The last week or so has seen a lot of debate on the effects of austerity around Europe and today I intend to look at the situation concerning the UK. The driver of this debate was something of an about-face by the International Monetary Fund in its World Economic Outlook (WEO). This highlighted what is called the fiscal multiplier which matters if you are undertaken either a stimulus programme or an austerity one as it measures what can be summed up as your “bang for your buck”.
What did the IMF say?
It had a go at sneaking the data in unawares and you may note that there is no real admittal of error here,let alone a mea culpa or apology.
Research reported in previous issues of the WEO finds that fiscal multipliers have been close to 1 in a world in which many countries adjust together; the analysis here suggests that multipliers may recently have been larger than 1 (Box 1.1).
Later we got a more explicit working of the numbers.
The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2,
This is quite a serious oops moment to say the least!
Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.
Let me put the significance of this into plainer language.
What is a multiplier?
This is used to measure the effect of a change in public-sector spending on overall output. So if we take the original reading and consider austerity the IMF was telling people that £10 billion of austerity generates some £5 billion of output loss. This was used as an argument for austerity programmes by amongst others the IMF itself. Indeed you could say that it was the basis for the bailout programmes for Greece,Ireland and Portugal. Now it is arguing that between £9 billion and £17 billion of output would be lost which is very different.
Putting it in a nutshell we have gone from support for austerity to saying that it will be a contractionary influence. Whilst there has been a wide debate on this they seem to have missed an IMF Working Paper from June which suggested it could be as high as two.
A point I have seen ignored in the debate which has followed this is that if by its own admission the IMF was so wrong previously why should we believe it now? This is reinforced by the fact that it has veered from one extreme to another which to my mind only reinforces the view that can be summed up by the football terrace chant.
You don’t know what you are doing
Regular readers will be aware that I am a long-time critic of the IMF who feels that it has been perverted from its original role of helping with balance of trade problems to fiscal problems by politicians. Yes the same group who get into fiscal problems! If we look at the Euro area programmes it is involved in we see that countries following them have seen a better balance of trade performance. Put simply the old game has its successes the new game instead has failures so it is pressing ahead with the new game against all logic. If we consider this in the case of Portugal if it had been under an IMF trade help programme there would be light at the end of the tunnel rather than more pain.
There has been some questioning of the IMF’s data and results by Chris Giles on the Financial Times and Jonathan Portes of the NIESR. I would like to add a detail to this which is to say that there is no reason I can think of why the fiscal multiplier should be stable in these times. There are a whole range of results from country to country and from one time period to another so I do not think we learn much here. However there is one thing we can learn and it takes me back to the last election. Back on May 9th 2010 I pointed out this.
The truth is that none of the parties asking for your vote today have explained how exactly they will get a grip on the deficit and none of them have shown any clear clue as to how they will tackle public spending.
In reality we have seen cuts in capital spending rather than other parts. Put another way they have cut the bit that is easy and in so doing have cut the bit which should be towards the end of the cuts not the beginning. So it fell from just under £49 billion in 2009/10 to £26 billion in 2011/12. It is conceivable that returning to the IMF’s analysis that multipliers are higher on this type of cut.
Austerity or not?
The media is full of stories about austerity in the UK but the truth is that public-sector spending is rising and not falling. For example we see this in today’s public-sector finance numbers.
For the period April to September 2012, central government accrued current expenditure was £313.6 billion, which was £6.5 billion, or 2.1 per cent, higher than in the same period of the previous year, when central government current expenditure was £307.1 billion.
We are however being taxed harder so it would be more correct to say that austerity in the UK involves higher taxes combined with an attempt to restrict the growth of public-sector spending.
How are we doing?
There is more evidence today of the unreliability of a single month’s economic data as there have been some revisions to recent data which overall improves the numbers. However the quote below illustrates that we still have an issue.
The figures excluding the Royal Mail pension transfer show that, for the year to date, public sector net borrowing has risen by 4.2 per cent, which compares to a forecasted 1.4 per cent decline for the full year.
As you can see not only is it bad enough that we are doing worse than last year but we were supposed to be doing better!
There was always going to be a problem
If we move on from fiscal multipliers and the associated debate there was always going to be a problem as I pointed out back on May 6th 2010 just before the UK General Election.
Official forecasts for growth in the UK economy are very optimistic, what will happen if these are not achieved in reality? Just to give an example of point two our official UK forecast for growth in 2011/12 is 3%
In truth it was always very unlikely that the rose-tinted forecasts of 3% per annum economic growth were going to be achieved and that was whatever economic policy we followed. So there was trouble ahead and in many ways this trouble was probably more important than the austerity versus stimulus debate.After all if you look at the public-spending figures do we have austerity or stimulus? On the other side of the ledger we do have austerity as taxes have risen, but spending?
Is stimulus the answer?
As ever we see shades of grey here. There has been some interesting evidence on a small-scale effort in London this week. An estimated £60 million was spent building a cable car in East London across the Thames from the O2 Arena to the Excel Centre for exhibitions. However a local radio station called LBC counted the commuters in the morning peak hour and according to them there were 15 compared to a capacity of 5000! It also makes me muse the promises of an Olympics Legacy.
Lower Mortgage Rates
Tesco has marched boldly onto the scene today and cut its mortgage rates including a rather eye-catching two-year fix below 2% (1.99%). I welcome this as it represents some badly needed extra competition in our mortgage market which is currently mostly populated by zombie banks. However some nuance is required as you need a 40% deposit to qualify and there is a fee of £995 which means that in practice only relatively large mortgages with substantial equity will qualify for it. So we may also being seeing more evidence of a two-tier mortgage market where some pay less but some pay more.
This may be an indirect effect of the Bank of England’s Funding for Lending Scheme. Tesco is not one of the thirteen lenders who are currently participating but it could of course join it.
Also whilst in itself this is welcome it returns us to the deeper question of whether official policy really does mostly involve trying to reinflate the housing market/bubble.