As regular readers will be aware I am quite a fan of the monthly round up of independent economic forecasts published by the Treasury.
The August edition was published two weeks ago and contained the tri-annual additional set of ‘medium term forecasts’ out to 2015. These make for depressing reading.
The table below shows the average growth forecast for each year out to 2015 both as they currently stand and how they were just six months ago in February.
Not only has 2011 been downgraded (in a very substantial manner) but so has growth in each of the subsequent years.
To make these numbers more ‘real’ I’ve also included the medium term forecasts for claimant count unemployment in each year, as they are today and how they were six months ago. The orange bar is the difference between the forecasts.
The effect of the downward revisions to 2011, 2012, 2013, 2014 and 2015 is to move the peak of unemployment back a year from 2012 to 2013.
Unemployment in 2013 is now expected to be 770,000 higher than it was just six months ago.
I’m rather surprised this hasn’t generated more headlines.
UPDATE: 5th September – It seems that since I wrote this post the Treasury have re-issued their August forecast document.
It looks like their summary data included an error (including an ILO rather than claimant count figure) and rather then unemployment being 770,000 higher in 2013 it will be a ‘mere’ 130,000 higher.
At the start of this month I took part in a (highly enjoyable!) LSE/Radio 4 debate on Keynes versus Hayek (45 minute radio edit available here and ‘un-cut’ 90 minute video version available here) with Lord Skidelsky and myself representing Keynes opposed by George Selgin and Jamie Whyte..
The structure of the debate limited our opening contributions to around 4 minutes each and the format meant (rightly) that what was emphasised was the differences and disagreements. Which was entirely correct for a public debate/radio programme but the advantage of writing a blog is that allows me to be more nuanced.
I actually have a lot of time for some Hayek’s work – I usually disagree with the policy recommendations which (especially amongst Hayek’s modern day adherents) seem to be driven as much by political ideology as by economic analysis but there is something in Hayek’s analysis of the causes of financial crashes that the left cannot ignore.
So whilst I disagree with most modern day Hayekians on the supposed virtues of cutting public spending during a ‘balance sheet recession’ (Richard Koo’s term, recently used (perhaps unwittingly) by the Chancellor) I can see their point that, given how the modern financial system currently operates, a long period of low interest rates can lead to severe mal-investment and unsustainable bubbles.
The crucial word there being ‘currently’. I can also envisage circumstances in which low interest rates allow a heavily reformed financial system (more banks, more industry focussed banking, regional banks, less speculation) to actually support the productive economy.
But the question that really interests me at the moment, and what inspired this blog post, is the issue of how to deal with the failure of large banks. An issue that I hope doesn’t arise in the near future but which may well do rather quickly if the worst case scenarios come to pass).
At the debate Whyte and Selgin were keen to brand the policies pursued in 2008 (broadly put – huge central bank liquidity support coupled with direct government recapitalisation and varying degrees of nationalisation) as ‘Keynesian’. I’m not at all sure that is fair, I think Kaynes would been far more inventive – perhaps using QE to capitalise a National Investment Corporation. But, that aside, it certainly wasn’t Hayekian.
Their argument (again broadly put) was that bad banks should have been allowed to fail and that by propping them up the government is stopping money going to well functioning banks and holding bank the recovery. The ‘liquidation’ of bad assets has to be allowed to happen in order for a sustainable recovery to begin.
Back in 2008, I supported the actions taken by Western Governments, I thought large scale bank failures would have turned the recession into an actual depression as savers took large loses, payments systems broke down and cash machines actually ceased to operate. That would have been a disaster.
But bank failure in 2011 or 2012 or 2020 could be different. Back in 2008 the crisis surprised policy makers and the response was haphazard and driven by fear and confusion.
If an institution is not viable, it will fail eventually whatever steps are taken to prop it up. The problem is that when it does fail, it brings a lot of others down with it. The larger and more interconnected the failing institutions, the greater the risk they pose to the world economy - and the louder the cries of people who depend on those institutions that governments should act to prevent their failure.
If the international financial system is so fragile that it can only survive with constant infusion of mammoth amounts of public money, then IT IS ALREADY IN A STATE OF COLLAPSE. And as any mining engineer knows, propping it up is not only expensive, it is dangerous.
I would like to suggest that the international financial system should be ALLOWED to collapse. That doesn’t mean that governments should abandon their responsibility to protect the people affected and as far as possible prevent long-term damage to the economy. On the contrary, governments should be actively involved in managing the collapse of the current unsustainable system and the building of a new system that meets our needs better.
This point, which could be dubbed ‘Interventionist Hayekian’, seems right to me.
I also think it is possible to get to the same conclusion in a fundamentally Marxist way. Basic Marxist Crisis Theory says, amongst other things, that as booms expand the amount of capital employed increases, eventually the rate of profit begins to fall leading to a recession in which much of the capital stock is destroyed – allowing higher profits on the remaing capital stock and hence a resumption of expansion.
If we then add on some of the work of modern Marxist economists on how capital has been ‘financialised’ then we get to an interesting conclusion. Foster and Magdoff have written (in a book that I’d highly recommend despite it being somewhat to the left of my usual reading habits):
For the owners of capital the dilemma is what to do with the immense surpluses at their disposal in the face of a dearth of investment opportunities. Their main solution from the 1970s on was to expand their demand for financial products as a means of maintaining and expanding their money capital. On the supply side of this process, financial institutions stepped forward with a vast array of new financial instruments; futures, options, derivatives, hedge funds, etc. The result was skyrocketing financial speculation that has persisted now for decades.
One could then argue that if financial capital has replaced physical capital and the state is preventing financial assets from being destroyed there is no way, according to standard Marxist theory, for the ‘crisis’ to end. Which leads one into calling for revolution and the overthrow of capitalism or acknowledging that simply nationalising failed banks is unlikely to ever end the crisis.
We are in an odd place indeed when Marx and Hayek are pointing in the same direction.
Which take us to Minsky, who although he called himself a Keynesian was a far more interesting and nuanced thinker who paid as much attention to Fisher on debt –deflation as he did to Keynes (and his Keynes was far more about the Treatise and the Tract than the General Theory).
As the standard interpretation of Keynes was assimilated to traditional economics, the emphasis upon finance and debt structures that was evident in the 1920s and the early 1930s was lost. In today’s standard economic theory, an abstract nonfinancial economy is analysed. Theorems about this abstract economy are assumed to be valid for economies with complex financial and monetary institutions and usages. As pointed out earlier, this logical jump is an act of faith, and policy advice based upon the neoclassical synthesis rests upon this act of faith. Modern orthodox macroeconomics is not and cannot be a basis for a serious approach to economic policy.
And this is what we need – a modern way of thinking about the macroeconomy which takes asset bubbles seriously, we looks at over-speculation and which understands how banks operate rather than assuming them out of existence.
The odd thing is that it will probably draw as much from Hayek as from Keynes.
I’m now away for few days on the world’s most beautiful tax haven.
Blogging will resume next week.
In the mean time you should all read the excellent IPPR paper, ‘Surviving the Asian Century’, from Adam Lent & David Nash and the ‘must read’ note from UBS’s George Magnus on the political economy of the current crisis.
See you all next week,
It firmly roots the agenda of Rick Perry and Ron Paul in the tradition of Jefferson and Jackson and I’d highly recommend a read of it.
However (and to be fair they do acknowledge this in the post) I think there is a very important difference between the latest bout of GOP Fed-bashing and the long history of anti-bank politics in the US: the radicals are attacking the Fed not sticking to ‘hard money’ policy of high rates but for being too lax.
And this is, for me at least, a bit of a conundrum. There is now a (sizeable?) constituency in US politics arguing for not only fiscal tightening but monetary tightening as well (in the UK Fraser Nelson too seems to be in this camp).
The whole argument of the ‘Expansionary Fiscal Contraction’ camp is that government spending cuts allow the central bank to keep interest rates low and this supports the recovery. Whilst I may disagree with that argument I can at least understand it.
What I can’t understand is policy makers arguing for tight monetary policy coupled with tight fiscal policy at a time of faltering global demand. That’s a recipe for depression and the fact that major political figures are now advocating it is a worry to be very concerned.
Disclaimer: For the first time in two and years of blogging I have been driven to swearing in a blog post. Apologies but I lack the words to express what’s happening.
A short post but there really isn’t a great deal to say.
We have falling equity prices, falling commodity prices, record low bond yields across UK, Germany and the US and the worst hit shares are financials (where rumors of problems in the European banking system are once again circulating) and those most exposed to global growth.
This is a growth scare – and a big one.
And George Osborne is still taking comfort in low yields on government debt and declaring Britain a ‘safe haven’.
I’m afraid a bond yield of 2.3% on 10 year UK government debt isn’t the market saying ‘well done you, nice deficit reduction plan you’ve got there mate’ it’s the market screaming ‘for Christ’s sake, everything is fucked and we’re terrified about vanishing growth’.
Markets, as we know, can be irrationally optimistic but they can of course also be irrationally pessimistic. Let’s hope that’s what’s happening now.
In the past nine months theUKeconomy has grown by 0.2%,Belgiummeanwhile has grown by 2.2% – a very healthy performance. In the second quarter of this year it racked up quarterly growth of 0.7% – putting it near the top of the Eurozone growth league.
What’s the secret of the small state’s recent faster growth?
Oddly enough, the answer appears to be its lack of functioning government.
But before the small state libertarians open the champagne – the connection isn’t the one they might expect and hope for.
It’s not that the lack of an intrusive, interfering government has set the forces of enterprise free – instead the political paralysis afflicting Belgium has meant that, unlike most Euro-area governments, it has not embarked on an austerity drive.
As the FT reports the of absence of austerity (and the fact that Belgian salaries and pensions are indexed to inflation) is providing a boost to growth.
Belgium can’t avoid austerity forever, public debt to GDP stands at over 100% (much higher than the UK) but in the short to medium term it is certainly outperforming its neighbours. The FT quotes a perplexed economist from ING:
“In the case of public spending, the short-term gain is paradoxical. It makes it more and more clear that we will have to undertake deeper austerity measures in the future.”
I don’t think this is paradoxical at all – nor do I agree that an effective short term stimulus now necessarily means deeper austerity later. As Christine Lagarde argued yesterday, the right policy mix for most states is a short term stimulus to get growth moving coupled with a medium to long term programme to balance the budget.
Belgium, in the absence of a functioning government, lacks the ability to commit to a credible medium term plan – hence the recent market pressure on its bond yields, but in the short term its current policy mix is certainly generating growth – as of result of which the government’s deficit narrowed from 4.6% of GDP in 2010 to an estimated 4.0% this year (according to the IMF’s Fiscal Monitor).
Christine Lagarde, the new IMF director, has written an important article for the FT today. Tellingly it is entitled ‘Don’t Let the Fiscal Brakes Stall Global Recovery’.
The essential points are (i) that markets worry about growth as well as deficits and (ii) that states ‘that are not under market pressure’ and have room for expansion should be looking at slower tightening and/or additional fiscal measures to help growth in the short term.
She is basically arguing for the same postion as IMF’s Chief Economist did last year – the appropriate policy action now by Finance Ministry’s is for short term stimulus coupled with creditable (and meaningful) medium term fiscal tightening.
What is interesting is that her argument explicitly accepts that spending cuts mean lower growth & higher unemployment – something the government (and its cheer leaders) have occasionally denied.
As she notes – markets worry about high deficits BUT they also worry about low or negative growth.
The question then becomes what is the right balance. As I wrote earlier this year:
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.
It’s nice when the Director of the IMF agrees with you.
It is now fairly widely acknowledged that the British recovery has stalled in 2011. Whilst Britain may yet avoid a double dip recession growth looks set to be sluggish.
Given the more pessimistic outlook it is important that policy makers are clear about the reasons for this slow down, otherwise we risk a misguided policy response.
George Osborne is relatively clear that the slower growth profile of theUKeconomy, and the reasons that 2011 growth may well miss the OBR forecasts, is because of a more troubled global outlook – the debt standoff in the United Statesand the ongoing Eurocrisis in particular.
The left meanwhile are mainly focussed on the impact of austerity.
Both answers risk missing the point – what is killing the UK recovery is actually falling real wages.
Each month he Treasury publishes a compilation of independent forecasters views on the UK economy. The table below shows the median forecast from back in January (when optimistic observers expected growth of 2.0%) and the most recent forecasts from July, when the estimate had fallen to just 1.3%.
For completeness sake I have also included the OBR’s own numbers.
Whilst there has been a lot of attention (rightly) paid to the falling headline number, I have seen less comment on the make up of that falling growth forecast.
The first thing to notice is that since January independent forecasters have revised up their export growth forecast and revised down their import forecast (as a result of domestic weakness meaning less imports). The end result is that the contribution of net trade to GDP growth was expected to be 0.5% in January but is now expected to be 1.3%. In other words – for all George Osborne’s talk of global headwinds hitting growth independent forecasters now expect Britain’s export performance to be better than they did in January. A questionable assumption maybe – but weaker external is not a fact explaining the downgrades to the growth forecast.
What has caused growth to be revised down is dramatic collapse in domestic demand forecasts from an expected 1.5% contribution to growth in January to just 0.1% now.
The chart below demonstrates this:
What has caused this collapse in domestic demand? A huge fall in private consumption forecasts from expected growth of 1.2% in January to an expected contraction of 0.3% in July.
Whilst the government has talked up exports and investment for the past year and the opposition has focused on spending cuts, the consumer outlook has become dire.
Why has consumer spending been revised down so heavily?
A substantial part of the answer can be found in falling real wages. Back in January independent forecasters expected RPI inflation to be 4.0% in 2011 and average earnings to grow 2.6%, implying real wages would fall by 1.4%. They now forecast RPI of 5.3% and average earnings growth of 2.5%. Real wages are now expected to fall by 2.8% – double the estimate of January.
Because of this consumption estimates have been radically revised down and GDP with it.
If one wants an answer to why the recovery is faltering, one would do well to start looking at real wages – an area policy makers haven’t spent anywhere near enough time talking about.
Is ECB intervention in the Italian and Spanish bond markets working?
Since Monday the ECB has been buying Spanish and Italian debt in the secondary market aiming to drive down the yields and hence ensure that both countries can afford to borrow from the debt markets.
The yields on both countries’ debt had increased sharply in the preceding fortnight (post-the latest Eurozone crisis summit) in a pattern which has become strangely familiar over the past year – the yield hits 6%, the country denies there is a problem, it hits 6.5%, more denials and suddenly it is at 7% and a ‘bailout’ is being arranged.
Whilst Ireland, Portugal and Greece represent 4.5% of EU GDP between them, Spain is 8.7% alone and Italy is 12.7%. They are too big to fail - but also possibly too big to bailout.
If Italy and/or Spain were to require a bailout they would obviously not be able to participate in the EFSF – at which point the increased costs to France (in particular) would become perhaps insurmountable. In other words if one of these two go, the whole crisis coping mechanism goes with it. (Not to mention the fall out in the banking sector).
So – back to the original question, is the ECB intervention working?
But in the CDS market (credit default insurance) a different picture emerges – one of continuing and rising concern for Spain and Italy.
If the markets were genuinely reassured we would expect CDS rates and bond yields to fall together. As CDS rates (where, crucially the ECB is not intervening) are continuing to rise this looks like entirely artificial price moves in the bond market caused by the ECB acting as buyer of last resort.
The question becomes – what happens when the ECB stops buying? The answer may be a swift return in bond yields to uncomfortably high levels.
So – why can’t the ECB just continue buying? Well it could. But it would soon own a substantial proportion of outstanding Italian and Spanish government debt – something which Northern European tax payers are unlikely to be happy about and a situation which may be sustainable. What will it do to confidence if an international central bank (with no power of taxation) is standing behind a substantial segment of the debt of two major economies?
Once more it looks like the Eurozone’s ‘solution’ is just an attempt to buy time – let’s hope they use this time well.
The past few weeks have seen a vicious equity market sell off which now seems to have paused, huge swings in the European peripheral bond market and major falls in commodity markets (outside of gold) all accompanied by rising volatility.
It seems fair to conclude that uncertainty has risen and that this will probably impact on firms’ investment decisions and consumers’ spending patterns.
Drawing on work by Ben Bernanke (from a long forgotten 1983 paper) Nicolas Bloom (assistant professor of economics at Stanford) has a succinct and highly recommended post up at Vox, which aims to forecast how this increase in uncertainty will impact the economy.
Based on my research, I predict another short, sharp contraction in late 2011 of about 1%, with a rebound in spring 2012. This research looks at the average impact of the previous 16 uncertainty shocks to predict the impact of future shocks. Typically these leads to reductions of growth of about 2% immediately after the shock, with a recovery about six months later once uncertainty subsides.
(With a hat-tip to regular commentator Luis Enrique)