In its latest Commodity Special Feature (pages 43 to 53 of the October 2020 World Economic Outlook), the IMF examines the future of oil and other commodity prices. With the collapse in oil demand during the early stages of the coronavirus pandemic, oil prices plummeted. Brent crude fell from around $60 per barrel in late January to below $20 in April.
However, oil prices then rose somewhat and have typically been between $40 and $45 per barrel since June 2020 – still more than 35% lower than at the beginning of the year (see chart below: click here for a PowerPoint). This rise was caused by a slight recovery in demand but largely by supply reductions. These were the result partly of limits agreed by OPEC+ (OPEC, Russia and some other non-OPEC oil producing countries) and partly of reduced drilling in the USA and the closure of many shale oil wells which the lower prices had made unprofitable.
The IMF considers the future for oil prices and concludes that prices will remain subdued. It forecasts that petroleum spot prices will average $47 per barrel in 2021, up only slightly from the $42 average it predicts for 2020.
On the supply side it predicts that ‘stronger oil production growth in several non-OPEC+ countries, a faster normalization of Libya’s oil production, and a breakdown of the OPEC+ agreement’ will push up supply and push down prices. Even if the OPEC+ agreement holds, the members are set to ease their production cut by nearly 25% at the start of 2021. This rise in supply will be offset to some extent by possibly ‘excessive cuts in oil and gas upstream investments and further bankruptcies in the energy sector’.
On the demand side, the speed of the recovery from the pandemic will be a major determinant. If the second wave is long-lasting and deep, with a vaccine available to all still some way off, oil demand could remain subdued for many months. This will be compounded by the accelerating shift to renewable energy and electric vehicles and by government policies to reduce CO2 emissions.
Oil price data
- Describe a scenario in which oil prices rebound significantly over the coming months. Illustrate your answer with a supply and demand diagram.
- Describe a scenario in which oil prices fall over the coming months. Again, illustrate your answer with a supply and demand diagram.
- How are the price elasticities of demand and supply relevant to the size of any oil price change?
- Project forward 10 years and predict whether oil prices will be higher or lower than now. What are the major determinants of supply and demand in your prediction?
- What are oil futures? What determines oil future prices?
- How does speculation affect oil prices?
In March 2020, the UK government introduced a Coronavirus Job Retention Scheme. Businesses that had to close or cut back could put staff on furlough and the scheme would allow employers to claim 80% of workers’ wages up to £2500 per month. This would be passed on to workers.
There was large-scale uptake of the scheme. By the end of August, 9.6 million employees were on furlough (28% of the workforce) from around 1.2 million employers (61% of eligible employers). The scheme significantly stemmed the rise in unemployment. The claimant count rose 121% from March to August from 1.24 million to 2.74 million, far less than it would have done without the furlough scheme.
Since 1 August the level of support has been reduced in stages and is due to end on 31 October. It will then be replaced by a new ‘Job Support Scheme (JSS)‘ running from 1 November 2020 to 30 April 2021. Initially, employees must work at least 33% of their usual hours. For hours not worked, the government and the employer will pay a third each. There would be no pay for the final third. This means that an employee would receive at least 77.7% (33% + (2/3)67%) of their full pay – not far short of the 80% under the furlough scheme.
Effects on unemployment
Will the scheme see a substantial rise in unemployment, or will it be enough to support a gradual recovery in the economy as more businesses are able to reopen or take on more staff?
On first sight, it might seem that the scheme will give only slightly less job protection than the job furlough scheme with employees receiving only a little less than before. But, unlike the previous scheme, employers will have to pay not only for work done, but also an additional one-third for work not done. This is likely to encourage employers to lay off part of their staff and employ the remainder for more than one-third of their usual hours. Other firms may simply not engage with the scheme.
What is more, the furlough scheme paid wages for those previously employed by firms that were now closed. Under the new scheme, employees of firms that are forced to stay closed, such as many in the entertainments industry, will receive nothing. They will lose their jobs (at least until such firms are able to reopen) and will thus probably have to look for a new job. The scheme does not support them.
The government acknowledges that some people will lose their jobs but argues that it should not support jobs that are no longer viable. The question here is whether some jobs will eventually become viable again when the Covid restrictions are lifted.
With Covid cases on the rise again and more restrictions being imposed, especially at a local level, it seems inevitable that unemployment will continue to rise for some time with the ending of the furlough scheme and as the demand for labour remains subdued. The ending of the new scheme in April could compound the problem. Even when unemployment does begin to fall, it may take many months to return to pre-pandemic levels.
Update: expansion of the scheme
On 9 October, with Covid-19 cases rising rapidly in some parts of the country and tighter restrictions being imposed, the government announced that it was extending the scheme. From 1 November, employees of firms in certain parts of the country that would be required to close by the government, such as bars and restaurants, would be paid two-thirds of their previous wages by the government.
Critics of this extension to the scheme argue many firms will still be forced to shut because of lack of demand, even though they are not legally being required close. Employees of such firms will receive nothing from the scheme and will be forced onto Universal Credit. Also, the scheme will mean that many of the workers who do receive the money from the government will still face considerable hardship. Many will previously have been on minimum wages and thus will struggle to manage on only two-thirds of their previous wages.
- Job Support Scheme: What will I be paid after furlough?
BBC News, Eleanor Lawrie (1/10/20)
- Chancellor unveils new Job Support Scheme and extends self-employed grant
MSE News, Callum Mason (24/9/20)
- Sunak has bought himself time, but his big test will come as crisis eases
IFS Newspaper article, Paul Johnson (28/9/20)
- The businesses that feel left behind by Sunak’s jobs support scheme
Channel 4 News, Paul McNamara (25/9/20
- Covid: Jobs scheme ‘won’t stop major rise in unemployment’
BBC News (25/9/20)
- How the new Job Support Scheme will work
FT Adviser, Richard Churchill (30/9/20)
- Covid scheme: UK government to cover 22% of worker pay for six months
The Guardian, Phillip Inman (24/9/20)
- Hard winter ahead as Sunak tries to stop job losses hitting postwar record
The Guardian, Larry Elliott (24/9/20)
- Job Support Scheme ‘won’t reduce job losses’
Personnel Today, Ashleigh Webber (25/9/20)
- Sunak’s new job support scheme offers warm words but no escape from the coming unemployment chill
The Conversation, David Spencer (24/9/20)
- If people on furlough were counted as unemployed, find out what would have happened to the unemployment rate between March and August 2020.
- If an employer were previously employing two people doing the same type of job and now has enough work for only one person, under the Job Support Scheme would it be in the employers’ financial interest to employ one worker full time and make the other redundant or employ both of the workers half time? Explain your arguments.
- What are the arguments for and against the government supporting jobs for more than a few months?
- What determines the mobility of labour? What policies could the government pursue to increase labour mobility?
- Find out what policies to support employment or wages have been pursued by two other countries since the start of the pandemic. Compare them with the policies of the UK government.
The LSE’s Centre for Economic Performance has just published a paper looking at the joint impact of Covid-19 and Brexit on the UK economy. Apart from the short-term shocks, both will have a long-term dampening effect on the UK economy. But they will largely affect different sectors.
Covid-19 has affected, and will continue to affect, direct consumer-facing industries, such as shops, the hospitality and leisure industries, public transport and personal services. Brexit will tend to hit those industries most directly involved in trade with Europe, the UK’s biggest trading partner. These industries include manufacturing, financial services, posts and telecommunications, mining and quarrying, and agriculture and fishing.
Despite the fact that largely different sectors will be hit by these two events, the total effect may be greater than from each individually. One of the main reasons for this is the dampening impact of Covid-19 on globalisation. Travel restrictions are likely to remain tighter to more distant countries. And countries are likely to focus on trading within continents or regions rather than the whole world. For the UK, this, other things being equal, would mean an expansion of trade with the EU relative to the rest of the world. But, unless there is a comprehensive free-trade deal with the EU, the UK would not be set to take full advantage of this trend.
Another problem is that the effects of the Covid-19 pandemic have weakened the economy’s ability to cope with further shocks, such as those from Brexit. Depending on the nature (or absence) of a trade deal, Brexit will impose higher burdens on trading companies, including meeting divergent standards and higher administrative costs from greater form filling, inspections and customs delays.
- Referring to the LSE paper, give some examples of industries that are likely to be particularly hard hit by Brexit when the transition period ends? Explain why.
- Why have university finances been particularly badly affected by both Covid-19 and Brexit? Are there any other sectors that have suffered (or will suffer) badly from both events?
- Is there a scenario where globalisation in trade could start to grow again?
- Has Covid-19 affected countries’ comparative advantage in particular products traded with particular countries and, if so, how?
- The authors of the LSE report argue that ‘government policies to stimulate demand, support workers to remain in employment or find new employment, and to support businesses remain essential’. How realistic is it to expect the government to provide additional support to businesses and workers to deal with the shock of Brexit?
In a little over a decade economies around the world have experienced two ‘once-in-a-lifetime’ shocks. First, there was the global financial crisis of the late 2000s, which saw an unsustainable expansion of banks’ balance sheets that resulted in a global economic slowdown. Now in 2020, a global health emergency has meant unprecedented falls in economic activity. In both cases, the public sector has been the economy’s shock absorber but this has had dramatic effects on its financial wellbeing. We consider here the effect on the UK public finances and reflect on their sustainability in light of the recent Fiscal Sustainability Report published by the Office of Budget Responsibility (OBR).
The COVID-19 pandemic saw the government initiate a range of fiscal interventions to support people and businesses. Interventions directly affecting public-sector spending included a series of employment support measures. These included the Coronavirus Job Retention Scheme, commonly referred to as the furlough scheme, the Self-employed Income Support scheme, a ‘Kickstart Scheme’ of work placements for universal credit recipients aged between 16 and 24 and a ‘Job Retention Bonus’ whereby employers can receive a one-off payment of £1,000 for every furloughed employee continuously employed from the cessation of the Job Retention Scheme on 31 October through to 31 January 2021.
Further spending interventions have included small business grant schemes, such as the Coronavirus Small Business Grant Fund, the coronavirus Retail, Hospitality and Leisure Grant Fund and the Coronavirus Local Authority Discretionary Grants Fund.
Meanwhile, taxation relief measures have included a business rates holiday for retail, hospitality and leisure businesses and a reduced rate of VAT of 5 per cent for hospitality, accommodation and attractions until 12 January 2021.
OBR’s central scenario
The OBR in its Fiscal Stability Report in July 2020 attempts to assess the wellbeing of the public finances not just in the short term but in the medium and longer term too. This longer-term perspective allows it to assess the sustainability of the public finances.
Its analysis is based on some key assumptions, including population growth and future demands on public services, but, understandably, the timing of this report has necessitated some key assumptions around path of the economy, including the extent to which the economy will experience scarring effects, also known as hysteresis effects. While the analysis does not incorporate the Chancellor’s measures announced in its summer statement on the 8 July, including the kickstart scheme, job retention bonus and the reduced rate of VAT, which would have a material effect on this year’s numbers, the OBR concludes that there would be less significant impact on its medium-term analysis.
In what it describes as its ‘central scenario’ the OBR forecasts that national output (real GDP) will fall by 12 per cent in 2020 before growing by 9 per cent in 2021 and 4 per cent in 2022. National output therefore reaches its pre-virus peak at the end of 2022. However, 20 quarters on from the pandemic shock in Q1 2020 output is estimated to be 3.2 per cent less than it would otherwise have been, while the cumulative loss of output is expected to be 6.4 per cent over the period. The cumulative loss of output in the 20 quarters following the financial crisis (Q2 2008) is estimated to have been 9.3 per cent of actual cumulative output.
While national output is expected to be permanently lower because of the pandemic, consistent with hysteresis, the forecast assumes that the longer-term growth rate is unaffected. In other words, there is not expected to be what some now refer to as ‘super hysteresis’, whereby the scarring effects have persistent effects on rates of capital accumulation, innovation and productivity, which therefore depress structural economic growth rates.
Meanwhile, the unemployment rate is expected to peak at 11.9 per cent in the final quarter of this year, before falling to 8.8 per cent in Q4 2021 and 6.3 per cent in Q4 2022. By Q4 2025 the unemployment rate is forecast to be 5.1 per cent, one percentage point higher than the OBR was forecasting at the time of the Budget in March.
Spending and receipts
Chart 1 shows shows the predicted paths of (nominal) public-sector receipts and expenditures as a percentage of (nominal) GDP. Receipts are expected come in at £740 billion this financial year (excluding the impact of the summer statement measures), some £133 billion lower than was forecast at the time of the March budget. This will amount to a 10 per cent fall in receipts in the financial year, driven by a much-shrunken economy. However, the fact that nominal GDP falls somewhat more means that the receipts-to-GDP ratio ticks up slightly. (Click here for a PowerPoint of the chart.)
Public-sector spending is expected to be higher in 2020/21 than was forecast in the March by £135 million (excluding the summer statement measures) reflecting the COVID-19 interventions. This would result in spending rising to £1.06 trillion, a 20 per cent rise in the financial year. It would also mean that public-sector spending as a share of GDP rises to 54 per cent – its highest since 1945/46.
Going forward, in cash terms receipts are permanently lower than forecast because GDP is lower, though as a share of GDP cash receipts increase very slightly, but remain below what was expected at the time of the March budget. Spending in cash terms is expected to fall back by close to 8 per cent next financial year before increasing by 3 per cent per year up to 2024/25. This means that the spending-to-GDP ratio falls back to around 43 per cent by 2024/25, a couple of percentage points higher than was forecast back in March.
Deficits and debt
The difference between spending and receipts is known as public-sector net borrowing. While the extent of borrowing can be inferred by inspection of Chart 1, it can be seen more readily in Chart 2 which plots the path of public-sector net borrowing as a share of GDP.
The OBR is now forecasting a budget deficit of £322 billion (excluding the summer statement measures) in 2020/21 compared to £55 billion at the time of the March Budget. This would be equivalent to over 16 per cent of GDP, the highest since the Second World War. In a follow-up presentation on the Fiscal Stability Report on the 14 July the OBR suggested that the inclusion of summer statement measures could mean the deficit being as high as £375 billion, implying a deficit-to-GDP ratio of just shy of 19 per cent. (Click here for a PowerPoint of the chart.)
Deficits represent borrowing and are therefore a flow concept. The accumulated deficits over the years (minus any surpluses) gives total debt, which is a stock concept. The public-sector’s net debt is its gross debt less its liquid assets, principally deposits held with financial institutions and holdings of international reserves. This is also affected by Bank of England interventions, such as the Term Funding Scheme which enables banks and building societies to borrow funds at close to Bank Rate for up to four years. Nonetheless, the key driver of net debt-to-GDP ratio going forward is the persistence of deficits.
Chart 3 shows the expected path of the net debt-to-GDP ratio. The OBR expects this to exceed 100 per cent in 2020/21 for the first time since 1960/61. This reflects an increase in cash terms of the stock of net debt to £2.2 trillion, up from £1.8 trillion at the end of 2019/20, as well as a fall in GDP. By 2024/25 the net debt stock is expected to have risen to £2.6 trillion, £600 billion more than expected at the time of the March budget, with the net debt-to-GDP ratio still above 100 per cent at 102.1 per cent. (Click herefor a PowerPoint of the chart.)
The higher debt-to-GDP ratio raises longer-term questions about the sustainability of the public finances. The government is currently reviewing its fiscal rules and is expected to report back in time for the autumn budget. A key question is what debt-stabilising level might be considered appropriate. Is it the 102 per cent that the OBR is predicting at the end of 2024/25 (the medium-term horizon)? Or is it the 75 per cent that was being forecast for this point back in the March budget? This has profound implications for the fiscal arithmetic and, specifically, for the primary balance (the difference between non-interest spending and receipts) that the public sector needs to run.
If the government accepts a higher debt-to-GDP ratio as a ‘new norm’ that eases the fiscal arithmetic somewhat. However, some economists would be concerned about the economic consequences of larger public-sector debts, most notably so-called potential crowding-out effects on private-sector investment if upward pressure on interest rates was to materialise (see the news item MMT – a Magic Money Tree or Modern Monetary Theory?).
Even if the higher stabilising debt level was deemed appropriate, the OBR’s report analysis suggests problems in the government meeting this because it could still be running a primary deficit of 3.7 per cent of GDP by 2024/25. Therefore, even with interest rates expected to be lower than economic growth rates in 2024/25 (a negative growth-corrected interest rate) that enable governments to run primary deficits and yet maintain debt-to-GDP ratios, the debt-stabilising primary deficit for 2024/25 is estimated at only 3.2 per cent. All in all, this points to difficult fiscal choices ahead.
- What do you understand by the term financial wellbeing? What might this mean in respect of the government?
- What is meant by the fiscal arithmetic of government debt? Explain the factors that determine the fiscal arithmetic and the path of government debt?
- What is the difference between an increase in the size of a government deficit and an increase in the stock of government debt?
- Discuss the economic argument that, following the COVID-19 pandemic, government should avoid a return to an agenda of fiscal austerity ?
- What is the difference between the budget deficit, the primary deficit and the structural deficit?
- What are hysteresis effects? Discuss their relevancy in the design of the UK’s COVID-19 interventions.
Is there a ‘magic money tree’? Is it desirable for central banks to create money to finance government deficits?
The standard thinking of conservative governments around the world is that creating money to finance deficits will be inflationary. Rather, governments should attempt to reduce deficits. This will reduce the problem of government expenditure crowding out private expenditure and reduce the burden placed on future generations of having to finance higher government debt.
If deficits rise because of government response to an emergency, such as supporting people and businesses during the Covid-19 pandemic, then, as soon as the problem begins to wane, governments should attempt to reduce the higher deficits by raising taxes or cutting government expenditure. This was the approach of many governments, including the Coalition and Conservative governments in the UK from 2010, as econommies began to recover from the 2007/8 financial crisis.
‘Modern Monetary Theory‘ challenges these arguments. Advocates of the theory support the use of higher deficits financed by monetary expansion if the money is spent on things that increase potential output as well as actual output. Examples include spending on R&D, education, infrastructure, health and housing.
Modern monetary theorists still accept that excess demand will lead to inflation. Governments should therefore avoid excessive deficits and central banks should avoid creating excessive amounts of money. But, they argue that inflation caused by excess demand has not been a problem for many years in most countries. Instead, we have a problem of too little investment and too little spending generally. There is plenty of scope, they maintain, for expanding demand. This, if carefully directed, can lead to productivity growth and an expansion of aggregate supply to match the rise in aggregate demand.
Government deficits, they argue, are not intrinsically bad. Government debt is someone else’s assets, whether in the form of government bonds, savings certificates, Treasury bills or other instruments. Provided the debt can be serviced at low interest rates, there is no problem for the government and the spending it generates can be managed to allow economies to function at near full capacity.
The following videos and articles look at modern monetary theory and assess its relevance. Not surprisingly, they differ in their support of the theory!
- Modern monetary theory: the rise of economists who say huge government debt is not a problem
The Conversation, John Whittaker (7/7/20)
- Modern Monetary Theory: How MMT is challenging the economic establishment
ABC News, Gareth Hutchens (20/7/20)
- What is Modern Monetary Theory and is it THE answer?
Sydney Morning Herald, Jessica Irvine (2/7/20)
- MMT: what is modern monetary theory and will it work?
MoneyWeek, Stuart Watkins (14/7/20)
- MMT: the magic money tree bears fruit
MoneyWeek, Stuart Watkins (17/7/20)
- Modern Monetary Theory is no Magic Money Tree
Adam Smith Institute, Matt Kilcoyne (20/5/20)
- “Modern Monetary Theory” Goes Mainstream
Forbes, Nathan Lewis (10/7/20)
- How Boris Johnson’s Conservatives have become Magic Money Tree huggers
The Scotsman, Bill Jamieson (16/7/20)
- Ignore the impacts of debt-fuelled stimulus at your peril
Livewire, David Rosenbloom (14/7/20)
- Modern Monetary Theory, explained
Vox.com, Dylan Matthews (16/4/19)
- Compare traditional Keynesian economics and modern monetary theory.
- Using the equation of exchange, MV = PY, what would a modern monetary theorist say about the effect of an expansion of M on the other variables?
- What is the role of fiscal policy in modern monetary theory?
- What evidence might suggest that money supply has been unduly restricted?
- When, according to modern monetary theory, is a rising government deficit (a) not a problem; (b) a problem?
- Is there any truth in the saying, ‘There’s no such thing as a magic money tree’?
- Provide a critique of modern monetary theory.