Economic prospects for the UK - PowerPoint Presentation

Slide1

Economic prospects for the UK

Andrew Smith

Chief Economic Adviser

Industry Forum

June 2015

a

ndrew.smith.economist@gmail.com

Twitter: @

AndrewSmithEconSlide2
What are we talking about?

International economic background and economic policyIssues in Europe

Grexit

UK narrative

Labour over-spent and over-borrowed

This precipitated financial crisis and recession

Conservatives had no option but to adopt austerity

This is what has brought about recovery

Productivity puzzle

Brexit

Secular stagnationSlide3
Financial boom, bust and balance sheet

repair

Balance sheet recession

Over-borrowing by

private sector

precipitated financial crisis

and left legacy of u

nder-priced

debt, over-priced assets, over-stretched borrowers and under-capitalised

lenders (property)

Private sector saving more/de-leveraging, depressing demand

Desired saving > desired borrowing

Liquidity trap – ZIRB

Government deficit reduction the wrong policy

S

ector surpluses/deficits must balance

Household + corporate + government + overseas = 0

Government deficit

reduction

depresses demand

Reliant on unconventional monetary policies

QE, FG

etcSlide4
UK Net Lending (+)/

Borrowing (-) by sector

Source: ONS

£m

Rest of the world

Corporations

Household

GovernmentSlide5
“Recoveries” to date

Source:

Eurostat

GDP % away from peakSlide6
Unemployment rates (%)

Latest June 2015Slide7

Source:

Eurostat

Eurozone

– in(de)

flation

%Slide8
Collapsed bond yieldsSlide9
Background summary

Advanced countries experienced one of the deepest recessions ever and one of the slowest recoveriesOutput remains below previous peak across much of Europe and dramatically below level if it had followed pre-recession trend

Persistent high unemployment in many countries

Positive

output

gaps

ie

unused productive potential

Business investment slow to pick

upMany countries flirting with deflation, led by oil and food prices – but core inflation rates sliding tooGovernment bond yields at unprecedented lows and negative in some countriesAll suggestive of chronic shortage of demandRisk/payoff ratio suggests policymakers should be doing more to boost demandSlide10
Annual growth forecasts

(%)

2010

2011

2012

2013

2014 (f)

2015 (f)

2016 (f)

US

2.5

1.6

2.3

2.2

2.4

3.1

3.1

Japan

4.7

-0.5

1.8

1.6

-0.1

1.0

1.2

Eurozone

2.0

1.6

-0.8

-0.5

0.9

1.5

1.6Developing Asia9.67.76.87.06.86.66.4China10.49.37.87.87.46.86.3Latin America6.14.93.12.91.30.92.0Sub-Saharan Africa6.75.04.25.25.04.55.1

Source:

IMF April 2015 Slide11
Eurozone no longer a crisis, it’s chronic

Monetary union

brought

German-style low interest

rates to PIIGS, resulting

in

private

over-borrowing, property booms, wage inflation, loss of competitiveness and trade

deficits

Financial crisis and recession pushed up government deficits, particularly in “periphery” ECB’s refusal to act as LoLR caused panic in financial markets in 2012 until volte face – “do whatever it takes” and OMT

Germany dictated continuing fiscal austerity across eurozoneRisk of new recession/deflation prompted ECB to adopt form of QE last yearLong-term, to stay together need to complete EMU:Banking union and strengthening of banksFiscal union to validate fiscal transfersPolitical union to legitimise fiscal unionSlide12
Greece “sui generis”Slide13
GREXIT?

In Greece, government over-borrowing/profligacy/lying/corruption

etc

WAS a cause of collapse

Mistake not to agree realistic debt restructuring/write-offs earlier

Bail-out was for German banks which had lent Greece the money – not Greece

Greece can’t run a primary deficit,

nor

a large primary surplus (troika demanded 5% of GDP),

nor realistically pay back its borrowing (debt/GDP 180%)Should be a new deal to run a small primary surplus, but IMF etc insisting on pension and labour market reforms as wellConsequences of GREXIT (default and new currency)Economic and financial markets hiatus

Banks would need to be recapitalised Contracts re-denominated (creditors lose)Contagion risk – financial (markets call ECB bluff) and politicalCould euro survive?Geo-political implicationsInitially more misery for Greece, but if a few years on devaluation worked…….Slide14
UK: GDP growth (% quarter-on-quarter

)

Source: ONSSlide15
UK recessions and recoveries Slide16

UK: household debt to income ratio and household savings ratio

Source:

OBR/ ONS/

Datastream

%

Debt to income (RHS)

Savings ratio (LHS)

%Slide17
UK: employment changes

%

Source: ONS

Months from peakSlide18

UK: consumer confidence

Source: DataStream

BalanceSlide19
UK: inflation and earnings

Source: ONS

%Slide20
Tax

rises and spending cuts (£bn)

Source:

HM TreasurySlide21
Was it all Labour’s fault? Public spending and receipts (% GDP)Slide22
Did Osborne stick to Plan A? UK current budget

deficit (%GDP)Slide23
Front-end loaded austerity?Slide24
UK summary

Osborne’s first-term policy was deficit reduction to produce growth, but didn’t get as much of either as he expected“Expansionary fiscal contraction” doesn’t work when interest rates can’t be reduced further to offset the negative impact on demand – at best will subtract from private sector recovery, at worst overwhelm it

This year’s budget and election manifesto suggest new Government is about to repeat the experimen

t,

with “other half” of deficit reduction to come from swingeing cuts, particularly to welfare (the more so if health,

schools

and overseas aid are “protected”)

What lesson has Osborne learnt from first-term? Tough at start, ease off later, win election?

Budget on July 8 and new Spending Plans later in year

What if another big shock or economic downturn for some other reason?Current contingency planning is to keep fingers crossedIf expansionary fiscal policy ruled out and monetary policy has shot its bolts, left with “helicopter money” – BoE prints money to finance payments to householdsSlide25
UK productivity normally rebounds in and after recessionsSlide26
UK productivity growth – GDP per hour worked, 1979Q1 to 2014Q3Slide27
Productivity puzzle

Measurement problemsDirect effect reduced availability of finance following crisis

Reduced

investment/slowdown in innovation

Impaired resource

reallocation

Low no of

insolvencies/failure to cleanse - firms survived which shouldn’t have?

Labour

hoarding/new jobs are lower productivity jobs?Substitution of cheaper labour for capitalWeakness of demandMost of loss seems to be from within sector and within firm…..……and in TFP – management?Cyclical or structural?Slide28
BREXIT?

What does Cameron want?

Opt-out

from

"

ever closer union"

European ambition (core principle)

Safeguards

to ensure changes in the single market cannot be imposed on non-

eurozone members by the eurozoneProtection for the City of London financial markets from EU legislationGreater powers for national parliaments to block EU legislation“Better“ regulation and flow-back of powers to Member States Continued enlargement of the EU but with new mechanisms “to prevent vast migrations across the Continent“ (but free movement core principle)

Restrict access to in-work and out-of-work benefits to EU migrantsReferendum Q: Should the United Kingdom remain a member of the EU?Referendum to be held by end 2017 – but aiming for 2016? Major Treaty change seems to be ruled out by time-table but scope to fudge, post-dated cheques, etcIf “NO” up to 2 years to negotiate exit terms – could we keep same market access?Followed by SCOXIT?Slide29
Should we be worried about permanent

weak growth?“Secular stagnation” – structural demand issue?

Will desired saving continue to exceed demand for finance for investment?

Ageing populations in West and lack of insurance in EMs raise precautionary savings and increase supply of funds globally?

Tech progress means less capital spending needed - more (cheap) computers, fewer (expensive) steel

mills?

“Natural

” real rate of interest may be negative for extended period

Interest rates could remain low for very long time

Case for expansionary fiscal policy and higher inflation targetOr supply-side weakness?Potential growth rate = change in labour force + productivity growthAgeing populations/declining workforces in West (and China!)IT hasn’t been a transforming technology like electricity, trains, planes?BUT earlier technology waves took time to boost productivity tooSlide30

Budget March 2015

% change y-o-y

2012

2013

2014

2015

2016

2017

2018

GDP

0.3

1.7

2.6

2.5

2.3

2.3

2.3

Household consumption

1.5

1.7

2.0

2.6

2.7

2.5

2.3

Business investment

3.9

5.3

6.8

5.1

7.5

6.56.4Govt consumption1.6-0.31.50.8-0.7-0.9-0.2Exports1.11.50.43.94.04.54.4Public borrowing £bn114.8107.890.275.339.412.8-5.2BofP C Account%GDP-4.0-4.5-5.4-4.3-3.2-2.6

-2.4

Source: HM TreasurySlide31

Economic prospects for the UK

Andrew Smith

Chief Economic Adviser

Industry Forum

June 2015

a

ndrew.smith.economist@gmail.com

Twitter: @

AndrewSmithEcon