Showing posts from tagged with: Economic growth

Stable Growth likely to Continue

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In my last monthly e-mailed note (on 28th June) I said that money growth patterns in the four leading advanced country jurisdictions (USA, Eurozone, Japan and the UK) were more or less perfect. To recall, “4% a year is a more or less ideal rate of broad money growth in developed countries, with a trend rate of output growth of 1% - 2% and an aim to keep inflation around 2%. Amazingly, and no doubt more by happenstance than design, 4% a year is at present common to the USA, the Eurozone, Japan (just about) and the UK.” Well, not much has happened since then to alter the assessment. The picture is as follows,2016-08-25_11-45-20The numbers  for China and India, the two big developing countries (both with trend growth rates of output of over 5% a year), are as follows2016-08-25_11-47-55  

Japan: monetary base vs. quantity of money

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Japan’s ‘Abenomics’ is reported to have three arrows, - a ‘revolution’ in monetary policy with ‘the Bank of Japan injecting huge amounts of “money” (whatever that means) into the economy’ (or something of the sort), - a short-term fiscal stimulus accompanied by long-term action to bring the public finances under control, and - ‘a growth strategy’ (which means in practice shaking up such over-protected parts of the Japanese economy as farming and retailing). Commentary on the last two of the three arrows has often been sceptical. Initial ‘stimulus’ (i.e., a widening of the budget deficit) is not easily reconciled with ultimate fiscal consolidation (i.e., a narrowing of the budget deficit), while Abe’s Liberal Democratic Party has drawn much of its traditional support from groups that benefit from protection and restrictive practices. By contrast, most media reporting has suggested that the Bank of Japan has definitely changed course and that a major upheaval in monetary policy is under way. This note argues  that,  although  Japanese  monetary policy  has  indeed  shifted  in  an expansionary direction, the shift is far less radical than the rhetoric that has accompanied it. Japanese policy-makers and the greater part of the commentariat seem to believe that the monetary base by itself has great macroeconomic importance. This is a mistake. National income and wealth in nominal terms are a function of the quantity of money, which must be distinguished sharply from the base. Movements in the monetary base and the quantity of money may be related, but the relationship is not necessarily all that precise or reliable. It is the quantity of money, not the monetary base by itself, that matters to macroeconomic outcomes.  

Cost of the EU – The Direct Fiscal Cost

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Its membership of the European Union requires the UK government to make certain payments to EU institutions, and entitles it to a number of receipts. How much are these direct fiscal costs and benefits, and what is the net position? That may seem like a simple question which can be answered with a single number or set of numbers. Surely, when the government spends £100 million, it spends £100 million, and it does so without fuss or ambiguity. In fact, a range of complexities mean that no one  figure  for  many  EU  financial  concepts  is  exactly  ‘right’.  Like  love,  the  UK’s  financial contribution to the EU is a ‘many-splendored thing’. Again like love, it causes many squabbles.  

QE era sees lowest nominal GDP increases since the 1930s

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Four years ago, at the worst point in the Great Recession, several leading American economic gurus said that the Fed’s easy monetary policy risked higher inflation which might imperil the recovery. In some of the early commentaries  from  International  Monetary  Research  (in  the  spring  and summer of 2009), I argued that these gurus – who included the revered Alan Greenspan and Martin Feldstein, a prominent adviser to President Reagan – were seeing ‘ghosts’. Also at that time Liam Halligan of Prosperity Capital Management used his column in The Sunday Telegraph to attack ‘quantitative easing’ (i.e., the large-scale creation of money by the state) as aggressive ‘money printing’ which would lead to a sharp rise in inflation. In a letter to the Financial Times published on 19tJune, I showed that the inflation jeremiahs had been wrong. The last five complete years (i.e., the five years  to  2012)  saw  the  lowest  increases  in  nominal  GDP  in  all  the  G7 economies since the deflationary 1930s. The jeremiahs of 2009 made a serious analytical  mistake.  They  thought  that  inflation  was  caused  by  excessive growth of the monetary base, not of the quantity of money broadly-defined to include all bank deposits. In future economic commentators should pay more attention to the quantity of money as such and de-emphasize the monetary base by itself.  

Is the British economy now recovering?

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Recent survey news on the British economy has been satisfactory, even quite good, particularly given the continuing travails of the Eurozone. The purpose of the current note is to relate these developments to the latest monetary trends.  The central point is that broad money growth has been consistent with the recovery, in that it has been running in the mid-single digits (at an annual rate) for several quarters. However, the monetary expansion has not been the result of banks’ increasing their loan portfolios. Instead it has been due to the Bank  of  England’s  purchases  of  long-dated  government  bonds  from  non- banks (i.e., to ‘quantitative easing’, as it has become known). The Monetary Policy Committee of the Bank of England appears to be split on the wisdom of maintaining QE in coming months, with one supporter of continued QE (Sir Mervyn King, the governor) due to step down in a few weeks. The main cause of the persisting weakness of credit growth is that the banks remain subject to official pressure to raise capital/asset ratios, to ‘tidy up their balance sheets’ and so on. The government and the Bank of England have pushed artificial schemes – such as Funding for Lending and the Help to Buy (i.e., to buy a home) initiative – without apparently understanding that the regulatory assault on the banks is to blame for their reluctance to expand their assets. At any rate, over the last year or so a moderate rate of money growth and very low interest rates have been associated with healthy rises in asset prices, and private-sector balance sheets (i.e., the balance sheets of households and companies) have improved dramatically compared with early 2009. As long as broad money growth remains positive and in the mid-single digits (at an annual rate), a steady recovery is to be expec The new Bank of England governor, Mark  Carney,  is  something  of  an  unknown  quantity as regards money targeting, although he has expressed interest in ‘nominal GDP targeting’. (The subject of nominal GDP targeting is not discussed here.)  

Is the UK deficit too high only because economic growth has stopped?

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A commonly-expressed view in the media is that Chancellor Osborne’s failure to curb the budget deficit is due to weak tax revenues, which in turn are to be explained by the economy’s weak supply-side performance. According to this analysis, the economy’s inability to generate more tax revenue is attributable to its more fundamental inability to increase output at all. Since supply-side remedies take a long time to work. Osborne is by implication not to blame for the persistence of budget deficits in the range of 5% - 10% of gross domestic product. In the note below I dispute this position. I show that in the last few quarters the Conservative-LibDem coalition government has let general government consumption rise faster than total national expenditure, which is dominated by the private sector. General government  consumption is not to be seen as equivalent to total public expenditure, which also includes capital expenditure and transfer payments [i.e., welfare expenditure, pensions, debt interest]. Nevertheless, a government genuinely committed cutting the  deficit would have made a better job at trimming public expenditure.  

Is UK monetary policy on the right lines? 1 ½.

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I had hoped this week to finish my note on ‘Is UK monetary policy on the right lines?’. However, after writing 2,000 words (and putting together the data for four charts), I have run out of time. This note is therefore numbered 1 ½ rather than 2, and I will return to the exercise next week. The note below concentrates on the years running up to the crisis of 2007 and, more particularly, of 2008, years which passed by the reassuring label of ‘the Great Moderation’. In this period the growth of the quantity of money was consistent with nominal GDP growth of about 5% a year and 2% inflation. Money balances grew as banks expanded their loan assets and ‘bank lending to the private sector’ was the dominant so-called ‘credit counterpart’ to bank deposits. A consistent negative influence on money came from banks’ capital- building. This was necessary of course as banks added to the risk in their balance sheets, and incurred non-monetary liabilities in the form of equity and bond capital. From mid-2007 the pattern of money growth changed radically. From Q3 2008 officialdom placed intense pressure on banks to hold more capital relative to their balance-sheet risks, causing i. a contraction in ‘lending to the private sector’ (in fact, implemented mostly by sales of securities), and ii. a massive programme of capital-raising. These two shocks caused money growth, which has been too high in 2006 and early 2007, to collapse and even threaten to go negative. In early 2009 policy-makers, facing a macroeconomic catastrophe, had quickly to find a means of boosting the quantity of money. (The next instalment of this note – which should be the last – will discuss the role of ‘quantitative easing’ in the resulting macroeconomic salvage effort.)  

Is UK monetary policy on the right lines?

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Rising employment in Britain in recent quarters  argues  that a  recovery is under way,  even  though  it  is  disappointing  by the  standards  of  the  past. Official data in recent quarters almost certainly understate the level and rate of growth of output. The understatement may arise because of the difficulty of calculating price indices in an economy dominated  by service output, and characterised by extensive product innovation and improvement. (I have no idea how the national income accountants measure the output of Facebook. Twitter and Google.) At any rate, the persistence of employment growth suggests that macroeconomic conditions are normalizing after the trauma of the  Great Recession.  How  should  monetary policy now  be  organized?  Do policy-makers need to ‘do more’ to stimulate the recovery? Or is monetary policy already on the right lines? The following note proposes that low and stable growth of the quantity of money remains the key to achieving macroeconomic stability with low inflation in line with the official target. It is suggested that the annual growth in the quantity of money, broadly-defined, should lie between 3% and 5% (or perhaps 2% and 6%) if policy-makers want to maintain consumer inflation of about 2% and moderate output growth at roughly the trend rate (which does not seem to be much above 1 ½% a year and may be lower). For the moment banks seem reluctant to expand their loan assets, despite the continuing verbal assault on them  from  Mervyn  King,  the  media  and  others.  But  money  growth  at  the desired low rate can easily be attained by varying the degree to which the budget deficit is financed from the banks rather than non-banks. Theological debates about ‘quantitative easing’ are unnecessary; they symptomize widespread misunderstanding about how monetary policy can and should be conducted. (This is the first half of a note which will be completed next week.)  

Are puzzling labour market trends due to EU immigration?

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Official statistics say that UK output has still not recovered its previous peak in the first quarter of 2008, but that employment has risen to an all-time high. By implication, recent productivity performance has been appalling. Indeed, it seems  to  have  been  worse  in  the  five  years  to  end-2012  than  in  any comparable peacetime period since the start of the Industrial Revolution. In a presentation I gave earlier this year at Investec I argued that one reason – but only one – for the weakness of productivity was that the composition of the labour force had changed during the Great Recession. (See the 21sMay weekly e-mail on ‘UK productivity check’.) The opening of the UK’s borders to East European workers in 2004, as eight former Soviet bloc countries joined the EU, was followed by heavy immigration from these relatively poor countries.  The  immigration  was  mostly  from  people  of  working  age  and seeking employment.  I suggested that,  because  on  average the  immigrant workers had lower pay than their UK-born counterparts, they were on average less productive. It followed that – if their share of employment increased – productivity would fall. This suggestion has often been met very critically, not least because it seemed to imply that the East European migrant workers were in  some  sense  unsatisfactory.  I  meant  nothing  of  the  sort  and  have  no personal animus towards East Europeans whatsoever. However, it must be possible to make statements about the pay and productivity levels of groups of workers, while a 2010 ONS paper confirmed that East European employment has been particularly ‘at the bottom end’ of the labour market in terms of pay and productivity. (See footnote 6 below.)  

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