slog of correcting the fiscal deficit, with higher taxes for all. Austerity would be back. While overall growth could continue, things would not feel much fun.

We shouldn’t begrudge the coalition its moment in the sun. That its economic policies were praised in Davos by Christine Lagarde, head of the International Monetary Fund, makes a change from the “playing with fire” attack by the IMF’s economist three years ago. But we should be honest, and acknowledge that the coalition has engineered a pre-election boom.