As the Chancellor of the Exchequer, Philip Hammond, delivers his first Autumn statement, both the Office for Budget Responsibility (OBR) and the National Institute for Economic and Social Research (NIESR) have published updated forecasts for government borrowing and government debt.
They show a rise in government borrowing compared with previous forecasts. The main reason for this is a likely slowdown in the rate of economic growth and hence in tax revenues, especially in 2017. Last March, the OBR forecast GDP growth of 2.2% for 2017; it has now revised this down to 1.4%.
This forecast slowdown is because of a likely decline in the growth of aggregate demand caused by a decline in investment as businesses become more cautious given the uncertainty about the UK’s relationships with the rest of the world post Brexit. There is also likely to be a slowdown in real consumer expenditure as inflation rises following the fall in the pound of around 15%.
But what might be more surprising is that the public finances are not forecast to deteriorate even further. The OBR forecasts that the deficit will increase by a total of £122bn to £216bn over the period from 2016/17 to 2020/21. The NIESR predicts that it will rise by only £50bn to £187bn – but this is before the additional infrastructure spending and other measures announced in the Autumn Statement.
One reason is looser monetary policy. Following the Brexit vote, the Bank of England cut Bank Rate from 0.5% to 0.25% and introduced further quantitative easing. This makes it cheaper to finance government borrowing. What is more, the additional holdings of bonds by the Bank mean that the Bank returns to the government much of the interest (coupon payments) that would otherwise have been paid to the private sector.
Then, depending on the nature of the UK’s post-Brexit relationships with the EU, there could be savings in contributions to the EU budget – but just how much, no-one knows at this stage.
Finally, it depends on just what effects the measures announced in the Autumn Statement will have on tax revenues and government spending. We will examine this in a separate blog.
But even though public-sector borrowing is likely to fall more slowly than before the Brexit vote, the trajectory is still downward. Indeed, the previous Chancellor, George Osborne, had set a target of achieving a public-sector surplus by 2019/20.
But, would eventually bringing the public finances into surplus be desirable? Apart from the dampening effect on aggregate demand, such a policy could lead to underinvestment in infrastructure and other public-sector capital. There is thus a strong argument for continuing to run a deficit on the public-sector capital account to fund public-sector investment – such investment will increase incomes and social wellbeing in the future. It makes sense for the government to borrow for investment, just as it makes sense for the private sector to do so.
Autumn Statement: Why the damage to the public finances from Brexit might not be as bad as some think Independent, Simon Kirby (22/11/16)
Three Facts about Debt and Deficits NIESR blogs, R Farmer (21/11/16)
Autumn Statement: Big increase in borrowing predicted BBC News, Anthony Reuben (23/11/16)
Economic and fiscal outlook – November 2016 Office for Budget Responsibility (23/11/16)
- Why have the public finances deteriorated?
- How much have they deteriorated?
- What is likely to happen to economic growth over the next couple of years? Explain why.
- How has the cut in Bank Rate and additional quantitative easing introduced after the Brexit vote affected government borrowing?
- What is likely to happen to (a) public-sector borrowing; (b) public-sector debt as a proportion of GDP over the next few years?
- Why is a running a Budget surplus neither a necessary nor a sufficient condition for reducing the government debt to GDP ratio.
- What are the arguments for (a) having a positive public-sector debt; (b) increasing public-sector debt as a result of increased spending on infrastructure and other forms of public-sector capital?
The first article below, from The Economist, examines likely macroeconomic policy under Donald Trump. He has stated that he plans to cut taxes, including reducing the top rates of income tax and reducing taxes on corporate income and capital gains. At the same time he has pledged to increase infrastructure spending.
This expansionary fiscal policy is unlikely to be accompanied by accommodating monetary policy. Interest rates would therefore rise to tackle the inflationary pressures from the fiscal policy. One effect of this would be to drive up the dollar and therein lies significant risks.
The first is that the value of dollar-denominated debt would rise in foreign currency terms, thereby making it difficult for countries with high levels of dollar debt to service those debts, possibly leading to default and resulting international instability. At the same time, a rising dollar may encourage capital flight from weaker countries to the US (see The Economist article, ‘Emerging markets: Reversal of fortune’).
The second risk is that a rising dollar would worsen the US balance of trade account as US exports became less competitive and imports became more so. This may encourage Donald Trump to impose tariffs on various imports – something alluded to in campaign speeches. But, as we saw in the blog, Trump and Trade, “With complex modern supply chains, many products use components and services, such as design and logistics, from many different countries. Imposing restrictions on imports may lead to damage to products which are seen as US products”.
The third risk is that the main beneficiaries of Trump’s likely fiscal measures will be the rich, who would end up paying significantly less tax. With all the concerns from poor Americans, including people who voted for Trump, about growing inequality, measures that increase this inequality are unlikely to prove popular.
That Eighties show The Economist, Free Exchange (19/11/16)
The unbearable lightness of a stronger dollar Financial Times (18/11/16)
- What should the Fed’s response be to an expansionary fiscal policy?
- Which is likely to have the larger multiplier effect: (a) tax revenue reductions from cuts in the top rates of income; (b) increased government spending on infrastructure projects? Explain your answer.
- Could Donald Trump’s proposed fiscal policy lead to crowding out? Explain.
- What would protectionist policies do to (a) the US current account and (b) dollar exchange rates?
- Why might trying to protect US industries from imports prove difficult?
- Why might Trump’s proposed fiscal policy lead to capital flight from certain developing countries? Which types of country are most likely to lose from this process?
- Go though each of the three risks referred to in The Economist article and identify things that the US administration could do to mitigate these risks.
- Why may the rise in the US currency since the election be reversed?
The linked article below from The Economist looks at whether the election of Donald Trump, the effects of the Brexit vote and policies being pursued elsewhere in the world mark a new macroeconomic era. We may be about to witness rising inflation and the end of the era of tight fiscal policy and loose monetary policy. We might see a return of a more Keynesian approach to macreconomic policy.
According to the article, since the financial crisis of 2008, we have been witnessing economies stuck in a liquidity trap. In such cases, there is little scope for further reductions in interest rates. And increases in money supply, in the form of quantitative easing, tend to be held in idle balances, rather than being spent on goods and services. The idle balances take the form of increased bank reserves to rebuild their capital base and increased purchases of assets such as shares and property.
Even if people did believe that monetary policy would work to boost aggregate demand and result in higher inflation, then they would also believe that any such boost would be temporary as central banks would then have to tighten monetary policy to keep inflation within the target they had been set. This would limit spending increases, keeping the economy in the liquidity trap.
With a liquidity trap, fiscal policy is likely to be much more effective than monetary policy in boosting aggregate demand. However, its scope to pull an economy out of recession and create sustained higher growth depends on the extent to which governments, and markets, can tolerate higher budget deficits and growing debt. With governments seeking to claw down deficits and ultimately debt, this severely limits the potential for using fiscal policy.
With the election of Donald Trump, we might be entering a new era of fiscal policy. He has promised large-scale infrastructure spending and tax cuts. Although he has also promised to reduce the deficit, he is implying that this will only occur when the economy is growing more rapidly and hence tax revenues are increasing.
Is Donald Trump a Keynesian? Or are such promises merely part of campaigning – promises that will be watered down when he takes office in January? We shall have to wait and see whether we are about to enter a new era of macroeconomic policy – an era that has been increasingly advocated by international bodies, such as the IMF and the OECD (see the blog post, OECD goes public).
Slumponomics: Trump and the political economy of liquidity traps The Economist (10/11/16)
- Explain what is meant by ‘the liquidity trap’.
- Why is monetary policy relatively ineffective in a liquidity trap? Use a diagram to support your argument.
- Why is fiscal policy (in the absence of public-sector deficit targets) relatively effective in a liquidity trap? Again, use a diagram to support your argument.
- Examine how the Japanese government attempted to escape the liquidity trap? (Search this site for ‘Abenomics’.)
- In what ways may the depreciation of the pound since the Brexit vote help the UK to escape the liquidity trap?
- Could a different form of quantitative easing, known as ‘helicopter money’, whereby government or private spending is financed directly by new money, allow countries to escape the liquidity trap? (Search this site for ‘helicopter money’.)
- Why may a political upheaval be necessary for a country to escape the liquidity trap?
The article below looks at the economy of Brazil. The statistics do not look good. Real output fell last year by 3.8% and this year it is expected to fall by another 3.3%. Inflation this year is expected to be 9.0% and unemployment 11.2%, with the government deficit expected to be 10.4% of GDP.
The article considers Keynesian economics in the light of the case of Brazil, which is suffering from declining potential supply, but excess demand. It compares Brazil with the case of most developed countries in the aftermath of the financial crisis. Here countries have suffered from a lack of demand, made worse by austerity policies, and only helped by expansionary monetary policy. But the effect of the monetary policy has generally been weak, as much of the extra money has been used to purchase assets rather than funding a growth in aggregate demand.
Different policy prescriptions are proposed in the article. For developed countries struggling to grow, the solution would seem to be expansionary fiscal policy, made easy to fund by lower interest rates. For Brazil, by contrast, the solution proposed is one of austerity. Fiscal policy should be tightened. As the article states:
Spending restraint might well prove painful for some members of Brazilian society. But hyperinflation and default are hardly a walk in the park for those struggling to get by. Generally speaking, austerity has been a misguided policy approach in recent years. But Brazil is a special case. For now, anyway.
The tight fiscal policies could be accompanied by supply-side policies aimed at reducing bureaucracy and inefficiency.
Brazil and the new old normal: There is more than one kind of economic mess to be in The Economist, Free Exchange Economics (12/10/16)
- Explain what is meant by ‘crowding out’.
- What is meant by the ‘liquidity trap’? Why are many countries in the developed world currently in a liquidity trap?
- Why have central banks in the developed world found it difficult to stimulate growth with policies of quantitative easing?
- Under what circumstances would austerity policies be valuable in the developed world?
- Why is crowding out of fiscal policy unlikely to occur to any great extent in Europe, but is highly likely to occur in Brazil?
- What has happened to potential GDP in Brazil in the past couple of years?
- What is meant by the ‘terms of trade’? Why have Brazil’s terms of trade deteriorated?
- What sort of policies could the Brazilian government pursue to raise growth rates? Are these demand-side or supply-side policies?
- Should Brazil pursue austerity policies and, if so, what form should they take?
The IMF has just published its six-monthly World Economic Outlook. It expects world aggregate demand and growth to remain subdued. A combination of worries about the effects of Brexit and slower-than-expected growth in the USA has led the IMF to revise its forecasts for growth for both 2016 and 2017 downward by 0.1 percentage points compared with its April 2016 forecast. To quote the summary of the report:
Global growth is projected to slow to 3.1 percent in 2016 before recovering to 3.4 percent in 2017. The forecast, revised down by 0.1 percentage point for 2016 and 2017 relative to April, reflects a more subdued outlook for advanced economies following the June UK vote in favour of leaving the European Union (Brexit) and weaker-than-expected growth in the United States. These developments have put further downward pressure on global interest rates, as monetary policy is now expected to remain accommodative for longer.
Although the market reaction to the Brexit shock was reassuringly orderly, the ultimate impact remains very unclear, as the fate of institutional and trade arrangements between the United Kingdom and the European Union is uncertain.
The IMF is pessimistic about the outlook for advanced countries. It identifies political uncertainty and concerns about immigration and integration resulting in a rise in demands for populist, inward-looking policies as the major risk factors.
It is more optimistic about growth prospect for some emerging market economies, especially in Asia, but sees a sharp slowdown in other developing countries, especially in sub-Saharan Africa and in countries generally which rely on commodity exports during a period of lower commodity prices.
With little scope for further easing of monetary policy, the IMF recommends the increased use of fiscal policies:
Accommodative monetary policy alone cannot lift demand sufficiently, and fiscal support — calibrated to the amount of space available and oriented toward policies that protect the vulnerable and lift medium-term growth prospects — therefore remains essential for generating momentum and avoiding a lasting downshift in medium-term inflation expectations.
These fiscal policies should be accompanied by supply-side policies focused on structural reforms that can offset waning potential economic growth. These should include efforts to “boost labour force participation, improve the matching process in labour markets, and promote investment in research and development and innovation.”
IMF Sees Subdued Global Growth, Warns Economic Stagnation Could Fuel Protectionist Calls IMF News (4/10/16)
The World Economy: Moving Sideways IMF blog, Maurice Obstfeld (4/10/16)
The biggest threats facing the global economy in eight charts The Telegraph, Szu Ping Chan (4/10/16)
IMF and World Bank launch defence of open markets and free trade The Guardian, Larry Elliott (6/10/16)
IMF warns of financial stability risks BBC News, Andrew Walker (5/10/16)
Backlash to World Economic Order Clouds Outlook at IMF Talks Bloomberg, Rich Miller, Saleha Mohsin and Malcolm Scott (4/10/16)
IMF lowers growth forecast for US and other advanced economies Financial Times, Shawn Donnan (4/10/16)
Seven key points from the IMF’s latest global health check Financial TImes, Mehreen Khan (4/10/16)
Latest IMF forecast paints a bleak picture for global growth The Conversation, Geraint Johnes (5/10/16)
IMF Report, Videos and Data
World Economic Outlook, October 2016 IMF (4/10/16)
Press Conference on the Analytical Chapters IMF (27/9/16)
IMF Chief Economist Maurice Obstfeld explains the outlook for the global economy IMF Video (4/10/16)
Fiscal Policy in the New Normal IMF Video (6/10/16)
CNN Debate on the Global Economy IMF Video (6/10/16)
World Economic Outlook Database IMF (October 2016)
- Why is the IMF forecasting lower growth than in did in its April 2016 report?
- How much credibility should be put on IMF and other forecasts of global economic growth?
- Look at IMF forecasts for 2015 made in 2013 and 2012 for at least 2 macroeconomic indicators. How accurate were they? Explain the inaccuracies.
- What are the benefits and limitations of using fiscal policy to raise global economic growth?
- What are the main factors determining a country’s long-term rate of economic growth?
- Why is there growing mistrust of free trade in many countries? Is such mistrust justified?