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.
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
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
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?
The fiscal numbers quoted by Mario Draghi were on this basis.
Average cyclically adjusted primary balance as a percentage of potential GDP