Cycles in economic life have been known about at least since the time of Joseph, the Keynes of his day, who introduced countercyclical measures to the pharaohs of Ancient Egypt. The Josephian cycle was predicted to be 14 years and driven by harvests. Many different cycles of varying length were identified later. At one end lies the Kondratiev Long Wave of 25 years up and 25 down, a boon to prophets of doom.

Since Britain’s industrial revolution, shorter cycles have been linked more often to financial excess, including 19th-century railway building, more recent property booms and the brief US recession after the dot-com bubble. The UK slump of the 1920s and early 1930s was probably caused by structural shortage of demand abroad and at home in the wake of the First World War, as diagnosed by the modern Keynes. The deeper American Depression of the 1930s, the downside of a 20-year cycle, was exacerbated and perhaps caused by a boom and collapse of credit and money supply, as Milton Friedman argued. It even had an agricultural dimension.

In postwar Britain, overly zealous use of Keynes’s fiscal remedies, when the economy had nothing worse than a light chill, inaugurated the policy-driven stop-go cycle of about four years and an inbuilt tendency to inflation. In the 1970s, Opec became a new agent of instability, widening six-year cycles.

Lady Thatcher’s cure, a mix of monetary control and higher taxes, had the side-effect of a new mini money cycle of about two years, dubbed stop-go Mark 2. It is still with us, because phases of tightening and loosening take time to register.

The British economy has been growing continuously for 15 years, mostly at a fair pace. Hubris surfaced in America in the dot-com era, when a new paradigm of continuous strong growth was posited. After that lesson, no one now suggests that cycles have been banished by sound monetary control by the Bank of England and sound finances at the Treasury.

On the contrary, the economic cycle forms the framework for fiscal policy. Under the “golden rule”, tax and government current spending are to balance over the cycle, so that we borrow only for public investment. But this rule does not work.

The cycle is defined as starting and ending at the point where output rises above its long-term trend. Yet trend growth is said to have risen to 2.75 per cent, which changes everything. Dating of this cycle keeps being revised, mainly for statistical reasons, so that Gordon Brown’s ten years as Chancellor have neatly been identified as one full cycle.

Even if that is accepted, Treasury projections do not quite add up. After a year when employment peaked, after rising for a decade, an £8.8 billion current deficit has just been recorded. Joseph would not approve.

More puzzlingly, we have just started a new phase of output rising above the norm when the Treasury says the economy as a whole has no spare capacity. The “output gap”, a key to dating the cycle, is predicted to be zero. Inflationary pressures should appear straight away, as they are, and the Bank should curb growth quickly, as it probably will. If so, time spent above trend will be minuscule.

The official get-out clause is that the economy will just keep growing at trend rate, attached to its ceiling like a hyperactive snail. But that is another way of saying that the cycle has been banished. The Commons Treasury Select Committee, in its report on the Budget, suggests that the output gap is no longer meaningful, because unlimited migration can boost capacity at will. The Bank has dropped it.

Peter Spencer, who runs the Treasury model for the Ernst & Young ITEM Club, argues that there is no ceiling at a national level. In a global economy, in which consumer goods prices are determined in China and share prices in New York, an economy powered by London financial services is limited only by the world output gap.

Conventional economic cycles lean heavily on factors specific to industry, such as investment in new capacity and changes in materials and parts. But UK industry is now too small to drive the cycle, which is as well because manufacturing has been in near-recession for years. Our lack of an electronic manufacturing industry even helped us to avoid the postbubble recession.

A new fiscal rule is needed. Tax and spending could be balanced on a rolling five-year view to fit the electoral cycle. Or Budget balances could be judged against an annual snapshot of the economy, as mooted by Ed Balls in 1997.

New cycles geared to financial markets or global trade will be different from those centred on fluctuations in UK industry. They will still creep up to bite us.

graham.searjeant@thetimes.co.uk

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