Fiscal expansionism is on the menu for the UK

Today has opened with UK future fiscal policy taking some headlines. This is the result of various factors of which the most obvious is that we are in an election campaign with politicians competing to win the fiscal equivalent of kissing the most babies. But there is more to it than that as we have been observing over the past few years. Underlying the situation has been a shift in the general establishment view bring expansionary fiscal policy back into favour. This was reflected last week by the valedictory speech of outgoing ECB President Mario Draghi.

In other regions where fiscal policy has played a greater role since the crisis, we have seen that the recovery began sooner and the return to price stability has been faster. The US had a deficit of 3.6% on average from 2009 to 2018, while the euro area had a surplus of 0.5%.

That baton was rapidly taken up by his successor Christine Lagarde who was perhaps hoping that people would forget she was responsible for disastrously introducing exactly the reverse in Greece and Argentina.

Christine Lagarde has asked Germany and the Netherlands to use their budget surpluses to fund investments that would help stimulate the economy. The soon-to-be president of the ECB said there ‘isn’t enough solidarity’ in the single currency area. ( Financial Times)

Back in the UK

The Resolution Foundation gives us a new perspective on the post credit crunch era and a new definition of austerity.

The austerity programme delivered since 2010 has produced an unprecedentedly long pause in the real-terms spending growth that has characterised the majority of the post-WWII period. Total managed expenditure (TME) increased by just £5 billion (or 0.6 per cent) between 2010-11 and 2018-19, with this eight-year flatlining eclipsing the six-year pause recorded in the 1980s and far outstripping any other previous period of austerity.

As you can see austerity is defined as government spending not growing in real terms or very little. Looking at their chart the 1980s actually looks more severe so I am not sure about “far outstripping” although there is a difference here.

Government spending per person is set to
come very slightly under £13,000 in 2019-20 (in 2018-19 prices), which remains 3.6 per cent down on the 2010-11 peak of £13,465.

On that basis there has been so more genuine austerity. Let me welcome their use of the GDP deflator as the inflation measure which has a couple of flaws ( it can be erratic and is prone to revisions) but is better than the woeful CPIH.

Looking Ahead

The current government has announced ch-ch-changes already.

The current plans result in spending rising
to 40.6 per cent of GDP; still well down on the immediate postcrisis peak of 46.6 per cent, but slightly above the ratio recorded just before the crisis struck, and well up on the 37.4 per cent of GDP logged between 1985-86 and 2007-08.

So austerity is over and they think more might come from any Conservative victory as Chancellor Javid is a fan of this.

In more concrete terms, during his bid for the Conservative
Party leadership back in the summer he outlined plans for a
£100 billion (multi-year) “National Infrastructure Fund” targeted outside London.

So as you can see the trajectory looks upwards.

They point out that Labour looks even more ambitious.

Its 2017 election manifesto included more than £70
billion in new spending pledges, comprising £48.6 billion of dayto-day spending (covering both departmental spend and social security payments) and £25 billion of capital (as part of a pledge to deliver a ten-year £250 billion “National Transformation Fund”).

They are not entirely sure it will repeat this but think it will in terms of spending totals.

But the party has outlined a range of additional
ambitions in recent months that imply that it intends to set out a 2019 manifesto pledge that is similar in scale to the 2017 one.

If we switch to comparing with the size of the economy we are told this.

Our modelling suggests that a ‘Conservative’ approach that
delivers on the Spending Round commitments on current
spending and thereafter maintains the value of that expenditure as a share of GDP, alongside delivering a £20 billion annual boost to the capital budget (on the assumption that something along the lines of the proposed “National Infrastructure Fund” is delivered over five years), would lift TME to 41.3 per cent of GDP
by 2023-24.

And the alternative.

Following a Labour approach that tops up the post-Spending Round baseline to the tune of £49 billion of current spending and £25 billion of capital spending by 2023-24, lifts TME to 43.3 per cent of GDP. That would take us back to 1982-83, and would stand as the ninth highest spending total in the entire post-war period.

So both will be opening the fiscal taps the difference simply being how much.

We then arrive at an issue which leaves the Resolution Foundation in something of a class of one ( h/t Brian Clough).

Even before accounting for any post-election spending surge, the fiscal rules look set to be broken, leaving the UK effectively without a fiscal anchor.

Maybe it bothers you if you live in the political world but as we have observed over the past decade they end up singing along with Earth Wind and Fire.

Every man has a place, in his heart there’s a space,
And the world can’t erase his fantasies
Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away

Comment

The conventional view is to then ask how this can be afforded or paid for? We are all familiar with the question how will this be funded? But times are different now driven by factors such as this.

Bank of America sees a risk that yields on some Treasuries will go negative by 2021 as the Fed cuts rates all the way to zero ( Bloomberg )

In such a scenario then the UK would if market relationships stay as they are have its whole yield curve go negative, or if you prefer be paid to borrow at all maturities.

That may or may not happen but we do know that we can borrow very cheaply right now. The UK benchmark ten-year Gilt yield is a mere 0.7% and even if we borrow for fifty years the yield is only 1.1%. Thus borrowing as a means of financing deficits is quite plausible in a world where there is a hunt for yield. The only issue is how much we would be able to borrow? With a sub-plot that hopefully we would borrow over the very long-term to trim the future risks of doing so. Just to be clear I am not advocating large extra borrowing just observing that circumstances have changed. That reinforces even further my point about fiscal rules.

Also it would be helpful to note the plans of the Liberal Democrats and the nationalist parties. The SNP in Scotland seem set to have some role to play and whilst winning seems unlikely for the Lib Dems they could quite easily find themselves in a coalition government again.

The rub as Shakespeare would put it is that we now seem hooked on stimulus and as the monetary injections fail to give much of a hit we are now searching for a new high. This brings us back to economic growth as it lack of it and of course in the “green era” whether we should have any at all?

Podcast

 

NB

The fiscal numbers quoted by Mario Draghi were on this basis.

Average cyclically adjusted primary balance as a percentage of potential GDP

 

14 thoughts on “Fiscal expansionism is on the menu for the UK

  1. Hi Shaun

    And so it begins, the politicos bribing us with our own money.

    Wrf to this:

    The current plans result in spending rising to 40.6 per cent of GDP;

    I assume the GDP figure includes the ‘fantasy’ imputed rents figure. So removing that spending will be much higher? Spend Spend Spend!!!!

    • Hi Anteos

      It is a case of no and then yes. Let me explain. We use the output version of GDP as the main measure and they are not in that, But the income version which they are a component of is used to refine the figures at times. So there may be an influence.

      Actually the income measure of GDP has its uses as long as you realise that ~10% is just a residual item to fill in a gap.

  2. Shaun, as we all live in ‘model world’ now, does any of this really make any difference?
    The only testing done in ‘model world’ is one model versus another. Physically humans still exist by interacting with objects, we still need to eat and the rest , but the forces that determine our sphere of existence are almost entirely ‘modelled’.
    Lagarde says we should be grateful that jobs are put before savings. This is to justify another wave of ‘injections’ . What ever the outcome of the GE, the UK will be ‘injecting’ billions ‘for free’ to satisfy modelled climate concerns.
    Borrowing not saving is good. No adverts for savings in the US, just adverts for boosting your credit rating on phone apps.
    Selling a property in the US, had two offers on the same day from people who had a virtual tour of the house, never set foot in it.
    Perhaps we are all dreaming this, bit of a nightmare.

    • re :Selling a property in the US, had two offers on the same day from people who had a virtual tour of the house, never set foot in it.

      I think there’s a business opportunity here, if virtual touring a house is acceptable, why not virtually own one?

      you could take “trips” and “live” at a virtual house over the internet. Imagine the Mansions or castles you could “own”

      Buckingham Palace ? virtually live as the Queen ….. the possibilities are endless

      As everything else is “virtual” why not ?

      Forbin

      • I seem to remember one of my kids playing a computer game like that some years ago. That was in those hazy days when computer games were not ‘real life’.

  3. Great blog and podcast as usual, Shaun.
    With regard to your podcast comment on the next governor of the Bank of England, you didn’t mention Kristin Forbes as a possible candidate. It would be interesting to see a Canadian governor succeeded by an American governor, sort of like a UK homage to the original US-Canada Free Trade Agreement. I noticed that the Central Bank of Iceland has a new governor, Ásgeir Jónsson, who started in August. He and Kristin Forbes were both members of the 2018 Task Force on Monetary Policy Reform, which Jónsson chaired. With Jónsson now the governor, I would assume there is a greater likelihood that proposal 5 of the task force, excluding owner-occupied housing from target inflation indicator of the central bank, will be adopted. If adopted, the Bank of Canada would become the only country left in the world that still has a target inflation indicator sensitive to mortgage rate changes.
    By the way, I got a response from the office of the Canadian environment minister, Catherine McKenna, on the issue of taking mortgage interest cost out of the Bank of Canada’s target inflation measure. As you recall, when I asked her a question about this at the all-candidates’ meeting on October 15, she responded that she didn’t know but she was open to discussing the matter with me. However, when I sent her a note on the subject, which did mention the situation in Iceland, I was told by one of her aides that I should redirect my complaint to Finance Minister Bill Morneau. This makes little sense even in terms of responsibilities, since the Parliament is dissolved, and Morneau may no longer be the finance minister after November 20, whereas she will still be my MP in Ottawa Centre. Also, it is somewhat two-faced to claim to be open to examining this issue before an audience of several hundred people, most of whom hadn’t voted, and then to say “not my department” privately after the election.

    • Hi Andrew and thank you.

      No I did but I did make the case for Kristin Forbes on Twitter, at least in comparison to Nemat Shafik.

      “Just so I am not misunderstood having a woman as Bank of England Governor is a good idea but sticking to past policymakers the competent and intelligent Kristin Forbes would be much better than the incompetent Shafik,”

      It broke a brief entente cordiale between me and Danny Blanchflower.

      As to Iceland there must be quite a few issues based around the small sample size for measuring anything. Although of course there are advantages in that too.

      Moving to politicians I guess yours are just like ours.

  4. Shaun,

    What-“negative” you said? and the BOE said they would not go negative as I recall, and posted previous on your blog hers here, yet I said they would have to change their minds.

    Borrow borrow borrow and it goes on but it will have to be paid back, or a default as Gillian Tett pointed out in the last financial crisis.

    It is possible to repay but not in a world slowdown which is existing at the moment.

    Anyone for a hamlet cigar? I don’t smoke but remember the TV commercials !

    Something will go up in smoke for sure and many fingers burnt!

  5. Hi Shaun

    One of the delights of fiscal spending is that once you write the cheque it’s in GDP. Now the spending may be wise; it may be unwise but, as you say, with such low interest rates it’s an ideal opportunity to upgrade infrastructure.

    Monetary policy on the other hand is far more indirect which is why it’s common to use such phrases as “trickle down” or “lagged effects” to rationalise the fact that a great deal of the supposed benefits end up as dormant computer entries or as part of the funds of IBBS – the Irresponsible Bankers Benevolent Society.

    It seems to me that the only reason this new fondness for fiscal policy is because the supposed failure of austerity. However the judgement on Alberto Alesina’s theory of fiscal retrenchment seems to be provisional rather than final, despite it falling out of favour. However, one of the bases for Alesina’s theory was that fiscal policy had to be seen as sustainable and if it were not then this would affect employment and spending. This may be right but I have doubts if most people spend any time on reflecting whether the fiscal stance is unsustainable; they’re too busy earning a living.

    Austerity was of course also tied up with neoliberalism and the shrinking of the state but doing this immediately after the deep recession of 2009 seems not the best timing to start such an experiment which is why most programmes of austerity seem to have been abandoned.

    As history will probably judge that we’ve had ill judged monetary policy for the last eight or nine years we may yet have some redemption if we can show we’ve taken advantage of the errors of the central bankers in using low rates to improve things directly.

    • Hi Bob J

      It should be although the extra French fiscal deficit of ~1% of GDP has only led to 0.6% of extra GDP growth, although of course it may catch up later. If we could find something really good to invest in now would be the time as you say. Although the example I have quoted over the years of cold nuclear fusion seems to be as far away as ever if the Woodford write-downs are any guide.

      I like the phrase “dormant computer entries” which sums up a fair bit of QE 🙂

    • In order to spend fiscally the money has first to be borrowed or created – in this case it is being created to finance fiscal expansion so the 2 go hand in hand

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