Archive for the ‘monetary policy’ Category

Monetary and Fiscal Policy for 2015 onwards: Seven Years Too Late

Better late than never

It is clear that we have been doing something wrong. I have no doubt what it is: fiscal austerity.  “But the debt, the deficit, the debt!” cry the bankers and the Germans.  Their fears are misplaced (at least, the Germans’ are. The banks cannot be regarded as impartial).

The Bank of England has been practising QE to ease monetary conditions and in so doing has taken a lot of public debt onto its own balance sheet.  It needs to continue to do this, effectively printing money for the government to finance the deficit.  Yes, I know, breaking every rule beloved of dear Prudence.

The Government, on the other hand, should be pushing forward fast with major infrastructure projects, principally the development of offshore wind power and the associated industrial capacity to install it. We should be world leaders in this technology (we are already in installed capacity).   It should also take on the development of more nuclear power stations, not by making ridiculous unit price promises (tying us in to paying well over the odds for new nuclear electricity)  but by commissioning contractors to build them. Put money into nuclear research and developing prototype novel reactors under the management of university physics and nuclear engineering departments – let them teach practical, as well as theory. Not just nuclear research, by the way, but really back our scientific base so that a career in science makes sense.   Better rail links – don’t just talk about HS3 for the north, build it now.  Home Insulation projects – not the weaselly Green Deal, but a programme of grants focussed particularly on social housing. Talking of social housing, build some. Build a lot. That’s what we should be doing with the money printed by QE.

Now this will, eventually, trigger some inflation and in so doing it will devalue the debt and peoples’ savings. QE has already been devaluing people’s savings, for no apparent benefit other than papering over deep deflationary cracks.  In the 20th century, big national debts have only ever been repaid by inflation, which doesn’t really repay them.  It will probably be the way today’s debt is repaid, but if we have a truly growing economy (unlike today’s phoney growth) there is a chance that some of the money owed to us – most of the government debt, by the way, is owed to us, we the people, the pensioners, the baby boomers –  will be paid for real. And this programme of managed government investment will pay us back.

A good deal of this government investment will generate a return. Offshore wind farms and nuclear power stations can be sold, or kept so we earn from the electricity they sell. Social housing capital can be recycled through Right-to-Buy (need to look at those discounts though, currently far too generous).  For others  the return will be less direct.

Osborne almost gets it

I have very little time for George Osborne but he does understand that infrastructure spending matters. He didn’t cancel Crossrail, for example.  But he didn’t go nearly far enough in boosting infrastructure spending in the recession.

Keep a lid on current spending

Current spending does need to be kept under control.  The overall budget does need to be in surplus across the economic cycle but cutting current spending in a recession is completely counterproductive.

Rebalance taxes

This is very important. The ConDems’ actions in increasing tax thresholds are, mostly, to be applauded, but they have been much more expensive than they needed to be.  They should have been balanced by an increase in rates.  For every penny off average tax rates for those on less than median earnings,  a penny more on average rates for those above the median.  Increasing allowances without an increase in the basic and or higher rate reduces average rates for everyone.  It doesn’t have much effect in making the tax system more progressive. But allied to an increase in tax rates – even the basic rate – it does make it more progressive.

I have clear views on simplifying the tax system and ultimately I think Income Tax should be scrapped, replaced with a CashFlow Tax that wraps up the benefit system as well and provides everyone with a Basic Income.  But in the meantime it is important to keep it gently progressive, by which I mean simply that the average tax rate paid should increase for higher incomes.

The German Concern

Germans are terrified of hyperinflation brought on by excessive government spending using paper money; rightly so, since it triggered the economic collapse of the Weimar republic out of which came Hitler. But Weimar would never have been in that state had it not been for the war reparations it had to pay. It was the reparations, not the deficit, that did for Weimar. Now, in the Eurozone as a whole, German reluctance to tolerate monetary expansion is keeping the entire zone barely above the deflation level. Europe needs the same medicine as the UK and the US: monetary and fiscal expansion.

The Bankers

QE was supposed to have provided banks with the liquidity they needed to start lending to small businesses to get the economy growing.  However, they really needed it to fix their balance sheets and weren’t about suddenly to start lending to enterprises without customers.  Banks aren’t in the business of providing equity capital or of taking entrepreneurial risks in the real economy; it’s not in their DNA.

Banking continues to need reform. Bankers need to be held accountable to politicians, and politicians to the electorate.  Nowaday’s its backwards: politicians are firstly accountable to bankers.

 

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Disguising deflation

A deflationary world

This is a post about the conventional world economy, particularly the USA and the UK.

Both economies have been suffering from low-wage employment growth. Unemployment, normally a clear indicator of a failing economy, has fallen; and so have wages.

Both have had major financial crises and both governments have had to stage bank rescues.

The Eurozone and Japan are also primarily in sync with this movement. The Eurozone has suffered worse because it has had less QE.

There are a few differences, cultural, institutional, but essentially, the whole developed world has been stagnating since at least 2008, with the underlying malaise probably starting as much as a decade earlier.

The facts are that despite the key commodity (oil) being at well-above-average real price levels for most of that time, inflation has remained low and wages have fallen. We have, essentially, been living through deflationary times, saved only by quantitative easing.  Without the actions of both the Federal Reserve and the Bank of England, things would have been much, much worse over the last six years. Unfortunately, QE could not solve the underlying problems and now it is being withdrawn, they are likely to emerge with a vengeance next year.

I could be wrong; I often am and in this case I  really hope so. But I  don’t think so.

Classical economic theory (on all sides of the fence) says that recessions are the consequence of inadequate demand. Keynesian analysis says that the way to deal with that is for government to increase spending and/or reduce taxation during a recession, thus putting more more money in people’s pockets and increasing demand.  These two things aren’t, however, equivalent. On the liberal right, tax-cutting is the preferred mechanism because it lets people, not governments, decide how to spend the money and determine where the demand goes; the interventionist left favours more public works (the Mersey Tunnel, the Tennessee Valley Authority, re-arming for the second world war).  Intervention means that the money is actually spent;  individuals and companies, as is their right,  don’t always choose to do so, particularly when there’s deflation about.  The monetary authorities (central bankers) respond to this by devaluing money, making real interest rates negative. This is normally a strong incentive to spend, after all, why keep the money in the bank losing value? One of the problems of today’s global economy is that consumers, and particularly companies, haven’t been spending their money.

Quantitative Easing (QE): blowing bubbles

QE is a emergency lever used by central bankers to devalue money when the interest rate lever has come to the end of its range.  Global interest rates have been near-zero since the crash.  The central bankers create money to buy bonds from financial institutions. Creating money without creating a corresponding amount of stuff inevitably devalues it, which is the point of the exercise. However, QE has operated at a scale far beyond that originally intended.

The problem with QE is that it is used to buy assets: government securities, commercial paper, and in the US in particular the toxic securitised debt that had triggered the first crisis. This has the result of pushing up asset prices.  Suppose a bank holds $1bn of toxic debt, which it sells to the Fed. The result is that it has $1bn of cash instead of the toxic debt. That needs to go somewhere; held as cash, it will decline in value. So it spends it on other assets. Up to a point, this is a good thing. For related reasons, banks have been under great pressure to “strengthen their balance sheets”, since many had to be rescued during the crash.  New international rules on capital adequacy have come into force and QE has helped them meet the requirements, most clearly in the USA. German refusal to let the ECB do much in the way of QE, allied to the Eurozone’s structure, means that some Eurozone banks have found it harder to pass the new stress tests.    But beyond a point, it is a bad thing: it pushes up the price of assets, creating asset bubbles. There are lots of these around the world, fuelled mainly by dollar QE.  London property is one.  If the bubbles are relatively local, they can burst without bringing the system down.  The market for luxury property in Istanbul – definitely a QE bubble –  has been hit by regional unrest. But the collective effect of asset bubbles bursting is that investors lose money and the effect of the QE evaporates.  A significant factor here is the way insiders offload inflated assets just before the bubble bursts, thus passing off the losses to schmucks, or retail investors as they are more politely known.

The underlying problem is much more serious and none of the actions of the authorities since 2008 have done anything to address it.  It is structural,  based on continued weakness of real productive industries outside the newly-industrialising countries.  Growing income inequality creates a large class of people able to afford only the most basic goods and another, much smaller class of super-rich people with nowhere to put their money. Together, these two groups’ spending isn’t enough to support a prosperous middle-income, working class.  Making money by making useful stuff has been eclipsed by making money from inflating assets. Austerity policies have exacerbated and prolonged the structural problems.

I continue to believe that QE was, perhaps is, a necessary evil, but not a sufficient response to the structural failings of the global economy.  On its own, all it has done is  disguise the intrinsic deflationary phase; that needed addressing by significant state intervention on capital infrastructure projects.

The end of QE without solving the underlying deflationary nature of the economy threatens to bring deflation out into the open. That’s what I’m worried about for next year, although I believe that it’s more likely that central bankers will resume QE to prevent that particular disaster. I really don’t think they have a choice; it’s governments who need to act.

It’s Clegg’s fault

Someone asked “has there ever been a worse politician than Nick Clegg”?, and at first sight it is hard to think of one, other than GW Bush. And actually, most American politicians.

But Clegg has been spectacularly rubbish. He has squandered the opportunity of coalition and  politically, ruined his party. Financially, it was already ruined.  He could have, should have been a much feistier coalition partner, not afraid of the odd harsh word (they are different parties, anyway) but always standing up for what is right. He’s failed, but for the nation as a whole, his biggest failure came last Thursday.

If Clegg, not Cameron, had been doing his job, Thursday night’s Brussels fiasco could have been prevented. Cameron was doing his, for the sake of his mates and his toxic backbenchers, but Clegg was asleep in Sheffield.

Clegg doesn’t have a country to run. He doesn’t have the Eurosceptic baggage that Cameron has, he speaks several languages, and he could have spent time building alliances before the meeting.

With those alliances in place, there might not have been the need for a Tory veto at all; if Clegg had done his job, the options on the table might have been palatable even to Cameron.

Had he been in Brussels, as he should have been – he’s Deputy Prime Minister, after all – he’d have been able to say to Cameron, as he was considering his veto at four in the morning, “Listen, Dave, don’t be such a twat.” Or words to that effect. He might have been able to negotiate a better deal on the Tobin Tax – “yes we support it in principle, and we will agitate for it internationally, but it must be global, so we want a deferred implementation”.

But he didn’t. He was asleep in Sheffield.

What a useless fuckwit he has been.

The spectre of inflation

is a horrible journalistic cliche.

Sooner or later, we are going to have to face up to inflation. Yet the Bank of England is hurriedly dropping its base rate because it can see inflation falling fast in the coming months, and if the inflation rate falls below zero the economy enters a period of deflation, which – according to the economic textbooks – is universally-bad.  So who is right: me, a lowly blogger, or the great and the good on the Bank of England Monetary Policy Committee?

We both are: it’s just a matter of timing. First comes the fall in inflation, against which the Bank is attempting to defend by its interest rate cuts. This fall is an inevitable consequence of the burst of the bubble. The prices of assets and commodities peaked during the bubble, and consumer prices tend to lag these.  The inflation I am talking about comes afterwards, as the effects of the big injections of liquidity into the global economy begin to be felt, and it may be quite a good thing when it does.

Growth

The money that the governments of the world are putting into the economy is intended to stimulate growth. Whether it does so or not will depend on lots of different factors; but not all of it will. Corruption and cock-ups are inevitable, some of the extra loot will go awol: it won’t stimulate growth. Governments will back companies which then go bankrupt; individuals will spend their tax credits on cocaine. It is this unproductive loot sloshing around in the economy which creates inflation. But, if it’s accompanied by any positive economic growth, it’ll be OK.  Overall, when there’s positive economic growth, what people earn goes up faster than the prices of the stuff they spend their earnings on, all of which is fine if you are in work.

Pensions…

But not so good if you are a pensioner on a fixed income. And more and more of us are going to be; or at least, that’s the assumption. Personally, I think its time to ditch that assumption. Improved healthcare and improved lifespan mean that as we live longer, we should expect to work for longer.  The economy will not be able to continue supporting the idleness of a growing cohort of fit sixty- and seventy-somethings. But as we grow older, we should  manage our lives to make an income from a variety of investments as well as from our labour. This will be be the best strategy to deal with the inflation which is on its way.