Economy slows to 0.2%: deadly stagflation is here

So it's official; nine months into the coalition's programme of debt reduction and public austerity, the economy is not just flat-lining, we have also fallen into the deadly trap of stagflation. The Chancellor may not care to admit as much, but on this occasion the figures really do speak for themselves.

In his first full budget last autumn, George Osborne's projection was that growth this year would be 2.3 per cent. At current rates, with just 0.2 per cent achieved in the last quarter, we'll be lucky to scrape half that for the year as a whole.

Meanwhile the Retail Price Index - still the best indicator of inflation despite efforts to downgrade it - is likely to come in at over four per cent.

In such circumstances it is not surprising that consumers are holding back and businesses are not investing. When that happens, growth dries up. As anyone who lived through the 1970s knows, not only is stagflation demoralising and damaging, it is also horribly difficult to shake off.

To be fair to Osborne, a lot of the problems that are pressing down on our economy have little to do with him. The financial difficulties of the eurozone and the US can hardly be laid at his door. The surge in world commodity and energy costs which is fuelling inflation is likewise not his fault.
 
Nor is he alone in getting his forecasts wrong. Two years ago, the Bank of England thought growth by now would be four per cent and inflation around half that level. But excuses are no substitute for policy, especially if you are the Chancellor of the Exchequer. The question now is what can we - and more particularly he - do to get us growing again?

There is a school of economic thought that says the answer is nothing. According to this, when an over-indebted country has just been through a massive banking crisis abnormally low growth for anything up to a decade is only to be expected. On occasion, the Governor of the Bank of England, Mervyn King, has hinted that it is a view he may share.

Such defeatism, though, is hardly an option for Osborne. His grand plan, first to reduce the deficit and then to restore prosperity, depends on growth. If he gives up on growth the markets, which he relies on to fund his borrowing, could all too easily give up on him. Were that to happen, the consequences for both sterling and interest rates could be very nasty indeed.

The markets would also take fright at any hint that he might give up on deficit reduction, as his Labour shadow, Ed Balls, keeps urging.

Balls has a point, however, when he says that for too long the coalition has assumed that its plan to cut the deficit is also a plan for growth. In the medium term, deficit reduction will allow the economy to grow. But it needs to be accompanied by other, more immediate measures to reassure consumers and persuade businesses to start investing again.

One reason the coalition has been slow off the mark on this is that its two component parties have very different instincts on the economy. The Conservatives would like to see a much bigger reduction in red tape, especially regarding employment law, a firmer line with Europe on new regulation, and at least an indication of lower taxes when things finally improve.

But deregulation is not a subject that the business secretary, Vince Cable, has ever shown much interest in, even though he is supposed to be in charge of it. His priority has been to reform the banks and make them lend more, which Osborne is meant to be in charge of. He also wants more quantitative easing by the Bank of England, which the Prime Minister yesterday declined to endorse.

Meanwhile the Lib Dem energy secretary, Chris Huhne, has set his heart on a huge and costly investment in green energy, which many Conservatives think is economic madness. And no Lib Dem, of course, wants to pick a fight with Europe.

Both parties have good points, notably the Lib Dems on the banks and the Tories on employment law. What they cannot afford is to bicker any longer while the economy stagnates.

Perhaps the coalition's biggest achievement is that it has managed to build a broad consensus behind its plan to reduce the deficit. After a year of procrastinating, it now urgently needs to get its act together on growth. ·