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 . . .

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6 thoughts on “The CEBR’s view on the economy

  1. Just bizarre!

    I lost faith in the CEBR quite a while back, it just seems to be nohting but pro-Tory, ultra-free market spin!

    The real confusion for the Toires now appears to be over the level of sterling. This time last year they got very excited about it falling – I remember Fraser Nelson invoking 1976 and the IMF whilst Osborne spoke of a currency crisis. Now they seem to have noticed that weak sterling is actually a good thing – but they can’t stop themselves lamenting it any way. Witness Hannan’s speech to Brown at the EP.

    This could become a bigger issue if (actually I suspect its ‘when’) we hit Euro parity, expect a lot of mainstram media coverage – probably mainly consisting of tourists being interviewed at Heathrow and complaining. Interesting to see how Osborne reacts. My guess? He attacks the Government for having ‘devalued’ Sterling…

  2. As an aside, Argentina seems to have done ok by defaulting on $95bn. Now that it’s been decided theyre not going to pay it back a deal is quietly being done to allow Argentina back in and domestic bonds are soaring.

    Perhaps the Uk govt should be a little more robust in its approach?

  3. Paul

    I would not take Argentina as an encouraging example. It still caused huge social disruption and pain, and they only clambered out because of an enormous commodity bull market.

    I share the view that defaulting is really shameful. We borrow money off a bunch of pensioners and then refuse to pay it back because . . . that would be bowing the knee to capitalism? It’s stealing, really, on a national scale.

  4. No, I wasn’t being too serious about following the Argentina lead.

    I was just suggesting that when push comes to shove the ‘investment community’ can have as much at lose from an economy being downgraded as the country itself can. Heh, if the credit ratings industry can strike a ‘compact’ with the financial world so that reality of investment risk is ignored, surely countries might have the institutional strength to set up a similar compact which allows the truth about the size of the deficit to go unspoken, in a financialized twist on the Baudrillardian post modern ‘lucidity pact’, where we all agree tacitly to live in a never-never alternative reality, accommodating the truly Marxian notion of fictitious capital in a worldwide spatio-temporal fix to capitalism.

    But perhaps I grow whimsical……

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