UK fiscal policy is setting off on a Magical Mystery Tour

At times we find ourselves observing events that appear to be a major change in themselves but are also part of a longer trend. For example the world-wide trend to lower and indeed negative interest-rates and bond yields. There has been another fashion in recent times which has been the call for more expansionary fiscal policy, often from those who have pushed for more expansionary monetary policy. Let us park for today the promises many of them made about how that monetary policy would succeed and move onto fiscal policy. However of course regular readers may well already be thinking about policies that sit astride the boundary between the two such as Quantitative Easing and policies which operate in both arenas such as helicopter money.

Let me give you an example of this from the Financial Times on the 18th of February.

Seen from Tokyo, the most helpful thing the G7 could do is a co-ordinated fiscal stimulus, but that is improbable given the politics in countries such as the US, UK and Germany.

By the end of May ( the month not Theresa ) then Reuters were telling us this.

Japan Prime Minister Shinzo Abe plans to propose a fiscal stimulus package of as much as 10 trillion yen ($90.7 billion) after warning Group of Seven leaders that the global economy faces significant risk of another crisis, according to the Nikkei newspaper.

If we just stick with Japan this is awkward on two counts. Firstly Japan already runs a considerable annual fiscal deficit so it is an extra fiscal boost which poses the question of why it will work when the existing one does not? Secondly under the original plan for Abenomics the fiscal boost was supposed to work so well that we should now be seeing an improvement. So many places approved of this and even told us it was working.

Japan was not alone as there was some support from the new government in Canada for more fiscal policy. From The Japan Times on the 27th of May.

Prime Minister Shinzo Abe and his Canadian counterpart, Justin Trudeau, have agreed on the need for boosting fiscal stimulus to bolster global growth, a Japanese official said.

This was no great surprise if we consider that Prime Minister Trudeau had relaxed Canadian fiscal policy.

There has been a fiscal boost in Italy

There is another example of a cross-over between fiscal and monetary policy and Itlay exhibits this. From The Walking Debt (h/t @Suanzes ) and apologies for the clumsy translations.

The low shot rates, in fact, have allowed a significant decrease in interest payments that the Bank of Italy, in his last annual report, referring to the three-year period 2013-15 is estimated at about 30 billion euro.

There are some interesting consequences to this.

Last year the net debt, or deficit, it fell by 0.4% of GDP, rising to 2.6. This decrease corresponds exactly to the recorded decline in interest payments, fell from 4.6% of GDP in 2014 to 4.2, while the primary surplus remained stable at 1.6%.

So the recorded austerity was in fact due to Mario Draghi and his policies. Indeed we can go further.

” in a context in which economic activity was still well below potential, fiscal policy had a moderately expansionary effect, “says Bank of Italy.

So there you have it as my financial lexicon for these times comes to the fore. Claimed austerity turns out to have been expansionary if we allow for the much lower sovereign bond yields. Grazie Mario!

The UK

It is not only stealth jets that have been sighted in the UK – another entry for my financial lexicon – but there have been sightings of our stealth Chancellor of the Exchequer George Osborne. He too has been hammering out a fiscal policy beat.

George Osborne is planning to slash corporation tax to less than 15 per cent in an effort to woo business deterred from investing in a post- Brexit Britain as part of his new five-point plan to galvanise the economy.

So a fiscal boost via lower taxes is planned and spending is to carry on regardless.

he also called for the next prime minister to continue investing in the HS2 rail project from London to the north and trans-Pennine rail improvements and approve a new third runway for the south-east.

This of course is very different to what he was saying only a few short weeks ago.

Before the referendum Mr Osborne had threatened to make £30bn of tax rises or spending cuts in a post-Brexit emergency Budget;

Up is the new down again.

Whereas now we can not only cut taxes and hint at more spending but also do this.

On the public finances Mr Osborne promised to “maintain the consolidation that we put in place last year”

Time for the band America to stop riding the horse with no name and help us out with this.

You can do magic
You can have anything that you desire
Magic, and you know
You’re the one who can put out the fire

The Fiscal Charter

This was supposed to do this.

a target for a surplus on public sector net borrowing by the end of 2019-20……….a target for a surplus on public sector net borrowing in each subsequent year…..a target for public sector net debt as a percentage of GDP to be falling in each year.

As I pointed out at the time the use of “in normal times” made the whole thing pretty much pointless as we note that according to the original plans we are supposed to be in a fiscal surplus now.

Of course in terms of realpolitik Theresa May had pretty much changed fiscal policy for the Chancellor and since then others have announced fiscal boosts such as the £100 billion plan of Steven Crabb.

Standard and Poors

They have weighed in with a forecast for the UK. From the Financial Times.

The credit rating agency predicts Brexit will cause a 1.2 percentage point drag on economic growth in 2016 and a 1 point hit in 2018. That takes the 2016 growth forecast to 1.5 per cent, and the 2017 forecast to 0.9 per cent.

This is being reported as “barely escape a full-fledged recession” which is interesting as these have been the sort of numbers produced by Italy and Portugal for years and indeed decades now

One needs to be cautious about ratings agency forecasts as of course if they actually had a crystal ball there would have been no credit crunch in 2007/08! But if we get a slow down then fiscal policy will tighten.


The mood music is clear that UK fiscal policy is about to be loosened. As far as we can be sure of anything right now! In terms of the technical issues some of this may appear costless. What I mean by this is that the fall in UK Gilt or sovereign bond yields makes it very cheap to borrow and much cheaper than the 5% expected for now by the Office for Budget Responsibility at the time of the Coalition government’s formation in 2010. The numbers for this are changing all the time but in recent years we have spent between £45 billion and £50 billion per year on debt interest. As we have borrowed more the cost of the debt has dropped offsetting the annual cost.

To put this into numbers the UK has a Gilt which matures in 2018 and pays a coupon ( interest) of 5% per annum. If we issued a replacement it is not inconceivable at all that it might have a coupon of 0% as that is the part of our yield curve that went negative after Governor Carney’s speech on Thursday.

As to the economy then according to the business surveys manufacturing if anything has picked up but construction contracted. As to where we are well the Beatles were on the case.

The Magical Mystery Tour
Is waiting to take you away
Waiting to take you away
Roll up
Roll up for the Mystery Tour
Roll up
Roll up for the Mystery Tour






22 thoughts on “UK fiscal policy is setting off on a Magical Mystery Tour

  1. Sorry to be political but it’s hard to avoid one of the central problems of our time and that is that George Osbourne should be given his P45 by the next leader.

    His woeful EU Ref ‘Brexit’ budget aside,the best thing he could do is leave everything alone.Let sterling sell off,get some inflation in the system(after that’s what the BoE has been trying to generate for 8 years) and get some wage growth going.

    Osbourne has always been looking for an excuse to move his fiscal surplus projections to the right.Now he has it.

    The comedy gold is that he genuinely thought of himself as a leadership contender.

    • Hi Dutch

      Politics is an occupation where individual’s can survive and even thrive even after episodes of abject failure. The rules which apply to the likes of us do not seem to apply to them. The worst case scenario if you have had one of the major jobs seems to be a peerage.

  2. Shaun,
    Rumours that EU is adding to democracy deficit by nodding through the Canadian trade deal without needing Italy or any other governments approval or backing. Junker antics upsetting Merkel so perhaps delaying Brexit a cunning plan?

    • Hi Chris

      It is certainly time for Rumours (Fleetwood Mac) or Rumour has it ( Adele).

      In return I offer almost any rumour you like about the Italian banking system. Also one which flicked up saying that Germany had full confidence in the European Commission. If that is like “full confidence” in football it will not take too long. The latter fits with your rumour.

      • Excellent news that Germany has full confidence, or more accurately Merkel has full confidence because the quickly rising AfD does not.

        Merkel has zero incentive to reform the EC for voters, as Germany’s budget contribution means they call the shots. So I expect another overpaid clown will replace Juncker. Which just isn’t good enough. All Europeans deserve referendums on Europe wide law. All Europeans need substantive cuts to the excessive EC salaries – in a time of deficits and austerity it is unacceptable that 10,000 nameless eurocrooks get paid more than the PM.

  3. Hi Shaun

    You mention a loosening of fiscal policy in the sense of deliberate action but the fiscal position will surely turn worse due to the operation of the cycle.

    From what I recall Osborne’s actual out turn target was not a cyclically adjusted one; it required a cyclically adjusted forecast to be in surplus but not the actual out turn (?!). The rule regarding PSND was an anchor of sorts but very inadequate. However, the fiscal charter is now history anyway; it was PR not serious economics.

    It seems to me that the latest proposal to cut corporation tax will simply compound the problems we were already going to have with the operation of the cycle and both the deficit and PSND could be headed substantially higher over the next few years. If we go into recession, which has to happen sooner or later, then we could have a very large PSBR.

    How can this square with low interest rates, particularly as we have the (unsustainable) trade deficit as well? Frankly I can’t see this and there has to come a point where everyone realises that the position is unsustainable and IRs will have go up, OMO/FG or not.

    • Hi Bob J

      What is happening here is that you are thinking ahead and allowing for other events whereas the UK political establishment wants to get out of this summer and even the end of 2016 is ages away. Accordingly they have tunnel vision and do not consider the potential impact on trade as you say and also inflation.

      We have seen in the past where a recovery has an impact on the PSBR but an equivalent slow down has a much larger effect the other way.

      As to interest-rates that is a worldwide trend but of course countries who get into a real mess do find that even in the current environment yields can rise.

  4. The U.K. Economic position has been worsening for several decades we have achieved a level of public and private indebtedness that can never be repaid.This has had a devastating effect on disposable income,the level of political and economic incompetence from politicians,central bankers and most economists (not you Shaun)is beyond belief.
    We are headed for a monetary and economic catastrophe lowering interests rates and QE leading will only make things worse.
    How can you solve a debt crisis with more debt? You don’t need much common sense to see that,yet these people refuse to change course,refuse to even consider their policies might have caused our current plight.

    • I suspect that we are in so deep that any politician who stood up to say that he/she really would sort out our debt problem would have to instigate policies that would ensure that he/she would lose their seat at any election.
      I always like to point out to people that QE is effectively printing money to paper over the difference between tax collected and money already spent. It also manages to drive down interest rates so as to make government finances look better.
      The general confusion between, austerity, the annual deficit and the debt pile is also a rich source for politicians to pull the wool over our eyes. For example, how many times have you heard:
      1. That we are in times of austerity etc etc,
      2. That we are “paying down the debt”.
      I hardly know anyone who realises that expenditure is still rising or that the debt goes up every day.

      • I agree but it is clear that debt cannot continue to rise at its current rate of increase with no improvement in the economy.
        The Ponzi scheme that is the housing market must be addressed we simply cannot allow ever increasing debt with no return for anyone except the banksters

  5. dunno Shaun ,

    Seems policy is being made on the fly to suit a political ends. Namely we should have been in the Euro zone confirmed now . but we’re not

    so all the guff about economically worse off was, well, guff


    they out to wreck the joint just to show the public how stoopid they were not to vote the right way

    indeed why should a company be on 15% tax when mines 20% , 40% and 45% ( on bands) ?

    How do I know he wasnt going to that any way ? the conservatives have been dropping company tax since being elected and made noises they wanted to compete with Ireland . And they’re going to give this tax spree to companies who are hanging onto the loot anyways?

    as far as the rating agencies go , they lost all credability after 2008 , who believes the codswallop they publish anyways and why cant they be sued ?


    • Hi Forbin

      You have made me think about why George Osborne said less than 15% as a prospect for Corporation Tax? Was there a hint of matching or even undercutting Ireland? So if we lose some finance sector businesses we poach from there and in future compete on corporate tax? As you say our government is a lot keener on competing with that sort of tax!

      You must have gone through quite a bit of popcorn recently. Corn futures are still dropping in price and are US $3.53. Not quite trading places yet but a decent fall recently.

  6. Osborne promised austerity on Brexit and he’s u-turned already. Time to resign because he has destroyed all credibility and given up on a balanced budget for 2020.

    Continued deficits are risky, should a future recession combine with an interest rate crunch / currency crunch the consequences for British finances will be decidedly unpleasant

    • Hi Expat

      I suppose with Nigel Farage and then Chris Evans of Top Gear resigning today’s allocation was all used up. Will Nigel Farage unresign tomorrow? As for the Chancellor I guess he will cling on like the Barnacles that Charles Dickens wrote about.

  7. Hi Shaun
    I note that Standard Life have
    their own fiscal problems, I wonder which
    new female prime minister will help them
    and others in a few weeks?


    • Hi JRH

      I was thinking earlier about when that had happened and was pleased with my memory but less pleased with the possible portents. Although the £2.9 billion and shrinking is not enormous when we look at other numbers these days it does represent pain for some and may cause margin calls elsewhere. It also provides something to think about for the West Lothian issue.

      The rise and fall of politicians currently is dizzying but as you say it does look to be a time for girl power.

      • It is ironic that this story has been forgotten about

        Basically, London’s new financial centre was built on loans in the height of a credit boom, which went bad. Jefferson Starship are said to have put it more succinctly in a concert for Ivan Boesky: “We built this city, We built this city, On high yield bonds” (Boesky subsequently got 3 years for insider trading).

        Girl power? So, tell us, Shaun, do you “really want to zig-a-zig-ah”? Leadsom and May look like two versions of Mrs. Merton without the sharpness of the sadly departed Caroline Aherne – correction, more like Cissie & Ada (Les Dawson & Roy Barraclough)

      • On the fall of politicians, I was listening to the news at 6 yesterday and half the time was spent on the resignations at the Tory party, UKIP and the non-resignation at Labour. Given the disappearance of the Lib Dems, it does make you wonder who anyone will vote for at the next election and what policies will be on offer.

  8. Steve Priest for PM, Chancellor, Governor …. England manager, Top Gear lead presenter … the list goes on!

    Monetary policy has been run out way beyond where it should have gone. It has merely pumped up asset prices and encouraged the borrowing necessary to sustain them. This has sucked the life out of current demand consumption, which is actually where most tax has its origins – in contrast, most assets have various shelters and means of avoidance, while the rates are low too (esp CGT). The end result is the Government is not getting enough from Income Tax, VAT and the losses are not being made up by duties and CGT. Further falls in housebuilder shares are no surprise as the construction PMI tanks and now Standard Life are getting whacked by nervous investors (many of whom have just seen their investments fall in value by about 10%) coming after the Singaporean bank halting loans. We are now headed for a recession without having had a boom choked off with higher rates. It has just put off the evil day when the money runs out and property crashes.

    Monetary policy having failed, fiscal policy is all there is left to try to put cash into the hands of people and companies. So, GO is starting with corporation tax to start a race to the bottom with Ireland (no doubt forgetting that we loaned them £6bn precisely because their corporation tax wasn’t producing enough revenue!). However, that is money, which will have to be found from elsewhere – either by raising borrowing yet further or cutting spending elsewhere. It won’t work.

    Time to face reality, guys.

  9. Pingback: The unreliable boyfriend takes center stage at the Bank of England | Notayesmanseconomics's Blog

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