Saturday 22 October 2016

Time for the "Baby Boomers" to give something back

While there is little doubt that it will be Brexit - and the success thereof - that will define Mrs May's administration, a secondary theme will be that of how far she succeeds in implementing greater fairness in the country - in her own words  "a country that works for everyone". While every PM in the last 25 years has made similar noises she has seemed to have a greater commitment. And there is evidence that the policies of the last Cameron government are all being reevaluated not least in terms of their fairness. But, no doubt though that any politician should be judged by actions not words!

An important aspect of the fairness agenda, but one not as often mentioned as others, is what economists call intergenerational equity - a concept of fairness between children, youth, adults and seniors. It is a term often used in investment management but has become more prominent in the world of economics in recent years because governments have run up large deficits and debts which have benefited a current generation through welfare benefits, tax cuts and government jobs, potentially at the expense of future generations.

Baby boomers refer to a cohort of the population born between 1946 and 1965 when the birth rate materially accelerated. It was thought that because this cohort was very big, a person born then would suffer in terms of greater competition for jobs and housing. But the reality has been that they have been the beneficiaries of a number of developments and events at the cost of other mainly future generations.

The welfare system may be seen as having a natural life cycle. Thus we tend to mainly benefit from it in our youth and in our old age. Conversely our contribution to government revenues tend to occur during our working life in between. Keeping this in mind, baby boomers, as the biggest group, when they started working, they tended to push the dependency ratio sharply down, ie the number of people earning rose relative to the number of dependents, whether the young or retired. During this period, roughly from Thatcher to the coalition administration, the government was able to spend more freely because of this, and also over and above this they spent during the Labour government years stacking up debt for future generations to pay for. But now that the baby boomers are increasingly retiring, the dependency ratio has in the last couple of years increased significantly. Immigration actually delayed this phenomenon, but it will continue rising for a long time yet. This means that those working now have to pay for more dependents than in the past and for excess spending in the Labour years.

This demographic trend is storing up massive problems for governments not just in this country but most of the developed world, most notably in Japan and Germany. Moreover, baby boomers have benefited from a number of other events.

In the housing market, baby boomers were relatively easily able to afford to get a deposit and buy a house. Today so many people cannot do so. In fact on average it takes them 22 years to save for a deposit! In pensions they have done well too. Pensions have been heavily protected from welfare cuts, by the infamous triple-lock, while other pensioner benefits have been protected too. Furthermore, the massive rise in the pensions deficit (notably due to low long term interest rates) has been primarily responsible for driving a wedge between productivity growth and pay growth. Companies have had to pay into their pension funds, so that people working today are not benefitting from rising productivity.

Only in one respect are pensioners losing out, that is in terms of very low savings rates, while mortgage holders, who tend to be workers from generations after the baby boomers, have done very well. Nevertheless, overall the baby boomers have done exceedingly well.

It is time that government policy looks at rectifyting this siuation. This includes reducing pensioners benefits,  increasing inheritance tax, and raising housing supply at a more rapid rate.


Friday 7 October 2016

A shift from monetary to fiscal stimulus a sensible one economically and politically

PM May's speech at the annual Tory party conference is being viewed as a massive change in policy direction. In a populist speech, in some ways, she talked about a need for greater fairness, to help those, the poorest that have been most affected by austerity. As well as talking about greater intervention to attend to market failures, she signalled changes in economic policy to, if you like, a greater emphasis on Keynesian policies.

Clearly her speech made sense from a political viewpoint. May is laying claim to the centre ground of politics which has been vacated by the Labour party. Labour continues to shift to the hard left, and under an unelectable leader does its best to make sure it is the case it will not be elected. Corbyn has refused to make any attempts to unify the parliamentary party with his latest reshuffle electing only his very closest allies, which is likely to lead to further infighting. Corbyn also refuses to acknowledge that the levels of  immigration seen is a problem, a key issue for many traditional working class supporters. But at the same time, May's speech also tried to appeal to UKIP supporters by emphasising the importance of control of borders and by adopting about the only non-Brexit UKIP policy - namely allowing new grammar schools. UKIP continues to implode struggling with finding  a raisin d'etre and a new leader to follow the highly successful Nigel Farage. But what I would say is that Theresa May should be judged not by what she says but what she does. Many new administrations start off with such sentiments of fairness but fail to follow through not least because of events as well as other priorities. This is not to say she is not committed to making a fairer society.

A shift from monetary stimulus to fiscal stimulus makes sense from both a fairness and macroeconomic point of view. When the coalition government came to power in 2010, it inherited a massive structural budget deficit partly due to the global financial crisis but largely reflecting years of irresponsible spending from the previous Labour administration. The government was left with little choice but to cut spending and raise taxes. This resulted in a greatly reduced budget deficit albeit that debt continues to accumulate and targets to balance the budget have been missed.

At the same time, monetary policy was eased. And in common with most other advanced countries we have experienced ultra low interest rates. Base rate was cut to a record low 0.5% over seven years ago and further to 0.25% in August. Quantitative easing (QE) has seen some £375bn of gilts purchased, with a further programme announced in August of an additional £60bn of gilts and £10bn of corporate bonds in response to the Brexit vote and largely unfounded fears that the economy would be plunged into recession.

Now there is no doubt that monetary policy has been overburdened and there have been many side effects from the semi-permanent monetary stimulus. One of these side effects has been the distributional consequences. Economic policy has favoured holders of fixed assets and mortgage holders as against savers and potentially pension holders. A Bank of England study found for example that QE did boost growth but that the benefits tended to go to the richest 5% who own 40% of assets. And of course spending cuts have impacted on the poorer too.

It is not good that savers cannot get a decent return as it disincentivises, especially people to do so for retirement, increasing the prospect that people will rely on the government and increase  their own already high household debt. Similarly long-term investors like pension funds and insurance companies can no longer earn a real rate of return threatening their solvency. It is also not good if the burden of providing a pension falls on the government when we have an ageing population. Corporate pension fund deficits reached a record high at £459bn at the end of August due to plunging bond yields which have also raised fears that firms might cut their investment plans. Although as has been pointed out by our UK economists at Oxford Economics, assets held by defined benefit schemes have actually increased by £135bn in the four months to August. Bank's profitability have been badly impacted by low interest rates too, affecting their ability to lend.. And while most people would not be sad about bank'statement plight, it could also contribute for the need for expensive bailouts given the pivotal role that banks do play in the economy. As it is not good for savers, low interest rates are great for borrowers. However again we are storing up problems for the future in building up such debt. If and when interest rates rise again, we are likely to see many distressed borrowers given the highly leveraged position of the household sector. Finally, ultra low interest rates lead to the mispricing  of financial markets  pushing up equity and bond prices. In addition they lead to a misallocation of capital  with a rash of low-return capital projects.

There is no doubt that monetary policy  has been asked to do too much and that it has reached the end of its effectiveness. Thus for example, negative interest rates will not work in the UK. But with a greatly reduced budget deficit and long term rates close to zero, this is an ideal time to ease fiscal policy a little to meet the uncertainty regarding the medium term impact of Brexit.  The government has built up a lot of policy credibility so can afford some slippage towards its aim of balancing the budget. It certainly makes little sense to remail committed to reach budget balance by 2020 at such a time. Increased spending on infrastructure can boost growth and boost the supply side of the economy without "crowding out" the private sector given the low cost of funding. But it will still be important to not waste money on cost ineffective and spurious projects which offer political rather than any economic returns. It will be important to identify "shovel ready" projects. We shall have to wait  until the Autumn Statement on 23 November to see what exactly the Chancellor does to reset fiscal policy, but there was speculation already yesterday of the re-introduction of government backed high interest fixed-term bonds (and not just for the over 65s) which could be a good move.


Saturday 1 October 2016

From the impact of Brexit to the prospect of a European Banking Crisis

Well it is becoming increasingly clear that the initial impact of Brexit or more strictly the announcement of a Brexit will not bring forth recession. This is indeed what I said in my blog of 14 July when it was very much a minority view. Forecasts have all been revised up by various institutions like the OECD and the IMF and by international banks to around the GDP growth numbers that I suggested back in the gloom of July, namely 1.75% for this year and 1% next year - and if anything I would say these are now on the Conservative side. Thus nearly all major indicators are doing well including retail sales and consumer confidence, house prices, services sector output, and business confidence. In addition financial market variables have generally done well, with even sterling recovering somewhat.

So why were the forecasts so gloomy and clearly wrong? Well I think there are four reasons. Firstly the economic data underestimated the strength of the economy going into the referendum. For example, GDP in Q2 is now thought to have risen by 0.7% on the quarter well above initial estimates. Secondly it was due to the politicisation of key institutions including the IMF (see blog 29 July) and more obviously the UK Treasury and Bank of England. Thirdly, is reflects the state of macroeconomics and the herd instinct of many economic commentators (wait for a future blog here) and finally it is fair to say that the Bank of England took prompt and appropriate action in loosening monetary policy via a number of methods.

But of course I am not naive to believe it is all going to be rosy. In the medium-term there will be adverse consequences on what will be difficult and protracted negotiations with an EU which is standing firm on its unwillingness to compromise on the trade-off between access to the single market and control of borders, despite the prospect of the EU being adversely affected too. However as we seemingly move towards a hard Brexit again  as previously predicted, it is hoped that these negotiations can be completed more quickly enabling us to travel to the point where we can free trade with the rest of the world and hopefully with the EU too, via being an independent member of the World Trade Organisation. I continue to have a very positive outlook for the UK in the long term, perhaps as part of a Commonwealth free trade union with Australia, Canada and New Zealand leading the way. These are countries we have so much more in common with than the EU.

Finally I would also like to mention the banking problems in Italy and now Germany. While not wanting to minimise the impact of Brexit on the UK and on the Eurozone too,  the biggest immediate fear is that of a European Banking Crisis.  The problems are hardly surprising in that they largely reflect the poor health of the Euro Zone and the flaws of European monetary union without fiscal and political union. At the moment the problems at Deutsche are unlikely to be Europe's Lehmann moment and a boost its capital should help. I am more concerned about the solvency of Italian banks and the not unrelated constitutional referendum in early December which will in effect be another big test for the EU and could see the Italian government fall.