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

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

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Sunday, December 14, 2014
Relax: lower oil prices will be good for growth
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.

Rejoice. That is my normal response to lower oil prices. Filling up the car ranks second only to paying gas and electricity bills as the kind of spending you would rather not do. Anything that brings down the cost of such spending has to be good news.

The average price of a litre of petrol has dropped below 120p a litre, compared with more than 131p in the summer, with a similar reduction in the price of diesel. Had the reduction so far been achieved through cuts in excise duty, the cost would have been £6bn.

With the oil price having fallen by more than 40% to under $65 a barrel, and with analysts predicting that petrol could drop to just over £1 a litre, there should be more of this to come. By the time the process is done, consumers will be benefiting from the equivalent of a tax cut of £10-15bn, much more than in any recent budget.

That is not the only effect. Falling oil prices are cutting industry’s costs. In the past 12 months raw material and fuel costs have fallen by 8.4%, driven by the fall in oil prices. Cheaper oil is cutting inflation directly – it is now just over 1% - and will keep it low in coming months as these very weak pipeline pressures (no pun intended) feed through to energy bills and the price of goods in the shops.

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Sunday, December 07, 2014
Eliminating the deficit: hard work but not impossible
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.

Has the world changed? We knew before Wednesday’s autumn statement that George Osborne would be forced to concede that the budget deficit remains uncomfortably close to £100bn, so there would rightly be no room for a meaningful pre-election giveaway.

We knew that the growth numbers would be better but that it would be hard to generate too much of a political lift out of essentially rearranging the deckchairs.

So how was it? The budget deficit is uncomfortably large but Osborne wrong-footed Labour, and most commentators, by announcing that this year’s borrowing total, £91.3bn, will be below last year’s £97.5bn. That is still an overshoot of nearly £5bn compared with the official forecast in the March budget but it is still on the way down.

The Office for Budget Responsibility (OBR), which slightly encouraged the idea that borrowing this year would be up rather than down in its monthly commentaries, might turn out to be wrong. But a good rule of thumb is that this chancellor will find always a way of announcing that his deficit reduction plan has not gone into reverse.

Similarly, by deft footwork involving debt interest and a few other factors, Osborne managed to avoid the prolonged deficit overshoot confidently predicted by many economists. Again the OBR may be wrong but the big picture is that a slightly higher deficit this year and next is balanced by lower deficits later. That does not mean, of course, that the public finances are in any sense healthy.

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Friday, December 05, 2014
Back to the 1930s?
Posted by David Smith at 08:45 AM
Category: Thoughts and responses

In the light of the Office for Budget Responsibility's observation, endorsed by the Institute for Fiscal Studies, that the ratio of government spending to GDP is set to fall to its lowest level for 80 years - since the 1930s - a little clarification might be useful.

The OBR has no good data for overall government spending before 1948 so has extrapolated this from a narrower and different measure produced by the Bank of England: the contribution of government consumption of goods and services to GDP. It might be appropriate to do this, but this is not hard data.

A better measure of spending on public services is public sector current expenditure, not least because during the past half century - when more of industry was in the public sector - public sector gross investment often reached 10% or more of GDP, three times its current level.

On this measure, public spending will fall to its lowest level in relation to GDP since 1972-3 to deliver a 1% budget surplus, and its lowest since 1973-4 to eliminate the budget deficit.

In real terms, government spending is set to fall to its lowest level since the early 2000s.

In cash terms, total managed expenditure will rise by 8.3%, to £779.9 billion, in 2019-20 compared with last year, 2013-14. On the same cash basis, current spending will rise by 7.4% to £707 billion.

Sunday, November 30, 2014
Osborne confronts his failure on the deficit
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.

The autumn statement, George Osborne’s fifth and possibly final one, is on Wednesday and it is hard not to feel a sense of déjà vu. I have previewed very many of these over the years, and I can count on the fingers of one hand the times when I have expected a chancellor to stand up and announce that the budget deficit is coming in lower than he expected.

On Wednesday, the chancellor will do the opposite, as is often the case, and confront his failure. This year the budget deficit will be close to £100bn, with the independent Office for Budget Responsibility (OBR) set to revise up the prediction it made in March by around £10bn. It is touch and go whether the deficit will be up or down this year compared with last. It was, of course, supposed to fall, by 12% or nearly £12bn.

So it will be another miss, and an even bigger one compared with Osborne’s original June 2010 plan. The definitions have changed, making precise comparisons more difficult, but this year the deficit was supposed to be below £40bn, with all the hard work of deficit reduction completed ahead of the election. At £100bn, there is another parliament’s work to be done, if politicians and voters have the appetite for it.

Osborne’s deficit failure is not, as I say, untypical. We have had autumn statements since 1976, though there was a time under the Tories in the 1990s when they were known as single unified budgets (the March budget was scrapped) and Gordon Brown called them pre-budget reports. ‘Chancellor to miss borrowing targets’ is usually a pretty safe headline for these events.

It matters more now though, and not only because the deficit is still so big. Deficit reduction was central to the coalition government’s programme; its main purpose. It has not been achieved. Theresa May, the home secretary, admitted the other day that David Cameron’s target of reducing net migration to the high tens of thousands would not be met, by a mile.

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

In its email poll closing Thursday 27th November, the Institute of Economic Affairs (IEA) Shadow Monetary Policy Committee (SMPC) recommended by six votes to three that Bank Rate should be raised on December 4th, including two votes for a rise of ½% and four for a rise of ¼%.

Those advocating a rise contended that more rapid economic growth is an opportunity to normalise rates. Some emphasized that such normalisation should be combined with a relaxation of bank capital and liquidity requirements so as to encourage more market-oriented lending. Others noted the political uncertainties associated with the 2015 General Election. Several noted that recent very low inflation is driven by one-off factors that may reverse and policy acts with a lag.

Those that preferred to keep rates on hold noted that not only is current inflation below target (indeed, perhaps there may even be a Governor letter soon), but pipeline inflationary pressures are also low, as are wage growth, money growth and credit growth. For them there remains inadequate reason to raise yet.

It is noteworthy that two of those advocating a rise suggested they might revert to a hold or cut position in forthcoming months (either because of a Eurozone crisis or weak monetary growth) whilst one of those advocating a hold indicated he might soon switch to voting for raising rates if stronger economic growth continues.

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Sunday, November 23, 2014
Risks aplenty - but the world isn't about to go pop
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.

The Cassandras are out in force, from the prime minister down, predicting doom and gloom for the world economy and by extension a knock-on effect for Britain.

If China sneezes, Japan starts going backwards and Germany is forced to retire to bed with a warming glass of gluhwein, then surely the world will catch a cold. Britain’s plucky consumers, who in October bought 4.3% more than a year earlier, cannot after all keep us going on their own.

Is the world economy about to lurch downwards? Even more worrying, looking at some of the headlines generated by David Cameron’s “red warning lights … flashing on the dashboard of the global economy” are we about to have a re-run of the global financial crisis?

Nobody doubts that there are risks out there. The Russia-Ukraine crisis, unspeakable Islamic State murders in the Middle East and the Ebola epidemic in parts of Africa are all things we could do without.

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Sunday, November 16, 2014
The Bank conjures up a sweet spot for Osborne
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.

The Bank of England’s latest quarterly inflation report has attracted a lot of comment, mainly because it confirmed the Bank’s “lower for longer” view on interest rates and because of an upbeat assessment of prospects for wage inflation.

What has received rather less attention is that, even apart from its views on wages, the Bank has set out an economic scenario which any chancellor would die for. If the Bank is right, the main risk of the sweet spot it sees for the economy in election year is that it will be too sugary.

Consider the evidence. The Bank’s forecast for growth next year is 2.9%, close enough to 3% to make no difference. Unemployment, now 6% of the workforce, will continue its fall, to 5.4%, on its way down to a near-normal 5% rate.

Inflation, after a period in which Labour has based its pitch to voters on the so-called cost of living crisis, will run at close to 1% over the next year, the Bank expects, with Mark Carney, the governor, saying it is “more likely than not” that he will have to write an open letter to George Osborne, explaining why it has dropped below 1%.

This will be a significant moment. There have been 14 open governor-chancellor letters, all of them from Mervyn (now Lord) King, during the 2007-2012 period. All of them were to explain why inflation was more than a percentage point away from the 2% target on the upside; an overshoot.

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