Fiscal Policy will now take centre stage as France has shown

One of our themes is now fully in play. We have observed over the past year or two a shift in establishment thinking towards fiscal policy. This had both bad and good elements. The bad was that it reflected a reality where all the extraordinary monetary policies had proved to be much weaker than the the claims of their supporters and even worse for them were running out of road. The current crisis has reminded us of this as we have had, for example, two emergency moves from the US Federal Reserve already, in its role as a de facto world central bank.

A more positive factor in this has been the change we have been observing in bond yields. We can get a handle on this by looking back at the world’s biggest which is the US Treasury Bond market. Back in the autumn of 2018 when worlds like “normalisation” ans phrases like “Quantitative Tightening” were in vogue the benchmark ten year yield saw peaks around 3.15%. Basically it then spent most of a year halving before rallying back to 1.9% at the end of last year and beginning of this. But this move took place in spite of the fact that we have the Trump Tax Boost which was estimated to have an impact of the order of one trillion US Dollars. I mention this because as well as the obvious another theme was in play which was that the Ivory Towers were wrong-footed yet again. The Congressional Budget Office has had to keep reducing its estimate of debt costs as the rises it expected turned into falls. Also whilst I am on this subject I am not sure this from January is going to turn out so well!

In 2020, inflation-adjusted GDP is projected to grow by 2.2 percent, largely because
of continued strength in consumer spending and a rebound in business fixed investment. Output is
projected to be higher than the economy’s maximum sustainable output this year to a greater degree
than it has been in recent years, leading to higher inflation and interest rates after a period in which
both were low, on average.

Best of luck with that.

Meanwhile we have seen a fair bit of volatility in bond yields but the US ten-year is 0.8% as I type this. Even the long bond ( 30 years) is a relatively mere 1.4%.

Thus borrowing is very cheap and only on Sunday night the US Federal Reserve arrived in town and did its best to keep it so.

 over coming months the Committee will increase its holdings of Treasury securities by at least $500 billion and its holdings of agency mortgage-backed securities by at least $200 billion.

Step Forwards France

There was an announcement yesterday evening by President Macron which was announced in gushing terms by Faisal Islam of the BBC.

The €300 billion euro fiscal support package announced by Macron for the French economy, to ensure businesses dont go bust and taxes/ charges suspended, is worth about 12% of its GDP – in UK terms that would mean £265 billion…

This morning the French Finance Minster has given some different numbers.

French measures to help companies and employees weather the coronavirus storm will be worth some €45bn, the country’s finance minister Bruno Le Maire said on Tuesday. ( Financial Times)

He went on to give some details of how it would be spent.

He told RTL radio the package of financial aid, which includes payments to temporarily redundant workers and deferments of tax and social security bills, would help “the economy to restart once the corona virus epidemic is behind us”. Previously he had referred to “tens of billions of euros”.

Now let us look at the previous position for France. We had previously note that France was in the middle of a fiscal nudge anyway as the first half of 2019 saw quarterly deficits of 3.2% and 3.1% of GDP respectively, The third quarter was back within the Maastricht rules as it fell to 2.5% of GDP but we still had a boost overall and as you can see below the national debt to GDP ratio went over 100%

At the end of Q3 2019, Maastricht’s debt reached €2,415.1 billion, up €39.6 billion in comparison to Q2 2019. It accounted for 100.4% of gross domestic product (GDP), 0.9 points higher than last quarter. Net public debt increased more moderately (€+15.0 billion) and accounted for 90.3 % of GDP.

Of course debt to GDP numbers have gone out of fashion partly because the “bond vigilantes” so rarely turn up these days. There was a time that a debt to GDP ratio above 100% would have them flying in but they restricted their flying well before the Corona Virus made such a move fashionable. The French ten-year yield is up this morning but at 0.27% is hardly a deterrent in itself to more fiscal action. However whilst it is still as low as it has ever been before this stage of the crisis a thirty-year yield of 0.8% is up a fair bit on the 0.2% we saw only last week. Another factor in play is this.

Third, we decided to add a temporary envelope of additional net asset purchases of €120 billion until the end of the year, ensuring a strong contribution from the private sector purchase programmes. ( ECB )

Whilst only a proportion of the buying we can expect monthly purchases of French government bonds to rise from the previous 4 billion Euros or so and accordingly the total to push on from 434.4 billion. Also whilst President Lagarde was willing to express a haughty disdain for “bond spreads” I suspect the former French Finance Minister would be charging to the rescue of France if necessary.

One feature of French life is that taxes are relatively high.

The tax-to-GDP ratio varies significantly between Member States, with the highest share of taxes and social
contributions in percentage of GDP in 2018 being recorded in France (48.4%), Belgium (47.2%) and Denmark
(45.9%), followed by Sweden (44.4%), Austria (42.8%), Finland (42.4%) and Italy (42.0%). ( Eurostat )

Short Selling Bans

France along with some other European nations announced short-selling bans this morning which stop investors selling shares they do not own.

#BREAKING French market regulator bans short-selling on 92 stocks: statement ( @afp )

I pointed out that these things have a track record of failure

These sort of things cause a market rally in the short-term but usually wear off in a day or two.

The initial rally to over 4000 on the CAC 40 index soon wore off and we are now unchanged on the day having at one point being 100 points off. Of course some policy work will be writing a paper reminding us of the counterfactual.

Comment

I am expecting a lot more fiscal action in the next few days. The French template is for a move a bit less than 2% of GDP. That will of course rise as GDP falls.

The French government was assuming the economy would shrink about 1 per cent this year, instead of growing more than 1 per cent as previously predicted, Mr Le Maire said. ( Financial Times)

Frankly that looks very optimistic right now. The situation is fast moving as doe example Airbus which only yesterday expected to remain open announced this today.

Following the implementation of new measures in France and Spain to contain the COVID-19 pandemic, Airbus has decided to temporarily pause production and assembly activities at its French and Spanish sites across the Company for the next four days. This will allow sufficient time to implement stringent health and safety conditions in terms of hygiene, cleaning and self-distancing, while improving the efficiency of operations under the new working conditions.

Let me now shift to the other part of the package.

Mr Le Maire said ammunition to prop up the economy also included €300bn of French state guarantees for bank loans to businesses and €1tn of such guarantees from European institutions. ( FT )

The problem is how will this work in practice? The numbers sound grand but for example the Bank of England announced up to £290 billion for SMEs only last week which everyone seems to have forgotten already! One bit that seemed rather devoid of reality to me at the time was this.

The release of the countercyclical capital buffer will support up to £190bn of bank lending to businesses. That is equivalent to 13 times banks’ net lending to businesses in 2019.

Returning to pure fiscal policy I am expecting more of it and would suggest it is aimed at two areas.

  1. Supporting individuals who through not fault of their own have seen incomes plunge and maybe disappear.
  2. Similar for small businesses and indeed larger ones which are considered vital.

Just for clarity that does not mean for banks and the housing market where such monies have a habit of ending up.

Meanwhile a country which badly needs help is still suffering from the “ECB not here to close bond spreads” of Christine Lagarde last week as its ten-year yield has risen to 2.3%. Her open mouth operation has undone a lot of ECB buying.

The UK is beginning to see its fiscal boost take shape

The mood music has discernably changed for fiscal policy. well apart from Greece which is being forced to run surpluses and to some extent Italy. Many establishments ( the European Central Bank and International Monetary Fund for example) have switched from pressing for austerity to almost begging for fiscal action. If we switch to the UK we see that the same forces at play with the addition of a government that looks like it wants to be fiscally active. Even the BBC has caught on although oddly the example on BBC Breakfast this morning showed the super sewer for London which was planned some years back. Although on the upside it does seem to be a positive example as it is progressing well and seems to be on budget.

UK Gilt Market

Developments here are a major factor in changing the consensus views above and can be taken as a guide to much of the word where Middle of the Road in the 1970s were prescient about future government borrowing.

Ooh wee, chirpy chirpy cheep cheep
Woke up this mornin’ and my momma was gone
Ooh wee, chirpy chirpy cheep cheep
Chirpy chirpy cheep cheep chirp

In terms of economic impact we look at the five-year yield which is 0.45% and the benchmark these days is the ten-year which is 0.57%.As you can see these are low levels and there is a hint in that they are below the Bank of England Bank Rate. Oh and for newer readers who are wondering why I pick out the five-year that is because it influences most of the mortgage market via its impact on foxed-rate ones. But for infrastructure projects for the long-term the relevant yield in my opinion is the fifty-year one which as I have been reporting for a while has been spending some time below 1% and is 0.9% as I type this.

As you can see it is not only historically low but outright low and this is confirmed if we subtract any likely level of inflation to get a real yield. Some of you may recall the economist Jonathan Portes came on here some years back to suggest we should borrow via index-linked Gilts whereas I argued for conventional ones. You know where you stand ( borrowing very cheaply) and do not run an inflation risk.

As you can see this does begin a case for infrastructure investment because the hurdle in terms of financing is low.

Today’s Data

Last month I pointed out that the revenue figures for the UK economy were more positive than the GDP ones and that theme continues.

self-assessed Income Tax receipts in January 2020 were £16.2 billion, an increase of £1.5 billion compared with January 2019; this is the highest January on record (records began in January 2000)

Care is needed as some payments for the income tax season are delayed into February but so far so good. Although it is also true that VAT receipts were flat so we apparently had more income but did not spend it. Also the numbers were boosted by a 991 million Euro fine for Airbus even though it will not be fully paid until 2023 in another example of these numbers being if we are polite, somewhat bizarre.

Switching now to expenditure and continuing the fiscal boost theme there was this.

Departmental expenditure on goods and services in January 2020 increased by £2.1 billion compared with January 2019, including a £0.8 billion increase in expenditure on staff costs and a £1.2 billion increase in the purchase of goods and services.

Also there was this.

The UK contributions to the European Union (EU) in January 2020 were £2.1 billion, an increase of £1.1 billion on January 2019. This increase is largely because of the profile of 2020 payments made to the EU by all member states rather than a reflection of any budgetary increase.

As you can see it will wash out as time passes but for now makes the numbers worse and in total we saw this.

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in January 2020 was in surplus by £9.8 billion, £2.1 billion less of a surplus than in January 2019.

If we now switch to the trend we see this.

Borrowing in the current financial year-to-date (April 2019 to January 2020) was £44.8 billion, £5.8 billion more than in the same period the previous year.

Economic Growth

The number above gives us a flavour of the fiscal boost taking place in the UK but not the full flavour. This is because the improving economy will have meant that the number should be lower. Now we have not had much economic growth but we have seen employment and wages rise. Looking ahead that seems set to continue if this morning’s flash Markit PMI is any guide.

Flash UK Composite Output Index
Feb: 53.3, Unchanged (Jan final: 53.3)

Their view on this seems rather mean of 50 truly is the benchmark of no-growth.

“The recent return to growth signalled by the manufacturing and services PMIs provides a clear indication that the UK economy is no longer flat on its back, with our GDP nowcast pointing to 0.2% growth
through the first quarter of the year.

Also after what happened to the manufacturing PMI in Germany earlier ( a deterioration in supply times believe it or not boosted the index) we need to treat manufacturing PMIs with even more caution.

National Debt

The economic growth situation comes in here too as we look at the numbers.

At the end of January 2020, the amount of money owed by the public sector to the private sector stood at approximately £1.8 trillion (or £1,798.7 billion), which equates to 79.6% of gross domestic product (GDP) (the value of all the goods and services currently produced by the UK economy in a year).

In absolute terms we owe more but in relative terms we owe less.

Though debt has increased by £41.4 billion on January 2019, the ratio of debt to GDP has decreased by 0.7 percentage points, implying that UK GDP is currently growing at a faster rate than debt.

Comment

Today has brought more evidence of the fiscal boost being seen by the UK which is more than the headlines suggest because the deficit would have continued to fall otherwise. In terms of scale the Bank of England has estimated the impact of the boost to be around 0.4% of GDP or around half that deployed by France last year.

There are various contexts of which the first is that it is the QE era and its effect on government bond yields that makes this all look so affordable. That is another reason to match any infrastructure spending with very long-dated Gilts, as otherwise there is a risk should yields rise. Rather curiously some commentators seem to be expecting the return of the “bond vigilantes” in the UK. This would be curious because as a species they seem to be nearly extinct. After all their return would no doubt see even more Bank of England QE purchases. Perhaps these commentators are trying to justify their own past forecasts.

Another context is that the debt continues to pile up and in terms of a capital issue that does matter. For example I think Greece has been an example of this where the size of the debt has weighted down the economy in addition to the austerity. So even though annual costs are low, that is not the only metric we should watch.

 

 

UK tax receipts hint that economic growth is better than GDP tells us

Today the UK Public Finances are in the news and that is before we even get to the data release. This is because there has been a flurry of announcements on transport policy and the railways in particular. According to LBC we should soon get some clarity on out subject from a couple of days ago.

The Transport Secretary said he was making the biggest infrastructure decision taken in the UK in peacetime and promised it in “weeks rather than months”.

Mr Shapps told LBC: “We are nearing the conclusion. I am now in the final stages of gathering all the data together for HS2, so it’s a mega decision for this country.

“It’s maybe the biggest infrastructure project, certainly in Europe, and the biggest this country’s ever taken, certainly in peacetime. So we’ve got to get that right.

Bigger than when the Victorians built the railways? As opposed to one line! Also there were some announcements to help deal with what has been the headliner of the problems with UK railways.

Network Rail is being investigated over its poor service on routes used by troubled train operators Northern and TransPennine Express.

The government-owned firm has been put “on a warning” for routes in the North West and central region of England, the Office of Rail and Road (ORR) said.

The regulator said it was “not good enough” in those areas and was probing Network Rail’s contribution to delays.

Network Rail apologised for “very poor service” in the Midlands and the North. (BBC )

The solution to that problem according to the Transport Minister is to build a new railway for somewhere above £10 billion and in the meantime spend some £2.9 billion on improving the existing line. That is rather vague as it lacks timescales and will we be making improvements just in time to close them? But the issue here for the public finances is that the UK government is more willing to spend than it was. There is also an issue as to why if traffic on these railways has expanded so much why money has not been spent along the way to help it cope? That of course goes much wider as we note energy infrastructure where yet again we see an enormously expensive project after years and indeed decades of little action.

Today’s Data

We open with something against the recent trend.

Borrowing (public sector net borrowing excluding public sector banks, PSNB ex) in December 2019 was £4.8 billion, £0.2 billion less than in December 2018.

Maybe it is just a quirk that we borrowed less as the monthly numbers are volatile. But we do perhaps get a little more from this.

Central government receipts in December 2019 increased by £2.2 billion (or 3.7%) to £62.2 billion, compared with December 2018, while total central government expenditure increased by £1.7 billion (or 2.7%) to £63.9 billion.

As you can see the rise in receipts even if we use the highest inflation measure ( RPI) hints at a better growth rate than we are expecting from the GDP data. This does tie in with the employment and wages numbers we looked at yesterday. But only in a broad sweep because of this.

Central government receipts were boosted by increases in National Insurance contributions (NICs) of £0.5 billion, interest and dividends receipts of £0.3 billion, and across many of the taxes on production (such as Value Added Tax (VAT), tobacco duty and stamp duty) totalling £1.1 billion.

Taxes on income and wealth saw a small reduction (less than £0.0 billion), with an increase in petroleum revenue tax of £0.3 billion being offset by decreases in both Corporation Tax and Income Tax receipts of £0.3 billion and £0.1 billion respectively.

The highlighted part is because after yesterday’s data you might reasonably expect higher income tax payments and I was asked this question yesterday. Yet as you can see we got 0! It may be that due to the changes in the Personal Allowance that the National Insurance numbers are a better measure. So my answer goes from a no, to definitely,maybe.

There is also some awkwardness with the production receipts when we are being told production is struggling and in the latter part of 2019 retail moved from growth to decline. So let us note that these numbers hint at a stronger economy than we otherwise would have thought.

So far you might reasonably be wondering where the fiscal stimulus has gone? Well if you add the number below back in you can see that the deficit number was in fact driven by lower inflation rather than lower general government spending.

Interest payments on the government’s outstanding debt decreased by £1.1 billion, compared with December 2018.

Perspective

If we look back we see stronger signs of a fiscal boost than seen in December alone.

Borrowing in the current financial year-to-date (April 2019 to December 2019) was £54.6 billion, £4.0 billion more than in the same period last year.

Although care is needed as the numbers well they keep seeing ch-ch-changes.

ONS revisions again significantly lowered estimated borrowing in the earlier months of the
financial year. Last month, borrowing was revised down by £5.2 billion for earlier months while
this month’s release reduced borrowing by a further £1 billion.  The ONS has also revised down 2018-19 borrowing by £3.3 billion in this month’s release. ( OBR last month)

Assuming the numbers are accurate we see that the rise in borrowing so far this year has not only been caused by more spending but also by weakish receipts.

In the current financial year-to-date, central government receipts grew by 2.3% on the same period last year to £548.2 billion, including £402.7 billion in tax revenue.

On that road we see again a hint of a pick-up in the economy in December.

The National Debt

This turns out to be a complex issue and the simple version is this.

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of December 2019 was £1,819.0 billion (or 80.8% of gross domestic product, GDP); this is an increase of £35.5 billion (or a decrease of 0.9 percentage points) on December 2018.

Actually the Bank of England managed to make things even more complex as one of its bank subsidies ended up boosting the national debt.

Debt at the end of December 2019 excluding the Bank of England (BoE) (mainly quantitative easing) was £1,644.2 billion (or 73.0% of GDP); this is an increase of £48.0 billion (or a decrease of 0.1 percentage points) on December 2018.

Actually it was the Term Funding Scheme which was badly designed rather than QE as the release seems to realise later.

The introduction of the Term Funding Scheme (TFS) in September 2016 led to an increase in public sector net debt (PSND), as the loans provided under the scheme were not liquid assets and therefore did not net off in PSND (against the liabilities incurred in providing the loans). The TFS closed for drawdowns of further loans on 28 February 2018 with a loan liability of £127.0 billion.

Unfortunately I seem to be the only person who ever calls out the Bank of England about this.

Comment

There are three lessons from today’s numbers. The first is that there is an ongoing fiscal boost especially if we allow for the impact of lower debt costs via lower inflation ( RPI). Next we again see a hint of the UK economy being stronger than indicated by economic output or GDP if December’s receipts data are to be relied upon. However and thank you to Fraser Munro of the Office for National Statistics for replying there is always doubt as the December income tax receipts are a forecast rather than a known number.

PAYE in December is based on HMRC’s cash forecast for January so we could see a revision next month.

So the truth is that the numbers are a rather broad brush and on that theme let me end with some national debt numbers which are internationally comparable.

General government gross debt was £1,821.9 billion at the end of the financial year ending March 2019, equivalent to 84.0% of gross domestic product (GDP) and 24.0 percentage points above the reference value of 60.0% set out in the protocol on the excessive deficit procedure.

Me on The Investing Channel

 

Is the US fiscal stimulus working?

One of the problems of economics is that reality rarely works out like theory. Indeed it is rather like the military dictum that tells us that a battle plan rarely survives first contact with the enemy. However we are currently seeing the world’s largest economy giving us a worked example of the policy being pushed by central bankers. Indeed it rushed to do so as we look back to the Jackson Hole symposium in the summer of 2017.

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.

Back on August 29th of that year I noted a paper presented by Alan Auerbach and Yuriy Gorodnichenko which went on to tell us this.

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.

Since then those two voices have of course been joined by something of a chorus line of central bankers and their ilk. But there was somebody listening or having the same idea as in short order Donald John Trump announced his tax cuts moving us from theory to practice.

Where are we now?

Led me hand you over to CNBC from two days ago.

The U.S. fiscal deficit topped $1 trillion in 2019, the first time it has passed that level in a calendar year since 2012, according to Treasury Department figures released Monday.

The budget shortfall hit $1.02 trillion for the January-to-December period, a 17.1% increase from 2018, which itself had seen a 28.2% jump from the previous year.

There is a sort of back to the future feel about that as the US returns to levels seen as an initial result of the credit crunch. If we look at the US Treasury website it needs a slight update but gives us an overall picture.

Year-end data from the September 2019 Monthly Treasury Statement of Receipts and Outlays of the United States Government show that the deficit for FY 2019 was $984 billion, $205 billion higher than the prior year’s deficit[3]. As a percentage of GDP, the deficit was 4.6 percent, an increase from 3.8 percent in FY 2018.

So the out-turn was slightly higher but we see something a little awkward. If the US economy was booming as the Donald likes to tell us why was their a deficit in the first place and why is it rising?

We see that on the good side revenues are rising.

Governmental receipts totaled $3,462 billion in FY 2019. This was $133 billion higher than in FY 2018, an increase of 4.0 percent,

But outlays have surged.

Outlays were $4,447 billion, $339 billion above those in FY 2018, an 8.2 percent increase.

Economic Growth

Three, that’s the Magic Number
Yes, it is, it’s the magic number
Somewhere in this hip-hop soul community
Was born three: Mase, Dove and me
And that’s the magic number

It turns out that inadvertently De La Soul were on the ball about the economic growth required to make fiscal policy look successful. So there was method in the apparent madness of President Trump proclaiming that the US economy would grow at an annual rate of 3% or more. In doing so he was mimicking the numbers used in the UK,for example, after the credit crunch to flatter the fiscal outlook. Or a lot more bizarrely ( the UK does at least occasionally grow by 3%) by the current coalition government in Italy.

Switching now to looking at what did happen then as 2018 progressed things looked okay until the last quarter when the annualised growth rate barely scraped above 1%. A brief rally back to target in the opening quarter of last year was followed by this.

Real gross domestic product (GDP) increased at an annual rate of 2.1 percent in the third quarter of 2019 (table 1), according to the “third” estimate released by the Bureau of Economic Analysis. In the second quarter, real GDP increased 2.0 percent. ( US BEA )

If we now move forwards there is this.

The New York Fed Staff Nowcast stands at 1.1% for 2019:Q4 and 1.2% for 2020:Q1.

News from this week’s data releases decreased the nowcast for 2019:Q4 by 0.1 percentage point and left the nowcast for 2020:Q1 broadly unchanged.

Negative news from international trade data accounted for most of the decrease.

Should this turn out to be accurate then it will be damaging for the deficit because the revenue growth we observed earlier ( 4%) will fade. There is a risk of the deficit ballooning should things weaken further and outlays rise to to social spending and the like if the labour market should turn.So far it has only signalled a slowing of real wage growth.

Cost of the debt

A rising fiscal deficit means that the national debt will grow.

As deficits have swelled, so has the national debt, which is now at $23.2 trillion. ( CNBC )

Or as the Congressional Budget Office puts it.

Debt. As a result of those deficits, federal debt held by the public is projected to grow steadily, from 79 percent of GDP in 2019 to 95 percent in 2029—its highest level since just after World War II. ( care is needed here as it only counts debt held by the public not the total)

But as I pointed out back in August 2017 the baying pack of bond vigilantes seem soundly muzzled these days.

 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.

So as a consequence we find ourselves in an era of “Not QE” asset purchases and more importantly for today’s purposes a long bond ( 30 year) yield of 2.25% or less than half of what it was at times in 2011. So the debt has grown but each unit is cheap.

The government’s net interest costs are also anticipated to
grow in 2019, increasing by $47 billion (or 14 percent),
to $372 billion.

This means that the total costs are much lower than would have been expected back in the day.

Comment

Has it worked? Party so far in that the economic outcome in the US was better than that in the UK, Europe and Japan. But the “winning” as President Trump likes to put it faded and now we see that economic growth at an expected just over 1% is rather similar to the rest of us except the fiscal deficit and national debt are higher. So whilst it was nice now we look ahead to a situation where it could become a problem. I do not mean in the old-fashioned way of rising bond yields because let’s face it “Not QE” would become “Not bond buying” to get them back lower.

But if you keep raising the debt you need economic growth and should the present malaise continue then the US will underperform the CBO forecasts which expect this.

After 2019, consumer spending and purchases of goods and services by federal, state, and local governments
are projected to grow at a slower pace, and annual output growth is projected to slow—averaging
1.8 percent over the 2020–2023 period—as real output returns to its historical relationship with
potential output.

There is also another problem which the CBO has inadvertently revealed showing that the certainty with which some speak is always wrong.

The largest factor contributing to that change
is that CBO revised its forecast of interest rates downward, which lowered its projections of net interest
outlays by $1.4 trillion.

So the fiscal stimulus has helped so far but now the hard yards begin and they will get a lot harder in any further slow down. In the end it is all about the economic growth.

The Investing Channel

 

 

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.

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.

 

 

My thoughts on the IFS Green Budget for the UK

Today we find that the news flow has crossed one of the major themes that I have established on here. It is something we looked at yesterday as we mulled the debt and deficit issues in Japan where the new “consensus” on public finances has been met by Japan doing the reverse. So let me take you to the headlines from the Institute for Fiscal Studies for the UK.

A decade after the financial crisis, the deficit has been returned to normal levels, but debt is at a historical high. The latest estimate for borrowing in 2018–19, at 1.9%
of national income, is at its long-run historical average. However, higher borrowing during the crisis and since has left a mark on debt, which stood at 82% of national
income, more than twice its pre-crisis level.

There are several issues already of which the first is the use of “national income” as they switch to GDP later. Next concepts such as the one below are frankly quite meaningless in the credit crunch era as so much has changed.

at its long-run historical average

This issue gets worse if we switch from the numbers above which are a very UK style way oh looking at things and use more of an international standard.

general government deficit (or net borrowing) was £41.5 billion in the FYE March 2019, equivalent to 1.9% of GDP

general government gross debt was £1,821.9 billion at the end of the FYE March 2019, equivalent to 85.3% of GDP…  ( UK ONS)

As you can see the deficit is the same but the national debt is higher. In terms of the Maastricht Stability and Growth Pact we are within the fiscal deficit limit by 1.1% but 25.3% over the national debt to GDP target.

What will happen next?

The IFS thinks this.

Given welcome changes to student loan accounting, the spending increases announced at the September Spending Round, and a likely growth downgrade (even assuming a smooth Brexit), borrowing in 2019–20 could be around
£55 billion, and still at £52 billion next year. Those figures are respectively £26 billion and £31 billion more than the OBR’s March 2019 forecast. Both exceed 2% of national
income.

It is hard not to have a wry smile at the way my first rule of OBR ( Office for Budget Responsibility) Club which is that it is always wrong! You will not get that from the IFS which lives in an illusion where the forecasts are not unlike a Holy Grail. Next comes the way that the changes to student loans are used to raise the number. If we step back we are in fact acknowledging reality as there was an issue here all along it is just that we are measuring it now. So it is something we should welcome and not worry too much about. This year has seen growth downgrades in lots of countries and locales as we have seen this morning from the Bank of Italy but of course the IFS are entitled to their view on the consequences of any Brexit.

Next the IFS which has in general given the impression of being in favour of more government spending seems maybe not so sure.

A fiscal giveaway beyond the one announced in the September Spending Round could increase borrowing above its historical average over the next five years.
With a permanent fiscal giveaway of 1% of national income (£22 billion in today’s terms), borrowing would reach a peak of 2.8% of GDP in 2022–23 under a smooth-Brexit
scenario, and headline debt would no longer be falling.

Actually assuming they are correct which on the track record of such forecasts is unlikely then we would for example still be within the Maastricht rules albeit only just. You may note that a swerve has been slipped in which is this.

headline debt would no longer be falling

As an absolute amount it is not falling but relatively it has been as this from the latest official Public Finances bulletin tells us.

Debt (public sector net debt excluding public sector banks, PSND ex) at the end of August 2019 was £1,779.9 billion (or 80.9% of gross domestic product, GDP), an increase of £24.5 billion (or a decrease of 1.5 percentage points of GDP) on August 2018.

Next if we use the IFS view on Brexit then this is the view and I note we have switched away from GDP to national income as it continues a type of hokey-cokey in this area.

Even under a relatively orderly no-deal scenario, and with a permanent fiscal loosening of 1% of national income, the deficit would likely rise to over 4% of national income in 2021–22 and debt would climb to almost 90% of national income for the first time since the mid 1960s. Some fiscal tightening – that is, more austerity – would likely be required in subsequent years in order to keep debt on a sustainable path.

The keep debt on a sustainable path is at best a dubious statement so let me explain why.

It is so cheap to borrow

As we stand the UK fifty-year Gilt yield is 0.85% and the ten-year is 0.44% and in this “new world” the analysis above simply does not stand up. Actually if we go to page six of the report it does cover it.

Despite this doubling of net debt, the government’s debt interest bill has remained flat in real terms as the recorded cost of government borrowing has fallen. As shown in Figure 4.3, in 2018–19, when public sector net debt exceeded 80% of national income, spending on debt interest was 1.8% of national income, or £37.5 billion in nominal terms. Compare this with 2007–08, when public sector net debt was below 40% of national income but spending on debt interest was actually higher as a share of national income, at 2.0%.

As you can see we are in fact paying less as in spite of the higher volume of debt it is so cheap to run. Assuming Gilt yields stay at these sort of levels that trend will continue because as each Gilt matures it will be refinanced more cheaply. Let me give you an example of this as on the 7th of last month a UK Gilt worth just under £29 billion matured and it had a coupon or interest-rate of 3.5%. That will likely be replaced by something yielding more like 0.5% so in round numbers we save £870 million a year. A back of an envelope calculation but you get the idea of a process that has been happening for some years. It takes place in chunks as there was one in July but the next is not due until March.

The role of the Bank of England

Next comes the role of the Bank of England which has bought some £435 billion of UK debt which means as we stand it is effectively interest-free. To be more specific it gets paid the debt interest and later refunds it to HM Treasury. As the amount looks ever more permanent I think we need to look at an analysis of what difference that makes. Because as I look at the world the amount of QE bond buying only seems to increase as the one country that tried to reverse course the United States seems set to rub that out and the Euro area has announced a restart of it.

Indeed there are roads forwards where the Bank of England will engage in more QE and make that debt effectively free as well.

There are two nuances to this. If we start with the “QE to infinity” theme I do nor agree with it but it does look the most likely reality. Also the way this is expressed in the public finances is a shambles as only what is called “entrepreneurial income” is counted and those of you who recall my £2 billion challenge to the July numbers may like to know that our official statisticians have failed to come up with any answer to my enquiry.

Comment

I have covered a fair bit of ground today. But a fundamental point is that the way we look at the national debt needs to change with reality and not stay plugged in 2010. Do I think we can borrow for ever? No. But it is also true that with yields at such levels we can borrow very cheaply and if we look around the world seem set to do so. I have written before that we should be taking as much advantage of this as we can.

https://notayesmanseconomics.wordpress.com/2019/06/27/the-uk-should-issue-a-100-year-bond-gilt/

Gilt yields may get even lower and head to zero but I have seen them at 15% and compared to that we are far from the literal middle of the road but in line with their biggest hit.

Ooh wee, chirpy chirpy cheep cheep
Chirpy chirpy cheep cheep chirp

The caveat here is that I have ignored our index-linked borrowing but let me offer some advice on this too. At these levels for conventional yields I see little or no point in running the risk of issuing index-linked Gilts.