16 June 2010

Don't Panic

The verdict on Sir Alan Budd's report is mostly gloomy.I can't help thinking that the report is actually quite optimistic.

The deficit falls faster on Sir Alan's calculations, as everyone has reported.

Growth is lower than the old Treasury forecast, but actually still very good. Sir Alan predicts that, after this year, growth will be above trend for the next four years.

There is some good news on public sector pensions too. Tucked away on page 59 of the report is a table on the impact on spending of an aging population. It shows that in 2009-10 public sector pensions cost 1.8% of GDP. That rises to 1.9% in 2019-20 and 2029-30, then falls back to 1.8% in 2039 and 1.7% in 2049-50. So the hysteria over public pensions is unnecessary.

The cover of the OBR report should have the words "Don't Panic" written in large friendly letters.

05 June 2010

Spain on the Naughty Chair

Gavin Hewitt came over all censorious in his BBC blog last week:
To an extent Spain's problem is Europe's problem. For a decade many of the eurozone countries used the cover of the single currency to borrow and expand their welfare states. In fact they were living way beyond their means. Putting that right is not just a financial dilemma - it challenges what many Europeans see as their way of life.
You could forgive him for talking bollocks because
a) he is a European correspondent not an economist
b) he is just parroting the conventional wisdom.

What does it mean for a country to live beyond its means? I don't know, but did the Spanish government live beyond its means, did it borrow to expand its welfare state?

No, until the crisis struck Spain had a fiscal surplus not a deficit. Here are the figures from Eurostat for Spain's public balance (-ve means a deficit):

2001  -0.6
2002  -0.5
2003  -0.2
2004  -0.3
2005   1.0
2006   2.0
2007   1.9
2008  -4.1

In 2007, Spain's government debt was 36.2% of GDP compared with 64% in France, 65% in Germany and 66% in the eurozone as a whole. Unemployment had fallen to 8% from over 15% a decade earlier, which I suppose would make the welfare state somewhat more affordable.

Were those profligate Spaniards loading up on government handouts? Not if you look at the data instead of relying on uninformed prejudice.

What really happened in Spain is that it joined the Euro. The ECB's job is to set interest rates for the eurozone as a whole and in the naughties big eurozone economies like Germany needed low interest rates. Peripheral states like Spain and Ireland found themselves with monetary policy which was too loose. Their economies were running too hot with fast growth but rising inflation. In Spain, inflating property prices fed a construction boom. As part of the eurozone Spain could not adapt its policy to restrain the boom or choke off inflation.

When the downturn came, Spanish prices and wages had risen out of step with other eurozone economies. Higher costs put Spanish firms at a competitive disadvantage compared to other producers. So now we have a slump in which tax receipts fall and benefit claimants increase, which is why Spain now has a large government deficit.

The target here is not Gavin Hewitt, who is a competent and entertaining journalist, it is the conventional view that the Euro crisis has been brought on by feckless Mediterranean types shirking their responsibilities. Spain gives the lie to that popular narrative.

03 June 2010


Is the UK about to star in a remake of Japan - the Lost Decade? That is the question behind a recent talk by Adam Posen, one of the team that sets interest rates at the Bank of England.

Professor Posen is an expert on the Japanese experience, so his views are worth hearing. He adds to the fun by peppering his talk with references to films by Japanese director Akira Kurosawa. Kurosawa's films, such as The Seven Samurai, have led to Hollywood remakes. Most recently one of my favourites, Rashomon was turned into a children's film, Hoodwinked (hence the frog).

After Japan's property bubble burst at the start of the 90s, the country fell into a deflationary trap. For the next decade its economy refused to recover. Could we be in for the same fate?

Prof Posen argues that Japan's continuing malaise was caused by policy mistakes. At several points the economy did pick up only to fall flat due to mistakes by policymakers. Economic growth did not flat-line; it saw-toothed. The key mistakes were withdrawing stimulus too soon and not forcing the banks to recognise bad loans and clean up their balance sheets. It was also too slow to try unconventional monetary policy once interest rates had reached zero.

In Britain and in Europe we have avoided that last mistake; but I worry about the other two. Have we done enough to fix the banks? Certainly across Europe more needs to be done - the Spanish Cajas and the German Lanesbanken need to face up to the loans they made which will never be repaid. Banks also need to take a realistic view of the sovereign debt they hold, and raise their capital accordingly. Will Greek bonds really be repaid at 100 centimes to the Euro?

On stimulus, I've already had my say - reduce the deficit over the medium term but not yet.

Deflation is too little understood concludes the good professor as he calls for more research. Inflation is a danger we know and can deal with, deflation is still mysterious. If we have to balance risk then risking inflation is the better choice.