Andrew Bailey’s appointment as Governor shows yet again how accurate Yes Prime Minister was

The pace of events has picked up again as whilst there is much to consider about the likely UK public finances something else has caught the eye.

Today, 20 December 2019, the Chancellor has announced that Andrew Bailey will become the new Governor of the Bank of England from 16 March 2020. Her Majesty the Queen has approved the appointment.

In order to provide for a smooth transition, the current Governor, Mark Carney, has agreed to now complete his term on 15 March 2020.

Making the announcement the Chancellor said: “When we launched this process, we said we were looking for a leader of international standing with expertise across monetary, economic and regulatory matters. In Andrew Bailey that is who we have appointed.

Andrew was the stand-out candidate in a competitive field. He is the right person to lead the Bank as we forge a new future outside the EU and level-up opportunity across the country.

It is hard not to have a wry smile at Governor Carney getting yet another extension! I think we have predicted that before. As to Andrew Bailey I guess that the delay means he will be busy in his present role as head of the Financial Conduct Authority covering up yesterday’s scandal at the Bank of England before he can move over. A new definition of moral hazard straight out of the Yes Prime Minister play book. There is the issue of the scandals he has overlooked or been tardy dealing with in his time at the FCA but there is something even more bizarre which was in the Evening Standard in 2016 and thank you to Kellie Dawson for this.

I was interested in the story of Andrew Bailey, new Bank of England chief battling a bear. Turns out his WIFE battled the bear while he was on the phone. Rolls knowing eyes at all women everywhere.

Economic Growth

There was also some good news for the UK economy this morning.

UK gross domestic product (GDP) in volume terms was estimated to have increased by 0.4% in Quarter 3 (July to Sept) 2019, revised upwards by 0.1 percentage points from the first quarterly estimate…..When compared with the same quarter a year ago, UK GDP increased by 1.1% to Quarter 3 2019; revised upwards by 0.1 percentage points from the previous estimate.

So still an anaemic rate of annual growth but at these levels every little helps. One of the ironies in the Brexit situation is that annual growth is very similar as the Euro area is at 1.2%. As to the UK detail there is this.

Services output increased by a revised 0.5% in Quarter 3 2019, following the weakest quarterly figure in three years in the previous quarter. Manufacturing grew by 0.1% in Quarter 3 2019, as did production output. Construction output experienced a pickup following a weak Quarter 2 (Apr to June), increasing by 1.2%

So the “march of the makers” has in fact turned out to be the opposite of the “rebalancing” promised by the former Bank of England Governor Baron King of Lothbury. As I regularly point out services are becoming an ever larger component of UK GDP.

Also for once there was good news from the trade position.

The current account deficit narrowed to 2.8% of GDP in Quarter 3 2019, its lowest share of GDP since early 2012,

That is obviously welcome but there is a fly in this particular ointment as they seem to be splashing around between trade and investment.

The latest figures mean that net trade is now estimated to have added 1.2 percentage points to GDP growth over this period compared with the almost flat contribution in the previous estimate.

Gross capital formation is now estimated to have subtracted 1.2 percentage points from GDP growth since Quarter 1 2018 compared with the negative contribution of 0.5 percentage points previously recorded.

Also UK business investment over the past year has been revised up from -0.6% to 0.5% which is quite a change and deserves an explanation.

Public Finances

There were some announcements about future government spending in the Queen’s Speech yesterday. From the BBC.

Schools in England are promised more funding, rising by £7.1bn by 2022-23, which the Institute for Fiscal Studies think tank says will reverse the budget cuts of the austerity years.

Also there was this about the NHS.

The five-year plan, which sees the budget grow by 3.4% a year to 2023, was unveiled last year and was included in the Tory election manifesto.

The proposal to help on business rates was more minor than badged so we are seeing something of a mild fiscal expansion that the Bank of England thinks will add 0.4% to GDP. So can we afford it?

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of November 2019 was £1,808.8 billion (or 80.6% of gross domestic product (GDP)), an increase of £39.4 billion (or a decrease of 0.8 percentage points) on November 2018.

As you can see whilst the debt is rising in relative terms it is falling and if we take out the effect of Bank of England policy it looks better.

Debt at the end of November 2019 excluding the Bank of England (mainly quantitative easing) was £1,626.6 billion (or 72.5% of GDP); this is an increase of £46.9 billion (or a decrease of 0.2 percentage points) on November 2018.

I am not sure why they call in QE when it is mostly the Term Funding Scheme but as regular readers will be aware there seems to be a lack of understanding of this area amongst our official statisticians.

It also remains cheap for the UK to borrow with the benchmark ten-year Gilt yield at 0.82% and more relevantly the 50-year yield being 1.2%. We have seen lower levels but as I have seen yields as high as 15% we remain in a cheaper phase.

Current Fiscal Stimulus

The UK has been seeing a minor fiscal stimulus which has been confirmed again by this morning’s data.

Borrowing in the current financial year-to-date (April 2019 to November 2019) was £50.9 billion, £5.1 billion more than in the same period last year; this is the highest April-to-November borrowing for two years (since 2017), though April-to-November 2018 remains the lowest in such a period for 12 years (since 2007).

If we go the breakdown we see this.

In the latest financial year-to-date, central government receipts grew by 2.1% on the same period last year to £485.7 billion, including £356.5 billion in tax revenue.

Over the same period, central government spent £514.6 billion, an increase of 2.8%.

With the rate of inflation declining we are now seeing increases in public spending in real terms and they may well build up as we have not yet seen the full budget plans of the new government.

Care is needed however as the numbers have developed a habit of getting better over time.

PSNB ex in the financial year ending March 2019 has been revised down by £3.3 billion compared with figures presented in the previous bulletin (published on 21 November 2019) as a result of new data.

Comment

We are at times living an episode of Yes Prime Minister as proved by the appointment of the new Governor.

Doesn’t it surprise you? – Not with Sir Desmond Glazebrook as chairman.

 

– How on earth did he become chairman? He never has any original ideas, never takes a stand on principle.

 

As he doesn’t understand anything, he agrees with everybody and so people think he’s sound.

 

Is that why I’ve been invited to consult him about this governorship?

Sir Desmond would be called a “safe pair of hands” too and no doubt would also have run into all sorts of issues if he had been in charge of the FCA just like Andrew Bailey has. Favouring banks, looking the other way from scandals and that is before we get to the treatment of whistle blowers. I do not recall him ever saying much about monetary policy.

Also the timing has taken yesterday’s scandal at the Bank of England off the front pages again like something straight out of Yes Prime Minister. We will never know whether this announcement was driven by that. However should it continue to be so accurate we can expect this next.

If I can’t announce the appointment of Mr Clean as Governor –
Why not announce a cut in interest rates?
Oh, don’t be silly, I What? Announce a cut in interest rates The Bank couldn’t allow a political cut – particularly with Jameson.
It would with Desmond Glazebrook.
Now, if you appoint him Governor, he’ll cut Bartlett’s interest rates in the morning – you can announce both in your speech.
– How do you know?
He’s just told me.

India has an economic growth problem

As 2019 has developed we have been noting the changes in the economic trajectory of India. Back on October 4th we noted this from the Reserve Bank of India as it made its 5th interest-rate cut in 2019.

The MPC also decided to continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remains within the target.

This was in response to this.

On the domestic front, growth in gross domestic product (GDP) slumped to 5.0 per cent in Q1:2019-20, extending a sequential deceleration to the fifth consecutive quarter.

For India that was a slow growth rate for what we would call the second quarter as they work in fiscal years.

What about now?

Friday brought more bad news for the Indian economy as this from its statistics office highlights.

GDP at Constant (2011-12) Prices in Q2 of 2019-20 is estimated at `35.99 lakh crore, as against `34.43 lakh crore in Q2 of 2018-19, showing a growth rate of 4.5 percent. Quarterly GVA (Basic Price) at Constant (2011-2012) Prices for Q2 of 2019-20 is estimated at `33.16 lakh crore,
as against `31.79 lakh crore in Q2 of 2018-19, showing a growth rate of 4.3 percent over the corresponding quarter of previous year.

The areas which did better than the average are shown below.

‘Trade, Hotels, Transport, Communication and Services related to Broadcasting’ ‘Financial, Real Estate and Professional Services’ and ‘Public Administration,
Defence and Other Services’.

The first two however slowed in the year before leaving us noting that the state supported the economy as you can see below.

Quarterly GVA at Basic Prices for Q2 2019-20 from this sector grew by 11.6 percent as compared to growth of 8.6 percent in Q2 2018-19. The key indicator of this sector namely, Union Government Revenue Expenditure net of Interest Payments excluding Subsidies, grew by 33.9
percent during Q2 of 2019-20 as compared to 22.2 percent in Q2 of 2018-19.

Regular readers will not be surprised what the weakest category was.

Quarterly GVA at Basic Prices for Q2 2019-20 from ‘Manufacturing’ sector grew by (-)1.0
percent as compared to growth of 6.9 percent in Q2 2018-19.

Also those who use electricity use as a signal will be troubled.

The key indicator of this sector, namely, IIP of Electricity registered growth rate of 0.4 percent during Q2 of 2019-20 as compared to 7.5 percent in Q2 of 2018-19.

In terms of structure the economy is 31.3% investment and 56.3% consumption. The investment element is no great surprise in a fast growing economy but it has been dipping in relative terms. The main replacement has been government consumption which was 11.9% a year ago and is 13.1% now as we get another hint of a fiscal boost.

Switching to a perennial problem for India which is its trade deficit we see that it was 3.8% of GDP in the third quarter of this year. That is a little better but there is a catch which is that it has happened via falling imports which were 26.9% of GDP a year ago as opposed to 24% now. So another potential sign of an internal economic slowing.

We can move on by noting that this time last year the GDP growth rate was 7% and that The Hindu reported it like this.

Growth in the gross domestic product (GDP) in the July-September quarter hit a 25-quarter low of 4.5%, the government announced on Friday.

The lowest GDP growth in six years and three months comes as Parliament has been holding day-long discussions on the economic slowdown, with Union Finance Minister Nirmala Sitharaman assuring the Rajya Sabha that the country is not in a recession and may not ever be in one.

4.5% growth is a recession?

Unemployment

The numbers are rather delayed am I afraid leaving us wondering what has happened since.

Unemployment Rate (UR) in current weekly status in urban areas for all ages has been estimated as 9.3% during January-March 2019 as compared to 9.8% during April- June 2018.

Inflation

This has been picking up as the Economic Times reports below.

Inflation touched 4.62%, according to the data released by the statistics office on Wednesday, compared to 3.99% in the month of September. Inflation, as measured by the Consumer Price Index (CPI), was 3.38% in October last year.

Sadly for India’s consumers and especially the poor much of the inflation is in food  prices as inflation here was 7.9%. Vegetables were 26.1% more expensive than a year before and it would seem the humble onion which is a big deal in India is at the heart of it. From India Today.

Households and restaurants in India are reeling under pressure as onion prices have surged exponentially  across the country. A kilo of onion is retailing at Rs 90-100 in most Indian states, peaking at Rs 120-130 per kilo in major cities like Kolkata, Chennai, Mumbai, Odisha, and Pune.

For those wondering about any inflation in pork prices then the answer is maybe.The meat and fish category rose at an annual rate of 9.75%.

Manufacturing

We noted in the GDP numbers that there was a fall but this seems to have sped up at the end of the quarter as it fell by 3.9% in September on a year before driven by this.

The industry group ‘Manufacture of motor vehicles, trailers and semitrailers’ has shown the highest negative growth of (-) 24.8 percent followed by (-) 23.6 percent in ‘Manufacture of furniture’ and (-) 22.0 percent in ‘Manufacture of fabricated metal products, except machinery and equipment’ ( India Statistics)

Fiscal Policy

From Reuters last month.

After the corporate tax cuts and lower nominal GDP growth, Moody’s now expects a government deficit of 3.7 per cent of GDP in the fiscal year ending in March 2020, compared with a government target of 3.3 per cent of GDP.

Also there is this from the Economic Times.

In India, private debt in 2017 was 54.5 per cent of the GDP and the general government debt was 70.4 per cent of the GDP, a total debt of about 125 of the GDP, according to the latest IMF figures.

The ten-year bond yield is 6.5% showing us that India does face substantial costs in issuing debt.

Comment

We get another hint of the changes at play as we note this from the Reserve Bank of India in November and note that the result was 5%.

For Q1:2019-20, growth forecast was revised
down from 7.2 per cent in the November 2018 round
to 6.1 per cent in the July 2019 round.

As we look forwards it is hard to see what will shake India out of its present malaise.Of course if the daily news flow that the trade war is fixed ever turns out to be true that would help. But otherwise India may well still be suffering from the demonetarisation effort of a couple of years or so ago.

After the falls of last year the Rupee has been relatively stable and is now at 71.6 versus the US Dollar. A lower Rupee is something which gives with one hand ( competitiveness) and takes away with another ( cost of imports especially oil). But as it starts its policy meeting tomorrow the RBI will feel the need to do something in addition to changing its fan chart for economic growth ( lower) and inflation ( higher) giving us what is for India something of a stagflationary influence.

Podcast

 

 

Christine Lagarde trolls Germany and asks for more fiscal stimulus

This morning has seen the first set piece speech of the new ECB President Christine Lagarde and it would not be her without some empty rhetoric.

The idea of European renewal may, for some, elicit feelings of cynicism. We have heard it many times before: “Europe is at a crossroads”; “now is Europe’s moment”. Often that has not proven to be the case. But this time does in fact seem different.

To her perhaps, just like the Greek bailout was “shock and awe” which I suppose in the end it was just as a doppelganger of what she meant.

We also got some trolling of Germany.

Ongoing trade tensions and geopolitical uncertainties are contributing to a slowdown in world trade growth, which has more than halved since last year. This has in turn depressed global growth to its lowest level since the great financial crisis.

These uncertainties have proven to be more persistent than expected, and this is clearly impacting on the euro area. Growth is expected to be 1.1% this year, i.e. 0.7 percentage points lower than we projected a year ago

A lot of the reduction and impact has been on Germany but what Christine does not say is that this has become a regular Euro area issue where economic growth has been downgraded or poor or both. Briefly around 2017 we had the Euro boom but that required the monetary taps to be wide open. Missing here in the analysis is the fact that the stimulus was withdrawn into a growth slowdown.

Did I say there was some trolling of Germany?

At the same time, there are also changes of a more structural nature. We are starting to see a global shift – driven mainly by emerging markets – from external demand to domestic demand, from investment to consumption and from manufacturing to services.

Then we move onto rhetoric that is simply misleading.

The answer lies in converting the world’s second largest economy into one that is open to the world but confident in itself – an economy that makes full use of Europe’s potential to unleash higher rates of domestic demand and long-term growth.

She is setting policy for the Euro area and not Europe and the ECB itself tells us this about the Euro area.

Compared with its individual member countries, the euro area is a large and much more closed economy. In terms of its share of global GDP, it is the world’s third-largest economy, after the United States and China.

Economics

It is revealing that the next section was titled “resilience and rebalancing” words which these days send a bit of a chill down the spine. This chill continues as we see a call for this.

And when global growth falls, stronger internal demand can help protect jobs, too. This is because domestic demand is linked more to services – which are more labour-intensive – while external demand is linked more to manufacturing, which is less labour-intensive.

We are seeing that shield in action in the euro area today: the resilience of services is the key reason why employment has not yet been affected by the global manufacturing slowdown.

The word “yet” may turn out to be rather important. Also there is a catch which is sugar coated..

In the euro area, domestic demand has contributed to the recovery, helping to create 11.4 million new jobs since mid-2013.

But then reality intervenes.

But over the past ten years, domestic demand growth has been almost 2 percentage points lower on average than it was in the decade before the crisis, and it has been slower than that of our main trading partners.

In addition there is a problem.

The ECB’s accommodative policy stance has been a key driver of domestic demand during the recovery, and that stance remains in place.

This is highlighted if we think what Euro area domestic demand would have been without all the ECB stimulus. Her predecessor Mario Draghi suggested that this was in the area of a 2% boost to both GDP and inflation. I guess Christine left that out as it would be too revealing, or it could be that she is simply unaware of it.

A Double Play

The space for monetary policy is limited as Mario Draghi in what I think was a revealing move tied the new ECB President’s hands for a bit by resuming QE ( 20 billion Euros a month) and cutting the deposit rate to -0.5%. So we are left with what some might call interference in politics.

One key element here is euro area fiscal policy, which is not just about the aggregate stance of public spending, but also its composition. Investment is a particularly important part of the response to today’s challenges, because it is both today’s demand and tomorrow’s supply.

The problem is defining what investment is and which bits are  genuinely useful. For example I recall in the Euro area crisis the example of new toll roads in Portugal which were empty because people could not afford them.

However as with some many central bankers these days Christine firmly presses the climate change klaxon.

While investment needs are of course country-specific, there is today a cross-cutting case for investment in a common future that is more productive, more digital and greener.

There is a clear problem below if we look at growth prospects in the light of this speech alone.

But a stronger domestic economy also rests on higher business investment, and for that raising productivity is equally important. Firms need to be confident in future growth if they are to commit long-range capital.

Because as even Christine is forced to admit the US has done better in this area.

Though all advanced economies are facing a growth challenge, the euro area has been slower to embrace innovation and capitalise on the digital age than others such as the United States. This is also reflected in differences in total factor productivity growth, which has risen by only half as much in the euro area as it has in the United States since 2000.

How do we deal with this? Well she is a politician so bring out some large numbers that most will immediately forget.

And the projected gains are significant: new studies find that the full implementation of the Services Directive would lead to gains in the order of €380 billion], while completing the digital single market would yield annual benefits of more than €170 billion.

Comment

The most revealing part of all this is below as you know you are in trouble when politicians start talking about opportunities.

We have a unique possibility to respond to a changing and challenging world by investing in our future, strengthening our common institutions and empowering the world’s second largest economy.

Maybe by the next speech someone will have told her it is the third largest. Also what growth and why has it not be tried over the past 20 years?

In this way, we could tap into new sources of growth that would otherwise be suppressed.

Let me switch tack and welcome a new female head of a central bank but if we look at the other main example we see yet another problem. Here is Janet Yellen on CNBC.

“Some of the most disturbing notes came from people who said, ’I work and I played by the rules and I save for retirement and I have money in the bank, and you know, I’m getting absolutely nothing,” Yellen recalled. “Savers are getting penalized. It’s true.”

This is even more true in the Euro area as we looked at on Tuesday but Lagarde  just skates by.

fewer side effects

The problem has been highlighted this morning by the Markit PMI business surveys.

The eurozone economy remained becalmed for a
third successive month in November, with the
lacklustre PMI indicative of GDP growing at a
quarterly rate of just 0.1%, down from 0.2% in the
third quarter.

Another nuance is that you can read the speech as in essence the French trolling Germany which seems to be a theme these days and a source of Euro area friction.

Also if we look at money markets there may be trouble ahead.

SPIKE IN ECB’S NEW OVERNIGHT RATE ESTR THIS WEEK SPARKED BY REGULAR CONTINGENCY PLANNING BY FRENCH BANKS – TRADERS  ( @PriapusIQ )

Why the 20th of the month?

We end by returning to an all too familiar theme, why do we always need stimulus?

 

 

 

It turns out that the UK government has been borrowing less than we thought

As we look at the latest numbers for the UK fiscal situation we cannot avoid this thought for the post election situation which was expressed by Shirley Bassey some years ago.

Hey big spender,
Spend a little time with me
Wouldn’t you like to have fun, fun, fun
How’s about a few laughs, laughs
I could show you a good time
Let me show you a good time!

Yesterday produced an example of that on the tax front as Prime Minster Boris Johnson proposed cuts in National Insurance contributions in the same manner as the personal allowance for income tax was raised. This would start with a rise to £9500 in the National Insurance threshold and might go as high as £12.500 to align it with income tax. The initial cost would be around £3 billion a year.

Housing has also come to the front line with Labour promising to build a lot more homes.

In 2017, they promised 100,000 council or housing association homes a year. Now it’s 150,000 between them…..Labour’s £75bn plans will be paid for using half of its £150bn Social Transformation Fund – a pot it says it will use to “repair the social fabric” in the country, if they win a majority in 12 December’s general election. ( BBC)

On the other side of the coin there is less explicit spending from the Conservatives but a clear implicit burden for the taxpayer from these.

The party will promise to introduce a new mortgage with long-term fixed rates, and only needing a 5% deposit, to help renters buy their first homes.

And it will create a scheme where local first-time buyers will be able to get a 30% discount on new homes in their area.

State mortgages? Also a type of help to buy on steroids. So extra liabilities for taxpayers which should be a debit somewhere in the public finances.

The Liberal Democrats offer this.

On Wednesday, the Liberal Democrats launched their manifesto, promising to build 300,000 homes a year by 2024, including 100,000 social homes.

The problem with all of these is twofold. We seem to be building more houses now anyway so how many more do we need? The issue seems to be more of one of them being in the wrong place rather than a total shortage. Also we have had lots of schemes to build more houses which have been full of hot air including one which built none at all. Whoever gets in power there will be more spending in this area it seems.

The Liberal Democrats

Last time around their manifesto was not available but we see now that actually they plan to be relatively fiscally responsible.

A good government should responsibly manage the nation’s finances: taking advantage of opportunities to borrow to invest in key infrastructure while making sure that day-to-day spending does not exceed the amount of money raised in taxes…….Ensure overall national debt continues to decline as a share of national income.

The “day to day” bit looks a continuation of the swerves we see to look like you are being restrained when you are spending but the national debt plan does imply a brake. Compared to the plans of the Tories and Labour quite a brake actually.

Where things get confused is here, because we would under their plan to stay in the European Union just carry on so the “bonus” is what precisely?

Use the £50 billion Remain Bonus to invest in services and tackle inequality, giving a major boost to schools and combatting in-work poverty.

On the other hand they do move from fantasy to reality with their plan to raise the basic rate of income tax by 1 pence. That is I believe for improvements to education in theory although of course it just goes in the same pot. But at least it is reasonably clear.

How much are we taxed?

Here are the calculations of the Resolution Foundation.

Total revenue as a share of GDP has risen to its highest level since 1985-86 but remains very close to its post-war average of 37 per cent. Tax revenue excluding other receipts has hit its highest share of GDP since 1981-82.

Today’s Data

This should bring us back to reality although there are issues with the version of reality presented to us as regular readers will be aware. There is yet another example of that today and let me illustrate with something you might have been expecting.

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in October 2019 was £11.2 billion, £2.3 billion more than in October 2018; this is the highest October borrowing for five years (since October 2014).

If we stay with the October figures then yet again the phrase “as expected” can be used.

Departmental expenditure on goods and services increased by £2.3 billion, compared with October 2018, including a £1.0 billion increase in expenditure on staff costs and a £1.0 billion increase in the purchase of goods and services.

That is consistent with what we have been seeing with a hint of spending ahead of the supposed Brexit date at the end of October. Indeed overall the spending was higher overall because we see that there was a cut.

Interest payments on the government’s outstanding debt decreased by £0.5 billion, compared with October 2018, largely resulting from movements in the Retail Prices Index (RPI), to which index-linked bonds are pegged.

But I am afraid if you look deeper there is a swerve as hinted at below.

Borrowing in the current financial year-to-date (April 2019 to October 2019) was £46.3 billion, £4.3 billion more than in the same period last year; this is the highest April-to-October borrowing for two years (since 2017), though April-to-October 2018 remains the lowest in such a period for 12 years (since 2007).

So much of the extra borrowing was October which made me thing hang on! We have been told for a while spending has been higher and last month the year so far was £5.9 billion higher.So we should be £8.2 billion higher now not £4.3 billion. The difference is found below.

PSNB ex in the current financial year-to-date (April to September 2019) has been revised down by £3.9 billion compared with figures presented in the previous bulletin (published as corrected on 29 October 2019) as a result of updated central government data.

 

 we find out that  the problems have been mostly with expenditure.

Over the same period, we have reduced our previous estimate of central government current expenditure by £2.5 billion. Reductions in previous estimates of the purchase of goods and services, social assistance and “other” current grants of £3.2 billion, £0.6 billion and £0.6 billion, respectively, were partially offset by a combined upward revision to previous estimates of staff costs and grants to local government of £1.4 billion and £0.5 billion.

Seeing as that is the expenditure which we are told has gone up this month the situation looks a bit of a mess.

Also we never seem to be able to quite shake off issues with the banks whatever subject we look at.

The previous estimate of interest and dividends receipts has been increased by £0.7 billion, largely because of a £0.8 billion misrecording of the Royal Bank of Scotland (RBS), paid in April 2019, being captured in cash receipts but not in central government net borrowing. Further, updated bank levy data increased tax receipt estimates by £0.2 billion.

Comment

So there you have it a clear case of value from my style of work as in actually looking at the numbers and data. You will find loads of reports in the media that we have spent more whereas overall we have spent less than we thought! Or if you prefer today’s revisions mean that the UK’s fiscal stimulus has so far been smaller than we have been told. In a way that about sum’s up the years I have been looking at this area.

Looking ahead we do seem set to spend more whoever forms the next government and in some cases much more. We can borrow more presently at cheap rates ( 1.21% for the 50 year Gilt yield) but as to taxation I intend to wait and see as in recent times governments have not found it easy to actually raise it. The last big move I can recall was the post crash rise in Value Added Tax and some taxes have the issue illustrated by Ireland and the way big companies use it.

 

 

 

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

 

The UK has opened the fiscal taps and started a fiscal stimulus

The credit crunch era has seen some extraordinary changes in the establishment view of monetary policy. The latest is this from the Peterson Institute from earlier this month.

On October 1, Prime Minister Shinzo Abe’s government raised the consumption tax from 8 percent to 10 percent. Our preference would have been that he not do it. We believe that, given the current Japanese economic situation, there is a strong case for continuing to run potentially large budget deficits, even if this implies, for the time being, little or no reduction in the ratio of debt to GDP.

Indeed they move on to make a point that we have been making for a year or two now.

Very low interest rates, current and prospective, imply that both the fiscal and economic costs of debt are low.

The authors then go further.

When the interest rate is lower than the growth rate—the situation in Japan since 2013—this conclusion no longer follows. Primary deficits do not need to be offset by primary surpluses later, and the government can run primary deficits forever while still keeping the debt-to-GDP ratio constant.

As they mean the nominal rate of growth of GDP that logic also applies to the UK as I have just checked the 50 year Gilt yield. Whilst UK yields are higher than Japan we also have (much) higher inflation rates and in general we face the same situation. As it happens the UK 50 year Gilt yield is not far off the annual rate of growth of real GDP at 1.17%.

They also repeat my infrastructure point.

To the extent that higher public spending is needed to sustain demand in the short run, it should be used to strengthen the supply side in the long run.

However there are problems with this as it comes from people who told us that monetary policy would save us.

Monetary policy has done everything it could, from QE to negative rates, but it turns out it is not enough.

Actually in some areas it has made things worse.One issue I think is that the Ivory Towers love phrases like “supply side” but in practice it does not always turn out to be like that. Also there is a problem with below as otherwise Japan would have been doing better than it is.

And the benefits of public deficits, namely higher activity, are high…….The benefits of budget deficits, both in sustaining demand in the short run and improving supply in the long run are substantial.

Are they? There are arguments against this as otherwise we would not be where we are. In addition it would be remiss of me not to point out that one of the authors is Olivier Blanchard who got his fiscal multipliers so dreadfully wrong in the Greek crisis.

UK Policy

If we look at the latest data for the UK we see that in the last fiscal year the UK was not applying the logic above. Here is the Maastricht friendly version.

In the financial year ending March 2019, the UK general government deficit was £41.5 billion, equivalent to 1.9% of gross domestic product (GDP) ; this is the lowest since the financial year ending March 2002 when it was 0.4%. This represents a decrease of £14.7 billion compared with the financial year ending March 2018.

In fact we were applying the reverse.

Fiscal Rules

The Resolution Foundation seems to have developed something of an obsession with fiscal rules which leads to a laugh out loud moment in the bit I emphasise below.

Some of the strengths of the UK’s approach have been the coverage of the entire public sector, the use of established statistical definitions, clear targets, a medium term outlook, and a supportive institutional framework. But persistent weaknesses remain, including the disregard for the value of public sector assets, reliance on rules which are too backward or forward looking, setting aside too little headroom to cope with forecast errors and economic shocks, and spending too little time building a broad social consensus for the rules.

Actually the “clear targets” bit is weak too as we see them manipulated and bent. But my biggest critique of their obsession is that they do not acknowledge the enormous change by the fall in UK Gilt yields which make it so much cheaper to borrow.

Today’s Data

That was then but this is now is the new theme.

Borrowing (public sector net borrowing excluding public sector banks) in September 2019 was £9.4 billion, £0.6 billion more than in September 2018; this is the first September year-on-year borrowing increase for five years.

Actually there was rather a lot going on as you can see from the detail below.

Central government receipts in September 2019 increased by £4.0 billion (or 6.9%) to £61.2 billion, compared with September 2018, while total central government expenditure increased by £4.3 billion (or 6.8%) to £67.6 billion.

As to the additional expenditure we find out more here.

In the same period, departmental expenditure on goods and services increased by £2.6 billion, compared with September 2018, including a £0.9 billion increase in expenditure on staff costs and a £1.6 billion increase in the purchase of goods and services.

The numbers were rounded out by a £1.6 billion increase in net investment which shows the government seems to have an infrastructure plan as well.

It is noticeable too that the tax receipt numbers were strong too as we saw this take place.

Income-related revenue increased by £1.7 billion, with self-assessed Income Tax and National Insurance contributions increasing by £1.1 billion and £0.6 billion respectively, compared with September 2018.

VAT receipts were solid too being up £500 million or 4%. But the numbers were also flattered by this.

Over the same period, interest and dividends receipts increased by £1.6 billion, largely as a result of a £1.1 billion dividend payment from the Royal Bank of Scotland (RBS).

Stamp Duty

We get an insight into the UK housing market from the Stamp Duty position. September was slightly better than last year at £1.1 billion. But in the fiscal year so far ( since March) receipts are £200 million lower at £6.3 billion.

Comment

We find signs that of UK economic strength and extra government spending in September. They are unlikely to be related as the extra government spending will more likely be picked up in future months. If we step back for some perspective we see that the concept of the fiscal taps being released remains.

Over the same period, central government spent £392.4 billion, an increase of 4.5%.

The main shift has been in the goods and services section which has risen by £11.6 billion to £145.7 billion. Of this some £3.5 billion is extra staff costs. Some of this will no doubt be extra Brexit spending but we do not get a breakdown.

As to economic growth well the theme does continue but it also fades a bit.

In the latest financial year-to-date, central government received £366.5 billion in receipts, including £270.0 billion in taxes. This was 2.8% more than in the same period last year.

How strong you think that is depends on the inflation measure you use. It is curious that growth picked up in September. As to the total impact of the fiscal stimulus the Bank of England estimate is below.

The Government has announced a significant increase in departmental spending for 2020-21, which could raise GDP by around 0.4% over the MPC’s forecast period, all else equal.

If we move to accounting for the activities of the Bank of England then things get messy.

If we were to exclude the Bank of England from our calculation of PSND ex, it would reduce by £179.8 billion, from £1,790.9 billion to £1,611.1 billion, or from 80.3% of GDP to 72.2%.

Also it is time for a reminder that my £2 billion challenge to the impact of QE on the UK Public Finances in July has yet to be answered by the Office for National Statistics. Apparently other things are more of a priority.

 

 

The UK government has opened the spending taps

Today we open with some good news as the UK Office for National Statistics has been burning the midnight oil and has come up with this.

The total package of current price GDP improvements increases the size of the economy in 2016 by approximately £26.0 billion, around 1.3% of GDP……Average growth of volume GDP over the period from 1998 to 2016 has been revised up 0.1 percentage point to 2.1% per year.

Actually they have also decided the credit crunch impact was not quite as bad as previously thought.

The peak-to-trough fall of the 2008 economic downturn in GDP has been revised from 6.3% to 6.0% and the UK economy is now estimated to have returned to its pre-downturn levels one quarter earlier in Quarter 1 2013.

Those who can remember back then will recall that it was a period when the labour market data signalled an upturn in the economy a year or so before the output or GDP data. You may recall there were fears of a “triple-dip” back then and from back then ( January 2013) here is Howard Archer in The Guardian.

While we believe the economy is essentially flat at the moment, it is worrying to note that GDP in the fourth quarter of 2012 was 3.3% below the peak level seen in the first quarter of 2008. We suspect that GDP will not return to the level seen in the first quarter of 2008 until the first half of 2015 – a gap of seven years.

As you can the perception is very different now. This takes us back to all of yesterday when we noted that the opening of 2018 in Germany is now thought to be very different to what we think now.

Also there was something to make supporters of nominal GDP targeting follow the advice of Iron Maiden and run for the hills.

 In the decade leading up to the financial crisis, average nominal GDP growth remains unchanged at 5.0%, while there has been a slight upward revision from 3.6% to 3.7% in the period following the financial crisis.

For those unaware there are more than a few around who argue that targeting a nominal GDP growth rate of 5% would produce something of an economic nirvana. The theory is that if we then get the inflation target of 2% per annum then economic growth would be 3%. Or if you prefer Hallelujah we are saved! Meanwhile they got it and the economy then collapsed. You could not make it up. The more subtle point is to wonder if the Bank of England was actually targeting this? This seems unlikely as let’s face it they so rarely hit any target on a consistent basis. Oh and I do not expect this to deter supporters of nominal GDP targeting as there are other problems as you may have already spotted which they choose to look away from.

Also I note that these revisions support my view that the service sector is larger than our statisticians have told us.

Service industries has been revised upwards in both the pre- and post-crisis periods, and accounts for 90% and 85% of total GVA growth in these periods respectively.

If we now move onto today’s news then we see that the consequence of the UK economy being recorded as larger is that our national debt to GDP ratio has been lower than we thought it was. We will have to wait for the full chained volume data set to discover exactly how much.

Also I can specify now something I mentioned before which was the boost to UK GDP by switching from using the RPI to the CPI as it was in the 2011 Blue Book which had average upwards revisions to GDP of 0.23%.

Today’s Data

Let me get straight to the crucial point which is that the spending taps have been opened by the UK government.

Central government receipts in July 2019 decreased by £0.4 billion (or 0.5%) compared with July 2018, to £67.9 billion, while total central government expenditure increased by £4.1 billion (or 6.5%) to £67.6 billion.

Please ignore the receipts numbers for now as I will explain later. But as you can see expenditure has risen again as we saw this in June. Here is some further detail on this.

In the same period, departmental expenditure on goods and services increased by £1.6 billion, compared with July 2018, including a £0.7 billion increase in expenditure on staff.

We need a deeper perspective and it is provided by this.

In the latest financial year-to-date, central government received £246.5 billion in income, including £182.5 billion in taxes. This was 2.3% more than in the same period last year.

Over the same period, central government spent £260.3 billion, an increase of 5.3%.

As you can see in the fiscal year so far the UK government has opened the spending taps. Whilst the report does not explicitly point this out much of the extra spending has been in the areas mentioned above, as we see expenditure on goods and services up by £7.2 billion and staff costs up by £2.4 billion.

This has had a consequence for the deficit as we look at the July and then the fiscal year to date numbers.

Borrowing (public sector net borrowing excluding public sector banks) in July 2019 was in surplus by £1.3 billion, a £2.2 billion smaller surplus than in July 2018; July 2018 remains the highest July surplus since 2000………….Borrowing in the current financial year-to-date (April 2019 to July 2019) was £16.0 billion, £6.0 billion more than in the same period last year; the financial year-to-date April 2018 to July 2018 remains the lowest borrowing for that period since 2002.

Care is needed here because this is much lower than we saw in the past crisis but none the less after a lot of false dawns the UK government seems to be actually fulfiling its promises to spend more.

Receipts

I did promise to address this as they were heavily affected this July by the QE programme of the Bank of England.

This month interest and dividend recipts were down £1.5 billion compared to July 2018. This fall was largely because of a £2.0 billion reduction in dividend transfer from the Bank of England Asset Purchase Facility Fund (BEAPFF) to HM Treasury.

So if we are looking for the impact of the UK economy on the numbers it showed some growth not a fall.

If we were to exclude these transfers, then central government receipts would decrease by £0.6 billion to £67.3 billion in July 2019 and decrease by £2.6 billion to £65.7 billion in July 2018.

Actually there has been an issue this fiscal year as well.

So far in this financial year-to-date (April to July 2019), £3.5 billion in dividends have transferred from the BEAPFF to HM Treasury, compared with £5.9 billion in the same period last year.

So as you can see without this receipts were positive in July and growth in the fiscal year so far was better than the 2.3% quoted. It is curious that the Bank of England numbers are ebbing and flowing because they have the same £435 billion holdings so I will investigate later.

Comment

We see that the UK government has indeed opened the spending taps. How much of it is Brexit driven is hard to say but at least some of it must be. Can we afford it? With a thirty-year Gilt yield just above 1% ( 1.03%) then we certainly can in terms of repayments. The catch is in terms of the national debt and the amount of capital borrowed but in relative terms that has been falling recently.

Debt (public sector net debt excluding public sector banks) at the end of July 2019 was £1,807.2 billion (or 82.4% of gross domestic product, GDP), an increase of £29.6 billion (or a decrease of 1.3 percentage points of GDP) on July 2018.

Whether any extra spending would be well spent is an entirely different matter. But we find ourselves in a position where this time around it is cheap to borrow.

Meanwhile of course these numbers are for a government that has now been mostly removed…..

 

 

 

Will Italy get a 250 billion Euro debt write-off from the ECB?

Up until now financial markets have been very sanguine about the coalition talks and arrangements in Italy. I thought it was something of calm before the storm especially as these days something which was a key metric or measure – bond yields – has been given a good dose of morphine by the QE purchases of the European Central Bank. However here is a  tweet from Ferdinando Guigliano  based on information from the Huffington Post which caught everyone’s attention.

1) Five Star and the League expect the to forgive 250 billion euros in Italian bonds bought via quantitative easing, in order to bring down Italy’s debt.

My first thought is that is a bit small as whilst that is a lot of money Italy has a national debt of 2263 billion Euros or 131.8% of its GDP or Gross Domestic Product according to Eurostat. So afterwards it would be some 2213 billion or 117% of GDP which does not seem an enormous difference. Yes it does bring it below the original 120% of GDP target that the Euro area opened its crisis management with but seems hardly likely to be an objective now as frankly that sank without trace. Perhaps they have thoughts for spending that sort of amount and that has driven the number chosen.

Could this happen?

As a matter of mathematics yes because the ECB via the Bank of Italy holds some 368 billion Euros and rising of Italian government bonds and of course rising. However this crosses a monetary policy Rubicon as this would be what is called monetary financing and that is against the rules and as we are regularly told by Mario Draghi the ECB is a “rules based organisation”. Here is Article 123 of the Lisbon Treaty and the emphasis is mine.

Overdraft facilities or any other type of credit facility with the European Central Bank or with the central banks of the Member States (hereinafter referred to as ‘national central banks’) in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the European Central Bank or national central banks of debt instruments.

Now we hit what Paul Simon would call “troubled water” as the ECB has of course been very close to the highlighted part. The argument for QE purchases rested on the argument that buying in the secondary market was indirect and not direct or as the ECB puts it.

There will be no primary market purchases under the PSPP, regardless of the type of security, as such purchases are not allowed under Article 123 of the Treaty on the Functioning of the European Union.

It is a bit unclear as to when they become available but if I recall correctly as an example the Bank of England limit is one week.

The reason for this is to stop a national government issuing debt and the central bank immediately buying it would be a clear example of round-tripping. The immediate implication would be a higher money supply raising domestic inflation dangers  although there would be an initial boost to the economy. We did look at an example of this a couple of years ago in the case of Ghana and whilst we never get a test tube example in economics the Cedi then fell a substantial amount and inflation rose . Thus the two worrying implications are inflation and a currency plunge on a scale to cause an economic crisis.

Would this happen in the case of Italy? That depends on how it plays out. Inside the boundaries of the Euro maybe not to a  great extent initially but as it played out there would be an effect as Italy would not doubt be back for “More,More,More” once Pandora’s Box was open and of course others would want to get their fingers in the cookie jar.

Oh and if we go back to the concept of the ECB being a “rules based organisation” that is something that is until it breaks them as we have learnt over time.

Fiscal Policy

You will not be surprised to learn that they wish to take advantage of the windfall. Back to the tweets of Ferdinando Guigliano

5) The draft agreement would see the Italian government spend 17 billion euros a year on a “citizens’ income”. The European Commission would contribute spending 20% of the European Social Fund

That raises a wry smile as we mull the idea of them trying to get the European Commission to pay for at least some of this. Perhaps they are thinking of the example of Donald Trump and his wall although so far that has been more of a case of a “Mexicant” than a “Mexican.”

Next came this.

According to , the 5 Star/League draft document says there would be a “flat tax”… but with several tax rates and deductions

So flat but not flat well this is Italy! Also we see what has become a more popular refrain in this era of austerity.

Italy’s pension reform would be dismantled: workers would be able to retire when the sum of their retirement age and years of contribution is at least 100.

Over time this would be the most damaging factor as we get a drip feed that builds and builds especially at a time of demographic problems such as an aging population.

So a fiscal relaxation which would require some changes in the rules of the European Union.

The two parties want to re-open European Treaties and to “radically reform” the stability and growth pact. The coalition would also want to reconsider Italy’s contribution to the EU budget.

Market Response

That has since reduced partly because the German bond market has rallied. Partly that is luck but there is an odd factor at play here. You might think that as the likely paymaster of all this Germany would see its bonds hit but the reality is that it is seen as something of a safe haven which outplays the former factor. On that road it issued some two-year debt yesterday with investors paying it around 0.5% per annum. Also I think there is such a shock factor here that it takes a while for the human mind to take it in especially after all the QE anaesthetic.

The Euro has pretty much ignored all of this as I use the rate against the Yen as a benchmark and it has basically gone “m’eh” as has most of the others so far.

Comment

There are quite a few factors at play here and no doubt there will be ch-ch-changes along the way. But the rhetoric at least has been raised a notch this morning.

We are in favor of a consultative referendum on the euro. It might be a good idea to have two euros, for two more homogeneous economical regions. One for northern Europe and one for southern Europe. ( Beppe Grillo in Newsweek)

I do not that the BBC and Bloomberg have gone into overdrive with the use of the word “populists” as I mull how you win an election otherwise? If we stick to our economics beat this is plainly a response of sorts to the ongoing economic depression in Italy in the Euro era. Also it was only on Monday when the Italian head of the ECB was asking for supra national fiscal policy. For whom exactly? Now we see Italy pushing for what we might call more fiscal space.

Meanwhile if we look wider we see yet more evidence of an economic slow down in 2018 so far.

Japan GDP suffers first contraction since 2015

Very painful for the Japanese owned Financial Times to print that although just as a reminder Japan is one of the worst at producing preliminary numbers.

An expansion of fiscal policy in the Euro area might help to keep Italy in it

After the action or in many ways inaction at the Bank of England last week there was a shift of attention to the ECB or European Central Bank. Or if you prefer from Governor Mark Carney to President Mario Draghi. This is because tucked away in a rather familiar tale from him in a speech in Florence was what you might call parking your tanks on somebody else’s lawn. It started with this.

One is the ECB’s OMTs, which can be used when there is a threat to euro area price stability and comes with an ESM programme. The other is the ESM itself.

Actually rather contrary to what Mario implies Outright Monetary Transactions or OMTs were never required as the ECB instead expanded its bond puchases via the Quantitative Easing programme which is ongoing currently at a flow of 30 billion Euros a month. One might also argue the European Stability Mechanism has caused anything but in Greece however the fundamental point is that via such mechanisms monetary policy has slipped under and over and around the border into fiscal policy. For example after the progress in the coalition talks in Italy the financial media has moved onto articles about the Italian national debt being un affordable when in fact the factor that has made it affordable is/are the 342 billion Euros of it that the ECB has purchased. The Italy of 7% bond yields at the time of the Euro area crisis would not have reached now in the same form whereas the current Italy of around 2% yields has.

But there is more than tip-toeing onto the fiscal lawn below.

So, we need an additional fiscal instrument to maintain convergence during large shocks, without having to over-burden monetary policy. Its aim would be to provide an extra layer of stabilisation, thereby reinforcing confidence in national policies.

As no doubt you have already recognised that particular lawn has been mined with economic IEDs as Mario then implicitly acknowledges.

And, as we have seen from our longstanding discussions, it is certainly not politically simple, regardless of the shape that such an instrument could take: from the provision of supranational public goods – like security, defence or migration – to a fully-fledged fiscal capacity.

The only one of those that is pretty non contentious these days is the security issue and that of course is because of the grim nature of events in that area. However the movement of ECB tanks onto the fiscal lawn continued.

But the argument whereby risk-sharing may help to greatly reduce risk, or whereby solidarity, in some specific circumstances, contributes to efficient risk-reduction, is compelling in this case as well, and our work on the design and proper timeframe for such an instrument should continue.

All of that is true and just in case people missed it then the ECB broadcasted it from its social media feeds as well.

Why has Mario done this?

One view might be that as he approaches the end of his term he feels that he can do this in a way he could not before. Another ties in with a theme of this website which is to use the words of Governor Carney that monetary policy may not be “maxxed out” but there are clear signs of fatigue and side-effects. Mario may well have had a sleepless night or two as he thinks of his own recent words about the Euro area economy.

When we look at the indicators that showed significant, sharp declines, we see that, first of all, the fact that all countries reported means that this loss of momentum is pretty broad across countries. It’s also broad across sectors because when we look at the indicators, it’s both hard and soft survey-based indicators.

Where this fits in with my theme is that this is happening with an official deposit rate of -0.4% and not only an enormously expanded balance sheet but ongoing QE. Thus the sleepless nights will be when Mario wonders what  to do if this also turns out to be ongoing? The two obvious monetary responses have problems as whilst what economists call the “lower bound” has proved to be yet another mirage that is so far and plunging further into the icy cold world of negative interest-rates increases the risk of a dash to cash. The second response which ties in with the issue of policy in Germany is that the ECB is running out of German bunds to buy so firing up the QE operation again is also problematic.

Fiscal Policy

The problem puts Mario on an Odyssey.

And if you’re looking for a way out
I won’t stand here in your way.

In terms of economic theory there is a glittering prize in view here but sadly it only shows an example of what might be called simple minds. This is because at the “lower bound” for interest-rates in a liquidity trap  fiscal policy will be at its most effective according to that theory. So far go good until we note that the “lower bound” has got er lower and lower. There was of course the Governor Carney faux pas of saying it was at 0.5% and then not only cutting to 0.25% but planning to cut to 0.1% before the latter was abandoned but also some argued it was at 0% and of course quite a bit of the world is currently below that.

So Mario is calling for some fiscal policy and as so often all eyes turn to Germany which as I have pointed out before is operating fiscal policy but one heading in the opposite direction as I pointed out on the 20th of November.

Germany’s federal budget  surplus hit a record 18.3 billion euros ($21.6 billion) for the first half of 2017.

This poses various problems as I then pointed out.

With its role in the Euro area should a country with its trade surpluses be aiming at a fiscal surplus too or should it be more expansionary to help reduce both and thus help others?

As you can see Mario is leaving the conceptual issue behind and simply concentrating on his worries for 2018. This of course is standard Euro area policy where changes come in for an emergency and then find themselves becoming permanent. Although to be fair they are far from alone from this as I note that Income Tax in the UK was supposed to be a temporary way of helping to finance the Napoleonic wars.

Comment

This speech may well turn out to be as famous as the “Whatever it takes ( to save the Euro) one. In terms of his own operations Mario has proved to be a steadfast supporter of it but the monetary policy ammunition locker has been emptied. It is also true that it means he has been something of a one-club golfer because the Euro area political class has in essence embraced austerity and left Mario rather lonely. Now his time is running out he is in effect pointing that out and asking for help. Perhaps he is envious of what President Trump has just enacted in the United States.

There are clear problems though. We have been on this road before and it has turned out to be a road to nowhere in spite of many talking heads supporting it. In essence it relies in the backing of Germany and it has been unwilling to allow supranational Eurobonds where for example Italy and Greece could borrow with the German taxpayer potentially on the hook. If anything Germany seems to be heading in the direction of being even more fiscally conservative.

If we look wider we see that at the heart of this is something which has dogged the credit crunch era. If you believe one of the causes of it was imbalances well the German trade surplus has if anything swelled and now it is adding fiscal surpluses to that. Next if we look more narrowly there are the ongoing ch-ch-changes in Mario’s home country Italy. From the Wall Street Journal.

Both parties vowed to scrap or dilute an unpopular pension overhaul from 2011 that steadily raises the retirement age. Economists say the parties’ fiscal promises, if enacted in full, would greatly add to Italy’s budget shortfall, likely breaking EU rules that cap deficits at 3% of gross domestic product. Italy’s public debt, at 132% of GDP, is the EU’s highest after Greece.

So is it to save the Euro or to keep Italy in it?

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
period.

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.

Comment

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