Sunday, January 25, 2015
Near-zero rates and QE look to be here to stay
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

It has been a big week for monetary policy, led of course by the European Central Bank’s €1 trillion-plus quantitative easing (QE) programme but also here, with the two hawks on the Bank of England’s monetary policy committee having unexpectedly flown into the dovish nest.

The only big central bank that seems to be on track to raise interest rates this year is the Federal Reserve, with the markets expecting a move from the summer onwards. Even that may be a movable feast, however. On Wednesday the Bank of Canada, admittedly managing monetary policy in an economy vulnerable to oil price falls, surprised markets by cutting its main interest rate from 1% to 0.75%.

If you needed evidence that we are in a highly unusual period for monetary policy, there has been plenty of it in the past few days. This is becoming the near-zero decade for interest rates, even leaving aside the unusual and controversial tool of QE. Not since the period covering the 1930s, the Second World War and the few years after it have we seen anything like it, and Bank rate was higher back then than today’s 0.5%. And we did not have QE.

Will we ever see the return to anything like normal as far as monetary policy is concerned? Let me start with the European Central Bank’s QE “bazooka”, before coming closer to home.

Sunday, January 18, 2015
How to prevent good deflation turning bad
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

How unusual is deflation? The Office for National Statistics has an inflation measure which goes back to 1800, mainly based on the retail prices index (RPI). In nearly 70 of those years, prices fell -Britain experienced deflation - though the closer you get to today, the rarer the phenomenon is.

So in the 19th century, slightly more than half the years, 52, had annual deflation. This dropped to 15 out of 50 in the first half of the 20th century, including much of the 1920s and the early 1930s. From 1950 onwards, however, deflation has been very unusual. In only one year, 2009, did prices fall on the ONS’s measure, by 0.5%, and this only because it was distorted by the very sharp reductions in interest rates. Other measures showed modest inflation even in the depths of the crisis.

To add a bit more historical perspective, prices at the end of the 19th century were 34% lower than that at the start. Some of that reflected developments in commodity prices, but much of it reflected technical progress and lower prices for industrial products.

The story of the 20th century was very different. Prices at the end were 73 times those at the start, 72,000% higher. Most of that occurred in the second half. While prices in 1950 were 3.5 times their level in 1900, in 2000 they were 20 times their 1950 level. Most of us have only known inflation, and often very high inflation.

Did the deflation of the 19th century inhibit economic growth? I only have numbers going back to 1830 – the Bank of England’s “three centuries of data” series - but they show that real gross domestic product in 1900 was more than four times its level 70 years earlier. Mostly it was good deflation.

I write this because, as everybody will have noticed, Britain’s inflation rate fell to just 0.5% last month. On this measure, based on the consumer prices index which is not directly influenced by interest rate changes, inflation in 25 years has only been this low once, in May 2000. Nobody took any notice of this particular measure back then. Only when it became the Bank of England’s target measure a few years later did we pay attention.

Sunday, January 11, 2015
Why politicians struggle to even trim the size of the state
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

It may already be too late, given that the election campaign is already in full swing and the claims and counter claims about the public finances and public services will be flying thick and fast for many weeks to come. If you are not confused now, you very soon will be.

But, just in case there is still time to offer some context, let me attempt to do so. All of my figures come from the independent Office for Budget Responsibility. Some of them may surprise you.

Let me start with the numbers for overall government spending, total managed expenditure. George Osborne is accused of wanting to take Britain back tom the 1930s, while the Tories, for their part, say Labour would take us back to the fiscal irresponsibility of the Blair-Brown era.

In inflation-adjusted terms, 2013-14 prices, there was a massive increase in total managed expenditure over the 2000-2010 period. Spending in real terms in 2009-10, £737.3bn, was 51% higher than it was in 1999-2000, £488.5bn.
Think about that for a second. In a decade, the size of the state increased by just over a half. It was the biggest sustained increase in public spending in British history.

Monday, January 05, 2015
IEA's shadow MPC votes 5-4 for rate hike
Posted by David Smith at 12:00 PM
Category: Independently-submitted research

In its email poll closing Thursday 2nd January, the Institute of Economic Affairs (IEA) Shadow Monetary Policy Committee (SMPC) recommended by five votes to four that Bank Rate should be raised on January 8th, including four votes for a rise of ½% and one for a rise of ¼%.

Those advocating a rise contended that current low inflation is the result of one-off factors (such as oil price falls) that do not change the basic story of an opportunity to normalise rates in a healthier economy.

Those that preferred to keep rates on hold noted that inflation is well below target, monetary growth is low and some contended that the real debate should be whether policy might be loosened further in the months ahead, with one suggesting he might soon favour the resumption of QE.

Sunday, January 04, 2015
Election and the current account will weigh down on sterling
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

It would be nice not to have to look ahead into the reminder of 2015 at this point. Barely have we got over thinking about 2014 when another year comes along.

Nor, just a few days in, do we yet have much of a feel for how 2015 is doing. How much better, and potentially much more accurate, this piece might be if I were able to postpone writing it until after the May 7 general election or, even better, until November.

But needs must – it has to be written now - and I mention the election for good reason. There are some general election years which pass without much direct impact on the economy. These, it should be said, are usually the predictable ones.

So the elections of 1983, 1987 (Margaret Thatcher’s second and third victories) , 1997, 2001 and 2005 (Tony Blair’s three wins) all coincided with periods of strong growth and saw no significant post-election slowdowns.

John Major’s surprise April 1992 victory probably gave the economy a boost: it only really started growing after it, while Gordon Brown’s defeat in May 2010 was followed by slower growth as the eurozone crisis and austerity (Labour’s delayed measures and the coalition’s new ones) kicked in. I note, however, that the infamous snow-affected drop in gross domestic product at the end of 2010 has now been revised away by the official statisticians.

Saturday, January 03, 2015
Has the budget deficit halved?
Posted by David Smith at 11:30 AM
Category: Thoughts and responses

A minor row has broken out over Conservative claims that the budget deficit has halved under the coalition.

Most economists would say that it has. Public sector net borrowing this year will be 5% of GDP according to the Office for Budget Responsibility, down from 10.2% in 2009-10, the last year of the previous government.

Non-economists would say that it has not, because this year's projected deficit, £91 billion, is down by only 41% on its 2009-10 peak of £153 billion. It should have halved by next year, 2015-16, but has not done so yet.

Deficit definitions matter, however. The new definition of public sector net borrowing excluding banks, introduced a few months ago by the Office for National Statistics, included important changes. On the old measure, public sector net borrowing excluding financial interventions, the deficit did virtually halve, from £157.3 billion in 2009-10 to £80.7 billion in 2012-13, though the figures were heavily distorted by special factors.

One problem is that there is no generally accepted definition of the deficit and all suffer from significant imperfections. The OBR lists five, and there are others.

So the primary deficit, one measure, has halved in cash terms, from £131.9 billion in 2009-10 to £66.3 billion in 2013-14, with a projected deficit of £60.4 billion this year.

In the 1980s, the then Conservative government targeted the public sector borrowing requirement (PSBR), now renamed the public sector net cash requirement (PSNCR). More than most measures, it is subject to significant distortions, but on the ex banks measure it has come down from £198.8 billion in 2009-10, to £63.8 billion in 2013-14. The latest figures are here.

Sunday, December 28, 2014
A better year than most expected
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


The table to accompany this piece is available on

My regular column is available to subscribers on This is an excerpt.

What did we make of that? Whether we should lay it down and save it for later (rather than lay it down and forget it, as for some recent years) , there is no doubt that 2014 was a good year for the economy. It started well and ended better. A year ago there were doubts about whether the recovery starting to build would last. Now we know it did.

The job market continued to perform minor miracles, with the latest figures showing a rise in the number of people in work of 588,000 over the past year, 95% of them full-time roles. Unemployment has dropped by more than 450,000.

The icing on the cake was provided by the drop in oil prices in the final months of the year and the consequent weakness of inflation. Strong growth and low inflation are an unusual combination. At the end of the year Britain has an economy growing by 3% alongside inflation of just 1%.

That November inflation rate of 1% will not mark the low point for inflation in this cycle; Mark Carney has his inkwell filled ready to write that letter of explanation next month when it drops further. It is also one reason why real wages – earnings adjusted for inflation – have begun to rise in recent months.

I took part in a debate organised by the Resolution Foundation in January in which there was unanimity that 2014 would be the year of the real wage rise. All the panellists have been saved from red faces. Eventually 2014 was the year of the real wage rise.

On interest rates, things blew a little hot and cold. This time last year we were still in the early phase of Mark Carney’s forward guidance, which pointed to no rate rise until 2016 (conditional on unemployment no falling too fast).

Though markets were sceptical about the Bank of England’ forecasts given the pace of the fall in unemployment even 12 months ago, few expected an early move in rates. That changed in June, the Bank governor’s Mansion House speech, in which h he appeared to point the way towards a hike before the end of this year. Things move on from that, but only as far as an early 2015 hike by the start of autumn. Now are close to coming full circle to the original guidance.

Sunday, December 21, 2014
Don't be too afraid of the big bad wolf of deflation
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

A few days ago something happened which I have not experienced for a very long time, if ever. Inflation fell to just 1% and will surely go even lower when the figures for December are published next month.

This will mean that Mark Carney will be obliged to write an open letter to George Osborne to explain why inflation has deviated by more an a percentage point from the 2% target. This will also be, for now at least, a unique occasion.

There have been 14 such Bank of England governor letters since Gordon Brown announced Bank independence in 1997. All of them were written by (Lord) Mervyn King, and all of them were to explain an inflation overshoot; a rate of more than 3%. This will be the first undershoot letter and, while Bank governors are meant to be neutral on these things, Carney wouldn’t be human if, with interest rates already at record lows, he will find this one easier to write.

Why is 1% so unusual? After all, the Office for National Statistics said last week that this was merely the lowest rate of consumer price inflation for 12 years. Twelve years ago, however, we did not know much about the consumer prices index. It was promoted by Brown in 2003 – and became the Bank’s target – ostensibly to make it easier for Britain to join the euro, which may surprise you. This was because, as a “harmonised” inflation measure, it was used by other countries in Europe.

In the early 2000s, we still used the retail prices index, and its close relative, the retail prices index excluding mortgage interest payments (RPIX). Both fell very sharply in the crisis in 2009, but by that time we had moved on. Until then the RPIX measure had never been as low as 1% and you had to9 go back to 1960 for the last time RPI inflation was 1%. Even I wasn’t following these things closely then.