As one of his first acts, the new UK Coalition government’s Chancellor, George Osborne, set up an independent Office for Budget Responsibility (OBR) (see Nipping it in the Budd: Enhancing fiscal credibility?. The role of the OBR is to provide forecasts of the economy and the data on which to base fiscal policy.
On 14 June, the OBR produced its first forecast in time for the Budget scheduled for 22 June. It has some bad news and some good news. First the bad news: it forecasts that growth for 2011 will be 2.6% – down from the 3–3.5% forecast by Labour in its last Budget in March. But now the good: it forecasts that the public-sector deficit in 2010/11 will be 10.5% of GDP – down from the 11.1% forecast by Labour; and that public-sector debt will be 62.2%, not the 63.6% forecast by Labour. These forecasts are before any policy changes announced in the Budget on 22 June.
Meanwhile, the accountants BDO have published a survey of business confidence. This shows the largest drop since the survey began. Talk by the government of cuts and worries that this will impact directly on the private sector have caused many businesses to cut investment plans. The worries are compounded by fears of a decline in export demand as countries abroad also make cuts.
So what does the future hold? Should we put any faith in forecasts? And should we be more worried about a double-dip recession or by failure to make sufficient inroads to deficits to calm markets?
Articles
Growth forecast is cut but borrowing improves Guardian, Phillip Inman and Hélène Mulholland (14/6/10)
UK watchdog slashes growth forecasts Financial Times, Chris Giles (14/6/10)
Fiscal watchdog downgrades UK growth forecast BBC News (14/6/10)
OBR UK growth forecast downgraded BBC News blogs: Stephanomics, Stephanie Flanders (14/6/10)
‘Sorry it is so complicated’ BBC Daily Politics, Stephanie Flanders (14/6/10)
Britain’s new economic forecasts: what the analysts say Guardian (14/6/10)
Spending cuts under fire amid new borrowing forecasts Independent, Russell Lynch (14/6/10)
The self-fulfilling deficit spiral Guardian, Adam Lent (14/6/10)
UK business confidence sees ‘record drop’ BBC News (13/6/10)
Britain to avoid double dip but recovery will be weak, CBI warns Independent, David Prosser (14/6/10)
A winding path to inflation The Economist (3/6/10)
Is inflation or deflation a greater threat to the world economy? The Economist: debate (1/6/10)
A question for chancellor Osborne Financial Times, Martin Wolf (11/6/10)
Fiscal conservatism may be good for one nation, but threatens collective disaster Independent, Joseph Stiglitz (15/6/10)
Hawks v doves: economists square up over Osborne’s cuts Guardian, Phillip Inman (14/6/10)
Data and forecasts
Pre-Budget forecast Office for Budget Responsibility (14/6/10)
Pre-Budget Report data Google docs (14/6/10)
Forecast for the UK economy: a comparison of independent forecasts HM Treasury (May 2010)
Questions
- How reliable is the OBR’s forecast likely to be? What factors could cause the forecast for economic growth to be (a) an overestimate; (b) an underestimate?
- What is likely to happen to aggregate demand over the coming months? Explain.
- What is meant by the ‘structural deficit’. Why might the structural deficit fall as the economy recovers? Would you explain this in terms of a shift or a movement along the short-term aggregate supply curve?
- Which is the greatest threat over the long term: inflation or deflation?
- Do you agree that the debate about cutting the deficit is merely a question of timing, not of the amount to cut?
- Why may policies of fiscal tightening, if carried out generally around the world, involve the fallacy of composition?
- Is there any common ground between the fiscal ‘hawks’ and fiscal ‘doves’ (see the last Guardian article above)?
In 2008 and 2009, as the global recession deepened, so governments around the world turned to Keynesian policies. Aggregate demand had to be boosted. This meant a combination of fiscal and monetary policies. Fiscal stimulus packages were adopted, combining increased government expenditure and cuts in taxes. On the monetary policy front, central banks cut interest rates to virtually zero and expanded the money supply in bouts of quantitative easing.
The global recession turned out not to be a deep as many had feared and the Keynesian policies were hailed by many as a success.
But how the tide is turning! The combination of the recession (which reduced tax revenues and increased welfare spending) and the stimulus packages played havoc with public finances. Deficits soared. These deficits had to be financed, and increasingly credit agencies and others were asking how sustainable such deficits were over the longer term. These worries have been compounded by the perilous state of the public finances in countries such as Greece, Portugal, Ireland and Hungary. The focus has thus turned to cuts. In fact there is now an international ‘competition’ as to which country can wear the hairiest hair shirt. The new Coalition government in the UK, for example, is busy preparing the general public for deep cuts to come.
We are now seeing a re-emergence of new classical views that increased deficits, far from stimulating the economy and resulting in faster growth, largely crowd out private expenditure. To prevent this crowding out and restore confidence in financial markets, deficits must be rapidly cut, thereby allowing finance to be diverted to the private sector.
But if the contribution to aggregate demand of the public sector is to be reduced, and if consumption, the largest component of aggregate demand, is also reduced as households try to reduce their reliance on borrowing, where is the necessary rise in aggregate demand to come from? We are left with investment and net exports – the remaining two components of aggregate demand, where AD = C + G + I + (X – M).
But will firms want to invest if deficit reduction results in higher taxes, higher unemployment and less spending by the government on construction, equipment and many other private-sector goods and services. Won’t firms, fearing a decline in consumer demand, and possibly a ‘double-dip recession’, hold off from investing? As for export growth, this depends very much on growth in the rest of the world. If the rest of the world is busy making cuts too, then export growth may be very limited.
The G20, meeting in Korea on 4 June, wrestled with this problem. But the mood had definitely turned. Leaders seemed much more concerned about deficit reduction than maintaining the fiscal stimulus.
The following articles look at the arguments between Keynesians and new classicists. The disagreements between their authors reflect the disagreements between economists and between politicians about the timing and extent of cuts.
Articles
Time to plan for post-Keynesian era Financial Times, Jeffrey Sachs (7/6/10)
The Keynesian Endpoint CNBC Guest Blog, Tony Crescenzi (7/6/10)
Keynes, Recovered Boston Review, Jonathan Kirshner (May/June 2010)
How Keynes, not mining, saved us from recession Sydney Morning Herald, Ross Gittins (7/6/10)
The verdict on Keynes Asia Times, Martin Hutchinson (2/6/10)
The G20 Has Officially Voted For Global Depression Business Insider, Marshall Auerback (7/6/10)
Deficit disorder: the Keynes solution New Statesman, Robert Skidelsky (17/5/10)
Hawks v doves: economists square up over Osborne’s cuts Guardian, Phillip Inman (14/6/10)
Reports and data
OECD Economic Outlook No. 87, May 2010 (see)
Economics: Growth rising faster than expected but risks increasing too, says OECD Economic Outlook OECD (26/5/10)
Economy: responses must reflect governments’ views of national situations OECD (26/5/10)
Editorial and summary of projections OECD (26/5/10)
General assessment of the macroeconomic situation OECD (26/5/10)
Statistical Annex to OECD Economic Outlook No. 87 OECD (10/6/10)
Communiqué, Meeting of Finance Ministers and Central Bank Governors, Busan, Republic of Korea G20 (5/6/10)
Questions
- Summarise the arguments for and against making rapid cuts in public-sector deficits.
- What forms can crowding out take? Under what circumstances will a rise in public-sector deficits (a) cause and (b) not cause crowding out?
- Assess the policy measures being proposed by the G20.
- How important is confidence for the success of (a) fiscal stimulus packages and (b) deficit reduction policies in boosting economic growth?
Fears of growing debt problems in the EU have caused global stock markets to plummet. On 25th May, the FTSE was down by 2.6%, Germany’s Dax index fell by 2.34% and in France the Cac 40 was also down 2.74%. Shares across Asia fell, including those in Australia, Hong Kong, Japan and Thailand. On top of this, there are concerns of rising military tensions between North and South Korea. This has only added to the pessimism of investors.
Then came the rescue of the Spanish bank Cajasur by the Bank of Spain, which did little to restore confidence in the world economy. The Spanish deficit has reached 11% of GDP, which is nearly 4 times higher than eurozone rules allow. Spain is also suffering from unemployment of more than 20%, which has led the IMF to call for massive structural reform in the country. The euro has also weakened, as investors sell the currency, because of growing fears of debt default amongst the eurozone countries.
Amid concerns of possible default by Greece, Spain and other countries, the IMF and the members of the European Union have agreed an emergency package of €750 billion (£650 billion). €250 billion comes from the IMF, with €440 billion available as loan guarantees for struggling nations and €60 billion from emergency European Commission funding. We can only wait to see how effective this rescue package will be in restoring confidence in the Eurozone economies.
Articles
Global stock markets see sharp falls BBC News (25/5/10)
Spain must make wide ranging reforms, weak recovery – IMF Reuters (24/5/10)
FTSE falls another 2.5% after Europe’s debt crisis sparks fears in Asian markets Mail Online (25/5/10)
IMF raises fresh concerns about the Spanish economy BBC News (24/5/10)
IMF Chief Economists – doubts over Greek aid remain Reuters, John Irish (24/5/10)
Markets still tense over eurozone debt Independent, Ian Chu (21/5/10)
FTSE falls below 5,000 due to eurozone crisis Telegraph (21/5/10)
FTSE plunges nearly 3% in opening seconds (including video) Sky News (25/5/10)
The contagion of austerity BBC News blogs: Gavin Hewitt’s Europe (25/5/10)
Europe debt crisis threatens recovery, OECD warns BBC News (26/5/10)
Data
In graphics: Eurozone in crisis BBC News (24/5/10)
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission (especially sections 1, 6, 16 and 18)
Questions
- Using a diagram, illustrate why the euro has weakened.
- Explain why stock markets have fallen across the world.
- What type of reforms are needed in Spain?
- What factors are likely to determine the effectiveness of the IMF emergency package?
- Are the austerity measures in the Spanish economy likely to lead to the similar outcomes that we saw in Greece, such as widespread strikes?
- Discuss the advantages and disadvantages of the rescue package. Does rescue involve a moral hazard?
At the start of the new decade, many commentators are getting out their crystal balls to take a look into the future. Below you will find a selection of their predictions, including six extracts from The Economist’s ‘The World in 2010’.
In 2009, the world economy shrank for the first time since 1945. Will it now bounce back, or will global recovery be slow, or will there be a ‘double-dip recession’ with output falling once more before sustained recovery eventally sets in? And what about particular economies? How will the UK fare compared with other countries? How will the USA and the eurozone perform? Will China and India be the powerhouses of global recovery?
Then there is the whole question of the financial sector. Is it now fixed? Will businesses and consumers have sufficient access to credit – is the credit crunch over? Has toxic debt been expunged from the banking system? Do banks now have sufficient capital?
And what about debt? Even though private-sector debt is falling in many countries as households and businesses scale back borrowing and as banks have imposed tighter lending criteria, public-sector debt is soaring around the world. Will financial markets continue to support these growing levels of sovereign debt? Will central banks have to continue with quantitative easing in order to support these levels of debt and to keep interest rates down?
Economic Outlook: 2010 may narrow gap Financial Times, Chris Flood (27/12/09)
CIPD Annual Barometer Forecast: UK economy to shed a further 250,000 jobs before unemployment peaks at 2.8 million in 2010 Chartered Institute of Personnel and Development (CIPD) (21/12/09)
Unemployment ‘set to peak in 2010’ Guardian (29/12/09)
Unemployment ‘will peak at 2.8m’ in 2010 BBC News (29/12/09)
What employment prospects lie ahead in 2010? BBC News, Shanaz Musafer (3/1/10)
Money printing scheme is working, Bank of England says Times Online, Gráinne Gilmore and Francesca Steele (1/1/10)
Bank optimism rises as credit to business eases Guardian, Ashley Seager (31/12/09)
The world in 2010: China continues its unstoppable economic charge Independent, Alistair Dawber (2/1/10)
The US slowly emerges from the gloom of 2009 Independent, Alistair Dawber (2/1/10)
Year dominated by weak dollar Financial Times, Anjli Raval (2/1/10)
A year when tipsters took a tumble Times Online, David Wighton (1/1/10)
PMEAC pegs growth at 8% in ’10-11 Times of India (2/1/10)
China and the other Brics will rebuild a new world economic order The Observer, Ashley Seager (3/1/10)
Five countries that crashed and burned in the credit crunch face a hard road to recovery The Observer, Heather Stewart, Ashley Seager, David Teather, Richard Wachman and Zoe Wood (3/1/10)
HSBC goes out on a limb and predicts growth beyond dreams of Chancellor Times Online, Gráinne Gilmore (2/1/10)
Uncertainty dogs sterling Financial Times, Peter Garnham (2/1/10)
A tough year to forecast as recovery hangs in the balance Scotsman, George Kerevan (30/12/09)
Unstable equilibrium in 2010 BBC News blogs, Peston’s Picks (30/12/09)
Intriguing economic questions for 2010 BBC News blogs, Stephanomics (23/12/09)
The hard slog ahead The Economist (13/11/09)
In the wake of a crisis The Economist (13/11/09)
Now for the long term The Economist, Matthew Bishop (13/11/09)
Recessionomics The Economist, Anatole Kaletsky (13/11/09)
The World in 2010: From the editor The Economist, Michael Pilkington (13/11/09)
The hard slog ahead The Economist (13/11/09)
For forecasts of various economies and regions see
World Economic Outlook (OECD)
European Economic Forecast – autumn 2009 (European Commission)
Tables set A and Tables set B from World Economic Outlook (IMF)
Questions
- What is likely to happen to the major economies of the world in 2010?
- How much reliance should be placed on macroeconomic forecasts for the medium term (1 or 2 years)?
- For what reasons might the UK economy fare (a) better or (b) worse than forecast?
- Why has unemployment risen less in the UK, and many other countries too, during the current recession compared to previous recessions? Does the flexibility of labour markets affect the amount that unemployment rises during a period of declining aggregate demand?
- Why may the world face a ‘long hard slog’ in recovering from recession?
- Why is the world in 2010 ‘balanced precariously’ and why are there huge uncertainties? (See Robert Peston’s blog.)
- Why are China and India likely to see much faster rates of economic growth than the USA, the EU and Japan?
- What is likely to happen to stock markets over the coming 12 months? What will be the main factors influencing the demand for and supply of shares?
- What fiscal and monetary policies are most appropriate during the coming 12 months?
There has been much in the news recently about the attempts of governments around the world to tackle two problems: (a) soaring deficits and debt and (b) a slow recovery and a possible slide back into recession. As the previous news item, Over stimulation? Trying to prevent a double dip as Japan’s debt soars, reported, Japan’s approach has been to tackle the second problem first and to give a massive fiscal boost to the economy. Its debt can be tackled later as the economy, hopefully, recovers.
The Irish government, by contrast, in its Budget on 9 December announced sweeping cuts in government expenditure. This included substantial pay cuts for public-sector employees. Getting the public-sector deficit down (projected to be 11.6% of GDP in 2010) was the government’s major priority.
Greece too is under tremendous pressure to cut its public-sector deficit and debt. Forecast to be 125% of GDP in 2010, its public-sector debt is the highest in the eurozone. There are serious worries as to whether Greece will be able to fund the debt.
Meanwhile in the UK, Alistair Darling presented the government’s pre-Budget report. This took a mid-course between the two objectives. He announced modest increases in tax, including a 1% increase in national insurance contributions from 2010, and modest increases in benefits. The overall effect was pretty neutral, leaving the projected public-sector deficit at around 12.6% of GDP in 2010/11, hopefully falling to around 4.4% by 2014/15 as economic growth increases tax revenues. So was this the best compromise: not too tough so as to stifle recovery and not too expansionary so as to cause a soaring of debt and difficulty in funding the necessary borrowing?
So what is the correct balance? Are the situations very different in the four countries or have they merely chosen to prioritise them differently? Should countries make cuts early in order to get their deficits down and avoid a collapse in confidence, but risk falling back into recession? Or should they get growth firmly established before tightening fiscal policy? The following articles look at the issues.
The UK
Key points: The pre-Budget report at-a-glance BBC News (9/12/09)
Alistair Darling to borrow more this year (including video) BBC News (9/12/09)
Walking the line BBC News, Stephanomics, Stephanie Flanders’ blog (10/12/09)
Larry Elliott’s analysis on the pre-budget report (video) Guardian, Larry Elliott and Mustafa Khalili (9/12/09)
Pre-budget report: All boxed in Guardian (10/12/09)
Tax and mend Economist (9/12/09)
Darling defends economic forecasts (including video) Financial Times, Chris Giles and George Parker (9/12/09)
Prevarication and Newspeak will not fix our finances Financial Times, Willem Buiter (9/12/09)
Is UK government debt really that high? BBC News, Richard Anderson (22/12/09)
The measures announced in the pre-Budget report along with a video of the speech, press releases and the full report as a PDF document can be found at the Treasury’s Pre-Budget Report 2009 site.
The Institute for Fiscal Studies has a part of its site dedicated to the pre-Budget report. This contains briefings and analysis. See Pre-Budget Report 2009
Greece
Why Greece Could Be the Next Dubai Time, Adam Smith (9/12/09)
Greece’s debt crisis signals problems for the European Central Bank Guardian, Nils Pratley (8/12/09)
Greek stocks fall 6% on fears over the country’s debt BBC News (8/12/09)
Greek stocks fall 6% on fears over the country’s debt (video) BBC News (8/12/09)
Greece threatens bankruptcy, and the eurozone The Atlantic, Megan McArdle (8/12/09)
Greece Struggles to Stay Afloat as Debts Pile On New York Times, Rachel Donadio and Niki Kitsantonis (11/12/09)
Greece ‘worthy’ of eurozone place BBC News (14/12/09)
Greek PM to unveil steps to allay deficit fears Forbes, Dina Kyriakidou (14/12/09)
Default lines The Economist (3/12/09)
Greeks denying gifts BBC News blogs, Stephanomics, Stephanie Flanders (29/1/10)
Davos 2010: Greece denies a bail-out is needed BBC News (28/1/10)
Ireland
Ireland suffers harshest budget in decades Financial Times, John Murray Brown (9/12/09)
Strong medicine fails to soothe Irish Financial Times, John Murray Brown (9/12/09)
Irish Wince as a Budget Proposal Cuts to the Bone New York Times, Sarah Lyall (9/12/09)
A time to grin and bear it Irish Times (10/12/09)
Germany
German government heads for record debt BBC News (29/12/09)
German minister warns of fiscal crackdown Financial Times, Bertrand Benoit (17/12/09)
Goverment’s draft budget includes record debt levels Deutsche Welle (16/12/09)
General
The banking crisis: Till debt us do part Times Online, David Smith and Jenny Davey (13/12/09)
Sovereign debt burdens keep traders on red alert Fiinancial Times, David Oakley (12/12/09)
Questions
- Are the objectives of tackling recession and getting the public-sector deficit and debt down contradictory aims, or is it merely a question of sequencing?
- To what extent are the situations in the UK, Japan and Ireland similar? Should they be following similar macroeconomic policies?
- Why does it matter if a country has a rising public-sector debt as a proportion of GDP?
- Distinguish between a cyclical deficit and a structural deficit. Why has the UK’s structural deficit got worse? Will it fall as the economy recovers, or will it be only the cyclical deficit that falls?
- Why does Greece’s debt crisis signal problems for the European Central Bank?
- What determines a country’s sovereign credit rating?