UK Budgets end up having no fiscal rules

This morning has seen something of a think tank old reliable in play. The Institute for Fiscal Studies has put out a press release on the issue of fiscal rules in the UK so let us take a look. The emphasis is theirs.

On current policy borrowing next year could be £63 billion, £23 billion more than the most recent official forecast and £19 billion more than our estimate of borrowing this year. With borrowing not forecast to fall before 2022–23 it is not clear that the manifesto pledge to target current budget balance three years out would be met even under current policy.

The drama fades with the use of could which reminds me of this from Scritti Politti.

Nothing, oh nothing
Because baby, baooo
I’m a would be
W. O. O. D
I’m a would be would be
B. E. E. Z

Actually if you look at the numbers the situation has improved by £4 billion as one of my themes is in play.

If the pattern observed in the first ten months of the financial year continues for the next two, government borrowing will be £44 billion this year. This would be £3.5 billion lower than implied by the OBR’s restated March 2019 forecast.

Yes the first rule of OBR club is that the OBR is always wrong. In fact the accuracy of its forecasts is the exact opposite of the seriousness with which its missives are received by the chattering and think tank classes. The problem here is partly one of spurious accuracy as the numbers are far more doubtful than it implies. Also a collective one that it gives the impression that it knows things that it would be more honest to say are unknown and indeed unknowable. I did warn at its inception that it would turn out to be like the Congressional Budget Office which in theory is a great idea, but in practice I simply note that it has changed its forecasts recently by one trillion dollars due to lower US Bind yields and hence debt costs. Or the size of President Trump’s fiscal boost.

Indeed the IFS press release shows a clear case of theory crumbling in practice. So let us start with the theory.

Fiscal targets can help guide and constrain policy and ensure sustainability.

And now the practice.

 There have now been 16 fiscal targets announced over the last decade.

Actually it gets worse.

 If the target to balance the current budget were abandoned in this Budget it would be the shortest lived of them all. Abandoning it now would surely undermine any credibility attached to fiscal targets set by this government.

Now  the second sentence just looks silly after the one in bold above. Actually it has its problems even without that as there have been two major changes for the government. Firstly that Chancellor who set the rules has departed and secondly we have a government with a solid parliamentary majority as opposed to being a minority one.

Whilst I am looking at the problems here let me slay another beast.#

The Chancellor has a fiscal target to ensure that current spending is no higher than tax receipts, and so borrowing is for investment only.

Anyone with even a cursory knowledge of the public finances will know that “current spending” is a vague, vacuous beast hard to specify. Indeed both Goodhart’s Law and the Lucas Critique imply that under such a rule investment may not be what we think it is.Some bright spark will be dispatched to make sure that favourite schemes qualify.

The Trend

The IFS have picked out the nearest date to the EU Leave vote they can without being too indiscreet and calculated this.

Then, the Government was forecasting an overall budget surplus of £10 billion in 2019–20, whereas we are now on course for borrowing to run at around £44 billion: an increase of almost £55 billion.

Along the way they are kind enough to demonstrate again my first rule of OBR Club.

back in March 2016, the OBR was assuming that growth would by now have returned to the robust real growth rates of about 2% annually that were considered normal before the crisis.

There are all sorts of begged questions here. For example did the EU Leave vote reduce growth? Probably via the higher inflation that the Bank of England encouraged. But it is also true that we have seen growth slow downs elsewhere and more recently we have seen a fiscal boost.

Although I note the IFS is unable to avoid a point I have been making which is that another indicator tax revenues suggest the economy has been doing better than the GDP numbers imply.

Instead, revenues have held up remarkably well in the face of low growth since the 2016 referendum.

Indeed in one of its never-ending investigations into its own mistakes the OBR has been on the case too.

 They highlight that household spending has proved more robust than expected, boosting VAT revenues, and capital allowances have been used less, increasing corporation tax revenues.

Although care is needed as whilst bad is bad so can good be.

While this has actually worked to boost tax revenues in the short run, it will disguise a negative long-run effect as depressed investment now gradually feeds into lower growth and therefore reduced tax revenues in the future.

In fact in the IFS world good may be even worse than bad. I would simply point out that whilst in theory we want higher investment we learn again and again that such definitions can be unreliable in practice.

A Missing Piece

My jigsaw would start with this piece as opposed to it being tucked away towards the bottom of the monthly report and only 3 words in the press release.

On the other hand, the cost of servicing the UK’s debt has been lightened by enduring record-low interest rates. As a consequence, debt interest spending is on course to be over £4 billion lower than what the OBR forecast in March 2016. And this is despite higher than forecast borrowing in the intervening period.

Let me put this another way. I recall the original OBR forecasts and they would have the Gilt yield they use about 4% higher than what it is now. Typically they look at a 15 year yield which is 0.67% as I type this as opposed to more like 5%. Of course for infrastructure purposes we should be looking much longer but these days that does not make the difference it used to as the 50 year yield is 0.76%. Or if you prefer the yield curve is pretty flat.

Whatever happened to those who were all over social media about the yield curve?

We can out it another way which is the longest-dated UK Gilts yield the same as Bank Rate if you are willing to overlook 0.01% which is an extraordinary development when it is a mere 0.75%.

Comment

There are several lessons here and let me do a song from think tanks like the IFS and Resolution Foundation to government about fiscal rules.

Here I am, I’m playing daydreaming fool again
My favourite game
And you are the one who’s got my head in the clouds above
You’re the one that I love and
You’re my-i-i-i-i-i, baby, you’re my favourite waste of time
My-i-i-i-i-i, baby, you’re my favourite waste of time ( Owen Paul)

Next comes the extraordinary gift that “independent” central banks have given to governments and public finances. Both new borrowing and refinancing have been done on ever more favourable terms. Let me give you an example as in just over a week a UK Gilt with a coupon of 4.75% will mature and even if we borrow for 50 years we will pay 4% less than that for the £32 billion. Actually for the bit the Bank of England will buy even less but let’s not over complicate the issue.

Also there is the issue that we are entering a phase which may be ever more uncertain than usual. What I mean by that is that a pick-up in the UK economy looks set to be overrun at the pass by the impact of the Corona Virus. Of course the latter is extremely uncertain by virtue of being new. The only thing we can be reasonably certain of is this.

While taxes are already high by UK historical standards, they are often increased in the first year of a parliament. ( @IFS )

 

Was that the bond market tantrum of 2019?

Sometimes economics and financial markets provoke a wry smile. This morning has already provided an example of that as Germany’s statistics office tells us Germany exported 4.6% more in September than a year ago, so booming. Yes the same statistics office that told us yesterday that production was down by 4.3% in September so busting if there is such a word. The last couple of months have given us another example of this do let me start by looking at one side of what has taken place.

QE expansion

We have seen two of the world’s major central banks take steps to expand their QE bond buying one explicitly and the other more implicitly. We looked at the European Central Bank or ECB only on Wednesday.

The Governing Council decided to restart net purchases under each constituent programme of the asset purchase programme (APP)……….. at a monthly pace of €20 billion as from 1 November 2019.

More implicitly have been the actions of the US Federal Reserve as it continues to struggle with the Repo crisis.

Based on these considerations, last Friday the FOMC announced that the Fed will be purchasing U.S. Treasury bills at least into the second quarter of next year.7 Specifically, the Desk announced an initial monthly pace of purchases of $60 billion.

That was John Williams of the New York Fed who added this interesting bit.

These permanent purchases

Also there is this.

In concert with these purchases, the FOMC announced that the Desk will continue temporary overnight and term open market operations at least through January of next year.

Maybe a hint that they think dome of this is year end US Dollar demand. But we find that the daily operations continue and at US $80.14 billion as of yesterday they continue on a grand scale. So the Treasury Bill purchases and fortnightly Repo’s have achieved what exactly?

If we move from the official denials that this is QE to looking at the balance sheet we see that it is back above 4 trillions dollars and rising. In fact it was US $4.02 trillion at the end of last month or around US $250 billion higher in this phase.

Bond Markets

You might think and indeed economics 101 would predict that bond markets would be surging and yields falling right now. But we have learnt that things are much more complex than that. Let me illustrate with the US ten-year Treasury Note. You might expect some sort of boost from the expansion of the balance sheet and the purchases of Treasury Bills. But no, the futures contact which nearly made 132 early last month is at 128 and a half now. At one point yesterday the yield looked like it might make 2% as there was quite a rout but some calm returned and it is 1.91% as I type this.

As an aside this is another reminder of the relative impotence of interest-rate cuts these days as if anything a trigger for yields rising was the US interest-rate cut last week. The Ivory Towers will be lost in the clouds yest again.

The situation is even more pronounced in the Euro area where actual purchases have been ongoing for a week now. However in line with our buy the rumour and sell the fact theme we see that the German bond market has fallen a fair bit. In mid-August the benchmark ten-year yield went below -0.7% whereas now it is -0.26%. So Germany is still being paid to borrow at that maturity but considerably less. Indeed at the thirty-year maturity they do have to pay something albeit not very much ( 0.24%).

The UK

There have been a couple of consequences in the UK. The first I spotted in yesterday’s output from the Bank of England.

Mortgage rates and personal loan rates remain near
historical lows, with the rates on some fixed-rate mortgages continuing to fall over the past few months (Table 2.B).
Interest rates on credit cards have increased, although the effective rate paid by the average borrower has remained
stable, in part because of the past lengthening of interest-free periods.

Whilst this is true, if you are going to parade the knowledge of the absent-minded professor Ben Broadbent about foreign exchange options then you should be aware that as Todd Terry put it.

Something’s goin’ on

The five-year Gilt yield has risen from a nadir of 0.22% to 0.52% so the ultra-low period of mortgage rates is on its way out should we stay here.

If we move to the fiscal policy space in the UK then we see that the message that we can borrow cheaply has arrived in the general election campaign.

Although debt stocks are high in many developed countries, debt service ratios are very low. The UK gross debt stock has doubled from 42 per cent of GDP in 1985 to 84 per cent of GDP today, yet debt interest service has halved, from 4 per cent of GDP to below 2 per cent over the same period. It has rarely been lower. A rule using the debt stock would argue for fiscal consolidation, whereas a debt service metric suggests there is ample room for fiscal expansion. Especially as market interest rates are extraordinarily low. (  FT Alphaville)

https://ftalphaville.ft.com/2019/11/06/1573068343000/Is-it-time-for-a-shift-in-fiscal-rules–/

I have avoided the political promises which peak I think with the Greens suggestion of an extra £100 billion a year. But the Toby Nangle and Neville Hill proposal above has strengths and has similarities to what I have suggested here for some time. But I think it needs to come with some way of locking the debt costs in, so if you borrow more because it is cheap you borrow for fifty years and not five. It reinforces my suggestion of the 27th of June that the UK should issue some 100 year Gilts.

Comment

There is a fair bit to consider here and let me start with the borrow whilst it is still cheap theme. There are issues as highlighted by this from Francine Lacqua of Bloomberg.

London’s Elizabeth line has been delayed by a year, and will require extra funding, according to TfL

For those unaware this was called Crossrail ( renaming is often a warning sign) which will be a welcome addition to the London transport infrastructure combing elements of The Tube with the railways. But it gets ever later and more expensive.

There was also some irony as regards the Bank of England as in response to the sole decent question at its presser yesterday (from Joumanna Bercetche of CNBC) Governor Carney effectively suggested the next rate move would be down not up. Yet Gilt yields rose.

Next comes the issue of whether this is a sea-change or just part of the normal ebb and flow of financial markets? We will find out more this afternoon as we wait to see if there were more than just singed fingers in the German bond market for example or whether some were stopped out? After all reporting you had taken negative yield and a capital loss poses more than a few questions about your competence. Even the most credulous will now know it is not a one-way bet but on the other hand if you are expecting QE4 to come down the New York slipway then you can place your bets at much better levels than before.