Two sets of economists slam Tory ‘cuts’ in FT


12:55 am - February 19th 2010

by Sunny Hundal    


      Share on Tumblr

Two separate letters have been published in the Financial Times slamming Conservative Party proposals that government spending should be cut immediately. Both will be printed in the morning edition of the FT.

A letter by Lord Skidelsky and others is titled: First priority must be to restore robust growth

Sir, In their letter to The Sunday Times of February 14, Professor Tim Besley and 19 co-signatories called for an accelerated programme of fiscal consolidation. We believe they are wrong.

There is no disagreement that fiscal consolidation will be necessary to put UK public finances back on a sustainable basis. But the timing of the measures should depend on the strength of the recovery. The Treasury has committed itself to more than halving the budget deficit by 2013-14, with most of the consolidation taking place when recovery is firmly established. In urging a faster pace of deficit reduction to reassure the financial markets, the signatories of the Sunday Times letter implicitly accept as binding the views of the same financial markets whose mistakes precipitated the crisis in the first place!

They seek to frighten us with the present level of the deficit but mention neither the automatic reduction that will be achieved as and when growth is resumed nor the effects of growth on investor confidence. How do the letter’s signatories imagine foreign creditors will react if implementing fierce spending cuts tips the economy back into recession? To ask – as they do – for independent appraisal of fiscal policy forecasts is sensible. But for the good of the British people – and for fiscal sustainability – the first priority must be to restore robust economic growth. The wealth of the nation lies in what its citizens can produce.

The two letters are signed by over 60 leading economists and have prompted the Financial Times to declare that they ‘have backed Alistair Darling’s decision to delay spending cuts until 2011’.

The second letter, signed by Prof Lord Layard and others, is titled: ‘Sharp shock now would be dangerous

It says:

Second, Britain’s level of government debt is not out of control. The net debt relative to GDP is lower than the Group of Seven average, and on present government plans it will peak at 78 per cent of annual GDP in 2014-15, and then fall. Even at its peak, the debt ratio will be lower than in the majority of peacetime years since 1815. Moreover British debt has a longer maturity than most other countries, and current interest rates on government debt at 4 per cent are also low by recent standards.

A sharp shock now would not remove the need for a sustained medium-term programme of deficit reduction. But it would be positively dangerous. If next year the government spent less and saved more than it currently plans, this would not “make a sustainable recovery more likely”. The weight of evidence points in the opposite direction.

Liberal Conspiracy reported a few days ago that the letters were expected.

The two letters now put Conservative economic policy at odds with the consensus that the economy should be allowed to recover before the deficit is reduced.

The signatories to the letters include two Nobel laureates – Joseph Stiglitz and Robert Solow – and five former members of the Bank of England’s monetary policy committee, including Sir Andrew Large and Rachel Lomax, two former deputy governors. Alan Blinder, a former vice-chairman of the Federal Reserve, is also a signatory.

    Share on Tumblr   submit to reddit  


About the author
Sunny Hundal is editor of LC. Also: on Twitter, at Pickled Politics and Guardian CIF.
· Other posts by


Story Filed Under: News

Sorry, the comment form is closed at this time.


Reader comments


My initial first reaction is that there will some professionally interesting debates between academic colleagues at the LSE.

My second is that what will ultimately matter is the willingness of the finance markets to absorb new British government debt, without forcing up yields, in the light of news reports like this on Friday:

“The Office for National Statistics (ONS) said public sector net borrowing – the gap between the exchequer’s tax-take and its spending – was £4.34bn [in January] compared with a repayment of £5.27bn a year earlier. The figure was also much worse than the £2.8bn repayment forecast in a Reuters poll by City analysts, who in previous months had largely underestimated the state of the public finances.”
http://www.guardian.co.uk/business/2010/feb/18/uk-government-borrowing-january-record

A table in a piece in last Saturday’s The Economist shows how Britain’s debt position stacks up compared with other indebted countries:

“MARKETS have suddenly woken up to the idea that not all government debt is risk-free. There is a long and not very honourable history of sovereign default, either explicitly or implicitly via inflation and currency depreciation.”
http://www.economist.com/businessfinance/displaystory.cfm?story_id=15498265

Remember, the New Labour government neglected to heed warnings about fiscal holes in budgets going back to 2000 and warnings about the inflating house-price bubble going back to 2002 – which are among the reasons of why we are where we are now.

Astroturf * Ad Populum Fallacy = SUNNY HUNDAL

A futile debate as no-one really has a clue what will happen next (dare I ask whether any of these 60 economists accurately predicted the credit crunch before it happened?) but here is my take on the story.

My second is that what will ultimately matter is the willingness of the finance markets to absorb new British government debt, without forcing up yields, in the light of news reports like this on Friday

Well initial indications are not exactly good.

The yield on Britain’s 10-year gilt just shot up to about 4.2 per cent, according to Reuters data…Using the 4.2 per cent Reuters yield, then, the spread between 10-year gilts and German bunds is now about 100bps. Oh dear.

The jump is probably down to just-released UK deficit data. Public sector net borrowing was £4.3bn in January 2010, compared with a £5.3bn surplus the same time last year. Running a deficit in the first month of the new year is rather unusual for British public finances . . .

Or as a market analyst puts it:

10 year Greek government bonds currently yield 6.5%, the Portuguese yield is around 4.65% and 10 year Gilts trade at 4.20% While it is still more likely than not that the rating agencies will wait until after the general election to put any pressure on the AAA/Aaa ratings these numbers are so bad that we cannot rule out them taking a look at the rating pre election.

Amusingly, Letters from a Tory actually supports Labour’s position on public spending.

He wants the government to make efficiency savings in 2010/11, but not cut the number of public sector jobs significantly. Which is also what Alastair Darling wants.

In contrast, proper right-wingers like the Reform think tank want to get rid of one million frontline public sector jobs.

Funny old world.

I liked this bit in BobB’s set of links:

MARKETS have suddenly woken up to the idea that not all government debt is risk-free.

Yet again, “markets” prove they’re miles behind the curve. Anyone who thinks any investment is “risk-free” is deluded.

Like the letter says above why should “we accept as binding the views of the markets whose mistakes precipitated the crisis…?”.

Why should “we accept as binding the views of the markets whose mistakes precipitated the crisis…?”.

Because we’re asking for money from them.

This might also be of interest too – a similar bunch calling for wage subsidies

BenM I think you may have over interpreted that setence. Compare with “Labour has finally realised there’s an election coming up”.

Rich country government debt is regarded as risk free (it defines the risk free rate) on the basis that in any scenario that sees the USA unable to pay its debts, debt payments will be the least of anybody’s worries. I think that sentence just means something like investors have recently revised upwards the estimated risk of certain governments’ debt.

Also, Tim Besley explains himself to Brad de Long

More from the Skidelsky letter:

They argue that the UK entered the recession with a large structural deficit and that “as a result the UK’s deficit is now the largest in our peacetime history”.”

This is of course true. The current deficit is a result of both a structural one and a cyclical one.

“There is no disagreement that fiscal consolidation will be necessary to put UK public finances back on a sustainable basis.”

Quite. When seems to be the argument, not whether.

So we all agree that we need to hack £100 billion out of state spending then.

From Layard’s:

“The net debt relative to GDP is lower than the Group of Seven average, and on present government plans it will peak at 78 per cent of annual GDP in 2014-15, and then fall.”

Anyone believe that peak number? Given the undershooting of the estimates for the past however many years? Today’s news about nett borrowing even in January?

“Moreover British debt has a longer maturity than most other countries,”

That is true and is indeed highly beneficial.

“and current interest rates on government debt at 4 per cent are also low by recent standards.”

And last week Barclays (I think it was) said they’d move up over 10% as a result of demographic issues. Eeeek!

“Of course there needs to be a clear plan for reducing the government deficit. But the existing one for next year appears sensible. What is needed then is much more detail for the following years, and a radical plan for the medium term. That is what the debate should be about.”

Yup, we are all agreed, we’ve got to cut that £100 billion of structural deficit out of the spending plans.

@5 Don Paskini: “He wants the government to make efficiency savings in 2010/11, but not cut the number of public sector jobs significantly. Which is also what Alastair Darling wants.”

I’m not talking about efficiency savings in isolation, I’m looking for schemes, initiatives, useless quangos, useless policies and many other things to be cut (which includes public sector pay and pensions, incidentally, because no-one will necessarily lose their jobs). Hope that clarifies the point.

The point is it follows a pattern over the last eighteen months of the Tories latching on to any person or forecast that seems to support their position. When this is later contradicted by others or events show the forecast to be wrong then all the political posturing makes them look opportunistic. For example, in late 2008 they were all over IMF forecasts that Britain would suffer the deepest recession in the G7. They seemed totally unaware that the IMF are useless forecasters. Great analysis why something happened but don’t rely on them to tell you what will happen in the next 12 months. The IMF forecast was rubbish for a number of reasons, not least being it was highly unlikely that a current account deficit country in a global recession would suffer the same loss of output as a surplus country. The IMF amended their forecast the next Q and thereby invalidated all the political points scoring based on the previous forecast.

There have been numerous other examples where the Tories have sought to make political capital from a monthly data release or the opinion of one economic think tank. As soon as you latch on to one opinion there will be someone else along probably more credible to contradict that opinion. It might go down well with the base but it strongly suggests that they do not understand the subject. If the Tories want their economic policies to be seen as credible and correct then they need to provide evidence why they are correct and stop trying to use others as a proxy vote of confidence. That is why the FT writes in their editorial today.

‘ Friday’s letters are an embarrassment for the Tories, above all, who sought to capitalise on the first letter. They must learn – soon – that their desire for simple political messages is no excuse for nuance-free policy positions. ‘

Luis @9: Many thanks for that Tim Besley link to Brad De Long’s esteemable blog.

Besley’s post is well worth reading as it clarifies much and helps to push along a rational discussion of the substantive differences between the letter writers in the Sunday Times and those in today’s Financial Times.

The differences are not huge in terms of the respective envisaged scales of fiscal tightening over the course of the next Parliament and it’s important to recognise that both courses carry downside risks, albeit different downside risks.

The periodic attempts here and in previous threads on these issues to rubbish economists and economics are to be deplored. At times like this we urgently need informed illumination of the feasible policy options along with greater clarity of their respective likely downstream consequences. The alternative is that mumbo-jumbo economics will prevail.

It is wrong to caricature the ST letter as promoting the Conseravtive line for two or more reasons:

– the Conservatives are committed to more fiscal tightening over the next Parliament compared with Darling’s plan but Cameron has promised no “swingeing” cuts in the first year.

– the signatories of the ST letter include known supporters of the Labour Party, including a past shadow minister from when Labour was in opposition.

– there is telling evidence of wasteful and inefficient public spending – for starters, try the reports of the Public Accounts Committee.

….and how many of the economists were Labour Party members or supporters?

Let’s get something straight – the Tories have already effectively won the argument. A few months ago Labour types were talking about “growing our way out” of the deficit. That has been blown out of the water, so now they’ve changed the line to delaying cuts till the country is growing again.

All sides know that massive cuts are coming, which is probably a good thing. There are numerous examples of countries where large cuts caused a short fall in GDP and then put growth back on track more rapidly (Canada, New Zealand are good examples) and also good examples where consistent significant deficit spending has caused long periods of sub-par growth (Japan) or worse (Greece).

There are very very few examples were sustained deficit spending has ever led to sustainable growth. The payback is unavoidable.

When it comes down to it, the left simply don’t want to cut spending. Does it really matter if spending is reduction starts now or in 9 months time? In terms of growth, probably not really.

I’ll ask those in the “cut later/Labour” camp this (rhetorical) question. What happens if spending is maintained at current levels (no cuts till 2011) yet we see little or no growth?

By Labour’s logic, we should not cut, and maintain the huge budget deficit. Problem is, the market won’t let you do that. You will see Gilt yields rise, debt servicing costs rise wiping out a lot of the benefits of growth, and if it gets too large a run on the currency. In the worst case you get a situation like Greece and investor confidence totally fails. Even now corporates are pulling out of the UK because of the uncertainty caused by the deficit.

So, faced with all that, is continuing to spend money to prop up a client state and Labour’s chances at election really in the best interests of the country?

I think we all, deep down, know the answer to that one.

deep down tyler – you can carry on believing whatever you like.

As can you Sunny, but your statement makes none of my points any less valid.

The economy is what can be politely described as a train wreck, and Gordon Brown was at the controls when it happened.

@14: “How many were Labour Party members or supporters?”

At least two, to my knowledge.

@17: “The economy is what can be politely described as a train wreck, and Gordon Brown was at the controls when it happened.”

How come the deep recessions in other G7 economies? Was GB personally to blame for all those as well?

As this graph shows, the slide in the world economy in 2008 was looking like a re-run of the start of the Great Depression of the 1930s:
http://krugman.blogs.nytimes.com/2009/11/03/the-story-so-far-in-one-picture/

In the event, another Great Depression didn’t materialise because of prompt fiscal boosts in leading economies, all according to keynesian stabilisation policy prescriptions.

There’s a somewhat calming assessment in The Economist of prospective sovereign debt risk for Britain, with a chart showing 10-year bond yields in Britain are running lower now than they were in the mid 1990s:
http://www.economist.com/businessfinance/displaystory.cfm?story_id=15545882

Analysis of the economic issues at stake is more illuminating than playing a (rather puerile) political blame game.

Tyler, the problem is the Tory argument is incoherent. I don’t count myself as having any particular affinity to Labour. However, in the circumstances and faced with the alternative they need to run deficits. The caveat I would add is the government must come out and be more explicit in how they are going to halve the deficit.

The Tories say we must slash public spending. However, they also say the non-government corporate and household sector should pay down debt. The non-government sector are reducing their debt but they can only do that if the government sector run deficits. The government can only eliminate the fiscal deficit if the private sector dis-saves. However, the Tories want us to rely less on debt in the future. But households and corporates can only do that by paying off existing debt. If the government slashed the deficit, the private sector would be unable to service their high debts. The only way they could service their debts would be if the country was running a current account surplus. The current account should be balanced within 18 months or so but it is in deficit at the moment. Slashing spending in an economy where there is so much private sector debt and no current account surplus would lead to bankruptcies and unemployment. The cuts would not achieve the objectives because revenue would fall through the bankruptcies and unemployment.

Canada and New Zealand are not altogether valid examples. Globally the world they faced was very different to the current one. Therefore, it was easier for them to export their surplus and their unemployment to others. The world we face is one where all our main trade partners are seriously impaired.

‘ I’ll ask those in the “cut later/Labour” camp this (rhetorical) question. What happens if spending is maintained at current levels (no cuts till 2011) yet we see little or no growth? ‘

I am not in the Labour camp but the issue is not cuts or no cuts. The fiscal consolidation already planned is the most severe in British history. The problem is the Tories want to go further and the economists are arguing that this will be counterproductive and make things worse. The point of the fiscal deficits is to give the private sector time to repair their balance sheets by reducing their debts. Therefore, as the private sector recovers growth will recover.

Obviously there are risks of rising yields causing a snow-ball effect on debt when debt servicing costs are rising faster than nominal GDP. However, that is also a risk when GDP is declining through fiscal retrenchment. Currently about 20% of the debt service interest payments that appear on the Treasury budget are paid to the BoE, who pay it back to the Treasury at the end of the year.

‘ So, faced with all that, is continuing to spend money to prop up a client state and Labour’s chances at election really in the best interests of the country? ‘

I’m sorry but that is just cliched nonsense. The government fiscal deficit is currently propping up the British private sector not some mythical client state.

@ Bob B #18

No, Brown wasn’t to blame for recessions in other countries. That doesn’t excuse him for the fact that UK is particularly badly placed to weather such a recession, given our huge structural deficit. We are the last out of recession, and then only just. That other countries have made similar mistakes to Brown doesn’t make his mistakes any better – we are now grouped in with traditionally much weaker economies – the so called PIGS.

Your great depression vs today chart shows industrial production, not GDP. If you compare GDP it looks a lot more like the 30s.

As for your arguments about bond yields…well, I don’t know where to start really. Rates and inflation in the 90s were far higher, so its absolutely no surprise. It doesn’t tell us anything about the credit worthiness of the UK, or anything about real yields. I assume you know what REAL yields are?

As for anothe great depression; there are still huge problems out there in many economies. Certainly the UK is not out of the woods yet. Massive government overspending over the last decade has increased the chance of us slipping back into recession – debt overhangs really do reduce long term growth.

@Richard W #19 #20

Canada and New Zealand did not export surpluses or unemployment. Not sure what you are talking about. They were overspending, cut it heavily, endured a short, sharp recession but their economies became less bloated and more competative. They exited recession more rapidly and resumed a good growth path. Japan has basically kept up deficit spending since the 80s in a vain attempt to break out of recession. They now have debt servicing costs approaching the total income tax take, little growth to show for it and an economy which really is in a lot of trouble.

As for the rest of your argument; I’m sorry but you are really quite wrong. Given you start talking about the current account (not sure it’s 100% relevant) I think you are trying to make some roundabout argument about governments stepping in to boost demand, which in turn keeps businesses afloat. The problem is though, that most of the deficit is structural and therefore won’t have a huge effect on aggregate demand either way. It certainly will have almost no effect on private balance sheets.

In fact, if anything, large deficits will have a negative effect on corporate balance sheets and make it harder to borrow, service debt and invest. Why? As the soverign CDS/interest rate climbs, so do all corporate rates on top of it. Issuing huge volumes of new goverment paper also crowds out other issuance….which corporates would use to invest, but governments use to pay current bills.

Labour isn’t borrowing money to invest. It is borrowing money to pay public sector wage and pension bills, and to pay for the benfits system. Basically the balance between the public and private sectors has tilted too far. Like it or not, the structural deficit will have to be eliminated, meaning large cuts (roughly £140bn). You can’t keep deficit spending forever, so I think the “growth” argument between cutting now and cutting a year later is pretty fatuous. Labour don’t want to cut now because they have an election coming up, and they know full well that large public sector job losses will lose them votes, and cause trouble with their only financial backers, the unions.

1. Tyler

@Richard W #19 #20

‘ Canada and New Zealand did not export surpluses or unemployment. Not sure what you are talking about. They were overspending, cut it heavily, endured a short, sharp recession but their economies became less bloated and more competative. They exited recession more rapidly and resumed a good growth path. Japan has basically kept up deficit spending since the 80s in a vain attempt to break out of recession. They now have debt servicing costs approaching the total income tax take, little growth to show for it and an economy which really is in a lot of trouble. ‘

I don’t really disagree with that, Tyler. However, my general point was that the global situation is currently different and that makes adjustment much harder. Of course they exported their surplus and unemployment. Any country with a current account surplus is exporting their surplus output and exporting unemployment to others. Global current accounts must balance so surplus countries export unemployment to the deficit countries.

‘ As for the rest of your argument; I’m sorry but you are really quite wrong. Given you start talking about the current account (not sure it’s 100% relevant) I think you are trying to make some roundabout argument about governments stepping in to boost demand, which in turn keeps businesses afloat. The problem is though, that most of the deficit is structural and therefore won’t have a huge effect on aggregate demand either way. It certainly will have almost no effect on private balance sheets. ‘

The current account is relevant. In the absence of a current account surplus through nett exports the British private sector would be unable to reduce their debts without government deficit spending. The government fiscal deficit is the mirror image of the deleverage and retrenchment in the private sector. Of course individual firms and persons can deleverage through business won from each other. However, there can be no nett repayment of debt in the non-government sector without a current account surplus or the government running a deficit. The government national accounts are taking the strain of the private sector deleveraging. It is rather silly to say that government spending has ‘ almost no effect on private balance sheets ‘. No matter what government spends on the money does not disappear into a black hole. All that happens is it gets a new owner and becomes a financial asset for someone. If they pay off debt they reduce their leverage and the redemption of the debt becomes a financial asset for the creditor. Therefore, the nett debt of the non-government sector falls. If the initial spending circulates in the economy then money velocity rises generating GDP. For each owner no matter what they do it is a financial asset and in a deleveraging economy someone will use it to clear outstanding debt. Without a government deficit the only way this deleveraging could occur is through bankruptcies leading to higher unemployment.

‘ In fact, if anything, large deficits will have a negative effect on corporate balance sheets and make it harder to borrow, service debt and invest. Why? As the soverign CDS/interest rate climbs, so do all corporate rates on top of it. Issuing huge volumes of new goverment paper also crowds out other issuance….which corporates would use to invest, but governments use to pay current bills. ‘

I agree that large government borrowing raises long-term interest rates. Not much evidence that government issuance has been crowding out corporate issuance. It was the QE programme that helped to reduce the spread between corporate bonds and gilts last year that facilitated large issuance of corporate bonds.

‘ Labour isn’t borrowing money to invest. It is borrowing money to pay public sector wage and pension bills, and to pay for the benfits system. Basically the balance between the public and private sectors has tilted too far. Like it or not, the structural deficit will have to be eliminated, meaning large cuts (roughly £140bn). You can’t keep deficit spending forever, so I think the “growth” argument between cutting now and cutting a year later is pretty fatuous. Labour don’t want to cut now because they have an election coming up, and they know full well that large public sector job losses will lose them votes, and cause trouble with their only financial backers, the unions. ‘

I think it is safe to say no matter who was in power at the moment they would be borrowing to pay the bills. Wages, pensions and benefits are not really discretionary. I agree we have tilted too far. Of course the structural deficit has to be eliminated that is not in dispute. I don’t know where you got the 140 billion as the size of the structural deficit but it is too high. The structural element of the deficit is around half of that. Our deficit in the long-run is unsustainable but it is not strictly true to say you can’t deficit spend forever. It is perfectly possible to run a fiscal deficit every year forever. As long as nominal GDP growth is higher than the fiscal deficit the ratio of debt to GDP would fall even with a permanent deficit. I don’t really think of them as the ‘ Labour government ‘. To me they are just the government and their economic policies are either right for the circumstances or they are wrong.

@ Richard W

I’ll try to be brief.

I really don’t get what you are saying about Canada and New Zealand. They had no surpluses, and unemployment went up (initially) in both their “deficit cutting ” recessions. I don’t really see how they exported unemployment….

I’m afraid you are simply wrong about current account deficits. We are set to run approx £56bn current acct deficit this year (a record btw). That is £56bn of capital flowing OUT of the UK economy. That in itself has no effect on corporate balance sheets. There CAN most definately be significant corporate delevaraging in the corporate world when governments run deficits in the current acct – it is happening now in many cases.

QE has INCREASED the spread between Gilts and corporate bonds (as has huge Gilt issuance, crowding out corp paper). QE has pushed Gilt yields lower, whilst not providing a buyer of last resort for corporate paper (unlike the US version of QE, which bought predominantly corp/tier 2 paper) so the spread has widened – QE has made the relative financing costs for corporate paper more expensive. This, by the way, is why mortgage costs have remained stubbornly high – mortgages are often funded by bank paper.

Structural deficit is approx 9-10% GDP. So call it £135bn of cuts then – my bad.

Um…if nominal GDP growth is higher than the deficit…..you end up running a surplus. In theory you could only run a fiscal deficit forever if you are happy to continually inflate away the debt. In real life though, that would crush the pound, basically bankrupt the pensions industry and people would simply stop lending at osme point. Not to mention that you can’t inflate your way out of inflation linked Gilts, which are a large % of UK debt now.

Just an addendum on the above re: QE.

In the UK QE has been used mainly as a tool to fund the government’s deficit.

The stated aim of QE is to reduce long term rates and increase bank lending. However, banks have to keep a certain amount of (Tier 1) capital on their balance sheets. In UK banks this is cash is normally stored in the form of liquid Gilt issues – so basically banks CAN’T be net sellers of Gilts into QE as they have to retain their net captial adequacy ratios. In the US, QE bought corporate paper and other Tier 2 stuff. This is removed from the banks’ balance sheets, freeing it up so they CAN lend more.

Effectively UK QE has done nothing more than allow the government more breathing room before a bond market selloff, and even that hasn’t worked – when QE started 10y Gilts were at 3.70% and now are at 4.17% DESPITE huge purchases by the BOE – effectively every pension fund manager worth his salt has gone out and sold what Gilts they can into it (and then put the money into equities – why the hell do you think equity markets have performed so well even though global GDP growth is muted?).

On those letters from economists in the Sunday Times (14 February) and the two in the Financial Times (19 February), do watch this interview on Saturday of Martin Wolf, the lead economics columnist in the FT, for a balanced assessment:
http://www.ft.com/cms/84d2eba2-2a26-11dc-9208-000b5df10621.html?_i_referralObject=14628177&fromSearch=n

Martin Wolf has been described as the world’s leading financial journalist by Larry Summers, previously US Treasury secretary for the last year and a half of the Clinton administration, then economics prof at Harvard and currently director of the US national economics council in the Obama administration.

@24: “In the UK QE has been used mainly as a tool to fund the government’s deficit.”

Quantitative Easing (QE) has been used to buy government debt because that avoids the hugely awkward and controversial issue of what corporate debt or equity to buy, a prospective minefield.

But it’s nonsense to suggest or hint that the main purpose of QE by the Bank of England was to finance the government’s fiscal deficit.

When base interest rates of central banks are down at 0.5 per cent – as in both Britain and America – then the potential for any further monetary policy stimulus to alleviate the recession has run out of mileage. QE is the only option remaining for a monetary policy stimulus.

And btw discussion in Conservative blogsphere and media in late 2008 was at one time suggesting that monetary policy and only monetary policy was the appropriate policy response for dealing with (even severe) recessions. A fiscal policy stimulus for contra-cyclical policy was deemed entirely inappropriate. Keynes and all he stood for were rubbished.

My personal trouble is that I come from both the keynesian and the “speak truth unto power” traditions. The course of economic developments in the last two or three years had demonstrated the continuing relevance of keynesian economics. A primary aim of Keynes’s general theory was to offer an explanation for the persisting economic depression of the 1930s:

“it is an outstanding characteristic of the economic system in which we live that, whilst it is subject to severe fluctuations in respect of output and employment, it is not violently unstable. Indeed it seems capable of remaining in a chronic condition of sub-normal activity for a considerable period without any marked tendency either towards recovery or towards complete collapse.” [General Theory of Employment, Interest and MOney (1936) p.249]
http://homepage.newschool.edu/het//texts/keynes/gtcont.htm

“I’m afraid you are simply wrong about current account deficits. We are set to run approx £56bn current acct deficit this year (a record btw). That is £56bn of capital flowing OUT of the UK economy.”

Eh? While I’n broadly with Tyler’s analysis here that looks like a howler to me.

If we’ve a current account deficit then we must have a capital account surplus for the two together make up the balance of payments which must indeed balance.

Part of the financing of that current acount defiit comes from things like the Kraft takeover: capital coming into the country to purchase assets.

Current account deficits necessarily mean capital inflows.

In case anyone here hasn’t already noticed:

“Amid the vigorous debate between Labour and the Conservatives – and different groupings of economists – over whether public spending should be cut or not in the coming financial year, it is worth noting that some cuts are already under way. . . ”
http://www.ft.com/cms/s/0/7a996710-1d53-11df-b12e-00144feab49a.html

This news from a little while back came as a surprise to me at the time:

“The National Health Service can make the £15bn to £20bn of savings needed during the next three years without damaging the quantity or quality of care – indeed while even improving the latter – according to David Nicholson, the NHS chief executive.”
http://www.ft.com/cms/s/0/6fba7dfe-e683-11de-98b1-00144feab49a.html

Those dedicated to maintaining public spending come what may, will perhaps be surprised to learn that the NHS can lose £15-£20 billion out of its c. £100 bn annual budget without that affecting the quality of patient care. If so, how much of the same can be said of other public spending budget lines?

Who cares what economists think ?????

@29: “Who cares what economists think ?????”

If anything goes then bring on the mumbo-jumbo stuff. For starters, mumbo-jumbo is so much easier to write when there’s no constraining professional discipline.

The intelligent issue to probe is to ask why economics grads are paid so much better than the grads in most other subjects? Try this graduate salaries league table published last April for the benefit of applicants for university places:
http://www.independent.co.uk/news/education/higher/table-what-do-graduates-earn-1675502.html

Previous league tables in other places have come up with rather similar conclusions about the salary rank of economics grads so this report doesn’t appear to be a one off. The question then changes to how come economics grads manage to sustain this position in salary league tables, given market pressures in what must be a rather sophisticated marketplace for university grads.

@ Tim W #27

My bad – I meant cash flowing out of the country. and as you rightly state that is being used to buy capital assets. However, most of those capital assets are very hard to turn back into cash – my argument still stands – and we are running twin deficits.

@ Bob B #26

QE in the US was used to buy corporate issuance, and a small amount (~1%) of UK QE was too. Why couldn’t UK QE been set up to have bought Tier 2 paper?

Instead, as I say, QE was used to buy Gilts in record size and effectively finance the government deficit. It certainly hasn’t had its intended effect of lowering interest rates – Gilts are higher now than the start of QE and credit spreads have widened.

@ 30 – Economics is perceived to be one of the harder degrees – because it sits just about at the centre of the arts/science axis. Few people are good at both, therefore the ability of economics graduates is arguably higher than the average, or at least their abilities are in short supply. Add to that it’s dull as ditchwater to study, and the fact that lot of them end up working in the city where, as everyone knows, even the toilet cleaners are on six figure salaries and you have a small pool of potential recruits chasing highly paid jobs.

My serious point was economists cannot predict anything, they can only guess at, sorry “explain” , why something happened *after* the event, and even then they are wrong more often than right – just look at the number of “explanations” they have come up with for the recession. Gordo would be better off asking some random bloke down the pub for advice on fiscal policy.

And is it just me or has Robert Peston got the most annoying voice on television, ever ?

Matt @ 32: “My serious point was economists cannot predict anything, they can only guess at, sorry ‘explain’, why something happened *after* the event”

C’mon. Governments and businesses have to make policy decisions contingent on some sort of predictions about the most likely downstream consequences of the decisions. The question is whether they try sophisticated means for making those predictions or the equivalent of reading tea leaves and entrails.

Famously, HM Treasury staff maintain an economic forecasting model which usually attracts plaudits for the accuracy of its forecasts compared with other forecasting agencies. Forecasts of the NIESR also usually come out relatively well. The Treasury publishes a regular survey of forecasts of the UK economy made by independent agencies, mostly financial institutions in the City. This is the latest survey:
http://www.hm-treasury.gov.uk/d/201002forecomp.pdf

Compare economics with the news today about climate scientists:

“Fallout from a loss of public confidence in climate science is affecting other fields of research, a top US academic claimed.

“American opinion polls point to a general deterioration in people’s faith in science, according to Dr Ralph Cicerone, president of the National Academy of Sciences.

“It came after two major public relations setbacks for the global warming gurus.

“One was the ‘climategate’ scandal involving leaked emails from the Climatic Research Unit at the University of East Anglia, which led to accusations that scientists manipulated and suppressed data.

“The other was an admission by the United Nations’ influential climate change body that it issued flawed data about the rate at which Himalayan glaciers were melting.

“Two years ago the Intergovernmental Panel on Climate Change (IPCC) reported that the mountain range could lose all its glaciers by 2035. In fact the claim had no valid scientific backing.”
http://www.independent.co.uk/news/science/scientists-hit-by-climate-doubt-fallout-1905414.html

And as for medics:

“Almost 4,000 NHS patients in England died last year following ‘safety incidents’, in which some aspect of their care went wrong.

“A further 7,500 patients suffered severe harm as a result of accidents or botched medical treatment.

“Figures for the final six months of 2008-9, published yesterday by the National Patient Safety Agency, show that over the year 11,504 patients died or suffered severe harm as a result of medical errors, a rate of almost 1,000 a month.”
http://www.independent.co.uk/life-style/health-and-families/health-news/why-hospital-is-a-dangerous-place-to-be-1799083.html

Btw some of us regard economics as a continually exciting subject – and this year I shall be celebrating my graduation with a degree in economics 50 years ago.

23. Tyler

@ Richard W

‘ I’ll try to be brief.

I really don’t get what you are saying about Canada and New Zealand. They had no surpluses, and unemployment went up (initially) in both their “deficit cutting ” recessions. I don’t really see how they exported unemployment….’

It is quite simple, Tyler. We know that countries are better off trading with each other rather than trying to operate as a closed self-sufficient economy. They are both better off through the gains from trade. We also know in the absence of exports to Martians that in aggregate global current accounts must balance. Therefore, when a country runs a current account surplus another must run a deficit so the surplus country is exporting their excess capacity to others. That is why surplus countries are considered to be exporting unemployment. There is broad agreement that the UK must rely less on imports and increase net exports. This will happen over time through the mechanism of the depreciation in the sterling effective exchange rate. Although the current account deficit does not impact the government fiscal deficit, it is still relevant to this issue. Without the government fiscal budget taking the strain the necessary and currently ongoing deleveraging in the private sector without the current account being balanced or in surplus would result in bankruptcies and unemployment. It is much harder for there to be a boost in net exports when your trade partners are impaired. That is not a situation that New Zealand or Canada faced. Therefore, the pressure falls to the fiscal budget.

‘ There CAN most definately be significant corporate delevaraging in the corporate world when governments run deficits in the current acct – it is happening now in many cases. ‘

This is gobbledygook. The government does not run a deficit in the current account. The current account is just an aggregate of our international trade in goods and services, our capital and financial account. The non-government sector can deleverage without the government running a fiscal deficit. However, it would lead to a huge upsurge in bankruptcies and even higher unemployment. Bankruptcies and the subsequent unemployment will still occur. However, it is better that they occur over a period in time when the rest of the economy is stronger to absorb the unemployed.

‘ QE has INCREASED the spread between Gilts and corporate bonds (as has huge Gilt issuance, crowding out corp paper). QE has pushed Gilt yields lower, whilst not providing a buyer of last resort for corporate paper (unlike the US version of QE, which bought predominantly corp/tier 2 paper) so the spread has widened – QE has made the relative financing costs for corporate paper more expensive. This, by the way, is why mortgage costs have remained stubbornly high – mortgages are often funded by bank paper. ‘

This is clearly not the case. I know of no other person in the UK who believes QE has widened the spread between corporate bonds and government debt. There was record corporate bond issuance 2009. For example see the BoE quarterly bulletin P 267-269, which disproves your assertion.

http://www.bankofengland.co.uk/publications/quarterlybulletin/qb0904.pdf

For commercial paper.

‘ Quoted primary market CP spreads narrowed further and
remained below the spreads at which the Asset Purchase
Facility (APF) offers to purchase CP. This meant that some
issuers found it more economic to issue to investors rather
than use the APF.’

For corporate bond spreads between the primary and secondary market.

‘ During 2009, gross bond issuance has
been strong and net issuance has also increased. For new
issues, the ‘new issuance premium’ (ie the difference between
the yields based on the offer price and the secondary market
price) fell, dropping from between 75 basis points to 100 basis
points in January to perhaps less than 10 basis points.
Conditions in the secondary market also improved, with both
credit (Chart 19) and bid-offer spreads narrowing considerably
from their highs in March 2009.’

Multiple charts here with narrowing spreads.

http://www.bankofengland.co.uk/publications/other/markets/apf/apfquarterlyreport1001.pdf

Charts here showing the narrowing spreads.

http://blogs.ft.com/money-supply/2009/09/30/the-bank-of-englands-view-of-quantitative-easing/#more-5336

‘ Um…if nominal GDP growth is higher than the deficit…..you end up running a surplus. In theory you could only run a fiscal deficit forever if you are happy to continually inflate away the debt. In real life though, that would crush the pound, basically bankrupt the pensions industry and people would simply stop lending at osme point. Not to mention that you can’t inflate your way out of inflation linked Gilts, which are a large % of UK debt now. ‘

You would only be running a fiscal surplus if government revenue exceeded expenditure. The national debt is always expressed as a ratio of GDP. If an economy has a nominal GDP growth of 5% and real GDP growth of 3% and a fiscal deficit of 2%, the ratio of debt to GDP would fall even with a fiscal deficit. Since 1930, the US has had a federal deficit for 67 out of 79 years, 84% of the time. They only became unsustainable from 2002 onwards. I am not speaking about ratios not inflating debt away. Inflation would be implied in the nominal/real GDP and nominal/real interest rate. Fiscal deficits only impact the currency when they exceed GDP growth. Moreover, I am not advocating that the government runs fiscal deficits forever. I was just responding to you saying that they can’t. Index-linked gilts are 24% of the total stock.

2:35 am, February 20, 2010
24. Tyler

Just an addendum on the above re: QE.

‘ In the UK QE has been used mainly as a tool to fund the government’s deficit.

The stated aim of QE is to reduce long term rates and increase bank lending. However, banks have to keep a certain amount of (Tier 1) capital on their balance sheets. In UK banks this is cash is normally stored in the form of liquid Gilt issues – so basically banks CAN’T be net sellers of Gilts into QE as they have to retain their net captial adequacy ratios. In the US, QE bought corporate paper and other Tier 2 stuff. This is removed from the banks’ balance sheets, freeing it up so they CAN lend more. ‘

The aim of QE is to boost the money supply in order for the bank to achieve their 2% inflation target. Buying gilts from a bank would not increase the money supply as the security is already part of the money supply. Only buying from the non-bank sector increases the money supply. A consequence of QE is to narrow spreads and boost lending but it is not the ‘ stated aim ‘.

http://www.bankofengland.co.uk/monetarypolicy/assetpurchases.htm

The banks were net sellers of gilts between March 2009 and October 2009.

See Simon Ward blog.

http://www.moneymovesmarkets.com/journal/?currentPage=7

I agree that QE should have bought more corporate bonds and commercial paper for the reasons you state. I think this reflects the conservatism of the governor who appears to be reluctant to take credit risk onto the banks balance sheet.

‘ Effectively UK QE has done nothing more than allow the government more breathing room before a bond market selloff, and even that hasn’t worked – when QE started 10y Gilts were at 3.70% and now are at 4.17% DESPITE huge purchases by the BOE – effectively every pension fund manager worth his salt has gone out and sold what Gilts they can into it (and then put the money into equities – why the hell do you think equity markets have performed so well even though global GDP growth is muted?). ‘

There seems to be no doubt that yields will rise. The yield you quote is still below the average yield that prevailed before the financial crisis. The pension funds are net buyers of gilts and will continue to be net buyers. They have liabilities and must match their portfolios with liabilities, as a consequence they can’t get enough of long-dated debt. The first gilt auction a few weeks ago after the ending of QE had the highest bid-to-cover for eight years. Who will buy the government debt is not an issue. The issue is at what price.

“There seems to be no doubt that yields will rise.”

That is to be expected as economic activity picks up from the perspective of thoroughly keynesian analysis.

@34 Richard W

Canada’s recession of the 90s coincided with the general recession of the 90s. The point I was trying to make though is that cutting large deficits does not necessarily make a recession more severe. By making your economy more competative, long term growth trneds *increase* not decrease, as Brown seems unable to see. You seem to be using some GCSE level economic argument about current accounts and exporting unemployement. It simply isn’t as simple as that any more – in the good years we’ve seen countries running huge current acct. surpluses and deficits, yet employement going UP in both. Your model doesn’t really account for service industries, just hard goods.

Corporates are going bust or shedding jobs, the few that can still raise debt are doing so but most (certainly smaller ones) are being forced to de-lever, because they either can’t issue debt or the cost is too high.

Commercial paper is short term issuance, normally up to about 3 months.They aren’t truly bonds. Still, in chart 4 of the link you give;

http://www.bankofengland.co.uk/publications/other/markets/apf/apfquarterlyreport1001.pdf

it shows what is happening – CP has FALLEN from about 7bn to 3bn of issuance in 2009. That is deleveraging or corporates finding it harder to borrow. THe BoE quarterly bulletin also states that it is mostly the alrge investment grade firms issuing at the moment. It should also be noted that without the government gaurantees the banks got, 2009 would have been a poor year for issuance.

CDS spreads have fallen since Lehman blew up, which is to be expected really – they were blown sky high. They are still roughly double pre-crisis levels though (see chart 19, BoE quarterly report)

On QE;

Yes, QE was supposed to be used to boost the money supply. For some reason (can’t think why) it was chosen to do this by allowing the government to spend more freely, rather than allowing banks to lend more freely. The APF *IS* QE and from the BoE minutes you can see that it has been used predominantly to buy Gilts, not CP or other corp debt.

Using Simon Wards figures, Banks + Building societies were net sellers of £2bn Gilts. That is what is known as “pissing in the wind”. BoE by this point had bought £171bn.

Non-bank private sector, pension funds to you and me, had SOLD £24bn Gilts. Yes, they will continue to buy in general, but because they are legally obliged (something enacted by a certain G. Brown by the way) a certain amount of Gilts or are mandated to. Clearly pension funds have lightened up on Gilts – net sellers, £24bn. That is BEFORE accounting for £21bn of redemptions, which in effect is the same as selling Gilts.

As for bond yields….is it that surprising that yields are lower now than the average yield? After all, we’ve had QE and rates are 0.5%, not 5% as they were a few years ago. REAL YIELDS are not that low historically though – you have to compare like with like (or, for a quick and dirty, check out charts of inflation linked bonds).

Thanks for the complement Tyler but it is a few years since I was at school. I am surprised that you do not see the relevance and importance of global imbalances. It is after all global imbalances that are the cause of the GFC. All that has happened in recent years are merely symptoms, but imbalances are at the heart of the crisis. Here is a Martin Wolf article outlining what I mean about exporting unemployment.

‘ Some argue that an attempt by countries with external deficits to promote export-led growth, via exchange-rate depreciation, is a beggar-my-neighbour policy. This is the reverse of the truth. It is a policy aimed at returning to balance. The beggar-my-neighbour policy is for countries with huge external surpluses to allow a collapse in domestic demand. They are then exporting unemployment.’

http://74.125.155.132/scholar?q=cache:1St7HBUKXu0J:scholar.google.com/+author:%22Wolf%22+intitle:%22Global+imbalances+threaten+the+survival+of+liberal+trade%22+&hl=en&as_sdt=2000

Services change nothing because they can be exported just like tangible goods. The UK runs a huge surplus in services, which helps to balance the goods deficit. What matters is overall balances.

I am old fashioned enough to believe that nations should live within their means and if they want to increase spending then politicians should be honest and raise taxes. If the public disapprove then they can vote them out. In normal times spending by borrowing is dishonest as it defers tax raising to future governments who did not enjoy the political benefits. However, we are not in normal times. I really don’t think there is much disagreement that the UK fiscal deficit is unsustainable and must be eliminated. Moreover, no one of any relevance now believes that the deficit can be eliminated by taxes alone. Therefore, expenditure must fall and the state shrink as a ratio of the economy. The dividing line if you like is over timing. A few years ago I would have considered such fiscal deficits as indefensible. However, we now have a paradigm shift and the alternative to the deficit is even worse. Therefore, I believe the best option is to give the corporate and personal sector time to adjust.

From what I read smaller firms access to credit and just as important the price is an ongoing issue. That is part of a wider repricing of risk. I certainly agree that the BoE could have done a better job in purchasing assets to make sure it benefited smaller firms.

The declines in the size of the commercial paper market is the inverse of the corporate sector destocking inventories. Even in the US, the CP market was half the size in October compared to 2007. I don’t have a chart for the UK but in Q3 the US non-financial corporate sector had their highest financial surplus since 1960. A high financial surplus through retained earnings allied with destocking would obviously lead to a decline in the size of the commercial paper market as they rely less on short-term debt issuance. I would assume the UK was following a similar pattern.

I agree that global imbalances are important, but I strongly disagree that the only solution when running a current acct deficit is to also run a fiscal deficit to prop up the real economy.

I agree that nations should live within their means over time. Had we been running a surplus before the crisis, I would be all for running a large deficit now, but we weren’t. Brown and Labour have been running deficits, sometimes significant ones, even in times of record growth. As such, the national debt has doubled in size, and by 2015 the interest burdon on the economy is set to equal the entire defence budget. That needen’t have happened, but Labour has left the UK with an enrmous structural deficit and very little to show for it. By the time spending is back under control, it will be lower than 1997 levels. Hardly a success story.

If you read the BoE report, the CP and corporate bond markets have been dominated by large investment grade corporates, and it has becomes significantly harder for anyone less than IG to issue paper. CP tends to be used by lower grade corps (it’s cheaper for them) so the massive fall in the size of the CP market is symptomatic of how hard it is to borrow for anyone under the top tier. That’s a bad sign, not a good one.


Reactions: Twitter, blogs
  1. Ben Cooper

    RT @libcon: Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  2. Tim Ireland

    RT @libcon: Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  3. Mr Omneo

    RT @libcon: Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  4. Chris Paul

    RT @libcon: Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  5. john band

    RT @libcon: Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  6. Adam White

    http://bit.ly/aOJN0E lib con article on rebuttal of times cuts letter.. good stuff sunny! @pickledpolitics @libcon

  7. Michael Hanley

    RT @libcon: Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  8. Liberal Conspiracy

    Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  9. sunny hundal

    RT @libcon: Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  10. Jonathan Taylor

    RT @pickledpolitics: RT @libcon: Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  11. topsy_top20k_en

    Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  12. uberVU - social comments

    Social comments and analytics for this post…

    This post was mentioned on Twitter by libcon: Ouch! Two sets of Economists slam Tory ‘cuts’ in joint letters to FT http://bit.ly/aAjNuX

  13. Milena Buyum

    RT @pickledpolitics RT @libcon: Ouch! Two sets of Economists slam Tory 'cuts' in joint letters to FT http://bit.ly/aAjNuX

  14. Rogue

    RT @libcon: Two sets of economists slam Tory 'cuts' in FT http://bit.ly/bmp5ox

  15. Amanda

    RT @Rogue_Leader: RT @libcon: Two sets of economists slam Tory 'cuts' in FT http://bit.ly/bmp5ox





Sorry, the comment form is closed at this time.