Monday, December 05, 2005

In August of last year, I hinted on this blog that interest rates might be reaching levels that were threatening economic growth. The Bank of England's Monetary Policy Committee (MPC) is required to hit an inflation target, and it moves interest rates in order to hit that target as closely as possible. But it is not required to aim for any particular rate of economic growth. We are now seeing the effect that policies that are suited for one purpose can have on another key indicator of macroeconomic performance.

The Chancellor of the Exchequer has slashed his growth forecast for 2005 to 1.75%, just half the rate that he forecast just a few months ago in the Budget. He blames this in part on oil prices - though oil prices have affected also the economies of mainland Europe that are now growing faster than that of the UK. The UK's own monetary policies - the responsibility for which is now of course (quite rightly) devolved to the Bank of England - have as much to do with this year's disappointing growth outturn as anything else.

Fortunately, the UK economy looks set for a soft landing, with growth remaining uninterrupted into another cycle. In the longer term, the relationship between the MPC target and other key macroeconomic variables is something that may need to be revisited if we are to avoid less fortunate economic outcomes.
Gordon Brown is at it again - he has once again changed his definition of the economic cycle. A few months ago, he redefined the start of the current cycle from 1999 to 1997, a controversial move on which I have written earlier. Now he wishes to redefine the end of the cycle to 2007.

This latest move is truly bizzare. He has described, with some justification, the current year as 'the toughest year'. If that is the case, then surely this is when the cycle ends. The move to redefine the end of the cycle to 2007 is transparently a ploy to boost the public finances with the fruits of a couple of years of above par growth. There's nothing particularly wrong about that, but the Chancellor should stop pretending that he is adhering to some sort of 'golden rule' when the truth is that he keeps moving the goalposts.

In his pre-budget statement, the Chancellor has revised growth forecasts for the current year down to 1.75 per cent. This is just half the growth rate he was predicting at the time of the Budget earlier this year. To be sure, some of the slowdown is due to rising oil prices, but they affect the relatively fast-growing economies of mainland Europe too. More pertinently, the slowdown is due in part to restrictive monetary policies. Back in August of last year, I was hinting on this blog that interest rates might have been hiked too far and too fast. We are now seeing the fruits of the Monetary Policy Committee's decisions of 15 months ago - while those decisions were arguably in line with the MPC's need to meet an inflation target, we are now seeing the consequences of their decisions on economic growth, an important variable which the MPC does not target.

Friday, December 02, 2005

Tony Blair is making last ditch attempts to secure agreement on the EU budget. He says that there is no question of the UK giving up its rebate, other than in exchange for wholesale reform of agricultural support. Yet he is willing to see the rebate reduced (as opposed to scrapped) in order to secure an agreement - and this without any corresponding cut in support to other countries through the Common Agricultural Policy (CAP).

The desire to seek a deal during the period of Britain's presidency of the EU (which ends at the end of this month) is natural enough. But Mr Blair has left it until the eleventh hour before making any strenuous efforts in this direction. The consequence is that he has had to offer up a key bargaining chip in order to secure the support of the eastern European accession countries. They may be (and it is only a maybe) willing to cut some of their calls on the EU budget for development if the UK is willing to sacrifice something too. So - since the UK has the presidency and since Mr Blair can make decisions for Britain but not for other western European countries - the UK offers up a slice of its rebate.

This is politics liberated from any economic rationale. The UK's rebate was set up to ensure that - so long as the CAP existed and distorted budgets - the UK got a fair deal in relation to other western European countries. If there is no change in budgetary arrangements for the other western European countries, the rebate should remain intact. It is doubly important that it should do so, since the rebate serves as Britain's only pressure point on other countries to reform the CAP. Mr Blair is playing dice with our ability ever to cure Europe of its most damaging institution - one that penalises consumers, hurts farmers in developing countries, and sustains inefficient agricultural practices within Europe.

Mr Blair's offer seems to be to cut the rebate by about half a billion pounds per year. At a time when his Chancellor, Gordon Brown, is struggling to plug the hole in the public finances, the Prime Minister's largesse could not be more unwelcome.

Friday, November 25, 2005

Gordon Brown is in the news again. It seems that he is intent on blocking one of the proposals made in the forthcoming Turner report on pensions reform. That proposal would reinstate the automatic link between pensions and the average earnings index, and would (eventually) raise the age at which people become eligible for the state pension to 67 years.

This is another example of a knot in which the Chancellor has managed to get tied. Index linking of pensions obviously reduces the degree of control that he has over public expenditure. He needs to rein in that expenditure as far as possible at present, because tax revenues are currently falling quite a long way behind expenditures. In other words, the public finances are in a mess, and the Chancellor is in no mood to sign cheques. The shortfall of tax revenues was predictable and predicted.

Most economic commentators have been less sanguine than the Chancellor about the propspects for growth over the last couple of years; they, not he, turned out to be right, and the consequence has been that incomes have failed to rise sufficiently quickly to fill the Treasury's coffers.

Mr Brown owes economists an apology. But before that, he should apologise also to the pensioners and the public sector workers who will pay the price for his mistake.
Gordon Brown, Chancellor of the Exchequer, has urged public sector pay review bodies to keep pay settlements down below 2% over the coming year. This is in spite of the fact that price inflation has been above 2% for several months now.

He is right. The recent surge in inflation has been a blip, fuelled largely by the increase in oil prices. Over the last couple of months, however, oil prices have fallen, and so has inflation. Last month's inflation rate (excluding mortgage interest) was 2.3%, down from 2.5% the month before. To allow high settlements in the coming pay round would risk perpetuating the blip in the same way that the oil price blip of the 1970s was perpetuated. Then, inflation rates rose to 28%, an experience we would rather avoid repeating.

However, there is also a more cynical reason why Mr Brown would like to see public sector pay restraint. Owing to his overoptimistic growth forecasts, tax revenues are lower than he expected. As a result, there is a gaping hole in the public finances. High public sector wage settlements would aggravate this situation.

While Mr Brown is right to urge for pay restraint, it is nonetheless the case that public sector workers are being expected to pay for the Chancellor's own lack of prudence.

Wednesday, September 14, 2005

There is a lot of public pressure on the UK government to respond to the petrol price situation by lowering duty on fuel. While all parties in the discussion understand that it is international factors that have pushed up the price of petrol, there is much disquiet about the fact that the government's tax take on petrol has risen - because while the duty is a fixed sum, VAT is raised as a percentage. There are therefore accusations that the government has allowed the VAT windfall arising out of the petrol price hike as a kind of stealth tax. This is what is causing people to call for a reduction in the rate of duty.

Should the government respond? I think not. If they did, it would signal to the petrol producers that they are prepared to absorb (in the form of a reduced tax take) any further increases in the price at which the petrol is sold to the garages. This would insulate the petrol producers from the disciplines of the market - and the profits made by the petrol giants do not suggest that their industry is sufficiently cut-throat to ensure that Shell, BP and the rest will discipline each other through competition. (Shell and BP each make annual profits that are roughly the same as the national incomes of countries like Estonia, Cyprus, Lebanon or Botswana; about twice as much as the national income of Niger.)

If government cut duties, petrol companies would likely hike prices again.

The root cause of the current difficulty in the petrol market is high demand (much of it speculative) and OPEC-restricted supply. The high demand is something we're going to have to learn to live with. The artifical restriction of supply by the OPEC cartel is likely to continue for a while yet, although political pressure in advance of the OPEC meeting on 19 September could possibly bring about some easing of the situation. Eventually - as happened in the 1970s - the cartel will find the maintenance of high prices unsustainable, but that could take some time.

Tuesday, September 13, 2005

The petrol price protesters are out in force again. Oil prices have pushed the pump price to an unprecedented £1 per litre in the UK. In a country where travel by car has become the norm, the rapid price increase has understandably made many people unhappy.

Demand for oil is forecast to rise dramatically over the next few years, as the rapid pace of development in the large high growth economies of China and India brings motorised transport within the budget of many more people. With some forecasters predicting a rise in the per barrel price of oil to over $100 within two years, it is hardly surprising that the demand has increased now, when prices are 'only' $57.

To be sure, the high price is being sustained by the behaviour of the OPEC cartel, which is restricting output to around 28 million barrels per day. While prices are on the rise, discipline within the cartel is likely to be maintained; members of the cartel will recognise that they are better off not breaking the output quotas agreed within the organisation just yet. (Or at least not breaking them too wildly - OPEC recognises that its members do in fact break the rules.) The cartel is the real reason why output is restricted. Of course oil supplies are not infinite, but it's cartelisation rather than limited supplies that is the immediate problem. OPEC will be meeting on 19 September to review its quotas; we can expect there to be a lot of international pressure on them to increase supplies in order to dampen the upward pressure on prices.

In the 1970s, restrictive practices by OPEC brought about inflation on a grand scale in the UK. That happened because the government of the day 'accommodated' the oil price rise by relaxing monetary policy. That led to a general and sustained increase in prices - inflation. So long as today's authorities keep a tight rein on monetary policy, there is no reason why that episode should be repeated. But it does make it likely that the interest rate will need to be increased in the near future.

Thursday, September 01, 2005

The European Union's dispute with China about textile imports comes like a blast from an unwelcome past. It exhibits the EU at its worst.

At its best, the EU exists to promote free trade - albeit free trade within a prescribed trading bloc. Free trade encourages the most efficient international pattern of production possible. If we are best off when France produces wine and Italy produces pasta, then that is exactly what free trade will stimulate. We will get relatively cheap wine from France and relatively cheap pasta from Italy, and - given an amount of money to spend - we'll be able to buy more wine and pasta than we could under any other production arrangement.

In the case that is now making the headlines, China wants to sell the EU cheap textiles. I say let them. The EU says no. The EU is concerned about European jobs in the textile industry, and is imposing protectionist policies to prevent what they consider to be excessive textile imports from a low cost producer. But why not let China do what it is good at, and let us concentrate on producing things where we have a comparative advantage?

For some textile workers in the EU, this might mean adjustment. It might mean reskilling, either to move up the value chain in the textile industry, or to move out of the textile industry altogether. Change hurts, and that being so, the EU is resisting the change. But change is also inevitable, and if EU labour markets do not act flexibly now, they will be forced to do so, more painfully, later.

Meanwhile, the EU is seeking to deny hundreds of millions of European consumers the right to choose between cheap imported textiles and more expensive domestically produced goods.

And all the time the tide keeps rolling in, and the EU still needs to learn from the experience of King Cnut.

Friday, July 22, 2005

China has unpegged its currency from the US dollar, and has revalued the renmimbi by 2%. This will make its exports less competitive, and will make it easier for other countries to export their goods to China. The Chinese currency will now float against other currencies, but the float will be managed by reference to a basket of currencies of its major trading partners. This lessens the influence of the (relatively weak) dollar in determining China's trade.

Inflation in China remains low, at below 2%, and growth has eased somewhat from the supercharged 13% figures of a few months back. Domestic pressure for the change in policy is unlikely to have been the driver, therefore. But the Chinese government has come under increasing pressure from other countries to free its currency. Notably, the US, with which China has a huge trade surplus, has been especially keen to gain leverage from the extra degree of freedom that independent exchange rates for the two giant countries can afford. For Americans (as for Brits, and as for China's other trading partners) the move may make flashdrives slightly more expensive, but will it will stimulate their economies. This is welcome news.
Chancellor of the Exchequer, Gordon Brown, has a reputation for prudence, won largely as the result of his careful management of the economy during the Labour government's first period in power. Since then he has been more relaxed about spending, and the government budget surpluses earned in the early years have turned into deficit. Key to his prudent image has been his self-imposed 'golden rule' that, over the course of the business cycle, government should not borrow other than to pay for capital investments.

During the current cycle that golden rule looks like being breached. Or at least it did until the Chancellor employed a sleight of hand to give himself more wiggle room. That sleight of hand entailed redefining the time when the current cycle started from 1999 to 1997. Since the government made a surplus in 1998, this gives him more to play with.

Certainly the case for stating that the cycle began in 1999 always looked weak. Growth was much higher then than in 1997. So far so good for the Chancellor. But if we roll the years forward to 2000, things don't look so compelling. In that year, growth dipped once more, and indeed on some measures growth was slower in 2000 than in 1997. The Chancellor was right to change the date that the cycle began. But he still hasn't got the right date.

Since the years after 2000 have been characterised by government budget deficits, the truth of the matter is that the golden rule is being broken in style. Fortunately this has not yet led to inflationary pressure, but it does build up problems for the future. Taxes will need to rise to pay for the excess government spending, and if people anticipate those tax rises they will be cautious about their own spending now. Consumer pessimism dampens demand and stifles growth, making it all the harder for the Chancellor to meet his targets. Unless he starts to pull rabbits out of hats (without a sleight of hand this time), the Chancellor's reputation for prudence is set to wane.