Could US fiscal expansionism lead us to QE4?

The credit crunch era has been one where monetary policy has taken centre stage. There are many ways of expressing this but one is that technocrats ( central bankers) have mostly run the economic show as elected politicians have chosen to retreat to the sidelines as much as possible. Whatever you may think of President Trump he is not someone who is happy to be on the sidelines as he has exhibited publicly once or twice with some pushing and shoving. But more importantly we are seeing something of a shift in the balance of US economic policy as the monetary weapon gets put away at least to some extent but the fiscal one seems to be undergoing a revival.

A relatively small reflection of this was last night’s budget deal. We have become used to talk of a US government shutdown followed by an eleventh hour deal and no doubt there is a fair bit of both ennui and cynicism about the process. But as the Washington Post notes as we as giving the national debt can another kick there was this in the detail.

According to outlines of the budget plan circulated by congressional aides, existing spending caps would be raised by a combined $296 billion through 2019. The agreement includes an additional $160 billion in uncapped funding for overseas military and State Department operations, and about $90 billion more would be spent on disaster aid for victims of recent hurricanes and wildfires.

An increase in military spending was a Trump campaign promise so it is no surprise but spending increases come on top of the tax cuts we saw at the end of last year.

The Trump Tax Changes

According to the US Committee for a Responsible Fiscal Budget there was much to consider.

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, leading debt to rise to between 95 percent and 98 percent of Gross Domestic Product (GDP) by 2027 (compared to 91 percent under current law). However, the bill also includes a number of expirations and long-delayed tax hikes meant to reduce the official cost of the bill. These expirations and delays hide $570 billion to $725 billion of potential further costs, which could ultimately increase the cost of the bill to $2.0 trillion to$2.2 trillion (before interest) on a conventional basis or roughly $1.5 trillion to $1.7 trillion on a dynamic basis over a decade. As a result, debt would rise to between 98 percent and 100 percent of GDP by 2027.

This is a familiar political tactic the world over where the numbers depend on others taking the difficult decisions in the future! One rather sneaky move is the replacement in terms of income tax thresholds of inflation indexation by the US Consumer Price Index by the chained version which is usually lower. So jam today but more like dry toast tomorrow.

Won’t this boost the economy?

There are enough problems simply doing the direct mathematics of government spending and revenue but the next factor is how do they effect the economy? Well the US Congress has given it a go.

The Joint Committee staff estimates that this proposal would increase the average level of output (as measured by Gross Domestic Product (“GDP”) by about 0.7 percent relative to average level of output in the present law baseline over the 10-year budget window. That
increase in output would increase revenues, relative to the conventional estimate of a loss of $1,456 billion over that period by about $451 billion. This budget effect would be partially offset by an increase in interest payments on the Federal debt of about $66 billion over the budget

The idea of tax cuts boosting the economy is a reasonable one but the idea you can measure it to around US $451 billion is pure fantasy. To be fair they say “about” but it should really be if you will forgive the capitals and emphasis “ABOUT“. Anyway for the moment let us move on noting that there is already a fair bit of doubt about the impact on the US deficit over time from US $1 trillion or so to a bit over US $2 trillion.

What is the deficit doing?

According to the US CBO ( Congressional Budget Office) it has been rising anyway in the Trump era.

The federal budget deficit was $174 billion for the first four months of fiscal year 2018, the Congressional
Budget Office estimates, $16 billion more than the shortfall recorded during the same period last year.
Revenues and outlays were higher, by 4 percent and 5 percent, respectively, than during the first four
months of fiscal year 2017.

As you can see revenues are doing pretty well and in fact are being led by taxes on income being up by 8%. However spending rose even faster at an annual rate of 5% which at a time of economic growth gives us food for thought. There was one curious detail and one familiar one in this.

Social Security benefits rose by $11 billion (or 4 percent) because of increases both in the number of beneficiaries and in the average benefit payment.

That seems odd at a time of economic growth but the next bit reminds us that the rise in inflation has a cost too due to index-linked bonds called TIPS.

Outlays for net interest on the public debt increased by $13 billion (or 14 percent), largely because of differences in the rate of inflation.

More Spending?

It looks as though we will find out more about the much promised infrastructure plan next week. From Bloomberg.

President Donald Trump expects to release on Monday his long-awaited plan to generate at least $1.5 trillion to upgrade U.S. roads, bridges, airports and other public works, according to a White House official.

How much of this will come from the government is open to debate. The modern methodology is to promise some spending ( in this case US $200 billion) and assume that the private-sector will do the rest. One of the more extraordinary efforts on this front was the Juncker Plan in the Euro era which assumed a multiplier of up to twenty times. But returning stateside we can see that there will be upwards pressure on spending but so far we are not sure how much.


In my opening I suggested that the United States was switching from monetary expansionism to fiscal expansionism. Let me now introduce the elephant in this particular room.  From the Atlanta Fed

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2018 is 4.0 percent on February 6, down from 5.4 percent on February 1.

They may well be somewhat excitable but if we look at the 3.2% predicted by the New York Fed the view is for pretty solid economic growth. So the fiscal position should be good especially if we add in the fact that for all the media hype treasury bond yields are historically still rather low. Yet none the less the fiscal pump is being primed. Or to put it more strictly after a period of pro-cyclical monetary policy we now seem set for pro-cyclical fiscal policy.

There are obvious implications for the bond market here as there will be increases in supply on their way. No doubt for example this has been a factor in pushing the thirty-year bond yield above 3%. You might have expected more of an impact but I am increasingly wondering about something I suggested some time ago that the path to higher interest-rates in the United States might be accompanied by QE4 or a return to bond buying by the US Federal Reserve. Should the economy slow at any point which would boost the deficit on its own then we could see it. Also this could be a factor in the weaker US Dollar as in is it falling to reflect the risks of a possible return to Quantitative Easing?

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

Me on Core Finance TV





Fiscal policy was on the march at Jackson Hole

Over the weekend many of the world’s central bankers were guests of the Kansas Federal Reserve in Jackson Hole Wyoming. In terms of location I believe it was chosen because a previous chair of the US Federal Reserve Paul Volcker was a keen fisherman. However this late August symposium has become one which influences the economic winds of change as central bankers discussed easing policy in response to the credit crunch and in more recent times a speech was given on what were perceived to be the wonders of Forward Guidance. Michael Woodford was very clever in suggesting to a group who wanted to believe that they could influence events via mere speaking or what has become called Open Mouth Operations.

I shall argue that the most effective form of forward guidance involves advance commitment to definite criteria for future policy decisions.

They are still at that today to some extent although the definite criteria theme has mostly been ignored especially in the UK where it went wrong for the Bank of England almost immediately.

What about now?

The problem for the central bankers is that to coin a phrase that monetary policy may be “maxxed out” or as it is put more formally below.

despite attempts to set economies on normalization paths after the Great Recession and the Global Financial Crisis, the scope for countercyclical monetary policy remains limited: benchmark interest rates have continued to hover near or even below zero.

This is from a paper presented on Saturday by Alan Auerbach and Yuriy Gorodnichenko of the University of California Berkeley. In their conclusion they go further.

Although economists do not believe that expansions die from old age, the prolonged U.S. expansion will end sooner or later and there is serious concern about the ability of policymakers in the United States and other developed countries to fight the next economic downturn. Indeed the ammunition of central banks is much more limited now than before the Great Recession and it is unlikely that expansionary monetary policy can be as aggressive and effective as it was during the crisis.

Actually if monetary policy had been effective the paper would not be necessary as the various economies would have responded and we would be on a road where interest-rates were say 2/3% and central bank balance sheets were shrinking, In reality such interest-rates to quote Star Wars are “far, far away”.

Fiscal policy

If monetary policy has less scope for action then our central planners face being irrelevant so they will be grasping for an alternative and fortunately according to our two valiant professors it is at hand.

With tight constraints on central banks, one may expect—or maybe hope for—a more active response of fiscal policy when the next recession arrives.

The problem with this the familiar theme of the “bond vigilantes” turning up.

It is certainly conceivable (see e.g. Aguiar et al. 2017) that a significant fiscal stimulus can raise doubts about the ability of a government to repay its debts and, as a result, increase borrowing costs so much that the government may find its debt unsustainable and default.

This of course was last seen on a major scale in the Euro area crisis particularly in Greece, Ireland, Portugal and Spain. Of course the European Central Bank intervened by buying bonds and later followed another part of Michael Woodford’s advice by introducing a larger and more widespread QE or bond buying program. So we have seen central banks intervening in fiscal policy via a reduction in bond yields something which government’s try to keep quiet. We have individual instances of bond yield soaring such as Venezuela but the last few years have seen central banking victories and defeats for the vigilantes. In another form that continued this morning as I note that a North Korean ballistic missile passed over Japan but the Nikkei 225 equity index only fell 87 points presumably influenced by the way that the Bank of Japan buys on down days.

What about more overt fiscal policy?

Apparently this can work.

We find that in our sample expansionary government spending shocks have not been followed by persistent increases in debt-to-GDP ratios or borrowing costs (interest rates, CDS spreads). This result obtains especially when the economy is weak. In fact, a fiscal stimulus in a weak economy may help improve fiscal sustainability along the metrics we study.

Indeed this for them is essentially a continuation of past work.

This constraint on monetary policy coincides with a resurgence in activist fiscal policy (Auerbach and Gale, 2009), which has moved from a focus on automatic stabilizers to a stronger reliance on discretionary measures, reflecting not only necessity but also growing evidence of the effectiveness of such policy to fight recessions (e.g., Auerbach and Gorodnichenko, 2012, 2013).

Also I am reminded that we should never believe something until it is officially denied.

Given the nature of the sample analyzed, our results should not be interpreted as an unconditional call for an aggressive government spending in response to a deteriorating economy.

The UK

Jonathan Portes who is an advocate for fiscal policy has written this in Prospect Magazine.

The answer is very technical—£100 billion or so of the extra debt relates to the Bank of England’s Asset Purchase Facility. Briefly, the BoE makes loans to banks and buys corporate bonds, in return for cash (“central bank reserves”).

He suggests that as this has been mostly ignored( not on here) we could borrow for other purposes.


There is a fair bit to consider here as I note that North Korea has done its bit as bond markets have risen today and yields fallen. For example the UK ten-year Gilt yield has dropped to 1% giving us food for thought with inflation at either 2.6% ( CPI) or 3.6% ( RPI). A clear factor in the expected push for fiscal policy is that bond yields are so low as conventional UK Gilt yields do not go above 1.7% and other countries such as Germany Switzerland and Japan can borrow for much less. Against such bond yields theoretical analysis is always likely to look good so the first issue is whether they would be maintained in a fiscal expansion. Or to put it another way are central banks being asked here for a type of QE to infinity?

Next is the issue of how a fiscal stimulus is defined as for example countries which have stopped borrowing and run a surplus like Germany and Sweden are relatively rare. Most have continued to borrow and run annual fiscal deficits albeit usually declining ones. Thus the ballpark seems to have shifted to increasing deficits rather than having one at all which is the sort of “junkie culture” road that monetary policy went down. If we look back to a past advocate of fiscal stimulus John Maynard Keynes he was also someone who suggested that when the growth came there would be a period of payback.

What we also find ourselves mulling is the difference between the specific and the general. I am sure that everyone can think of a project that would provide plenty of benefits and gains but as we move to a more generalist position we find ourselves facing a reality of Hinkley Point and HS2. To be fair our two professors do acknowledge this.

Bridges to nowhere, “pet” projects and other wasteful spending can outweigh any benefits of countercyclical fiscal policy.

As a conclusion the Ivory Tower theory is that fiscal policy will work. There are two catches the first is that if they were even regularly right we would not be where we are. The next is that on some measures we have been trying it for quite some time.

In reality the establishment seems likely to latch onto this as we have discussed before.



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]


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.


The UK looks on course for a fiscal policy reset and boost

The last few months have seen more and more bodies come out in favour of easier fiscal policy or a fiscal stimulus. For some such as the International Monetary Fund or IMF this has been something of a U-Turn as it had of course previously imposed austerity on several nations in the Euro area particularly Greece. For others it has been a policy shift from telling us that easier monetary policy would work as they decided that people would figure out that  8 years of ever easier monetary policy meant by definition that it had not. Some of course were always in favour and will be pleased to note the economic mood music joining them. There have been signs that UK economic policy was moving that way to and we have leaned some morning this morning already as UK economic announcements become subject to the political conference timetable. However some care is needed as of course the UK has run a series of fiscal deficits and the talk of a fiscal surplus was just that. I have pointed out many times that the former Chancellor George Osborne seemed to be 3/4 years away from a surplus at whatever point in time one might choose. Although there was apparently at least one person who believed them if this from Robert Peston is any guide.

Amazing that borrowing rules torn up & we don’t have new ones. Think what City would say if this happened on Labour’s watch

What has changed for the UK?

There has been a change of Chancellor as George Osborne was removed and replaced with Phillip Hammond and it looks as though the new government will be fiscally looser. However there was also a major change in an element of the UK public finances as bond yields or what are called Gilt yields fell heavily making it much cheaper for the UK to finance a fiscal deficit. This meant that the much vaunted “bond vigilantes” have had all the success of General Custer at Little Big Horn.

It  seems like another world now to look back and see that the UK entered 2016 with a 10 year Gilt yield of around 2%. We saw international yields plunge helped by ECB and Bank of Japan policy and the song was clearly this from Alicia Keys.

Oh, baby
I, I, I, I’m fallin’
I, I, I, I’m fallin’

Depending on which date you choose this took us to around 1.3% and then post the EU Leave vote Gilt yields fell even faster and price rose. This was a more domestic move and to some extent this time around the UK helped pull international yields lower. The Bank of England was expected to add to its existing £375 billion portfolio of UK Gilts and duly announced another £60 billion as well as Open Mouth Operations saying that more would be done if it considered it necessary. Thus the 10 year Gilt yield fell and is 0.74% as I type this as the Bank of England purchases an extra £3.51 billion of UK Gilts each week.

If we now switch to the yield which really matters for fiscal policy we see the impact of this. If we borrowed for 30 years right now as I type this the Gilt yield is 1.46%. That is extraordinarily low for the UK and as a comparison over my career ( also 30 years or so) I have seen it as high as 15%. This means that more projects should be viable due to the lower cost of financing the project.

What has the Chancellor actually said?

The Guardian has been hot in the case and reports this claimed early wire on his speech later on.

The Conservatives were elected “on a promise to restore fiscal discipline”, Hammond is to note, adding: “And that is exactly what we are going to do. But we will do it in a pragmatic way that reflects the new circumstances we face.”………“But when times change, we must change with them. So we will no longer target a surplus at the end of this parliament.”

That seems to open the door for an easing of policy which would be consistent with the hints we have had so far. Speculation is of an easing of the order of a bit more than 1% of economic output of GDP but of course that is speculation for now. We did however get one specific plan.

Hammond will also unveil a £3bn package to speed up homebuilding, including using surplus public land and brownfield sites, encouraging smaller builders and innovations such as prefabricated modular homes…….Of the £3bn total, a third will be used as short-term loan funding for smaller housebuilders and what are described as “custom builders and innovators”, intended to create an extra 25,500 homes before 2020.

An extra 25,500 homes does not sound much does it? Also there is something very familiar at play here for announcements about extra UK housing which is that some of it has been announced in the past! So only around a third is actually new here. Perhaps we should be grateful that announcements of more have in reality meant less as has happened at the Ebbsfleet project.

They should get in the person I watched for a while on Saturday evening dismantling one of the cranes by Battersea Power Station! Quite a work ethic and very brave too.

The BBC has gone further.

“As we go into a period where inevitably there will be more uncertainty in the economy, we need the space to be able to support the economy through that period,” he said. “If we don’t do something, if we don’t intervene to counteract that effect, in time it would have an impact on jobs and growth.”

As ever it is the two i’s of infrastructure and investment which lead the rhetoric.

“I do think there is a case that we should look at very carefully for targeted, high-value investment in our economic infrastructure”


There is a fair bit to consider here. The fiscal policy of the UK is on its way to a reset and is doing so from a position of an existing deficit as shown below. From the Office for National Statistics.

In the financial year ending March 2016 (April 2015 to March 2016), the public sector borrowed £76.5 billion. This was £18.9 billion lower than in the previous financial year and less than half of that in the financial year ending March 2010 (both in terms of £ billion and percentage of GDP).

So austerity was a reduction in the overall deficit over time rather than a real push to a surplus. In the meantime circumstances have changed because the UK can borrow at around 1.5% for the longer-term rather than the 5% or so expected back in the day by the Office for Budget Responsibility.

Can we rise to the challenge or will it be another example of what is called “pork-barrel” spending? I am sure you can all think of examples of both. If we just look at travel infrastructure there are clear cases yet sadly we seem ever more wedded to the expensive HS2 project which will not actually carry that many people. As Battersea Power Station is on my mind perhaps Pink Floyd could have another go but this time replacing the pink elephant with a white one. An HS3 style plan for northern cities seems much wiser to me. Although of course there are capital style risks for the future in letting the national debt rise and rise as well as dangers for inflation with money supply growth also strong as I pointed out on Thursday..

Meanwhile UK manufacturing appears to be doing rather well if this morning’s Markit PMI survey is any guide but of course that is so far…..

Number Crunching

There are regular reports that we can borrow at negative levels via index-linked Gilts which may lead some to conclude that this is the way to go. However some of this is another Ivory Tower misunderstanding. Yes there are elements that look cheap here but unlike conventional Gilts there is a variable which needs to be assumed which is inflation and in particular inflation as defined by the Retail Price Index. An inflationary episode would lead our new experts to be declaring yet another “surprise” which of course “could not possibly have been expected”



Ever lower government bond yields are not “free money”

In terms of interest-rates there have been several phases in the credit crunch era. First we saw large reductions in official interest-rates which were badged as temporary and emergency but of course now look ever more permanent. Then we had various ” extraordinary monetary measures” such as QE to reduce longer-term interest-rates and bond yields. Some years later we saw a new phase of interest-rate reductions as an increasing number of nations took their official interest-rates into negative territory. This was often accompanied by yet more QE with my own country joining the new QE wave only last month. As I pointed out from the early days this has looked much more like a type of junkie culture than any cure unless of course someone can think of a cure that takes 8 years or so not to work. After all if it was working why are we where we are? The one country which is trying to buck the trend has managed only one interest-rate increase so far and keeps mentioning negative interest-rates.

Fiscal Policy

There has been an extraordinary boost here provided by the fall in sovereign bond yields and this has been highlighted by Fitch.

Cash flow benefits have effectively been transferred from global investors to sovereign issuers, as sovereign borrowing costs have dropped in response to central bank monetary stimulus.

We are left wondering if this was the plan all along! Treasuries around the world will no doubt have been keen to rubber stamp QE plans by central bankers which will reduce their borrowing costs. What price independence anyone?

We also get an idea of the boost provided.

Relative to yields available in 2011, global investors are foregoing over $500 billion in annual income on $38 trillion in currently outstanding bonds as a result of the collapse in sovereign yields.

A US $500 billion a year gain to government’s is nothing to be sniffed at and provides a backdrop to the current cries for more fiscal stimulus. It has been produced as a result of this.

The median 10-year yield for the countries in Fitch’s study dropped to 1.17% today from 3.87% in July 2011.

Some countries have benefited more than others.

The largest declines in weighted-average sovereign yields among the top issuers over the past five years have been seen in Spain (down 422 bps) and Italy (down 413 bps). Both countries faced elevated spreads during 2011, when investor concerns surrounding Eurozone risk were peaking.

That is interesting as their economic performance proves that this is no panacea on its own. Spain has seen an economic recovery whilst Italy continues to struggle and currently they could not look much more different. There is something of a contradiction here as Italy benefits more from the change ( US $79 billion per year) than Spain ( US $45 billion per year).

For other countries the Financial Times offers us these estimates.

Japan has saved more than $95bn a year as a result of the decline in rates, while the US, UK and Germany collectively pay $104bn less annually, the study estimates.

Also some countries now get paid to borrow.

Stimulus from the European Central Bank and Bank of Japan has unleashed a rally across fixed income markets, with nearly $13.2tn of debt trading with a yield below zero at the end of last week. Japan, France, Germany and Switzerland are now paid to issue short-dated sovereign bonds.

It is not just short-dated bonds as ten-year yields in Japan,Germany and Switzerland are negative as well. Being paid to borrow is a credit crunch phenomenon which impacts on the number below which must have Bond Vigilante’s in floods of tears.

The median 10-year yield for the countries in Fitch’s study dropped to 1.17% today from 3.87% in July 2011.

The UK

Let me bring a couple of things together which is that whilst it heads in another direction Fitch does seem to understand the correct methodology.

Fitch notes that the effects materialise as higher coupon bonds mature and are refinanced with low or negative yields.

If we look at the UK we see that conventional issuance will be of the order of £100 billlion this year which with yields some 1.8% lower than in 2011 is an annual bonus of £1.8 billion. Actually against OBR forecasts it is a lot better because it was assuming more like 5% for Gilt yields so the annual gain is currently of the order of £4.3 billion.

Also Fitch skirts around something else which is that central banks invariably return the coupons and yield from their QE purchases to the home treasury. Here is the latest data on the Bank of England.

In July 2016, there was £1.1 billion transferred from the BEAPFF to HM Treasury, bringing the total money transferred to HM Treasury under the APF scheme to £5.0 billion in this financial year-to-date (April to July 2016).

The Bank of England entrepreneurial income for the financial year ending March 2016 (April 2015 to March 2016) was calculated as £11.9 billion.

Not all of it is counted in the public finances believe it or not but we know that as the Bank of England expands its conventional QE operations by another £60 billion the benefit to HM Treasury will rise.

It is really quite clear why politicians steer clear of this sort of thing as people may wonder why the public finances do not look a lot better……?

Even the losers get lucky some times

Tom Petty is right here because whilst Fitch is in effect whining on behalf of income investors some have pocketed a lot of cash.

Given the significant downward moves in interest rates over the past five years, many investors have already seen large gains in their bond portfolios.

There have been extraordinary gains so where have they gone? Who now has all this wealth? i think we should be told don’t you? Also someone should tell Fitch that the sentence below makes things worse and not better.

In addition, central banks’ holdings of sovereign securities have grown sharply, mitigating the prospective impact of ultra-low rates on private investors.

Future investors and savers are hit

We are back to this issue.

Still, for many “buy and hold” income-oriented investors, the roll-off of maturing securities requires that new cash be invested at much lower coupon rates. Should rates remain low for an extended period, it would likely erode earnings power for many large investment institutions and pension funds.

That is a polite way of explaining how many of the business models for longer-term saving such as defined benefit pensions have been blown up by the policies Andy Haldane of the Bank of England is so keen on. Not his pension though as the UK taxpayer backs it.


If we take a broad brush approach to the falls in sovereign bond yields we see that there have been two main gainers. Firstly existing holders of government bonds and secondly governments which pay less for new borrowing and receive transfers from the operations of their central banks. Quite a wealth shift in the first instance and an income shift in the second. This has the implication that monetary policy has strong fiscal effects which blows up the independence bubble that central bankers and their acolytes keep trying to maintain.

But there is a price and it is in the process of being paid by people and companies who reply in income both now and in the future. It has become a lot more expensive if you try to purchase it and in other variants is either very low or zero. So future income has been taken from them and they represent not only pensioners and savers both now and in the future but companies with pension plans.

Oh and who has all the new wealth? What economic benefits has it brought?


What is the economic and fiscal situation in Scotland?

Yesterday brought us some new information on the economic situation in Scotland as the government there published its latest public finance data and updated us on the economic growth situation. So let us go straight to the GDP data.

In quarter 1 2016 the output of the Scottish economy was flat (0.0 per cent change), following growth of 0.3 per cent in quarter 4 2015. Equivalent UK growth was 0.4 per cent……Scottish GDP per person was also flat during the first quarter of 2016.

So an underperformance compared to the rest of the UK which in fact is something that can also be seen if we look back over the previous year.

Compared to the same period last year (i.e. quarter 1 2016 vs quarter 1 2015), the Scottish economy grew by 0.6 per cent. Equivalent UK growth was 2.0 per cent.

If we look back we see that the Scottish economy had a similar pattern to the rest of the UK in that economic growth pushed up to between 2% and 3% and in fact for a while did better. But since the beginning of 2015 economic growth has been slip-sliding away which has a cause you are probably already thinking of but please indulge me and hold your horses as there are complications.

Scotland’s economic structure

This is different to the rest of the UK as shown by the numbers below.

Scotland’s economy is broken down into four weighted industry categories. The breakdown for 2013 is services (75 per cent), production (18 per cent), construction (6 per cent), and agriculture, forestry and fishing (1 per cent).

So agriculture is a little higher but the main change compared to the UK numbers below is more production and  a smaller services sector.

The current 2013 – based weights are: services 78.8%; production 14.6%; construction 5.9%; and agriculture 0.7%.

You might be thinking that the production numbers should be even higher but the numbers we are given are on this basis.

This publication presents results for what is commonly referred to as the “onshore economy”, which means they exclude oil and gas extraction activity in the North Sea.

I have looked these up as they are in the overall UK numbers.

Within the production sub-industries, output from mining and quarrying, including oil and gas extraction, decreased by 2.3%;

However on an annual basis the picture was much brighter.

Mining and quarrying, including oil and gas extraction, increased by 5.3%,

For those wondering how this can be with the oil price where it is I have checked before and the numbers have been affected by past maintenance shut-downs.

Whilst the explicit oil and gas output numbers are removed there are still implicit effetcs from the industry as towns like Aberdeen depend to a large degree on it. Over the past year the break down of Scottish economic growth is shown below.

The growth in Scottish GDP in this period was due to the tail end of growth in the construction industry plus growth in the services industry (particularly distribution, hotels and catering), tempered by contractions in the production industry (particularly manufacturing).

I would be interested in readers thoughts and explanations of the construction boom. In terms of the numbers it seems to have been affected by the ESA 10 methodological changes which pushed it higher.

Construction output saw extremely strong growth in 2014 and 2015 and drove much of GDP growth over this period

The Fiscal Position

Yesterday saw the publication of the GERS dataset which estimates the revenue and public spending situation for Scotland. If we start with the revenue situation there is something glaring in the numbers.

Including an illustrative geographic share of North Sea, Scottish public sector revenue was estimated as £53.7 billion (7.9 per cent of UK revenue). Of this, £60 million was North Sea revenue.

As you can see the North Sea is not ignored here and the last sentence is not a misprint.

Scotland’s illustrative share of North Sea revenue fell from £1.8 billion in 2014-15 to £60 million, reflecting a decline in total UK North Sea revenue.

Ouch! This means that the individual position is as follows.

Scotland’s public sector revenue is equivalent to £10,000 per person, £400 less than the UK average, regardless of the inclusion of North Sea revenue.

Just to show how times change this is what we were told about 2011/12.

In 2011-12, oil and gas production in Scottish waters is estimated to have generated £10.6 billion in tax revenue, 94% of the UK total…….Total tax revenue (onshore and offshore) in Scotland was equivalent to £10,700 per person in 2011-12, compared to £9,000 in the UK as a whole.


The situation here is of higher public expenditure per person compared to the rest of the UK which is an example of regional policy in action.

Total expenditure for the benefit of Scotland by the Scottish Government, UK Government, and all other parts of the public sector was £68.6 billion. This is equivalent to 9.1 per cent of total UK public sector expenditure, and £12,800 per person, which is £1,200 per person greater than the UK average.

The Fiscal Deficit

The situation here is that Scotland is receiving the large fiscal stimulus that is being recommended by some for the rest of the UK although to be fair there have been very few suggesting one of the size below. Also at current oil prices it is noticeable how little difference North Sea Oil & Gas makes.

Excluding North Sea revenue, was a deficit of £14.9 billion (10.1 per cent of GDP)….Including an illustrative geographic share of North Sea revenue, was a deficit of £14.8 billion (9.5 per cent of GDP).

This compares to an overall UK position of.

For the UK, was a deficit of £75.3 billion (4.0 per cent of GDP).


If we stick to the economics we see an economy that is suffering from a fall in price of a natural resource that it produces. Whilst the GDP data excludes the oil & gas sector explicitly there are clear implicit effects and the fiscal position has been hit hard. However it has been shielded to some extent by its membership of the UK. This comes in various forms. Firstly the regional policy I mentioned earlier. Next we have the fact that it does not have its own currency as a Sottish Pound would presumably have been hit hard or at least a lot harder than the UK Pound has been post Brexit!Indeed there would have been very wide swings in the value of a Scottish Pound. Also a stand-alone fiscal deficit of that size would see the debt vigilantes looking to party even in these hard times for them. I do realise there are so many ironies here but as part of the UK Scotland can borrow much more cheaply than it would on its own. Oh and Bank of England policy seems much better suited to the Scottish economic situation assuming you believe that more monetary easing is a stimulus. Finally there is the size of the fiscal deficit itself which is a substantial stimulus.

Meanwhile as a sign of ch-ch-changes I would like you to join me in a journey in Doctor Who’s TARDIS back to March 2013 when we were told “the balance of risk being on the upside” for oil prices by the Scottish Government leading to this.

analysis published by the OECD in March 2013 suggests that rising demand in East Asia and continued tight supply could result in oil prices rising above $150 by 2020…….could result in oil and gas production in Scottish waters generating £57 billion in tax revenue between 2012-13 and 2017-18

Let me remind you of the words of the late and great Yogi Berra.

The future ain’t what it used to be.



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.


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.