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Cost of the floods

• Evan Davis | Notes on Real Life |
• 25 Jul 07, 09:47 AM

Flood repair is expected to cost billions of pounds. One estimate today suggests that insurers stand to pay out 拢3bn from this summer's weather. And there are likely to be repercussions for food prices. The Grocer magazine estimates that forty per cent of the British pea harvest has been lost for example.

But it's easy to exaggerate the costs of these events in the heat of the coverage.

So here are three points I would make about the economic damage of these floods.

First, they will cost us billions of pounds, and we should not trust precise estimates of these things. News from Hull that the number of homes affected by the floods there last month was 6,500, rather than the 16,000 reported at the time shows how easy it is for us all to overstate these things.

Taking into account the insured and uninsured damage, plus some cost deriving from loss of output, and some extra taxpayer support for flood relief and reconstruction, drives me to conclude the cost of the floods is several billion - with the total cost likely to be closer to five than say, one billion or ten billion. I wouldn't go more precise than that!

Secondly, if it was five billion, it would still represent under half a per cent of our national income, which is quite small.

We often find that big news events do not turn out to be big economic events. It's easy, gazing at TV news pictures, to put too much weight on what you are seeing. Most of the country is not flooded and economic life has carried on as normal, if a little damp.

Of course, a lot of life has been affected. I wouldn't want to understate the importance of the National Ballooning Championships in Ludlow, which have been cancelled. But we should not allow these things to crowd out of our minds all the things that are still going ahead.

And to see this, it's worth doing some back-of-an-envelope mental arithmetic. If 50,000 homes have been badly affected by flooding, that's probably 125,000 residents. Probably half of them are working. The average annual output per worker in our economy is (very roughly) 拢1,000 a week. If all the affected workers took a month off to deal with their flooded homes, we would lose a quarter if a billion of pounds of national income. That is less than a quarter of a tenth of a per cent of annual national income.

Or to put it another way, our economy is huge, and it takes something big to destabilise it.

But there is a third point. These floods might be carrying some economic news with them, as well as rain.

They might be giving us some information that has bigger economic implications than the havoc they are causing in parts of the country, because they might be telling us that floods now occur more often than we have generally thought. Then, we have a bigger economic story to cope with.

Five billion pounds looks very significant for a one in five year weather event, even if it seems quite bearable for a one in sixty year event.

The last two years of first drought and then flood possibly suggest a potential need for vastly greater investment in weather-proofed infrastructure. That could amount to many billions.

So perhaps the real economic significance of the flooding, is that it raises concern that all the expense derived from our apparently freakish weather is not that freakish after all.

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My prediction - July

• Evan Davis | Small Change |
• 5 Jul 07, 10:00 AM

My prediction today is that interest rates will rise, but I am much less sure of that than everybody else appears to be.

My approximate probabilities are:

Quarter point rise - Two-thirds
No change - One-third

The reason you might expect a change is that the Bank's last inflation forecast implied at least one more is necessary. And if only one member switches vote, we'll get that rise today. Moreover, the governor, Mervyn King, is in favour of a rise. He was opposed by three of his own internal bank colleagues last time, so one of them might move on to his side now, to avoid the (minor) embarrassment of him being out-voted twice in a row.

The reason you might not expect a rise is that little has changed since the last vote which was to delay acting; we are only now a month away from the next inflation report, when there is a new inflation forecast. The MPC prefers to move in those months.

But most significantly, it is still rather early to tell just how biting the previous four rate rises will be. The pain seems to have been delayed by the prevalence of fixed rate mortgages that have yet to expire. Once they do expire of course, the pain to the mortgage-holders is delivered in one hefty dose. We are only beginning to see that occur.

Until we know what the full effect of the other rises is on the economy, the bank has to be wary about over-doing it. Several MPC members think that delaying another rise for a month to see how the existing rises bed down is not particularly dangerous.

Incidentally, if the MPC does vote against the governor again, there will undoubtedly be a flurry of talk about his position being awkward and possibly untenable. Some commentators will say the MPC "lacks confidence" in Mervyn King's leadership..

I'm deeply sceptical.

Disagreements around the timing of quarter point changes in interest rates are of little real intellectual significance. Surely anyone who understands interest rates understands that.

It would be odd if a system built around individual voting - as ours is - rather than collective responsibility, accidentally morphed into one in which everyone had to agree with the governor (or that the governor had to agree with everyone else).

That's not to say there aren't real disagreements on the MPC over other things - such as the importance of money supply in determining inflation. But if our system can't cope with these stresses, MPC members would forever have to be thinking about the politics of how they vote as well as the economics, which would be unlikely to improve decision-making.

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