Increasing deficit cuts right through the Chancellor’s spin on Britain’s economy

Our downgraded Chancellor claimed the economy is growing, which is a bit rich


It has now become clear that George Osborne has a strategy to increase the deficit. Wasn’t the point of all this austerity garbage to get the deficit down? Well that hasn’t worked, as many of us warned it wouldn’t. If you deal with growth, the deficit takes care of itself – trying to cut spending has smashed growth.

The Office for National Statistics made it clear that, despite all of the Chancellor’s attempts to fiddle the data, borrowing rose last year. Excluding one-offs such as the transfer of the Royal Mail pension fund and the Bank of England’s gilt holdings under quantitative easing, borrowing was £118.8bn in 2012-13, up from £118.5bn the year before.

This is an immediate blow to Slasher’s deluded claims in his Mansion House speech that the economy has moved from “rescue to recovery”, and “Britain has left intensive care”, which it indubitably hasn’t.

The green shoots are extremely thin on the ground. Our downgraded Chancellor also claimed the economy is growing, which is a bit rich given that it has hasn’t grown at all over the last six months and four of the last six quarters have been negative.

Even if we see some growth in the second quarter, this is likely to disappear in the second half of the year. For the umpteenth time, Mr Osborne claimed “the British economy is healing”,’ which seems as much of a stretch as his claims that “record numbers are in work”.

Let’s take a quick look at this one. It is true that the number of people in employment is higher than it has ever been but so is the number of inactive people, who are out of the labour force. Taking this into account, the employment rate in April was 58.5 per cent compared with 60.0 per cent in April 2001, 60.1 per cent in April 2005 and 59.0 per cent in April 2009. Not so good after all. More spin.

Also last week, a couple of my good friends, a present professor at the London School of Economics and a former one, received richly deserved knighthoods – Nobel laureate in economics Chris Pissarides and the chairman of the Migration Advisory Committee and external examiner on my PhD thesis, David Metcalf. This is two for the good guys.

Also, the incoming Bank of England Governor Mark Carney, who is going to inherit a sticky wicket, started appointing his folks at the Bank, making Charlotte Hogg the chief operating officer, hopefully to sweep out the dross at the Bank of England and run its day-to-day operations. It’s a good start on changing the culture, and hopefully the new rock-star governor will bring in more of his people soon.

The outgoing Governor, Sir Mervyn – now Lord – King, got his peerage, which he clearly did deserve for his years of service and hard work.

In economic terms, though, the main event that caused all sorts of gyrations on the financial markets was the much-awaited policy decision of the US Federal Reserve.

The fear had been that the 12 voting members of the policymaking Federal Open Market Committee, comprising seven Federal Reserve governors and five Reserve Bank presidents, might taper the level of quantitative easing from the $45bn (£29bn) a month of Treasury bonds and $40bn a month of mortgage backed securities (MBS).

In my view, the market got it wrong and misinterpreted it as being hawkish – it was not. The Fed’s chairman Ben Bernanke simply made it clear that the exit strategy was path-dependent, and would move according to where the data went.

The FOMC determined that there would be no change for now to the asset purchase programme but did note in the statement it issued that “fiscal policy is restraining growth”, just as it is in the UK.

The committee made clear that the target rate for the Federal funds rate would remain at 0 per cent to 0.25 per cent as long as the unemployment rate remains above 6.5 per cent, inflation between one and two years ahead is projected to be no more than half a percentage point above the committee’s 2 per cent longer-run goal, and longer-term inflation expectations continue to be “well-anchored”.

In determining how long to maintain a highly accommodative stance on monetary policy, the committee will also consider other information, including additional measures of labour market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.

It is clear from the projections provided in the table, based on the views of all 19 participants, that both unemployment and inflation are expected to be lower than they were in March.

If the economy was to follow these projections, it is likely that quantitative easing would cease when unemployment hit seven per cent and interest rates would start to rise when it hit 6.5 per cent.

But if the economy worsened, rates would remain lower for longer, and QE would increase. It is perfectly plausible that employment rises because non-participants get jobs and the unemployed don’t; indeed the most recent data showed the unemployment rate increasing from 7.5 per cent to 7.6 per cent, with the number unemployed increasing by 71,000 on the month while the number inactive fell by 420,000.

Given the slowing of the world economy and the evidence that fiscal policy is hitting the tech sector in the US especially hard, I suspect more QE is likelier than less.

One major additional measure the FOMC will watch to see if the economy is tightening are wages, which have shown no real increase since 2008.

A new chairman will take over at the Fed at the end of January 2014, when Mr Bernanke’s term expires, although his term as a governor has six further years to run. President  Barack Obama has hinted it may not be Mr Bernanke next time around; the bookmakers’ favourite is his deputy Janet Yellen, who is my choice.

This means the markets have little clue what will happen after that, so it looks like forward guidance doesn’t amount to a hill of beans – sorry Mr Carney!

It all depends on the data. Don’t assume tapering from the Fed is a foregone conclusion, despite what the markets think.

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