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Posts Tagged ‘budget deficit’

A more active fiscal policy? Changing the rule book

In his 2016 Autumn Statement, the new Chancellor of the Exchequer, Philip Hammond, announced that he was abandoning his predecessor’s target of achieving a budget surplus in 2019/20 and beyond. This was partly in recognition that tax revenues were likely to be down as economic growth forecasts were downgraded by the Office for Budget Responsibility. But it was partly to give himself more room to boost the economy in response to lower economic growth. In other words, he was moving from a strictly rules-based fiscal policy to one that is more interventionist.

Although he still has the broad target of reducing government borrowing over the longer term, this new flexibility allowed him to announce increased government spending on infrastructure.

The new approach is outlined in the updated version of the Charter for Budget
Responsibility
, published alongside the Autumn Statement. The government’s fiscal mandate would now include the following:

 •  a target to reduce cyclically-adjusted public-sector net borrowing to below 2% of GDP by 2020/21;
 •  a target for public-sector net debt as a percentage of GDP to be falling in 2020/21.

It also states that:

In the event of a significant negative shock to the UK economy, the Treasury will review the appropriateness of the fiscal mandate and supplementary targets as a means of returning the public finances to balance as early as possible in the next Parliament.

In the Autumn Statement, the new approach to fiscal policy is summarised as follows:

This new fiscal framework ensures the public finances continue on the path to sustainability, while providing the flexibility needed to support the economy in the near term.

With his new found freedom, the Chancellor was able to announce spending increases, despite deteriorating public finances, of £36bn by 2021/22 (see Table 1 in the Autumn Statement).

Most of the additional expenditure will be on infrastructure. To facilitate this, the government will set up a new National Productivity Investment Fund (NPIF) to channel government spending to various infrastructure projects in the fields of housing, transport, telecoms and research and development. The NPIF will provide £23bn to such projects between 2017/18 and 2021/22.

But much of the additional flexibility in the new Fiscal Mandate will be to allow automatic fiscal stabilisers to operate. The OBR forecasts an increase in borrowing of £122bn over the 2017/18 to 2021/22 period compared with its forecasts made in March this year. Apart from the additional £23bn spending on infrastructure, most of the rest will be as a result of lower tax receipts from lower economic growth. This, in turn, is forecast to be the result of lower investment caused by Brexit uncertainties and lower real consumer spending because of the fall in the pound and the consequent rise in prices.

But rather than having to tighten fiscal policy to meet the previous borrowing target, the new Fiscal Mandate will permit this rise in borrowing. The lower tax payments will help to reduce the dampening effect on the economy.

So are we entering a new era of fiscal policy? Is the government now using discretionary fiscal policy to boost aggregate demand, while also attempting to increase productivity? Or is the relaxation of the Fiscal Mandate just a redrawing of the rules to give a bit more flexibility over the level of stimulus the government can give the economy?

Videos
Autumn Statement 2016: Philip Hammond’s speech (in full) GOV.UK (23/11/16)
Philip Hammond’s autumn statement – video highlights The Guardian (23/11/16)
Key points from the chancellor’s first Autumn Statement BBC News, Andrew Neil (23/11/16)
Autumn Statement: higher borrowing, lower growth Channel 4 News, Helia Ebrahimi (23/11/16)
Autumn Statement: Chancellor’s growth and borrowing figures BBC News (23/11/16)
Markets react to Autumn Statement Financial Times on YouTube, Roger Blitz (23/11/16)
Hammond’s Autumn Statement unpicked Financial Times on YouTube, Gemma Tetlow (23/11/16)
Autumn Statement 2016: The charts that show the cost of Brexit Sjy News, Ed Conway (24/11/16)
BBC economics editor Kamal Ahmed on the Autumn Statement. BBC News (23/11/16)
Autumn statement: debate Channel 4 News, Financial Secretary to the Treasury, Jane Ellison, and Labour’s Shadow Business Secretary, Clive Lewis (23/11/16)
Autumn Statement: Workers’ pay growth prospects dreadful, says IFS BBC News, Kevin Peachey and Paul Johnson (24/11/16)

Articles
Autumn Statement 2016: Expert comment on fiscal policy Grant Thornton, Adam Jackson (23/11/16)
Philip Hammond loosens George Osborne’s fiscal rules to give himself more elbow room as Brexit unfolds CityA.M., Jasper Jolly (23/11/16)
Britain’s New Fiscal Mandate Opens Way To Invest For Economic Growth Forbes, Linda Yueh (23/11/16)
Autumn Statement 2016: experts respond The Conversation (23/11/16)
Chancellor’s ‘Reset’ Leaves UK Economy Exposed And Vulnerable Huffington Post, Alfie Stirling (23/11/16)
Britain’s Autumn Statement hints at how painful Brexit is going to be The Economist (26/11/16)
Chancellor’s looser finance targets highlight weaker UK economy The Guardian, Phillip Inman (24/11/16)
Hammond’s less-than-meets-the-eye plan that hints at the future Financial Times, Martin Sandbu (23/11/16)
Economists’ views on Philip Hammond’s debut Financial Times, Paul Johnson, Bronwyn Curtis and Gerard Lyons (24/11/16)

Government Publications
Autumn Statement 2016 HM Treasury (23/11/16)
Charter for Budget Responsibility: autumn 2016 update HM Treasury

Reports, forecasts and analysis
Economic and fiscal outlook – November 2016 Office for Budget Responsibility (23/11/16)
Autumn Statement 2016 analysis Institute for Fiscal Studies (November 2016)

Questions

  1. Distinguish between discretionary fiscal policy and rules-based fiscal policy.
  2. Why have forecasts of the public finances worsened since last March?
  3. What is meant by automatic fiscal stabilisers? How do they work when the economic growth slows?
  4. What determines the size of the multiplier from public-sector infrastructure projects?
  5. What dangers are there in relaxing the borrowing rules in the Fiscal Mandate?
  6. Examine the arguments for relaxing the borrowing rules more than they have been?
  7. If the economy slows more than has been forecast and public-sector borrowing rises faster, does the Chancellor have any more discretion in giving a further fiscal boost to the economy?
  8. Does the adjustment of borrowing targets as the economic situation changes make such a policy a discretionary one rather than a rules-based one?
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When the light at the end of the tunnel is yet another oncoming train: Greece’s woes set to continue

As we saw in several posts on this site, last year was a tumultuous one for the Greek people and their economy. The economy was on the verge of bankruptcy; the Greek people rejected the terms of a bailout in a referendum; exit from the eurozone and having to return to the drachma seemed likely; banks were forced to closed at the height of the crisis; capital controls were imposed, with people restricted to drawing €60 a day or €420 a week – a policy still in force today; unemployment soared and many people suffered severe hardship.

To achieve the bailout, the Syriza government had to ignore the results of the referendum and agree to harsh austerity policies and sweeping market-orientated supply-side policies. This, at least, allowed Greece to stay in the eurozone. It held, and won, another election to seek a further mandate for these policies.

But what are the prospects for 2016? Will it be a year of recovery and growth, with market forces working to increase productivity? Does 2016 mark the beginning of the end and, as prime minister Alexis Tsipras put it, “a final exit from economic crisis”?

Or will the continuing cuts simply push the economy deeper into recession, with further rises in unemployment and more and more cases of real human hardship? Is there a hysteresis effect here, with the past six years having created a demoralised and deskilled people, with cautious investors unable and/or unwilling to rebuild the economy?

The article below looks at the rather gloomy prospects for Greece and at whether there are any encouraging signs. It also looks at the further demands of the troika of creditors – the IMF, the ECB and the European Commission’s European Stability Mechanism (ESM) – and at what the political and economic impact of these might be.

Greece’s economic crisis goes on, like an odyssey without end The Guardian, Helena Smith (4/1/16)

Questions

  1. Construct a timeline of Greece’s debt repayments, both past and scheduled, and of the bailouts given by the troika to prevent Greece defaulting.
  2. What supply-side reforms are being demanded by Greece’s creditors?
  3. What will be the effect of these supply-side reforms in (a) the short run; (b) the long run?
  4. Explain the meaning of hysteresis as it applies to an economy in the aftermath of a recession. How does the concept apply in the Greek situation?
  5. Discuss the alternative policy options open to the Greek government for tackling the persistent recession.
  6. Would it be better for Greece to leave the euro? Explain your arguments.
  7. “I cannot see how this government can survive the reforms. And I cannot see how it can avoid these reforms.” Is there any way out of this apparent impasse for the Greek government?
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A deus ex machina at last?

It was argued in an earlier blog on the Greek debt crisis that a deus ex machina was needed to find a resolution to the impasse between Greece and its creditors. The most likely candidate for such as role was the IMF.

Three days before the Greek referendum on whether or not to accept the Troika’s proposals, the IMF has stepped onto the stage. To the undoubted surprise of the other two partners in the Troika (the European Commission and the ECB), the IMF argues that Greece’s debts are unsustainable and that much more is needed than a mere bailout (which simply rolls over the debt).

According to the IMF, Greece needs €52bn of extra funds between October 2015 and December 2018, large-scale debt relief, a 20-year grace period before making any debt repayments and then debt repayments spread over the following 20 years. In return, Greece should commit to supply-side reforms to cut out waste, reduce bureaucracy, improve tax collection methods and generally improve the efficiency of the economic system.

It would also have to agree to the previously proposed primary budget surplus (i.e. the budget surplus excluding debt repayments) of 1 per cent of GDP this year, rising to 3.5 per cent in 2018.

So it this what commentators have been waiting for? What will be the reaction of the Greeks and the other two partners in the Troika? We shall see.

Articles
IMF says Greece needs extra €50bn in funds and debt relief The Guardian. Phillip Inman, Larry Elliott and Alberto Nardelli (2/7/15)
IMF: 3rd Greek bailout would cost €52bn. Or more? Financial Times, Peter Spiegel (2/7/15)
IMF: Greece needs to reform for sustainable debt, financing needs rising CNBC, Everett Rosenfeld (2/7/15)
The IMF has made an obvious point about Greece’s huge debt. Here’s why it still matters Quartz, Jason Karaian (3/7/15)
Greece: when is it time to forgive debt? The Conversation, Jagjit Chadha (2/7/15)

IMF Analysis
Greece: Preliminary Draft Debt Sustainability Analysis IMF (2/7/15)
Preliminary Debt Sustainability Analysis for Greece IMF (25/6/15)

Questions

  1. To which organisations is Greece indebted? What form to the debts take?
  2. To what extent is Greece’s current debt burden the result of design faults of the euro?
  3. What are the proposals of the IMF? What effect will they have on the Greek economy if accepted?
  4. How would the IMF proposals affect aggregate demand (a) directly; (b) compared with the proposals previously on the table that Greece rejected on 26 June?
  5. What would be the effects of Greek exit from the euro (a) for Greece; (b) for other eurozone countries?
  6. What bargaining chips can Greece deploy in the negotiations?
  7. Explain what is meant by ‘moral hazard’. Where in possible outcomes to the negotiations may there be moral hazard?
  8. What has been the impact of Greek austerity measures on the distribution of income and wealth in Greece?
  9. What are the practicalities of pursuing supply-side policies in Greece without further dampening aggregate demand?
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Imposing a new fiscal straitjacket

In his annual Mansion House speech to business leaders on 10 June 2015, George Osborne announced a new fiscal framework. This would require governments in ‘normal times’ to run a budget surplus. Details of the new framework would be spelt out in the extraordinary Budget, due on 8 July.

If by ‘normal times’ is meant years when the economy is growing, then this new fiscal rule would mean that in most years governments would be require to run a surplus. This would reduce general government debt.

And it would eventually reduce the debt from the forecast ratio of 89% of GDP for 2015 to the target of no more than 60% set for member states under the EU’s Stability and Growth Pact. Currently, many countries are in breach of this target, although the Pact permits countries to have a ratio above 60% provided it is falling towards 60% at an acceptable rate. The chart shows in pink those countries that were in breach in 2014. They include the UK.

Sweden and Canada have similar rules to that proposed by George Osborne, and he sees them as having been more able to use expansionary fiscal policy in emergency times, such as in the aftermath of the financial crisis of 2007/8, without running excessive deficits.

Critics have argued, however, that running a surplus whenever there is economic growth would dampen recovery if growth is sluggish. This makes the rule very different from merely requiring that, over the course of the business cycle, there is a budget balance. Under that rule, years of deficit are counterbalanced by years of surplus, making fiscal policy neutral over the cycle. With a requirement for a surplus in most years, however, fiscal policy would have a net dampening effect over the cycle. The chancellor hopes that this would be countered by increased demand in the private sector and from exports.

The rule is even more different from the Coalition government’s previous ‘fiscal mandate‘, which was for a ‘a forward-looking target to achieve cyclically-adjusted current balance by the end of the rolling, five-year forecast period’. The current budget excludes investment expenditure on items such as transport infrastructure, hospitals and schools. The fiscal mandate was very similar to the former Labour government’s ‘Golden rule’, which was to achieve a current budget balance over the course of the cycle.

By excluding public-sector investment from the target, as was previously done, it can allow borrowing to continue for such investment, even when there is a substantial deficit. This, in turn, can help to increase aggregate supply by improving infrastructure and has less of a dampening effect on aggregate demand. A worry about the new rule is that it could lead to further erosion of public-sector investment, which can be seen as vital to long-term growth and development of the economy. Indeed, Sweden decided in March this year to abandon its surplus rule to allow government borrowing to fund investment.

The podcasts and articles below consider the implications of the new rule for both aggregate demand and aggregate supply and whether adherence to the rule will help to increase or decrease economic growth over the longer term.

Video and audio podcasts
George Osborne confirms budget surplus law Channel 4 News, Gary Gibbon (10/6/15)
Osborne To Push Through Budget Surplus Rules Sky News (10/6/15)
OECD On Osborne’s Fiscal Plans Sky News, Catherine Mann (10/6/15)
‘Outright fiscal madness’ Osborne’s Mansion House Speech RT UK on YouTube, Harry Fear (11/6/15)
A “straightjacket” [sic] on future government spending? BBC Today Programme, Robert Peston; Nigel Lawson (11/6/15)
Thursday’s business with Simon Jack BBC Today Programme, Gerard Lyons (12/6/15)

Articles
Osborne seeks to bind successors to budget surplus goal Reuters, David Milliken (10/6/15)
George Osborne to push ahead with budget surplus law The Telegraph, Peter Dominiczak (10/6/15)
Osborne Wants U.K. to Build Treasure Chest During Good Times Bloomberg, Svenja O’Donnell (10/6/15)
Questions over Osborne’s Victorian-era budget plans BBC News (10/6/15)
Years more spending cuts to come, says OBR BBC News (11/6/15)
Is Chancellor right to want surplus in normal times? BBC News, Robert Peston (10/6/15)
George Osborne Unveils New Budget Surplus Law, But Critics Warn It Means Needless Cuts Huffington Post, Paul Waugh (10/6/15)
George Osborne’s fiscal handcuffs are political, but he does have a point Independent, Hamish McRae (11/6/15)
Osborne’s budget surplus law follows UK tradition of moving goalposts Financial Times, Chris Giles (10/6/15)
George Osborne’s budget surplus rule is nonsense and it could haunt Britain for decades Business Insider, Malaysia, Mike Bird (10/6/15)
To cut a way out of recession we need growth, not austerity economics Herald Scotland, Iain Macwhirter (11/6/15)
George Osborne moves to peg public finances to Victorian values The Guardian, Larry Elliott and Frances Perraudin (10/6/15)
The Guardian view on George Osborne’s fiscal surplus law: the Micawber delusion The Guardian, Editorial (10/6/15)
Academics attack George Osborne budget surplus proposal The Guardian, Phillip Inman (12/6/15)
Osborne plan has no basis in economics Guardian letters, multiple signatories (12/6/15)
Is there an optimal debt-to-GDP ratio? Vox EU, Anis Chowdhury and Iyanatul Islam
No basis in economics Mainly Macro, Simon Wren-Lewis (16/6/15)

Questions

  1. Explain what is meant by a ‘cyclically adjusted current budget balance’.
  2. How does the speed with which the government reduces the public-sector debt affect aggregate demand and aggregate supply?
  3. What are the arguments for and against running a budget surplus: (a) when there is currently a large budget deficit; (b) when there is already a budget surplus? How do the arguments depend on the stage of the business cycle?
  4. Do you agree with the statement that ‘the biggest issue with the UK economy right now is not the government deficit’. If so, what bigger issues are there?
  5. How could public-sector debt as a proportion of GDP decline without the government running a budget surplus?
  6. How might the term ‘normal times’ be defined? How does the definition used by the Chancellor affect the rate at which the public-sector debt is reduced?
  7. How sustainable is the current level of public-sector debt? How does its sustainability relate to the interest rate on long-term government bonds?
  8. If there is a budget surplus, such that GT is negative, what can we say about the balance betwen (I + X) and (S + M)? What good and adverse consequences could follow?
  9. Why do George Osborne’s plans for budget surpluses ‘risk a liquidity crisis that could also trigger banking problems, a fall in GDP, a crash, or all three’?
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Wanted: a Deus ex Machina for Greece

With talks ongoing about resolving the Greek debt crisis, it is clear that there is no agreement that will satisfy both sides – the Greek government and the troika of lenders (the IMF, the ECB and the European Commission). Their current negotiating positions are irreconcilable. What is needed is something more fundamental to provide a long-term solution. What is needed is a ‘deus ex machina‘.

A deus ex machina, which is Latin for ‘god from a machine’, was a device used in Greek tragedy to solve an impossible situation. A god would appear from above, lowered by a crane, or from below through a trap door, and would put everything right. The tragedy would then be given a happy ending.

So what possible happy ending could be brought to the current Greek tragedy and who could be the deus ex machina?

The negotiations between Greece and the troika currently centre on extending credit by €7.2bn when existing debts come up for repayment. There are repayments currently due to the IMF, or by the end of June, of €1.5bn and more in July, September and December (another €3.2bn). There are also €6.7bn of Greek bonds held by the ECB, as part of the 2010 bailout programme, that are due for repayment in July and August. Without the €7.2 billion bailout, Greece will be unable to meet these debt repayments, which also include Treasury bills.

But the troika will only release the funds in return for harsh austerity measures, which involve further cuts to pensions and public expenditure. Greece would be required to run a substantial budget surplus for many years.

Greece could refuse, but then it would end up defaulting on debt and be forced out of the euro. The result would probably be a substantial depreciation of a newly restored drachma, rising inflation and many Greeks suffering even greater hardship – at least for a period of time.

So what is the possible deus ex machina? If you’re looking for a ‘god’ then it is best, perhaps, to look beyond the current actors. Perhaps the Americans could play the role in finding a solution to the impasse. Perhaps a small group of independent experts or politicians, or both, could find one. In either case, the politics of the situation would have to be addressed as well as the economics and finance.

And what would be the ‘fix’ to satisfy both sides? Ultimately, this has to allow Greek debt to be sustainable without further depressing demand and undermining the fabric of Greek society. This would almost certainly have to involve a large measure of debt forgiveness (i.e. debts being written off). It also has to avoid creating a moral hazard, whereby if the Greeks are seen as being ‘let off lightly’, this might encourage other indebted eurozone countries to be less willing to reduce their debts and make demands for forgiveness too.

Ultimately, the issue is a political one, not an economic one. This will require clever negotiation and, if there is a deus ex machina, clever mediation too.

Videos
Greek PM Tsipras warns lenders bailout plans ‘not realistic’ BBC News, Jim Reynolds (5/6/25)
Greece defers IMF payment until end of June BBC News, Chris Morris (5/6/15)
Greek debt talks: Empty shops and divided societies BBC News, Chris Morris (10/6/15)
Potential Grexit effects Deutsche Welle (13/6/15)

Articles
It’s time to end the pretence: Greece will never fully repay its bailout loan The Guardian, Andrew Farlow (9/6/15)
Greek exit would trigger eurozone collapse, says Alexis Tsipras The Guardian, Phillip Inman, Helena Smith and Graeme Wearden (9/6/15)
The eurozone was a dream of unity. Now Europe has turned upon itself The Guardian, Business leader (14/6/15)
Greece bailout talks: an intractable crisis with three possible outcomes The Guardian, Larry Elliott (2/6/15)
Greece needs an economic defibrillator and a debt write-off Financial Times letters, Ray Kinsella (25/3/15)
Greece’s new debt restructuring plan Times of Change, Peter Spiegel (5/6/15)
Eurozone still in denial about Greece BBC News, Robert Peston (3/6/15)
Greece bailout talks – the main actors in a modern-day epic The Guardian, Phillip Inman, Ian Traynor and Helena Smith (9/6/15)
Greece isn’t any old troubled debtor BBC News, Robert Peston (15/6/15)
Greece in default if debt deadline missed, says Lagarde BBC News (18/6/15)
Burden of debt to IMF and European neighbours proves too much for Greece The Guardian, Heather Stewart (17/6/15)

Paper
Ending the Greek Crisis: Debt Management and Investment led Growth Greek government

Questions

  1. To which organisations is Greece indebted? What form to the debts take?
  2. To what extent is Greece’s current debt burden the result of design faults of the euro?
  3. Would it be possible to restructure debts in ways that make it easier for Greece to service them?
  4. Should Greece be treated by the IMF the same way it treated the highly indebted poor countries (HIPCs) and granted substantial debt relief?
  5. What would be the effects of Greek exit from the euro (a) for Greece; (b) for other eurozone countries?
  6. What bargaining chips can Greece deploy in the negotiations?
  7. Explain what is meant by ‘moral hazard’. Where in possible outcomes to the negotiations may there be moral hazard?
  8. What has been the impact of Greek austerity measures on the distribution of income and wealth in Greece?
  9. What are the practicalities of pursuing supply-side policies in Greece without further dampening aggregate demand?
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Scotland: Fiscal Autonomy?

Scottish voters will be crucial in the upcoming election, with the SNP poised to take many of Labour’s seats north of the border. The future of Scotland will depend on which party comes to power and what decisions are made with regards to its finances.

Nicola Sturgeon wants government spending and taxation powers transferred to the Scottish Parliament, but would this mean spending cuts and tax rises for the Scottish people? Ed Miliband, Labour’s leader has been vocal in pointing out what this might mean, with cuts to pensions or raising taxes. However, given that it is Labour that is facing the biggest threat from the SNP, it is perhaps hardly surprising.

However, as the first video below shows, there would be an estimated £7.6bn deficit in Scotland, according to the IFS if spending and taxing was to be transferred here. This is because the tax revenues raised in Scotland are lower per person and spending per person is higher than across the whole of the UK. Oil prices are extremely low at present and hence this is reducing tax revenues. When the oil price does rise, revenues will increase and so if the split in finances was to occur this would reduce that deficit somewhat, but it would still leave a rather large hole in Scotland’s finances. The following videos and articles consider the SNP’s plans.

Videos
SNP fiscal autonomy plan: What would it do to Scotland’s finances? BBC News, Robert Peston (10/4/15)
Labour attacks SNP’s ‘devastating’ economic plans BBC News (10/4/15)

Articles
Ed Miliband attacks SNP plan for Scottish fiscal autonomy The Guardian, Severin Carrell (10/4/15)
Ed Miliband wars pensions will be cut under SNP plans The Telegraph, Auslan Cramb (10/4/15)
SNP fails to account for billions in welfare and pensions pledge, says IFS The Guardian, Severin Carrell (10/4/15)

Questions

  1. What is a budget deficit?
  2. What does fiscal autonomy for Scotland actually mean?
  3. The IFS suggests that there will be a large deficit in Scottish finances if they gain autonomy. How could this gap be reduced?
  4. Why has Labour claimed that tax rises would occur under the SNP’s plans? What could this mean for Scottish growth?
  5. Why do lower oil prices reduce tax revenues for Scotland?
  6. If Scotland had control over its finances, it could influence where government spending goes. Which industries would you invest in if you were in charge?
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The need for fiscal integration in the eurozone

In a speech in Dublin on 28 January 2015, titled ‘Fortune favours the bold‘, Mark Carney, the Governor of the Bank of England, compared the UK economy to that of the 19-nation eurozone. While he welcomed the ECB’s recently announced quantitative easing programme, he argued that the current construction of the eurozone is unfinished and still has two fundamental weaknesses that have not been addressed.

The first is the fragmented nature of banking:

With limited cross-border banking in the euro area, savings don’t flow to potential investments. Euro-area corporates’ cash balances have risen to the tune of €420 billion, or 3% of GDP, since the crisis, for example. Modest cross-border equity flows mean inadequate risk sharing.

The second is the lack of an integrated fiscal policy.

For complete solutions to both current and potential future problems, the sharing of fiscal risks is required.

It is no coincidence that effective currency unions tend to have centralised fiscal authorities whose spending is a sizeable share of GDP – averaging over a quarter of GDP for advanced countries outside the euro area.

… If the eurozone were a country, fiscal policy would be substantially more supportive. However, it is tighter than in the UK, even though Europe still lacks other effective risk sharing mechanisms and is relatively inflexible. A more constructive fiscal policy would help recycle surplus private savings and mitigate the tail risk of stagnation. It would also bridge the drag from structural reforms on nominal spending and would be consistent with the longer term direction of travel towards greater integration.

But fiscal integration requires a political will to transfer fiscal surpluses from the stronger countries, such as Germany, to the weaker countries, such as those in southern Europe.

Overall, the financial and fiscal position in the eurozone is strong:

Gross general government debt in the euro area is roughly the same as in the UK and below the average of advanced economies. The weighted average yield on 10-year euro area sovereign debt is around 1%, compared to 1½% in the UK. And yet, the euro area’s fiscal deficit is half that in the UK. Its structural deficit, according to the IMF, is less than one third as large.

But, unlike the UK, where, despite the rhetoric of austerity, automatic fiscal stabilisers have been allowed to work and the government has accepted a much slower than planned reduction in the deficit, in the eurozone fiscal policy remains tight. Yet unemployment, at 11½%, is twice the rate in the UK and economic growth, at around 0.7% is only one-quarter of that in the UK.

Without a eurozone-wide fiscal policy the problem of slow growth is likely to persist for some time. Monetary policy in the form of QE will help and structural reforms will help to stimulate potential output and long-term growth, but these policies could be much more effective if backed up by fiscal policy.

Whether they will be any time soon is a political question.

Speech
Fortune favours the bold Bank of England. Mark Carney (29/1/15)

Articles
Bank of England’s Carney urges Europe to take plunge on fiscal union Reuters, Padraic Halpin (28/1/15)
Bank Of England’s Mark Carney Attacks ‘Timid’ Eurozone Recovery Attempts Huffington Post, Jack Sommers (29/1/15)
BoE’s Mark Carney calls for common eurozone fiscal policies Financial Times, Ferdinando Giugliano (28/1/15)
Carney attacks German austerity BBC News, Robert Peston (28/1/15)
Bank of England governor attacks eurozone austerity The Guardian, Larry Elliott (28/1/15)

Questions

  1. Compare the financial and fiscal positions of the UK and the eurozone.
  2. In what way is there a ‘debt trap’ in the eurozone?
  3. What did Mark Carney mean when he said, ‘Cross-border risk-sharing through the financial system has slid backwards.’?
  4. What options are there for the eurozone sharing fiscal risks?
  5. What would a ‘more constructive’ fiscal policy, as advocated by Mark Carney, look like?
  6. How do the fiscal policies of other currency unions, such as the UK (union of the four nations of the UK) or the USA (union of the 50 states) or Canada (union of the 10 provinces and three territories), differ from that of the eurozone?
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A VW recession for the eurozone, as German growth revised down?

Europe’s largest economy is Germany and the prospects and growth figures of this country are crucial to the growth of the Eurozone as a whole. The EU is a key trading partner for the UK and hence the growth data of Germany and in turn of the Eurozone is also essential in creating buoyant economic conditions within our borders. The bad news is that the economic growth forecast for Germany has been cut by the German government.

The German government had previously estimated that the growth rate for this year would be 1.8%, but the estimate has now been revised down to 1.2% and next year’s growth rate has also been revised downwards from 2% to 1.3%. Clearly the expectation is that low growth is set to continue.

Whenever there are changes in macroeconomic variables, a key question is always about the cause of such change, for example is inflation caused by demand-pull or cost-push factors. The German government has been quick to state that the lower growth rates are not due to internal factors, but have been affected by external factors, in particular the state of the global economy. As such, there are no plans to make significant changes to domestic policy, as the domestic economy remains in a strong position. The economy Minister said:

“The German economy finds itself in difficult external waters … Domestic economic forces remain intact, with the robust labour market forming the foundation … As soon as the international environment improves, the competitiveness of German companies will bear fruit and the German economy will return to a path of solid growth … [for this reason there is] no reason to abandon or change our economic or fiscal policy.”

The global picture remains relatively weak and while some economies, including the UK, have seen growth pick up and unemployment fall, there are concerns that the economic recovery is beginning to slow. With an increasingly interdependent world, the slowing down of one economy can have a significant impact on the growth rate of others. If country A begins to slow, demand for imports will fall and this means a fall in the demand for exports of country B. For countries that are dependent on exports, such as Germany and China, a fall in the demand for exports can mean a big decline in aggregate demand and in August, Germany saw a 5.8% drop in exports.

Adding to the gloom is data on inflation, suggesting that some other key economies have seen falls in the rate of inflation, including China. The possibility of a triple-dip recession for the Eurozone has now been suggested and with its largest economy beginning to struggle, this suggestion may become more real. The following articles consider the macroeconomic picture.

Articles
Germany cuts growth forecasts amid recession fears, as Ireland unveils budget The Guardian, Graeme Wearden (14/10/14)
As cracks in its economy widen, is Germany’s miracle about to fade? The Observer, Philip Oltermann (19/10/14)
Why the German economy is in a rut The Economist (21/10/14)
Germany’s flagging economy: Build some bridges and roads, Mrs Merkel The Economist (18/10/14)
Germany cuts 2014 growth forecast from 1.8% to 1.2% BBC News (14/10/14)
IMF to cut growth forecast for Germany – der Spiegel Reuters (5/10/14)
Fears of triple-dip eurozone recession, as Germany cuts growth forecast The Guardian, Phillip Inman (15/10/14)
Germany slashes its economic forecasts Financial Times, Stefan Wagstyl (14/10/14)
Merkel vows austerity even as growth projection cut Bloomberg, Brian Parkin, Rainer Buergin and Patrick Donahue (14/10/14)
Is Europe’s economic motor finally stalling? BBC News, Damien McGuinness (17/10/14)
Why Germany won’t fight deflation BBC News, Robert Peston (16/10/14)

Data
World Economic Outlook Database IMF (15/10/14)
World Economic Outlook IMF (October 2014)

Questions

  1. How do we measure economic growth and is it a good indicator of the state of an economy?
  2. What are the key external factors identified by the Germany government as the reasons behind the decline in economic growth?
  3. Angela Merkel has said that austerity measures will continue to balance the budget. Is this a sensible strategy given the revised growth figures?
  4. Why is low inflation in other economies further bad news for those countries that have seen a decline or a slowdown in their growth figures?
  5. Why is interdependence between nations both a good and a bad thing?
  6. Using AS and AD analysis, illustrate the reasons behind the decline German growth. Based on your analysis, what might be expected to happen to some of the other key macroeconomic variables in Germany and in other Eurozone economies?
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Over the cliff: an update

In a News Item of 1 October, Over the Cliff, we looked at the passing of the deadline that same day for Congress to agree a budget. We also looked at the looming deadline for Congress to agree a new higher ceiling for Federal Government debt, currently standing at $16.699 trillion. Without an agreement to raise the limit, the government will start becoming unable to pay some of its bills from around 17 October.

One week on and no agreement has been reached on either a budget or a higher debt ceiling.

Failure to agree on a budget has led to the ‘shut-down’ of government. Only essential services are being maintained; the rest are no longer functioning and workers have been sent home on ‘unpaid leave’. This has led to considerable hardship for many in the USA. It has had little effect, however, on the rest of the world, except for tourists to the USA being unable to visit various national parks and monuments.

Failure to raise the debt ceiling, however, could have profound consequences for the rest of the world. It could have large and adverse effects of global growth, global trade, global investment and global financial markets. The articles below explore some of these consequences.

U.S. Congress enters crucial week in budget, debt limit battles Reuters, Richard Cowan (7/10/13)
Debt ceiling: Understanding what’s at stake CBS Moneywatch, Alain Sherter (7/10/13)
Q&A: What is the US debt ceiling? BBC News, Ben Morris (3/10/13)
Five Reasons to Fear the Debt Ceiling Bloomberg (6/10/13)
A U.S. Default Seen as Catastrophe Dwarfing Lehma Bloomberg Businessweek, Yalman Onaran (6/10/13)
China tells US to avoid debt crisis for sake of global economy BBC News (7/10/13)
US shutdown is starting to hit business, says Commerce Secretary BBC News (6/10/13)
Why Australia should fear a US government default The Guardian, Greg Jericho (7/10/13)
Could the US default over just $6bn? BBC News, Linda Yueh (11/10/13)
IMF piles pressure on US to reconcile differences and prevent debt default The Guardian, Larry Elliott and Jill Treanor (10/10/13)
Republicans offer to raise US debt ceiling for six weeks The Telegraph, Peter Foster and Raf Sanchez (11/10/13)

Questions

  1. If a debt ceiling is reached, what does this imply for the budget deficit?
  2. How serious are the two current fiscal cliffs?
  3. How would a continuation of the partial government shut-down impact on the US private sector?
  4. What multiplier effects on the rest of the world are likely to arise from a cut in US government expenditure or a rise in taxes? What determines the size of these multiplier effects?
  5. Explain the likely effect of the current crisis on the exchange rate of the dollar into other currencies.
  6. Why might the looming problem of reaching the debt ceiling drive up long-term interest rates in the USA and beyond?
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Over the cliff

For the second time in nine months, the USA has approached a fiscal cliff. This is where the federal government is forced to make government expenditure cuts and/or impose tax rises. There are two types of cliff face. The first is a legal limit on the size of the federal government debt and hence deficit. The second is failure to agree on a budget.

On January 1st this year, a fiscal cliff was narrowly averted by a last-minute agreement to raise the size of the permitted debt. On the 1st October (the beginning of the financial year), however, the US economy ‘fell over the cliff’. This time is was a failure by Congress to reach agreement over the federal budget. The sticking point was an unwillingness of the Republican majority in the House of Representatives to agree to a budget without the government making concessions on its healthcare reform. The government was unwilling to do that and so no budget was passed.

With no budget, much of government has to shut down! In practice, this means that all non-essential workers will cease to be paid. That includes workers in housing, parts of healthcare, the civil law part of the justice system, immigration, regulatory agencies, the passport service, parks and museums. Even workers in essential areas, such as civilian workers in the military, police and social services, are likely to see their pay delayed until the problem is resolved. The articles below look at some of the implications of this partial shut-down.

It is hoped that, within a few days, agreement on a budget will be reached. But that will not be the end of the story because a second fiscal cliff looms. And that is of the first type. There is currently a legal limit to Federal Government debt of $16.699 trillion. Because that limit was reached earlier this year, from May 18 the government has been able to use various ‘extraordinary measures‘ to carry on borrowing. These measures will run out, however, around 17 October. From then, if a new higher debt ceiling has not been agreed by Congress, the government will be unable to pay some of its bills. For example, on 1 November it will get a bill of $67billion for social security, medicare and veterans benefits. As the second Independent article below explains:

In a government shutdown, the federal government is not allowed to make any new spending commitments. By contrast, if we hit the debt-ceiling then the Treasury Department won’t be able to borrow money to pay for spending that Congress has already approved. In that case, either Congress will have to lift the debt ceiling or the federal government will have to default on some of its bills, possibly including payments to bondholders or Social Security payouts. That could trigger big disruptions in the financial markets — or a long-term rise in borrowing costs.

Not surprisingly, financial markets are nervous. Although the direct effect of lost output will be relatively small, provided agreements on the budget and the debt are reached fairly soon, the impact on confidence in the US system of government could be more damaging. Not only could this curb recovery in the USA, it could have a significant effect on global recovery, given the size and importance of the US economy to the rest of the world.

Webcasts
What does the shutdown mean for normal Americans? BBC News, Keith Doyle (1/10/13)
How the government shut down is being reported in the US BBC News (1/10/13)
Shutdown could slam frail U.S. economy Reuters, Bobbi Rebell (1/10/13)
Shutdown Will Cost U.S. Economy $300 Million a Day, IHS Says Bloomberg, Jeanna Smialek & Ian Katz (1/10/13)
How will the US government shutdown affect the global economy? The Guardian, Larry Elliott and Guy Grandjean (1/10/13)
How would a government shutdown affect the rebounding economy? Aljazeera, Duarte Geraldino (30/9/13)
How will the US government shutdown affect the economy? BBC News, Richard Lister (1/10/13)
Shutdown continues as Obama and Republicans fail to agree BBC News, Rajini Vaidynathan (2/10/13)
Former US Secretary of Labor Robert Reich on shutdown BBC News, Robert Reich (2/10/13)
Government shutdown: What’s the cost? CBS News, Rebecca Kaplan (1/10/13)
US shutdown will have ‘minimal impact’ on global economy One News (New Zealand), Dan Zirker (2/10/13)
What is the US debt ceiling? BBC News, Hugh Pym (14/10/13)

Articles
US wakes up to government shutdown as Congress fails to strike budget deal Independent, Nikhil Kumar (1/10/13)
US begins government shutdown as budget deadline passes BBC News (1/10/13)
David Cameron warns on world growth as US government shuts down The Telegraph, Damien McElroy (1/10/13)
Shutdown showdown: A glossary Aljazeera, Ben Piven (30/9/13)
Everything you need to know about how the partial shutdown will work in US Independent, Brad Plumer (1/10/13)
What’s the economic impact of a US government shutdown? BBC News, Kim Gittleson (1/10/13) (follow links at top of screen for further articles)
US government shutdown isn’t the worst of it BBC News, Linda Yueh (30/9/13)
Onset of the storm BBC News, Robert Peston (1/10/13)
The gathering storm? BBC News, Robert Peston (30/9/13)
Government shutdown: what’s really going on – and who’s to blame? The Guardian, Dan Roberts (30/9/13)
Government shutdown threat is getting very old, very fast CNN, Julian Zelizer (30/9/13)
US fiscal cliff fears rattle the markets The Australian, Adam Creighton (1/10/13)
U.S. Government Shutdown Sinks Dollar Forbes, Dean Popplewell (1/10/13)
US Government Shutdown: European Markets Not Fretting Over Temporary Closure International Business Times, Ishaq Siddiqi (1/10/13)
The States to plunge into abyss of debt, off fiscal cliff Pravda, Irina Sabinina (1/10/13)
Shutting down the United States government nothing new The Vancouver Sun, Andrew Coyne (1/10/13)
Christine Lagarde urges US that debt crisis threatens world economy The Guardian, Larry Elliott (3/10/13)
U.S. failure to lift debt ceiling could damage world – IMF Reuters (3/10/13)

Data
US government shutdown: in numbers The Guardian (see also)
US Budget: Historical Tables White House Office of Management and Budget (includes estimates to 2018 as well as historical data)

Questions

  1. If a debt ceiling is reached, what does this imply for the budget deficit?
  2. How serious are the two current fiscal cliffs?
  3. How would a continuation of the partial government shut-down impact on the US private sector?
  4. What multiplier effects on the rest of the world are likely to arise from a cut in US government expenditure or a rise in taxes? What determines the size of these multiplier effects?
  5. Explain the likely effect of the current crisis on the exchange rate of the dollar into other currencies.
  6. Why might the looming problem of reaching the debt ceiling drive up long-term interest rates in the USA and beyond?
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