Anyone who has read my posts regularly will know that I am not a huge fan of calculations of the structural deficit. I have accused people who put too much weight on the numbers to be suffering from “structural deficits disease“. I have criticised the establishment of the Office for Budget Responsibility on the grounds that it would one day get into a fight with government on the (unknowable) amount of spare capacity in the economy. I have noted how weird the OBR’s initial forecast was once you looked beyond the headlines.
I would prefer to consign calculations of structural deficits to a dustbin. Unfortunately, this cannot be done because the coalition decided to place the current structural budget deficit at the heart of its fiscal policy. It promised to eliminate this deficit during this Parliament. The promise is actually a bit more complicated than that, but as far as the public were told, the deficit that mattered would be gone by the time they next came to vote.
Five interesting things arise from the Financial Times analysis of structural deficits this morning, which show the likely structural deficit to be significantly worse because the OBR’s estimate of spare capacity looks too high. If the OBR were to revise spare capacity down to levels that seem more plausible now, it would have to revise down growth rates into the medium term (and revise up deficits) because the scope for catch-up growth is much lower.
Here are my five new thoughts on the matter.
1. Are the calculations nuts? Read more
The Institute for Fiscal Studies, along with Barclays, are currently presenting their annual fiscal forecasts and Budget judgement. Most of the central headlines are comforting to the government. The economists think that on the basis of the official economic forecasts, the public finances are broadly on track – the hole in the public finances will be closed by 2015 or so.
The concern is that all the risks seem to be on the downside relative to official forecasts.
There are good reasons to worry that the economy might be hit harder from austerity than the Office for Budget Responsibility thinks, such as the difficulty the Bank of England will have in offsetting tight fiscal policy with loose monetary policy. Consumers are being hit hard from high import prices squeezing incomes. UK investment rarely bounces back sharply from recessions. And export performance has been disappointing and we don’t really know why. Read more
Today’s UK GDP shocker once again raises the question of whether the rapid, pre-announced tightening of fiscal policy underway in Britain is wise. But at least one new academic paper suggests that chancellor George Osborne has it right.
Ignazio Angeloni and colleagues at the Kiel Institute for the World Economy run fairly comprehensive simulations on exit strategies from crisis fiscal and monetary policies and conclude: Read more
Greece is poised to accept tough conditions, including widespread job cuts and labour market reforms, in order to secure the third and fourth loan tranches of its €110bn bail-out by the European Union and the International Monetary Fund. George Papaconstantinou, finance minister, said on Monday the socialist government tried “to preserve the country’s interests as best we could,” in discussions with the “troika” – representatives of the European Commission, European Central Bank and the Fund.
The troika’s latest monitoring mission came amid rising concern in Athens that a future transfer might be blocked – a move that could trigger an immediate default and a disorderly restructuring of Greece’s €340bn sovereign debt. “It’s a difficult negotiation every time . . . bearing in mind that the next loan tranche is at risk,” Mr Papaconstantinou said. Read more
Today’s public finances figures show net borrowing roughly on track to reach the Budget forecast for the deficit in 2010-11, as the chart shows.
This should be good news as persistent slippage on the public finances has stopped and the very early evidence shows the consolidation is roughly on track.
But because of the dotty way the Treasury and Office for Budget Responsibility have looked at the public finances in the past, this is not good enough. In fact, on plausible assumptions, we need another £5bn of tax rises or spending cuts a year to meet the fiscal mandate of eliminating the current “structural” budget deficit within five years.
Why is good news actually bad in the weird world of government forecasting?
In a nutshell because Read more
A speech just made by an ECB board member illustrates perfectly the divergent fortunes of the ECB, Bank of England and the Fed.
In the UK and US – where the recovery is more fragile – markets, economists and journalists are increasingly looking to their central banks for a monetary solution. Not in Europe. The economy is on a “good recovery track”, which can be ensured by fiscal responsibility and structural reform, says the ECB. So, no monetary solution here: responsibility is firmly back with the state. Read more
Today’s announcement that British higher rate taxpayers will no longer receive child benefit from 2013 represents the triumph of simplicity over fairness.
This will cause problems for the coalition government because it disproves the government’s claim that it always pays to work more, it will feel unfair to well-off single-earner families, it will feel wrong to some very well-off two-earner families and, unless the administration is perfect, it will recognise marriage in the tax system in the reverse way to that desired by the Conservative element in this government.
You have to ask yourself – has George Osborne picked the right spot on a difficult trade-off between simplicity and fairness? And all for £1bn of deficit reduction? Scrapping the benefit altogether and tweaking the existing means-tested benefits system would make more sense.
- The cliff-edge. A family with three children with income currently of £43,875 (the personal allowance of £6,475 plus the higher rate threshold of £37,400) receives £2,456 in child benefit. In future, if that family works a bit of overtime and receives an extra £1 in income, it will lose £2,456 in child benefit. The tax rate is infinite at the point of the higher rate threshold. A day after David Cameron, prime minister, said: “It will be worth it for everyone to work, wherever they are in the income scale, whatever benefits they receive,” the coalition announces a policy which refutes that claim. Does the left hand of government know what the right hand is doing?
Ewald Nowotny, Austria’s central bank governor, appears to have gone slightly off-message in an interview with WirtschaftsWoche, the German business magazine. The European Central Bank was seeking to correct “inefficiencies” and “imbalances” in bond markets with the purchase programme it launched at the height of the eurozone crisis in May. “As long as there are these inefficiencies, we will correct them,” he said.
That gave the impression the ECB was somehow trying to control the market. The official line is that the bond purchases are meant, simply, to restore the monetary policy “transmission mechanism”.
Still, I am not sure Mr Nowotny was really suggesting the programme had been scaled-up to bring down, say, Irish bond spreads. Indeed, he emphasised that the ECB had spent only about €60bn under the programme since May, which was “not a lot”. Read more
Structural deficits disease is pretending you know the precise size of the hole in the public finances, basing the entire fiscal strategy of government on an estimate of the unknowable output gap, using a measure of that structural deficit which contains many cyclical elements and allowing perverse conclusions to be drawn from data. So what is the cure?
John Kay beat me to a pretty good answer in the FT today, when he said the basic question that should be answered is:
“What is the level of taxation that is needed to support current and future expenditure plans on a sustainable basis?”
Where I would disagree with John is that to provide a credible answer to this question, you still need to look into a crystal ball. But crucially, what you do not need to do is come up with spuriously ‘precise’ estimates of the output gap and the structural deficit. Read more
Three suggestions are to be implemented from the government’s spending challenge – a public consultation that sought ideas for spending cuts. With a total identifiable saving of up to £2million, the first two ideas may be underwhelming in scope; cynics will say the Treasury had to be seen to do something:
1. To reduce the number of CRB checks for Junior Doctors, by taking a more common-sense approach across the NHS, so that junior doctors are not checked repeatedly over a short space of time. This will save up to a £1 million a year and cut administrative burdens for the NHS; Read more
Beware governments sporting 90 per cent public debt-to-GDP ratios: that’s the conclusion of a new research paper from the ECB.
Up to 90-100 per cent, increasing public debt increases GDP growth, finds the research. Beyond this magic range, increasing debt is associated with ever lower growth rates (see chart, right).
More than this, debt-fuelled increases in the growth rate start to slow when public debt reaches 70-80 per cent of GDP. Austerians will be pleased. A handy map from the Economist, left, shows us which countries are likely to feel the heat first. But even German debt may classify.
The paper, by Cristina Checherita and Philipp Rother, looked at the average impact for 12 eurozone countries since 1970:
It finds a non-linear impact of debt on growth with a turning point—beyond which the government debt-to-GDP ratio has a deleterious impact on long-term growth—at about 90-100% of GDP.
Yes, you can now vote on the best way for the UK government to cut spending. It might take you a while: there were 44,000 suggestions and they have received only rudimentary classification.
Nonetheless, people are busy voting. Popular suggestions so far include: Read more
A baby born today in Italy will be supporting almost twice the elderly population of a baby born in the UK by 2050. (Assuming that child doesn’t realise the problem, and emigrate.)
With all the perspective that 10,000 miles provides, the Reserve Bank of Australia has given a summary of conditions in Europe as part of its quarterly monetary review.
A fiscal tightening comparison is instructive: the tightening is inversely proportional to the size of the economy, with France and Germany only forecast to tighten by 0.5 per cent each by the end of next year. Read more
Sir Alan Budd, interim chairman of the Office for Budget Responsibility, was on the money this morning in highlighting what a difficult job his successor faces. He said:
“No one in their right mind would take on a job in which your success is judged by your success in fiscal forecasts”.
The OBR is not alone in this plight. Members of the Monetary Policy Committee take interest rate decisions which are predicated on the Bank of England’s forecasts. But in having a decision as well as a forecast, the MPC is always able to claim that it took the right decision based on the information available at the time, which takes the focus away from its often poor forecasts.
So much for the communication surrounding errors. The origination of forecast errors is more important. And the OBR’s greater, though far from perfect, transparency shows that its Budget forecast hinges on very thin and quite weird stuff. Read more
Top brass in the OECD will be meeting with George Osborne and others tomorrow, to lay out a roadmap to “new growth” in the UK economy.
In United Kingdom: Policies for Sustainable Recovery, recommendations range from regulation to education, and from workers’ health to the green economy. The report recommends continued fiscal consolidation, while protecting areas such as R&D. Choice excerpts from the recommendations include: Read more
It’s been a bad two weeks for the Office for Budget Responsibility and today was the day Sir Alan wanted to repair some of the self-inflicted damage.
Although there was no apology given for tweaking the assumptions underlying the forecasts in the week before the Budget, nor for releasing the OBR’s forecasts for public sector jobs less than an hour before prime minister’s questions, Sir Alan did regret the consequences of his actions and any naivety on the OBR’s part.
The most important action of the OBR today is not in the public theatre of the OBR’s discomfort in front of the Treasury Select Committee, but in the release of the changed assumptions made shortly before the Budget and revealed by the FT. As shown below Read more
The latest warning on the fate of the global economic recovery today came from the International Monetary Fund, which rather ominously stated that the risks of a slowdown have risen considerably in recent months.
In that context, I came across a fascinating – and worrying - note by John Makin, a visiting scholar at the American Enterprise Institute, a Washington think-tank, and former consultant to the Treasury department.
Mr Makin, who is also a partner at Caxton, the hedge fund, is firmly in the camp of economists who believe deflation is emerging as the biggest danger to the economic recovery, and he eloquently lays out his case. Read more
European Union governments that persistently violate the bloc’s rules on low budget deficits and public debts could be denied EU financial aid under proposals unveiled on Wednesday by policymakers in Brussels.
The European Commission, which enforces the EU’s fiscal rules, also suggested that countries in the 16-nation eurozone should have to pay interest-bearing deposits into an EU fund if they ignored warnings to keep their public finances in order. Read more
Adam Posen has just finished speaking at the Society of Business Economists’ annual conference. He repeated regularly he was speaking for himself not the Bank of England or the Monetary Policy Committee. And his remarks were a breath of fresh air because he didn’t duck difficult issues nor assume them away. Two things stood out:
- Mr Posen’s conclusion that British inflation expectations are drifting up and neither one-off effects such as sterling’s depreciation nor higher commodity prices can fully explain the drift of inflation higher.
- British monetary policy is again walking on a tightrope, suspended above higher inflation on one side and a renewed downturn on the other, making monetary policy very difficult to set. This is likely to make it reactive not proactive and liable to large errors.
Rising inflation expectations Although many in the audience disagreed, Mr Posen’s argument on inflation expectations rested on the argument that Britain’s recovery has been broadly similar to other countries, but its inflation performance has been very different. This he argued was easiest to explain, not by sterling’s depreciation, but by persistent inflation overshoot and mildly adaptive inflation expectations the public hold, as the chart shows.
“The most logical and empirically reasonable explanation for inflation creep is some unanchoring of inflation expectations, caused by the series of above-target outcomes for UK inflation in recent years.”
In a welcome display of transparency, Read more
The US will have much less room to grow than it believes and should therefore tighten fiscal policy more rapidly, according to estimates by the International Monetary Fund.
In the first report of the G20’s “mutual assessment process”, by which leading economies are supposed to hold each other accountable for growth, the IMF suggests that the “advanced deficit countries” – dominated by the US – should tighten fiscal policy more rapidly than planned. Read more