The Guardian reports the latest GDP growth figures for Germany and France - which are positive.  Given their importance as trading partners, this must be good news for the UK as well, which must help explain the continued strength of the stock market today.

The euphoria is a contrast with the prevailing tone in the Bank of England's Inflation report; Mervyn King's commentary demonstrated why he saw growth remaining weak, and the output gap high.   Most of the reasons for this might be termed "balance sheet related":

The financial sector is the most obvious, but not the only, sector that is likely to restructure its balance sheet. Households may save more in response to the falls in financial asset prices, or simply to create a uffer of savings to guard against uncertain times ahead. And the public sector, having cushioned the slowdown in spending, will over time need to adjust its finances to a more sustainable position. Such actors mean that the pace of recovery over the next few years is highly uncertain.

 The thick green part of the chart is around 3.75% or so.  That is robust growth - ahead of the go-go days of the mid 2000's.  Mervyn seems to be saying "read my lips not my charts" here - something confirmed by Ashley Seager on today's Guardian Podcast. The rest of the BOE's report is here: enjoy. 

If growth is to remain weak, then the Bank can in theory extend its QE programme aggressively until growth - and expectations of growth, which are dynamically linked - return to a satisfactory path (I think this is what Scott Sumner would call for - I am in the tortuous process of going back through his posts from March to understand his radical viewpoint). 

Various economists have put up a straightforward "Reasons for the Crunch" piece that is worth reading over on VoxEU. It fits into the Blame Greenspan model:

We have argued that the massive financial instability of 2007-8 was primarily the result of lax monetary policy, mainly in the US. The regulatory system compounded this error by tolerating excessive leverage and maturity transformation by banks in the US and Europe. Innovation did contribute to credit expansion and instability, but in all likelihood, without lax money and excessive leverage, reckless bets on asset price increases would have been much reduced.

The logical conclusion is that a repeat of this instability could be avoided in the future by correcting those two policy faults. By and large, there is no need for intrusive regulatory measures constraining non-bank intermediaries and innovative financial instruments. Our main message in designing the new rules for the global financial system is “keep it simple

I would love that to be true: my pad has about 20 "solutions" to the crunch*, and if they all lay within one institution (the central bank), my job would be a doddle.  

But away from this hopeful MACRO solution to the crunch and onto the MICRO, and in particular the favourite "solution" from the left: greater curbs on the level and manner of bankers' pay. So they are a bit dismayed with the FSA's piece on this, which seems to roll back from tight regulation. Here, for example, is John Kampfner:

 Britain – the Britain of New Labour – has become the world leader in indulging the super-rich and the very rich. Forget for one moment issues of natural justice and social harmony: has this culture of greed produced better performance? Excessive wealth has not produced an incentive to improve the nation's lot.

The FT's leader takes the other side:

Its proposals, unveiled on Wednesday by Hector Sants, the FSA chief executive, are well-judged, robust and they will take effect soon: from January 2010, companies will need to demonstrate to the regulator that their pay structures encourage employees to do what is expected of them . . . It does not demand that specific proportions of income should be deferred nor mandate how closely individuals’ pay should be linked to company performance. This is a climbdown, but the rulebook is better for having lost these details . . . A principles-based approach is smarter. In the long run, being too specific about what is allowed and what is not permitted may encourage companies and regulators to fall into box-ticking habits, rather than thinking through what their pay systems actually achieve.

 I side with the FT here: principles-based approaches are more liberal, allow companies to reflect conditions on the ground.  And I am sceptical that more invasive pay practises will somehow guarantee behaviour that is more robust for the system itself: that level of alignment sounds almost impossible to achieve. Concern about high pay is more about social justice, if we are honest: financial sector pay seems to produce rewards that are not linked to social function, and that irks people, understandably: but that is not the FSA's job to fix. 

In 2-5 years' time when the economic trough is a memory, there will be a furious academic debate about what exactly got us out.  The excellent Mark Thoma has considered this question: or more, its unanswerability, in "Can Econometricians Tell Us which Macroeconomic Model is Best?":

Much of the uncertainty in economics derives from our inability to do laboratory experiments, and that includes uncertainty about which model best describes the macroeconmy . . .Some New Keynesians will cite fiscal policy as the important policy response, and the timing of the policy relative to the recovery will likely support that argument. Other New Keynesians along with Monetarists (e.g. Lucas and others who believe monetary policy can help, but fiscal policy is ineffective) will insist it was monetary policy that saved us. The timing of the monetary policy response will support their position as well. Still others, those such as Prescott who believe in Real Business Cycle models, will say the economy recovered despite policy, and would have recovered all that much faster if government hadn't gotten in the way.

  In many ways, this is a despairing conclusion.  We want to be able to give policy makers ever improving advice, and the wildly different conclusions reached by monetarists (see Sumner) and the likes of Brad DeLong about the importance of Fiscal Policy are a justifiable reason to be anxious.  I was half-contemplating a long piece on the monetarist solutions, particularly those of Sumner which almost seem Panglossiain in the ease with which they prescribe solutions to what seems to be a complex problem.  Read, for example, Tim Congdon here.

 The way to stop the recession is not to bully the banks into lending more. Many companies and households have been traumatised by the events of the past 18 months and will want to spend the rest of 2009 repaying bank loans. Instead, the answer to the recession is to increase the amount of money in the economy . . . Roughly speaking, operations of the necessary size – say, £100bn ($143bn) to £200bn of asset purchases – can add 5 to 10 per cent to the quantity of money in a few months. Company money holdings are more volatile than money as a whole. So company bank deposits might jump 10 to 20 per cent by the summer, ending the recession with surprising speed

If this were true, and recessions could be fought without any fiscal measures (or even with fiscal tightening, leaving no government debt costs), imagine how easy policy would be!  No need to worry about banks, future government debts, the household balance sheet - just crank up M0 or whatever M you care about until people expect growth again and do the things that make such growth happen (i.e. spend).  

Can it really be true?  All my instincts rebel against such easy and centrally-directed solutions.  But to confront them means diving into a deep dark hole called Monetary Economics. Not many people climb out unscathed. 

*for example, see the answers posed in this report from the Treasury Committee