In yesterday’s piece on the timing of fiscal tightening, Chris Giles pointed out that the classic Macro 101 reasons for a fiscal tightening NOT MATTERING might not apply now. The countervailing monetary easing and lower exchange rate that are meant to somehow replace demand lost from fiscal tightening are both highly suspect in conditions where (a) a liquidity trap is quite possible (b) the main credit channel (the banks) is unable to convert liquidity into aggregate demand and (c) many other countries are hoping to rely on the export channel to ressurrect their overleveraged economies. For example, the US . . ..
This is not noticed by the CEBR, or not acknowledged. They blithely write:
The policies depend for their success on keeping monetary policyvery loose –a combination of quantitative easing and base rates at 0.5% until mid 2011 at least and a fall in the 10 year bond yield to 2.5% in two years.This leads to a continued weak exchange rate –the pound falls to $1.40 and could temporarily reach parity with the euro unless the markets become aware at anearly stage of the euro’s structural weaknesses.
Have they heard of Japan? Do they really think that having the Pound just 7% weaker against the Euro, and 10% weaker against the dollar will be enough to find 100 billion of lost demand? Do they not realise why rebalancing between surplus and deficit countries is such a fraught issue for the G20? Do they not think that the surplus nations may resist this?
No, all these difficulties disappear within the simplicity of CEBR’s equations.
I also can’t work out what the CEBR think about our credit-issues with the markets. On the one hand:
in normal circumstances, the deficit could be reduced gradually but because of the UK’s bad image internationally and with the financial markets, the need is probably more pressing at present
While on the other
[Conservative] policies depend for their success on keeping monetary policyvery loose –a combination of quantitative easing and base rates at 0.5% until mid 2011 at least and a fall in the 10 year bond yield to 2.5% in two years.
In one world, we have to scramble to reduce the deficit quick or the financial markets will spank us. In the other, they are lending us money at 2.5% for 10 years. The Tories are persistently confused on this one, and love the drama of a potential default. Wow, things move quickly.
UPDATE: Jeremy Warner on the Telegraph blogs has added up the implications of Conservative plans to stop both QE and fiscal easing – deflation. Just what an overleveraged economy doesn’t need – unless you are cash-rich, of course – like, say, someone inheriting a great fortune soon. In which case you’re sorted. Thanks George and David . . .