Economics

Chris Cook

The Office for Budget Responsibility is going to irritate lots of people this week. When it comes out with its assessment of the Budget, its multipliers and assumptions will come under attack. After years now (years!) of phoney arguments about the deficit, this will be A Good Thing. Indeed, all the Labour leadership candidates should embrace the new institution.

First, it should improve the credibility of the fiscal framework. No Briton can credibly claim that any fiscal rules could have any real disciplining effect: only an institution that can nip at the government can do that now. This framework offers the golden combination of clear red lines for governments and the flexibility to respond to as-yet-unforeseen economic circumstances.

Second, farming out forecasting should improve the quality of projections that inform fiscal decisions. As an excellent Social Market Foundation pamphlet puts it, an independent forecaster would help overcome some problems with internal forecasting:

  • Organisational bias in projection-making: promotion, reward and status may be linked - most likely implicitly – potentially excluding valuable contrarian opinions from influencing fiscal projections. This effect may be particularly strong if fiscal decision-makers have significant powers over the institution. Indeed, academic research has shown that in several European countries, official growth forecasts used for fiscal policymaking are biased toward being over-optimistic.
  • Policymakers risk being subject to group-think where all elements of fiscal policymaking are housed in the same institution with no institution charged with an “official challenge” role. For example a shared belief in what is actually unsustainable growth may be self-reinforcing and amplified if all the functions of a fiscal policymaking are combined in the same institution.
  • When combined with the credibility associated with longstanding institutions, such as that of HM Treasury, this can also lead to another behavioural economic phenomenon known as anchoring, whereby other, non-governmental organisations take the cue for their economic forecasts from HM Treasury. This is particularly likely to occur since no institution wishes to stand out against received wisdom: for any independent forecaster it is far less reputationally damaging to be wrong with everyone else than to be wrong on their own.

At the moment, being seen to have credible forecasts is particularly worthwhile: investors have, in recent months, fixated on suspect growth forecasts. But all of those benefits rely on the OBR actually becoming independent – something it currently is not.

The body – now established on an interim basis – is a Whitehall beast. Sir Alan Budd, OBR chief pro tem, leads a team of Treasury lifers, based in the Treasury, running Treasury models. This is all forgiveable: the apparatus was set up rapidly and has yet to find its feet.  It is important, however, that it does not become a permanent feature of the OBR.

The most important aspect of the institution’s independence is staffing. OBR staff cannot be borrowed from the chancellor, going back to the Treasury at the end of a stint at the slide-rule. Otherwise they will still be creatures of their political masters. The OBR needs its own recruitment stream. (I’m sure George Osborne will be alive to this issue: he has long had an interest in the independence of Bank of England monetary policy committee members.)

As David Miliband has written, the OBR should, moreover, answer to parliament – not to the Treasury. Furthermore, MPs and peers should be allowed to submit written questions to the institution and it should be ultra-transparent.

Chris Cook

The new UK government, which will present its first Budget next Tuesday, has pledged to learn its lessons from the retrenchment in Canada between 1994 and 2000. Good for them: Paul Martin did much right.  He realised that, if you are going to rein in a colossal structural deficit, you need a wide consensus. The Canadian regime has also recognised that consolidation requires you to cut where the fat is. It did not salami-slice every budget, but went for where there were savings to be found.

But the Ottawan lesson only goes so far. As Paul Krugman says, it doesn’t help the UK with the macroeconomics of cutting. Its retrenchment took place as the US was booming. The political pain of cutting would have been much higher, the process much more difficult and the results less successful if its giant cousin to the south hadn’t had its nose in the punchbowl.

Britain is going to cut its deficit in what will probably be a weak neighbourhood. German manufacturing has been roaring, but the eurozone is weak and vulnerable. The whole continent’s states are tightening their belts. So while the weak pound might help the UK build market share, the market might be sickly. George Osborne’s confidence that Britain can grow while consolidating looks like hubris.

So what is to be done? Well, the chancellor of the exchequer should press ahead with his ambition to rein in the structural deficit. I don’t really want the government spending more on pay and pensions to prop up output. Stimulus needs to be temporary programmes that come to a defined end. Raising structural spending, only to slash it when the economy recovers, is bonkers. So Mr Osborne should work out temporary packages to offset the deflationary effects of his structural cutting.

The FT has come to the view that Mr Osborne needs to prepare stimulus measures, and so has Martin Wolf. In his open letter to George Osborne, he asked the chancellor:

Are you going to stand by if the economy goes into a steep decline? … In such circumstances, the most effective instrument might be central bank financing of additional public spending. But your commitment to pre-programmed spending cuts would seem to rule this out. The alternative might be a temporary reduction in taxes, of the kind you condemned under the previous government. In any case, the UK should have a plan for growth of nominal demand at a rate of 6 per cent and preferably more, for some years. Who is to take responsibility for this and how?

There are major attractions to setting out plans for stimulus measures now. Moving towards a clearer rule-based system for discretionary fiscal policy would make it possible to take stimulatory action without spooking holders of gilts. You can make sure they’re ready to go where they’re needed. The Treasury should compile a list of names and addresses to which it could post cheques. In case the UK’s troubles are longer-term, the finance ministry should prepare a list of infrastructure projects it would like to build.

Setting out such contingency plans would require a bit of political bravery. Mr Osborne would be the first chancellor to admit that he is not, in fact, in charge of the economy and not its master. He would be required to admit there is uncertainty in the world and limits to his powers and foresight.

Now that would be new politics.

James Mackintosh

Nouriel Roubini built his reputation, and that of his Roubini Global Economics consultancy (RGE), on his gloomy, but accurate, predictions of financial doom. He isn’t always right though; and the decision by RGE to publish a call for a military overthrow of the democratic Brazilian government is clearly a mistake.

Ricardo Amaral, a Brazilian economist, pulls no punches in an article on the RGE web site (EDIT: RGE has taken the post down. Here’s the Google cache of the article):

I am suggesting that the military should seize power again in Brazil through a coup d ‘état, because we all know that this massive crime problem that is devastating the Brazilian population can’t be solved under a democratic system of government, and because of the actions that have to be taken to bring peace to all neighborhoods in Brazil. It is time for a benevolent military dictator to take power in Brazil and get the job done.

Mr Amaral even recommends General Augusto Heleno Ribeiro Pereira, commander of the UN Stabilisation Mission in Haiti, as a possible candidate.

This comes after hagiographies of the last three “benevolent dictators” of Brazil, who he credits with laying the groundwork for Brazil’s economic success.

Under the dictatorship of a civilian politician, and later under the dictatorship of the military important economic changes were adopted and implemented in Brazil that planted the seeds for long-term Brazilian economic prosperity.

So who is Mr Amaral? It turns out he’s a direct descendant of José Bonifácio de Andrada e Silva, Brazil’s “patriarch of independence” – and Mr Amaral’s first example of a benevolent dictator, although technically he was minister under the then Prince Regent. Mr Amaral wrote a book about him: “Jose Bonifacio de Andrada e Silva – The Greatest Man in Brazilian History”.

Would Mr Amaral take a post in a new military government? No idea. But here’s what he says in his biography:

Mr. Amaral is a member of the two most politically influential families in Brazilian history the “Andrada Family” and the “Souza Queiroz” – The “Andrada Dynasty” in Brazil is still alive and well, and in the last 200 years we had more than 50 members of our family who were Prime Ministers, Finance Ministers, Secretary of various branches of government, state Governors, Mayors, Attorney General, various Ambassadors, and so on.

It is worth highlighting that RGE explicitly distances himself from anything written for its Economonitor web site, which aims to reflect different views; a sort of online op-ed page. From personal experience I can say it is often hard to convince readers that opinions expressed on the FT op-ed page are not necessarily the opinions of the newspaper; it will be harder still for an economic consultancy to pull that off. One has to wonder how welcome Mr Roubini will be in Brasilia from now on.

James Mackintosh

The campaign to persuade the British people that they the banks should pay a new tax is backed by charities – but it is funded by them too.

A smart (but rather offensive) reader of Guido Fawkes looked up the “Robin Hood Tax” campaign’s web site, and found that Comic Relief, the charity behind the country’s much-loved Red Nose campaign, had paid for it.

I happen to think the tax is a bad idea, but I accept that plenty of very clever people would like to see it implemented. Whatever your views on the tax, it is reasonable to ask whether this is an appropriate way to spend charity money – even if it is only a small amount of money.

James Mackintosh

Moving on from poetry to rap, this should be amusing for economists, if a little long. (h/t Greg Mankiw) It includes the lyric “Prepare to get schooled in my Austrian perspective”!

James Mackintosh

Barack Obama has decided to side with a state solution, if not yet a well-thought-out one, to preventing bank failures bringing down the world economy. But there is a market alternative: fix the banks so the bondholders keep bank risk-taking under control – and bear the costs if they fail in that task.

This important debate is not being framed as a state vs market discussion, but it should be. Remember state control has a dismal record in general, and in the finance sector in particular. Regulators entirely missed the bubble, missed the banks’ reliance on short-term financing and missed the fact that so much regulatory arbitrage was going on. Don’t expect things to be much different in 20 years if a state solution is accepted.

The problem is the banks (and potentially non-banks) being too big to fail, creating perverse incentives to take risks and leaving the taxpayer paying for mistakes. The state solution accepts banks are too big, but tries to control that through regulations, restrictions on what they can do (no prop trading or hedge funds), and potentially a cap on size.

A working market solution would obviously be better, as it would be pretty much immune to the high likelihood of regulatory capture – but can a market solution be made to work? I think so.

James Mackintosh

So you’re back in the stock market, thinking about a bigger house and preparing for the thrill of paying a whole new round of taxes on your bonus? Stop. Be afraid. It isn’t just that we’re back in a bubble, that soaring government debt is going to push up interest rates in the US and UK, that investors are making the exact same mistakes as before the crisism, or that yet another round of US house price falls is being predicted. According to a series of doom-mongers, civilisational breakdown may not be far away.

Paul Farrell at MarketWatch has produced an excellent round-up of the most apocalyptic forecasts from mainstream gloomsters. Most are about the likelihood of a double-dip recession/depression, but two go further:

11. Biggs: Sell everything, buy guns, food, head for the hills
In his 2008 bestseller “Wealth, War and Wisdom” former Morgan Stanley research guru Barton Biggs warns us to prepare for a “breakdown of civilization … Your safe haven must be self-sufficient and capable of growing some kind of food … It should be well-stocked with seed, fertilizer, canned food, wine, medicine, clothes, etc … A few rounds over the approaching brigands’ heads would probably be a compelling persuader that there are easier farms to pillage.” Biggs sounds like an anarchist militiaman.

12. Diamond: Nations ignore obvious till it’s too late, then collapse
The end will be swift. In our age of short-term consumerism and instant gratification, few hear the warnings of our favorite evolutionary biologist, Jared Diamond. Societies fail because they’re unprepared, will be in denial till it’s too late: “Civilizations share a sharp curve of decline. Indeed, a society’s demise may begin only a decade or two after it reaches its peak population, wealth and power.”

The BBC is helping to dampen the general economic mood further, showing John Wyndham’s apocalyptic Day of the Triffids over Christmas to scare viewers, and starting a new series of Survivors, its post-flu survivalist show guaranteed to have watchers thinking about buying farms and guns (not to mention Tamiflu). Perhaps now is a good time to re-read the excellent FT holiday piece by Bryan Ward-Perkins about how much worse a civilisational collapse would be today, compared to the 800-year recession of the Dark Ages.

James Mackintosh

Excellent rant by Pimco’s Bill Gross today against the broken Washington political system. Gross, who runs the world’s biggest mutual fund and whose words on government solvency are closely watched by the markets, loses his rag over the failure of politicians to pass sensible legislation, overcome special interests or do anything other than raise money for their own campaigns. A selection:

Our government doesn’t work anymore, or perhaps more accurately, when it does, it works for special interests and not the American people

What most politicians apparently are working for is to perpetuate their power – first via district gerrymandering, and then second by around-the-clock campaigning financed by special interest groups

What amazes me most of all is that politicians can be bought so cheaply. Public records show that combined labor, insurance, big pharma and related corporate interests spent just under $500 million last year on healthcare lobbying (not much of which went to politicians) for what is likely to be a $50-100 billion annual return

He’s not wrong. The system is clearly fixed to ensure representative democracy works for the benefit of the representatives, rather than the voters. But it has been ever thus; remember, before 1974 there was no Federal Elections Commission. The Union Pacific Railroad and Credit Mobilier offered straight bribes to Congressmen to grant land for the first transcontinental railway, 140 years ago; today the healthcare lobby has to channel its payments through PACs, but the outcome is much the same (potentially the regulation actually makes it cheaper to bribe Congress, by reducing the competition!).

Gross, though, is not one of the world’s premier money managers for nothing. After his extended rant at the deficiencies of Congress, he moves on to a sober discussion of government borrowing. He predicts the Fed could “exit” from its quantitative easing moves by March – following the partial exit already agreed – and that over the next several years, the US, UK and Japan will see rises of about 1 percentage point in interest rates relative to Germany. Conclusion? Buy bunds and sell gilts sounds like the obvious answer. But Gross goes a lot further – and it is doesn’t make for a nice vision for investors:

if exit strategies proceed as planned, all U.S. and U.K. asset markets may suffer from the absence of the near $2 trillion of government checks written in 2009. It seems no coincidence that stocks, high yield bonds, and other risk assets have thrived since early March, just as this “juice” was being squeezed into financial markets

Perhaps the answer is for Gross to put some money into K Street lobbying. After all, according to a study reported by the Washington Post last year, corporate “investments” in lobbying yielded returns of 22,000 per cent – not bad, if you can overcome your moral scruples.

James Mackintosh

Bad as the past two years have been, are we better off with unfettered “casino capitalism” than with the plethora of regulations and controls the world is now heading towards? The idea is little short of heresy; even advocates of free markets believe the system was broken before the crash (although their solution would be to remove the problem of banks being too big to fail, having an implicit government guarantee, rather than to wrap them in red tape).

Today, though, Alistair Darling, British chancellor, reduced the UK’s estimate of losses from supporting the banks from £50bn to £10bn. Of course, we’ve all become a bit blasé about the size of these numbers; £10bn is still a lot of money (£400 a household); but it is far less serious than we thought. And as this chart from a Martin Wolf column on deregulation shows, the UK and US, with their deregulated economies, grew far faster than Germany, France or – of course – Japan during the past decade, and remain far better off, even after large falls.

Hence the thought: even assuming terrible growth over the next few years in the US and UK as we deal with the burden of our debt overhangs, might we be better off accepting bubbles and an occasional economic implosion than we would be trying to regulate and control?

I suspect this is not the case; choosing to rebase this chart to 1980, instead of 1990, would have shown the Japanese economy apparently doing brilliantly as it lived through its own bubble years. And while going from £50bn to £10bn of losses is great, the fiscal deficit does not just consist of banking losses. If we now have 10 years of deep economic pain, as seems eminently possible, the smoothed growth of France or Germany may appeal. But if the Anglo-Saxon capitalist countries manage to keep growing, just at a slower rate, maybe this would be worth further investigation.

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Politics, economics, high finance and morality – this blog addresses the issues being considered by the FT’s comment team, and their thoughts.

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Christopher Cook is an FT editorial writer. Before joining the FT in 2008 as a Peter Martin Fellow, he worked for three years for the Conservative party.

Lorien Kite is deputy comment editor, a post he took up in 2009 after four years as a commissioning editor on the analysis page. He joined the FT in 2000.

Ian Holdsworth became assistant features editor in 2009 and was previously chief production journalist for the features pages.


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