It's Demand stupid

The UK economy shrank in the last three months of 2012. The cause is partly due to recession in the EU, they simply can't afford to buy more of our goods.

Ed Balls tries to claim he saw it coming, which he didn't and should be ridiculed as a naive opportunist who got lucky. But his view that there isn't enough demand in the economy is fundamentally correct.

Yet the Chancellor George Osbourne refuses to see to point. He wants to continue his deficit reduction plan, cutting public spending and raising taxes. While the deficit may shrink, so will Aggregate Demand.

Yesterday Oliver Blanchard, Chief Economist at the IMF (a New-Keynsian) said austerity had gone to far and that an easing up on the [plan was called for. It seems like good advice.

The Government could continue with their cost cutting in government, but they need to learn the lessons of their own explanation of the downturn. If Europe can't add to AD by raising our exports  then its time Government spending did. A one off investment in infrastructure, something 'shovel ready', such as offering all schools a new building or subsidising new low cost homes as long as they start the work within 2013 will help. Such programmes can be extended if need be.

The VW recession is now a possibility.

The BBC report the figures here

Blanchard's view is in this article from the Independent

Inflation targets and QE - lessons from Japan

The Japanese economy has been struggling for a while, since before the Global Financial Crisis. The problem has been a period of prolonged recession and deflation and virtually all policy attempts have failed to correct the situation.

Exports are now falling, previously one of the few bright areas for Japan, and now a serious situation faces the country.

One problem is that the Japanese people just don't want to spend and domestic demand is weak. This is encouraged by the falling price level (deflation), why should you buy goods today when in a few months they will be cheaper? The mentality of the population needs to be changed to help boost Aggregate Demand.

What does not work is lowering interest rates, they have tried that and actually had years of negative real interest rates. There have also been fiscal stimulus packages that have seen tax cuts and more government spending,  things would have been even worse had they not done this but the problems continue. So what can they do?

One suggestion is that the Bank of Japan raise its inflation target from 1% to 2%. One reason why the Bank of England has a target of 2% is to prevent any chance of a slide into deflation. This seems sensible, but all a bit late now.

The next alternative is massive Quantitative Easing (QE). Print Yen and pump them into the economy. Here they will rely on households and firms having very high money balances as a result and so they will want to spend the cash to re-balance their portfolios. (The resulting fall in yields - already very low - has already failed to work).

Of course Japan also requires Europe to sort itself out so they can start buying Japanese exports again. But when you here people telling you that QE has gone too far and will be inflationary you must point of that this is exactly what is needed - higher demand and stable inflation - not deflation.

The BBC report Japan's woes here

Accelerator effects about to kick in?

The semi-technical sector of the Economics industry (the press and interest groups in the main) are very fond of quoting statistics on ratio's to predict a change in the economy.

For example in the 1990's the ratio of average earnings to house prices was often quoted as being at a historic high. This was used, usually by the Daily Mail/Express to predict an imminent collapse of house prices. The fact this didn't happen explains the dangers of such statistics. (In this case the change in the workings of the financial markets and low interest rates allowed a much higher ratio of house prices to earnings so the comparison was not valid.)

Now there is a great deal of interest in the age of consumer durables in the USA (refrigerators, cars etc). The average age of these items has risen during the recession as households put of replacing them as money was tight and confidence low. A similar change must have happened in Europe as the failure of Comet would support.

So many of these household items must be wearing out,  reason many, and that means they must be replaced soon. This will give a much needed boost to the economy.

This may be true. But there are several reasons to be wary. Firstly modern appliances and cars last a lot longer. There are cars sold with seven year warranties, something that would be inconceivable in the 1980's (It was said British Leyland cars were guaranteed for a year - that is guaranteed to break down in a year).

Secondly if there was a rise in demand for these products they most will be made overseas. While retailers may see better business the rise in employment may not be that great and we will have to wait for the recovery of those trading partners.

This cycle of obsolescence is part of the explanation of the business cycle provided by the multiplier-accelerator theory. While intended to be applied to capital goods the same cyclical pattern may be relevant today. I guess we shall see.

Some data is presented in this industry blog here

Unemployment down - at least in some ways

The debate on whether the recovery is going to be sustained will go on for a long time. Yesterday there was some good news on unemployment, although not consistently, and a warning from the Bank of England that the recovery will be slower than they previously expected.

The unemployment figures on the ILO measure fell by 49,000, largely due to a fall in youth unemployment. This really is good news as it means that the jobs market at the bottom end may be recruiting again. If school and university leavers had to endure another year of poor recruitment then then problems of long term, but young unemployed would present a massive policy problem for a decade at least.

Unusually the claimant count measure of unemployment rose. This difference is unusual because it is harder to get Job Seekers Allowance than it is to say you are unemployed according to the ILO definition. However we should wait for more data before reading too much into this.

Meanwhile the Bank of England said that the growth of the economy will be much slower than they thought in their last report, just three months ago. They now think the economy will return to 2008 levels of output in 2015 and not 2013. That is really quite a big difference.

The bank expects recovery to be uneven and does not rule out future declines in output in some quarters. The Euro area recovery is key. If Europe does not recover, and today it was announced that the Euro area slipped back into recession, then Britain will suffer too.

The BBC review the unemployment figures and comment of future prospects here

End of recesion or just heading for VW?

People often talk about the shape of a recession. The 'best' is V shaped - a short and sharp drop in GDP with a rapid recovery. U shaped is second best, still a strong recovery. The dreaded L shaped is the one to avoid and the reason why the policy response was so robust in 2008/9.

The UK has now officially reached the end of the W shaped - double dip - recession. Feared for so long and lengthened by the one-off impact of the Jubilee. Officially the UK grew by 1% in the quarter July to September, the fastest growth for five years.

Actually there were special considerations for this growth spurt, mainly the Olympics and the 'catch-up' from the previous quarter, so don't get too excited yet.

The headline figure is, as always, hiding a lot of detail. Look at the BBC economy page for that. It should be noted that the construction sector really is the problem area at present.

Construction continues to shrink and is making a really big impact on the figures. We should be worried about this. Not only does construction employ a lot of people and use lots of locally produced resources, but it is also a 'leading sector' in recoveries. We would expect construction to turn up before we saw a sustained rise in Real GDP.

The other point that might be worth noting is that the economy shrank by 6.4% in the first 'dip' and so far only half of that has been recovered even counting the last quarters growth.

Below is an article by The Guardian's Larry Elliott. You could not find a more miserable and biased economic commentator and he puts the latest recovery in the worst light he can. I'm surprised he wasn't the first to name the next stage as the triple dip or VW shaped recession. Glad I got in first!

Elliott's article is here

Employment at a record high

If there is something to celebrate it is that there are more people in work in the UK than ever before. In addition unemployment has fallen from 8.1% to 7.9%, a significantly larger drop than was expected.

This is good news for the economy because more people in work implies higher Real GDP and so an improvement in the standard of living. The Government will be pleased because tax revenues should rise leading to a smaller deficit.

The question of why employment is so high in a recession is one we must visit again. It is almost certainly due in part to a demographic anomaly. The size of the workforce must have risen. Fewer people leaving the workforce (for example not retiring at the previous normal age) and more people gaining jobs would explain this. While a substantial number of people remain unemployed there are more jobs.In other periods unemployment would have fallen substantially already.

There are particular concerns. The young are finding it increasingly difficult to get work and the difference between geographical areas is also widening. Scotland saw a rise in unemployment as did Northern Ireland. Cambridge has the lowest jobless rate overall in the country. Horsham has 1.6% unemployment, Birmingham Ladywood 12.2%. These are big differences showing the costs of unemployment are not evenly distributed.

Good news has to be welcomed. It will help boost confidence in both households and firms, but we really have to start asking about how youth and long term unemployment will be solved over the next few years.

The Telegraph report the figures here with numerous links to related stories.

The case for Plan A

Yesterday the Conservatives put the argument for continuing their plan to reduce the government budget deficit in the strongest terms for over a year.

Fundamentally there is on two types of news on the economy, bad and absolutely awful. Given that the government might as well take it on the chin and express their beliefs.

George Osbourne, The Chancellor, said he would find more money through benefit cuts. This plays surprisingly well outside of the Conservative Party with the general public. It remains to be seen if it can be done and whether people will accept the reality.

The Prime Minister asserted the cuts will continue, despite the growth forecast for the UK by the IMF being cut. (Well we all knew that!). He pointed out that one million new private sector jobs have been created and this is compensating for public sector cuts.

The government argues that the deficit needs to be reduced to avoid problems in the future. The Opposition says a boost is needed to get the economy growing again.

The IMF says that a short term stimulus might be appropriate, but that the markets will take fright on any large scale and longer term rise in spending that will raise the deficit. So some support for both sides there.

One issue that is clear is that the government has not reduced the deficit as far as they wanted to. This shows just how difficult it is to cut spending. Good luck with the plan George.

The Independent cover the current issues here

Consumer confidence returning?

Consumption is by far the largest component of Aggregate Demand. Around two-thirds of the total. Therefore rising consumer confidence will be good news for the economy as it struggles out of the double dip of this recession.

Consumers have been shell shocked since 2009. Real income is down due to low wage rises and inflation which is higher than the wage rises (in the public sector and some industries wages have been frozen or even fallen in money terms). Also the uncertainty associated with the recession, the Eurozone crisis and government cuts has led to a higher savings rate.

Currently the economy needs short-run growth desperately. Just using up more of the idle resources of the economy will help a lot. Output and employment will rise and there is then a good chance that a sustainable rate of growth will emerge. Households spending more will allow this to happen.

So the news from Visa that shoppers have spent more in September (around 3%) is great news. One swallow does not make a summer, but it really is a good sign.

The BBC report the figures and speculate on whether the economy has really turned the corner here.

Can government spending really help the recovery

It is the turn of the Labour Party to have their conference this week and opposition parties generally have a free hit at the government.

The Shadow Chancellor, Ed Balls, used his speech to suggest that the government should spend more money (£4 billion) on building new houses and giving a tax break to first time house buyers to try and boost economic activity.

This is standard Keynesian stuff. The government spends more money to boost Aggregate Demand. The multiplier effect then raises national income and employment by even more than that. Balls claims it will 'kick start' the economy.

It's good politics, but not really believable as economic policy. The government is already spending far more than it raises (around £170 billion) to boost Aggregate Demand. Although using government spending on construction keeps a lot of the spending local at first the multiplier is very low (maybe 1.25?) and so it might raise GDP by £5billion if its new money.

The biggest hole in the Balls argument is how it would be funded. According to him Labour would use the money raised from the auction of 4G licences by the mobile phone companies. That money has already been earmarked for use so actually it would be financed by more borrowing.

The argument about how much to stimulate the economy will go on for ever. See what you think of the Balls plan.

The Independent report the policy proposal here

The unemployment puzzle

The economy is supposed to be in recession. The relationship we expect between GDP and Unemployment is that as GDP falls unemployment rises. But it has fallen.

To make it even more strange the number in work rose by a staggering 236,000 in three months. There are now 29,600,000 people employed in the UK.

Of course there are other factors to consider. Only 100,000 of the new employees were working full time for example.

Also the long term unemployed, those unemployed for more than a year, rose again.  This is worrying because some people seem to becoming detached from the workforce.

The figures need to be treated carefully. What was the Olympics influence? Will it be reversed in the next figures> But the most important question - is there really a recession if unemployment is falling and employment is rising?

The BBC cover the figures here

Click through to the BBC economy page for more data

Is it really going to work?

Despite a lot of talk about boosting growth the government has announced only a modest scheme to help and much of it is only an extension of previous measures.

The scheme will underwrite construction projects, allowing lower borrowing rates because the government will guarantee repayment. A third runway at Heathrow is to get another hearing.

The main measure is a promised relaxation in planning laws. At present it is very difficult to get approval in some areas for new building, partly because of objections from those protecting their own vested interest. This simply holds up projects and so delays growth.

These are supply-side measures that will not necessarily act very quickly, although they will help in time. Some people call for tax cuts.  For households, cuts in VAT or Income tax, to boost Consumption and so AD. For firms tax write-offs to cut the costs of new investment and so boost AD.

The argument about whether further boosts to AD or AS are most appropriate will continue. However both sides cannot escape the fact that confidence is so low and uncertainty over so many variables is so high, that governments are almost powerless to influence growth rates by more than a fraction of one percent.

The BBC report the 'new' initiatives here

Growth now the key issue

 For those who are just starting Economics this week it will be important to get a sense of perspective on recent economic events.

It would have been hard not to have noticed that times are tough due to a global recession that started in 2008. Despite a period of recovery the world economy is shrinking again with a particular crisis in the EU.

The causes of the crisis and why it has gone on so long are a matter of debate. It is far too complex a subject for this post. However consequences of the present situation are very serious and worth pointing out.

Households are worse off because:
1. Incomes are rising slowly or not at all.
Inflation - the rate at which prices are rising - is higher than the rate at which incomes are rising meaning everyone is worse off in real terms.
2. Unemployment is high.
Some people are therefore earning far less than before the recession, concentrating the costs of the recession on those who are unlucky enough to have lost their jobs and can't get another one.

Firms are worse off because:
1. Households and firms have less money to spend.
So firms have lower sales and they have little confidence that new investments will make a profit. So the new jobs we need are not being created.

The economy is worse off because:
1. There is less investment by firms and so low growth.
Firms must have confidence to invest and low demand and a shrinking economy mean this is missing.
2. The government have lower tax revenues and higher expenditure.
Governments get money from taxes on income and spending, both are lower in recession. But expenditure rises on things like unemployment benefits. So there is less money to spend on hospitals, schools and other services that makes life better for everyone.

This is a very brief overview of the problems. The article below highlights the problems of the current growth position and the pressure of government to act to improve the situation.

The Guardian article is here

Bank's latest attempt to get lending going

Today the Bank of England started providing cheap loans to banks. This is effectively the same tactic as increasing the money supply, but deals with a problem in the system.

With Quantitative Easing the money supply rises and, in theory, asset prices rise and market interest rates fall. This should lead to more investment and so rising AD and output.

But the problem QE encountered was that banks were reluctant to lend the extra money that would make this process work. This was known before the process began, but it was hoped enough money would get through to make a difference.

Banks are, quite rightly, concerned with building up their balance sheets so that a future financial crisis will not lead to their collapse. As the Euro crisis and double dip recession show there are more than a few reasons to be cautious. So this scheme encourages banks to lend.

The scheme overcomes the QE weakness by lending to banks at very low interest rates on the, fairly weak, condition that their lending will be monitored. The implied threat is that if banks don't up lending to households and firms then the loans will be withdrawn.

The signs are that market rates for borrowers have fallen already and so that is the first objective achieved. Next will be getting firms and households to actually borrow. So far firms have claimed they can't get funds, but we will now see if they are really confident enough to borrow.

The BBC covers the story here

Oh dear, oh dear, oh dear

A government statement here

Britain reported a third quarter of falling economic growth on Wednesday. This is exceptionally disappointing news and leads to a situation where action to at least make people feel better seems inevitable.

The raw figures were that GDP fell by 0.7%. There are factors to be taken into account that mean the fall is as not as bad as it seems, but once they are accounted for GDP would still have fallen. This 'second recession' means that the UK is far from a recovery that will provide the income and jobs people need.

It is an odd type of recession however. It's a recession that is creating jobs, 180,000 in the last three months. That is not typical, recessions should see fewer jobs.

So what is the cause of the problem?

* The main problem is the world economic situation. Markets are weak and so sales are down. The continuing Euro saga means that confidence is low in financial markets and with the overhang from the 2007/8 global financial crisis banks are not lending.

* The EU is the UK's largest export market and recession there means that they are buying less from us. This shows how interdependent economies are.

* Consumer confidence is very low which means consumers are saving (about 8% of income at present, up from 1 to 2% during the period before 2008).

* The governments of the world are very concerned about the level of debt they hold and are making efforts to reduce it. This means higher taxation and lower government spending (and jobs) and so in the short term this helps to contract the economy.

Some people argue for greater government short-term stimulus to rectify the current problems. This would mean stopping the deficit reduction program (or at least delaying it). It also means government investment in infrastructure and probably tax cuts.

Most people completely overestimate the ability of governments to influence economic activity. Governments are actually pretty powerless even when they act together, but when they are seen to be acting this often raises consumer and business confidence. That seems to be the key now, not actually what is done, but being seen doing more.

Of course the weakness of the financial system will remain and it is, frankly, a house of cards which could collapse at any moment. But for once the illusion of Keynesian style stimulus packages might actually be what we need and its about time these cheap conjuring tricks were given top billing.

The BBC have the figures here

Helping ease the credit channel

The government is to help ease the tight credit situation by providing 'soft loans' to banks so they can in turn lend to businesses and households. The Independent described it as a 'panic measure' but that seems more than harsh.

The measure is presented as a precaution against a second 'credit crunch' which might follow a partial collapse of the Euro area. This is too simple because one of the major issues preventing recovery is that when firms or households approach banks for loans they are turned down. Although the banks deny it, they are very cautious and this caution is stopping growth.

So banks will be able to borrow around £5 bn a month which they can then pass on in loans to firms and households. The risk to the bank is reduced as the cost of these funds is lower than the market rate and as the funds can only be used for relending they make nothing if they don't use the funds.

The result should be a rise in bank lending, followed by higher Consumption and Investment and so an increase in AD.

Ed Balls says it won't work. Odd as his entire economic plan relies on exactly the same principle. He also says that the previous policy has failed and this acknowledges that. Well that may well be true, QE and low interest rates have not persuaded banks to lend and the recovery has stalled, this can only help. The sensible question (something Balls can rarely ask) is will it be enough?

The Independent covers the story here

EU 'not in recession'

'Lies, damn lies and statistics' as Disraeli put it can be illustrated by the way Eurostat has claimed that the Eurozone is no longer in recession.

The attached story has the details, but it shows that Italy, Spain and Greece are in dire recessions, with output contracting and France just managed to maintain output. So what is the reason that Eurostat says the Eurozone isn't in recession? Well Germany grew strongly and overall Eurozone GDP rose when added together.

This means that recessions are now not only defined by arbitrary dates, but also arbitrary borders. It depends how you group countries together.

Of course the real point of interest is the effect of cutting government budget deficits on GDP. As Government spending is a component of AD changes in it have a multiplier effect. Add to that higher taxation and we see disposable income falling and so Consumption dragging AD down further.

Today the new French President, a man worryingly named after a sauce, will argue for more stimulus to boost short-run growth. But today the people of Italy, Spain and Greece, and I think France and Britain, might agree with him.

The BBC cover the story here

Permanent damage to supply side - NIESR

A regular report by the National Institute for Economic and Social Research (A bit like the IFS without the political posturing) has said they expect unemployment to reach 9% and not decline until the end of 2013.

This continued economic weakness will do long-run damage to the supply side of the economy. This will include the loss of motivation and skills of many workers who find themselves in long term unemployment. It will also lead to the loss of productive capacity, which had initially fallen into disuse but is eventually derelict and scrapped.

Interestingly the NIESR suggest, as I have, that there is a need for a moderate and targeted fiscal boost. They say:

It remains our view that fiscal policy could be used to raise aggregate demand in the economy with little to no loss of fiscal credibility. We have never and do not now advocate scaling back the government’s medium- to longer-term policy of fiscal consolidation. However, the UK also suffers from a lack of demand in the short term. As we noted in our January Review, a 1 per cent of GDP increase in government investment this year would boost GDP by around 0.7 per cent, assuming no reaction by the MPC. A temporary boost to net investment, which has been cut extremely sharply, would have no direct effect on the government’s primary fiscal target of balancing the cyclically-adjusted current budget in 2016–17. 


Interestingly there is a one year estimate of the multiplier effect in that paragraph. Suggesting that governments are not really that powerful when it come to demand management.

The BBC covers the story here

When is a double dip not a double dip?

The Office for National Statistics (ONS) reported that GDP fell for the second successive quarter (January to March) and so the press have heralded a recession. The much feared 'double dip'.

What are the implications of this? The most important is the impact on confidence. Consumer and business confidence is incredibly low and this will do it no good at all. We can expect people to save more and firms to hold back on investment. This is going to reduce the rise in AD over the coming months and that will hamper recovery.

An important question about the data has to be asked however. The definition of a recession as 'two quarters of falling GDP' is not a technical one. It was coined by the semi-technical press and has now passed into the literature as if it is true. Actually it is at best a guide in order to point out that a single quarter of falling GDP is not a trend. So is this definition accurate?

Actually a better definition of a recession is six months of continuously falling GDP. That is GDP falls in each month of the six. The problem of ONS data is that it is based on calender quarters, January to March, April to June etc. But this means it is quite possible for two bad months, say December and January, to make GDP appear to fall in two quarters, while in fact there was growth in four and the current trend is still for growth.

In this case it is not at all clear that there is a recession, and it is not even certain that the Jan to March figure won't be revised back to very low growth. In addition a recession usually is accompanied by rising unemployment, and yet the latest figures show falling unemployment.

What is clear is that the news alone is potentially damaging, especially as the idiot Balls will cynically exploit figures he knows to be exceptionally dodgy and encourage the very behaviour that will further damage the recovery.

The BBC page shows the news in context here