Since the economic debate is all about being scared or depressed by something, and the IFS Green Budget is by far the most comprehensive combined-economic-and-fiscal event of the year, what does it leave me worrying about the most? In no particular order, blog-style:
A sterling crisis and/or downgrade
Not at all, and the consequences if it does happen does not bother me. I agree with Chris Dillow that it is silly to make a fetish of this rating; what matters is the cost of our debt. He writes:
Spain and Japan have credit ratings of AA, a notch below the UK, but 10 year Spanish government bonds yield just 4.1%, only 0.1 percentage points more than UK gilts, whilst 10 year Japanese government bonds yield only 1.4%.
On top of this, the maturity schedule matters (as yesterday’s post pointed out. Sorry for not putting the figures around this, yet – how much matures at which point. I will, some day). The consequences of a downgrade and higher cost on the incremental debt are made clear by the IFS. Look at slide 21 from Carl Emmerson’s bit:
It shows how, if the gilt market gradually started demanding an extra 100bps for fresh borrowing, the result would be . . . . debt interest rising from 3.3% to 4% of GDP. In other words, less than the revenue raised by a 2% rise in VAT. It is not a risk to keep you awake at night, in my view (though it seems to bother Ed Conway more). Because if the market repudiated gitls in that way, it would have to be because it has better sterling assets to invest in, IMHO, and that means a general economic recovery above current expectations. All IMHO.
And (see the Times) people still want gilts: ‘yesterday’s gilt auction, the first since the quantitative easing programme ended last week, drew the highest bid-to-cover ratio in eight years.’
Personally, no. But Simon Hayes of Barclays pointed out that the UK is the only economy to have had inflation surprises on the upside (see this presentation, slide 6). Then again, it is the only one with such a steep devaluation. Furthermore, given how weak household consumption growth is (slide 8), it is hard to see the demand side of the inflation. Look how high the graph goes during the real high inflationary periods:
Perhaps there will be some means by which the created money goes into prices, without first passing through higher consumption of some sort. But personally I think it would have to be driven by higher cash output first. I don’t think we are in some world in which the economy marks up prices without having the customers walking through the door, because of some sort of extraordinary ‘rational expectation’ that the so-far-unimpressive QE will do this for us.
A double dip
I do fear this, and the IFS went out of its way to advise policy makers to consider possibilities far from the central case. One of the main reasons is that, contrary to the prevailing political rhetoric, we are already set to have a significant fiscal squeeze THIS YEAR. See Carl’s slides again, slide 14:
The government is going from adding23 billion of demand to the economy, to taking some out. If that 23bn is not replaced in terms of demand by the private sector in some way, then we get a second dip into recession. In which case, scrap all these projections, add several negative percentages to them. Simon Hayes’ slides (see e.g. number 17) highlight this possibility. And, as I had already highlighted in Slash and Grow, there is a real risk that weak sterling will not lead to exporters rebuilding output – just margins. Hayes mentioned this at length.
The already steep fiscal retrenchment – no other country is already doing this – is one excellent reason the perpetually confused Conservatives (see Jonathan Freedland) are wrong to argue for even steeper earlier cuts. The NIESR, no socialists, clearly agree:
“There is no reason for tightening fiscal policy now. People are worrying about long-term debt problems when they should be worried about short-term output problems.”
They also back a recommendation of mine: less QE, more credit easing.
Separately, Mr Barrell noted the “credit easing” undertaken by the US Federal Reserve and the Bank of Canada, in which the central banks bought private sector assets, appeared to have done more to boost demand in those nations than the Bank of England’s quantitative easing programme, under which it purchased almost entirely gilts
A permanent hit to our output potential
This, the subject of the first presentation, is easily what bothers me most. We have an economy currently unable to provide the employment and government revenues necessary for general happiness and contentment. If we are also at our supply limit, then that is what we are stuck with. Extra demand will just lead to inflation. We have a need to negotiate, as a society, a 10% cut in our living standards, somehow.
I have always personally thought that (a) the UK was not doing all the ‘wrong’ things before the recession and (b) there are plenty of ‘right’ things that give us growth – like housebuilding – that are under utilised. I also think that recessions can help boost productivity by throwing out some marginal activities. You cut the fat first, etc etc. But the longer the recession goes on, the more capital is wasted, the more human beings become discouraged, the more skills are lost.
My big worry: fear that we are doing enough stops the policy makers from pursuing growth with sufficient vigour, and the “Barclays Gloomy We Need Another 50bn of Cuts” situation (see Stephanomics) actually comes true. Then it will get really nasty.