Transcript The Great Unraveling

The Great Unravelling
Macro policy-making in uncertain and turbulent times
Geoff Riley, Head of Economics, Eton
March 2009
Today’s Presentation
 Quick macro update – where are we NOW?
 Reaching for a Viagra stimulus – are we at
the end of fine-tuning
 Does the Bank of England matter anymore?
 Searching for green shoots
Quick Macro Update for AS and A2
 Indicator and latest value (annual % change unless stated)
 GDP (Gross Domestic Product) -1.8% (final Q08)
 CPI Inflation (Consumer Price Index) 3%
 Policy Interest Rate 0.5%
 Unemployment (Labour Force Survey) 6.6%
 Consumer Confidence -31.5 (index) (long term average = -10)
 Current Account Balance £-7.7bn (final Q08)
 Industrial Production -9.3% year on year
 House prices -17.2% year on year
 Source: ONS and Reuters
Hold on Tight
The Cycle - Growth in UK National Output
Percent
Annual percentage change in GDP at constant prices
6
6
5
5
4
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
-3
-4
-4
-5
-5
76
78
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
Source: UK Statistics Commission
"Now in Britain, we
are saying, as you
know, that inflation is
low, interest rates are
low and we expect
there to be growth.
Gordon Brown, 27th
January 2008
What type of recession? L, V or U?
Real National Income for the UK Economy
325
325
300
300
275
275
250
250
225
225
200
200
175
175
150
150
billions
Constant 2001 prices (billions)
Gross Domestic Product at constant 2001 prices, source: Office of National
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
Source: Reuters EcoWin
Did rising inflation in 2008 cause the Bank
to move too late?
Economic Growth and Inflation
Percent
Interest
UK Real GDPBase
Growth
andRates
Consumer Price Inflation. annual percentage chang
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
6
Percent
5
6
5
Consumer price inflation
4
4
3
3
2
2
1
1
0
0
-1
-1
Real GDP growth
-2
-2
02
03
04
05
06
07
08
09
10
Source: Reuters EcoWin
-450 BP – a race to the bottom
Base Rates Reach Historic Lows
Percentage, since May 1997 base rates have been set by the Bank of England
7.0
7.0
6.5
6.0
6.0
5.5
5.5
5.0
5.0
4.5
Percent
6.5
LIBOR 3-Month Interest Rate
4.5
Bank of England Base Rate
4.0
4.0
3.5
3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
1.5
1.0
1.0
0.5
0.5
0.0
0.0
05
06
07
08
09
Source: Bank of England
Jobs cull – but (much) worse to come
Unemployment in the UK Economy
per cent of the labour force
people aged 16-59 (women) / 64 (men), seasonally adjusted
11
11
10
10
9
9
8
8
7
7
6
Labour Force Survey
6
5
5
4
4
Claimant Count
3
3
2
2
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Source: Reuters EcoWin
Consumer confidence has taken a hit
Consumer Sentiment
Expectations over next 12 months, % balance of optimists over pessimists
Net balance
20
20
Own Financial Situation
10
10
0
0
-10
-10
-20
-20
Likely to make major purchases
-30
-30
General economic situation
-40
-40
-50
-50
-60
-60
01
02
03
04
05
06
07
08
09
Source: Reuters EcoWin
With housing mired in a slump
How much further will UK house prices fall?
Index
Halifax house price index, Seasonally adjusted data, monthly averages, 1983=100
650
650
600
600
550
550
500
500
450
450
400
400
350
350
300
300
250
250
200
200
97
98
99
00
01
02
03
04
05
06
07
08
09
Source: Reuters EcoWin
And mortgages hard to find
UK Gross Mortgage Lending
35.0
35.0
32.5
32.5
30.0
30.0
27.5
27.5
25.0
25.0
22.5
22.5
20.0
20.0
17.5
17.5
15.0
15.0
12.5
12.5
10.0
10.0
01
02
03
04
05
06
07
billions
GBP (billions)
£ billion per month
08
Source: Reuters EcoWin
Equities take a pounding
Is the Bear Market Over?
Index
Index of the UK's 100 leading shares - daily closing value
7000
7000
6500
6500
6000
6000
5500
5500
5000
5000
4500
4500
4000
4000
3500
3500
3000
3000
97
98
99
00
01
02
03
04
05
06
07
08
09
Source: Reuters EcoWin
Business animal spirits head south
British Chambers of Commerce Survey
Net balance
Survey on confidence over turnover going forward
70
70
60
60
50
50
40
40
30
30
20
20
10
10
0
0
-10
-10
-20
-20
-30
-30
-40
-40
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Manufacturing
Services
Source: Reuters EcoWin
And the ‘accelerator effect’ becomes
negative
Value of UK Capital Investment Spending
60
60
55
55
50
50
45
45
40
40
35
35
30
30
25
25
billions
GBP (billions)
Quarterly value of capital spending at constant 2003 prices, £ billion
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Source: UK Statistics Commission
UK manufacturing is in freefall
UK Manufacturing Index of Production
110
110
105
105
100
100
95
95
90
90
85
85
80
80
75
75
70
70
80
82
84
86
88
90
92
94
96
98
00
02
04
06
millions
Index of output 2001=100 (millions)
Seasonally adjusted index of production, 2001 = 100
08
Source: Reuters EcoWin
Despite the lower pound
Dollar-Sterling and Interest Rate Differentials
GBP/USD
US dollars per £1, daily closing exchange rate; US and UK official policy interest rates (%)
2.2
2.2
2.0
2.0
1.8
1.8
1.6
1.6
1.4
1.4
1.2
1.2
7
7
6
6
Percent
5
5
UK Interest Rates
4
4
3
3
US Interest Rates
2
2
1
1
0
0
00
01
02
03
04
05
06
07
08
09
Source: International Monetary Fund
Spare a thought for Japan
Manufacturing Output in Japan
Index
Seasonally adjusted index of output, 2005=100
120
120
115
115
110
110
105
105
100
100
95
95
90
90
85
85
80
80
75
75
70
70
03
04
05
06
07
08
09
Source: Reuters EcoWin
And Germany
Germany - Industrial Production
Index
Seasonally adjusted index of production, 2000=100
125
125
120
120
115
115
110
110
105
105
100
100
95
95
90
90
85
85
97
98
99
00
01
02
03
04
05
06
07
08
09
Source: Reuters EcoWin
Deflation is a key risk in 2009
Retail Price and Consumer Price Inflation in the UK
Annual percentage change in the retail price index and CPI
6.0
6.0
Evaluation:
5.0
5.0
Percent
All items retail price index (RPI)
4.0
4.0
3.0
3.0
2.0
2.0
1.0
1.0
Consumer price index
0.0
0.0
-1.0
-1.0
-2.0
-2.0
97
98
99
00
01
02
03
04
05
06
07
08
09
Source: UK Statistics Commission
Was the decision by
Brown to change the
Monetary Policy
Committee target
from retail price
index to consumer
price index in 2003
a mistake?
Especially if discounting spreads
UK Non-Food Shop Price Index
Index
Index of Prices, December 2005=100
105.0
105.0
102.5
102.5
100.0
100.0
97.5
97.5
95.0
95.0
92.5
92.5
90.0
90.0
87.5
87.5
85.0
85.0
82.5
82.5
Dec
05
Mar
Jun Sep
06
Clothing
Dec
Mar
Electrical
Jun
07
Sep
Dec
Furniture
Mar
Jun
08
Sep
Dec
09
Hardware
Source: Reuters EcoWin
And commodity prices head lower
The Economist Commodity Price Index
Index of Prices 2000=100
325
325
Industrial Metals
Index
300
300
275
275
250
250
225
225
All Commodities
200
200
175
175
150
150
125
125
Food
100
100
04
05
06
07
08
09
Source: Economist Commodity Price Index
BoE survey suggests price pressures are
falling – will this be enough for deflation?
Bank of England Regional Agents Survey: Costs and Prices
5 Costs of imported finished goods 3.2
Net balance
4
Costs; material costs
Manufacturers domestic prices
Retail services prices
5
2.1
1.3
1.4
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
-3
-3
97
98
99
00
01
Costs of imported finished goods
Costs; material costs
02
03
04
05
06
07
08
Manufacturers domestic prices
Retail services prices
Source: Bank of England
The Global Backdrop
 Global GDP will shrink in 2009…making this the worst global
downswing in the post-war period
 Growth in developing world will more than halve
 China slips below the 8% growth seen as a minimum target
 Japan suffers 4th recession in 12 years and manufacturing
slumps back to 1971 levels
 Germany shrinks by nearly 2%
 Export-dependent countries hit by contraction in global trade
 Bright spots? Brazil, India, Poland
China will need to rebalance
Percent
Annual Growth of Chinese Exports
60
60
50
50
40
40
30
30
20
20
10
10
0
0
-10
-10
-20
-20
00
01
02
03
04
05
06
07
08
09
Source: Reuters EcoWin
And Japan moves into deficit
Japanese Trade Balance
1.50
1.50
1.25
1.25
1.00
1.00
0.75
0.75
0.50
0.50
0.25
0.25
0.00
0.00
-0.25
-0.25
-0.50
-0.50
thousand billions
JPY (thousand billions)
Monthly balance of trade Yen trillion, seasonally adjusted
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
Source: Reuters EcoWin
Monetary and
Fiscal Policy – A
Shotgun Marriage
‘Ease his pain’ – pulling every lever
 Policy rates have moved to the floor (0.5%)
 £75bn quantitative easing (March 2009)
 25% depreciation of sterling over last 12 months
 Injection of capital into the banking system
 Government borrowing of more than 8% of GDP
 National debt that > 65% of GDP within 2 years
Adding stabilizers to the cycle
 Stage 1: Estimate likely impact of recession on the UK’s
GDP – say between 8 or 9%!
 Stage 2: Calibrate the likely impact of the policy stimulus
 Interest rate cuts: £12-16 billion or approaching 1% of
GDP
 Fiscal policy: £20 billion or a bit above 1¼% GDP
 Huge Sterling depreciation to an open economy: 3%
GDP
 BoE quantitative easing (impact unknown)
 Net effect – stimulus of more than 6% of GDP …
 So a contraction in UK of between 2 and 3% in 2009 – a
bad recession – but it could (might still) be much worse
Explaining a £120bn deficit
 Sharp fall in tax revenues (reverse fiscal drag)
 Bringing forward of capital spending
 Automatic stabilisers – higher welfare bill because
of rising unemployment
 Bail outs of banks and selected industries
 Deliberate Keynesian style stimulus to demand
 Evaluation …. Uncertain size of the fiscal multiplier
A fiscal tsunami – but who will pay?
UK Government Spending and Taxation
Measured as a percentage of national income
49
49
48
48
47
47
46
46
Government Spending
Per cent of GDP
45
45
44
44
43
43
42
42
41
41
Total Tax Revenue
40
40
39
39
38
38
37
37
36
36
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Total tax revenues as a share of GDP
Government spending as a share of GDP
Source: OECD World Economic Outlook
Evaluation:
Consider raising a
counterfactual in
your essays – what
would have
happened if there
had been no fiscal
stimulus.
Borrowing and nationalisation
UK Government Net Debt
750
750
700
700
650
650
600
600
550
550
500
500
450
450
400
400
350
350
300
300
98
99
00
01
02
03
04
05
06
07
billions
GBP (billions)
£ billion at current prices, monthly data
08
Source: Reuters EcoWin
Is the Bank still independent?
 Nowhere to go on policy interest rates – liquidity trap reached?
 Inflation target is being ignored for now (will there be a change?)
 The key rate now is on government bonds - not the base rate
 Government committed to HUGE borrowing
 Will the Bank buy as many bonds as the government needs?
 Will the Bank be strong enough to tell the government to stop?
 For most people the base rate of interest is an irrelevance
 Look at the cost of unsecured credit
 Even if borrowing costs are low, can you actually get a loan?
0.5% - Does anyone pay this?
The Cost of Borrowing
Per cent, source: Bank of England
20.0
20.0
Overdrafts
18.0
18.0
Percent
Credit cards
16.0
16.0
14.0
14.0
12.0
12.0
10.0
10.0
8.0
8.0
Mortgage rates
6.0
6.0
4.0
4.0
Base Interest Rates (set by BoE)
2.0
2.0
0.0
0.0
04
05
06
07
08
09
Source: Bank of England
Borrow now – ask questions later?
Yields on Govt Bonds and the UK Budget Balance
per cent of GDP, data for 2009-10 forecast from the OECD
14.0
14.0
Interest rate on 10 year government bonds (per cent)
12.0
12.0
10.0
10.0
8.0
8.0
6.0
6.0
4.0
4.0
2.0
2.0
Fiscal stimulus
0.0
0.0
-2.0
-2.0
-4.0
-4.0
Cyclically adjusted budget balance (% of GDP)
-6.0
-6.0
-8.0
-8.0
88
90
92
94
96
98
00
02
04
06
08
10
Source: Reuters EcoWin
Evaluation:
Is there evidence
here of crowdingout? Do bond
yields rise when
borrowing
increases?
Keep a close eye on corporate bonds
Percent
UK Corporate Bonds, AAA Rated, Yield (%)
6.5
6.5
6.0
6.0
5.5
5.5
5.0
5.0
4.5
4.5
4.0
4.0
3.5
3.5
3.0
3.0
2.5
2.5
2.0
2.0
1.5
1.5
02
10 Years
03
04
2 Years
05
06
07
08
09
5 Years
Source: Reuters EcoWin
Risky Business
Percent
Spread of Yields on Corporate Debt, %
8.5
8.5
8.0
8.0
7.5
7.5
7.0
7.0
6.5
6.5
6.0
6.0
5.5
5.5
5.0
5.0
4.5
4.5
4.0
4.0
3.5
3.5
3.0
3.0
Jan
Feb
A Rated
Mar
Apr
May
AA Rated
Jun
Jul Aug
08
AAA Rated
Sep
Oct
Nov
Dec
Jan
Feb
09
BBB Rated
Source: Reuters EcoWin
The risk of corporate default is growing
UK Corporate Credit Default Swaps
Basis point
Difference between corporate and government bond yields, per cent, in basis points
175
175
150
150
125
125
100
100
75
75
50
50
25
25
0
25
9
29
Mar-08 Apr-08
10 Years
0
9
19
3
3
May-08
Jun-08
5 Years
9
16
Jul-08
1
14 20
4
Aug-08 Oct-08
4
3
Feb-09
9
Source: Reuters EcoWin
The (shotgun) marriage of macro-policy
 Monetary and fiscal policy are now joined at the hip
 Short term – appetite (demand) for bonds eases the problems of
financing an eye-wateringly large fiscal deficit
 Good fiscal stimuli are timely, targeted, and temporary
 But there is no such thing as a free lunch
 Fiscal policy will need to be tightened
 There will be some crowding out of the private sector
 We cannot ignore the risk of resurgent inflation in a recovery
 Weak sterling poses a major credit (solvency) risk for the UK
government – even if we are not (quite) an Iceland
Looking for Green Shoots
 Financial market recovery is pre-condition
 Bank lending to commerce and property
 Getting through the 2009 corporate debt crisis
 Change in business & consumer sentiment
 Aggressive de-stocking might end
 Look for data on prices and profit warnings
 Impact of policy stimulus – note the time lags
 Lower commodity prices – impact on real income
 But unemployment will continue rising – a lagging indicator