The paper at this year’s US Monetary Policy Forum – where market economists get to present to central bankers – is called “Crunch Time: Fiscal Crisis and the Role of Monetary Policy“. It shows a new wrinkle on US fiscal problems: if there is any kind of debt sustainability crisis it could make the Fed’s exit from easy monetary policy a whole lot more painful.
This is the money chart. Black is the baseline for Fed profit and loss in the coming years. Red is what happens if a fiscal crunch pushes up long-term bond yields (and hence causes losses for the Fed on its portfolio). Read more
It looks like Congress will not heed pleas from the Federal Reserve for a fiscal policy plan – see Bill Dudley’s speech last Thursday for another example – as we await confirmation that the ‘supercommittee’ has failed. This is very bad news for the coherence of US economic policy, something totally ignored by Congress, which seems to think it can have an extended philosophical argument about the correct size of government without any consequences.
As Mr Dudley noted (emphasis added):
“It would be greatly beneficial if the Administration and Congress could more effectively work together to craft a coherent fiscal policy. As I see it, this would consist of two elements—continued near-term fiscal support to underpin economic activity and long-term fiscal consolidation to ensure debt sustainability. Without action in Washington, fiscal policy will turn sharply restrictive in 2012—exerting a direct drag on real GDP growth of more than one percentage point. At the same time, the long-term path under current policy is unsustainable.”
Although it seems like a world away, the main economic policy argument in the early summer of 2010 was about the effectiveness of fiscal stimulus, in the wake of the Obama administration’s $787bn American Recovery and Reinvestment Act.
Now that the administration is asking for a new $447bn stimulus that question should be back at the top of the agenda – and thanks to two excellent new NBER papers it is going to be a lot harder for people to distort the economic argument.
Most of the new evidence suggests that in today’s specific circumstances – where the zero lower limit means that monetary policy is not as loose as the Fed would like – then fiscal stimulus could be very effective indeed. Read more
Macroadvisers have put out their estimates of the economic effect of passage of the House Republicans $61bn of FY11 spending cuts. They are lower than Goldman Sachs, higher than the Fed, and look pretty solid to me.
- Our simulation analysis suggests this near-term fiscal drag would reduce annualized growth of real GDP during the second and third quarters of this year by ¾ percentage point, with smaller impacts for a few subsequent quarters.
Giving evidence to the Treasury Select Committee this morning, George Osborne claimed the UK economy was back on track.
He added that it was pretty clear to him that the previous Labour government had overstated trend growth for much of its time in office and there had been a big “boom” in the economy for much of the decade.
Warming to this theme, the chancellor referred the Committee to his favourite chart of the June Budget, which shows what the output gap would have looked like if a more modest figure – and what Mr Osborne said was “more realistic” estimate for trend growth – had been assumed by the previous government. Read more
When the FT reported that senior Bank of England staff including Monetary Policy Committee members thought Mervyn King, Bank governor, had overstepped the line separating monetary and fiscal policy, the governor was dismissive.
He rounded on my excellent colleague, Daniel Pimlott, who asked him whether he had the unanimous support of the MPC in endorsing the political decision on the speed and scale of the new government’s deficit reduction.
“And, just for the record, I’ve spoken far less on this than almost any other central bank governor around the world; less than Ben Bernanke, less than Jean-Claude Trichet, both of whom have given speeches in great length and regularly. I haven’t spoken on this except in response to direct questions at the Treasury Committee, and when asked by the Coalition. So perhaps we’ll move on to a serious question about the economy.”
On Monday, the IMF cannot contain its enthusiasm the UK’s harsh austerity plans. On Thursday it releases research warning fiscal consolidation “will hurt” and “are likely to be more painful if they occur simultaneously across many countries, and if monetary policy is not in a position to offset them”.
The IMF finds that, “fiscal consolidation equal to 1 percent of GDP typically reduces real GDP by about 0.5 percent after two years”. Does the IMF left hand talk to its right hand?
Sadly for journalists, the answer is “yes”. Both IMF documents hype-up their conclusions to give the appearance of deep contradiction. They are, in fact, consistent.
How so? Read more
The reporting of the International Monetary Fund’s assessment of the British economy and the important speech by Adam Posen has given the impression that the Fund is optimistic about UK prospects while Mr Posen is pessimistic. That is the inevitable consequence of news reports focus on downside risks to policy (the IMF gushed while Posen fretted). In fact, the reverse is true.
The argument, once again, hinges on the assessment of the UK’s potential for growth.
- The Treasury, the IMF, the Office for Budget Responsibility and most in the Bank of England are the pessimists. They believe one of the two following possibilities: either that lots of capacity was lost permanently in the recession, or that the economy was fundamentally unsustainable before the downturn, as shown in this graph. I understand the IMF’s latest estimate is that the output gap is only 3 per cent.
- Mr Posen and Ed Balls, shadow schools secretary, are optimistic. They believe that output is fundamentally below potential and significant spare capacity exists, at least for now. That means growth can and should be higher.
What follows from this distinction?
Everything. In monetary policy, Read more
The IMF tends to be a bit sniffy about countries’ economic policies in its annual report on countries’ economies. That often helps finance ministries in domestic political battles to do the right thing.
But with the new government adopting Fund-friendly fiscal policy, the Bank of England insisting it is ready to act either way on monetary policy and a strengthening of financial policies on the way, the Fund has been reduced to a schoolkid’s crush in its latest assessment of the UK economy. I understand from the Treasury that the chancellor is pleased.
Here are some highlights. On the immediate economic outlook:
“This progressive strengthening of private and external demand should underpin a moderate-paced recovery, even as the public sector retrenches.”
Even though the IMF said Read more
On this blog, I have repeatedly noted with dismay how badly Britain is afflicted by structural deficits disease – the mistaken belief that you can measure the underlying budget deficit.
Various economists have sympathised with my campaign, but argued that governments need to set fiscal policy and to do so ministers need an estimate of the ‘size of the hole in the public finances’ or ‘the deficit which would remain once the economy got back to normal’.
Some Treasury officials have said that without a target path for the structural deficit, it would be impossible to follow a consolidation plan and have room for automatic stabilisers to work in the event that the economy is derailed.
Apart from the many other problems I have noted with these arguments, a new drawback of the Treasury’s position occurred to me this week. It is that the Treasury’s June Emergency Budget does not give one estimate of the hole in the public finances, but three. And they are not consistent. Take your pick, the hole is either £116bn, £128bn or £160bn. Read more
No surprise. It’s Robert Chote for the OBR. Subject to confirmation by the Treasury Select Committee, he will start as office for Budget Responsibility chair almost immediately.
Obviously on the agenda will be hiring the two other members of the Budget Responsibility Committee, setting up the OBR in new premises, negotiating its budget with the Treasury, recruiting staff and producing the autumn economic forecast towards the end of the year.
The new OBR chair has to restore confidence in the institution by demonstrating immediate independence from government. This must be a primary task of his confirmation hearing at the Treasury Select Committee next week.
The chancellor has certainly removed most doubts about the independence of the selection with the choice of Mr Chote, who has led the Institute for Fiscal Studies for the past eight years. The organisation has independence in its DNA and following criticism of Labour’s fiscal tricks, it recently demolished the Conservative’s silly claim to have delivered a progressive Budget.
But authority is more difficult. Read more
With worries about the huge US budget deficit running rampant in Washington – just look at Friday’s midsession budget review by the White House, which forecast deficits in excess of $1,400bn this year and next - fiscal policy options are clearly limited for Congress and the administration.
And so the attention of policymakers and politicians is quickly turning to longer-term tax policy issues, like the looming expiration of some $3,000bn of tax cuts enacted by President George W. Bush in 2001 and 2003, as I explain in today’s paper.
Last week, the big story was that Kent Conrad, the Democratic chairman of the Senate budget committee, broke with the administration’s official line that the tax cuts should only be extended for Americans earning up to $250,000, and allowed to expire for the wealthy. Read more
No-one predicted that the UK economy would storm ahead quite so much in the second quarter. Initial estimates from the Office for National Statistics suggest the economy grew by 1.1 per cent between April and June compared with the previous quarter – far above the already pretty strong consensus of 0.6 per cent. The surprise came because services was measured to have stormed ahead in May, by 1 per cent.
There is no doubt that this is above-trend growth and it helps to explain the favourable tax revenue, labour market and survey data that have been a feature of the British economy for some time. Construction, business services, finance and government services were the biggest contributors to this growth rate. While government services cannot continue to contribute 0.2 percentage points to growth in future quarters, given the looming cuts, there is no reason to say other sectors will automatically fall back.
For the authorities, this unexpected good news really puts the cat among the pigeons. For the Bank of England, this is evidence the recovery is gathering steam and ultra-loose monetary policy is working. It also helps to explain a little why inflation has been overshooting. It will certainly make it much easier for the Monetary Policy Committee to argue that there is no need to loosen monetary policy in response to the tough Budget. And it will raise expectations of higher interest rates again, if this remarkable quarter of growth continues. Read more
Greeks are waiting for a possible television address tonight by George Papandreou, their prime minister, on the country’s fiscal plight. If he does speak, the likelihood is that he will go further than before in accepting tougher measures will be needed to bring down the public sector deficit. Pressure he faced in Davos last week from global financial world leaders appears to have had an effect, and the Greek premier seems keen to get his retaliation in before the European Commission pronounces on his government’s plans tomorrow.
Still, past form suggests Mr Papandreou will not go far enough to calm financial markets. Greek politics appears to be preventing rapid changes in direction, even with the country facing a real risk of default. Read more
A recovery has been evident in the data for months and now it has finally been confirmed by the Office for National Statistics, but only just. It has just reported the economy grew by 0.1 per cent in the fourth quarter of 2009. Will it signal an end to the sniping between economists and the ONS over the quality of its data? Not really, economists think growth was faster and will expect the ONS to revise these figures higher in the months and years to come. But for now, what does this new data tell us about Britain’s economic prospects? Not much.
Monetary policy will not be changed. The Bank of England expected a recovery, one that was quite a bit faster than has been reported, but it will also expect these figures to be revised higher. The implication is that the Bank will do very little until the election, probably pausing the active process of purchasing assets under quantitative easing next week. Read more
Britain’s recession ended towards the end of last year. So said the National Institute of Economic and Social Research, a few minutes ago. In fact, the respected think-tank believes the trough of output was rather earlier in August and the economy has grown 1.6 per cent between August and December, not bad.
NIESR’s estimates are based on the industrial production numbers and, with the notable exception of the third quarter, are usually very accurate in front-running the official preliminary estimate of GDP. They suggest the official figures will show 0.3 per cent growth in the final quarter.
So if Britain has been out of recession for nearly half a year, what does this imply for monetary and fiscal policy? Read more
Mervyn King and four other members of the Monetary Policy Committee appeared before the Treasury Select Committee this morning, displaying no hurry to tighten monetary policy and stressing the depth of the recession will guide interest rates for some time to come, writes Chris Giles of the Financial Times Read more