My critique of the rising pressure for a fiscal stimulus

Today the Bank of England will or if you are reading this later in the day announce its monetary policy decision. For earlier readers care is needed as it voted yesterday and there is a danger that there are those trading in markets who already have the “Early Wire”. However those who used to be cheerleaders for monetary action have in many cases moved on to fiscal policy. Sadly they are very rarely asked why the policies of which they were not only enthusiastic advocates of but also promised success were apparent failures. After all why do we now need something else? Nobody except me seems to point out that it would be better to follow intellectual leaders who have a track record of being correct as opposed to being wrong.

Monetary policy as fiscal policy

The dividing line between the two supposedly separate types of economic policy has been crossed by the scale of the Quantitative Easing we have seen undertaken. If we look across the Channel to the Euro area we see that some 1.084 trillion Euros of bonds have been purchased under the current program of which some 875 billion are government bonds. The total is rising at some 80 billion Euros a month.

This means that debt repayments are much lower than they otherwise would be. This is because new bonds can be issued at such low yields. If I pick out one country Italy we see that its ten-year yield is a mere 1.2%. Yet it is a country where national debt is around 130% of GDP and only yesterday saw that banking problem theme return as an old favourite on this blog Unicredit reported not only lower capital ratios but lowered past ones too, “Tis but a scatch” etc. The Italian government is seeing quite a boost to its fiscal policy via debt interest. In more than a few cases at the shorter maturiites Euro area governments are actually paid to borrow now.

The Bank of England would step further onto such ground if it announces more QE itself today. But whatever it decides the net effect of all of the various policies is that the UK is before any announcement getting a fiscal boost from low Gilt yields. I cannot repeat enough how extraordinary a 1.62% yield for the 30 year Gilt actually is.

Why do we not here more about this? Governments like to take the credit themselves claiming confidence in their policies and so much analysis these days is simply copy and pasting such announcements.

The fiscal stimulus plan

There have been two versions of this over the past 48 hours or so. Let me start with the one for Japan by Adam Posen from the Financial Times. His ascent to prominence has been unaffected by the fact that he got UK inflation trends so  wrong it led to him departing from the Bank of England.

What is promising about Mr. Abe’s latest stimulus package is not its size—the real amount spent will certainly be less than half of the announced ¥28.1 trillion ($276 billion)—but its ties to labor market reforms. The first rounds of  Abenomics), the prime minister’s attempt to revitalize the Japanese economy in 2013 and 2014, showed the power of such a combination. Spending to increase the availability of public childcare places and cuts to taxes that penalized families’ second earners contributed to a substantial rise in  women joining the labor force.

You may note the effort to present Shinzo Abe as a reformer which including Shinzo himself makes 2 people I think. Whilst I welcome a change in the misogynistic nature of Japanese society the fact is we would not be where we are if the third arrow of reforms had happened. Later we get an explanation of success being lower wages which is odd as previously we were told by people like Adam it would represent high wages. Up is the new down that sort of thing! Although I can almost agree with this bit “the benefits were hidden.”

Missing also is a confession that in fact Japan is getting benefits from lower inflation as opposed to the higher inflation that people like Adam are always so keen on.

Helicopter Money

No not in Japan yet but no doubt Adam will be along soon. This has appeared in the UK where a group of 35 economists have written a letter to the Guardian.

Instead of policies designed to fuel asset price bubbles and increase household debt, the Treasury and the Bank should co-operate to directly stimulate aggregate demand in the real economy.

So the sound of RAF Chinooks getting ready to take off to deliver Helicopter Money can be heard. Could they play Ride of the Valkyries like in the film Apocalypse Now? Also as the world moves on perhaps the cash could be delivered by drone and outsourced to Amazon! Here are some more details.

A fiscal stimulus financed by central bank money creation could be used to fund essential investment in infrastructure projects – boosting the incomes of businesses and households, and increasing the public sector’s productive assets in the process. Alternatively, the money could be used to fund either a tax cut or direct cash transfers to households, resulting in an immediate increase of household disposable incomes.

Has nobody told them that group letters by economists to newspapers have a dreadful track record? Anyway let us move onto what they expect from this.

In any of these policy scenarios, new money will be directly introduced into the real economy, stimulating aggregate demand and boosting employment, investment and spending.

Do you note the use of the word “real” relating to economy? You see they completely miss or choose to ignore the likelihood of inflation from such a move. The one clear example of something along these lines came from Ghana a couple of years or so ago. In response the Cedi went south and drove inflation higher.

Also there is not much democracy in an elected government submitting all its economic policy to an unelected panel of technocrats at the Bank of England.

it would remain a decision for the monetary policy committee as to the timing and size of any future stimulus.

I am not sure that bit was thought through as it would require legislation which I suspect would struggle to get a majority in the House of Commons. Frankly it shows signs of not being well thought through. Also there is an issue which is that such a policy is a response to an economic depression and the UK has done this we are told.

In Quarter 2 2016, GDP was estimated to have been 7.7% higher than the pre-economic downturn peak of Quarter 1 2008.

What would they propose for Greece which has actually seen an economic depression? i do hope none of our 35 were supporters of the policies applied there.

Meanwhile at The Outer Limits.

Interest rate and Vat cut needed as economic data “horrible” says DannyBlanchflower,

A 5% cut in VAT. Perhaps things like different from a New England perspective.

Comment

There are three strands to my thoughts here. Firstly as I have pointed out earlier we were promised that monetary policy would work and instead we got “more,more,more” whereas now past supporters of this seem to be rushing for whatever you might call an intellectual exit. Sadly the world economy is left with the side effects.

Next we have the issue that the countries for which a fiscal stimulus are being proposed are ones which have in fact carried them on. For example the UK borrowed some £75 billion in the fiscal year that ended in March and Japan borrowed some 5.2% of GDP in 2015 according to the IMF. Are we back to “more,more,more” being our only strategy?

On the other side of the ledger is that it is currently amazingly cheap for governments to borrow with Japan having many negative yields and UK Gilt yields very low for an inflation prone nation. So there is scope on that basis but my suggestion is that we start from the more micro level than the grand macro plans which have so let us down in the credit crunch era. Rather than money looking for projects let us go the other way and look for projects that we feel would genuinely be beneficial. I am open to suggestions but as I discussed only on Friday the UK’s power infrastructure seems to have plenty of scope for ch-ch-changes and improvement to me.

The Vix

I did an explainer yesterday on TipTV Finance.

 

 

Advertisements

53 thoughts on “My critique of the rising pressure for a fiscal stimulus

  1. They just don’t seem to grasp that the reason why consumption demand has collapsed is that buyers are now spending some much on the capital component of borrowings to finance asset purchases at silly prices. Even when the bubble bursts, that capital debt will still be there as a drag on the economy – this will take years to unravel.

    • Steve Keen 26/8/2015
      Why China had to crash part 1

      ‘Demand is strictly monetary: there is some barter, but in the vast majority of cases, purchases of both goods and assets requires money. And there are two main private sources of money: you can either spend money you already have, or you can borrow from a bank. When you borrow from a bank, you increase your spending power without reducing anybody else’s: the bank records a new asset on one side of its ledger (the debt you now owe to the bank) and a new liability (the additional amount of money in your deposit account). When you spend that borrowed money, it becomes income for someone else. So total expenditure and income in our economy is the sum of the turnover of existing money, plus the change in private debt (I’m leaving the government and external sectors out of the argument for now).’

      ‘So if the rate of growth of debt slows down simply to the same rate of growth of nominal GDP, domestic aggregate demand in China could fall by 6%, even if both GDP and private debt continue to rise.

      This is the mechanism behind the empirical datum that the ex-banker and philanthropist Richard Vague identified in his book The Next Economic Disaster: Why It’s Coming and How to Avoid It. Richard looked at all economic crises across the globe over the last one and a half centuries, and found that every one of them occurred when the private debt to GDP ratio exceeded 1.5 times GDP, and when the ratio had risen by 17% or more over a 5 year period.’

    • I don’t understand your argument David. If you borrow £100,00 at 10%, then experience a 1% rate reduction this releases £1000 for you.

      If you borrow £200,000 at 5%, then experience a 0.5% rate reduction this releases the same £1000 for you?

      I get that eventually, when your repayment rate reaches zero no more cash may be released to you but by that time the bank/building society would’ve gone bust so you’ll never reach that stage, Yes?

      • No, this is the point people forget: The interest will change and release money, hence why interest rate changes will have an effect, especially at higher levels when the shift can be more significant. However, whatever happens, you have to pay back the £100K capital, so if low rates push up the asset prices, then that unchanged amount, which has to be paid anyway, is all the greater and doesn’t change. Hence it is the capital amount, which is sucking the cash out of consumption demand. The only way the capital amount will reduce is with high wage inflation, which with poor productivity, we cannot generate.

        Listening to Aberdeen away at Maribor – they have two Brazilians: Tavares (as in the late 70s group) and a defender called Defendi. We have just missed a penalty – not going to go well, I fear.

    • Hi Dave

      A sound idea I agree except that our establishment have been promising it for 20 and 30 years now without actually ever doing it! Could they change?

      Let us hope if they do that some decent quality housing is built.

  2. Hi Shaun

    There seems little likelihood of a decline in air travel as we all seem happy to go on holiday, increased airport capacity around London is inevitable.

    How about a new national airport and supporting road and rail infrastructure, East of London perhaps? That seems a much brighter prospect than HS2.

    Or tidal lagoons for pwer generation, they seem a better idea than Hinckley.

    And perhaps the government could invest in cleaning up brownfield land to enable housebuilding – won’t make any money but would solve land shortages.

    Got lots of other ideas too!

  3. Hi Shaun
    So its 0.25%, down to zero by end of year, more QE and purchase of corporate bonds, and of course more help for those poor banks. GBP down 1% or so.
    So Markit obviously has more ‘weight’ than CBI or BoE’s own agents. Just an excuse to do what they wanted to do anyway. The Brexit ‘expert’ advice had to be right, didn’t it?
    The effect on the ‘real world’? More expenditure delayed or abandoned as the future risk on savings and pensions has just ratched higher. But then of course the rationale for the BoE’s actions are nothing to do with its PR statements on the UK economy.
    Please stop this bus, I want to get off!

    • You are absolutely spot on as to the Brexit advice having to be proved right. I think that the BBC, in particular, is on a mission to ensure that we are all doomed. They even interviewed people in China today as to whether they would stop buying British…

      • The BBC’s economics reportage has been a national embarrassment for years.

        Quite why people on minimum wage are forced to pay two days salary for it is a mystery to me.

  4. Very interesting, as ever, Shaun.
    The reality to me is that no-one else seems to take a step back and think. I am sure that you are right in that governments take the credit for low interest rates, whereas they are caused by QE.
    People talk about the need for a fiscal boost because:
    1. Politicians have deliberately misled the public about the difference between debt and deficit. I have lost count of the number of times politicians and lazy journalists talked about us “paying the debt down” over the last few years. In fact, a number of people I know flatly deny it if you say that we are adding to the debt by £1.5 billion a week;
    2. The link between government expenditure and taxes has been broken by the introduction of QE. If the BoE can simply invent money to buy debt, why pay taxes?
    3. If it costs nothing to borrow, why not splurge?
    If we actually got the Chinooks out and sprayed the population with cash as in real ten pound notes, my guess is that this would be seen as crazy Zimbabwean/Weimar economics etc etc. Calling it QE and thereby creating a totally false market in asset prices, debt yields, bonds (corporate bonds today, as well, I notice) is, on the other hand, seen to be normal economic management nowadays.
    So, Shaun, we now have:
    1. GDP data buoyed up by imputed rents, drugs and prostitution;
    2. False inflation figures;
    3. A false market in gilts and, from now, corporate bonds;
    4. Shares and house prices held aloft by crazy low interest rates;
    5. Huge deficits;
    6. Huge debt levels.
    What could go wrong?

    • ‘So, Shaun, we now have:
      1. GDP data buoyed up by imputed rents, drugs and prostitution;
      2. False inflation figures;
      3. A false market in gilts and, from now, corporate bonds;
      4. Shares and house prices held aloft by crazy low interest rates;
      5. Huge deficits;
      6. Huge debt levels.
      What could go wrong?’

      A succinct summation.Despite the fact that these are barn door questions we never hear them being posed by the BBC or the MSM.

  5. from the lack of any credible data these bozos then decide that cutting interest rates and more QE will work ?

    memo to BoE please explain this move when the BoJ have been doing the same for more than 2 decades and why , this time , it will work ?

    a crisis is needed after Brexit as it promised before hand and will give the excuse to ignore the results ( which apparently is the plan ….. )

    There is nothing you or I can do , we’re not wanted and we only count when we agree with them .

    so pull up the sofa and settle for some popcorn

    Forbin

  6. What!! Who on earth could have predicted this shock decision (over two ago!)…

    Thanks Shaun, I have just won many pints of beer betting on this. I was beginning to lose faith when in the run up to the referendum Carney warned us, using his best stern face, that Brexit would mean higher (mortgage) interest rates.

    The man has zero professional credibility, could it go negative??

    Andy

  7. I do wonder where the problems are in the economy that demand such a dramatic response. I have spoken to senior management in pharmaceuticals, engineering, house building, retailing, a couple of small building businesses, banking and a city broker. Only the last two reported any issues, with those in the ‘real economy’ reporting that nothing had changed and that they were quite bullish for the future. Are we not in danger of having BoE policy being managed for the investment funds and for The City whilst the rest of the economy trundles along just fine? I also wonder what they are going to do in future if we ever face a real crisis! The ammunition has all been used up. The attempts by central bankers to micro manage economies, so that there is only ever growth, is doomed to failure and should be the job of the government not the bankers. Each time monetary policy is loosened, they back themselves further into a corner from which they have no idea how to escape.

    I also totally subscribe to the comments that have been written here before that cutting interest rates actually backfires as it makes folk less likely to spend not more. When the inevitable slowdown happens it will be Brexit that is blamed instead of the BoE cuts. The psychological impact of all this doom and gloom is going to do more damage than any future exit from the EU and the BoE’s moves today must make people think that things are much worse than what they appear. They really should have sat on policy until a clearer picture emerged as I just do not see problems that warrant such an over reaction.

    • ‘Are we not in danger of having BoE policy being managed for the investment funds and for The City whilst the rest of the economy trundles along just fine?’

      Insolvent banks squealing for cheap money shocker.

      Just listening to the live presser and it’s depressing stuff.

  8. https://www.theguardian.com/business/2016/aug/04/bank-of-england-cuts-uk-interest-rates
    ‘The package consists of:

    • A cut in official interest rates to 0.25%. The Bank last cut interest rates in March 2009 in a bid to cushion the UK economy from the global financial crisis

    • Plans to pump an additional £60bn in electronic cash into the economy to buy government bonds, extending the existing quantitative easing (QE) programme to £435bn in total

    • Another £10bn in electronic cash will be created to buy corporate bonds from firms “making a material contribution to the UK economy”

    • A new scheme to provide as much as £100bn of new funding to banks to help them pass on the base rate cut to the real economy. Under this new “term funding scheme” (TFS) the Bank will create new money to provide loans to banks at interest rates close to the base rate of 0.25%’

    So some cheap money for the poor banking classes and then some extra cheap money so they’ll give the peasantry the cheap money.Which bit am I missing here?

    QE at £435bn………..double down on a policy that was so successful they’ve never been able to unwind it.

    Raging.

    • Another £10bn in electronic cash will be created to buy corporate bonds from firms “making a material contribution to the UK economy”

      ah another Bank bailout

      Forbin

      • You couldn’t make this up…………the scope for picking one’s with ex MP’s on the board msut be hard to fight.Or even better ones with ex CBers ‘cos they’re worth it’

  9. More of the same, that hasn’t worked here or anywhere else for that matter. They are hiding behind the fact that everyone else is doing it, so it must be right, no blame on them when the next crash comes.
    More QE and negative interest rate are a certainty! So is more debt and higher house prices!

    Forbin, any room on the sofa, I will bring my own popcorn and let’s watch the show?

    • Hi Foxy

      The only objective seems to be higher asset ( equity and house) prices which of course also supports “The Precious” otherwise known as the banks. Meanwhile so little of that largesse escapes into the real economy.

      Some good news for you on the corn front. As I have been replying to Forbin recently the price has fallen a fair bit and even fell by enough today to offset the lower UK Pound £.

  10. So Shaun ,

    what to do

    it is currently amazingly cheap for governments to borrow – funny how they are shy these days

    build council houses of course

    then flog them off 20 years later to the occupants

    borrow trillions and drop the tax rate to zero , drop VAT to zero , basically fund the government spending on tick ( yes, just more so , you there shouting at the back ! )

    build a Transatlantic tunnel

    forbin

    • on a more serious note

      refund British Steel

      fund Nuclear AGR our own boilers

      and fund a house build , road building like never seen before

      Bristol channel tidal barrier

      solar panels on every roof – 2% electricity to HMG ( not my idea – read it some where )

      a tunnel and fast rail link from channel through Wales to Dublin

      rent vast tracts of desert , build HVAC lines to our shores and lots of solar panels to complement local source

      wipe out student debt on Maths , Physics and Chemistry ( and biology ) whilst making it compulsasory to have an “O” level in one Science and Maths for all the other courses

      and for the remainers buy land in France , build houses there , and settle our immigrants there ….. or should that be europhiles ?

      Forbin

      • Hi Forbin

        It turned into quite a day didn’t it? Mark Carney was itching to say I told you so and as the UK Pound £ fell I couldn’t help wondering if his money was in Loonies.

        Speaking of student debt which was my subject of Monday, it seems even more harsh to impose on them the interest-rates we do.

  11. I am sure the BOE felt that this was an opportunity that couldn’t be missed. It’s heads I win tails you lose. If the ‘Brexit effect’ isn’t as bad as they stated they will claim it was down to this rate cut and QE. If the economy tanks they will say it was good that they were pre-emptive in their actions.

    I was surprised that no journalist at the press conference mentioned that interest rates were supposed to go up if Leave won the referendum!

    • Hi Bez

      The press conference is mostly a Toad of Toad Hall style operation which is why the Financial Times gets the first question. However there were a couple of decent questions later in the piece from Louise Cooper about savers and Ben Chu on inconsistencies about Brexit.

      As to the Bank of England I agree that it will now claim success either way whereas the rest of us face a much less optimistic future.

  12. Interest rates are reduced in order to encourage spending and QE increases the supply of money.

    But the problem isn’t the supply of money; the problem is demand, a problem that is particularly acute when many are paying down debt and I am talking here of businesses in particular. This is the reason why the inflation dog hasn’t barked over the years; the money supply (M4) has increased by around 25% in 8 years; reserve balances + notes and coin is up nearly 500%! Bank lending is 15% below where it was 8 years ago (7/2007 =100; 1/2016 =85)!

    As to “more, more, more” it has to be this way because the CBs are intellectually bankrupt. The economist Richard Koo asked the economists at the Fed what scholarly papers there were on exiting from QE and they answered that couldn’t find any; there were plenty recommending it but none exiting it.

    The fiscal balance will get worse when the automatic stabilisers kick in but if I were going to spend more on top I’d go down the R & D / education/ training/AI route and also energy as our energy policy is not only insouciant but alarming.

    • Built the new Houses of Parliament in Sheffied, and turn the old one into affordable housing.
      No need for HS2, spend it on east/west connections.

    • ‘This is the reason why the inflation dog hasn’t barked over the years; the money supply (M4) has increased by around 25% in 8 years; reserve balances + notes and coin is up nearly 500%! Bank lending is 15% below where it was 8 years ago (7/2007 =100; 1/2016 =85)!’

      Telling stats bob.Thanks

  13. Shaun, thank you for all that you do to bring us the facts, as opposed to what the PTB would have us believe.
    The BoE’s decision, which you have long predicted, whilst being premature and probably unnecessary, is presumably to justify the warnings given by Carney before the referendum and to save face. Is it also to punish those who were deemed to have defied the “Establishment guidance” and had the temerity to vote for brexit?
    Those who will suffer most from this decision are pensioners, both through lower rates and the increased risk to defined benefit pension funds, possibly resulting in reductions in pensions actually in payment, and those about to retire, with annuity rates heading lower. As always the poorest will be most affected.
    The decision seems to have been taken, by an un-elected body, to keep the housing bubble going and hang the consequences. You have mentioned “Groupthink” on here before, it’s a polite term for collective intellectual failure, which seems to affect so many areas of public policy-making

    • Hi PieterC

      The establishment have long travelled in a pack and as they are all so intelligent – according to themselves at any rate- if things do not happen as they say it must simply be bad luck. That is why we get so many “surprises”…

  14. Since rates were already minimal the rate cut makes little actual difference but it is of symbolic significance.
    More QE for gilts and corporate bonds?
    The monetary and economic system is broken the state is manipulating sovereign and corporate bond markets to support a failing system,it is less than 30 years since the death of communism,it appears we may be witnessing the death capitalism.
    NIRP and ZIRP are not compatible with capitalism the fact we are now burdened with these is due to the huge expansion of debt over the last 35 years.
    It is not possible to solve a debt crisis with more debt these policies also constitute a war on savers and pension funds.
    Viv Nicholson is obviously the ideal role model for politicians and central bankers.
    This is lunacy they need to admit their system and policies are failing ….if not we are going to have the greatest economic meltdown in history

    • AT LAST! A light in the sdarkness!¬ Agree everything you said Pivate Fraser except witnessing the death of capitalism. It died in 2008/9. You now have corporatism, a kind of inverted Marxism where profits are privately retained whilst losses are socially shared.

  15. “Nobody except me seems to point out that it would be better to follow intellectual leaders who have a track record of being correct as opposed to being wrong.”

    and

    “Also there is not much democracy in an elected government submitting all its economic policy to an unelected panel of technocrats at the Bank of England.”

    Given that intellectual leaders are not generally democratically elected by the populace how do you justify these contradictory statements?

    How would investment in infrastructure such as transport links, extra power generation and fibre broadband along with better education enabling goods/services to be transported more quickly, no brown outs or blackouts halting production and a better skilled workforce able to be more innovative result in higher inflation?

    • Hi Noo2

      What I was hoping for what that politicians would look around for people with genuine ideas and thoughts rather than lazily pursuing what everybody in the establishment thinks. A current problem with democracy is actually that a change of government would not make anything like as much difference as people think.

      I am not quite sure what your second question actually is?

      • Second question relates to the following extracts:

        1. “A fiscal stimulus financed by central bank money creation could be used to fund essential investment in infrastructure projects – boosting the incomes of businesses and households, and increasing the public sector’s productive assets in the process.”

        2. “In any of these policy scenarios, new money will be directly introduced into the real economy, stimulating aggregate demand and boosting employment, investment and spending.”

        Your critique of which follows and is this:

        “Do you note the use of the word “real” relating to economy? You see they completely miss or choose to ignore the likelihood of inflation from such a move.”

        Whilst your critique is justified of the economists suggestion that tax cuts or direct tax transfers to households to the populace to spend as they wish (with no attendant increase in productivity), I fail to see it as a valid criticism of the suggestion re infrastructure projects for the reasons outlined in my original comment.

  16. Hi Shaun,

    Insightful as always – great to finally see you ‘in the flesh’ on the TipTV interview – are those turtles on your tie to subliminally promote the lack of speed in the UK government’s financial decision-making?!

  17. Has anyone noticed that the urgency with which the “economy” needs more stimulus corresponds to the outcome of the last batch of bank stress tests?

  18. We’ve had fiscal stimulus for 7 years. Helicopters dropping billions in Canary Wharf and at RBS in Edinburgh. More drops for the BOE staff and ascent to heaven for Brown and Blair. Massive stimulus in ZIRP and big deficits. Seems to have been SFA benefit for the people. So I’ll just assume that this is a scam by the people in power to keep their gravy train rolling.

  19. Assuming the hard data doesn’t match the surveys and there is evidence that the former is less recessionary, Carney’s moentary stimulus will just add growth to something that wasn’t the disaster the surveys claimed.
    https://www.home.barclays/news/2016/07/consumer-spending-remains-buoyant-despite-brexit-vote.html
    Confidence surveys and data are different things. Just spend 200 in Marks go round the corner and get nabbed by a survey team. Yes, things are terrible, as you hide the shopping bags behind your back.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s