Sunday, August 09, 2020
V, W or Aargh? It depends on the virus - and on jobs
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.

When the economy has been hit by as profound a shock as Covid-19, and the unprecedented lockdown measures adopted to limit its spread, we should take comfort where we can. The Bank of England, which gave us its latest forecast on Thursday in its quarterly monetary policy report, offered a modicum of such comfort.

On the basis of its new forecast, we no longer have to look at the early 1700s, the time of Queen Anne, the War of the Spanish Succession of 1706 and the Great Frost of 1709. If the Bank is right, and the economy shrinks by “only” 9.5% this year, it will merely be the worst since 1921, when it shrank by 9.7%. Anybody who talks about the roaring twenties, as some over-enthusiastic tabloids did not so long ago about the 2020s, has to remember that they did not roar last time in Britain.

The Bank, which in an “illustrative scenario” in May suggested that gross domestic product (GDP) could fall by 14% this year, hence the early 1700s’ comparisons, is not yet putting out the bunting. The UK’s recession this year is predicted to be worse than that of the eurozone, down 8%, and America, down 5.75%.

It also provides a health warning that would grace any cigarette packet or box of pills, noting that the outlook “will depend critically on the evolution of the pandemic, measures taken to protect public health, and how governments, households and businesses respond to these factors” and that its “projections assume that the direct impact of Covid-19 on the economy dissipates gradually over the forecast period”.

Those are the key assumptions for the Bank, and for other so-called V-shapers like me. It does not help when people talk about a second wave of Covid-19, because that is usually associated with flu outbreaks, which are more severe in the winter. This coronavirus, currently raging in very hot countries, does not appear to be weather-dependent. Even so, if easing lockdown means a return of the infections and deaths, to the point where lockdowns have to be reimposed (and if there are enough local lockdowns you get many of the effects of a national lockdown) that is bad news for the recovery.

On the assumption of a gradual dissipation of Covid-19, as has happened with previous pandemics, the recovery is both rapid and dramatic. After a huge 21% GDP fall in the second quarter, the Bank predicts an extraordinary 18% in the current third quarter. Both represent record-breaking quarterly changes, by a very large margin.

Similarly, after this year’s 9.5% fall, the economy grows by 9% next year, according to the Bank, and gets back to where it was at the end of 2019, before we knew what was coming, by late 2021. That, as Simon French of Panmure Gordon points out, would represent the most rapid recovery in 50 years.

It would also underline the highly unusual nature of this recession and recovery. We have the deepest recession in nearly a century but the downturn happened in just two months, March and April, as lockdown was imposed. Assuming the June GDP monthly GDP figures this week show a rise (the Bank expects a 9% increase on the month), the economy’s journey out of the low point will be confirmed.

Whether it continues depends, as noted, on the virus and the avoidance of a disruptive Brexit. That deserves a piece on its own but most observers expect a compromise, if limited, trade deal in the autumn. I shall return to that.

It also depends on the labour market, and here the Bank has done some invaluable work. The furlough or job retention scheme has been a huge government intervention but the Treasury and Her Majesty’s Revenue & Customs (HMRC) have little information on how many people are currently covered by it, as opposed to the cumulative 9.6m total of employees who have benefited from it at some stage.

The Resolution Foundation think tank has done some useful digging, and now so has the Bank. It estimates that, on average, 6m people were furloughed at any one time during the April-June quarter, and that numbers peaked at over 7m in May. This quarter, July-September, it thinks that the average number of people furloughed will come down to 2m, dropping further to 1m in October, the scheme’s final month. The Bank’s decision maker panel, the latest results of which were also out on Thursday, revealed that at 18% of employees were furloughed in July, down from 30% in June.

Sunday, August 02, 2020
We have to say farewell to the furlough scheme
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 idea that we have experienced two “once in a lifetime” shocks in little more than a decade is now becoming pretty well established. Both the global financial crisis and the Covid-19 pandemic share one thing in common. Nobody, despite many claims to the contrary, really predicted either.

Some warned about the unsustainability of the global economy, the build-up of debt and the dangerous reliance on risky financial derivatives in the run-up to the financial crisis but these general warnings did not add up to a prediction of the crisis in the way it panned out.

Similarly, from the time of the SARS (SARS-Cov-1) outbreak in 2003-4, plenty of people warned that there would in time be an even deadlier virus, in the sense of more infections and a higher death toll. Bill Gates, the Microsoft founder, did a few years ago. But these general warnings could never have told us about the extent of the economic impact, the lockdowns, and the timing of SARS-Cov-2, or as it is usually known Covid-19. I doubt that at the start of the year anybody had a global pandemic at the top of their list of risks for 2020.

Whether predicted or not, these two momentous shocks have had an enormous impact on the economy. The National Institute of Economic and Social research (Niesr), in its latest quarterly review, published a striking comparison of the UK economy’s pre-financial crisis trend, its pre-Covid trend and what the economic think tank now expects over the next few years.

We had got used to the idea that, in general, the economic cycle was rather like a laundry cycle, and that it all comes out in the wash. What was lost in recessions was made up during recoveries, which were usually strong, particularly in the early stages. The pre-recession trend was regained, with little or no overall loss. Between 1955 and 2005 the real level of UK gross domestic product almost quadrupled.

These two shocks are different. They have been big enough to knock the economy hugely off kilter, and to result in a permanently large loss of GDP. So, according to NIESR, real GDP in 2025 will be around £536bn a quarter. That compares with a projection in February, before the scale of the Covid-19 crisis was known, of around £584bn. It compares with a trend figure for 2025, if neither of these shocks had occurred, of around £743bn.

These are huge impacts. In the absence of these two shocks, the economy in 2025 would be nearly 40% larger than it looks like being. It will be almost 30% - 28% - smaller than it otherwise would have been. These shocks make us all poorer and reduce the size of the economy, and that may not have yet fully sunk in. For simplicity’s sake I have for now left out the Brexit shock, which also reduces the size of the economy relative to what it would have been.

Sunday, July 26, 2020
Austerity's off limits, but Sunak will try to squeeze spending
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.

There have been many tricky public spending reviews over the years. Some even informally revived the historic star chamber to resolve bitter disputes between Whitehall departments and the Treasury. This year’s review, announced by Rishi Sunak a few days ago, is perhaps the trickiest yet, however.

The chancellor’s task in providing support to an economy hit hard by Covid-19 is not yet over. During the crisis he has been handing out money hand over fist. Never before has the Treasury played Lady Bountiful to the extent it has in recent months. Her Majesty’s Revenue and Customs (HMRC), which is normally good at extracting money from firms and individuals, has proved surprisingly adept at handing it out. In the right circumstances, it seems, even tax officials have a soft spot.

Now, however, Sunak has to begin to pivot to a more traditional Treasury position, that of restraining and in some cases reducing public spending. The taps, he is already arguing, cannot be left on forever.

In launching the review, he said there would be “tough choices” and that departments have been asked to identify savings and ways of reprioritising their spending. Though he announced pay rises of up to 3.1% for 900,000 key workers, including doctors, teachers and police officers, he also warned of future pay restraint for the public sector.

This year, with public sector workers not having been furloughed, their pay has risen even as pay for most in the private sector has fallen. Sunak said it was important for the future that there was parity between the public and private sectors.

There are some who would say that the chancellor should carry on regardless with whatever spending the economy and public services need, now and in the future, regardless of a budget deficit which, according to a new EY Item Club forecast, will hit £335bn or 17% of gross domestic product this year, with a risk it could be higher.

This is not just conventional economists who believe that a repeat of post-2010 austerity would be disastrous. I have received many reader requests to write about modern monetary theory (MMT), which I promise to do. One of its most prominent advocates, Stephanie Kelton, has written a book called The Deficit Myth, which provides an indication of where MMT enthusiasts are coming from. More on this soon.

The Treasury does not quite see it like that, and does not regard the deficit as a myth, which will not surprise you. As a bit of background, there is a lot of unfinished business in this year’s spending review.

It was supposed to happen last year but was postponed because of uncertainty over Brexit. Some would say it is brave to hold it his year amid the uncertainty over Covid-19 and Brexit but that is what the government has decided to do.
It will cover everyday spending, current spending, from 2021-22, next year, to 2023-24, three years in total, and capital spending, infrastructure, for one further year, to 2024-25. The unfinished business is mainly on current spending, infrastructure having been a prominent feature of the March budget.

On the face of it, there will be no return to austerity. Sunak has promised that departmental spending, boh capital and current, will rise in real terms over the review period. This sounds more generous than it is.

Torsten Bell, chief executive of the Resolution Foundation think tank, points out that the chancellor has “given himself more flexibility to reduce the size of public spending increases over the coming years, rowing back on significant increases announced as recently as March”.

“The planned 2.8% real terms growth a year has now become a far vaguer promise of some growth in real terms. This could mean very tough times for some public services in the years ahead,” he added.

Sunday, July 19, 2020
How COVID and Brexit put the kibosh on business investment
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.

So far during this crisis there has been a lot of emphasis, understandably, on what it means for the economy in general, for unemployment, and for the public finances. We know that the economy suffered a record fall in March and April, and only a modest bounce in May, so is 24.5% below pre-crisis levels.

We also know that the unemployment dog has yet to bark in the official figures, where the rate is still, miraculously, below 4%, but that it surely will in coming months. As for the public finances, the question is whether government borrowing this year will be nearer to £300bn or £400bn, both previously unimaginable figures.

There has been little focus so far, however, on something that will drive future prosperity, productive business investment. Without it, there will be no recovery in productivity, and no sustained rise in living standards.

Rishi Sunak eschewed measures to boost business investment in his March budget, perhaps because he thought it would be like trying to put up an umbrella up in a hurricane, and his summer economic update was all about encouraging consumers to spend and firms to retain workers.

But there is a crisis for business investment, both actual and looming, and it has three causes. The first is the direct effects of the crisis and the economic damage it has caused. A few days ago the Office for Budget Responsibility, in its fiscal sustainability report, set out three scenarios for the economy.

All start from a 40% collapse in business investment in the second quarter, as projects were cancelled and firms hunkered down. Only in its upside scenario, which has a rapid recovery in the economy, does business investment quickly get back to where it was pre-crisis, attaining that level in the second quarter of next year.

In both its central and downside scenarios, in contrast, it takes years before business investment gets back to pre-crisis levels and the damage is significant. In the central scenario, business investment is a cumulative 6% lower than previously expected, and its downside scenario, as the OBR puts it,“none of the lost business investment is recovered and cumulative business investment is 10% lower over the whole period”.

Sunday, July 12, 2020
Rishi to the rescue, but we'll have to live with the debt
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.

Hindsight is a wonderful thing but I can honestly say, listeninging to Rishi Sunak’s plan-for-jobs statement last Wednesday, the words “deadweight cost” kept coming into my mind. This was except when he announced his “eat out to help out” 50% reduction in restaurant food bills on some days in August, when the word was “gimmicky”.

I am not going to criticise the saintly Sunak too much because he is more popular than any economic journalist is ever going to be, and because he is doing his best in very difficult circumstances. He is also refreshingly aware of the pros and cons of his policies and, unlike others, is not given to bluster.

The two obvious deadweight costs in his announcements were firstly, the £1,000 per worker job retention bonus, which could cost over £9bn, and which the permanent secretary to HMRC (Her Majesty’s Revenue & Customs) did not think was good use of public money. The second was the six-month cut in VAT for much of the hospitality sector from 20% to 5%.

The bonus will be paid to employers who furloughed staff only briefly and have had them back at work for some time. The VAT cut will benefit people who would have eaten out or visited attractions anyway. There may have been method in both, however. Refining the bonus would have taken too long and the VAT cut may be intended to funnel money to a troubled sector of the economy as much as persuading the reluctant to venture out.

The gimmicky “50% off” Treasury-backed restaurant promotion reminded me of those “buy one get one free” offers that are said to have contributed to the country’s obesity problem. The behavioural response to this will be interesting. When you halve the price of a burger, do people eat twice as many?

That is in the detail of what was another big announcement from this chancellor. City economists think the cost of last week’s package will be closer to £20bn than the “up to £30bn” costed by the Treasury. But this is on top of the £158.7bn of direct fiscal support already provided by the Treasury in response to Covid-19.

The appropriate way to think of the Covid-19 response, of course, is akin to that of fighting a war. You do what the chancellor has described as “whatever it takes”, lifting a line from the former European Central Bank president, and think about how to pay for it afterwards. In fact, the government is probably less constrained in its ability to borrow than its wartime predecessors, given the Bank of England’s large-scale quantitative easing (QE) purchases of UK government bonds, gilts. Its £300bn of additional QE this year is in the same territory as the likely budget deficit.

Debt has not always fallen after wars. In the 1920s and 1930s government debt averaged 170% of gross domestic product (GDP) after World War One, before pushing sharply higher during the Second World War. Its drop then from 250% of GDP or more reflected a combination of post-war austerity, demobilisation and financial repression; the government being able to fund its borrowing at sub-inflation rates. By the late 1970s debt was down to less than 40% of GDP.

Many people will say that, in response to this crisis, we should not worry too much about debt. The Resolution Foundation think tank expects public sector net debt to stay above 100% for the remainder of this parliament. That in itself is not worrying, though it is worth recalling that at one time, under Gordon Brown, the safe level of debt was thought to be 40% of GDP.

To put some numbers on this; official figures show that public sector net debt is currently £1,950bn, nearly £2 trillion, that government borrowing in the first two months of this fiscal year exceeded £100bn, and that the rise in debt over the latest 12 months, £173bn, is the biggest on record.

There are two things that make this situation unusual. One is the combination of high levels of debt and large-scale government borrowing. You may think this is always the case but it was not in the interwar years. Budget deficits were modest relative to GDP.

Sunday, July 05, 2020
Sunak has to spend now, and he will have to spend later
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.

On Wednesday, straight after prime minister’s questions, when Rishi Sunak stands up to address the House of Commons, it will feel like a budget. And expectations are probably higher than ahead of most budgets, particularly after Boris Johnson’s ‘no big deal’ speech last week, dressed up as his version of Franklin D Roosevelt’s New Deal of the 1930s.

The chancellor has been the undoubted star of the Covid-19 crisis and he will want to ensure that his crown does not slip this week. In some important respects this will not be a budget, however, but merely an economic statement. There will be no accompanying economic forecast or assessment from the Office for Budget Responsibility (OBR), and thus no formal assessment of the impact of this week’s announcements on the economy and the public finances.

The tension in the Treasury leading up to this week’s statement is between those who think the chancellor should act immediately and those that think he should keep most of his powder dry until the next formal budget in the autumn, when there will also be a spending review.

Sunak knows, however, that expectations are high and that politically, neither he nor the government can afford a damp squib. So, despite the unusual nature of this week’s statement it will be meaty.

There are reasons for holding some of the Covid-19 response back. Yesterday saw the reopening of much of the hospitality sector in England, so-called Super Saturday, and other parts of the UK will either follow or, in the case of Northern Ireland, got there slightly faster.

Last week also saw changes in the furlough scheme. From July 1, last Wednesday, employers have been allowed to bring back previously furloughed workers on a part-time basis. Firms will be required to pay for any hours worked, with the government still covering the proportion of usual hours that employees are not worked.

Further changes will take effect from August 1, when businesses will be required to may the National Insurance and pension contributions of furloughed workers. In October, at the end of which the scheme is due to come to closer, firms will pick up 20% of the pay of furloughed workers, the government 60%. The tapering in the scheme is intended to provide firms with an incentive to gradually bring back furloughed workers.

The great unknown, to the Treasury and everybody else, is how much unemployment this will leave us with. It should have better information than is publicly available on how many workers who benefited from the furlough scheme are still furloughed now. It is less than the cumulative 9.3m figure recorded by Her Majesty’s Revenue & Customs (HMRC), probably quite a lot less, but it is hard to be sure.

XpertHR, the employment consultancy, surveyed nearly 200 employers and found that one in 10 furloughed workers are set to lose their jobs by the end of August. Two-thirds will have returned to work by then. The Recruitment and Employment Confederation (REC) recorded nearly a million job postings in the last week of June, many of them in the hospitality sector ahead of reopening. Capital Economics has just revised down its forecast of the likely peak in the unemployment rate from 8.5% to 7%. That would be regarded by the Treasury as a great outcome, amid fears of much higher unemployment.

Sunday, June 28, 2020
After the bailout, Bailey plots the Bank's exit strategy
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.

When Andrew Bailey became governor of the Bank of England in March, the usual description of this Threadneedle Street veteran was that he was the ultimate safe pair of hands and a model of discretion. Mark Carney, his predecessor, had developed a reputation for generating headlines, and was happy to wander beyond his brief. Bailey, it seemed, would keep himself within the Bank’s solid walls.

This theory suffered a rather big blow a few days ago when the new governor generated headlines suggesting that Britain almost went bust in March but was saved by the Bank’s exceptional actions. At a stroke, Bailey out-Carneyed Carney and knocked his predecessor but one, Lord (Mervyn) King, out of the park.

The suggestion that the country could have gone bust a few weeks ago has produced an outbreak of harrumphing from economists, Bank veterans and others. Was the Bank doing in March 2020 what the International Monetary Fund did in 1976, bailing out the British economy at a time of great difficulty?

No, but I do not blame journalists for running with the story. You do not look a gift horse in the mouth and the governor’s remarks, in an interview with Sky News, were hard to resist. There was, he said, a “pretty near meltdown” in core financial markets and, had the Bank not announced more quantitative easing (QE) and other measures: “I think the prospects would have been very bad. It would have been very serious.”

It would also have been serious, he suggested, for the government because “we would have a situation where in the worst element, the government would have struggled to fund itself in the short run”.

Critics have pointed out that, ultimately, governments can always fund themselves, the question being at what price. The markets, in other words, would have soaked up whatever gilts (UK government bonds) the government needed to issue to fund its borrowing, if there terms were attractive enough.

This, however, rather spectacularly missed the point. If the government was only able to get its funding away at a high interest rate then that high interest rate would have percolated through to rest of the economy, scuppering the efforts of the authorities to keep short, medium and long-term interest rates down. It would have sent out a confidence-sapping signal and increased the damage to an economy already facing a significant hit.

The Bank’s additional QE, the £200bn in March and a further £100bn this month, has been timed to coincide with the period of maximum pressure on the public finances as a result of the furlough scheme and other emergency measures to support the economy. Those who get twitchy about Bank apparently working so closely with the government and worry that it might be compromising its independence should note, as Bailey did in a letter to the chancellor on Thursday, in his capacity as chairman of the Bank’s financial policy committee, that “the committee attaches great importance to its secondary objective of supporting the government’s economic policy, and will continue to have regard to the impact of its policies on the government’s economic objectives”. You can be independent and still very helpful.

As it is, thanks to the Bank, the government has had no difficulty funding its extraordinary borrowing, which will break all records this year, even managing to do so on occasion at marginally negative interest rates.

It has been hard to keep Bailey own in recent days, and of more importance in the long run than the fuss over whether the government could have funded itself or not were his comments in an article he wrote for Bloomberg, the financial news and information service.

Headed ‘Central Bank Reserves Can’t Be Taken for Granted’, and with a sub-head ‘The current scale of central bank balance sheets mustn’t become a permanent feature’, the article set out the case for unwinding this year’s emergency QE once the crisis is over.

Sunday, June 21, 2020
The floor's the limit - we must avoid negative interest rates
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.

As widely expected, the Bank of England announced additional quantitative easing (QE) on Thursday, pumping in a further £100bn. The Bank’s monetary policy committee (MPC) did not cut its main interest rate below zero, leaving it at 0.1%, despite some suggestions that it might do so, and hints from some members that negative rates are part of its armoury.

I shall come on to negative rates in a moment. It may seem a little odd, when the Bank announces a further £100bn of QE, to describe the decision as hawkish, but it was. Instead of a unanimous decision in favour of expanding the asset purchase programme, one member, the Bank’s chief economist Andy Haldane, voted against because “the recovery in demand and output was occurring sooner and materially faster than had been expected at the time of the previous MPC meeting”.

In general, while noting that the risks in the labour market were on the downside, the MPC said that emerging evidence pointed to a less severe Covid-19 downturn than it had set out last month in its May monetary policy report. The Bank, it seems, has moved from the gloomy end of the spectrum into the pack.

It has the same evidence to look at as the rest of us, but it also has a little more, in the form of the reports from its network of regional agents around the UK and from its decision-making panel (DMP), which consists of 8,000 chief financial officers from small, medium and large businesses. It is run from Nottingham University.

The latest survey, carried out last month, showed that businesses expect sales in the current quarter to be 42% lower than they otherwise would have been, and investment 43% down. This is very gloomy but marginally less so than in April, when the expectations were for second quarter falls of 44% and 50% respectively.

The survey also shows the impact of the chancellor’s furlough scheme, with firms now expecting a 6% drop in job numbers this quarter, down from 18% in April.

Perhaps most interesting was what the survey showed about the shape of the recovery. As noted, firms expect sales to be around 40% below normal in the current quarter; 30% below in the July-September quarter; 20% down in the final quarter of this year and 10% in the first quarter of next year. This is the economic “V” I have often referred to; the economy picking up quarter by quarter as activity returns.

What is also clear, however, is that there will be lasting negative effects elsewhere. Business investment will lag the recovery in sales and will still be 20% below normal in the first three months of the year. The employment shakeout, meanwhile, will be most intense in the post-furlough period at the end of the year, when firms expect a hefty 10% drop in job numbers.

It is a very plausible recovery scenario, but we are not out of the woods yet, and we are not beyond the point at which the Bank will have to consider further QE or negative interest rates. If the economy were to suffer a further setback, say from a second wave of Covid-19 in the autumn, all options would be back on the table. Negative rates have been avoided so far, but the story may not yet be over. I hope it is, but we shall see.

If you think that negative interest rates do not feel right, I agree. They turn the basics of finance on their head. An interest rate is the reward for deferring consumption from now until later. By the same token, borrowers have to pay an interest rate to spend money now they did not have. Only if there is an overwhelming case for bring forward consumption from the future is there an argument, though negative rates may or may not achieve this. Nor, to bring it to the current debate, would cutting interest rates on commercial bank reserves at the Bank necessarily make much difference to the amount that banks lend into the economy.

A better case for negative interest rates would be if current and expected inflation was itself heading below zero, in other words into deflationary territory. A Bank rate of 0.1% with inflation at 2% means that official interest rates are negative, in real terms, by almost two percentage points. A 0.1% rate with -2% inflation, falling prices, represents a significantly positive real interest rate.

Though inflation is currently low, at 0.5%, and set to fall further over the summer, it is expected to rise again as lockdown eases further and a degree of normality returns. Some, like the veteran monetarist economist Tim Congdon, suggest that current very high levels of money supply growth point to a significant inflation shock to come. The inflation outlook does not offer an argument for negative interest rates.