"Failure was Predictable"

In anticipation of the chancellor's Autumn statement, Lord Skidelsky goes on the attack:

The chancellor’s policy is based on the wrong theory of the economy; the BoE’s on the wrong theory of money. Failure was predictable.

 His argument is simply Keynesian. Keynes would have argued that:

 ...cuts would reduce the level of total spending in the economy and thus perpetuate the slump.

As for the bank:

The BoE’s mistake has been to believe it is the supply of money that is critical for economic recovery; Keynes said it was the demand for money.

His solution is to restore the programmes of capital investment, accelerate infrastructure projects, expand the programme of the Green Investment Bank and  replace the bank's inflation target with a nominal income target.

As Will Hutton once said - Keynes is best.

Lost Income

What happens to a country's income after a financial crisis? Obviously, if there is a recession then income falls and then, if there is a recovery, it goes back up. Does it ever catch up?

The IMF answered this question in a study it published last month in its World Economic Outlook. The figure shows GDP rising at a steady rate before the crisis, falling in the recession and then rising again at the same steady rate. It doesn't show GDP returning to the old track but rising at a lower level parallel to it. That matters because we previously thought that the economy would get back on track.
This month the Bank of England included a new chart in its Inflation Report. Spot the similarity?
My first thought on this chart is how smooth the upward curve of GDP was leading up to the crisis. We talk about the trend rate of growth but here we see a chart of how consistent the trend is.

My second thought is: do we never get back to the old trend line? The IMF study only looks at the medium term (7 years), perhaps growth is higher after 7 years?

If not my next question is what happens to unemployment? The trend line is often taken to represent the economy's full potential. If GDP is below the trend then resources are idle and more people are without work. Growth at the trend rate should be enough to keep pace with an expanding labour force but not enough to absorb the pool of unemployed labour.

IMF graphic thanks to Samual Britten and the FT, BoE graphic thanks to Stephanie Flanders and the BBC.

Reform not Regulation

I begin to like our stodgy central bank chief, Mervyn King:

reform of banking is essential

Not just regulation mind, Mr King wants banking to be reformed.
Battle lines are being drawn up between those who want to reform financial regulation and those who want to reform finance. Mervyn has chosen to be on the right side.

The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion.

As the press is reporting he supports splitting the utility side of banking from their speculative activities. He is right; anyone who wants to take deposits from the public shouldn't be allowed in the casino. Or as he puts it:

Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly. But that is where we now are.

Splitting utility from casino banks is not his only idea. He wants new tools to:

(a) moderate the growth of the financial sector and
(b) lean against the macroeconomic effects of the credit cycle

This is more than I could have hoped for. The finance sector is too big and finance should lend less in the boom and more in the bad times. Mervyn drops hints that he could be even more radical:

It is hard to see how the existence of institutions that are “too important to fail” is consistent with their being in the private sector.

But he doesn't say what sector they should be in.

It is important that banks in receipt of public support are not encouraged to try to earn their way out of that support by resuming the very activities that got them into trouble in the first place.

Ouch! Who could be encouraging such recklessness?
King for chancellor?

The End is Nigh?

What is wrong with this picture?



This is the Bank of England's projection for economic growth taken from the August Inflation Report published last week. At first sight it would appear to be good news. It shows a strong recovery from recession. Here we have a V shaped and not a U shaped or W shaped or even an L shaped recession. So what is the problem?

The first problem is that in the press conference, Mervyn King , the bank's governor, warned of a fragile recovery, "The pace of recovery over the next few years is highly uncertain." (See the BBC) The fan chart, on the other hand sees growth back to normal levels next year.

The next problem is interpreting the chart. This shows the annual growth rate, or more accurately, the 4 quarter growth rate. So when the central projection crosses the zero, as it does early in 2010, then the growth rate over the last four quarters is zero; ie the economy is the same size as it was in early 2009.

(Another difficulty is that it looks like the ONS data is only available up to the first quarter of 2009, but from the shape it is obvious that the latest data (Q2 2009) is included. See here) Reading off from the chart, annual GDP reaches about 1% at the end of Q1 2010.

This is where it gets interesting. GDP fell by 0.8% in the second quarter of 2009. So to get to 1% in March next year, the economy must grow by over 1.8% over the next three quarters, equivalent to an annual growth rate of 2.4%. So either the economy grows at its trend rate from now on, or it grows faster than its trend rate in the early months of 2010.

I know that the monetary policy committee is stuffed with people who know more about economics than I ever will. But I can't see how this projection is possible.

If there is a choice between an optimistic chart and a pessimistic governor, I'm with the governor.