Yesterday saw several interesting moves and not all of them were in the UK Budget of which more later. We got some further information on the austerity/fiscal expansion debate between Germany and the United States which they appear to be carrying on in public. We also saw a downgrade of the French bank BNP which seems to have triggered another French bank Credit Agricole to announce some losses in her Greek subsidiary Emporiki. And we saw another triple digit move in the Dow Jones Industrial Index as it fell 148 points. This has been slightly less volatile over recent days and triple-digit moves now only represent 17 of the last 30 days.
Austerity versus fiscal expansion
In an addition to this debate a German official was reported as saying by Reuters
Germany does not need further stimulus measures…….. and Germany must set (an) example in European Union in paring back deficit spending.
I think that this rather gratuitous statement was accompanied by a much more dubious one.
Nobody in G20 is demanding further debt-financed economic stimulus measures
Anyway it got me thinking about Germany’s role in the world and European economy. Regular readers will know that I do not subscribe to the view that if Germany changed and increased consumption then all of Europe’s economics problems would be solved. To my mind that has always required something of a schizophrenic nature of Germany where on the one hand they continue to manufacture products and export then in a very Germanic fashion and on the other they act like good Europeans and consume more as well as being happy to finance the bail outs of other European nations.
The German Economy
One factor that differentiates the euro zone economy from that of the United States is that it depends on trade more as a proportion of its economic output. Germany is the biggest factor in the euro zones export dependence as in the main it grows from exporting rather than relying on domestic demand growth,indeed private consumption, is often rather stagnant. Unfortunately this exporting success has not always been achieved in the way that Germany likes to see herself as she sees her international competitiveness as the fruit of Germanic hard work and productivity. Unfortunately for this argument German productivity growth since 1999 has not been as exceptional as she thinks and in fact what has mostly driven her export performance has been wage stagnation. So a large proportion of Germany’s higher competitiveness has been derived from reducing German wages relative to its European partners. This has led to some having the view that this is the equivalent of a beggar-thy-neighbor devaluation in pre-euro times, and such a policy is of course anti the spirit of the euro zone. A consequence of this strategy is that domestic consumption has rather stagnated in Germany which has tended to contribute to the euro zones problems.
The problem is the way out of this. My view has been that you can hardly make the Germans consume and export more! It is not their fault that other countries are not more like them. I am not a great subscriber to the line of thought that the country that runs up trade surpluses must either lend or grant transfers to the deficit countries that make its own surpluses possible. It sounds too easy a way out for the deficit countries to me. However the analysis above does explain a lot of the thinking behind Germany’s adherence to fiscal austerity, if you were an exporting country depending on wage competitiveness and productivity you might suggest it as a solution for other too.
The German Chancellor Angela Merkel put her position rather forcefully yesterday according to Reuters.
“If we don’t get onto a path of sustainable economic growth but have rather a growth bubble, then if the next crisis comes we won’t be able to pay for it.” and that reducing Germany’s fiscal deficit (by around 10 billion Euros a year) “won’t put a brake on the world’s economic growth,”
It might therefore be a G20 meeting with some intransigence in it! As to the American side I notice that President Obama’s Budget Director Peter Orszag has just resigned although it is too early to say if this will lead to any policy change.
Fiscal austerity Coalition style
Having had some time to consider the implications of yesterdays Budget in the UK I have some further thoughts.
1. It was at the austere end of the spectrum. Net reductions in the deficit of £40 billion by 2014/15 which represents some 2.2% of Gross Domestic Product and predictions of a fiscal surplus in 2016 were at the upper end of expectations. Another way of putting the £40 billion is is 89 Thiams.
2. There will be an impact on economic growth but this is difficult to measure ( actually this is always true in economics………..). The Office for Budget Responsibility feels that UK growth will be reduced by 0.3% in the fiscal year 2011/12 but that we will grow slightly faster in subsequent years. This is a difficult area as it includes both the objective and the subjective. The easy part is 2011/12 where cuts in the fiscal deficit will impact the economy. The hard subjective part is how much the reduction in the size of the public sector will boost incentive,entrepreneurship and enterprise in the economy and we come to the area of crowding out and its impact. So far later years we have something of a gamble by the UK government that the economy will respond favourably. I hope so too ( and my philosophy inclines towards it) but the truth is we simply do not know.
3. There is a clear implication for UK inflation going forwards in the VAT hike. Regular readers may remember me pointing out the Governor of the Bank of England’s lament that the impact of the change of VAT would remain in the figures for a full year ( a rather bizarre statement from him if you consider the full implications of it..). Well now just as it would be running out and he could heave a sigh of relief VAT will rise again. So what are called positive base effects will not take place. The way that this rise in VAT will come in means that it may now well be quite a while before the Consumer Price Index falls below the Bank of England target of 2%. The timing of the move January 2011 must have received some comment from the Governor although you would not believe it from his apparent relaxed demeanour watching the tennis at Wimbledon earlier this week.
4. Tucked away in the furore was a statement by the Debt Management Office that the UK is going to have to issue less government bonds or gilts going forwards. This news is good although of course even at the new reduced forecast levels we are going to have to issue plenty of them. For the fiscal year 2010/11 it now expects to issue some £162.5 billion which is £20 billion less than its previous forecast. The gilt market responded with a small rally to this and other news on the day with our ten-year gilt yield falling at one point to 3.42%. Some os the cut was due to the Budget and some due to the way that our public finances have been on an improving trend recently.
5. The change in Capital Gains Tax still seems something of a dog’s dinner to me. I am still curious as to how we ended up with rates of 18% and 28% which bear no relation to other tax rates or have any economic based reason I can think of. I can only conclude that there was a lot of political horse-trading along the lines of how was a camel created? Answer a horse designed by a committee.
The Change in the Uprating of Benefits
I wrote a second update on this subject as I feel strongly about such moves and wish today simply to remind readers of Chancellor Osbourne’s own thoughts on the subject of the Consumer Price Index as an inflation measure . Let us start with yesterday in his Budget speech.
The consumer price index not only reflects everyday prices better, it is of course now the inflation measure targeted by the Bank of England.
Rather than repeat my own view on this I thought I would give Chancellors Osbourne’s own words from a speech he gave in April 2009 and leave you to draw your own conclusions.
However, there is considerable debate about whether the current CPI inflation target reflects the true cost of living faced by consumers, and whether the target should be broadened to include housing costs, which were included in the previous RPIX target.
Gordon Brown changed the inflation target in 2003, but in little-noticed evidence to the House of Lords a few weeks ago Mervyn King made it very clear that this made the Monetary Policy Committee’s job more difficult:
“Certainly in the last two or three years, before the crisis began in 2007, it is fair to say that the change in the target probably made it more difficulty for us to achieve that balance… I think it would have been preferable have we stayed with an index in which House prices were still included.”
The European statistical authorities are currently debating how housing can be added to the Consumer Price Index in a way that is consistent across the EU.
Monetary Policy Committee Minutes
These have been released this morning and finally there is a dissenter to the previous unanimous orthodoxy. Step forward please Mr. Andrew Sentance who voted for a 0.25% rise in the base rate at the last meeting. According to the minutes his views were
Inflation had proved resilient in the aftermath of the recession, casting doubt on the future dampening impact of spare capacity on inflation. ……… Despite current uncertainties, for this member, it was appropriate to begin to withdraw gradually some of the exceptional monetary stimulus provided by the easing in policy in late 2008 and 2009.
So one of them has woken up from his slumber although lets face it has taken quite some time.