Current economic trends - call for evidence

[alphacalifragelistic]

Jeremy, I take your point that government expenditure, is - broadly speaking - dependant upon taxation revenue (and the expectation of future taxation revenue), which in turn is dependant upon the wider economy's health. An initial caveat would be that asset sales, mineral rights licences, etc, can obviously impact revenues. A second one would be that with a fiat currency, the government can do the equivalent of running the printing presses. (I believe the BoE is merely carrying out an electronic transaction for the current Quantitative Easing programme.) However, history has plenty of lessons for us to say that is not such a great idea.

So you are right. Except that you are not.

The government is an economic actor in its own right. By reneging on spending commitments, cancelling funding and reducing payments, it firstly reduces immediate demand. (People have less to spend, therefore they spend less.) Secondly, the insecurity and uncertainty it engenders, reduces the likelihood of private sector investment and commitment of funds on projects that are dependant upon that spending. 'Stop start' government expenditure introduces counter-party and liquidity risk into economic transactions that are reliant upon government expenditure. Since its effect is pervasive throughout the economy, that affects all of us, both directly and indirectly. (What use are the current collection of half built schools and FE colleges that have now had their funds cancelled?)

Let me give you another specific example. What if the next administration were to say that, all things considered, we cannot afford the 2012 Olympics after all and that all spending on it would be cancelled henceforth. The immediate fiscal consequences would be positive, as funding ceased immediately. However, which major commercial or residential property developer would ever trust HMG ever again? All of the future investment projects tied to the Olympics site in Stratford would be reviewed and - most likely - cancelled if possible. (I am ignoring the strictures of contract and tort law here, to simplify the case, as no doubt lawyers would be fired up if this were to occur in reality.) In other words, the secondary effects of reduced capital expenditure on that project would be damaging to the economy.

Rather than commit funds under conditions of either uncertainty, or rather the certainty of ongoing depressed demand, the paradox of thrift kicks in. It is rational to hoard resources if one expects continuous depressed demand. (E.g. Why buy a house if you think prices will fall further?) Keynes believed that economies do not necessarily mean revert to a single specific equilibrium, which was the envisaged classical model at the time. By contrast, he mooted that economies could have a series of different outcome equilibrium states, dependant - at least in part - upon people's expectations. If a government's actions improve the expectations of investors, consumers, producers, by - for the sake of argument - committing to purchase of otherwise abandoned property developments for alternative use as social housing, then - the argument would be that a vicious spiral downwards, via positive feedback, is potentially avoided.

In theory, therefore, there is the potential for government to act as a form of economic stabiliser. As long as it reads economic cycles correctly and spends or invests wisely. I would argue that neither condition has been fulfilled by the current bunch. Goodbye to boom & bust anyone?

Nevertheless, if you buy into the idea that economic cycles can oscillate widely and that there are hysteresis losses for people during the extremes of the cycle, via poor investments at the peaks and the social costs of mass unemployment during the dips, then moderating the amplitude of those cycles appears to make sense. (People who lose their jobs tend to be progressively less likely to find further employment the longer they are out of work.) If governments can effectively do this, then, well why not? (Please note the qualifier in that sentence.) If they are able to stimulate demand during conditions of temporary economic depression, then surely that is beneficial. The difficulty is with knowing when to commit funds, on what and when to stop. One could characterise this as the fiscal equivalent of monetary policy. The risk is committing funds to duff projects such as 'bridges to nowhere' (as witnessed in Alaska and Japan) and building up massive debts which - in turn - negatively affect expectations and drain resources in of themselves, or of throwing so much money into the economy that runaway inflation results.

Now then, a neo-classical economist of the Austrian school would be emitting smoke from both ears by now. It is worth noting that there are now plenty of revisionist reviews of the economic history of the 1930's. The UK did not appear to do as badly as cultural memories (based on contemporary work by Orwell, etc) make out. Nor did the New Deal act as a cure all in the US. (Double digit unemployment only ended there as a consequence of WWII.)

Moreover, the dead weight costs of taxation lower the incentives to produce and potentially reduce the circulation of money. (Check out the 'Laffer Curve' online.) I.e There are valid debates to be held whether government expenditure, or simple tax reduction, would be the better economic stimulus.

There are further complications to do with defining economic growth itself. (If your house is burgled and you claim on the insurance, the economy 'grows' due to the circulation of money. I doubt you would feel any better off though.) I would also add that the increased allocation of resources to the NHS over the past 12 years appears to have been accompanied by a reduction in its productivity. (Good luck measuring that BTW.)

An economy is a dynamic system (with lag effects). Reduced government expenditure, leads to reduced output, which reduces taxation revenue - in of itself, which in turn reduces funds for government expenditure. There is a (semi) closed feedback loop in play. To be fair, on also needs to take other phenomena, such as the 'crowding out' of private investment and consumption by public expenditure, into account.

However, just as bankruptcy risk can outweigh the benefits of altering the debt-equity ratio of a company's finances, the 'pump priming' benefits of government expenditure can be nullified by concerns about fiscal sustainability. If UK interest rates shoot up due to international investors downgrading UK government debt, over fears that it will be unable to repay it (or that the pound will sink due to economic concerns), then it is clearly counter-productive. (S&P has already downgraded its outlook for Britain's sovereign credit AAA rating. We may have already run out of runway.)

It is this constraint, along with fears of inflation if QE continues, which will prevent the UK government from continuing to use fiscal stimulus to maintain current levels of consumption in the economy. I just find it a bit of a stretch to see what will fill the gap. Perhaps I am underestimating our world beating financial services industry?

Lastly, have a look at how austerity measures are affecting Latvia and Ireland. Take a look at how government expenditure is softening the impact in Denmark, Sweden and Norway. (You may want to ignore Norway due to its unrepresentative oil & hydro-power resources.) If you want evidence of the effects of reduced government expenditure, along with control cases for comparison, check them out. Then factor in the forecast of a 7% reduction in UK government expenditure (as evaluated by the IFS) in the current budget.

P.S. Respect to Jeremy for coding the parallel processing of portfolio valuation. Sorry for the nerd question, but are you using something like CUDA on NVIDIA graphics processors?

[Jeremy]

Long post... too much for my tiny brain... point taken about how the action of the govt can stimulate or depress the economy.

[ we've been looking at GPU processing and Cuda... SciComp have a very nifty product in that space... but at the moment we run a datasynapse grid over 200 8-way servers, plus desktop scavenging. This lets us run something like 10,000 simulations over the entire book. ]

[alphacalifragelistic]

Jeremy, I think I'll take that claim of a tiny brain with the use of the same salt that Piers took a pinch from when you suggested you suffered from economic illiteracy.

To stay on topic, before I zoom off it, today's announcement of another ?50bn of Quantitative Easing should indicate what the BoE thinks of the current state of the economy.

In the unlikely event that you have yet to read these, or that anyone else will be remotely interested, there are a couple of papers linked to below on the use of parallel processing to carry out derivatives valuation:

http://techresearch.intel.com/userfiles/en-us/File/terascale/Ct-appnote-option-pricing.pdf

http://www.d-fine.co.uk/deutsch/Bibliothek/Fachartikel/WilmottMagazineJulyAugust2008ChristophBennemannMarkWBeinkerDanielEgloffMichaelGaucklerTeraflopsforGamesandDerivativesPricing.pdf

[Townleygreen]

http://www.telegraph.co.uk/finance/comment/edmundconway/6051182/How-to-save-the-economy-and-make-a-fortune--set-up-a-bank.html

This is an interesting article by Edmund Conway in which he argues that we need to set up a new bank or banks which would force the existing banks to start lending at sensible rates. What they need is a dose of competition from outside their rather cosy little cartel (if that's not too strong a word!), apparently!

[david_carnell]

Jonathan Friedland in the Guardian says something similar but points to Zopa and other peer-to-peer money lending websites as the trend of the future.

Anyone have any experience of these? The interest rates are meant to be favourable to lenders compared to savings accounts and favourable to borrowers compared to standard APR rates. Win win.

[Jeremy]

david_carnell Wrote:

-------------------------------------------------------

> Jonathan Friedland in the Guardian says something

> similar but points to Zopa and other peer-to-peer

> money lending websites as the trend of the

> future.

>

> Anyone have any experience of these? The interest

> rates are meant to be favourable to lenders

> compared to savings accounts and favourable to

> borrowers compared to standard APR rates. Win win.

Sounds interesting, I have not really come across this before. I assume there is a middle man who facilitates the loan - do you know if they cover the "lender" if the "borrower" fails to make a repayment?

[????]

Zopa the future laughing my F***** arse off as they say. Typical wishfull thinking from lefty Guardian writer shocker.....nice idea and check out their website but going to fund mortgages, er, no just a few vaguely socislist metropolitans Tuscany holiday for the kudos value. Shit, the co-op bank has been around for years, advertsing loads during the credit crunch and great 'left' credentials....it has an almost innsignicant share of the current account market. No siree, like it or not the big bag banks will be financing the majority of our credit and supplying us with financial services for the forseeable future.

[louisiana]

The US seems to be following the advice of this Status Quo classic.

Banks that went to the wall in 2008: 25?

Banks that have gone to the wall so far in 2009 (and we're only in August): 81

Meredith Whitney's prediction: 300 by the time it's over

(Meredith was the astute analyst who called the Citibank debacle. She has a good track record.)

[alphacalifragelistic]

I know it's wrong, but I like that Quo track. In fact, I like it, I like it, I like it, I like it, I li-li-like it.

Ahem. Anyway, back to business, or rather economics.

Roubini has yet to cheer up and is predicting a 'U' shaped anaemic recovery:

http://www.ft.com/cms/s/0/90227fdc-900d-11de-bc59-00144feabdc0.html

If you have missed it, Paul Krugman & Niall Ferguson are currently slugging it out over how much QE is too much:

http://business.timesonline.co.uk/tol/business/economics/article6806419.ece

I am not too sure how much to read into Whitney's prediction. Courtesy of state-by-state legislatures, the US does not really 'do' nationwide retail banking to the same extent as the UK, or Europe in general. As a consequence, there are loads of small, poorly capitalised banks, serving local geographic markets. There is actually a fair case to be made for rationalisation and consolidation in that part of the US banking sector, even if that runs against the sentiment of 'It's a Wonderful Life'.

BTW, I always thought Pottersville looked a more exciting place to live than Bedford Falls, but that might indicate that I am at fault, rather than the premise of the film. Although, I note that I am not alone:

http://archive.salon.com/ent/feature/2001/12/22/pottersville/index.html

Pardon me, I digress. Anyway, while aggregation may make sense in that part of the market, it was damaging elsewhere. With the 1999 de facto repeal of Glass-Steagall, commercial and investment banking have already been consolidated in the US, which enabled systemic risk to pass from the investment banks into the 'real economy' and ensure that the sector was too big to fail.

In other words, cross-sector consolidation helped get us into this mess, via the threat of systemic collapse. Sadly, a disaggregation, to give us safer 'utility' banking and high risk investment banking with a decent fire-break in between the two, is not in prospect. Osborne mooted enacting the legislation for it in the UK, but it was swiftly pointed out to him that without the US acting in concert, it would be pointless (and give UK banking a competitive disadvantage), courtesy of the international nature of finance.

Obama has people like Larry Summers (head of the US National Economic Council) in the heart of his administration, who supported the original 1999 repeal of Glass-Steagall while they were in the Clinton White House. So do not expect any movement on this. Fundamental reform, to address the root causes of current problems, looks unlikely. After all, Obama has enough problems with healthcare reform at the moment...

[macroban]

I think this chart is useful in tracking:

Declines in UK GDP

I am aware of the arguments about how GDP is calculated.

The blue line is the minor reduction in GDP in 1990-1993 which some young people call a "recession". Anyone born after 1959 has not been through a real recession as an adult. I don't know how well prepared these young people are for a continuing recession.

My gut reaction is that the GDP reduction may trough at -10%. Thereafter that black line may wobble along the horizontal for a long time.

I hope I an wrong.

[????]

Born 1960=21 in 1981.....arithmetic up there with your grasp of economics I see

[macroban]

Have another look at the data points ????.

[Mick Mac]

Commentary to go with Macroban's graph

"Our monthly estimates of GDP suggest that output rose by 0.2% three months ending in August after a decline of 0.3% in the three months ending in July. This is the first time our GDP indicator has been higher over a three month average since May of 2008 and re-inforces our view that the recession ended in May of this year"

[macroban]

I referenced the NIESR graph because I think it is a useful visual tool.

The NIESR report also has tables which undermine the commentary.

The widely used definition of a recession started life as a political fix in the USA. Two consecutive quarters of falling GDP is a recession. One quarter of falling GDP followed by one quarter of GDP growth is not a recession.

That is self-evidently silly.

The point of the NIESR graph is that it shows the cumulative fall in GDP.

I don't agree that one quarter of GDP growth leaving the cumulative fall in GDP at about 5.4% means the recession has ended.

[Jeremy]

macroban Wrote:

-------------------------------------------------------

> I don't agree that one quarter of GDP growth

> leaving the cumulative fall in GDP at about 5.4%

> means the recession has ended.

I would agree with this in principle... and the graph is quite interesting, it shows that even when there's growth it is often followed by further contraction.

Do you think it's a coincidence that the two obvious "double dips" are the earlier recessions, while the more recent ones don't really follow the same pattern?

[Mick Mac]

Well, based upon what NIESR have said above it suggests to me that a recession ends when you have a single quarter of economic growth.

But I have not googled if that is the right answer.

[alphacalifragelistic]

There is a decent round up of the likely depth of the public sector cutbacks we can expect, by Robert Chote (of the IFS) in today's Times.

http://www.timesonline.co.uk/tol/comment/columnists/guest_contributors/article6837508.ece

Vince Cable is now predicting that we will need a ?112 billion tightening of public sector expenditure over five years.

So, to recap:

- The BoE has put ?175bn of QE into the economy, with the underwhelming result thus far of a temporary plateau in the macroeconomy and house prices.

- Unemployment is increasing fast.

- 10%+ cuts in public spending over 2010-2015 apply directly to the 43% (approx) share of UK GDP that is the public sector's share. Therefore, to be (very) simplistic, Cable's envisaged fiscal tightening would contribute a ceteris paribus reduction in overall GDP of around 4.3% (10% x 43%) by itself. This is on top of the -5.7% (apr) fall detailed in the NIESR graph linked to above.

- The base rate is already at a minimum of 0.5% and will rise if QE induced inflation kicks in.

This is surely a 'W' scenario in the offing, with another dip on the way, even if the pain ends up being distributed selectively rather than broadly.

For instance, if a 10% cut in public sector expenditure is spread evenly, the proportional effect would be almost twice as bad for the North East as for the South East of the UK:

http://www.bbc.co.uk/blogs/thereporters/markeaston/2008/06/map_of_the_week_public_spendin.html

The VAT reversion back to 17.5% (or even the mooted 2010 increase to 20% under consideration by the Conservatives), looks awfully like the sales tax imposition that is thought to have helped snuffed out Japan's recovery in the 1990's. Add in the risk of public sector strikes and / or disruption in response to pay freezes, etc, along with energy price shocks or gaps over the next few years and there seems to be scope for further shocks to the system. Even if it looks as if governments seem determined to support any more wobbly institutions that have the potential to generate systemic financial contagion.

[SeanMacGabhann]

Given how everyone reacted when VAT was reduced ("What's the faaaahkin point of that then? It won't mean anything to me and it'll cost companies a fortune"), if I start hearing people complaining about being ripped-off when it reverts I am going to go spare...

[Jeremy]

House prices have stabilised, equity markets have rallied... I don't know what you were expecting, if you feel this is "underwhelming"? My personal feeling is that as much as I dislike the level of national debt, we have avoided a catastrophe of the proportions we all expected.

Changing the VAT back to 17.5% will have a similar impact to changing it to 15% - i.e. very little.

The double-dip is of course a possibility. Whether this will happen - and whether public spending will be the driver - remains to be seen!

[SeanMacGabhann]

and with respect to anyone going into detail about the various factors, debt values, GDP blah blah blah - I am officially not listening to ANYONE who is making any kind of prediction. If we have learned anything from recent times it's that no-one knows jack. A very very small number of people are able to point to predictions they made 3 years ago, which turned out to be largely true but that doesn't mean it was expertise on their part - it could just as easily have been a maverick reaction to prevailing consensus

It could all fall off a cliff tomorrow or it might start to get better, or it might through another sudden cycle - but we'll manage.

[SeanMacGabhann]

cross posting with Jeremy -

[mockney piers]

Oh dear, our dependency and confidence dependent upon on equity markets and house prices is what got us into this mess. If the signs of us getting out of it are house prices stabilising and equity markets rallying (which infully suspected was browns goal) then truly we have learned nothing and see you here agin in a few years time.

I know boom and bust is a natural cycle but this is silly.

[Brendan]

Mockney you obviously don?t understand the extremely complex nature of our financial system and should just shut up and be grateful that the city is full of fantastically intelligent people who are there to stea.. support and provide for you and everyone else in this country.

[Jeremy]

I disagree Mockney... confidence in property prices certainly had a part to play, but the deeper problem was confidence in people's credit-worthiness, and the endless queue of investors waiting to buy up CDOs. Mortgage lenders were handing out mortgages to people who should have never had them, because they knew they could just pass the liability on. The lessons to be learned are in credit exposure and cash reserves. And realising that risk can't always be managed mathematically.

Equity prices are not the be-all-and-end-all, but surely you remember that equities were in freefall - the FTSE almost halved over a year. This is a dangerous position for the companies, but also investors and pension holders. If you don't think that stopping the rot in the equities market is important... please enlighten us as to what is?

Property prices... I'm not so bothered about this in it's own right, but it is one measure of liquidity and consumer confidence.

[Jeremy]

.