The Governor of the Bank of England, speaking at an IMF conference yesterday evening:

Bank of England, as reported before breakfast this morning:

In between time, the pound had done this:

Modern central banking is mostly about the communications of modern central banking. Take former European Central Bank president Mario Draghi’s declaration that he would do “whatever it takes” to save the euro, in 2012. Did Draghi actually have to do “whatever it takes”? No, just declaring clearly and credibly that he would was enough to end the speculation around the terms of the euro’s disintegration and immediately improve financial condition in the eurozone and beyond.

What Bailey and the Bank of England have just done is the exact opposite.

Confusion

So why the confusion? Why the mixed messaging? The Bank’s fundamental problem, beneath whatever it wants to tell the world, is that its two major objectives now contradict. The Bank of England, like any central bank, has a primary task of ensuring financial stability. This is why central banks exist at all, in their modern form: central banks emerged as a “lender of last resort” for a currency’s banking system, meaning it was known by all other banks, financial institutions, and their customers, that the central bank was ready to step in and preserve the system’s stability if needed – by issuing emergency loans to failing institutions, for example.

Their second function, inflation targeting, emerged only very much later – really in the last few decades or so. Although much better-known today, inflation targeting by central banks is only possible because of their fundamental role in trying to preserve financial stability. By acting as the fundamental support for the whole monetary system, central banks develop great powers over the system. The interest rate central banks pay on the bank accounts the commercial banks hold with them grows to exercise a control over interest rates in the system more generally. When the Bank of England or some other central bank is reported to be adjusting “the” interest rate, this “Bank rate” is the rate it is adjusting. The idea is that by the central bank changing the interest rate paid out on its own reserves, every other bank and financial institution will adjust its own interest rates. (The Bank of England has a clear explainer here.)

Under normal circumstances, these two functions work together. The Bank of England’s Monetary Policy Committee (MPC) meets monthly to set the Bank’s main interest rate, aiming to keep inflation at the government’s target level of 2%. The Financial Policy Committee, meanwhile, keeps an eye out for future financial crises and potential instability. After the 2008 crash, the MPC has also overseen the massive programme of government bond-buying called “Quantitative Easing” (QE), taking decisions on the value of government bonds the Bank should buy with freshly-issued Bank money. Novel in early 2009 when it was introduced, for good or ill QE is now an accepted part of most central banks’ policy toolkits. Again, this has all been accepted as normal, innocent central bank behaviour – even when QE was expanded by some £400bn to cover the costs of covid in 2020. At the start of September, the MPC announced it would be reversing QE with “Quantitative Tightening” (QT) – selling government bonds back to the financial markets – as part of its effort to control inflation, alongside increasing the Bank rate.

Normal

Alas, the times are not normal, and haven’t been for a while. Kwasi Kwarteng’s mini-Budget on September 23rd, containing £45bn of additional borrowing (on top of the Energy Price Guarantee) and including an unexpected new tax cut for the wealthiest, sparked an almighty panic amongst those in financial markets. The pound fell rapidly in value against other currencies and the price demanded by traders for lending to the British government – the “gilt rate” – shot up. This sudden change in the gilt rate in turn seems to have destabilised British pension funds, who had, over the previous decade or more, developed sophisticated ways to try and match up the payments they make to pensioners with the earnings they receive from their assets. These techniques, collectively known as “Liability Driven Investment” were sophisticated but, it turned out, fragile if market conditions changed rapidly. By Monday 26th, there was a risk that some pension funds faced insolvency and therefore of much wider market disorder.

The Bank of England, as the situation worsened, moved on Wednesday 29th to operate its primary function: preserving financial stability, promising up to £5bn-worth of additional bond-buying a day for the next 13 working days, and ending Quantitative Tightening.

But notice that this is a screeching reverse of the earlier decision to start QT to combat inflation. The Bank’s aim of preserving financial stability runs directly counter, right now, to its aim of keeping inflation low. The same tools and instruments are being used to try and do two, contradictory things. This contradiction by itself would be a decent reason for the Bank to try and impose a time limit on the extra support it has offered, and was (presumably) the reason for setting that limit. But without the pension funds magically managing to reorganise themselves at very short notice – and the picture here is unclear – the time limit just delayed the inevitable, currently set to arrive on Friday morning.

This contradiction is the reason for the confusion at the top of the Bank. But the confusion should alarm all of us. The Bank of England has been the most important economic institution in the country for the last decade. Time and again its interventions have enabled an otherwise weak economy to steer through a series of crises, from Brexit to covid, with relatively little damage. If the Bank is now itself starting to look as dysfunctional as every other major institution, we are collectively in a very bad place. And it is absolutely not a good look for the governor of a central bank to say one big, important thing and then have himself immediately contradicted by his own bank a few short hours later.

Chicken

What to do? There might be ways for the Bank to try and manage this mess more effectively. Steven Major, HSBC’s head of global research has suggested they should make clear the financial stability intervention is only buying long-term bonds (which it is), whilst the monetary policy intervention (“Quantitative Tightening”) is only selling short term bonds (which it is). These are two different parts of the market and two different financial products, so – in theory – two different interventions could be applied. Major goes on to suggest that the Bank rate could still be used to signal the Bank’s intentions about inflation, with Bank rate rises (expected to be steep over the next few months) continuing.

Perhaps more fundamentally, as former Permanent Secretary to the Treasury Nick Macpherson has said, it isn’t actually the Bank’s job to bail out pension funds. That falls to the government – the Bank was only bounced into intervening as it became apparent, barely two weeks ago, that a general failure of pension funds had bigger market implications. That would mean the Treasury pulling together a rescue package for the funds, which, one way or another, means adding still further to the government’s rapidly rising pile of debt and more pressure on interest rates. One, possibly generous, reading of Bailey’s behaviour is that he has thrown down the gauntlet not so much to pension funds as to the government: that either the Treasury will have this mess resolved by Friday, or the Bank will not be responsible for the consequences. (You may think it’s a bad sign that a central bank is playing chicken with its own government, and you’d be absolutely right.)

So a quick, relatively low-cost resolution to the current mess would be for the government to U-turn on whatever remains of the Budget, although plausibly this would end Kwasi Kwarteng’s political career; the slower, higher-cost resolution would involve a government backstop for failed pension funds, although this might allow Chancellor Kwarteng to remain in Number Eleven. It’s a dilemma: who amongst us can truly say which of these options is best? Most likely, of course, is some fudge, whereby the Bank declares and end to the current round of exceptional support, but then cunningly reintroduces something quite similar looking for Monday morning whilst the government continues to chisel away at its own mini-Budget.

Either way, the resolution would only be temporary. The cost of government borrowing has been forced upwards, to heights unheard of even a few years ago, and is unlikely to come back down much in the future. The pound continues its long-term decline. The economy is shrinking as we slide into a probable recession. If we get right down to the fundamentals, Britain is a weak, unproductive, low investment, low wage, high debt economy with a massive dependence on imports for essentials like natural gas and food. It has run off fumes for much of the last decade, leaning more and more heavily on the historic reputation of its core institutions – like the Bank of England – to maintain a semblance of progress. But there are limits to how much the Bank can do with monetary policy, and the Truss government has cack-handedly exposed those limits in the last few weeks. Things are only likely to get worse, and potentially much worse, from this point onwards.

The post What is the Bank of England playing at? appeared first on The Progressive Economy Forum.

The main rate of inflation in the UK, the Consumer Price Index, fell from July’s 40-year peak of 10.1% to 9.9% in August. This reflects the impact of sharp declines in the global price of oil over the summer, which fed into the falling price of motor fuel. However, food prices are continuing to rise, and the increasing price of food made the biggest single upwards contribution to the overall figure.

The graph below, from the Office for National Statistics, shows the impact – excluding food and energy price rises from the overall figure would bring the reported rate of inflation down by about 4%.

It’s worth stressing that this general picture is the same across the globe: the surge in oil and gas prices, pre-dating Russia’s invasion of Ukraine (see the graph below), and the very rapid rise in food prices are common everywhere. The graph below shows the same measure of inflation across the G7 economies. The common experience is obvious, although Britain is the worst-affected by the rise:

It’s likely, although not a given, that oil and gas prices will continue to fall over the next few months, easing pressure on inflation significantly. (Goldman Sachs has a particularly optimistic view of this, expecting natural gas prices to “tumble” across Europe in the next few months.) In the UK, the energy price cap, to be introduced by government to limit the October increase in typical domestic energy bills to £600 is forecast, by government, to take 4% off the expected rate of inflation over the end of the year. Some of the predictions of a 20% or even higher inflation rates look less likely to come true – though subject to substantial uncertainty, not least around events in and related to the Russia-Ukraine war.

But this doesn’t mean the great inflationary surge is over. Far from it. There are two points to bear in mind. First, inflation is cumulative. If the rate of inflation today is lower than it was last month, that doesn’t mean prices in general are falling. It means the overall rate of increase is less fast. Those higher price rises are likely to be permanent – prices went up 10.1% in the 12 months to July, and went up 9.2% in the twelve months to August. They’ve not actually fallen. Unless incomes from wages, salaries, benefits and pensions rise rapidly, those high particularly high prices earlier in the year will represent a permanent loss to most people’s living standards. And prices, bear in mind, are still rising.

Second, inflation is unlikely to settle back down to the 2% or so level it has been at for the last two or three decades. The reason for this has less to do with the explanations usually offered, around wages being too high (if only!) or there being too much money in the system. It has to do with the way in which our global, money-based economy responds to continued environmental shocks. Many economic activities are getting harder to undertake, as the environment we live in changes. Extreme weather events are becoming more common. Resources, whether mineral or agricultural, are depleting, pushing up prices. Recent shocks to the food supply include:

• South Africa’s biggest locust plague for 25 years attacked farms in the eastern part of the country in April 2022, following “Biblical” plagues across East Africa in 2020. The worsening outbreaks are thought to be linked to increasingly volatile weather conditions associated with climate change;
• The Environment Agency forecasts that extreme heat in 2022 is will reduce UK production of “carrots, onions, sugar beet, apples and hops” by 10-50%;
• Europe’s “worst drought for 500 years” is forecast to reduce output for maize by 16%, soybeans by 15%, and sunflowers by 12% compared to the average for the last five years.

Some of the impacts of climate change can be quite unexpected, like extreme heat drying out the Rhine and so restricting goods transport across Europe, pushing up the price. But whatever the source, or the specific impact, these environmental shocks keep happening, pushing up the real costs of economic activity. In a global economy dominated by credit money, this translates into rising inflation – increased costs becoming rising prices which then pull more money into circulation.

This has, notably, nothing to do with wages: in fact, faced with shocks like this, the best thing to do in the short term is insist wages must rise to compensate, with profits adjusting to carry the strain of reduced outputs and higher costs, rather wages and household incomes. Wealth, rather than household incomes, can act as a better short-term shock absorber and when British companies have over £950bn stashed in their bank accounts – up  £500bn from 2010– there is no good reason to not put that money to better use. In the long term we need far more resilient energy, food, and transport systems – something likely to start with on-shoring production and the switch into renewables.  

The post Inflation down slightly, but the crisis continues appeared first on The Progressive Economy Forum.

Talk over the last year has been about the disruption to the supply of goods services as lockdowns and restrictions hit production and transport, damaging complex supply chains and creating bottlenecks right the way through the system. As economies opened after the initial shock, rapid increases in demand hit these supply chain disruptions, dragging up prices. This is fairly widely accepted amongst economists as an account of why inflation has risen so precipitously, across the world, from early 2021.

But it’s here that the two or three standard stories start to fall apart. For some Keynesians, these supply chain disruptions were only going to be temporary: a rebalancing of the economy, after covid, as the growth restarted. And in the mainstream Keynesian world, if supply was going to quickly expand, increasing demand – for example, by major government spending increases – was nothing to worry about. Many mainstream economists argued that inflation would only be transitory, as a result. They were wrong.

More pessimistic were the monetarists and the believers in “cost-push” inflation. The former, today a somewhat diminished group, argued that the extraordinary increases in the money supply over 2020, as governments used Quantitative Easing (QE) to help ease their economies through the shock of lockdown (and, implicitly, to help pay for their own expanded spending), would inevitably result in rising prices. “Inflation is always and everywhere a monetary phenomenon,” as Milton Friedman famously argued: he meant that increases in the money supply, more than “real” output increases, would lead to more money chasing the same amount of goods and services, bidding up the prices charged by suppliers. But with QE in operation since 2009 in major developed economies, on a huge scale, inflation over more than a decade in those same developed eocnomies has variously been about as high as today, moderately above zero, and, for a while, actually negative. There is no obvious link between issuing more money and getting more inflation: the causality is not there. Friedman was wrong.

And finally there are those arguing that cost-push inflation would take hold. This depended on the view that rises in a few goods and services would lead to workers demanding more pay to compensate, which would then, in turn, raise costs for businesses and so lead to more price rises. Cost-push could be the mechanism whereby one-off price spikes, caused by the one-off shock of covid, could turn into general and sustained price increases. This isn’t implausible: at the centre of covid’s shock to the economy is its disruption to how work is performed, and one element of that has been the sudden appearance of tight labour markets and at least some workers demanding more pay as a result – or simply walking off their job in the “Great Resignation”.  But labour markets overall, although disrupted in peculiar new ways by covid, are not showing much sign of general wage increases: with inflation rising, the opposite has kicked in, with real wages on average now falling behind price rises. Plausibly, this could change in the future, if pay demands pick up. But we are not there yet and, after a decade of flat or even falling real wages for most people, rising wages today should be the least of anyone’s economic concerns. It’s high time workers took a bigger slice of the pie.

Environmental shocks as a driver for inflation

Instead, as I’ve argued before, I think we are seeing the first years of a new form of inflation, one unknown, I’d suggest, in the years since World War Two when inflation became a general phenomenon in the developed world. (Prior to this point, prices had tended to track the general economic activity – rising in booms and falling in slumps. After WW2, inflation became pretty much continual.) It is price rises driven by successive, seemingly idiosyncratic shocks that have arisen as a result of environmental instability. Covid is the most obvious example of this; if we think of the virus as a disruption to the environment that economic activity takes place in, we can see it has acted as an enormous ecological supply shock – and one whose impacts are unlikely to fade any time soon. But in the same way we can see that (for example) the extreme weather events that have disrupted coffee or wheat production, or semiconductor manufacturing, are also smaller-scale examples of this kind of ecological shock. Each one seems idiosyncratic – some unique event disrupting production at some point in time. They’re nearly always reported like this, as CNN do here for disruption to coffee production – as just another extreme weather event that will fade away and allow normality to return.

But of course we know “normality” isn’t coming back. All the environmental modelling tells us extreme weather – along with desertification and greater constraints on food production – will worsen over time, as the climate rapidly changes. That means we should stop thinking about this or that extreme weather shock as a one-off disruption to production, whose impact will eventually wash out of the system, and as simply one more shock in an environment that produces them at an increasing rate. Prices rise as a result of one shock and then, as that impact fades away, another flood or drought occurs, disrupting prices of some other good or service. Taken in total, the overall impact is to force up prices: inflation remains permanently higher on average, but most likely more volatile, as result.

The existing mainstream models don’t deal with this. Putting up interest rates isn’t going to put out wildfires. (Indeed by making investment more expensive, and so restricting future supply, over the longer term higher interests could actively make inflation of this kind worse.) The best responses involve both building in more resilience to supply – removing just-in-time methods and creating more slack in the system overall. But also, if we have a concern for social justice, attempting to spread the costs of these shocks more evenly, leaning them towards the broadest shoulders. That would mean pay rises for most of those in work and more comprehensive insurance for those not in work – preferably as a form of Universal Basic Income.

And if idiosyncratic shocks are driving general price rises, there is a solid case for specific and selective controls on prices subject to shocks, redistributing the cost of those rises. Interestingly, the UK government appears to be looking at one such mechanism, intended to regulate household gas prices when the wholesale gas price spikes. Their plans are (inevitably) geared towards trying to protect company profits – thus exposing taxpayers to more risk than is needed – but at least in principle the idea of price regulation and social insurance against shocks is a good one to think about.

The post The economic mainstream is getting inflation wrong appeared first on The Progressive Economy Forum.

Good news as the Bank of England’s Monetary Policy Committee (MPC) voted to once again hold its base rate steady at 0.1%. This comes a day after the US Federal Reserve Board, the equivalent rate-setter for the US, voted to also leave rates untouched.

After months of warnings that a rates rises was imminent, with inflation now well above the Bank’s 2% target, this was a wise decision by policymakers. As the Bank’s governor, Andrew Bailey, has previously pointed out, with inflation coming in from the shocks to supply over the last 18 months or so, there is little fiddling with interest rates can immediately do:

In considering how to use monetary policy, it is also important to understand the nature of the shocks that are causing higher inflation. The shocks that we are seeing are restricting supply in the economy relative to the recovery of demand. This is important because monetary policy will not increase the supply of semi-conductor chips, it will not increase the amount of wind (no, really), and nor will it produce more HGV drivers. Moreover, tightening monetary policy could make things worse in this situation by putting more downward pressure on a weakening recovery of the economy.

He’s absolutely right: interest rate rises would do little to dampen the inflation we have today, but would hurt the economy more generally. But this didn’t stop Bailey making hawkish noises over the last few months. Nor did it stop the Bank’s new chief economist, Huw Pill dropping very substantial hints to the FT that he was minded to push for rates rises.

Nonetheless, by a 7-2 vote the MPC’s great and good – which include Bailey and Pill – have decided to hold off on interest rates, no doubt helped along by the Fed’s decision. Not everyone is happy. Some of traders lured into thinking they had a one-way bet on Bank of England rates rises have been whinging to the press, claiming that Bailey’s “credibility” would now be on the line.

Pressure will be on the MPC to shift rates upwards at their December meeting, since it is wholly unlikely that inflation will be coming down any time soon. But it must be resisted: the far bigger risk to the Bank’s “credibility” is, as Charles Goodhart and Majoj Pradhan have argued, if the Bank decides to incrementally raise interest rates but fail to materially influence inflation – as it surely would do.

Bailey has let it be known that rates rises will be heading down the line “in coming months”. But if the logic of holding steady today – that inflation is the result of supply factors, not demand – the same will hold in a few months’ time. For those who take a pessimistic view of likely future supply constraints, the same will hold at any point in the foreseeable future.

Interestingly, the Bank itself also looks increasingly pessimistic. Its forecasts for damage from covid-19 have been revised upwards, to the (in my view, still far too low) level of a 2% permanent loss to GDP from the virus, up from 1% and matching the Office for Budget Responsibility’s assumptions. And the Bank’s view of supply growth in the medium term is low, set at 1.75% as compared to 2.75% it has been estimated as in the decade before the financial crisis.

As this reduction in potential growth suggests, the economic slowdown had happened before covid. What seems likely (although the Bank do not yet accept this) is that covid, alongside the growing frequency of extreme weather, crop failures, and further disease outbreaks as the planet’s climate changes will all turn into hard barriers to supply growth (and therefore long-run growth overall) in the near future. Either way, its short-run forecasts for growth have been revised down for the next four years, hitting just 1.1% growth by 2024 (Table 1.A).

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The Bank of England’s new chief economist, Huw Pill, gave his first interview in the job to the Financial Times a few days ago. It will do little to confirm the fears of those of us think, at the worst possible moment, the Bank is about to lurch into a round of interest rate rises on the back of inflation fears.

The focus has been on his comments about the short-term outlook, noting that forecasts suggest it will reach 5% over the next year or so. This, claims Pill, is “very uncomfortable” for a central bank with a target for inflation of 2%. True – but an indicator of the weakness of the Bank’s inflation mandate, drafted 24 years ago in a very different world. As the previous Bank governor, Mark Carney, demonstrated, in practice a central bank has significant discretion over its interpretation. The principle of discretion is built in to the Bank’s operations, with the governor merely having to explain, in a formal letter to the Treasury, why the Bank was missing its inflation target should it do so. (This relative autonomy is, after all, the point of saying the Bank is “independent”.) Under current circumstances, with inflation very obviously driven by supply-side shocks, there is no reason for the Bank to be expected to hit its target.

More concerning, however, were Pill’s comments about his “mentor”, first chief economist at the European Central Bank, Otmar Issing. Issing was (and is) a notorious inflation hawk, acting as one of the leading academic advocates for the high interest, tight money policies of the 1970s and 1980s that were crucial to securing the neoliberal turn against post-war Keynesianism. As central banks like Germany’s Bundesbank, the Bank of England and, especially, the Federal Reserve drove up interest rates, supposedly with the aim of targeting inflation, businesses failed and millions were pushed into unemployment.

Issing himself joined the board of the Bundesbank in 1990, as the reunification of Germany following the fall of the Berlin Wall gathered pace. The same high-interest, tight money approach by the Bundesbank, pushed by Issing, helped bring devastation to the former East Germany, as factories closed under the lash of an overvalued deutschmark and skyrocketing borrowing costs. Ratcheting up the interest rate, supposedly to cope with inflationary pressures and rising budget deficits, saw East German unemployment peak in 1992 at around 15% – up from scarcely 1% a few years earlier.

Issing later brought the same approach to the ECB where he pushed for a similarly “sound money” approach to designing the euro – this time, attempting to hitch the entirety of the Eurozone on to a monetary policy designed around the preferences of the richest parts of its largest economy. When the Great Financial Crisis erupted over 2007-8, the ECB’s brutal enforcement of its tight money policies under its President, Jean-Claude Trichet, helped push southern Europe into a devastating recession.

Pill himself makes clear that he believes the primary focus of the Bank of England should also be “price stability”. After a number of years in which central bankers, including those at the Bank of England, have recognised that a central banks’ footprint is necessarily larger than just controlling inflation – including, for example, recognising that environmental instability also hurts financial stability, and so central banks must take account of the environment – this looks like a real step backwards.

Facing a spike in prices as a result, primarily, of environmental instability – including the impact of covid-19 – there could surely be no worse time to back away from the Bank’s welcome and growing focus on environmental issues, whilst at the same time threatening to drive up interest rates. Increasing the Bank’s base rate won’t deliver more gas, or grow more food, or end the semiconductor shortage; but it will make it harder for companies to finance themselves, and risk rising unemployment here in Britain.

The Bank of England has an unhappy history of lurching back to monetary orthodoxy at the worst possible time: the disastrous 1925 return to the Gold Standard is the outstanding example, resulting in an immediate fall in exports and rise in unemployment as the pound was overvalued. If that return to orthodoxy happens now – if the Bank starts pushing up rates in the belief this will restrain inflation – future students of economic history may well have cause to view it in the same light.

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The UK’s official measure of inflation, the Office for National Statistics’ Consumer Price Index (CPI) came in slightly lower than widely anticipated, falling from 3.0% in August to 2.9% in September. This is good news, not so much for the (slight to non-existent) impact it implies for most people’s living standards, but because it will help stay the hand of the Bank of England’s Monetary Policy Committee (MPC), otherwise poised to start cranking up interest rates for the first time since covid-19 struck.

Like Pavlov’s dogs, the tinkle of the inflation bell has set the hounds on the MPC slobbering over the prospect of rates rises, writing in its September report that “The MPC’s remit is clear that the inflation target applies at all times” and so “some modest tightening of monetary policy… was likely to be necessary.” Bank of England Governor Andrew Bailey has doubled down on the message since. This is despite Bailey also recognising that such rates rises would be useless, telling the financiers and academics of the Group of Thirty that “monetary policy cannot solve supply-side problems”. “Supply-side problems” describe precisely the kind of inflation we have right now: driven primarily not (as in the traditional models) by “excess” demand pulling up prices, but by severe supply-side constraints. In other words, covid and other shocks have made it harder and more expensive to use energy, transport goods, make things, and to ask people to perform some tasks (working in bars, for example). The result is that prices have risen.

It takes a small feat of cognitive dissonance to both recognise this supply-side reality, and then carry on acting as if we faced a demand-side problem. But interest rate rises would be worse than useless – and quite plausibly even worsen inflation, setting the setting the British economy up for the dreaded “stagflation” over the foreseeable future. We could expect overall growth to be squeezed by interest rates rises as a result of borrowing becoming more expensive. But because borrowing is more expensive, investment will be squeezed: yet the one thing that might, plausibly, begin to ease supply-side problems is investment. By investing in new equipment, new buildings, new technology and so on, investment by companies is one of the ways that the supply of goods and services can grow over time, and the price of those goods and services be brought down. So by making investment harder today, we are reducing the potential supply of goods and services in the future – but restrictions in supply are precisely what is causing inflation today.

Future instability

For now, a slight decline in the rate of inflation might stay this prospect. But there is a bigger issue. The MPC believes that “that current elevated global cost pressures will prove transitory.” In other words, that the current upsets and dislocations to the supply of goods and services will prove to be a temporary blip before the economy returns to its “trend” path of continual growth.

But we know covid will remain with us now, in some form, for the rest of our time on the planet – barring some fantastical new virus-zapping technology, the disease will circulate in endemic form alongside the other six coronaviruses we are known to contract. The path to something like peaceful coexistence – SARS-Cov-2 circulating in relatively benign form – is hardly likely to be smooth, however, as more infectious variants circulate, vaccine effectiveness wanes, and indeed vaccine distribution globally remains disastrously bad. The hard, global shocks of the 2020-21 lockdowns are not likely to return with the same severity, but clearly life will remain unsettled for some time.

And we also know – or at least can forecast with a high degree of certainty – that the environment is going to become more unstable. The number of environmental shocks now hitting global supplies is dramatic: drought in Taiwan and frost in Texas restricting semiconductor production; drought in Canada hitting wheat production; frost in Brazil hitting the production of corn, coffee and sugar, driving up global food prices. Bailey, noting the chaos, has joked that he was expecting a plague of locusts to appear – but of course they already have,  swarming across the Middle East and East Africa last year, destroying crops and devastating farmers’ livelihoods on a scale not seen for 70 years. Climate change has been plausibly blamed, with cyclones in southern Arabia in 2018 providing the perfect damp conditions for a desert locust population explosion. These swarms then spread outwards over 2019 and into 2020; the cyclones, meanwhile, are linked to the Indian Ocean Dipole, describing the difference in sea surface temperatures between the Arabian Sea and the eastern Indian Ocean. Severe differences in these two temperatures, attributed to climate change, are thought to have driven both Arabian cyclones and bushfires in Australia.

None of this is “transitory”. These sorts of supply-side shocks are here to stay, and the environmental modelling we have says they will worsen with rising average global temperatures. Yet our conventional understanding of economics lags far behind the changed reality: the models economists use, including those in the Bank of England, predict a future in which whatever dislocations are happening right now, the economy returns smoothly to a stable, balanced growth path. It’s not just that the MPC are likely to be (sadly) wrong about the “transitional” nature of current supply shocks; it’s that economics in general has serious problem even conceptualising supply constraints as anything other than temporary and conditional. Economic modelling – the social science of economics as such – is built on the fundamental assumption of a benign global environment. What happens when that no longer applies?

The post Inflation, interest rates, locusts appeared first on The Progressive Economy Forum.

The post Reinstating fiscal policy for normal times appeared first on The Progressive Economy Forum.

Edited by PEF Chair Patrick Allen and council members Suzanne Konzelmann and Jan Toporowski

Publication Date 29th April 2021. Agenda Publishing

40 years of neoliberalism has failed to provide prosperity or stability to the UK economy. Instead it has led to low growth, turbulence, grotesque inequality , poverty and ill health for millions . This is the outcome of damaging economic polices driven by free market dogma, rentier capitalism and ideology. It’s time for a change.

This book contains 18 essays by PEF council members and academics who outline the essential features of a progressive economy dealing with the five massive challenges of our times to the economy – Covid-19, austerity, Brexit , inequality and climate change.

PEF calls for bold public intervention. Shrinking the state and weakening our public institutions has undermined social and community resilience and promoted an out-of-control, value-sapping and high-inequality model of capitalism. 

The authors say the resources of the state must build a fairer and more dynamic post-Covid society, using a mix of regional and industrial policy and investment to revolutionise our public health, housing and social services. A progressive new society should construct a new income floor and new measures to spread wealth and give everyone an equal stake in the economy. 

The financial crash of 2008 proved that only the state can rescue the economy when all else fails including the biggest banks. Covid has shown how only the state can rescue us from death and the collapse of the economy during a devastating pandemic. Only the state can steer the economy and deliver the investment needed to cope with climate change

The 2008 crash showed the breathtaking incompetence of the private financial sector. Now Covid has once again laid bare the myth than private is best – outsourcing to companies the job of track and trace at a cost of £37bn has so far failed to show any discernible benefit say the Public Accounts Committee.

By contrast, the selfless work of millions of NHS workers and volunteers has delivered one of the most outstanding vaccination programmes which has been the envy of the world. This has been done at modest cost and was only possible with a national health service drawing on the vocational drive of its workers for the common good.

The Biden adminstration is today showing the mighty power of the US State with Biden’s Covid and infrastructure bills. The results are expected to cut child poverty in half. The UK government should follow this lead and bring in new models of public intervention to deliver a pandemic-resistant, green economy which works for all citizens.

For an outline , list of chapters and authors and to order a copy go to this webpage

You can obtain a 25% discount on the cover price by entering code AGENDA25 on the Agenda page here

Launch event on Zoom – Wednesday 19th May 2021 at 11am . Joining details to follow.

The launch will be chaired Miatta Fahnbulleh , CEO of NEF and attended by Ed Miliband, Shadow Secretary of State for Business, Energy and Industrial Strategy . Martin Sandbu of the FT will attend as commentator.

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This week’s budget appeared at first to be seismic shift away from conservative economic orthodoxy by the government. Alongside a further major expansion in borrowing to support jobs and incomes over the next six months, the chancellor adopted the previous left-wing Labour party’s policy of a major rise in corporation tax (from 19% to 25% of profits) to close a record peacetime budget deficit.

But as the dust has settled and the numbers interrogated, the budget looks rather less radical.

Firstly, it cannot be described as a rejection of austerity. The budget contained no explicit additional resources beyond the coming financial year for public services to deal with the legacy of the pandemic. Rather, as pointed out by the government’s own spending watchdog, the Office of Budget Responsibility (OBR), it involved an additional £4bn spending cut, alongside £11bn previously announced, beyond next year. For the most vulnerable, the proposed £20 cut in universal credit remains, even if pushed back to September. The freezing of income tax thresholds will also hurt lower paid workers, assuming wages do rise.

Annual revaccinations, ongoing test and trace capacity, a huge NHS catch up program on thousands of missed operations, and rising unemployment bills will all be somehow funded on pre-pandemic spending plans. Meanwhile, NHS workers can look forward to a miserly 1% pay rise in return for their heroic pandemic efforts.

Secondly, the budget was singularly lacking in ambition when it came to the government’s role in creating a sustainable, inclusive and investment-led recovery.

There was no mention of investment in social care, a sector that is badly organised, extremely low paid and clearly vital in improving the resilience of an ageing population and economy to future pandemic-type shocks.

There was no new green stimulus despite the UK facing a £100bn funding gap to reach its net-zero by 2050 target and despite its hosting of the global COP26 climate change summit this November. Neither was there any major program to help young people find work. Both the latter two challenges could have been tackled with green jobs and apprenticeships program focused on renewable energy and environmental conservation.

Meanwhile, the new National Infrastructure Bank will be capitalised with just £12bn (equivalent to just 0.5% of GDP) and again, be heavily reliant on private sector co-investment.

Indeed, it appears the government may have abandoned industrial policy altogether, shutting down the Industrial Strategy Council lead by Andy Haldane and moving industrial policy out of BEIS and in to HMT.

Reverting to economic orthodoxy

Instead, the Treasury is reverting to free-market economic orthodoxy, relying on business and the housing market to do the heavy lifting.

A 130% ‘super deduction’ tax break for capital investment by businesses in machinery and plant was the key pro-growth policy announcement. Whilst it makes sense to reduce tax on productive investment, it is highly questionable whether the majority of British firms believe there is sufficient demand in the economy for major new capital investment outlays. The OBR is predicting not, forecasting a return to anaemic growth of just 1.7% in 2023, following a boom in 2022.

“The Treasury is reverting to free-market economic orthodoxy, relying on business and the housing market to do the heavy lifting.”

The policy may bring forward some existing planned capital spending but is unlikely to create the structural shift in investment the economy needs. The exception may be those firms already doing rather well in pandemic conditions. Amazon, for example, has racked up record profits over the past nine months as physical retail has collapsed and may use the supertax break to wipe out its UK tax bill completely.

The corporate tax profits hike is a sensible policy. However, its timing — not being introduced to 2023 — is suspect and will likely mean it is subject to ferocious counter lobbying if the economy improves. If businesses are to be taxed, a more sensible approach would have been a phased in rise in corporate tax starting immediately, accompanied by a windfall tax on those companies — like Big Tech, Private Equity and the Supermarkets — that have done so well out of the pandemic.

On housing, the budget was an opportunity to push forward a big capital investment in public housing and retrofit of existing stock and rethink the country’s highly regressive property taxation system. Reducing property tax for the poorest would be a fair way of stimulating stagnating demand.

Instead, the government extended the stamp duty tax cut on home purchase into the summer and announced it will guarantee 95% mortgages. These are expensive policies that reveal the Treasury remains fixated on the idea that ever-rising house prices are the best way to stimulate the economy and private sector house building. This debt- and consumption-lead economic growth model is inefficient, leads to greater financial fragility as well as increasing inequality as more people are priced out of the housing market.

Meanwhile, there was no sign of any reform of property taxation, nor even a commitment to raise capital gains and remove exclusions as had been rumoured.

In summary, whilst the extension of government support to the Autumn should be welcomed and will help the country avoid a much more severe recession, this Budget was not the economic reset the country needed. It will do little to stimulate a sustainable recovery and help Britain on to a more progressive economic trajectory. Now was surely the perfect time to shift the focus of taxation on to economic rents and away from labour. Instead, it is a budget that mainly favours the rentier sectors already doing well — Big Tech, banks, developers, homeowners — at the expense of the public sector, lower paid workers and renters.UCL IIPP Blog

This blog first appeared on the blog for the UCL Institute for Innovation and Public Purpose

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To start with the first. The economy has shrunk  by 10% since last March. In that time the government has spent over  £300bn ‘supporting jobs,incomes,and businesses’. The OBR expects  the economy to  have recovered all this lost output  by mid 2022,  4%  this year, 7% next year. As  a consequence, government borrowing  to ‘support the econmy’ will  tail off from £355bn today to £234bn next year and decline  thereafter,  the cancellation of the furlough in September being the biggest saving.  The national debt will peak at 97% of GDP in 2023-4 and then start falling.

The  thought processes underlying this rosy prospectus seem somewhat as follows.  The lockdown stops this summer.  ‘Non-essential’ businesses reopen, helped by tax breaks and subsidies. Customers flock back, free at last to spend their ‘forced’ savings.   Employment picks up. The economy starts booming.   Inflation –the dog which failed to bark  for ten years –is set to take off at last.

It may go like this –no one knows for certain. But I am highly sceptical about this story of ‘pent-up demand’. A shrinkage  in national  income by  10% implies a fall, not rise, in national saving. Saving out of income may go up, but income itself is lower.  That’s why it’s not like in a war, when you have full employment and rising wages, but  less to spend money on. Today, the  wealthier sections of the population,  whose incomes haven’t fallen,  will now be free to spend more on restaurants, entertainment, holidays, and so on; but what about all those  whose incomes have fallen? Where is their ‘pent up demand’ supposed  to come from?

So it is dangerous to assume that the reopening of the economy will be automatically followed by a strong recovery. To give the economy a cushion of extra spending power  the Chancellor  has wisely kept furlough going till September. I would have preferred that this money, some £60bn, be given to local authorities to create public jobs in their areas, especially for young people.   Now it is too late, because no one in the Treasury was thinking along these lines. Only someone with a bit of history can tell   30-year old Treasury officials  that there used to be something called ‘public works’.

Since the 2008-9 financial crisis, macro economic  policy has been in a mess, like a ship without a navigation system, responding to storms as they blow  up. A start has been made  on the necessary job of developing a proper policy  framework.  Mr. Sunak means three things by ‘sustainable’ public finances: first, in ‘normal’ times the state should balance its day- to- day (or current spending) budget; second,national debt should not be rising over the medium term, and  ‘we need to pay attention to its affordability’; third, it makes sense when interest rates are so low ‘to invest in capital projects that can drive our future growth’. (The Chancellor put his money where his mouth was by     announcing    a UK Infrastructure Bank to invest ‘in public and private projects to finance the green industrial revolution’ .)

 Further, in a significant  passage Mr. Sunak said  that  the Bank of England’s  2%  inflation target  should reflect ‘the importance of environmental stability and transition to net zero’ –the first hint we have had of a formal modification of the Bank’s mandate.  

 These principles give  the start of a   sensible policy of fiscal and monetary coordination which we have lacked for ten years.

But the Treasury still finds it hard  to get rid of old habits of thinking.  For example, ‘it will take years to pay back the  debt’. Pay it back to whom? Most of the debt incurred since last March to support the economy has been borrowed from the Bank of England. Paying back the Bank is simply transferring money from one government  department to another.

Then,  what did Mr. Sunak mean which he  talked about the need to ‘fix’ the public finances,  as though they were  broken? In fact they are not broken, they are doing exactly what public finances should be doing,  which is to balance the economy, supporting it when it is collapsing and withdrawing support when it is booming. This is not just policy for emergencies: it is part of the state’s normal  stabilization function. It reflects  the fact that economies do not  automatically self-balance at full employment. The state budget is the balancing factor.  Therefore,  provided we have in place a policy which supports recovery,  we should not worry about the deficit: it will reduce automatically.

My worry is rather the reverse; that the measures to support the economy during the pandemic will be withdrawn,  without  being replaced by measures to stimulate the recovery.   If that turns out to be true, we will be in for a very severe recession and the Chancellor will have to come back in six months time to announce further  recovery measures. It’s important to start thinking now about what they should be.
Robert Skidelsky

This article was first published in the Catholic Herald

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