Sunday, May 24, 2015
A little bit of deflation does you good
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.

Britain’s drop into deflation has produced a mix of curiosity, celebration and, in some quarters, alarm. The fact that the consumer prices index (CPI) last month was 0.1% lower than a year earlier (as distinct from unchanged in February and March) is of little practical significance.

But it has certainly provoked a lot of curiosity. Though the CPI was not even a twinkle in the statisticians’ eyes in 1960 – back then inflation was measured by the retail prices index – the Office for National Statistics (ONS) has managed to “backcast” the data to then. So we have been treated to comparisons which show this is the first episode of CPI deflation since Princess Margaret married the future Lord Snowdon, the skiffle artist Lonnie Donegan topped the charts and Wolverhampton Wanderers last won the FA Cup.

If the current deflation episode is as short-lived as many believe, it is a slightly sobering thought that in 55 years’ time somebody could be looking back and running comparisons to the quaintness of life in 2015, and which tunes we were all whistling from the charts. I should probably add a "not" there.

Mostly, the reaction to the drop into mild deflation has been to celebrate it. This has to be right. When I wrote about “good” deflation last year, I think I was one of the first, if not the first in this episode, to do so.

Good deflation in when prices fall in response to a favourable global price shock, in this case a sharp fall in oil prices. Bad deflation is when prices are dragged down by a lack of demand in the economy and is associated with stagnation.

Monday, May 18, 2015
Austerity myths revisited
Posted by David Smith at 01:00 PM
Category: Thoughts and responses

My piece on Friday, The Myth of Abandoned Austerity, has attracted quite a lot of interest. It had a simple aim - to demonstrate that fiscal consolidation, deficit reduction, continued throughout the parliament, alongside recovery.

Simon Wren-Lewis, a professor of economics at Oxford, devoted a blog post to it, here.

Jonathan Portes, director of the National Institute of Economic and Social Research, was typically condescending, tweeting that I was "confused (& confusing)". I find it best to ignore him.

Let me respond to Simon. He wonders whether I was having a go at him with my piece. To that the answer is no. I think we used to talk many years ago about the exchange rate but I have not been a close follower of his recent work.

But Simon answers the question himself: “I know this cannot be the case because I have never said that austerity was abandoned in 2012. In fact I cannot think of anyone who did.”

That means, he suggests, that I am guilty of creating a straw man. Is it a straw man, to say that some people claim the coalition abandoned austerity halfway through the last parliament? I don’t think so. I hear it a lot but let me offer one or two examples.

The Guardian for example, in its pre-election leader on the economy, on April 17, was clear:
“By 2012, with his own backbenchers in revolt, Mr Osborne abandoned austerity; from then on, aided by a steadier world economy, the UK has enjoyed moderate growth.”

This is not quite the same, of course, as economists that Simon might know saying austerity has been abandoned. So how about Paul Krugman?

As Krugman put it in his long piece, again in The Guardian, last month:
‘A return to growth after austerity has been put on hold is not at all surprising. As I pointed out recently: “If this counts as a policy success, why not try repeatedly hitting yourself in the face for a few minutes? After all, it will feel great when you stop.”

There was also this, from Krugman, in June last year:
“As Simon Wren-Lewis has pointed out repeatedly, the Cameron government essentially stopped tightening fiscal policy before the upturn.”

That prompted me to look at what Simon has been saying, for example this piece, from 2013:
“Plan A was in fact put on hold, and the recovery we have had has followed a suspension of austerity.”

In 2014, he bemoaned the fact that the Left had missed a trick by not capitalising on Osborne’s “U-turn”:
“They could say the recovery only took place once austerity was (temporarily) abandoned.”

I am not sure when the suspension or (temporary) abandonment of austerity Simon refers to is supposed to have come to an end. One thing is clear, this was no straw man.

Sunday, May 17, 2015
Crunch looms as pay picks up but productivity struggles
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.

The dust has settled, though the politicians – on the winning side at least – have not yet paused for breath. George Osborne, when he has not been trying to turn the north into a powerhouse, has been laying the groundwork for renegotiating the terms of Britain’s membership of the European Union.

These are early days for both of those, so I shall leave them for this week. More interesting is whether the economy has been given a post-election splash of cold water. The Bank of England, whose praises I was singing last week, left it until the new government had its feet under the table before unveiling a downgrading of its growth forecasts.

Had the Bank told us that during the election campaign, say some, it could have eroded the Tory “stick with us for a stronger economy” message. The post-election shock was not a rise in interest rates – that is still perhaps 12 months off – but a gloomier growth outlook.

Hand on heart, I do not think we should get too excited about this. Until Wednesday, the striking thing about the Bank’s growth forecasts was how upbeat they were. Growth of almost 3% a year this year and next – 2.9% in each year - was perkier than almost all other forecasters.

Its new forecast of 2.5% growth this year (an inevitable downgrade following a weak first quarter) and 2.6% next brings the Bank more into line with the consensus. The Treasury’s latest compilation of independent forecasts has an average prediction of 2.6% growth this year, 2.3% next. There was no drama in the Bank’s downgrade. Nothing to see here.

In other respects, however, the combination of the latest very strong labour market figures and the Bank’s inflation report has exposed a dilemma for the British economy. A crunch may be looming, partly as a result of what John Hawksworth, PWC’s chief economist, describes as Britain’s “incredible job creating machine”.

Thursday, May 14, 2015
The myth of abandoned austerity
Posted by David Smith at 03:00 PM
Category: Thoughts and responses

One of the most enduring claims about the British economy in recent years is that the then coalition government abandoned austerity in 2012. It is a claim that gives comfort to those who see everything that has happened to the economy through the lens of fiscal policy. Only when austerity was abandoned in 2012, some argue, did the economy begin to recover. Unfortunately it does not fit the facts. It is a myth.

There are two elements to this. The first is the question of whether, in response to slower growth in the economy, or other factors, George Osborne abandoned his programme of fiscal consolidation.

The two foremost authorities on fiscal policy in Britain are the Institute for Fiscal Studies and the Office for Budget Responsibility. The IFS set out the position clearly after each budget and autumn statement during the last parliament. Chart 1.6 on p26 in its latest green budget, here, sets out the broad position. As it shows, consolidation continues through the parliament.

The IFS's updated figures, published as part of its Election 2015 coverage, has the following sequence of numbers for the fiscal consolidation: 2010-11, 1.5% of GDP, 2011-12 2.3%, 2012-13 1.1%, 2013-14 1.5%, 2014-15 0.7%, 2015-16 0.6%, adding up to a cumulative fiscal tightening between 2009-10 and 2015-16 of 7.7% of GDP.

The OBR also addressed this, in its paper, Crisis and Consolidation in the Public Finances, here. Chapter 3 is the relevant chapter which, like the iFS, shows a programme of fiscal consolidation extending through the parliament. There was no abandonment of austerity.

The OBR also, however, highlights why there is a debate about this. As it puts it (p61):

"Our bottom-up approach relies on estimates of the impact of individual policies on the public finances, which are rarely revised after the event. The top-down approach relies on estimating the output gap and the sensitivity of the public finances to it.

"In normal times, both approaches would paint a similar picture. But the recent and sometimes large revisions to estimates of potential output from forecast to forecast have caused the top-down approach to deliver some potentially misleading conclusions. Specifically, the large downward revisions to potential output in 2012-13 changed the path of the cyclically adjusted fiscal aggregates significantly, which was interpreted by some as a discretionary fiscal loosening, whereas the path of incremental policy measures was little changed.

"While it is true that the Government chose not to offset the upward revisions that we and the IMF made to the estimated path of structural borrowing by tightening policy, that seems qualitatively different to announcing and implementing discretionary tax cuts or spending increases."

Sunday, May 10, 2015
A victory for common sense - and the Bank
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.

This time last week, when you could still get very good odds on a Tory majority, I missed out on yet another good investment opportunity. In other respects, however, the election showed that, outside Scotland at least, the wisdom of crowds works.

The election, and the unexpected Tory majority, was a victory for economic common sense, though I was sorry to see the Liberal Democrats so badly punished. Whatever voters thought about the future fiscal plans of the parties, they had enormous doubt about putting Labour back in charge of the economy.

Had Ed Miliband conceded when he became leader in 2010 that Labour both messed up on banking regulation and overspent, he would have endured flak but could have had a clean slate. Denying overspending right up to election day, when the numbers show it clearly with hindsight, was a fatal error.

As it is, George Osborne now faces having to accommodate a series of campaign pledges – right to buy for housing association tenants, a law not to raise any of the main taxes and £8bn more for the NHS by the end of the parliament – into a tight fiscal framework. Whether these pledges made any difference is hard to say, but compared with the alternative of defeat, these are headaches the chancellor will regards as the most minor of ailments.

What was most encouraging for me was that voters did not fall for Labour’s populist interventions. I do not want to revisit the columns of recent weeks but there was something fundamentally wrong about an agenda of price freezes and rent controls, a return to “government knows best” interventions in business and the attempt to persuade people that pain could be avoided by soaking the rich, preferably the foreign rich. I have no doubt that all this would have harmed the economy. It is good that voters recognized that.

Sunday, May 03, 2015
Deja vu - but the choice is starker this time
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.

The election is upon us, the party leaders’ voices are getting hoarser, and I don’t suppose many people would mind if they never heard a “cast-iron pledge” aimed at “hard-working families” again.

You will have heard pundits say we have never seen anything quite like this election before. Certainly the rise of the Scottish National Party, and to a lesser extent Ukip, makes it different.

In other respects things are quite familiar. To confirm my sense of déjà vu, I looked back to what I wrote on the Sunday before the May 2010 election.

All three parties were on the receiving end of a battering from the Institute for Fiscal Studies (IFS), then run by Robert Chote, now chairman of the Office for Budget Responsibility, for not coming clean about their policies. Opposition parties took their lead from the government; Labour’s refusal to spell out how it would cut spending (Alistair Darling, under pressure from Downing Street, postponed his spending review). Change the names and not much has changed.

It looked then, as now, that we were heading for a hung parliament, though the Tories were well ahead in the polls. While not then knowing there would be a full coalition, I wrote of a first budget for a new Tory government with Liberal Democrat input and the “obvious” a rise in Vat to 20%. I also warned of a post-election hangover for the economy, whoever won. The eurozone crisis was intensifying, the banking system had not been fixed and deficit reduction was just getting going.

How has the past five years gone? Just in case the LibDems do not make it into government again – and it will be a surprise if they do not lose half of their current parliamentary seats – let me praise them.

Sunday, April 26, 2015
The budget black hole still matters in this election
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 was a big week for the public finances, both where we have been and where we might be going. We can now make a judgment on the past five years and say something meaningful about the next five, though through the murk that passes for serious political debate on debt and the deficit.

Let me start with the record of the past five years. Though the numbers for the public finances are prone to revision – usually downwards in the case of the budget deficit – the Office for National Statistics’ latest figures, released on Thursday, tell the story reasonably well of the past five years.

Public sector net borrowing in 2014-15 was £87.3bn, £3bn less than was expected in last month’s budget. In five years the deficit has come down from £153.5bn, the 2009-10 figure the coalition inherited. That is a drop of 43%, though relative to gross domestic product it has fallen from 10.2% to 4.8%, a fall of more than half.

What about the debt? Public sector net debt at the end of March – the end of the 2014-15 fiscal year – was £1,484bn, 80.4% of GDP, compared with £956bn at the end of 2009-10.

It has thus increased significantly under the coalition, as it was bound to do; you cannot eliminate a £150bn-plus deficit overnight. Nigel Farage keeps saying that debt has doubled under this government, which is wrong; the rise is 55%, though it did more than double in the previous five years under Labour, rising from £448bn in 2004-5 to £956bn in 2009-10, an increase of 113%.

Sunday, April 19, 2015
Parties obsess about "costings", while ignoring the elephants in the room
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.

I would not want anybody to think a theme is developing here but, having warned last week that we should take economists’ views on austerity with a pinch of salt, this week I have another warning about this kind of thing.

When you see the words “fully funded” or “properly costed” attached to the plans of political parties, take great care.

Be also sceptical about fake precision. I know why it made the headlines but the difference between an International Monetary Fund forecast that there would still be budget deficit of £7bn in 2020 and the Office for Budget Responsibility’s prediction of a £7bn surplus is margin of error territory.

The IMF predicts a deficit of 0.3% of gross domestic product in five years’ time, the OBR a surplus of a similar amount. This is small change, even when you factor in the possibility that we may have a government in place which is not even aiming to eliminate the overall budget deficit.

The IMF produces its fiscal monitor every six months. The 0.6% of GDP difference between it and the OBR’s projections is not untypical of the size of the IMF’s six-monthly forecast revisions for Britain’s deficit –in either direction – not for five years’ time but for the coming year. Until they have quite a lot of monthly data to go on, forecasters struggle to get within £10bn of the deficit for the current fiscal year, let alone what it will be in 2020. The difference between a small surplus and a small deficit in five years is, as the IMF managing director Christine Lagarde has pointed out, fake precision.

This is not to say that we should just allow the political parties to say what they like, without any nod in the direction of fiscal reality. This may be good enough for those at the fantasy end of the spectrum, like the Greens and the Scottish Nationalists, but neither are going to form a government and, it is to be hoped, will have little influence on the government that is formed.