Sunday, May 31, 2020
Levelling up has become even more of an uphill task
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

A long time ago, though not in a galaxy far, far away, we were in a different world. I am talking about early March in this country, less than three months ago. When, on March 11, Rishi Sunak presented his first budget, the economic costs of this coronavirus outbreak were starting to become clear.

The chancellor announced a small package of measures, intended to help hardest hit firm and, by the time he stood up on budget day, the Bank of England had cut interest rates from 0.75% to 0.25%, unveiled a new term funding scheme for small firms and relaxed the countercyclical capital buffer for banks.

Most of the budget, indeed most of the debate in government at that time, was, however, about the so-called “levelling up” agenda. Sunak had made it clear before the budget that he was not going to miss the opportunity to try to deliver on that agenda, mainly through a substantial boost to infrastructure spending. I do not blame him for that, even though his efforts have bene subsequently overshadowed. Budgets had become rare events – there was not one during the whole of 2019 – so he had to seize the moment.

What is clear, however, is that levelling up to improve the situation of “left behind” towns and regions presents an enormous challenge. This is partly, of course, because of Brexit. Every credible analysis, including the government’s own, shows that the biggest negative effects of leaving the EU will be on the regions. The government’s own assessment saw the northeast hit hardest, followed by the West Midlands, Northern Ireland and the northwest.

It is also because the trends firmly point in the other direction. On Thursday EY, the accountancy giant, published its 2020 UK Attractiveness Survey. The survey has for more than two decades recorded inward investment, foreign direct investment (FDI) projects, and ranked this country against competitors.

There was good and bad news in the survey. As an EU member, the UK was successful in attracting FDI, both from the rest of Europe and the rest of the world. Lighter-touch regulations, particularly in the labour market, helped, as did the English language and other factors. For many firms, a UK location was an attractive proposition for accessing the EU single market.

The bad news in the survey is that, while inward investment has continued, the UK lost top spot in 2019, for the first time since 1997. And, to add insult to injury for those who have little time for the entente cordiale, it was lost to France. Our near neighbour had 1,197 projects, the UK 1,109.

The good news, for those looking to the future, is that this country appears to be establishing a new comparative advantage in digital technology. Last year the UK secured 30% of all European FDI in digital technology, with 432 projects, which was more than France and Germany combined. Since 2013, digital technology has accounted for the biggest number of UK inward investment projects.

This, as I say, is good news, and it is logical. Digital technology is much less reliant on single market membership, or existing patterns of trade. The UK suffers from a lack of competitiveness in many sectors, but not in digital technology, including areas like fintech, financial technology.

This success, however, highlights the challenge in levelling up the economy. For foreign investors, digital investment mainly means London. It is London, by and large, where there is a successful tech cluster, with the right people, infrastructure and business climate. It meant that last year, 69% of digital projects were in London, and most of the rest was in or close to the UK’s so-called core cities; Birmingham, Bristol, Cardiff, Edinburgh, Glasgow, Leeds, Liverpool, Manchester, Newcastle, Nottingham and Sheffield. Small-town Britain barely got a look-in.

It also meant that last year, 538 inward investment projects were in London, 48.5% of the total. Yes, almost half of all FDI projects were in the capital, and its rising share of the UK total suggests that it will not be long before London has more than half of the FDI projects coming into the UK.

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Sunday, May 24, 2020
Signs of life start to flicker in our lockdown economy
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

When, a few days ago, Rishi Sunak warned of “a severe recession, the likes of which we have not seen”, the surprise was that nobody was surprised. He was also able to say it without facing criticism. Among the many changes brought about by this crisis, the old rule that chancellors should always be upbeat, even when standing on the burning deck, appears to have been shelved.

I could not help contrasting it with the fate of Alistair Darling, a month before the collapse of Lehman Brothers in 2008. The then chancellor, now Lord Darling, told an interviewer that the economic times were “arguably the worst they’ve been in 60 years” and the situation was going to “be more profound and long-lasting than people thought”.

He was pulled up for his comments, partly because there was a more economically aware prime minister in Downing Street – Gordon Brown had been chancellor for 10 years – and partly because there was at least some room for doubt about what would happen; the big bank failures were yet to happen.

This time, with both the official forecaster (the Office for Budget Responsibility) and the Bank of England setting out scenarios which envisage the deepest recession since the early 1700s, a chancellor who tried to pretend that the economy was just suffering from a little scratch would risk his credibility.

Jim Callaghan, Labour chancellor in the run-up to sterling’s 1967 devaluation, once described the deeply disconcerting feeling of seeing Britain’s currency reserves pouring away in a vain attempt to defend the pound. Sunak is experiencing the domestic equivalent; bucketloads of money flowing out of the Treasury to support the economy during the crisis and tax revenues only trickling, partly as an element of that support.

The fiscal consequences of the crisis are becoming clearer. Figures on Friday showed that the government borrowed £62bn last month, more than the £55bn officially predicted in March for the whole of 2020-21. Retail sales volumes slumped by 18% last month.

The monetary consequences are also pretty clear. For the first time in its 326-year history, the Bank of England is contemplating negative interest rates; charging commercial banks to keep their reserves at the Bank. We are in a world, it seems, in which even a 0.1% Bank rate is not low enough, even alongside an expected additional £100bn of quantitative easing (QE) next month. Already the government has sold some debt, gilt-edged securities, at a negative interest rate.

I think the Bank should hold off from crossing this particular rubicon. The economic effects of marginally negative interest rates would be tiny, at best, and there are other things the Bank can do first, including that extra QE.

Whether the Bank can hold off from negative rates depends of course, on how the economy does. There is some evidence from economists that, even in the absence of a lockdown, economies would have suffered a significant hit, as people adopted voluntary social distancing and businesses responded to customer and employee concerns.

The lockdown legitimised such concerns, however, and the government’s behavioural advisers, having thought that the most difficult thing would be to get people to abide by the lockdown, now finds it is harder to get them out of it.

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Sunday, May 17, 2020
There's no need for tax rises now, and maybe not later
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

In a moment I shall have something even more interesting to say on the economics of this pandemic, but first let me deal with the great lumbering elephant in the room. This is the extent of the government’s support for the economy during the crisis – including Rishi Sunak’s extension of the furloughing scheme last week – and how we will pay for it.

It is a question I get asked a lot. How much will taxes have to go up to pay for this and, whether Boris Johnson uses the A-word or not, will it mean a new round of austerity, or the cancellation of previously announced “levelling up” infrastructure spending?

That there is a lot more money sloshing around is not in doubt, though it is important to distinguish between different kinds of government supports. Some of the most eye-catching numbers, for example, the £330bn of loan guarantees announced a few weeks ago, are contingent liabilities.

That there has been actual spending is not in doubt. The Office for Budget Responsibility, the fiscal watchdog, updated its estimates on Thursday. It now thinks that the policy response to the crisis will cost £123billion this year, of which the bulk, £118bn, is extra spending.

It estimates that the addition to borrowing will be more than that. Its new estimate for the budget deficit this year, public sector net borrowing, is £298bn, up from £273bn in its first coronavirus scenario in April. That is roughly 15% of gross domestic product and compares with a March forecast, prepared before the extent of the coronavirus crisis and lockdown were clear, of just under £55bn. £298bn is almost double the maximum annual deficit, in cash terms, in the financial crisis.

The increase in borrowing goes beyond the direct effect of government measures because of the recession’s impact on tax revenues and the effect of significantly higher unemployment on the welfare bill.

It is a very big fiscal hole. What should the chancellor do about it? This year’s deficit has to be regarded as a sunk cost, an emergency increase in borrowing, for entirely understandable reasons, that cannot and should not be recovered.

That still leaves the question of what happens beyond this year. How quickly does the deficit come back down again, or has this crisis opened up a permanently much larger gap between government spending and tax revenues? And, as well as this, do the fiscal rules still matter, or has this crisis provided a cast-iron excuse for abandoning them? Before he was diverted on to other things, the chancellor said he would review the rules in his autumn budget.

Nobody sane would suggest that tax rises are the right thing to do when the economy is emerging from its deepest recession in modern times, so in the short term, talk of higher taxes should be safely put one side.

The question is what happens later, say after two or three years, and here the latest projections from the National Institute of Economic and Social Research (Niesr) provide a useful way of thinking about it.

The Niesr projections suggested that there will be a longer-term impact on the public finances from this crisis. So, in 2-23-24 and 2024-25, government debt is more the 90% of GDP – the permanent addition from around 80% as a result of this crisis, and the budget deficit is about 3% of GDP, higher than it has been recently; in 2018-19 it was less than 2%

Most importantly, in terms of the existing fiscal rules, the current budget deficit, excluding public investment, settles at about £20bn a year. The government is committed to borrowing only to invest, in other words balancing the current budget. This £20bn, rather than £300bn or even £500bn, provides a guide to the kind of extra revenues the government might want to raise in the medium term. It is a lot of money but in fiscal terms a drop in the ocean. We should not worry unduly about big tax rises to come.

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Sunday, May 10, 2020
Wartime lessons on deficits, debt and the role 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 www.thesundaytimes.co.uk This is an excerpt.

On Friday we marked 75 years since VE Day, and the end of the Second World War in Europe. Will we still be talking about this coronavirus crisis in 75 years’ time? Whether it becomes one of the great pandemics, in terms of the global death toll, remains to be seen, but if its economic effect is anything like the 14% fall in gross domestic product (GDP) this year sketched out by the Bank of England on Thursday, we will remember it for a very long time.

It could be, of course, that we are moving into an era in which very dramatic swings in GDP become the norm, as they were in the agricultural era, when harvests were all-important, though there is no good reason to think that. Normal service, in which annual changes in GDP are measured in low single-figure percentages, should be resumed in a year or so.

The Bank’s scenario, which according to its own database would represent the biggest fall in GDP since 1706 has had us scratching our heads. When the Office for Budget Responsibility (OBR) suggested a drop of just under 13% this year, the biggest since 1709, the year of the Great Frost, that was easy. But in 1706, the Act of Union (England and Scotland) was signed and there was the War of the Spanish Succession, but no obvious economic hit.

I shall leave that one for now but will return to the Bank later. However, as suggested by this weekend’s VE Day anniversary, it is another piece of history I wanted to draw on today. Now I know you are all pretty fed up of wartime analogies about the coronavirus crisis. And, to paraphrase a well-known political putdown, I didn’t know Winston Churchill and Boris Johnson is no Winston Churchill. There isn’t an obvious John Maynard Keynes around at the moment either.

But for somebody who grew up on Sunday afternoon black and white war films, the myth and reality of the Dambusters’ raids and had family members directly involved in some of the war’s great episodes, the Second World War has always been fascinating. And it is also fascinating that we are still finding out new things about it.

A new book from VoXEU.org and the Centre for Economic Policy Research, The Economics of the Second World War: Seventy Five Years On, edited by Stephen Broadberry and Mark Harrison, provides fresh insights. There is a lot in it but, in the context of the current crisis, I wanted to highlight just a few points.

At a time when we are seeing the economy transformed, if only temporarily, the much bigger transformation in the 1939-45 period is worth dwelling on. As the chapter by Broadberry points out, the UK went from being a small-state economy in the pre-war period, with public spending accounting for roughly 15% of GDP, to a large-state economy, with government spending around 50% of GDP, as the war effort was cranked up.

Some of hat increase was funded by taxation, including an excess profits tax, a device that was also employed during WW1. Mostly, the government borrowed, mainly domestic long-term debt, which covered two-thirds of the debt, including patriotic savers, but also short-term borrowing and an expansion of the money supply. The country was also, of course, left with external debts at the end of the war, mainly to America and Canada. These debts were not fully paid off until 2006, more than 60 years after the war’s end.

The economy grew strongly in WW2, by 27% or nearly 5% a year, Broadberry points out, though within that, consumer spending dropped from a pre-war GDP share of 78.8%, to just 51.9% in 1943, a drop of more than a third in its share of GDP. Then as now, if now only temporarily, consumers were limited in what they could spend. The war effort was extraordinary. In another chapter, David Edgerton notes that the UK outproduced Germany in the war years in production of planes, warships and tanks.

What lessons can we draw from that period? There are three, I think. One is that, when governments do exceptional things, and the current economic intervention is exceptional, they have to know when to let go, to have an exit strategy. At the end of WW2, letting go proved to be hard for policymakers to do, even if they wanted to. Rationing remained in place until the summer of 1954.

A larger role for the state was also accepted. The private sector had not covered itself in glory in the 1930s and a state-run economy had won the war. So, as Broadberry puts it: “Britain may have learned the lessons of the war economy too well, with the state too ready to accept restrictions on the operation of market forces, with adverse effects on Britain’s post-war productivity performance.”

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Sunday, May 03, 2020
We'll have a different economy - but will it be a better one?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

The extent of the economic shock from the coronavirus crisis and government-imposed lockdowns is becoming clearer by the day. China led the way in reporting a slump in gross domestic product in the first quarter and now other countries are following suit. These are just the appetisers, if that is the right word, ahead of much bigger falls in economic activity in the current April-June quarter.

America’s 4.8% annualised drop in gross domestic production the first quarter (1.2% in the way we would measure it) was milder than France’s 5.8% fall (in the way we do measure it), Italy’s 4.7% drop and the eurozone’s 3.8% fall. We will have to wait until May 13 for the first quarter GDP figures for the UK, though the eurozone’s record quarterly drop provides a pointer.

Today, I wanted to deal with a couple of things. The first is a question I get asked a lot, which is why a temporary lockdown in the economy, lasting a matter of weeks or months, has such a devastating impact on the economy, the effects of which will last for years. After all, the economy goes into something like a lockdown every year for a couple of weeks over Christmas and New Year.

The second question is whether we can improve on the dull post-crisis outlook envisaged by economists, in which the loss of output during this recession is never fully made up and productivity continues on its weak, pre-virus path. Could the forced changes in the economy lead to the “creative destruction” that gives us a better balanced and more productive economy?

The economic effects of the lockdown will have been at their most intense last month, April, with gradual easings mainly happening this month in Europe, as well as a modest private sector easing, including housebuilding sites and some DIY chains, in Britain. That will not prevent huge second quarter GDP declines, of which the Office for Budget Responsibility’s 35% drop provided a template.

Even if this is followed, as is likely, by some spectacular quarterly and annual gains in GDP – imagine the percentage growth between a Q2 2020 economy severely limited by lockdown and a much less affected Q2 2021 – the impact will linger. This is because, thanks to this year’s slump, which takes a big chunk out of GDP, any future gains will be from a much lower base.

The National Institute of Economic and Social Research set this out well in its latest quarterly review, which has just been published. It predicts a smaller annual fall in GDP than the OBR’s coronavirus scenario, 7.2% rather than 12.8%, and a GDP recovery from the third quarter onwards, which delivers 6.8% growth next year. But the economy does not get back to its level at the end of last year until late 2021, implying that the coronavirus has cost two years of growth. Even by 2024 the economy is nearly £60bn smaller than was expected before the crisis hit.

Some people have looked longingly towards the idea of a “roaring twenties” for the UK economy as we come out of the crisis. But the 1920s, which we associate with the flappers and the jazz and radio ages in America, did not roar much for Britain, as another article in the institute’s review points out. After the slump at the start of the decade, we had Winston Churchill’s blundering return to the Gold Standard in 1925 and the General Strike of 1926.

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Sunday, April 26, 2020
Lockdowns are different, and getting out of them is the hard part
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

A pandemic which originated in the Far East is sweeping across the country, leading to many thousands of deaths and putting the National Health Service under intense pressure. Aspects of normal life are significantly interrupted. The fear among experts is of a second wave even deadlier than the first.

I am not, for once, talking about the current coronavirus pandemic, which I shall come on to shortly, but about an earlier one, employing the technique used by the very good Radio 4 programme The Long View. This is the pandemic that affected Britain half a century ago, Hong Kong flu, and I have become a little obsessed with it.

Hong Kong flu hit Britain in two waves, the winters of 1968-9 and 1969-70. It caused some 80,000 deaths in those two waves, according to estimates in the government’s recent coronavirus action plan, out of what the World Health Organisation says was up to four million deaths worldwide.

It did have an impact. Nicholas Timmins, chronicler of the welfare state in his excellent book The Five Giants, recalls some of that impact on the website of the King’s Fund, the health think tank.

“For a briefish period, everything stopped for tea, so to speak, “ he writes. “There was no email in those days, and much of the post stopped being delivered, or was very late. The milk – almost all of it delivered to the door in glass bottles – stopped arriving. Trains and buses ran to heavily reduced timetables: not because of the sorts of decisions being taken now, but because drivers had the flu. Clinical staff, of course, also caught it, and for a period the NHS was overwhelmed.”

Hong Kong flu was serious. Ed Conway, Sky’s economics editor, who has been diligently tracking death tolls from the coronavirus in Britain and elsewhere, a few days ago highlighted a new dataset from the Office for National Statistics, providing weekly death tolls from the beginning of 1970.

The biggest weekly death toll in the period, bigger than has been experienced so far in this coronavirus crisis, was in the first week of 1970, with the second week not too far behind. This was during the deadlier second wave of the Hong Kong flu pandemic, when more deaths occurred than during the first.

I too lived through the Hong Kong flu pandemic and have written about the economics of the period extensively in books. One striking thing, however, in comparison with what we are currently going through, is that a public health emergency did not also become an economic emergency. Unless we all missed it, the government did not even contemplate a lockdown. Sporting fixtures, with spectators crowded onto terraces, continued.

The economic preoccupations in the 1968-70 period were the aftermath of the November 1967 devaluation of sterling - an economically necessary humiliation for Harold Wilson’s Labour government – and that government’s battles with the unions, which included Barbara Castle’s In Place of Strife proposals to limit their power.

The economy grew by a strong 5.5% in 1968, boosted by devaluation, slowed to 1.9% in 1969 as the government imposed post-devaluation austerity measures, but picked up to 2.7% in 1970. Growth over the three-year period exceeded its long-run average.

In his King’s Fund piece. Timmins rightly draws the contrast between flu and Covid19, which appears to be both more transmissible and result in a higher proportion of severe respiratory problems.

It is nevertheless worth asking the question about the response we have seen, and how lockdowns became the international norm, in a way we have not seen before.

Even a decade or so ago, in 2009, when Simon Wren-Lewis and Marcus Keogh-Brown wrote their paper, ‘The possible macroeconomic impact on the UK of an influenza pandemic’, they saw the main negative impact on the economy through the impact of school closures, though also through a reduction in “social consumption”, pubs, restaurants, hairdressers and so on, as people sought to reduce social interaction to minimise their chances of catching it.

That same year, 2009, when the swine flu pandemic hit, there was no question of a lockdown, though there was a rush to spend a lot of money acquiring doses of vaccine.

When China introduced its lockdown in Wuhan province in January, it initially seemed like something that only an authoritarian regime could do. Even when the lockdowns spread, including to countries like Italy, there was an element of “it could never happen here”.

But it has. Covid19 is not flu and perhaps for this reason earlier pandemics do not provide much of a template. But, while Hong Kong flu barely registered as an economic event, this one clearly has, with a bigger recession this year than during the global financial crisis, and possible since 2009. A new forecast from the EY Item Club, using the Treasury’s model of the economy, says that the economy will not get back to 2019 levels of gross domestic product until 2023.

The purchasing managers’ survey and the CBI’s industrial trends showed an economy pounded by the coronavirus lockdown. The Treasury and the Debt Management Office revealed the mountain of government borrowing that will be required to deal with the crisis, with £382bn of gilt issuance over the next 12 months, £225bn of it over the April-July period. The longer the lockdown persists, the more that mountain will grow.

The government, while its response to the crisis was slow and uneven, and lacked focused leadership, lurched from complacency to lockdown. It ended up in the same place as other countries, and this is not to criticise ministers for eventually putting public health first, almost whatever the cost.

Its approach, however, may have had unintended consequences. The lurch into lockdown successfully put the fear of God into people, as do the daily news reports from intensive care units. But it also went further than intended. Some of the businesses which have announced that they will be recommencing operations next month, such as DIY chains and building sites for new houses, were never required to close under government guidance and rules.

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Sunday, April 19, 2020
How to avoid the scars from a deep and nasty recession
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

Anybody who was shocked by the scenario drawn up by the Independent Office for Budget Responsibility (OBR) a few days ago, the one that suggested that Britain’s economy could shrink by a massive 35% in the second quarter of the year, should perhaps not have been.

Huge though the OBR’s numbers were, which included a rise to 3.4m in the level of unemployment and a budget deficit of £273bn, or 14% of gross domestic product, this year, they were the natural consequence of something I described here exactly a fortnight ago.

My piece then, “Despatches from an economy at two-thirds of normal”, informed by some ingenious work the Centre for Economics and Business Research (CEBR) had carried out on my behalf, likewise had an economy down by more than 30% as a result of the lockdown.

I want to talk about some of the longer-term effects of this medical recession, known in the jargon as scarring. But let me first share some dirty little secrets of these assessments, scenarios and forecasts.

The main reason why the OBR came up with such a big second quarter drop in GDP – 35% is 10 percentage points above the biggest private sector assessment I was aware of - is that it assumes the lockdown announced on March 23 lasts for a full three months. That takes in all but a week of the second quarter, with a gradual lifting over the following three months.

Other economists have assumed shorter lockdowns, which may or may not a correct assumption, and have also built in quite a sharp drop in first quarter GDP because parts of the economy were already shutting down before the formal lockdown. Their second quarter falls thus start from a lower base.

A second thing worth saying, or in my case reiterating, is that it is perfectly possible, indeed likely, that the statistics will show a very sharp bounce in activity, as lockdown measures ease. Suppose, to take an example, the economy goes from 65% of normal in the second quarter to something approaching 85% in the third, it does not mean that things are back to normal. It does mean you get the kind of numbers the OBR has in its scenario, a 27% rise in GDP in the third quarter, and a further 21% in the fourth, as the lockdown lifts entirely (its assumption), and GDP returns to its pre-crisis path.

You may ask, if this is so temporary, concentrated in the current quarter, why the OBR also has GDP for 2020 as a whole falling by 12.8% this year. This is one time when I can say this would be biggest fall in living memory. It is three times the drop in GDP in 2009, when the global financial crisis gave use the worst year in the post-war era. Nothing like it has been seen since the Great Frost of 1709.

The answer is that we measure growth, not from the beginning of the year to the end but comparing this calendar year with the previous one. The big loss of GDP in the second quarter, and a smaller on in the third, is enough to give this very dramatic result.

Though it was not intended that way, the 35% figure is quite useful to Rishi Sunak, the chancellor, in the internal government debate about the length of the lockdown. It describes starkly the extent of the economic hit, some of which – more than £40bn over three months according to the OBR – is being funded by the furlough scheme for employees.

Further food for thought, and potential ammunition for the Treasury, is provided by the Resolution Foundation, a think tank, in a new report “Doing whatever it takes”. Its estimates are slightly different from the OBR scenario but say that a three-month lockdown would lead to a still very hefty 10% drop in GDP this year, while six months would see the economy down by 20%. A 12-month lockdown, some of which would spill over into 2021, would see the economy contract by 24% this year. For perspective, that would wipe out nearly two decades of growth, taking GDP back to where it was in the early 2000s.

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Sunday, April 12, 2020
Even as we dive into recession, some worry about the return of inflation
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

At this time, indeed at all times, I am conscious of not wanting to add to the mood of concern, to put new bricks in the wall of worry. But it would be remiss of me not to address something that some people are worried about, which is that this modern great plague that we are seeing will be followed by a great inflation.

I say worried. Some would say that for governments racking up a lot of additional debt in their efforts to fight the coronavirus and trying to limit its economic impact, higher inflation would be no bad thing. It was part of what became known as financial repression is the period after the Second World War, when inflation reduced the real value of debt and governments were able to borrow at negative real interest rates.

For most people, however, inflation is unwelcome, particularly when the outlook is for wage growth, in cash terms, to remain subdued, and for official interest rates, and those most savers can expect, to stay close to zero.

Should we be worried about inflation? There was a flurry of concern on Thursday when the Bank of England and the Treasury announced, in effect, that the Bank was increasing the government’s overdraft facility. The Ways and Means facility, normally around £400m, will be increased, as during the financial crisis, when it reached £19.9bn.

When people and businesses have to increase their overdraft facilities it usually shows that they are in trouble. The government is not in financial trouble, but it does need cash to finance the crisis measures it has announced, smoothing the amount it can raise by selling gilts (UK government bonds).

That is how the announcement should be seen, rather than the so-called monetary financing – the Bank directly funding government spending – that the new governor, Andrew Bailey, has publicly set his face against. When the Bank creates money, as it is doing by expanding its QE (quantitative easing) programme by £200bn, and purchasing gilts, it is ensuring that it is doing so via the market. The government, via the Debt Management Office, issues gilts into the market. The Bank buys gilts, not necessarily the same ones, from the market. People may think this is convoluted, but it keeps things honest.

Despite this, some fear that the combination of ultra-low interest rates and other central bank measures, including QE, together with an explosion in budget deficits, is sending a big inflation warning signal.

Tim Congdon, once economics correspondent of The Times, then a much-followed City economist, now chairman of the Institute if International Monetary Research (IIMR) at the University of Buckingham, has had a commendably consistent view since the 1970s, when he helped shift economic policy towards monetarism.
He believes that the key to the outlook for inflation is the growth of the broad money supply, M4 I the UK, and one follows the other as sure as night follows day.
As he put in an IIMR note a few days ago, referring to the new governor: “Bailey needs to be told – like his predecessors – that the rate of increase in the UK price level depends on the rate of increase in the quantity of money relative to the rate of increase in the quantity of goods and services.”

Congdon’s particular worry at the moment is America where, he says, as a result of the exceptional measures being taken, this year may see the biggest increase in the broadly-defined quantity of money in peacetime. He does not blame the authorities for taking exceptional action, because they could not obstruct governments wanting to save lives. But: “The policy response to the coronavirus pandemic will be followed by an inflationary boom.”

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