The true cost of reflating the economy

At last, there is some positive news coming out of the Euro area. France and Germany are no longer in recession. Both economies recorded modest growth rates during the second quarter.

It won't be long before the UK economy will produce a similar story. It is a fair bet that the economy has now stopped contracting and that it will record a small increase in GDP during this quarter. No doubt, it will be followed up with a further quarter of growth during the closing months of this year.

However, what about the long run cost of generating this paltry spurt of pre-election growth? After all, it was achieved through an unprecedented expansion of the fiscal deficit and a dangerous experiment in monetary policy, which saw interest rates cut to an all time low and an unprecedented expansion in the monetary base.

These policy innovations are unsustainable. The government debt stock is exploding. At some point, it will need to drastically curtailed. Likewise, even the most optimistic exponent of quantitative easing recognizes that the printing presses will have to stop and interest rates will necessarily rise.

Unwinding these policies will be desperately painful. We will see growth again contract as government expenditure is slashed, taxes are hiked and interest rates return to more reasonable levels.

The sad reality is that the jokers running the UK economy have a time horizon of less than 12 months. No one is thinking about what the UK economy will look like in 2011, when the great policy unwinding is in full swing.

So when everyone begins to rejoice at the positive GDP numbers, which will be reported in October, think for a moment about the true cost of that short spurt in economic activity. Make no mistake, it was purchased by creating massive monetary and fiscal problems that we will have to face in the future.