Transcript KPMG Screen 3:4 (2007 v4.0)

Economic prospects for the UK
Andrew Smith
Chief Economic Adviser
Industry Forum
June 2015
[email protected]
Twitter: @AndrewSmithEcon
What are we talking about?
■ International economic background and economic policy
■ Issues in Europe
– Grexit
■ UK narrative
– Labour over-spent and over-borrowed
– This precipitated financial crisis and recession
– Conservatives had no option but to adopt austerity
– This is what has brought about recovery
■ Productivity puzzle
■ Brexit
■ Secular stagnation
Financial boom, bust and balance sheet repair
 Balance sheet recession
– Over-borrowing by private sector precipitated financial crisis and left legacy of underpriced debt, over-priced assets, over-stretched borrowers and under-capitalised lenders
(property)
– Private sector saving more/de-leveraging, depressing demand
– Desired saving > desired borrowing
– Liquidity trap – ZIRB
■ Government deficit reduction the wrong policy
– Sector surpluses/deficits must balance
– Household + corporate + government + overseas = 0
– Government deficit reduction depresses demand
■ Reliant on unconventional monetary policies
– QE, FG etc
UK Net Lending (+)/Borrowing (-) by sector
£m
130000
100000
Rest of the world
70000
40000
Corporations
10000
-20000
Household
-50000
-80000
-110000
-140000
-170000
2005
Government
2006
2007
2008
2009
2010
2011
2012
2013
2014
Source: ONS
16
14
12
10
8
6
4
2
0
-2
-4
-6
-8
-10
-12
-14
-16
-18
-20
Greece
Croatia
Slovenia
Latvia
Italy
Cyprus
Ireland
Spain
Portugal
Finland
Denmark
Iceland
Estonia
Netherlands
Bulgaria
Romania
Eurozone
Japan
France
Belgium
Austria
UK
Germany
Slovakia
Switzerland
Sweden
US
Poland
“Recoveries” to date
GDP % away from peak
Source: Eurostat
Unemployment rates (%)
Greece
Spain
Portugal
Italy
Eurozone
Poland
France
Ireland`
Netherlands
UK
US
Germany
0
5
10
15
20
25
30
Latest June 2015
Eurozone – in(de)flation
% 7
Euro area
Germany
Ireland
Greece
6
5
4
3
2
1
0
-1
-2
-3
Source: Eurostat
Collapsed bond yields
Background summary
■ Advanced countries experienced one of the deepest recessions ever and one of the slowest
recoveries
■ Output remains below previous peak across much of Europe and dramatically below level if it
had followed pre-recession trend
■ Persistent high unemployment in many countries
■ Positive output gaps ie unused productive potential
■ Business investment slow to pick up
■ Many countries flirting with deflation, led by oil and food prices – but core inflation rates sliding
too
■ Government bond yields at unprecedented lows and negative in some countries
■ All suggestive of chronic shortage of demand
■ Risk/payoff ratio suggests policymakers should be doing more to boost demand
Annual growth forecasts
(%)
2010
2011
2012
2013
2014 (f)
2015 (f)
2016 (f)
US
2.5
1.6
2.3
2.2
2.4
3.1
3.1
Japan
4.7
-0.5
1.8
1.6
-0.1
1.0
1.2
Eurozone
2.0
1.6
-0.8
-0.5
0.9
1.5
1.6
Developing
Asia
9.6
7.7
6.8
7.0
6.8
6.6
6.4
China
10.4
9.3
7.8
7.8
7.4
6.8
6.3
Latin
America
6.1
4.9
3.1
2.9
1.3
0.9
2.0
SubSaharan
Africa
6.7
5.0
4.2
5.2
5.0
4.5
5.1
Source: IMF April 2015
Eurozone no longer a crisis, it’s chronic
■ Monetary union brought German-style low interest rates to PIIGS, resulting in private overborrowing, property booms, wage inflation, loss of competitiveness and trade deficits
■ Financial crisis and recession pushed up government deficits, particularly in “periphery”
■ ECB’s refusal to act as LoLR caused panic in financial markets in 2012 until volte face – “do
whatever it takes” and OMT
■ Germany dictated continuing fiscal austerity across eurozone
■ Risk of new recession/deflation prompted ECB to adopt form of QE last year
■ Long-term, to stay together need to complete EMU:
– Banking union and strengthening of banks
– Fiscal union to validate fiscal transfers
– Political union to legitimise fiscal union
Greece “sui generis”
GREXIT?
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In Greece, government over-borrowing/profligacy/lying/corruption etc WAS a cause of
collapse
Mistake not to agree realistic debt restructuring/write-offs earlier
Bail-out was for German banks which had lent Greece the money – not Greece
Greece can’t run a primary deficit, nor a large primary surplus (troika demanded 5% of GDP),
nor realistically pay back its borrowing (debt/GDP 180%)
Should be a new deal to run a small primary surplus, but IMF etc insisting on pension and
labour market reforms as well
Consequences of GREXIT (default and new currency)
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
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Economic and financial markets hiatus
Banks would need to be recapitalised
Contracts re-denominated (creditors lose)
Contagion risk – financial (markets call ECB bluff) and political
Could euro survive?
Geo-political implications
Initially more misery for Greece, but if a few years on devaluation worked…….
UK: GDP growth (% quarter-on-quarter)
1.5
1
0.5
0
-0.5
-1
-1.5
-2
-2.5
-3
Source: ONS
UK recessions and recoveries
UK: household debt to income ratio and household savings ratio
%
%
Debt to income (RHS)
18
180
Savings ratio (LHS)
16
160
14
12
140
10
120
8
6
100
4
80
2
0
60
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: OBR/ ONS/ Datastream
UK: employment changes
1974 - 1979
%
3
1979 - 1987
1990 - 1999
2008 -
2
1
0
-1
-2
-3
-4
-5
-6
-7
0
6
12
18
24
30
36
42
48 54 60 66 72
Months from peak
78
84
90
96 102 108
Source: ONS
UK: consumer confidence
Balance
10
5
0
-5
-10
-15
-20
-25
-30
-35
-40
Source: DataStream
UK: inflation and earnings
%
6
CPI
Average earnings (regular pay)
5
4
3
2
1
0
-1
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Source: ONS
Tax rises and spending cuts (£bn)
120
100
80
60
40
20
0
2012-13
2013-14
Tax rises
2014-15
2015-16
Spending cuts
Source: HM Treasury
Was it all Labour’s fault? Public spending and receipts (% GDP)
Did Osborne stick to Plan A? UK current budget deficit (%GDP)
Front-end loaded austerity?
UK summary
■ Osborne’s first-term policy was deficit reduction to produce growth, but didn’t get as much of
either as he expected
■ “Expansionary fiscal contraction” doesn’t work when interest rates can’t be reduced further to
offset the negative impact on demand – at best will subtract from private sector recovery, at
worst overwhelm it
■ This year’s budget and election manifesto suggest new Government is about to repeat the
experiment, with “other half” of deficit reduction to come from swingeing cuts, particularly to
welfare (the more so if health, schools and overseas aid are “protected”)
■ What lesson has Osborne learnt from first-term? Tough at start, ease off later, win election?
■ Budget on July 8 and new Spending Plans later in year
■ What if another big shock or economic downturn for some other reason?
– Current contingency planning is to keep fingers crossed
– If expansionary fiscal policy ruled out and monetary policy has shot its bolts, left with
“helicopter money” – BoE prints money to finance payments to households
UK productivity normally rebounds in and after recessions
UK productivity growth – GDP per hour worked, 1979Q1 to 2014Q3
Productivity puzzle
■ Measurement problems
■ Direct effect reduced availability of finance following crisis
– Reduced investment/slowdown in innovation
– Impaired resource reallocation
– Low no of insolvencies/failure to cleanse - firms survived which shouldn’t have?
■ Labour hoarding/new jobs are lower productivity jobs?
■ Substitution of cheaper labour for capital
■ Weakness of demand
■ Most of loss seems to be from within sector and within firm…..
■ ……and in TFP – management?
■ Cyclical or structural?
BREXIT?
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What does Cameron want?
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Opt-out from "ever closer union" European ambition (core principle)
Safeguards to ensure changes in the single market cannot be imposed on non-eurozone
members by the eurozone
Protection for the City of London financial markets from EU legislation
Greater powers for national parliaments to block EU legislation
“Better“ regulation and flow-back of powers to Member States
Continued enlargement of the EU but with new mechanisms “to prevent vast migrations
across the Continent“ (but free movement core principle)
Restrict access to in-work and out-of-work benefits to EU migrants
Referendum Q: Should the United Kingdom remain a member of the EU?
Referendum to be held by end 2017 – but aiming for 2016? Major Treaty change seems to be
ruled out by time-table but scope to fudge, post-dated cheques, etc
If “NO” up to 2 years to negotiate exit terms – could we keep same market access?

Followed by SCOXIT?
Should we be worried about permanent weak growth?
■ “Secular stagnation” – structural demand issue?
– Will desired saving continue to exceed demand for finance for investment?
■ Ageing populations in West and lack of insurance in EMs raise precautionary savings
and increase supply of funds globally?
■ Tech progress means less capital spending needed - more (cheap) computers, fewer
(expensive) steel mills?
– “Natural” real rate of interest may be negative for extended period
■ Interest rates could remain low for very long time
– Case for expansionary fiscal policy and higher inflation target
■ Or supply-side weakness?
– Potential growth rate = change in labour force + productivity growth
– Ageing populations/declining workforces in West (and China!)
– IT hasn’t been a transforming technology like electricity, trains, planes?
– BUT earlier technology waves took time to boost productivity too
Budget March 2015
% change y-o-y
2012
2013
2014
2015
2016
2017
2018
GDP
0.3
1.7
2.6
2.5
2.3
2.3
2.3
Household
consumption
1.5
1.7
2.0
2.6
2.7
2.5
2.3
Business
investment
3.9
5.3
6.8
5.1
7.5
6.5
6.4
Govt
consumption
1.6
-0.3
1.5
0.8
-0.7
-0.9
-0.2
Exports
1.1
1.5
0.4
3.9
4.0
4.5
4.4
Public
borrowing £bn
114.8
107.8
90.2
75.3
39.4
12.8
-5.2
BofP C Account
-4.0
-4.5
-5.4
-4.3
-3.2
-2.6
-2.4
%GDP
Source: HM Treasury
Economic prospects for the UK
Andrew Smith
Chief Economic Adviser
Industry Forum
June 2015
[email protected]
Twitter: @AndrewSmithEcon