Fiscal austerity is needed; monetary tightening might be needed sooner than thought; and capital controls won’t work in the medium-term. Cheerful prognosis courtesy of the Bank for International Settlements, which has just released its Annual Report.
Chapter one is candid on the threats: “The combination of remaining vulnerabilities in the financial system and the side effects of ongoing intensive care threaten to send the patient into relapse and to undermine reform efforts.”
Stimulus is dead, long live austerity, says the Bank. In line with the G20: “The limits to fiscal stimulus have been reached in a number of countries. Immediate, front-loaded fiscal consolidation is required in several industrial countries.” The policy is not without its risks, of course: Read more
What do you do if you are part of the Group of 20 and cannot agree on a coordinated global economic strategy? Agree to differ and set your best communique drafters to work.
The first thing to do is to find areas on which everyone can agree. Growth is the answer. When have you heard a leader or a finance minister openly advocating policies for stagnation? But alongside justice and education, growth is one of those words everyone advocates, but is meaningless. Growth is not a policy, but an aspiration. Read more
The 2010 emergency Budget has lived up to its historic billing. Huge spending cuts and big tax rises are planned to bring borrowing down from its current rate in excess of 10 per cent of national income.
No allowance has been given to those who worry that such rapid deficit reduction might hit the economy too hard and make it counter-productive. We are back to Lord Snowden’s in 1931, described as an “evangelical Pennine socialist” by Lord Jenkins. I don’t think that description applies to George Osborne; and he must hope his reputation survives better than his 1930s predecessor. Here are four things that have interested me so far.
- The big news. Obviously, real spending cuts of 25 per cent in government departments outside health and overseas aid are big. Very big. This will mean the pain from this Budget will be felt for years and not just tonight. The really interesting thing is that
As a frame of reference, here are my broad brush predictions for the Budget later today. Some things I am pretty sure about, some I am certain about because they’ve been briefed and others are guesses, hopefully educated guesses.
- Fiscal mandate. George Osborne will commit the new government to eliminate the current structural deficit by the end of the Parliament (2014-15). He will also commit to the burden of public sector debt falling year-on-year by the same point.
- Growth. The Office for Budget Responsibility will cut the growth forecasts it released last week for 2011 and 2012 but raise them later in the Parliament, leaving the level of output in 2014-15 very close to that in last week’s announcement. The assumed medium-term Keynesian multiplier will be zero or negative.
- Public finances. Britain’s deficit will be scheduled to fall below 3 per cent of GDP in 2014-15 and will be close in 2013-14.
- Fiscal consolidation. There are
My contribution to Mark Thoma and Motoko Rich‘s call to label the two sides in the raging fiscal stimulus debate. Motoko Rich writes:
The raging debate over what to do about the deficit is now getting its own lingo. Read more
Has philanthropy been overlooked as a means of consolidation? Not in Germany. Fifty-one millionaires and billionaires have apparently formed a ‘Club of the Wealthy’. That club has written to chancellor Angela Merkel, offering 10 per cent of their income for 10 years, in a ‘rich tax’.
Such acts of kindness are all the more rare for being collective. Forming a club, rather than donating individually and noisily, speaks volumes about its members. It also increases the members’ chances to do good, now and in the future, by creating a structure that could attract more people over time, and even survive the 10-year time horizon of its founders. Who knows, the idea might catch on.
This morning the Financial Times is running quite a few Budget stories. My favorites are the pieces about the regional effect of spending cuts, which we have simulated (click on the beautiful maps). These show very simply that whether public spending is cut from social security or from government consumption, it will hit growth harder in the North than South and harder in poorer than in richer areas.
George Osborne’s constituency of Tatton in Cheshire suffers the least of any region on one of the comparisons. The chancellor will like that. Others might take a different view.
Some may say that is a description of the bleeding obvious since everyone know that public spending tends to follow need. Of course it is also not a dynamic model, just some very simple calculations, but they are important in showing the first-round effect of cuts. I have not seen anyone else doing this sort of thing. It might even make Nick Clegg, deputy prime minster, stop and pause before describing spending cuts as fair and progressive. The cuts might well be necessary, Read more
Jean-Claude Trichet has long made clear that the European Central Bank is not over-worried about the impact of fiscal austerity measures on growth, even in the short-run (whatever Washington thinks). The ECB’s latest monthly bulletin has a special section with a lengthy list of reasons why fiscal austeriy need not be so painful. Among its main points, which apply in varying degrees to eurozone countries, are:
(1) the short-run negative impact is lower when “the fiscal starting position is particularly precarious and thus confidence in the sustainability of public finances is rather low,” and when fiscal consolidation is part of a credible reform strategy.
(2) The impact is also less when Read more
The day after the Office for Budget Responsibility produced its initial forecasts for the UK economy, here are five things that are still worth noting.
1 Funniest treatment of a serious issue
For this you must go to the Daily Telegraph. It splashed this morning on a mathematical error. The paper calculated that public service pensions “commitment reaches £9.4 billion in 2014-15. This equates to almost £4,000 for each of Britain’s 26 million households”.
Any fool with a calculator knows that £9,400,000,000/26,000,000 is £362, which is not very close to £4,000 unless the Telegraph has a very loose definition of the word “almost”.
For those who like analysis, the real question is: why is the OBR forecasting that the cost of pensions for health workers teachers, the police and military is projected to rise from £3.4bn in 2008-09 to £9.4bn in 2014-15?
The Treasury does not have a perfect answer, but it does have a good initial explanation. The rise is
George Osborne won immediate plaudits for the early establishment of the Office for Budget Responsibility to take the politics out of government economic forecasts. The hyperbole that surrounded the announcement was overdone, but the new OBR should increase trust in government forecasts and underpin UK sovereign debt markets if its performance in practice meets its promise. Monday marks its first test.
Sir Alan Budd, OBR chairman, needs to move from the easy task of reveling in the OBR’s establishment to the more difficult task of building long-term credibility for the new body and demonstrating it has not been captured by the Treasury in its short life.
Note that Monday’s announcement is a new economic and public finance forecast, based on unchanged policies. It will not include the OBR’s assessment of whether the government’s tax and spending plans give ministers a 50:50 chance of meeting their own ambitions for the public finances.
If the Office meets or exceeds the following basic requirements on Monday, it will have got off to a good start.
- Clarity on forecast changes
The OBR must make it absolutely clear why forecasts for the economy and growth are different from those in the March 2010 Budget. This means deconstructing forecast differences into changes in assumptions and new information received. Any merging of the two would be a disaster for transparency. The forecasting changes for growth must flow clearly into forecasting changes in tax revenues and public spending on items linked to the health of the economy such as social security.
- Publish its assumptions on the link between growth and the public finances
The Treasury has been keen to speak privately over the past year or two about how it decoupled its growth forecasts from its public finance forecasts. Sensible though this was as ammunition for the Treasury in the fight between Gordon Brown and Alistair Darling, it was no way to run a government or a forecast.
This is the question I do not want to have to ask George Osborne on Budget day, 22 June. As the chancellor will know, it is also the question he repeatedly asked the previous chancellor, Alistair Darling, each time Mr Darling refused to divulge the implications of the then government’s budgetary forecasts for spending departments.
Mr Osborne asked the question last December after the pre-Budget report.
Mr Osborne asked the same question in Parliament in the debate on the March Budget.
It was the same question Mr Osborne asked on the radio last September when he revealed a leak of internal Treasury documents. “It’s about trust and honesty,” Mr Osborne said.
And in March he wrote to Sir Nicholas Macpherson, the permanent secretary to the Treasury, to explain why its projection for departmental spending was vital to a public debate on the public finances.
“Given the absence of a spending review, this information is the very least that should be provided in order to facilitate proper scrutiny of the government’s plans at the election”.
Before being in government, it seems that Mr Osborne was almost obsessed about getting an answer to the DEL/AME split question. So, a simple test for the Budget will be the degree of transparency Mr Osborne introduces to projections for public spending. Given this past commitment to trust and transparency, I fully expect the following:
- The chancellor will publish Treasury projections for total government spending
- The chancellor will publish projections for debt interest
- The chancellor will publish projections for other spending over which he has no control such as accounting adjustments
- The chancellor will publish projections for social security bills on the basis of unchanged policies
- The chancellor will publish the implications for the former for departmental spending totals.
Anything less than this would Read more
In the few days since Naoto Kan took over as Japan’s prime minister an economic narrative has emerged: he’s a deficit hawk who’s going to put up consumption tax and end Japan’s huge and enduring budget deficits.
Mr Kan’s comments and actions have certainly helped. On Tuesday he said that “rebuilding the nation’s finances is a prerequisite for growing the economy,” and he has appointed Yoshito Sengoku as chief cabinet secretary and Yoshihiko Noda as finance minister, both reputed to be deficit cutters.
But hang on a minute. Mr Kan’s focus on Japan’s debt is a clear break from previous prime ministers, but I think it’s only part of the story, and I wonder whether it’ll survive an encounter with the enemy.
Only part of the story
Mr Kan has just ended five months as finance minister. The main feature of those five months was Greece’s debt crisis. It’s hardly a surprise that Japan’s debt is at the top of his mind.
Fiscal policy is hardly the defining issue in Mr Kan’s career, however Read more
That is the question the new British government will ask every day until the emergency Budget in two weeks’ time.
Warning if the British public refuses to buy the “we’re all in it together” line, the government will continue the drip-drip of minor announcements about the disaster of borrowing and the possibility of London turning into Athens on Thames. The next date in this process will be on Monday, when the Office for Budget Responsibility (now with a suitably sober logo) will present its new forecast for the economy and the public finances.
Of course, the public have every reason and right to stick two fingers up to the politicians. They had an opportunity to say the deficit was a shocker before the election. We even provided a handy deficit buster to help them. But this stuff was described as scaremongering. Now it has made governing more difficult. Whatever George Osborne might claim, he does not have a mandate for public sector austerity.
That does not mean he is wrong Read more
David Cameron, prime minister, gave his big speech on his economic inheritance (bad) and plans (bold) today. And the one piece of news in the speech was the following number regarding debt interest:
“Based on the calculations of the last government, in five years’ time the interest we are paying on our debt is predicted to be around £70 billion. That is a simply staggering amount.”
This is a very useful number, one which the previous government shamefully hid from the public. What does this mean? For a start it implies the Treasury expects to pay an average interest rate of around 5 per cent on the £1,406bn deficit it expected in 2014-15. But Mr Cameron had a more vivid explanation of the figure’s relevance.
“Let me explain what it means. Today we spend more on debt interest than we do on running schools in England. But £70 billion means spending more on debt interest than we currently do on running schools in England plus climate change plus transport.”
Though these figures of departmental spending are extremely difficult to get, there are ways to make his claim add up with the combined total of the three spending groups coming in just below £70bn. I won’t bore you with them. But the important point is that the prime minister has just announced the new coalition government’s first fiscal rule.
If debt interest in five years’ time is more than 2001-11 spending on schools, transport and climate change, this is terrible. But if it is lower, things are fine. This fiscal rule is weird.
If you think I am exaggerating Read more
Here in Busan, South Korea, a port city which seems to double as the Blackpool of Korea, it is already clear that finance ministers and central bank governors will agree that growth is good for the world economy. Yes, really.
Is this surprising? No. Growth, like education and justice is generally a good thing. Everyone wants it. But no one is sure how best to achieve it when it comes to fiscal policy.
They are still unsure whether the global economy is best served by fiscal stimulus or prudence.
Everyone also agrees that the world economy is fragile and fiscal consolidation should be growth enhancing rather than detracting. But, in briefings before tomorrow’s Group of 20 meeting, few were willing to define exactly what they meant. Read more
What timing. On the day that the new coalition government starts down the road of rapid deficit reduction, Adam Posen, external member of the Bank of England’s Monetary Policy Committee, throws a well-aimed grenade into the mix. The questions he asks should make everyone pause for thought.
Today, the new government was displaying its new fiscal probity and claiming this was the route to economic happiness. George Osborne, chancellor, said: Read more
The first £5.75bn of spending cuts has just been announced by George Osborne, Conservative chancellor, and David Laws, his Liberal Democrat chief secretary, in the Treasury garden. It is something of a spectator sport for large numbers of Treasury officials, who seem either keen to get the knives out, or who have too little to work on and are ripe for the chop.
But these cuts represent just the starter, “the first steps” as Mr Laws admitted. The main course is coming later. This near £5.75bn (the announced £6.2 net the £500m which will be recycled back into frontline services) is tiny compared with the £40bn to £50bn that is coming from 2011 onward. So it is worth not getting too excited by today’s cuts. Read more
The Con-Lib coalition agreement includes lots of new spending commitments and pledges. That is what has made agreement between the two parties so easy. But the best bit is this green box at the back, which I presume was added by George Osborne and David Laws, who have seen the Treasury’s books.
Since Monday’s announcement of the Office for Budget Responsibility, it has become apparent that the new fiscal watchdog will enter an academic and policy-making viper’s nest when it produces its first forecasts. On top of some of the OBR’s obvious flaws, George Osborne has given Sir Alan Budd the hospital pass of making an explicit assumption of the fiscal multiplier, something policymakers like to fudge (see below).
Why so? The OBR will produce its first growth and borrowing forecasts a few days before the 22 June Budget. The Treasury’s unit handling the OBR says these forecasts will be on the basis of no policy change from the 29 March Budget.
The forecasts will therefore be the Budget forecasts, adjusted for any fiddling of the figures under Labour, updating for almost three months extra data and, perhaps, including the £6bn spending cuts for 2010-11 to be announced on Monday. I say “perhaps” because these spending cuts are for one year only and will be offset thereafter by tax reductions, so it would be seriously misleading to include them in a forecast alone (improving the outlook for borrowing) without the subsequent and known tax reductions.
Then, the chancellor will make the substantive spending cuts and tax increases he promised in his FT interview. And then the OBR will have to produce a second set of growth and and borrowing forecasts, taking into account the additional fiscal tightening planned by the new Con-Lib coalition government.
Here the OBR will have to make an explicit assumption of the fiscal multiplier – the ultimate effect on the economy of changes to tax or public spending. Its assumption will be easy to derive from the way it changes its growth and borrowing forecast. This will be an extremely political act for the OBR and it had better be ready to put its reputation on the line. It can also be an iterative process – if cutting public spending reduces growth, which in turn cuts tax revenues, borrowing still falls short of the chancellor’s fiscal goals and this requires further cuts in public spending etc.
When you talk to OBR people in the Treasury, they say: “Ah… the second round effects …hmm, we’ll get back to you”. And they don’t. Let’s think through what the outcomes could look like.