Sunday, March 01, 2015
If Europe keeps growing, Brexit won't happen
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.

Greece’s negotiations with its creditors have provided us all with an entertaining glimpse into the dysfunctional family that is the eurozone. So we have had Wolfgang Schauble, Germany’s finance minister, playing the part of the stern, unbending father figure, almost taking it beyond caricature.

Yanis Varoufakis, his Greek counterpart, has won admirers for his style and his straight-talking approach, the antithesis of most professional politicians. But ultimately he has been cast in the role of the rebellious teenager who insisted over and over again that he would never tidy his bedroom but has now got the vacuum cleaner out.

It remains to be seen where the Greek episode goes next. Syriza’s tactics have alienated many of its eurozone partners and the “deal” (or no deal) it achieved – which if not nothing was not far from nothing – has led to understandable disillusionment at home. Maybe Greek voters always took their new government’s promises with a pinch of salt but Syriza has made the mistake of over-promising and under-delivering, the opposite of what good governments try to do.

There are further episodes in this family struggle to go but, in a curious way, and despite its dysfunctional aspects, it has probably strengthened the euro. The chances of Greece leaving are smaller than they were, and the risks of other governments seeking to overturn austerity – which in many cases has already run its course – are quite low. Germany may not have won many friends but it has prevented what it would see as fiscal anarchy. “Grexit” – Greek exit – is off the agenda for now, and the 19-member euro lives to fight another day.

Less noticed amidst all this is that the eurozone economy, having looked like something of a basket case just a few months ago, has been quietly gaining strength. Maybe most people and businesses in Europe never took the prospect of Grexit seriously, or if they did were not troubled by it, but the eurozone is looking better, even before this month's bond-buying quantitative easing programme from the European Central Bank.

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IEA's shadow MPC votes 6-3 to keep rates on hold
Posted by David Smith at 08:59 AM
Category: Independently-submitted research

The Shadow MPC has voted to keep rates on hold, entrenching its reversal,
at the last meeting, of its long-standing call for rate rises.

Those favouring a hold included members arguing that there is no inflationary
pressure and/or that the recovery is not sufficiently rapid that the economy
needs or could tolerate rate rises. Others contended that with inflation so
far below target, with the notional inflation target (misguidedly) expressed
as it is, rate rises could not be considered compatible with that target. One
member urged, vigorously, that there should be a band of short-term
discretion set around the inflation target that constrains how far it is permitted
to deviate from target in the short-term, set at a level that the Chancellor
wants met and is prepared to enforce.

Those advocating raising rates have emphasized that the strategy of
maintaining near-zero rates has been damaging to real economic growth,
to productivity growth, to the pressure to achieve a sustainable fiscal
position and to longer-term financial stability. Low monetary growth has
been the result of excessively strict prudential and liquidity regulations
imposed upon banks. Monetary policy-makers should not collaborate in
such financial repression.

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Sunday, February 15, 2015
'Good' deflation boosts growth - will it bring forward rate rises?
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.

It is easy to get depressed about deflation. Deflation and depression are linked in the mind for good reason. In what economic historians call the first great depression, which lasted from 1873 to 1896, prices fell by a fifth. In the more familiar second great depression, in the 1930s, prices in 1934 were 12% lower than in 1928.

So why, when these gloomy associations are so powerful, has the Bank of England’s response to the prospect of deflation in Britain in the coming months been something close to hanging out the bunting?

Mark Carney, the first Bank governor to predict deflation (though he prefers to call it “temporarily negative inflation”) since Montagu Norman in the inter-war years – and back then the Bank did not do anything so vulgar as issuing a public forecast – was positively upbeat about the “stronger underlying dynamics” affecting the British economy.

The halving of oil prices over the past six months, the main factor pushing inflation towards negative territory is “unambiguously positive” for the global economy, he said. It is also, according to the Bank, manna from heaven for Britain.

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Sunday, February 08, 2015
Osborne needs to be careful with that axe
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.

George Osborne has, in spite of everything, a pretty good story to tell on the budget deficit. The scale of the borrowing problem the coalition inherited in 2010 was huge, and was subsequently discovered to be even bigger.

Yet the deficit has come down significantly. Depending on which measure you choose, and where the final destination for borrowing is, between 55% and two-thirds of the necessary action has been taken. Getting there requires a bit more than one more heave but looks far from impossible.

The question is why the chancellor is choosing to present the task ahead in quite the way he does. Stay with me is his message, and there will be years more of spending cuts. Not only will taxes not be used to help achieve the remaining reduction in the deficit but they will be cut. Merely eliminating the deficit, meanwhile, will not be enough. The aim will be to achieve a permanent surplus. I shall return to this curious pre-election message in a moment.

First, the record, and I draw on the Institute for Fiscal Studies’ always excellent annual green budget, which has been published for more than three decades, and is often more interesting than the budget itself. There is also an interesting new report on debt from the consultancy McKinsey.

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Sunday, February 01, 2015
Consumers are buoyed by the 'feel-better' factor
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 month into the year and questions about the recovery are already being asked. Growth slowed at the end of last year, with the smallest quarterly rise in gross domestic product for a year.

Are these the “red warning lights” David Cameron warned about coming into sharp focus? Is the recovery past its sweet spot? And what happened to that boost from lower oil prices that we have all been talking about?

The answer is to the last question is that it is still there. As Professor Peter Spencer, chief economic adviser to the EY Item Club puts it, if you put money into the hands of the British consumer, you can safely assume that he or she will spend it.

This is not just conjecture. Figures on Friday showed that the main measure of consumer confidence in Britain, produced by GfK-NOP, rose strikingly in January, by five points.

Every measure of the index rose, with people’s perception of their financial situation over both the past 12 months and the next 12 months each up by four points, their perception of the general economic situation over the past 12 months up by 5 points and over the next 12 months by four. Their willingness to make major purchases rose by six points on the month.

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IEA's shadow MPC votes to hold rates
Posted by David Smith at 08:59 AM
Category: Independently-submitted research

In a significant reversal of its longstanding recommendation to raise rates,
the Shadow MPC has voted to keep rates on hold. It should be emphasized
that the driver of this shift was not a change in the personnel voting.
Instead, three members that had, at previous physical meetings, supported
raising rates changed their votes to support a hold.

Those favouring a hold included members that have been long-standing
opponents of raising rates, arguing that there is no inflationary pressure
and that the recovery is not sufficiently secure that the economy could
tolerate rate rises.

To this group were added three new votes for a hold.
Two of these argued that raising rates at a time when inflation is far below
target was incompatible with the inflation targeting regime. A third felt that
political and geopolitical uncertainties are sufficiently high to warrant a
temporary delay in rate rises.

Those advocating raising rates emphasized that the strategy of maintaining
near-zero rates has been damaging to real economic growth, to productivity
growth, to the pressure to achieve a sustainable fiscal position and to
longer-term financial stability. There was an excuse for setting rates near
zero in 2008/09, but subsequently they have been kept at that level for far
too long, the taboo of rate rises should be broken and normalisation is
long overdue.

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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

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

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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

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

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