Duncan’s Economic Blog

Fiscal Policy: Time to heed the word of God

Posted in Uncategorized by duncanseconomicblog on April 28, 2011

I described yesterday’s GDP figures as on the border between ‘terrible’ and ‘merely bad’. I also pointed out how the number matches up with recent OBR forecasts.

Tony Dolphin put is very clearly, ‘the UK has just come as close as it is possible to come to a recession without actually being in one.’ He further stated that the real worry was the ‘possibility that the UK will experience several years of low growth, as Japan did in the 1990s.’ The dreaded L shape I also referred to yesterday.

The FT’s Lex column is clearer still, By any absolute standard they [the GDP figures] were awful’.

On Newsnight last night (iplayer) the panel of business-people discussing the numbers were unanimous in their gloom. Not just former Labour minister Lord Myners but fund manager Nicola Horlick and former ASDA CEO Andy Bond, who last year signed a letter backing Osborne’s approach. In a separate interview PWC’s Chief Economist John Hawksworth warned that a double dip recession was possible.

In other words it’s not just the usual suspects who are worried about the state of the economy. My own double-dip forecast is looking less radical.

It’s time for Osborne to take stock of the economy and think again. It’s time for Plan B and it’s time, as I say in the title, to heed the word of GOD.

Or Sir Gus O’Donnell, the Cabinet Secretary, as he is otherwise known.

Back in December Philip Stephens wrote in the FT that he had written a memo emphasising the uncertainty in the OBR’s forecasts and calling for “if not a plan B” than at least a series of “possible stimulus measures”.

As I blogged at the time government sources were quick to point out that ‘Treasury Ministers’ had not requested such a memo. Which of course was in no way a denial of the story, ‘Plan B’ came from the Cabinet Secretary and the Cabinet Office and was ignored by the Treasury.

This is the context one has to consider when reading a very important Jonathan Portes article in the FT. As today’s Guardian leader rightly says:

Yesterday, Jonathan Portes, former chief economist at the Cabinet Office, reiterated his call for “scaling back” the “fiscal overkill”. Mr Portes worked in a senior policymaking capacity with coalition ministers until recently; his intervention deserves to be taken very seriously.

Portes was, until very recently, the Chief Economist of the Cabinet Office and is now at NIESR. His CV states that hehe advised the Cabinet Secretary, Gus O’Donnell, and Number 10 Downing Street on economic and financial issues.’  

So I think his article is the best guide we can have to what the Cabinet Office Plan B looks like, in contrast to the well known Treasury Plan A, without having to wait 15 years for a series of candid interviews in a Michael Cockerell documentary.

It is a very significant intervention indeed. It describes the current policy out look as ‘misguided’ and ‘futile’ and concludes by saying:

Put simply, the UK is a large country, issuing debt denominated in its own currency. It has very long average debt maturities, and therefore no serious issues over its long-term solvency. Countries such as ours have considerable freedom over fiscal policy in the short to medium term. We should use it.

I couldn’t agree more.

GDP: Time to worry about the ‘L shaped’ recession again?

Posted in Uncategorized by duncanseconomicblog on April 27, 2011

We’ve been told today that over the past six months the economy has ‘flat lined’, ‘stagnated’ and been ‘on a plateau’.

All of which is true.

But sometimes a picture really is worth one thousand words.

How long until we start talking about ‘L shaped’ recessions again?

An L-shaped recession occurs when an economy has a severe recession and does not return to trend line growth for many years, if ever. The steep drop, followed by a flat line makes the shape of an L. This is the most severe of the different shapes of recession. Alternative terms for long periods of underperformance include “depression” and lost decade; compare also “malaise“.

GDP – Quick Chart

Posted in Uncategorized by duncanseconomicblog on April 27, 2011

I’ve got some reaction to the GDP release up at False Economy. Drawing on yesterday’s post previewing it.

To add a little more detail the chart below shows the OBR’s forecast for Q4 2010 and Q1 2011 as it was in June 2010, after Osborne’s emergency budget, in November 2010 and at the most recent Budget in March. It also shows the actual outturn of the data.

GDP is about 1.1% lower today than the OBR thought it would be 10 months ago, 0.8% lower than was assumed back in November and about 0.2% lower than the forecast from last month.

The question now is will the full year 2011 forecast be revised down? (For the fourth time).

Household Debt (Again)

Posted in Uncategorized by duncanseconomicblog on April 26, 2011

On Thursday the OBR put on a detailed note on their Household Debt forecasts. Something I welcome.

I planned to blog about this over the weekend, but given the excellent weather, a weekend of variously sitting about in Alexandria and Finsbury Parks seeing friends, getting a much needed hair cut and generally relaxing seemed a lot more pressing.

Matt Sinclair has blogged about these numbers today – claiming that they vindicate him and prove me wrong.

I wasn’t planning on writing this today and don’t really want to get into another argument (although I’m happy to if needed!), so here’s a very quick response – written with one hand whilst I enjoy my Tesco prawn sandwich lunch.

 -         I will accept that writing on False Economy in a way that suggested the entire £245bn increase in household debt was due to Osborne was ill advised. I should have  noted the increase in household debt and noted how Osborne was driving up it up, but not claimed he was entirely responsible. Hands up, sorry – poor wording on my part. But…

-         Osborne’s policies clearly have driven up household debt forecasts. In his post today, Matt only attributes direct policy changes to Osborne (and that still comes to £17bn). The effects of his policies in pushing up unemployment have also driven down wages. And falling earnings forecasts are a significant part of the reasons that the OBR has revised debt up. In table A.3 for example the earnings forecast change puts £40bn on household debt.

-         Matt’s original attack on my False Economy post was based on the idea that higher inflation has increased the debt forecast. Something we now know is not really the case.

-         Leaving aside how much Osborne is responsible for the forecast increase in household debt, the fact remains that it is forecast to soar to new record highs – something he regarded as unsustainable before he was Chancellor, but which he downplays now.

-         The OBR have also now told us that net household worth is forecast to fall in the next few years (i.e. this is a net not just a gross issue).

-         Finally I’d again say, that I think the OBR numbers will turn out to be wrong. I don’t see the household savings ratio falling and staying low until 2015. Which is a problem given consumer spending is forecast to account for about 40% of growth over the next 4 years.

A Social Democratic Economic Programme

Posted in Uncategorized by duncanseconomicblog on April 26, 2011

There’s been a fair bit of debate recently in Labour circles about ‘Blue Labour’ (handy reading list from Old Politics here), ‘Purple Labour’ and attempts to synthesise them (Graeme Cooke has an excellent article on this topic, which (unusually) actually outlines some specific and actionable policies).

Personally whilst I have a fair bit of time for a lot of the Blue Labour ideas, and a lot of time for much of what Graeme discusses, I actually am pretty old fashioned. I regard myself as a Social Democrat.

So, in that spirit, I tried a few months back to summarise my own ideas on economic policy into a 1,000 words or so (plus a couple of graphs, obviously).

Nothing there will be new to regular readers of the blog, but for those interested I’ve put my thoughts of Investment, Wages and Labour economic policy up as a page – available here. Comments most welcome.

GDP – what would be a good number?

Posted in Uncategorized by duncanseconomicblog on April 26, 2011

Tomorrow at 9.30 am the first estimate of GDP growth for the first quarter of 2011 will be released. Given that this will doubtless be accompanied by a blizzard of claims and counter-claims (not least from myself!), it makes sense to start thinking about this number now and considering what would be a good result and what would be a cause for concern.

First things first though – this is a first estimate based on incomplete data and will be subject to later revision. In any case – it almost never makes sense to get too caught up in any individual data point when analysing an economy.

What’s more this number is very hard to forecast, back in January we learned that the economy had shrunk by 0.5% in the last quarter of 2010, at that time most economists were expecting growth of around 0.5%.

The other important thing to remember is that this number will only tell us how the economy performed in January, February and March, i.e. after the VAT rise but before the impact of most of the cuts, which began in April. Whilst a bad number is obviously a reason to worry, a ‘good’ number doesn’t mean we are out of the woods yet. Severe cuts could easily crimp growth going forwards.

Important caveats aside what would be a good number?

The FT has a good summary on this very question today. They say -

-         Given that snow subtracted 0.5% from growth in Q4, we should expect this to ‘bounce back’ in Q1.

-         In addition, some services and purchases (according to the ONS) were postponed in Q4 and should now fall into Q1. So the real minimum we are looking for is about 0.7%.

-         If 0.7% would represent no real growth over two quarters, then 1.2% would show the expected bounce back from Q4 plus the economy growing at ‘an average pace’ in Q1.

-         ‘Arguably’ (says the FT) it should be even higher, around 1.7% if we account for some of the underlying stagnation in Q4 being reversed.

In terms of what observers expect,  the OBR and the Bank of England have both pencilled in 0.8%.  City analysts are more pessimistic with JP Morgan going for a very weak 0.2%, Citi saying 0.5% and Goldman at 0.6%.

So, I think it’s fair to say, that any number below 0.5% would be terrible, 0.6% to 1.2% would be merely bad, 1.3% to 1.7% would be reasonable (i.e. what we should expect but nothing to get excited about) and over 1.7% would be good.

What this really brings home is how important it is to consider the severe disruption the quarter before when looking at tomorrow’s figure.

For example if growth comes out at 1.2%, it will in reality mean that the economy has managed an average pace of growth over the past six months (ahead of the cuts). But that would also be the strongest quarter on quarter growth since 1999 and well ahead of the OBR forecast, something I’m sure certain observers would be very quick to point out.

We’ll know more tomorrow.

UPDATE:

The Spectator Coffee House says that:

A positive number, and we shall be recovering again. A negative number, and we shall have experienced two consecutive quarters of shrinkage — which is to say, the country will be back in recession. Happily for George Osborne, then, but less so for Ed Balls, most signs are pointing towards the former. The consensus among forecasters such as the NIESR and the CBI is for growth of around 0.5 percent; far from overwhelming, but growth nevertheless. And the Chancellor himself is said to have told Cabinet today that the economy is “on the right track. (My emphasis)

Talk about setting the bar low! Any growth at all would be a ‘happy’ result for Osborne and 0.5% growth (i.e. no growth in past six months) would be a decent one? Wow, I hadn’t realised we were aiming for stagnation.

Compare and contrast to the FT article linked to above:

Add in one quarter of the growth expected in 2011 – about another 0.5 per cent – and the figure necessary to show the economy growing at an average pace in the first quarter is at least 1.2 per cent.
 
 

Expecting a double dip

Posted in Uncategorized by duncanseconomicblog on April 19, 2011

Over the past few weeks I’ve become very worried about the state of the British, and indeed world, economy. So worried in fact that I’ve changed my central view. I used to think that we would experience a period of sluggish growth with a downside chance of an actual double dip, but now expect a double dip with sluggish growth as the most likely upside scenario.

I’m writing this a week and a half before we get the first look at the Q1 2011 growth figures, but I’m more concerned about Q2 and especially Q3 onwards. For me to change my view again, I’d have to see very strong figures next week. Something which looks unlikely.

Whilst there has always been a real worry about growth in 2011, I’ve until now been reluctant to suggest that a second downturn is likely. If we actually get growth of 1/1.2% for the year, I don’t like the idea of certain people ‘celebrating’ this as a success but I think the time for expectations management has passed.

For me the final piece of the jigsaw making me change my view came last week with the juxtaposition of the inflation and retail sales numbers on the same day. Inflation unexpectedly fell driven by grocers cutting costs but retail sales (despite price drops) suffered their worst fall since the records began.

I’m getting what can only be described as a ‘mid 2008 feeling’ – financial market troubles (this time mainly in the Euro area rather than directly in the banks), soaring commodity prices, signs of stress in the real economy and what can only be described as complacency in the forecasting community. Back in mid 2008 the consensus view (held by most city analysts, the BCC, the CBI, OECD, EU,* etc, etc) was that the UK would avoid a recession. We now know it had actually already started.

The OBR forecasts for 2011 and 2012 will doubtlessly be wrong – something they themselves admit. It’s next-door to impossible to produce accurate macro forecasts on that time frame, hence the fact they publish fan charts showing possible outcomes as well as a central forecast.

The only question is how wrong – will we see some sort of weak growth as they forecast or will we actually have two consecutive quarters of negative growth?

As I currently see it, for the OBR to be more right than wrong, four (nearly) impossible things have to happen.

1 – The impact of spending cuts on growth has to be a lot lower than the IMF estimate them to be.

2 – We have to experience very fast export growth (despite our major trading partner, the EU, being wracked by problems and austerity) and, at the same time, historically slow import growth.

3 – We need a mid/late 1990s style investment boom. Something that is not happening yet.

4 – The household savings ratio has to fall and households having to starting borrowing and spending again.

Whilst one or two of these things might happen, I just don’t see them all occurring. And that means that by Q2/Q3 the economy could be serious trouble. Again.

Does this mean we should forget about the deficit and concentrate entirely on growth?  No– and anyway that is something of a false choice as growth is a hugely important factor in deficit reduction. But it does suggest to me that the excessive front loading of deficit reduction that Osborne is trying should be rethought. I’m increasingly drawn to the Deficit Reduction Averaging approach suggested by Adam Lent and Tony Dolphin, but of course that would mean moving more of the pain back from 2011 and 2012 and into 2013 and 2014, dangerously close to an election from the government’s point of view.

I’ll write more on this topic in the coming weeks and eagerly await the data.

* Also worth a look at the EU’s deficit forecasts for the UK as of Spring 2008. A forecast of 3.5% deficit for 2009/10…

Economics in the Mirror Universe

Posted in Uncategorized by duncanseconomicblog on April 18, 2011

I’m something of a closet Star Trek fan, and like all true Star Trek fans I’ve always enjoyed the Mirror Universe episodes. For those not blessed by having seen these, the Mirror Universe is a dark parallel to the ‘normal’ Star Trek Universe in which familiar characters exist but things are suitably different. The world is a darker place and things we expect to be true no longer are. Spock, for example sports a rather fetching goatee beard.

I mention this because as I read the economic ideas and analysis coming from the right, I occasionally have to stop and ask – are we living in a Mirror Universe? They are using words and ideas that I’m familiar with but somehow they seem to think the normal chain of causation, of action and reaction has broken down.

Of course, Mirror World logic has existed on the right for a long-time. Most (in)famously there is the Laffer Curve, the idea that cutting tax rates raises tax revenues by making work more attractive.  Now whilst there may be cases where taxes have been set too high and lowering them will therefore raise revenue, in the real world such cases are comparatively rare. Not so in the Mirror World of the Tax Payers’ Alliance and the Spectator though, where we always seem to be on the right-hand side of the Laffer Curve and so any tax cut will increase revenues.  

In the past few years though Mirror World logic seems to have spread to the right’s entire approach to fiscal policy. Whereas the IMF has chosen to stay in the real world and argue that although government deficits must be cut, the impact of the cuts will hurt the economy, much of the right has adopted the Mirror World Logic that cuts will actually help the economy to grow. So rather than arguing that the cuts will be painful but are needed to appease the bond markets they instead embrace the new theory (actually the very old theory) of ‘Expansionary Fiscal Contraction’. This theory, recently described as ‘oxymoronic’ by former US Treasury Secretary Larry Summers (I’m not sure he needed to add the ‘oxy’), tells us that as the Government gets out the way the private sector will step in so the economy will almost seamlessly rebalance from public demand to private demand, from consumption to exports and investment. In the real world of course nothing is seamless, cutting public sector jobs does not automatically create private sector ones and slashing government demand doesn’t mean private demand will automatically take its place.

In the Mirror Universe it would appear that cutting government debt is utmost importance, even if household debt soars at the same time.  Leading to, as Paul Krugman put it, “the spectacle of a government that inveighs against the evils of debt pinning all its hopes on an assumption that over-indebted households will dig their hole even deeper”. As I said at the beginning, in the Mirror Universe things are not quite as they appear.

These are just some of the most extreme bits of Mirror Universe logic I’ve spotted in recent months  but I’m sure there are many more – for example the fact that those most keen on fiscal tightening are often also those most keen on monetary tightening at the same time.

Next time you hear someone expounding a theory that seems to not only make no sense but also reverses commonly understood logic it’s worth pausing for a moment and asking yourself -‘Does Spock have a beard?”

Debt Maturity & Macroeconomic Trade-Offs

Posted in Uncategorized by duncanseconomicblog on April 13, 2011

Last week I commented on the importance of the debt maturity profile, something which I feel is often missing in the economic debate in the UK.

I noted (referring to recent Bank of America research) how crucially important this is when judging how sustainable a government’s fiscal position is.

There’s a tendency in the UK political debate around the government finances to concentrate on one number – the annual deficit (on which measure Britain is supposedly  at risk of a loss of market confidence) – and to ignore other measures such as the existing stock of debt to GDP, the interest rate charged on debt and the maturity profile of that debt, on all which Britain is in a strong relative position.

In this context, yesterday’s IMF Fiscal Monitor is well worth a look. (All the following data is from statistical table 9).

The average maturity of British government debt is 13.8 years, higher than any other developed economy. Indeed only Estonia comes even close with 11.5 years. The maturity profile of British government debt is more than twice as long as that of the US, Germany, Canada or Italy.

This matters. Osborne is often keen to point out that the UK deficit is higher than that of Greece, or Portugal, or whoever is in the news with debt problems in any given month. But this misses the point. Britain might have a higher deficit than those countries but it still needs to borrow less in any given year.

This may seem counterintuitive, but it’s actually quite straight-forward. Whilst Britain has to issue more debt to fund its deficit, it has to refinance much less existing debt. The long debt profile means that less of the old debt is due each year.  

The chart below shows the gross (as opposed to net) borrowing requirements for advanced economies in 2011.

As can be seen rather than being ‘the worst’ the UK is actually in the middle of the pack. To make this even clearer, the chart below shows the same data for the G7 group of leading economies.

 

The UK actually has the second lowest gross issuance in this group. The UK will be issuing less debt than Canada, Japan, France, the US or Italy next year – despite a higher deficit.

I’m not using this data to claim that a deficit of around 10% of GDP is ideal, but I do think that this issuance profile coupled with the very low interest rates this debt attracts (around 3.75%) makes it much more the government’s fiscal position much more sustainable than many would have us believe.

In the end macroeconomic policy rarely comes down to a right or a wrong answer. Instead it’s about trade-offs and risk. This gets lost in a polarised political debate as the UK is now experiencing.

The Government claim that cutting the debt will lead to ‘expansionary fiscal contraction’ and a ‘rebalancing of the economy towards net exports and investment’. This is unlikely to be correct, the evidence (see this post for example on recent IMF work) suggests that austerity policies lead to weaker growth – especially if interest rates are already low or cannot fall further. I’d have much more time for Osborne if he acknowledged that the cuts will hurt growth but argued that not cutting as fast and deep as he plans would risk a loss of market confidence and problems funding the debt. That’s a justifiable and reasonable position to hold.

We face a trade-off between cutting and hence harming the economy and not cutting and hence risking a loss of bond market confidence. The real debate, away from the shouty world of Westminster, is about the balance of risks.

Taken together I think the UK’s low stock of debt, the low interest rates it attracts and the debt profile outlined above more than offset the high deficit. I think the risk of cutting as fast and deep as the Government intends is far worse than the risk of a loss of confidence. I certainly don’t say that there is no chance the markets would lose faith in a British government that’s adopted a different approach, I just think the balance of risks points towards a less extreme and more growth friendly fiscal package.

Benchmarking the Osborne & Darling Plans

Posted in Uncategorized by duncanseconomicblog on April 12, 2011

Last year the IMF’s Chief Economist Oliver Blanchard set out ’10 commandments’ for fiscal adjustment in advanced economies.

Whilst I don’t necessarily agree with them all, they represent a good benchmark of what a sensible technocratic, centrist fiscal adjustment would look like.

Given that I thought I’d score the Osborne and Darling plans against them.

The results (and some notes of my scoring) are below. I reckon Osborne comes out around 40% and Darling 75%. (In a couple of areas there isn’t enough infor to score Darling properly).

How could Osborne increase his score? Quite easily really – reduce the front loading (i.e. slow cuts down), introduce some proper reforms conducive to growth and make the plans more progressive. 

Number Commandment Osborne Darling
I You shall have a credible medium-term fiscal plan with a visible anchor (in terms of either an average pace of adjustment, or of a fiscal target to be achieved within four–five years). YES YES
II You shall not front-load your fiscal adjustment, unless financing needs require it.

 

NO YES
III You shall target a long-term decline in the public debt-to-GDP ratio, not just its stabilization at post-crisis levels. YES YES
IV You shall focus on fiscal consolidation tools that are conducive to strong potential growth. NO NO
V You shall pass early pension and health care reforms as current trends are unsustainable. YES No Info
VI You shall be fair. To be sustainable over time, the fiscal adjustment should be equitable. NO YES
VII You shall implement wide reforms to boost potential growth. NO No Info
VIII You shall strengthen your fiscal institutions. YES YES
IX You shall properly coordinate monetary and fiscal policy. NO NO
X You shall coordinate your policies with other countries. NO YES
Total   4/10 6/8
    40% 75%

Notes

I

Both Darling’s ‘half the deficit in four years’ and Osborne’s ‘eliminate it’ meet this criteria.

II

Osborne has front loaded despite no pressing need from market.

III

Both aimed for this (Osborne faster)

IV

Darling planned did involve big cuts to capital budget which are unhelpful to growth, Osborne plan hits growth even harder.

V

Osborne has (both by raising retirement age and by changing indexation from RPI to CPI), no infor from Darling as no spending review.

VI

Osborne’s plans are more regressive than Darling’s (according to the IFS). Osborne wants to get rig of 50p rate for example.

VII

Osborne would claim he has (Corp tax cut, etc), but the OBR say the effects are ‘minimal’. No information here from Darling plan.

VIII

Darling has the Fiscal Responsibility Act, Osborne has gone further with the OBR.

IX

Hard for either in an era of BOE Independence.

X

Darling was Chancellor at the height of G20 co-operation, this has since collapsed.

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