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

 

Japan gets paid to issue debt and yet it has just tightened its fiscal policy!

Today I am looking east to the country which is hosting the rugby world cup and let me congratulate them on their victory over Ireland. But there is another area where Japan is currently standing out and that is the arena of fiscal policy. The current establishment view is that it is time that fiscal policy took up the slack after years and indeed in Japan’s case decades of easy monetary policy. One feature of that type of thought is seen by the cheapness of public borrowing in Japan where the ten-year yield is -0.22% and the thirty-year is a mere 0.35%. So Japan is either paying very little or being paid to borrow right now.

Consumption Tax

Last week it did this.

After twice being postponed by the administration of Prime Minister Shinzo Abe, the consumption tax on Tuesday will rise to 10 percent from 8 percent, with the government maintaining that the increased burden on consumers is essential to boost social welfare programs and reduce the swelling national debt. ( The Japan Times )

This is an odd move when we note the current malaise in the world economy which just gets worse as we note the fact that the Pacific region in particular is suffering. We looked at one facet of this last week as Australia cut interest-rates for the third time since the beginning of the summer.

Things get complex as we note that there are offsetting measures.

The 2 percentage point boost is estimated to inflict about a ¥5.7 trillion burden on households. However, making preschool education free of charge, keeping the 8 percent rate for food and nonalcoholic beverages and beefing up social welfare are expected to lessen that burden to around ¥2 trillion — about a quarter of the ¥8 trillion cost of the 2014 hike, according to the government and the Bank of Japan. ( The Japan Times )

As you can see this takes away a lot of the point of making the change in the first place! According to the government the net effect will be a bit more than a third of the gross. Also it means the government interfering in more areas leafing to transfers of cash from one group to another. Now whilst free preschool education is welcome we have seen extraordinary transfers in the credit crunch era via policies such as negative interest-rates and QE bond buying.

As ever the numbers seem in doubt as NHK News thinks the impact will be larger.

Half the revenue will be spent on making preschool education and childcare free of charge, easing the financial burden of higher education, among other things. The rest will go to restoring the country’s fiscal health.

The economic impact

The very next day Japan’s Cabinet Office released this bombshell.

The Consumer Confidence Index (seasonally adjusted series) in September 2019 was 35.6, down 1.5 points from the previous month.

The Japan Times covered it like this.

A Cabinet Office survey showed earlier this week that consumer sentiment in Japan weakened for the 12th straight month in September, hitting its lowest since the survey started in April 2013……….The index was lower than the 37.1 marked during the first stage of the hike in April 2014.

The last sentence is especially ominous if we consider the impact of the 2014 Consumption Tax rise. If we return to the survey we see from the series that it has been falling since some readings above 44 in late 2017 and the fall has been accelerating. In terms of detail there is this.

Overall livelihood: 33.9 (down 0.9 from the previous month)
Income growth: 38.7 (down 0.8 from the previous month)
Employment: 41.5 (down 0.7 from the previous month)
Willingness to buy durable goods: 28.1 (down 3.6 from the previous month)

So all elements fell and the employment one is particularly significant when we note this.

 The number of unemployed persons in August 2019 was 1.57 million, a decrease of 130 thousand or 7.6% from the previous year…..  The unemployment rate, seasonally adjusted, was 2.2%. ( Japan Statistics Bureau )

As an aside this makes the various natural and equilibrium levels of unemployment look laughable. For newer readers that is demonstrated by the Bank of England thinking it is 4.25% when Japan has an unemployment rate around half that.

This morning has brought news that things have gone from bad to worse.

TOKYO (Reuters) – A key Japanese economic index fell in August and the government on Monday downgraded its view to “worsening”, indicating the export-reliant economy might face slipping into recession.

The outlook was mostly driven by this.

The separate index for leading economic indicators, a gauge of the economy a few months ahead that’s compiled using data such as job offers and consumer sentiment, dropped 2.0 points from July, the Cabinet Office said.

Fiscal Policy

The other side of this particular coin was illustrated by the response of Fitch Ratings to the Consumption Tax hike.

Japan’s consumption tax hike supports medium-term fiscal consolidation efforts, and the country’s sovereign credit profile, Fitch Ratings says. We estimate it will lower Japan’s debt ratio by about 8pp of GDP by 2028; however, very high public debt will remain a key credit weakness.

They further crunched the fiscal numbers here.

Total annual revenue from the tax hike is estimated by the government at about 1% of GDP, half of which is earmarked to reduce debt (the remainder will be used to permanently increase spending for education and long-term care). This would result in Japan’s gross general government debt-to-GDP ratio falling to just over 220% by 2028, from 232% at present.

It hardly seems worth it when it is put like that. Also perhaps unwittingly they let the cat out of the bag as to why Abenomics is so keen on raising the level of inflation.

We estimate that Japan’s public debt dynamics have stabilised due to the resumption of nominal GDP growth in recent years.

Nominal GDP growth includes inflation.

Comment

This is a story with several facets so let us open with the driving force of this which was the IMF or International Monetary Fund and the case it made in the earlier part of this decade for Japan to improve its national debt to GDP ratio. Here is the IMF Blog after the 2014 Consumption Tax rise.

Japan’s GDP declined by almost 7 percent in the second quarter, more than many had forecast including us here at the IMF.  Many cite the increase in the sales tax this April for this decline.  But that is not the full story.

That opening suggests there were other reasons for the fall but fails to state them as it then discusses general rather than specific issues. Oh and it does not day but it means annualised fall in GDP. The impact was so great that the 2015 rise was delayed to now rather ironically because of the recession risk. What it means is that Japan ends up doing this at a very risky time if we look at the world economic outlook.

We now find also that IMF fiscal conservatism is being applied just as it has switched to expansionism. That is quite a mess! No wonder Christine Lagarde shot out of the door. After all Japan can borrow quite cheaply mostly due to the fact that The Tokyo Whale ( Bank of Japan for newer readers ) owns so much of it. The IMF has just published a Working Paper on this so let me give you some numbers from 2017.

As shown in the Fiscal Monitor, Japan’s PSBS stands out as one of the largest PSBS in the world, with assets and liabilities of 533 percent of GDP in 2017. Japan’s
PSBS also includes cross-holdings of assets and liabilities within the public sector, exceeding 210 percent of GDP in 2017—the largest in the IMF’s PSBS database. Much of these come from public corporations’ financing of central government liabilities. ( PSBS = Public Sector Balance Sheet)

Next let me help the author out as the situation below is explained by world wide trends accompanied thsi decade by the enormous purchases of The Tokyo Whale.

Several previous studies considered it puzzling that the stock of Japanese Government Bonds (JGBs) has been increasing but their yields have been declining
for the last three decades.

Next we get a higher estimate for the national debt.

However, these may not fully explain why Japan has been able to build up 288 percent of GDP in public sector borrowing.

Also it is not only The Tokyo Whale that has bought this.

In 2017, the public sector finances 150 percent of GDP of public sector borrowing,

In some ways it has been buying off other parts of the public-sector.

For example, the Post Bank
reduced allocations to public sector financing from 95 percent of its total assets at its peak in
1998 to 33 percent in 2017. The social security funds also reduced asset allocations to public
sector financing from 77 percent at its peak in 1998 to 34 percent in 2017.

Oh what a tangled web we weave……

Meanwhile it would appear that even extraordinary fiscal expansionism has not done much good.

Borrowing of general government ballooned in the 1990s and 2000s. It was 60 percent of GDP in 1990 and
increased to 226 percent of GDP in 2017.

The ordinary Japanese may have a job but real wages are falling again and fell at an annual rate of 1.7% in August.

Podcast

 

 

Will fiscal policy save the US economy or torpedo it?

One of the features of the credit crunch era has been the shift in some places about fiscal policy. For example the International Monetary Fund was rather keen on austerity in places like Greece but then had something of a road to Damascus. Although sadly Greece has been left behind as it ploughs ahead aiming for annual fiscal surpluses like it is in a 2012 time warp. Elsewhere there have been calls for a fiscal boost and we do not need to leave Europe to see them. However as I have pointed out before there is quite a distinct possibility that President Donald Trump has read his economics 101 textbooks and applied fiscal policy into an economic slow down. Of course life these days is rarely simple as his trade policy has helped create the slow down and is no doubt a factor in this from China earlier..

Industrial output grew 5.0 percent in May from a year earlier, data from the National Bureau of Statistics showed on Friday, missing analysts’ expectations of 5.5% and well below April’s 5.4%. It was the weakest reading since early 2002. ( Reuters).

Also there has been another signal of economic worries in the way that the German bond future has risen to another all-time high this morning. Putting that in yield terms holding a benchmark ten-year bond loses you 0.26% a year now. Germany may already be regretting issuing some 3 billion Euros worth at -0.24% on Wednesday although of course they cannot lose.

US Fiscal Policy

Let us take a look at this from the perspective of the South China Morning Post.

The US budget deficit widened to US$738.6 billion in the first eight months of the financial year, a US$206 billion increase from a year earlier, despite a revenue boost from President Donald Trump’s tariffs on imported merchandise.

So we can look at this as a fiscal boost on top of an existing deficit. The latter provides its own food for thought as the US economy has been growing sometimes strongly for some years now yet it still had a deficit. In terms of detail if we look at the US Treasury Statement we seem that expenditure has been very slightly over 3 trillion dollars whereas revenue has been 2.28 trillion. If we look at where the revenue comes from it is income taxes ( 1.16 trillion) and social security and retirement at 829 billion and in comparison corporation taxes at 113 billion seem rather thin to me.

The picture in terms of changes is as shown below.

So far in the financial year that began October 1, a revenue increase of 2.3 per cent has not kept pace with a 9.3 per cent rise in spending.

If we look at the May data we see that the broad trend was exacerbated by monthly expenditure being high at 440 billion dollars as opposed to revenue of 232 billion. Marketwatch has broken this down for us.

Most of the jump can be explained by June 1 occurring on a weekend, which forced some federal payments into May. Excluding those calendar adjustments, the deficit still would have increased by 8%, with spending up by 6% and revenue up by 4%.

In terms of a breakdown it is hard not to think of the oil tankers attacked in the Gulf of Oman yesterday as I note the defence numbers, and I have to confess the phrase “military industrial complex” comes to mind.

What will recur are growing payments for Medicare, Social Security and defense. Medicare spending surged 73% — mostly because of the timing shift, though it would have rose 18% otherwise. Social Security benefits rose by 11% and defense spending rose 23%.

So we have some spending going on here and its impact on the deficit is being added to by this from February 8th last year.

The final conference committee agreement of the Tax Cuts and Jobs Act (TCJA) would cost $1.46 trillion under conventional scoring and over $1 trillion on a dynamic basis over ten years,

Thus policy has been loosened at both ends and the forecast of the Congressional Budget Office that the deficit to GDP ratio would be 4.2% this year looks like it will have to be revised upwards..

National Debt

This was announced as being 22.03 trillion dollars as of the end of May, of which 16.2 trillion is held by the public. Most of the gap is held by the US Federal Reserve. Just for comparison total debt first passed 10 trillion dollars in the 2007/08 fiscal year so it has more than doubled in the credit crunch era.

Moving to this as a share of the economy the Congressional Budget Office puts something of a spin on it.

boosting debt held by the public to $28.5 trillion,
or 92 percent of GDP, by the end of the period—up
from 78 percent now.

The IMF report earlier this month was not quite so kind.

Nonetheless, this has come at the cost of a continued increase in the debt-to-GDP ratio (now at 78 percent of GDP for the federal government and 107 percent of GDP for the general government).

Where are the bond vigilantes?

They have gone missing in action. The financial markets version of economics 101 would have the US government being punished for its perceived financial profligacy by higher bond yields on its debt. Except as I type this the ten-year Treasury Note is yielding a mere 2.06% which is hardly punishing. Indeed it has fallen over the past year as it was around 2.9% a year ago and last November went over 3.2%.

So in our brave new world the situation is one of lower bond yields facing a fiscal expansion. There is an element of worries about the economic situation but the main player here I think is that these days we expect the central bank to step in should bond yields rise. So the US Federal Reserve is increasingly expected to cut interest-rates and to undertake more QE style purchases of US government debt. The water here is a little murky because back at the end of last year there seemed to be a battle between the Federal Reserve and the President over future policy which the latter won. So much for the independence of central banks!

The economy

Let me hand you over to the New York Federal Reserve.

The New York Fed Staff Nowcast stands at 1.0% for 2019:Q2 and 1.3% for 2019:Q3. News from this week’s data releases decreased the nowcast for 2019:Q2 by 0.5 percentage point and decreased the nowcast for 2019:Q3 by 0.7 percentage point.

That compares to 2.2% annualised  for a month ago and 3.1% for the first quarter of the year. So the trend is clear.

Comment

As we track through the ledger we see that the US has entered into a new period of fiscal expansionism. The credit entries are that it has been done so ahead of an economic slow down and at current bond yields is historically cheap to finance. The debits come when we look at the fact that the starting position was of ongoing deficits after a decade long period of economic expansion. These days we worry less about national debt levels and more about the cost of financing them, although as time passes and debts rise that is a slippery slope.

The real issue now is how the economy behaves as a sharp slow down would impact the numbers heavily. We have seen the nowcast from the New York Fed showing a slowing for the summer of 2019. For myself I worry also about the money supply data which as I pointed out on the 8th of May looks weak. So this could yet swing either way although this from February 8th last year is ongoing.

The deep question here is can we even get by these days without another shot of stimulus be it monetary,fiscal or both?

 

What happens when the Bank of Japan has bought everything?

It is time for another chapter of our Discovering Japan ( h/t Graham Parker and the Rumour) series and let us open by dipping into Japanese culture.

As spring approaches, the country’s weather forecasters face one of their biggest missions of the year: predicting exactly when the famed cherry blossoms will bloom.

The nation’s sakura (cherry blossom) season is feverishly anticipated by locals and visitors alike. Many tourists plan their entire trips around the blooms, and Japanese flock to parks in droves to enjoy the seasonal spectacle. ( Japan Times).

This is something which can be shared to some extent by users of Battersea Park as the Japanese Embassy financed an avenue of cherry blossom trees there in a nice touch of what is called cherry blossom diplomacy.

If we switch to financial news that will be considered good by the Bank of Japan, then we can see three factors at the moment. We can start with the equity market where the Nikkei 225 index has risen 126 points to 21,431 this morning. This means that the dip of the end of December is now only a bad dream for it as we recall that central banks love higher equity markets especially when in this case they have been buying it. Japan is a country that literally has a Plunge Protection Team as what has become called the Tokyo Whale makes equity purchases on down days.

If we switch to the currency then the Bank of Japan will be a lot happier than it was in mid-January. At that point markets had what we might call a yen for Yen and in a “flash rally” it went below 105 versus the US Dollar which rather suspiciously broke more than a few Japanese exporters currency hedges and to 132.5 versus the UK Pound £. As a central bank with an objective to weaken the yen under the Abenomics strategy this will have upset the Bank of Japan and it will be much happier with the 110.87 to the US Dollar as I type this. It would of course prefer an exchange rate over 120 as it managed for a while but with a summit due with President Trump that can be overlooked for now.

Next we can look at what is a strong candidate for the most rigged market on earth which is the Japanese Government Bond market. So far the Bank of Japan has purchased some 473,087,792.358,000 Yen’s worth of Japanese government securities in as near to monetary financing as a first world country has actually got. Whilst the pure definition of the treasury issuing debt to the central bank does not take place over time it starts to rather look like that in effect. Here is the current description.

yield curve control, in which the Bank seeks a decline in real interest rates by controlling short-term and long-term interest rates, has been placed at the core of the new policy framework.

This means that Japan can borrow effectively for nothing as its ten-year yield is -0.04% as I type this and therefore a lot of its debt is adding to the world total of negative yielding debt. Not all of it as the thirty-year yield is 0.58% but even that is very low and means that should it so choose Japan can borrow incredibly cheaply.

So Governor Kuroda can sleep soundly at night on these three grounds.

The economy

This is much less satisfactory as it shrank in the second half of last year as quarterly growth of 0.3% followed -0.7%. This meant that at the end of 2018 the annual rate of growth was zero or as their official statisticians put it. -0.0%. This is quite a slowing on the 2.4% recorded at the end of 2017 but if we take a broad sweep we see that all this monetary action of negative interest-rates and QQE doesn’t seem to be doing that much good. This theme will hardly be helped by this morning’s news.

The nation’s trade deficit for January grew from a year earlier with exports to China tumbling in their worst decline in three years, government data showed Wednesday.

Japan logged a trade deficit for the month of ¥1.41 trillion ($12.8 billion), 49.2 percent larger than a year before, the Finance Ministry said. ( Japan Times)

The January data is generally a weaker month due to the timing of the Chinese New Year but as you can see there has been a sharper impact this year as we get another perspective on the Chinese economic slow down.

But last month, “exports of products such as microchip-making devices that are not related to China’s New Year celebration fell, showing that Chinese companies’ spending on equipment and plants is falling,” Minami said.

Overall Japanese exports in January were 8.4% lower in January than in 2018 and this will be a further deduction from an already weak economic outlook. This adds to this from Reuters.

Data released on Monday showed core machinery orders, considered a leading indicator of capital expenditure, fell 0.1 percent month-on-month in December……

Highlighting bigger concerns about the external environment, however, was a 21.9 percent month-on-month slump in orders from overseas, the biggest fall since November 2007.

This had previously been a strong series but whilst domestic demand has continued foreign demand has not.

Demographics

We have looked at the consequences of an ageing and indeed shrinking population many times and here is a new perspective from the World Economic Foundation.

In 2018, there were 921,000 births and 1.37 million deaths, meaning Japan’s population fell by 448.000 people. That was its largest ever annual natural population decline.

The number of male workers in 2040 will fall by 7.11 million from 2017, while the number of working women will decrease by 5.75 million.

Or to add it all up.

As many as 12 million Japanese people may disappear from the country’s workforce by 2040, according to official estimates. That’s a fall of around 20%.

Comment

Let me open by advancing my theme that it would be better if Japan simply accepted reality rather than undertaking what are King Canute style actions. On this road it would accept that a shrinking and ageing population will have periods of economic decline in GDP terms.  In many ways Japan deals with its ageing population better than we do and it could also be a leader in terms of a shrinking one. This could be a route forwards for our planet too as fewer humans would place less of a strain on Japan’s limited natural resources. Also it does have a very large national debt but it is mostly domestically owned and would benefit from a national debate of how to deal with it rather than snake-oil efforts. Instead we get ever more financial action pushing for growth accompanied by threats and sanctions based on a green response to the growth.

Meanwhile the chorus is tuning up for “more,more,more” as this illustrates.

“If (currency moves) are having an impact on the economy and prices, and if we consider it necessary to achieve our price target, we’ll consider easing policy,” ( Governor Kuroda yesterday according to Reuters).

Mind you even past supporters of the extraordinary monetary policies are giving up or rather switching to fiscal policy.

Japan must ramp up fiscal spending with debt bank-rolled by the central bank, the Bank of Japan’s former deputy governor Kikuo Iwata said, a controversial proposal that highlights the BOJ’s challenge as it tries to reignite an economy after years of sub-par growth. ( Reuters)

It is not that he would not like to expand monetary policy more but he is unable to look beyond his “precious”

He said there are few tools left to ease monetary policy further as cutting already ultra-low interest rates could push some financial institutions into bankruptcy.

Where these people never get challenged is that they promise success each time but in a burst of collective amnesia their past failures seem to give them credibility rather than demotion. I guess that is what happens when you do what the establishment wants….

Also the financial media that pushed the story of last autumn that the Bank of Japan was reducing equity purchases should be red faced now. For the rest of us we need to be thinking if the Vapors were prescient all those years ago.

I’m turning Japanese
I think I’m turning Japanese
I really think so
Turning Japanese
I think I’m turning Japanese
I really think so

 

 

A critique of the Keynesian fiscal expansion plans of Lord Skidelsky

Last night I attended a lecture by Lord Skidelsky at the Progressive Economic Forum. On a personal note it was amusing not only to be so near to my alma mater the LSE but also to have a chat with one of my past tutors from there Willem Buiter. Returning to the economics the lecture was based on the faith that Lord Skidelsky has in fiscal policy and his argument that we should have expanded it in the face of the credit crunch. Putting it another way he is an out and out Keynesian although the claim in the introduction that he was the greatest expert on the subject seemed a little harsh to me on John Maynard Keynes himself.

If we start with a strength of his approach it was the point that we have seen an extraordinary monetary response to the credit crunch. He also mentioned his discussions with central bankers and how they debated what the response had been in terms of growth and inflation. It was clear that he was unconvinced that it had done much good, but whilst  he did not seem to address the point of who should be held responsible for this, he did have a proposed solution which was for the government to take back control of monetary policy. In some ways I support that as it would return at least some democracy to an important process but it also creates another type of what I call the British Rail problem. This is a situation where we do not like the current scenario and sometimes forget that the proposed alternative is something that we did not like much either when we had it. In other words there is a clear danger of jumping from the frying pan into the fire. Indeed I found it troubling that when asked a question about QE and its consequences our noble Lord simply resorted to waffle.

Fiscal expansionism

The case here is that we would have been on a better path if in the dog days of 2008/09 and following we had expanded fiscal policy. The detail sounded like an argument for something of a control and command economy when the case was made for public investment “of course there will be mistakes but the private-sector makes mistakes too”. The latter point is true but glosses over the point that it is with their own money or with money given to them by shareholders. We know that it is far from perfect in a world where managers act as owners and even owners can appear on TV smoking weed and acting oddly.  But then again of course if we look at Tilray we see that taking advantage of people smoking weed is apparently the great new profit opportunity or something like that! The Steve Miller Band were of course on point many years ago.

I’m a joker
I’m a smoker
I’m a mid-night toker

The problem is that whilst Lord Skidelsky can assert his claims as so often in economics we lack evidence. The nearest example to a country I could think of to his preferred scenario is Japan. It’s fiscal deficit stayed quite high for a while in response to the credit crunch as in relation to GDP it went 9.5%, 8.3% twice, 8.1% and then 7.8%. Yet in terms of economic growth or wage growth it has seen its own struggles. Also one of the ways this has been financed has been by the QE bond purchases of the Bank of Japan which has bought 42% of the market now and its total balance sheet is just passing annual GDP. So via the depressive effect of  QE effect on bond yields, we see that a further stimulus was applied by QE, as otherwise a higher deficit would have been required for the same outcome. This brings me to another issue which I will expand upon more later but these thoughts seem unworldly with regard to financial markets, and a harsher critic might say from another world.

Another issue is a common one with advocates of expansionary monetary policy which is the “More, more,more” one. At whatever point we find ourselves we are told that the next step will lead us to the economic version of the land of milk and honey. It is of course not the fault of advocates of fiscal policy that the monetary policy advocates have pretty comprehensively queered this patch. But we are where we are and as Kelis points out.

Might trick me once
I won’t let you trick me twice
No I won’t let you trick me twice

Financial Markets

Here we got the strongest example of an unworldly line of thought which was the suggestion that UK banks should be restricted to domestic activities only. I could see two clear flaws in that. The first is that RBS and Barclays may well immediately collapse and HSBC would either shift to the places in its name and/or collapse. Next if we move to the international arena there is the case of Turkey where UK banks have lent around US $15 billion which presumably they would need to get rid of under the planned scenario. In its current state Turkish firms could hardly repay it and other banks would only take over the loans for quite a discount.

Regular readers will know that I am very critical of banking behaviour and am certainly no fanboy. But the problems with banking run deep as for example are we really expected to believe that Danske Bank somehow took on some US $234 billion of dodgy money in Estonia without anybody being aware of it? We cannot wish away this reality and retreat behind our own borders as we are likely to find the problem simply pops up somewhere else.

Next comes the issue highlighted by the mention of a requirement for capital controls to accompany the new policy. These were not specified and were rather vague leading to the fear that they might spread to more areas than intended. We also know that they have a patchy success record because if we look at China where some of the implementation has been ruthless we also see that a lot of money escaped via Bitcoin if nowhere else.

This was accompanied by the implication that financial markets are bad people and speaking from personal experience some of them certainly are. But in general they mostly represent investors and pensioners and if you are implementing policies they are worried about they have a right to ask for a higher rate of interest. This can be a dangerous downwards spiral which has become anaethetised to some extent in the credit crunch era because central banks have replaced investors as buyers of government debt. But as that option would not exist in Lord Skidelsky’s scenario as the government will be in charge of monetary policy we could see what would be regarded as outright monetisation of government debt. We have seen few examples of this but the one in Ghana we looked at a couple of years or so back was like an express lift going down.

Comment

An unspoken theme here was the issue if how much control any government actually has these days? In the scenario suggested in the lecture we saw a firm grip being taken in some areas but in my opinion a lack of understanding of not only second order effects but also some first order ones. That could go wrong very quickly. On an initially more minor point the idea that Labour should have devalued the Pound £ in 1964 rather than 1967 provoked two lines of thought. Firstly my understanding of the 67 devaluation was that due to later revisions of the balance of payments it was not necessary so why do it earlier? Next comes a much less minor point that an outspoken sub-plot might be that a much lower £ is also part of the plan. That might be arrived at on day one if the reference to doing things without telling voters was carried out – interestingly the source of this line of thought was a political opponent Nigel Lawson- as it would be somewhat like financial dynamite I think.

Moving to strengths of the proposal there are indeed some. Firstly we do have some control over events and some freedom of manoever and there are times fiscal policy can help.There are certainly areas which could do with more public money. I agree that monetary policy has spiraled out of control with the list of its advocates shrinking.  Also the point that what we have has at best a patchy record and at worst has not worked is a fair one. But to my mind that is quite some distance from assuring us that it is a type of Holy Grail for our economic problems.

 

 

What is happening with fiscal policy?

A feature of the credit crunch era has been the way that monetary policy has taken so much of the strain of the active response. I say active because there was a passive fiscal response as deficits soared caused on one side by lower tax revenues as recession hit and on the other by higher social payments and bank bailout costs. Once this was over the general response was what has been badged as austerity where governments raised taxes and cut spending to reduce fiscal deficits. Some care is needed with this as the language has shifted and often ignores the fact that there was a stimulus via ongoing deficits albeit smaller ones.

Cheap debt

Something then happened which manages to be both an intended and unintended consequence. What I mean by that is that the continued expansion of monetary policy via interest-rate reductions and bond buying or QE was something which governments were happy to sign off because it was likely to make funding their spending promises less expensive. Just for clarity national treasuries need to approve QE type policies because of the large financial risk. But I do not think that it was appreciated what would happen next in the way that bond yields dropped like a stone. So much so that whilst many countries were able to issue debt at historically low-levels some were in fact paid to issue debt as we entered an era of negative interest-rate.

This era peaked with around US $13 trillion of negative yielding bonds around the world with particular areas of negativity if I may put it like that to be found in Germany and Switzerland. At one point it looked like every Swiss sovereign bond might have a negative yield. So what did they do with it?

Germany

This morning has brought us solid economic growth data out of Germany with its economy growing by 0.6% in the last quarter of 2017. But it has also brought us this.

Net lending of general government amounted to 36.6 billion euros in 2017 according to updated results of the Federal Statistical Office (Destatis). In absolute terms, this was the highest surplus achieved by general government since German reunification. When measured as a percentage of gross domestic product at current prices (3,263.4 billion euros), the surplus ratio of general government was +1.1%.

So Germany chose to take advantage of being paid to issue debt to bring its public finances into surplus which might be considered a very Germanic thing to do. There is of course effects from one to the other because their economic behaviour is one of the reasons why their bonds saw so much demand.

But one day they may regret not taking more advantage of an extraordinary opportunity which was to be able to be paid to borrow. There must be worthy projects in Germany that could have used the cash. Also one of the key arguments of the credit crunch was that surplus countries like Germany needed to trim them whereas we see it running a budget surplus and ever larger trade surpluses.

In the detail there is a section which we might highlight as “Thanks Mario”

 Due to the continuing very low-interest rates and lower debt, interest payments decreased again (–6.4%).

Switzerland

The Swiss situation has been similar but more extreme. Membership of the Euro protected Germany to some extent as the Swiss Franc soared leading to an interest-rate of -0.75% and “unlimited” – for a time anyway – currency intervention. This led to the Swiss National Bank becoming an international hedge fund as it bought equities with its new foreign currency reserves and Switzerland becoming a country that was paid to borrow. What did it do with it? From its Finance Ministry.

A deficit of approximately 13 million is expected in the ordinary budget for 2018.

So fiscal neutrality in all but name and the national debt will decline.

 It is expected that gross debt will post a year-on-year decline of 3.3 billion to 100.8 billion in 2018 (estimate for 2017). This reduction will be driven primarily by the redemption of a 6.8 billion bond maturing combined with a low-level of new issues of only 4 billion.

The UK

Briefly even the UK had some negative yielding Gilts ( bonds) in what was for those who have followed it quite a change on the days of say 15% long yields. This was caused by Mark Carney instructing the Bank of England’s bond buyers to rush like headless chickens into the market to spend his £60 billion of QE and make all-time highs for prices as existing Gilt owners saw a free lunch arriving. Perhaps the Governor’s legacy will be to have set records for the Gilt market that generations to come will marvel at.

Yet the path of fiscal policy changed little as indicated by this.

Or at least it would do if something like “on an annual basis” was added. Oh and to complete the problems we are still borrowing which increases the burden on future generations. The advice should be do not get a job involving numbers! Which of course are likely to be in short supply at a treasury………..

But the principle reinforces this from our public finances report on Wednesday.

Public sector net borrowing (excluding public sector banks) decreased by £7.2 billion to £37.7 billion in the current financial year-to-date (April 2017 to January 2018), compared with the same period in the previous financial year; this is the lowest year-to-date net borrowing since the financial year-to-date ending January 2008.

So we too have pretty much turned our blind eye to a period where we could have borrowed very cheaply. If there was a change in UK fiscal policy it was around 2012 which preceded the main yield falls.

Bond yields

There have been one or two false dawns on this front, partly at least created by the enthusiasm of the Bank of Japan and ECB to in bond-buying terms sing along with the Kaiser Chiefs.

Knock me down I’ll get right back up again
I’ll come back stronger than a powered up Pac-Man

This may not be entirely over as this suggests.

“Under the BOJ law, the finance ministry holds jurisdiction over currency policy. But I hope Kuroda would consider having the BOJ buy foreign bonds,” Koichi Hamada, an emeritus professor of economics at Yale University, told Reuters in an interview on Thursday.

However we have heard this before and unless they act on it rises in US interest-rates are feeding albeit slowly into bond yields. This has been symbolised this week by the attention on the US ten-year yield approaching 3% although typically it has dipped away to 2.9% as the attention peaked. But the underlying trend has been for rises even in places like Germany.

Comment

Will we one day regret a once in a lifetime opportunity to borrow to invest? This is a complex issue as there is a problem with giving politicians money to spend which was highlighted in Japan as “pork barrel politics” during the first term of Prime Minister Abe. In the UK it is highlighted by the frankly woeful state of our efforts on the infrastructure front. We are spending a lot of money for very few people to be able to travel North by train, £7 billion or so on Smart Meters to achieve what exactly? That is before we get to the Hinkley Point nuclear power plans that seem to only achieve an extraordinarily high price for the electricity.

One example of fiscal pump priming is currently coming from the US where Donald Trump seems to be applying a similar business model to that he has used personally. Or the early days of Abenomics. Next comes the issue of monetary policy where we could of course in the future see news waves of QE style bond buying to drive yields lower but as so much has been bought has limits. This in a way is highlighted by the Japanese proposal to buy foreign bonds which will have as one of its triggers the way that the number of Japanese ones available is shrinking.

The establishment switches from monetary to fiscal policy

It was only yesterday that I was analysing the way that the Bank of England Governor was playing a game with the media. Today I wish to look at another issue where so many of those who told us that we needed ever more extraordinary monetary policy measures have changed their tune. For example a couple of years or so ago Governor Carney was assuring us that monetary policy was not “maxxed-out” but now he seems to be shuffling in that direction. Recently the Bank of England produced a working paper on itself which concluded it had been doing a good job.

It finds reasonably strong evidence of QE having had a material impact on financial markets, generating a significant loosening in credit conditions. There is also evidence of QE having served to boost temporarily output and prices, in a way not associated with other central bank balance sheet expansions.

Yet there is little sign of balance as the bad bits are simply ignored and put at the back of the darkest cupboard they could find.

This leaves to future research important issues such as the impact of a reversal in QE policies and the distributional consequences of QE.

Actually the Bank of England has suggested that the distributional consequences of QE are the responsibility of government as it sings along to Shaggy.

It wasn’t me……It wasn’t me

However there are a litany of issues here. Firstly the very concept of QE had fiscal elements to it. These were that it required treasury permission and that it made it cheaper for governments to borrow and loosened fiscal policy for them via lower bond yields.

Indeed you could argue that elements of what has been called monetary policy is simply a transfer to companies or another type of fiscal policy. For example this from the ECB (European Central Bank).

Corporate bonds cumulatively purchased and settled as at 28/10/2016 €37,815 (21/10/2016: €35,886) mln

Or this from this morning’s statement from the Bank of Japan.

The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 6 trillion yen and about 90 billion yen, respectively.

It is fast becoming the Tokyo Whale.

A Further Shift

Now rather than elements of fiscal policy being tucked away in monetary policy it is now emerging blinking into wider media exposure. Sadly there is virtually no challenge made about the fact that all the extraordinary monetary measures were supposed to rescue us. Below are the words of the former IMF Chief Economist Olivier Blanchard on the subject/

I think there is fiscal space in nearly every country.

Sadly they do not ask why as part of the IMF he applied fiscal austerity to places like Greece and Portugal and then did a complete U-turn on the subject. But there is something almost as extraordinary.

Take a country like Spain. They have a 100% debt-to-GDP ratio, a bit more. Investors don’t seem to be very worried. They think that is sustainable. Now suppose Spain decides to do a really big public investment program. So they decide to spend 2% more of GDP for two years. This is big. This is major fiscal expansion. With the multipliers, GDP goes up, so in fact spending 2% more, they get 1% in revenues so this increases the debt-to-GDP ratio from a 100% to 103%. Do you run for cover? No, I am quite sure they do not.

There are a whole litany of issues here. Firstly the economic news from Spain is very good right now with annual GDP growth at 3.2% so why does it need public investment as well? Spain had lots of investment pre credit crunch which led it to trouble and an economic cul-de-sac which our latter-day Dr.Pangloss ignores.

So the whole issue is whether governments spend the money right.

A bit like Portugal’s roads to nowhere. Also it is extraordinary that “Investors don’t seem to be very worried.” was unchallenged as the main new investor now is of course the ECB which has bought some 126.4 billion Euros and rising of Spanish government bonds.

Oh and on the subject of another crossover between monetary and fiscal policy I think he was right first time.

Yes. Initially I thought the proposal by [Harvard Professor] Ken Rogoff, among others, to basically eliminate cash was insane. But maybe it is less crazy than I thought.

World Economic Forum

This has entered the fray today with this from Chatham House ( originally written in September).

It is time for fiscal stimulus to gradually assume more of the burden of propping up a global economy that still looks worryingly fragile.

Really why? That seems to be missing. All we get are some political statements including an implication rather rare in these times that Donald Trump may be on one right track. What is missing is any analysis of why we are here?

The Bank of Japan (BoJ), which in 1999 became the first central bank to cut rates to zero, looks set to be the first to signal that monetary policy is approaching its frontier.

In the “lost decade” period Japan has had a lot of fiscal policy and is adding to existing stimulus as it has run fiscal deficits so we are back to “More, more, more” with no explanation of why it will work this time when it has not done so before.

Stanley Fischer

For a man who is apparently just about to raise interest-rates the Vice Chair of the US Federal Reserve spends a lot of time discussing stimulus measures! I have written before about how frequently he denies that he has any plans to introduce negative interest-rates. Well now he seems to be advocating expansionary fiscal policy.

Over the years, many economists–some of them textbook authors–have noted that expansionary fiscal policy could raise equilibrium interest rates. To illustrate this possibility, the next two bars on the slide show the estimated effect on interest rates of two possible expansionary fiscal policies, one that boosts government spending by 1 percent of GDP and another that cuts taxes by a similar amount. According to the FRB/US model, both policies, if sustained, would lead to a substantial increase in the equilibrium federal funds rate. Higher spending of this amount would raise equilibrium interest rates by about 50 basis points; lower taxes would raise equilibrium rates by 40 basis points.

 

So we see a shift towards fiscal policy here too. Will this Stan be like the one described by Eminem?

Well, gotta go, I’m almost at the bridge now
Oh sh*t, I forgot, how’m I supposed to send this sh*t out?
[car tires squeal][CRASH]
.. [brief silence] .. [LOUD splash]

Comment

The fundamental point is that we were led into a trap by those who argued for extraordinary monetary polices. Nearly eight years down the road there has been so little progress that we are seeing much more additional easing than any reversal or tightening. The US Federal Reserve opened 2016 hinting at “3-5” interest-rate rises this year and now we maybe will get one.  Yet the same establishment moves like the “Slippery People” sung about by Talking Heads onto fiscal policy and claims that will work.

The problem here is that quite a few countries have been seeing expansionary fiscal policy. Japan for example had an attempt at reining it back with the 2014 consumption tax rise but now adds ever more and the UK is a lower scale example but similar in principle. Germany has taken the other path and managed to apply it to some of the weaker Euro area economies but deficits have continued. So we are told stimulus is a good idea but we get no explanation of why it has not worked so far.

Meanwhile we get the occasional flicker from the bond vigilantes as bond yields rise but lets face it even 1.27% for a ten-year UK Gilt is historically very cheap and compared to inflation prospects may well be not far off insane.