Sunday, March 29, 2015
Don't forget asset prices. Cutting rates is not the right response to zero inflation
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 big fat zero. No inflation at all. Though it is not guaranteed, a run of deflation – prices lower than a year earlier – seems highly likely in the next 2-3 months.

For many people this is uncharted territory. Though retail price inflation fell to zero in February 2009, and was negative for the following eight months, this reflected the sharp reductions in interest rates of the time. Inflation measured by the consumer prices index (CPI) remained positive throughout.

No, you have to go back 55 years, I suspect before many readers were born, for anything like this. The Office for National Statistics (ONS) has usefully modelled the current CPI back to January 1950. It shows that inflation last fell to zero in December 1959, and was negative by 0.5%-0.6% for three months.

Zero inflation is proving to be good news for the economy. Retail sales volumes rose by 0.7% last month and were a booming 5.7% up on a year earlier. As far as retailing is concerned, deflation is not merely on the way. It has been with us for some time.

So what the ONS describes as average store prices fell by 3.6% in the 12 months to February, a record. Stores include petrol stations, so much of this reflected the drop in fuel prices over the past year. But prices were also modestly lower for both food and non-food stores. Falling prices genuinely are putting money into people’s pockets.

At this point it is customary to warn that, while a temporary bout of deflation is a good thing, you would not want to make a habit of it. Indeed.

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Sunday, March 22, 2015
No roller coaster - but the tail wagged the dog in a curious budget
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.

This is a strange world, and we have just had a rather strange budget. There was some jam today, though it was spread pretty thinly. There was also less austerity tomorrow, as suggested here last week. But the overall impression was odd.

George Osborne had two aims: to demonstrate that only he can be trusted on the deficit and debt, and to kill the silly idea that he was planning, if re-elected, to cut public spending to the levels of the 1930s.

The fact that achieving both of these aims means, at this stage, merely ensuring consistency with the forecasts of the independent Office for Budget Responsibility (OBR) – which even its best friends would say has a forecasting record that leaves a lot to be desired – added to the Alice in Wonderland quality of all this.

We have policy driven by forecasts which will almost certainly turn out to be wrong and, perhaps even worse, we have a fiscal watchdog, the OBR, which has produced a “rollercoaster” projection for spending by government departments over the next few years (down very steeply then up), which no sane person thinks is remotely likely.

How did it come to this? How did the forecasting tail come to wag the policy dog? Why did the OBR, having given us that 1930s’ comparison after the autumn statement in December, give us the rollercoaster this time?

For Osborne, having determined that he would not fight the election with a giveaway but by reinforcing his reputation as the man who brought Britain back from the fiscal brink, it was necessary to resort to a few gimmicks to achieve his original aim of having public sector debt falling as a percentage of gross domestic product by the end of the parliament.

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Wednesday, March 18, 2015
No giveaways - but one or two gimmicks
Posted by David Smith at 04:30 PM
Category: Thoughts and responses

George Osborne stuck to his "no giveaways" pledge in the final Budget before the election - there is actually a modest fiscal tightening of £745m for 2015-16.

That did not stop him sprinkling a few crowd pleasers through his Budget, including cuts in beer, cider and spirits duty and a further freezing of the duty on petrol and diesel. There was the expected pledge to increase the income tax personal allowance, but not immediately. It will go up to £10,600 in April and then to £10,800 and £11,000 respectively over the following two years. The higher rate threshold will also rise.

The main message of the Budget was, as expected, sticking to the long-term plan. Achieving his original 2010 aim of having debt falling as a percentage of gross domestic product was clearly important to Osborne. It is duly achieved, on the Office for Budget Responsibility's new projections, but mainly by selling assets acquired - including the stake in Lloyds Bank - in the banking rescues of 2007 and 2008. As far as debt is concerned, the old distinction between the level including the rescues (financial transactions) and excluding them has usefully gone away, enabling this to happen.

Another important, if odd, priority was to get rid of the 1930s' spending comparisons, which emerged after the autumn statement in December. So 2018-19 will apparently mark the end of austerity, when spending is down to 36% of GDP - slightly higher than the low point under Gordon Brown in 2000 - after which it can rise in line with GDP. 36%, rather than 35.2%, will mark the low point.

It is all a bit silly, and it is all a very long way off, but then so were the 1930s' comparisons. In December Osborne wanted a 1% of GDP budget surplus by the end of the decade. Now he is apparently happy with 0.3%, or maybe has had that imposed on him by Davivd Cameron.

As for public spending generally, the combination of a coalition government, an OBR given the decisions late, and the fact that a joint policy can only be presented for the first year of the next parliament means that very little that is useful can be gleaned from today's Budget and the OBR analysis accompanying it.

The Treasury says the OBR's numbers for deep departmental cuts in 2016-17 and 2017-18 can be disregarded because a Tory government would make savings on welfare and from clamping down on tax evasion and avoidance (again). The Institute for Fiscal Studies will try to make sense of it tomorrow and we will also have the Liberal Democrats' separate projections. But it is all a bit of a mess.

Living standards will be a battleground in the election. Osborne laid stress on the OBR's projection of a rise in real household disposable income per capita in this parliament. As I noted at the time, this was also what the OBR was predicting in December, though it did not get much picked up. In practice, the debate between Labour - real wages are falling - and the coalition, real incomes are up, is just likely to give statistics a bad name.

On Thursday March 19, I gave a presentation on the budget at Reed Global's annual post-budget breakfast in the City. The presentation and accompanying article can be found here.

Sunday, March 15, 2015
Osborne: some jam today, will there be less austerity tomorrow?
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’s sixth budget may not go down as his most memorable – the expectation is that it will be a political rather than an economic event – but it will be no less important for that.

The backdrop to the budget is better than the chancellor might have hoped, and not just the “feelgood” effects discussed here last week. The public finances are also looking a little better.

Price Waterhouse Coopers (PWC) predicts that the fall in oil prices and lower gilt (government bond) yields will reduce the budget deficit in each of the next five years compared with the Office for Budget Responsibility’s autumn statement forecast. The cumulative undershoot, £32bn, is not huge but it not to be sneezed at either.

Goldman Sachs predicts a deficit undershoot of £8bn for this year alone, followed by £13bn next year, 2015-16. Its prediction of £83bn of borrowing this year would take Osborne close to halving the deficit in cash terms, in addition to as a percentage of gross domestic product. Next year’s £63bn prediction would take us closer to normality; in the five years leading up to the crisis, the last government borrowed an average of £45bn a year in today’s prices.

The improving public finances should allow Osborne to sprinkle around a few sweeteners; some jam today. They should include a further raising of the personal income tax allowance, now and next year, as reported by this newspaper last week, as well as populist measures on beer, wine and petrol duty. I think we can safely assume that the chancellor will not take advantage of the fall in oil prices to push up petrol duty.

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Sunday, March 08, 2015
The feelgood factor's back - will it work for the Tories?
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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

The feelgood factor is often elusive. But it is back. Consumer confidence is riding high, wages are once more outstripping inflation and unemployment continues to fall.

The misery index, invented by the American economist the late Arthur Okun, is arrived at by adding the country’s unemployment and inflation rates together. Currently, with an unemployment rate of 5.7% and inflation of just 0.3%, it is at its lowest level since the late 1960s, according to Capital Economics. Both Capital and Oxford Economics expect further falls – a lessening of misery – as inflation and unemployment fall further.

If misery is in retreat, confidence is strong. The GfK-NOP measure of confidence, which has been running for more than three decades, has risen by 30 points over the past two years, is well above both its long-run average and pre-crisis levels and has not been higher for more than a decade.

The Institute for Fiscal Studies attracted a lot of coverage a few days ago for its report that living standards – real household incomes – are broadly back to pre-crisis levels. In fact that was not news; the Office for National Statistics said as much last year on the basis of its real household disposable income per head measure.

There was, though, plenty of interest in the IFS report. One surprise was that the fall in real incomes as a result of 2008-9 recession, the deepest in the post-war period, was at 4% smaller than the 5.7% drop in the early 1980s. That is testimony to The Bank of England’s alacrity in cutting interest rates hard, Alistair Darling’s temporary fiscal stimulus and the fact that benefits were protected until well into the coalition’s period in office.

The IFS also noted that real incomes are now increasing, if not at a riproaring pace, with some of the fastest increases coming through for young people, who were disproportionately hit by the fall in real wages.

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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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