Sunday, October 26, 2014
Eurozone starts to look a lot like Japan
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

How worried should we be about the eurozone? Is the single currency area, the weakest link in the global economic chain since the crisis, about to enter its third recession in the space of little more than six years? Worse, are those fears of euro break-up, which paralysed business and consumer confidence, returning?

The Bank of England is clearly concerned. Though two members of the monetary policy committee (MPC), Martin Weale and Ian McCafferty, continued to vote for higher interest rates this month, most MPC members were concerned, among other things, about the impact of the eurozone on Britain’s economy.

“There was mounting evidence of a loss of momentum in the euro area, including in Germany, where growth appeared to have stalled and industrial production had fallen sharply,” the MPC’s October minutes said. And: “Further downside news in the euro area had increased the risks to the durability of the UK expansion in the medium term.”

Today is quite a big day for the eurozone. The results of the Asset Quality Review (AQR) for the eurozone’s banks will be published, ahead of the European Central Bank taking responsibility for euro area banking supervision on November 4.

Though these stress test exercises have been criticised in the past for being too soft, there have been reports that up to 10% of the 130 banks covered will fail. The aim of the exercise is to demonstrate that the eurozone’s banking system is secure. At the margin, however, some banks will have to raise additional capital and this will depress bank lending.

The big picture in the eurozone, which the Bank of England was responding to, is one of desperately weak growth and very low inflation. Eurozone gross domestic product was flat in the second quarter and up by just 0.7% on a year earlier. The best that can be hoped for in coming quarters is growth of 0.1% or 0.2%. The fear is that GDP will turn negative again, following the recessions of 2008-9 and 2011-13.

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Sunday, October 19, 2014
Bank may eventually rue leaving rates low for too long
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Even before the stock market had an attack of the vapours, other factors — a sharp fall in Britain’s inflation rate, renewed weakness in the eurozone, and doubts about the strength of the job market — had led some in the City to push out their expectations of when the Bank of England will begin to lift interest rates.

Some, having thought the Bank would begin raising rates early next year, now think it will not happen until the second half of 2015, or possibly not even then.

Sure enough, on Friday morning Andy Haldane, the Bank’s new chief economist, offered plenty of succour to the “lower for longer” school on interest rates. Haldane, who said in June he marginally favoured being on the front foot on rates – raising them earlier – said he had now shifted to the back foot, mainly because he was on balance gloomier about the economic outlook.

Though his comments could be taken to mean that he thinks the peak for rates will be lower than he thought, they have been universally interpreted as signalling a delay in the first rate hike until later. And, while he is only one vote on the MPC, it is likely that his view is close to others in the Bank, including Mark Carney, the governor.

I shall return to the Bank in a moment. First, let me look at some of the other elements. The drop in inflation from 1.5% to 1.2% in September, its lowest for five years, was welcome. We should be wary, however, of concluding that Britain is about to join parts of the eurozone in experiencing deflation — falling prices.

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Sunday, October 12, 2014
Time to join the dots on infrastructure spending
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

How do we build the infrastructure the economy is crying out for and the new housing a growing population sorely needs?

Through the haze of the party conferences, I got that Labour and the Liberal Democrats want to borrow more to fund additional public investment in infrastructure – roads, railways, energy, schools, hospitals, flood prevention, etc - and social housing, with the LibDems rather bolder on this than Labour.

Superficially this makes sense. Government borrowing costs – gilt yields in Britain’s case - are very low, so why should the government not go directly to the markets to fund such spending?

The International Monetary Fund, concerned about the slowdown in the eurozone’s already anaemic growth, has called for debt-financed infrastructure spending – even in countries with debt and deficit problems – to generate activity.

Of course Britain’s government, like others, already directly funds infrastructure spending. Net capital spending will be around £28bn this year, just over 1.5% of gross domestic product (GDP). The trouble with adding to it significantly would be that borrowing for investment is not ringfenced; to the markets it would be indistinguishable from borrowing for everyday spending.

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Sunday, October 05, 2014
Don't forget the budget deficit's ugly sister
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

We have had the two main party conferences and the big revisions to Britain’s economic numbers. We now know the economy’s pre-crisis peak was exceeded in the third quarter of last year rather than in the second quarter of this one. This is not, of course, the end of the story.

I want to try to draw these political and economic themes together. At the party conferences the biggest announcement, of course, was David Cameron's pledge to raise the personal tax allowance to £12,500 and the higher rate threshold to £50,000 by 2020. The cost of doing so, over and above the normal indexation of allowances, will be some £7bn.

This policy, as I wrote last week, does not in combination with weak wages growth make deficit reduction easy. In fact it seriously hampers it.

But some of the reaction to this pledge from economists and commentators is overdone. The prime minister clearly did not want to do a Roy Jenkins: emulate the 1967-70 Labour chancellor whose hairshirt stewardship of the public finances probably helped Labour lose the 1970 election.

And, if a £7bn tax cut, just over half the £12-13bn the coalition has spent raising the personal allowance during this parliament, is the worse that we will get between now and May - it may not be - we should relax.

As it is, the Tories are calculating that because Labour is perceived to have very little fiscal credibility, fairly or not, they can afford to lose some, and still remain well ahead in the credibility stakes. In fact, we can put a number on that. Labour's plans imply about £28bn less fiscal tightening than the Tories - becaused it has a less demanding deficit goal - and £7bn is a quarter of that. Despite the Cameron pledge, the Tories will continue to be seen by the markets and the public as more credible on deficit reduction.

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IEA's shadow MPC votes 6-3 for half-point rate hike
Posted by David Smith at 08:59 AM
Category: Independently-submitted research

In its email poll closing Friday 3rd October, the Institute of Economic Affairs (IEA) Shadow Monetary Policy Committee (SMPC) recommended by six votes to three that Bank Rate should be raised on October 9th, including five votes for a rise of ½% and one for a rise of ¼%.

Those advocating a rise felt that although inflation is low and monetary growth weak, current growth strength and falling unemployment provided an opportunity for some normalisation in rates.

Those that preferred to keep rates on hold noted that not only is inflation low, but pipeline inflationary pressures are also low, as are wage growth, money growth and credit growth. For them there remains inadequate reason to raise rates yet.

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Sunday, September 28, 2014
Osborne's deficit plan gets lost in the statistical fog
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

Maybe Ed Miliband should have talked about the budget deficit, and not just for the obvious reasons.

Had the Labour leader done so he could have provided George Osborne and David Cameron with a bit of discomfort ahead of their conference this week. As far as we can tell, the budget deficit so far this year is up rather than down, and the chancellor is in danger of missing his deficit reduction targets. The “long-term economic plan” will look more than a little tarnished if the deficit starts going up again.

I shall return to that in a moment. I say “as far as we can tell” because the figures for Britain’s public finances have just been put through the statistical mill. The Office for National Statistics (ONS) has redone the numbers to comply with the new European System of Accounts (ESA10) requirements, which apply to all EU member states, and it has introduced a new measure of the budget deficit.

These changes have had even the experts scratching their heads. The independent Office for Budget Responsibility said the new figures make it “more difficult to draw inferences from the latest data for performance against our latest forecast".

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Sunday, September 21, 2014
Weak pay and low inflation mean no rate hikes just yet
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

After all the excitement - and for me the right result - time to return to some normal but rather interesting fare. While we have been preoccupied with other things, there have been developments. The question is which way they are pointing.

On the face of it the job market continues to roar away. The unemployment rate, now just 6.2%, is at its lowest since October 2008 – just as the financial crisis was starting to do really serious damage – and is down from 7.7% a year ago.

Without rubbing salt into old wounds, a year ago the Bank of England though it would take until 2016 just to get down to 7%, let alone to be knocking on the door of 6%.

The fall in unemployment over the past year, the fastest for 25 years, takes the wider jobless total down to just above 2m (2.02m), while the narrower claimant count has dropped below the symbolically important 1m level; it is now 966,500.

Add the rise in employment, an extraordinary 774,000 over the past year, with a record 30.61m people in work, and a near-record 73% of the workforce, and it looks like a job market on steroids.

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Tuesday, September 16, 2014
A different kind of politics - and not in a good way
Posted by David Smith at 03:45 PM
Category: Thoughts and responses

The Scottish referendum campaign has engaged people in politics as never before, it is said, and this is a welcome and different kind of politics. It is, of course, welcome that voters in Scotland are engaged and mainly intend to vote on what is the most important issue they will ever vote on.

But it is also a different kind of politics in another, less welcome, way. In general elections, the political parties are required to come out with detailed manifesto plans. Spending commitments are carefully costed, and holes in their policies are teased out and exposed by the other parties or by the press. This does not stop politicians keeping unpleasant surprises until after they are elected, but it is a good form of scrutiny.

In Scotland we are seeing something very different. The Scottish Nationalists, despite being the governing party, gloss over enormous holes in their policies, and accuse anybody who exposes them as being biased or scaremongering. And, it seems, escape serious scrutiny. If the vote were won on Thursday on that basis, far from being good for democracy would be a terrible advert for it.

Among those holes:

- Scotland has a bigger budget deficit than the rest of the UK now, has averaged a bigger budget deficit for the past 25 years (Government Expenditure and Revenue Scotland). That deficit will have widened relative to the UK in 2013-14, and will widen further in coming years.

- There will thus need to be more austerity with independence, alongside higher taxes, in Scotland compared with the rest of the UK.

- Even with oil, Scotland pays a smaller share of taxation, 9%, than in gets in spending, 9.3%.

- The fantasy of the NHS, already devolved, 'only being safe with independence'.

- There will be no currency union with the rest of the UK.

- If Scotland were to renege on its debts it would be a pariah in the markets and would be unlikely to be admitted to the EU. EU membership will, in any event, be a complex and lengthy negotiation.

These are not small points, but they are glossed over in the SNP's "fact-free" campaign. For sensible views, see the National Institute here, and the LSE's John Van Reenen here.