Stephanomics

Winners and losers

2009-11-25T17:41:12Z

Who are the winners and losers from today's surprising bank charges ruling from the Supreme Court? Colleagues have been exploring the nuts and bolts of the decision and its implications for customers. But here's a brief economic take.

It's been a good day for the banks, and a bad day for campaigners, and customers hoping for an easy refund. But when it comes to everyone else - the answer's not so clear.

According to the FT, it's "only a black day for those in the red". Banking isn't free, and it never will be. But thanks to Britain's unique free banking model, many of us like to think we enjoy free banking, by keeping in the black, and being savvy enough to shop around.

That's the theory. In practice, the OFT's research says that more of us pay fees than we might like to think. In a single year, the regulator found that nearly a quarter of all accounts paid a penalty for going overdrawn - and only 6% of customers actually switched banks in search of the best deal. Very few people had any idea of the difference in charging policies between the major banks.

It's not hard to see why the banks like the free banking model - studies suggest that retail banks make more money per customer in the UK than in most of the rest of Europe. A report by the European Commission (referenced on p49 of the OFT's study mentioned above) found that average revenues per customer were the fifth highest in the EU, after Luxembourg, Italy, Austria and Holland.

Many frugal consumers will be glad to see free banking live to fight another day. But if there is one resounding conclusion of the OFT's work in this area, it is that free banking doesn't come cheap.

GDP estimates becoming more accurate?

2009-11-25T10:43:06Z

A little more on the ONS's defence of its numbers against criticism by the likes of Goldman Sachs, whose chief economist, Jim O'Neill I recently interviewed for the Today programme and other BBC outlets. I wrote up the Goldman Sachs analysis of the figures on the day the first estimate came out ("First draft of UK economic history").

The key claim in the ONS article [64KB PDF] is that, far from getting less reliable, the first estimate of GDP has been getting more accurate over time, despite the fact that it covers only 40% of the economic activity included in the more mature, Blue Book estimate published a year later.

Specifically, the ONS finds that between the first estimate and the one from two years later, the average revision since the mid-90s has been a mere +0.05 percentage points. Although there is a bias in the revisions - the numbers tend to be revised up more often than down - but it is much smaller than suggested by some critics.

As the authors of the article admit, this greater accuracy may simply be down to the fact that the economy was more predictable in this period. We didn't have a recession, and output and inflation were, in the words of Mervyn King, unusually nice.

In the wake of the controversy over the preliminary numbers, some economists have taken the ONS's side - notably Danny Gabay, at Fathom Consulting, who recently published a detailed rebuttal to the Goldman Sachs analysis making some of the same points as in the ONS article [120KB PDF].

Gabay's basic point against the Goldman Sachs economists was that they were including too many data revisions that were due to changes in the way the ONS collated the data - like the introduction of "chain-linking" in 2003. When new statistical methods are introduced, the ONS will usually go back and amend past figures, to make the data set consistent over time - in some cases making quite significant changes as far back as 1961. But it is a little odd to then criticise, on the basis of these revisions, the first estimate in, say 1971, for failing to anticipate later techniques.

So, the ONS has come out fighting. And they may have the last laugh. But whatever the past record, there's no getting around the increasingly wide discrepancy between the surveys, and the employment data, on the one hand, and the official data on the other.

Three European economists published their own study of the numbers yesterday, including a monetary economist at the European Central Bank.

There's no reason to suspect they have an axe to grind with the ONS. But they think the third quarter numbers are pretty odd too, especially now that the Eurozone is thought to have grown by 0.4% in the same period.

They argue that "the lag with respect to the Eurozone would be very much at odds with historical experience." (See chart below.) Using their own model, based on both survey data and GDP, they estimate that the UK grew by 0.15% in the third quarter. Clearly, the debate is not over yet.

Quarterly GDP growth, EU vs. UK

UK still technically in recession

2009-11-25T10:19:56Z

We may not like the fact that Britain failed to follow the rest of the G7 out of recession in the third quarter, but we're stuck with it. At least for now.

The first revision of that "shocking" first estimate for GDP is in the right direction, but it doesn't change the fact that the UK is still technically in recession. And to judge by the robust defence of its numbers also produced today by the ONS [64KB PDF], our official statistical agency doesn't expect later revisions to change the picture substantially.

They now believe that the service sector and manufacturing did a little better than first thought, whereas the production industries fared a little worse. But these are modest changes.

Many more forward-looking surveys and leading indicators - national and international - paint a brighter picture of the UK economy today. But with the possible exception of the labour market data, that broad-based improvement is still not showing itself in the data collected by the ONS.

A healthy squeeze?

2009-11-24T16:07:20Z

We'll be debating the timing of Britain's fiscal budget squeeze until at least the next election. But what about the how?

On the Today programme this morning, Richard Murphy, director of Tax Research UK, made the case for raising an extra £47bn in taxes to fill the fiscal hole, almost entirely from the top 10% of earners or corporations. It has a good populist ring to it. But it doesn't seem likely to win over the public - or most economists.

True, the Liberal Democrats' tentative plan for a mansion tax drew a lot of support in our special BBC poll last week. No doubt a windfall tax on the banks would also go down well - especially if the revenue raised were used to fund, say, an extension of the cut in VAT. (I'd be surprised if the Treasury were not exploring something similar for the pre-Budget report. January could well be a fragile time for the economy - it won't help matters to have VAT go back up to 17.5%.)

Even Martin Wolf, the FT's chief economic commentator, now thinks that a bank windfall tax is a "ghastly idea" whose time has come. As he notes, "it's hard to argue in favour of exception interventions to bail out the financial sector at times of crisis, and also against exceptional interventions to recoup costs when the crisis is past. 'Windfall' support should be matched by windfall taxes".

Some say a tax on bonuses would be better - because that, by definition, is not money that could help underpin new lending. But even if a windfall tax on banks or banker bonuses were feasible (and some say it's not), it's going to have more a cathartic value than a fiscal one. It's never going to be more than a populist warm-up act for the main feature - namely years of higher taxes and/or spending cuts that will be felt by all of us.

When it comes to that, our poll showed that most people favoured spending cuts over tax rises. Policy Exchange, the centre-right think-tank, now has a report out [1.49MB PDF] claiming that economic history is on their side.

The authors look at 12 historical cases where governments have cut public spending sharply - on average by more than 6% of GDP, or £90bn in today's terms. They find that, on average, countries grew 3% a year over the four years following the cuts, "suggesting that getting debt under control helps recovery and growth".

They also find that the "successful" tightenings (ie where borrowing has not gone back up) have tended to place most of the burden on spending cuts - about 80% versus 20% on tax rises. This echoes a respected study by Alberto Alesina and Robert Perotti, first published in 1996 [215MB PDF]. It concluded that "fiscal adjustments which rely primarily on spending cuts on transfers and the government wage bill have a better chance of being successful and are expansionary. On the contrary, fiscal adjustments which rely primarily on tax increases and cuts in public investment tend not to last and are contractionary."

The Policy Exchange authors are especially taken with the Swedish example in the mid-to-late 1990s. There, spending was cut by 10% of GDP in five years (about 3% in real terms), and the government deficit moved from a peak of more than 11% of GDP to surplus in just five years. Yet the economy grew, on average by 3% a year.

So, does this settle yesterday's argument between Gordon Brown and David Cameron once and for all? Alas, no.

The study sheds some interesting light on what works and what doesn't - for example, the authors observe that the British have usually taken a very centralised approach to their budget cuts. Other countries - notably Canada, but also Sweden - have often left it up to individual departments to decide what to cut, apparently with some success. It can put pressure on departments to come up with savings that bureaucrats might never have thought of.

If they win the election, senior Conservatives are keen to decentralise the tough decisions as much as possible. One I spoke to told me it was the natural corollary to Labour's targets:

"when you're spending a lot more money, there's a case for targets to show that it's not being wasted. But when you're cutting budgets, you want to give officials in individual departments the freedom to cut in the least costly way."

(Assuming, he might have added, you have a public sector wage freeze so they can't spend it all on pay...)

But, this research does not answer - cannot answer - the multi-million pound question of whether a tighter budget squeeze next year will stall the economy. Why? Because, by definition, none of the case studies they explore are exact parallels to Britain's situation today.

In nearly all of these earlier examples, the countries concerned had two big advantages that Britain next year will almost certainly not have: room for a dramatic reduction in long and short term interest rates, and an external environment of healthy global growth.

In the Swedish case, as the authors point out, the budget's cuts halved the interest rate on government debt from 10% to 5% between 1994 and 1998. In Finland, which had also suffered a financial crisis, rates fell from 9% to 5%. There is no chance of that here.

A serious plan to curb borrowing could take something off gilt yields, but they are already historically low. Yes, it could prevent a rise in both short and long-term rates which might otherwise have occurred. But barring a major run on the pound, no-one can seriously suggest that the rise prevented would be on the order of five percentage points.

Between 1995 and 2000, when Sweden and Finland were doing their thing, growth in the OECD countries averaged 3.2%. Now, the OECD predicts on average its members will grow by 1.9% in 2010 and 2.5% in 2011 - and for our major trading partners in the Euro area, the forecast is for just 0.9% growth in 2010 and 1.7% in 2011.

Sweden is an awkward example for another reason too. They raised taxes almost as much as they cut spending - according to the report, the ratio of spending cuts to tax rises was about 55:45, though, looking at OECD figures I find that tax revenues did not rise very much as a share of GDP, probably because GDP was growing at the same time.

That, of course, is the key point. The report suggests that spending cuts can be consistent with economic growth, and maybe promote it. That much is true. But by definition, the 12 examples do not include all the times where governments have been preventing from cutting spending by a declining economy. It is almost impossible to lower spending (either in real terms or as a share of GDP) for any length of time when GDP itself is falling, and unemployment is going up.

As it happens, the Conservatives and Labour seem to agree that most of the budget squeeze should be achieved through tighter spending. In the chancellor's own budget plans for 2011-2014, the ratio of spending/investment cuts to tax rises is roughly four to one.

But history alone isn't going to tell us when the squeeze can safely begin. Pity.

Tories tweaking their message

2009-11-23T12:56:39Z

"We care about the recovery too, honest." That's the message from Conservative high command this week.

I've commented before that (in "More squeeze to come" and "A plan not a timetable") the Tories seemed to want to appear more single-minded in their determination to cut the deficit than they really were. They had allowed Labour to paint them as hell-bent on cutting spending, regardless of the state of the economy, though in practice, they were unlikely to tighten much more than Labour in 2010-11.

Privately, party officials have explained the disconnect as a matter of positioning: "you need to set clear dividing lines first. Later you can tweak the message."

To judge by some of the headlines this morning - for example, on the front page of the FT - this is more than a tweak.

In the past, David Cameron, George Osborne and others had argued that a tough budget programme would help the recovery, by preventing a run on British government debt. An absence of market panic over borrowing would enable interest rates to stay lower, longer, and thus help the recovery.

There was also the shakier claim that a weaker exchange rate would help exports fill any gap in demand created by cuts in public spending. (I say shaky because even if the economics point in that direction, many in the markets would expect sterling to rise following a tough Conservative first budget.)

But as I noted on the day of Osborne's conference speech, this argument for austerity left the party battling a counter-factual.

Until you could see signs of panic in the markets over UK debt - and we haven't seen many yet - it was that much harder to argue that deficit cuts were priority number one. And that much easier for the government to paint the Conservatives as debt fanatics who would put the recovery at risk.

Apparently, party strategists now agree. On the Andrew Marr show yesterday, David Cameron made the negative link between cutting debt and protecting the recovery. But he also tried out a much more positive line: a Conservative government first budget would "go for growth" , with a "proper plan to get the economy growing" - including, for example, a cut in corporation tax.

That tax cut might be popular with many businesses. It could even help them grow, at the margin. But it will be paid for by getting rid of various business allowances (and probably limiting the deductibility of debt interest payments). So many other firms could lose out. For obvious reasons, this would not be a give-away budget even if it was "going for growth".

George Osborne wants to reduce the bias in favour of debt finance in the UK. This is one of many ideas he has for boosting Britain's long-term growth. Opposition chancellors always have a bundle of them (see my earlier post "Are we all long-termists now?"). One would expect to see him include some of them in his first budget, though my understanding is that the tax changes would be phased in over several years.

Even Osborne would admit that these kinds of structural changes will not improve Britain's growth prospects overnight. Whereas many economists would argue that new spending cuts or tax rises which come into force next year - against a backdrop of a lot of spare capacity in the economy and possibly weak global demand - could potentially hurt growth in 2010. That's what Labour is going to be saying for at least the next six months.

After months of austerity talk, David Cameron does need to show he cares about growth after all. But he's not going to seal the deal talking about corporation tax cuts which pay for themselves, and small-bore changes to help small businesses. Labour will always be able to come back and point to all the areas where the Tories have said spending will be cut. (They've already been sending texts to journalists this morning along these lines).

It's difficult to get across the idea that cutting the deficit could help the recovery (leaving aside for the moment the question of whether it actually would). But tweaked or untweaked, the Conservatives are stuck with it. That's the argument they have to get across to the British public. And that, in fact, was the main focus of Cameron's interview yesterday and his speech to the CBI today. The question of the day is whether a strengthening economy makes it easier for him - or harder.

Three-way on the MPC

2009-11-18T13:26:20Z

The nine men and women who set British monetary policy agree that the next few years for the economy are not going to be much fun. But they don't all agree on what to do.

As the minutes of the November meeting reveal, seven members of the Monetary Policy Committee voted to buy another £25bn-worth of assets over the next three months. But two voted against.

David Miles wanted an expansion of £40bn, to keep the asset sales running at the same pace as before. (It would be £50bn, but quantitative easing was always going to take a breather over Christmas. Presumably the Bank thinks that injections of good cheer from Father Christmas will be more than enough to fill the gap.)

The second "no" vote is the more interesting, since it came from the Bank's chief economist, Spencer Dale, who preferred to leave policy unchanged.

Judging from unattributed comments in the minutes, this was partly because he was worried about the sheer uncertainty about the amount of spare capacity in the economy, and the implications of that for inflation.

But he also thought there was a risk that further injections of cash would result in "unwarranted increases in some asset prices that could prove costly to rectify, complicating the task of meeting the inflation target in future."

This has been a growing concern among policy-makers around the world in recent weeks. I raised it directly with the Governor, Mervyn King, at last week's press conference. He gave a robust response - some might say, surprisingly so. (You'll see he makes a scathing comment about people seeing "bubbles" in every asset price rise, when I had chosen my words rather carefully. Not that I took it personally, or anything...)

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Now, perhaps, we have one reason for his giving such a lengthy and forceful reply. He's been having the same debate with his Chief Economist.

Should we be worried about a new asset price bubble? The current answer - at the Federal Reserve and at the Bank - is "no". In fact, I doubt that Spencer Dale thinks it's something that needs to be addressed next week or next month.

The agreed wisdom, elucidated by Mervyn King in his answer to me, is that there are two types of bubble: those driven by sheer investor exuberance, and those driven by exuberance plus shedloads of new credit.

In theory, it's only the credit-fuelled binges you have to worry about, because they bring excess levels of leverage - debt - into the equation. Frederic Mishkin also provided a clear statement of this argument in the FT at the start of last week.

When you or I lose money in the stock market (assuming that most of you aren't hedge fund managers), it's usually going to be through our pension fund or ISA. All that happens is the value of the assets in the fund go down, and we are a bit cross. When you have an asset boom, without a heavy expansion of credit, most investors in the market are like that.

But with a credit boom, more of those assets are going to be held by people or institutions who borrowed to buy them. And if the price goes down, they may have to sell them to service that debt (or pay it back). That will lower the price again, causing another round of sales, and so on.

Leverage makes the returns that much tastier when asset prices are on the way up - which in turn takes prices up even further. But it also makes the collapse in prices that much more costly for everyone involved.

Of course, I'm grossly simplifying. In the past year or two, great tomes have been written on the precise dynamics of this latest boom and bust. But credit - and the leverage it created - was the core of the problem.

We know that small businesses and households are not seeing big a expansion of credit coming their way. But is loose credit driving a "risky" run-up in world asset markets? The conclusion of a report produced yesterday by Paul Ashworth, the Chief US Economist for Capital Economics, is "no".

Mr Ashworth went through the numbers looking for evidence to back up the view that the world was "awash with dollars", driving up asset markets in the US but also world-wide, via a revived version of the "carry trade". He didn't find find any. Yes, the monetary base - the narrowest measure of money supply - is expanding. It would be amazing it it weren't, given the Fed's asset purchases. But debt - or leverage - is not expanding. In fact, the evidence is that institutions are still trying to reduce the debt on their balance sheets.

He produces loads of charts to make the point. Let me just give you two here: the first shows how bank balance sheets are still shrinking. The second shows that the expansion of dollar liquidity (the amount of dollars in circulation) has been slowing down recently - though it's interesting to me that is still well above the rates of growth seen after the end of the dotcom boom in 2001.

I don't think this disposes of the question entirely. There's plenty of cash flowing into emerging market economies that wouldn't be captured in Mr Ashworth's charts. It may not be a "credit-type boom", but you could forgive those developing-country governments for failing to spot the difference.

More fundamentally, it is quite reasonable to worry - as Spencer Dale apparently does - about the long-term effect on asset markets of a prolonged period of extraordinarily loose monetary policy. It is just not very healthy to have the risk-free rate of interest (that is, the yield on government debt) set, in effect, not by investors but by the central bank.

Then again, there's a lot about the past few years that's been pretty unhealthy from an economic standpoint. We are where we are.

In the minutes of this latest MPC meeting, several are said to have pointed out that expanding the programme by £25bn would also "bring forward the point at which the extraordinary degree of stimulus could begin to be withdrawn, if the projected impact was realised."

They would rather not be here. And now here, they would rather get out sooner than later. They just need the broader economy to co-operate.

When and how to squeeze the budget

2009-11-17T17:52:42Z

The next government has to decide how to squeeze the budget, but as we all know, there's also the crucial question of when. As I reveal in a second film for the news bulletins tonight, in our BBC poll we asked people about that too (see yesterday's post for the first part).

Interestingly, 38% agreed with Labour and the Liberal Democrats that the economy was too weak to risk deeper cuts in spending next year. But more - 44% - agreed with the Conservatives, that not taking action posed even greater risks. An honest 18% said they didn't know. If asked, I suspect a lot of economists would be in that last camp as well.

On the question of timing, I suspect the difference in practice between a Labour and a Conservative government would be smaller than the difference in rhetoric suggests (see April's post "Spending slowing doing the work"). Both parties would expect to announce tough budget plans if elected - and both would tend to delay most of the pain until 2011 or 2012, when the economy is more firmly on the mend.

But if a new Conservative chancellor did want to act more quickly, he'd have to face the irony that it's hard to cut spending in a hurry - especially in a recession. As Geoffrey Howe discovered in 1981, the fastest way to cut borrowing is almost always to raise taxes.

The big moves in that famous - or infamous - budget were all tax rises. He froze personal allowances - a big tax rise with inflation running at more than 15% - and put a windfall tax on North Sea oil profits, and the banks. All told, he raised £4bn - around £12bn in today's money.

You might remember that 364 economists wrote to the Times protesting the Budget. I made a film about it for Newsnight in March 2006.

If you'd polled voters in advance, I doubt you'd have found many in favour of Howe's tax rises. And the same is true today.

As I revealed yesterday, a clear majority in our poll wanted spending cuts to take most of the burden. But 69% did say they would support the Liberal Democrat idea of a "mansion tax" on houses worth more than £1m. It didn't go down very well when Vince Cable announced it - to the surprise of many of his colleagues - at the Liberal Democrat party conference. But housing is relatively under-taxed in Britain today - Martin Wolf is one of several economists who have since supported Cable's idea.

The political downside of that kind of tax is you'd be handing a relatively small number of households - less than 250,000 - with a very large bill. The economic downside is that you wouldn't raise very much cash: the Liberal Democrats' initial estimate was that it would bring in £1.1bn, but there are a lot fewer £1m houses around than there were.

As the Howe example suggests, to raise a lot of money you have to raise a tax that lots of people pay or bring in something entirely new. Right now, that has some suggesting a carbon tax.

In our poll, 39% were willing to sign up to a carbon tax. The ABs were most keen, with 46% supporting the idea. Others were less keen, possibly because we reminded them that a carbon tax would raise the cost of heating and fuel.

Others, perhaps remembering Howe's first budget of 1979, tell us to expect the Conservatives to raise VAT, or, say, remove the zero-rating for books and newspapers, or the reduced rate for domestic fuel.

That was the least popular option in our poll. Only 31% would be willing to support a VAT rise to 20%, which would raise nearly £5bn a year. There was an interesting age difference here, with 37% of 16-24-year-olds in the poll coming out in favour, versus 29% of over-65s. If anything, you might have expected the reverse, given that VAT is the tax that younger people are most likely to pay.

As the Liberal Democrats have shown, the idea of a windfall tax on banks is unlikely to go away. Nor will the debate over the timing of deep budget cuts. But with borrowing so high, there aren't many either/ors. The answer may end up being "all of the above" - and a longer working life as well. But not quite yet.

Tough times ahead

2009-11-16T18:03:00Z

Is the great British public prepared for the tough budget times ahead? We recently commissioned a poll to answer that question. I'm unveiling the results in two films for the evening news bulletins tonight and tomorrow.

In the summer, the public debate on budget cuts moved further than many expected - including the prime minister. Voters know that things will be tight. But the message of our poll is that most voters have still not got their heads round the scale of the problem.

In the Budget, the chancellor forecast a public deficit of £175bn in 2009-10. As I'll be discussing later in the week, there are good reasons to think the final tally will be a bit lower. But by any reckoning, there's at least an £80bn hole in the budget that the recovery is not going to fill.

In considering where these savings might be found, economists and mainstream politicians have tended to emphasise spending cuts - and it looks like the voters agree. Asked whether borrowing should be cut through spending cuts and/or tax rises, a majority - 59% - said that cuts in spending (including benefits and tax credits) should do the work. 34% said it should be tax rises, and 22% did not have an opinion either way.

But voters were equally clear on the parts of spending they would protect. 63% agreed that "the NHS should be protected at all costs, even if it means imposing larger cuts on other public services or tax rises". Interestingly, the support for the health service was strongest among older people: 71% of over-65s agreed with this statement, compared to 55% of 25-34-year-olds. Regionally, the greatest support for the NHS was in the north-west, where 77% said the NHS should be protected from any cuts.

Both Labour and the Conservatives have said they will continue to increase spending on international development, in line with various government UN and G8 commitments. Some polls have found the public at odds with the politicians on this one. But in our poll, we were surprised to find strong support. That may well have been because we stated both the size of the budget (£6.3bn) and its share of public spending (just under 1%) in the background to the question.

Asked to choose between two statements, 64% agreed that Britain "... should keep its promises and protect the aid budget." Only 32% sided with the view that "helping others is a luxury we can't afford. Development aid should have no special protection."

What struck me here was the regional difference: a stonking 80% of respondents in Northern Ireland, and 77% in Yorkshire and Humberside, wanted to keep money flowing to DFID (Department for International Development). Among Londoners, the proportion was 59%.

The poll was taken after the party conference season, when the Conservatives had proposed a one-year pay freeze for public sector workers earning more than £18,000 a year, excluding the armed forces.

We asked people about a range of options for public sector pay, and 90% of respondents were in favour of at least one of them. (Specifically, 5% said they favoured none of them, and 5% said they didn't know.)

Just under half of those polled - 48% - supported the Conservative proposal of a one-year freeze, for an eventual saving of around £3.2bn a year. But only 31% would want to extend it to two years. The most support was for a 5% pay cut for the top 10% of public sector workers, with 56% in favour.

Interestingly, squeezing the high-earners in the public sector was most popular among the better-off, or "ABs" in the pollsters' terminology. They came out 64% in favour of a pay cut for the top ranks, compared to 52% among "C1s" and 54% among "DE" or working class respondents. According to a joint report by the Institute for Directors and the Taxpayers' Alliance, such a pay cut would raise about £1.2bn a year.

There are more potential savings on offer from reining back "middle-class welfare" - but, as the prime minister has discovered with the plan to get rid of childcare vouchers, perhaps also a lot of votes to be lost.

George Osborne has proposed ending tax credits to families on more than £50,000 a year. But, as I commented at the time he gave his speech, this would raise a paltry £400m a year.

No politician has dared to question the case for a universal child benefit, which is untaxed and costs nearly £12bn a year. As Reform pointed out recently in its report The End of Entitlement, that's four times as much as the government spends on Jobseeker's Allowance.

In our poll, we asked people what they thought of abolishing all child benefit and child tax credits for families on more than £31,000 a year, for a saving of around £6bn a year. 48% of respondents were in favour, and 42% against.

There was an interesting gender divide on this: men were clearly in favour, 51% versus 37%, but only 44% of women were in favour, and 47% against. Unsurprisingly, C1s were more supportive, with 52% in favour, than the ABs who would be affected. They were split down the middle, 44% against and 44% in favour.

Tomorrow, I'll be talking about the timing of budget cuts, and the options for raising taxes. We asked people about those as well. But the conclusion for the spending side of the debate is that we have a long way to go.

Imagine the next government did freeze the public sector wage bill for one year, and cut wages for the top 10% of public sector workers, and get rid of child benefits and tax credits for middle class families. That could deliver a permanent saving of maybe £10-£12bn a year, as against a structural budget hole of £70-80bn.

George Osborne gave his "brave" speech to the Conservative party conference. The chancellor will add some detail to his plans to cut borrowing in the pre-Budget Report next month.

Both men know that there will be a lot more tough choices ahead. The question is how many they can afford to share with the voters this side of the general election.

Update 17 Nov: An earlier version of this post contained slightly different numbers in paragraph 4 - now emended.

New name for a new economy?

2009-11-13T14:36:27Z

Do we need a new name for the kind of economy we live in today? I ask because it's becoming a bit of an issue.

We started the week celebrating the 20th anniversary of the fall of the Berlin Wall. It was, everyone agreed, ironic to be marking the fall of communism, when less than a year ago capitalism itself had seemed to be on its knees.

Capitalism has survived. But it's not the capitalism we thought we had. When you consider the scale and scope of government involvement in most of the advanced economies right now, "free market capitalism" seems a bit of a stretch.

Today we had confirmation that the eurozone economy had moved out of recession in the third quarter. But the public sector was almost entirely responsible for the modest growth that the major European countries have achieved since the spring.

The last 20 years were supposed to be about the end of the era of big government. And yet, public borrowing in the leading "free market" economies - Britain and the US - has never been as high as it is today, outside times of war.

You might see that as the statistical counterpart to the intellectual journey that economists have been forced to make as a result of the crisis, which I discussed on my radio programme last week (Analysis: The Economist's New Clothes).

Mainstream economists didn't assume that markets - or their participants - were perfect. But for decades they did assume, in effect, that they were good enough: that markets were competitive enough, and people were rational and well-informed enough, for market-led outcome usually to turn out best. Especially in matters of finance.

Now, it turns out that real-life financial markets were much, much, messier than they thought - and much much worse at self-regulation. The biggest short-term consequence of that mistake is that the government has suddenly become responsible for most of our economic growth.

In the US, economists agree that without the federal stimulus package, the US would still technically be in recession.

We're getting used to this post-crisis landscape. But don't forget to be surprised that decades of the "free market" have ended up here.

John Cassidy tells the story in How Markets Fail: the Logic of Economics Calamities. There have been plenty of books about the crisis landing on my desk in recent weeks, but Cassidy's is the only one I've seen that pulls together the what and the why quite so clearly. He covers some of the same ground as my programme, but in much more depth.

He reminds us that Adam Smith himself was very sceptical about leaving the financial system to its own devices. So was another fan of free markets, John Stuart Mill.

As Cassidy comments:

"[T]he combination of a Fed that can print money, deposit insurance, and a Congress that can authorize bailouts provides an extensive safety net for big financial firms. In such an environment, pursuing a policy of easy money plus deregulation doesn't amount to free market economics: it's a form of crony capitalism."

The outcome, he says, it's not just unfair - it doesn't work.

John Lanchester, the London Review of Books' chronicler of the crisis, said recently that "bankocracy" might be a better name for the current system.

If you think that sounds inflammatory, remember that Mervyn King, Lord Turner and Martin Wolf of the FT have all made essentially the same point. Unless the rules of the game change fundamentally, it's not really capitalism that we have today. Especially not for banks.

Any other ideas for a new name?

Cautious good cheer

2009-11-11T13:47:32Z

When Mervyn King does cautious optimism, you can keep the emphasis on cautious.

The Bank's new forecast for the economy is rather more upbeat than it was in August, and to judge by the "backcast" for GDP, it expects some upward revision of not just that disappointing third-quarter decline in output, but some earlier ones too (though not the kind of dramatic change to the picture predicted by the likes of Goldman Sachs).

Lest we get carried away, the governor insisted that the risks to the GDP forecast were on the downside. As he repeated many times at the press conference, the big picture was that the UK and other advanced economies faced "a long hard path" back to where we were. That has not changed.

The Bank's best guess is that we won't get back to the level of GDP before the
recession hit until at least the latter half of 2011:

And yet... even the Bank accepts that there is something odd happening in the labour market - and it's odd in a good way.

As the chart below from the Inflation Report shows, even before today's news, employment had fallen by much less than the fall in output would have led you to expect.

The October jobless figures only make the point more starkly - by either the quarterly ILO measure or the monthly claimant count, unemployment has risen by the smallest amount since the recession started last spring. This is not what anyone would have predicted even six months ago.

As the Bank points out, we can't declare a bright new world just yet. It could be that more onerous consultation arrangements and so on are making it harder for firms to lay off staff quickly. The largest rise could be yet to come.

But as I have said before, there has clearly been much more downward adjustment in wages and hours than in the past - including a sharp rise in part-time employment, as seen in today's data.

That has not done anything to help young people, as the figures show. And the squeeze on incomes is bad news for families who were already struggling - and for demand economy-wide in the future.

But given the long-term cost of being out of work - for individuals and for the economy - the slowing rate at which people are losing their jobs overall has to be cause for good cheer, however cautious.

Boxed in

2009-11-05T15:00:27Z

The more money they create, the more the Bank of England's policy makers must wish they had better things to spend it on than government debt.

Of the extra £175bn the Bank has created through its QE policy since March, around £173bn has been used to buy UK gilts. That's no great surprise. But it is far from ideal.

When the policy started, the chancellor authorised the Bank to buy £150bn worth of assets, of which "up to £50bn" could be private sector debt.

It's fair to say that limit has not been reached: as of now, the Bank's Asset Purchase Facility (APF) has spent just £2bn on commercial paper and corporate bonds.

Why buy mainly gilts? The justification was three-fold. First, by boosting demand for government bonds, you lower the interest rate on that debt, and since that (risk-free) rate sets the floor for rates across the board, you should lower the cost of borrowing for firms and households as well.

Second, by buying only risk-free public debt you prevented the Bank from taking a lot of private sector risk onto its balance sheet (a particular concern earlier in the year when there was so much uncertainty about what all that securitized private debt was worth).

But the final, and most telling, reason was that there simply wasn't enough British corporate debt out there to buy. The Bank would have swallowed up the entire market in a matter of weeks.

I've mentioned before that a number of observers have called for the Bank to extend the range of the APF: notably the IMF, Martin Weale, and Danny Gabay of Fathom Consulting.

The emphasis on gilts has put the Bank rather out on a limb relative to other central banks - notably the US Federal Reserve, which has been able to purchase a much broader range of assets under it's "credit easing" policy.

But, as Adam Posen, the newest MPC member, pointed out in his speech of 26 October, it's a function of British companies' disturbing dependence on the banking system for its funds. In his words:

"[T]he financial system in the UK doesn't seem to have a spare tyre for the provision of capital to non-financial businesses when the banking system has popped a leak".

That lack of a corporate bond market, he said:

"[R]eveals a major long term structural problem in UK financial markets which could be of potential harm as the UK economy begins to recover".

In its statement today, the MPC pointed to evidence that its policy was working. And the evidence is there: gilt yields are undoubtedly lower than they would have been without QE, and bigger companies are using that opportunity to issue debt on a larger scale than in the past.

But, as the MPC themselves note, the key question for the recovery is about the banks: whether they will ultimately provide the credit to finance a healthy recovery.

This has been a recurring theme here - I won't belabour the point. Just to note that, if the economy is recovering, now is the moment of truth.

Until now, the commercial banks have been able to say, with some justice, that the lack of lending is due as much to low demand from firms themselves as to insufficient supply by banks.

As a rule, companies don't want to take on a lot of new debt in a recession. But once things are looking up, they will be going to their banks for more working capital, or loans for new investment.

If the banks are demanding much tougher terms and/or limiting the amount they will lend at any price, now is when that constraint on the recovery will kick in.

We will wait and see - and so will the MPC. But in the meantime, many economists who supported the QE policy are left feeling a bit queasy that so much is being rested on an asset with such an uncertain relationship to the broader economy.

Thanks to QE we do not really know what the "risk-free" rate of interest is over any length of time into the future. All the city knows is that money is (almost) free and there's an (almost) unlimited supply of it.

We talk about it being hard to spot the impact of the Bank's policy (and that of other central banks). But in a sense, that's crackers. You can see the impact of easy monetary policy everywhere.

Across the global economy, cheap and plentiful money is doing wonders for asset prices. It's also making it easier for governments - especially the British government - to borrow an enormous amount. It's even causing headaches for emerging market governments, as they struggle to cope with shedloads of incoming investor cash.

But I'm sure the MPC would like to be able to point to more visible effects of its policy closer to home - for households and businesses in the real economy.

Not out of the woods yet

2009-11-05T12:27:15Z

The MPC is not ready to take its foot off the accelerator, but it is easing it off the floor.

By voting to inject a further £25bn into the economy, the Bank's policy makers have signalled that they don't think the economy's out of the woods yet.

But they have halved the rate at which that money is being spent. In the first five months of the QE, the bank was spending £25bn a month. Since August, the monthly purchases have fallen to around £17bn. Now the MPC plans to spend three months purchasing assets of £25bn - a monthly average of around £8bn.

If the economy behaves more or less as the MPC expects, you could say they have put themselves on a path to end QE at their February meeting - or at least put the policy on hold.

Is Britain growing yet?

2009-11-04T13:31:22Z

Is Britain growing yet? You would think the Bank's Monetary Policy Committee would like the answer to that question before deciding this week whether to keep injecting tens of billions of pounds into the economy.

Like many City forecasters, the Bank was fairly sure that the economy had come out of recession in the third quarter. That official estimate of a 0.4% decline in GDP, announced on 23 October 23, was a surprise to the MPC as well. We will find out in next week's Quarterly Inflation Report whether the Bank is revising its view - or rather waiting for the ONS statisticians to revise theirs. And of course, the Bank's policy-makers will have those new forecasts in front of them at their meeting.

You'll remember there was a lively debate about the reliability of the figures on the day they came out - much of it stirred by Ben Broadbent and Kevin Daly at Goldman Sachs (see my earlier post, First draft of UK economic history). If anything, the discussion has heated up since then, with the release of fresh data also seemingly at odds with the ONS view.

The CIPS/Markit UK manufacturing survey of purchasing managers showed UK manufacturing activity at its highest level in two years. Today we saw the fourth consecutive monthly rise in the service sector PMI as well.

As the CEBR pointed out, this is also the sixth month in which the index has been above the neutral mark of 50.

Folks at the ONS point out, rightly, that they are basing their estimates on hard data, whereas the critics tend to highlight mainly surveys. Graham Turner of GFC Economics added his voice to that debate today, stating his view that the PMI surveys have been systematically overstating the strength of the recovery, not just in the UK but "across the industrialised bloc".

For example, the various ISM indices suggest that the US manufacturing output has turned up rapidly, but in reality, "production has risen only 3.5% from its low point in May, and remains 13.8% below its peak."

Turner thinks the problem might be even more pronounced in the service sector surveys, because they have much lower coverage than the ONS among smaller companies, and there is evidence that it is the smaller firms that have been most affected by a decline in the availability of credit.

All of which might be true. But I guess if you think (as the critics do) that the PMI surveys often turn out to be closer to the final official version of economic reality than the ONS's own official estimates, simply to point out that the surveys are at odds with early estimates of (say) manufacturing output rather begs the question. And, as Turner admits, it's not just the PMI survey data that seems out of line. The CBI, BCC and other surveys are also at odds with the ONS.

(Apologies for giving so much space to Goldman Sachs on this debate, but they seem to me to have mounted the most robust critique of the figures to date. I'd be happy to hear from others who feel they have something to add).

There's also the fact that employment, extraordinarily for this stage in a recession, is flattening out, or even going up. As Charles Goodhart pointed out at Fathom Consulting's Monetary Policy Forum on Monday, this suggests that firms are taking on workers, at a time when output is falling - just the opposite of what you would expect.

The ONS's own official estimates for expenditure have also been weaker than the output numbers. Unlike many other official statistical agencies, it doesn't fully incorporate this data into its final GDP estimates for a year or two. That's when all the big revisions tend to be made.

Unhappily for us - because it means this tremendously important debate about whether or not the UK is already out of recession may not be resolved until 2010 - or even 2011.

As this chart shows, those final revisions made a big difference in the case of the early 1980s recession. And others too. Goldman Sachs calculates that of the 29 occasions between 1975 and 2007 on which the initial estimate of GDP was negative, the average revision has been a stunning +1.0% quarter-on quarter. In other words, if that average held true of the past two quarters, Britain might turn out to have gone out of recession six months ago.

Now, no-one (I know of) is suggesting the revisions will be that large. Indeed, the ONS might even revise that 0.4% decline downwards a little next month, because of slightly weaker than expected construction data. But the eventual version of history - one or two years down the road - could well be quite a bit brighter.

As for the folks at the ONS - well, they appear unperturbed. In their view, the surveys are often at odds with the official picture, and there is no unusual discrepancy with other data to be explained.

They are certainly not going to be swayed by the opinions of city economists, though privately they are puzzled as to why respected forecasters such as the Bank of England and the NIESR were also expecting something better.

But even if the Bank does think the ONS figures might be over-gloomy, it will not change their basic view that the recovery - regardless of when it turns out to have started - will be slow and uneven.

In the end, it is that longer-term prognosis that will matter most for the future of UK monetary policy.

Update 17:50: I've said that much of the debate, in effect, comes down to whether you trust the official output data or the surveys. Obviously the ONS data has the advantage that it's based on solid numbers, reported to them by a much larger number of companies across the country.

The surveys are often more "qualitative"; they ask firms more general questions about what's been happening to orders etc and what they expect in the future. On the other hand, they have the advantage of being more timely than the official data, which is why some see them as a better guide to where the economy is right now.

The director of the NIESR, Martin Weale has alerted me to a paper he and three colleagues have just written, available on the NIESR website [375KB PDF]. It looks at whether there is a predictable relationship between the answers that firms give in the CBI's Industrial Trends Survey, and what they tell the ONS. The paper's technical, but the main conclusion is that, where you can line up the two sets of answers against each other, the CBI survey doesn't give a more timely indication of what's happening to output than the ONS survey.

Specifically: "firm-level qualitative data do not provide a good coincident indicator of growth." And the CBI survey "has little role to play in enhancing our knowledge of what has happened to manufacturing output. However, where the CBI is asking questions not covered by the ONS - about future export orders, for example, the authors do find that the CBI survey provides some useful information.

Unfortunately they were not able to get the data to analyse the PMI surveys in the same way. But economists who think that people are making too much of the PMI surveys do point out that today's PMI surveys weren't around in the early 90s. We can't be sure that their predictive powers still hold when you're talking about an economy coming out of a recession (or not).

Clearly we've not heard of the last of this debate.

The economist's new clothes

2009-11-02T17:59:20Z

Economists, at least the macro variety, didn't have a good financial crisis. And they're not having much of a recovery either. Much like the UK.

You may remember that I wrote about the dismal state of the dismal science back in the summer. There's been a lot of talk about economists' role in causing the financial crisis, and it's an interesting debate. But not nearly as interesting, to me, as the question of where economics goes from here.

Somehow, somewhere, large parts of the profession seem to have lost their way - or at least lost their connection to the world as it is.

I've been talking to some heavy hitters inside and outside the profession to find out what economics needs to find its way back. You can hear the results of those conversations in a Radio 4 Analysis programme that first airs on 2 November.

I spoke to Professor Myron Scholes. He was pretty unrepentant, even though he won his Nobel Prize for helping to make modern financial derivatives possible. He also started a hedge fund, Long-Term Capital Management which created a mini credit crunch of its own, running up losses of more than $4.5bn in just four months in the summer of 1998.

But Charlie Bean has had to experience the gaps in modern economic thinking first-hand over the past few years, first as chief economist, now deputy governor of the Bank of England. He says you don't need to devise a lot of fancy new economic theories to explain what went wrong. But he does think that economists need a greater understanding of history - and their own limitations.

For Lord Robert Skidelsky, Keynes' biographer, it's all been further proof that economists lost their way when they departed from the master. Keynes understood uncertainty. If economists want to catch up with the way the world works, he thinks they're going to need to find a way to incorporate it too.

Large chunks of economic life could not be reduced to a set of probabilities. That, in turn, means they can only imperfectly translate into mathematical models.

"...in order to get determinate results, you can't have unknowns. And therefore to make the maths possible ...you have to theorise on the basis of perfect information and prices always being correct and so on. Now just... reduce the amount of maths in the subject and you get closer to real life."

In other words, the stuff you can count isn't necessarily the stuff that counts.

But for me, the most interesting contributions came from Richard Thaler, the leading behavioural economist, and Michael Sandel, a distinguished political philosopher at Harvard who taught me many years ago.

Thaler and his fellow travellers have had a good crisis. Ever since he co-wrote Nudge, politicians and policy wonks have been rushing to incorporate Thaler's ideas into policy - for example, we've had more discussion today of forcing people to decide whether or not to be organ donors. That's the fruit of experiments showing that we make different decisions when we are forced to choose, than if we can simply follow the path of least resistance.

Thaler had a good take on the failings of mainstream economics going into the crisis, particularly financial market economics. He said it partly grew out of a failure to distinguish between easy problems and difficult problems:

"We have the idea that people optimise, and they optimise regardless of how hard the problem is. So let's contrast two problems. One is figuring out how much milk to buy when you go to the grocery store. Now you know that's an inventory problem, we could write down the mathematics of it, but most families pretty much know how to do it and they do it through trial and error. So that's an easy problem in part because there's lots of opportunities for learning. Now compare that with, say, playing chess. No-one plays chess perfectly, even Gary Kasparov - otherwise the game wouldn't be interesting, it would be solved - and most of us play horribly. Now a theory that says we buy milk and play chess equally well is just preposterous. We need to accommodate degree of difficulty.

Now the way this relates to the banking crisis is that being a banker has just gotten a lot harder. If you go back to the world of the banker in that Christmas movie... It's A Wonderful Life, you know that guy was making loans to people he knew in his town. And you know that's a pretty easy problem. Now if, if you're buying and selling mortgage-backed securities, that's pretty hard. And if you're running a bank that has a hundred divisions, each of which are engaged in highly complicated transactions, the job of being a CEO has become immensely difficult..."

On this view, it's not just that the financial deals themselves were getting more complex - it's also that the economic models were assuming they had gotten easier.

"The models kept assuming people were smarter and smarter, but the world was getting harder and harder and so the models were getting further away from reality. So if banking was like in It's A Wonderful Life, then the old models might be fine. But when you have Citibank selling liquidity puts and the vice chairman of Citibank admitting later that he had never heard the term 'liquidity put', then you know you're dealing in a completely new world."

It's a great critique - but, as Thaler would be the first to admit, it is more a critique than a competing theory.

Useful though it is, you're not going to be able to base the future of economics on behavioural economics alone. Why? Well, for one thing, it doesn't lend itself very readily to concrete advice. Politicians like their economists to tell them what to do, even if they ignore them afterwards.

Behavioural economics isn't like that: it shows you that it matters how, exactly, a policy is designed - what the default options are, or how medical evidence is presented. We'll opt for an operation if it has a 90% success rate, for example, but not if the chance of dying on the table is 1 in 10. But it doesn't tell you which to choose. Economists who like to draw a sharp line between objective economic analysis and subjective value judgments think that's a big problem.

Funnily enough, outsiders like Professor Sandel thinks that's the great strength of that kind of economics (he's not a big fan of the other types). It brings the value judgements to the surface, rather than burying them deep in the assumptions of the models.

For similar reasons, Sandel has clearly enjoyed the recent popular uproar over bank bailouts and bankers' bonuses:

"I was interested in the economists [in the Obama Administration] who were making this critique. They said it's terribly greedy. What I wish the journalists had asked them was is there a distinction between greed and self-interest, do you think?

Strictly speaking, no mainstream economist would recognise any such distinction, and yet for political purposes they attack greed as if it's a thing independent of self-interest... Citizens generally who looked at this - at the bailouts and the bonuses and been outraged - they believe there is a difference between greed and self-interest. But there's no way of capturing that intuition in economic analysis because, according to economic analysis, in any case one is deploying self-interest or greed, which is simply self-interest squared, to serve a social purpose. That's what the economic model says. And you have to introduce some normative assumption about what is excessive pursuit of gain in order to make sense of greed as a vice independent of the self-interest that all of the economic models presuppose. So I think there are intuitions in everyday life that people have that the economic models simply don't capture, and greed is one of them."

I suspect that it will take more than a financial crisis to make Wall Street economists want to think about the quest for justice as well. But the economics being taught at universities around the world this autumn has already been changed by the events of the past few years.

It will change even more in the years to come, though don't expect it to happen quickly.

Professor Thaler reminded me of an old line: that "science marches on funeral by funeral". Most economists don't like admitting they've changed their mind about anything.

Analysis is on Radio 4 at 2030 on 2 November (repeated 2130 8 November) and will be available online to listen again for a week.

Why them and not us?

2009-10-23T14:54:57Z

What should matter most is what's happening to our own economy, not how we're doing compared to everyone else.

But that's not the way human nature works. As Gore Vidal once said: "it's not enough to succeed. Others must fail." And right now it's the UK that seems to be failing.

As commentators were quick to note this morning when the latest GDP figures came out, a sixth consecutive quarter of economic decline means that the UK is still in recession, while Germany, France and Japan are all now recovering.

Their economies all grew between April and June. They will probably have grown in the third quarter as well, and we're expecting the US to come out of recovery when we get their third quarter figures next week.

So, what's the problem? Chancellor Alistair Darling suggested in an interview for the BBC today that the likes of Germany and Japan had much sharper losses in output at the start, which would lead you to expect a sharper rebound.

It is true that the comparison between Britain and other countries looks a bit better when you compare the total decline in national income from peak to trough (or from the start of the recession until the end).

On that basis, Germany lost 6.7% of national income over the course of its recession. And many German economists don't think their country is out of the woods: they think another quarter or two of negative growth is quite possible.

Assuming the UK comes out of recession in the last three months of the year - and we're learning not to assume anything - then the overall loss of output for the UK would be somewhat lower, at 5.9%. The total decline for Japan has been a whopping 8.4%.

It is France and the US that come out best. The peak-to-trough decline for France will have been 3.5%. Assuming the US has now come out of recovery, its loss in income will have been 3.7%. (Thanks to Chris Apostolou at Fathom Consulting for pulling the numbers together for me).

The latest consensus forecasts are for growth of 1.3% in 2010 in the UK, similar to the government's own forecast. The prediction for Germany is 1.4%, and for France it's 1.2%. The US is expected to grow by 2.6% - but that, too, is a good deal lower than you would usually expect coming out of a steep recession.

Looking ahead, the similarities are greater than the differences. The road to recovery is expected to be fairly slow in all the major advanced economies, the UK included.

When you ask economists to explain why Britain is lagging behind, they can provide any number of reasons - particularly our greater reliance on the financial sector compared to our neighbours.

That prior dependence on the City, along with the poor state of the public finances and our long-term need to increase saving, could well lead us to enjoy slower growth than other economies in the next few years. But right now, we shouldn't fret too much about "falling behind".

It may not be comfortable for the government, but the truth is it's better for our economy to have other markets recover than for all of us to remain in recession.

After all, the cheap pound can't help British exports - or a long-term re-balancing of our economy - if there's no-one out there who wants to buy.

Growth in the rest of the world may rankle. But our own recovery won't get far without it.

PS Sorry a data mix-up resulted in earlier figures being different.