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The Great Unravelling Macro policy-making in uncertain and turbulent times Geoff Riley, Head of Economics, Eton March 2009 Today’s Presentation Quick macro update – where are we NOW? Reaching for a Viagra stimulus – are we at the end of fine-tuning Does the Bank of England matter anymore? Searching for green shoots Quick Macro Update for AS and A2 Indicator and latest value (annual % change unless stated) GDP (Gross Domestic Product) -1.8% (final Q08) CPI Inflation (Consumer Price Index) 3% Policy Interest Rate 0.5% Unemployment (Labour Force Survey) 6.6% Consumer Confidence -31.5 (index) (long term average = -10) Current Account Balance £-7.7bn (final Q08) Industrial Production -9.3% year on year House prices -17.2% year on year Source: ONS and Reuters Hold on Tight The Cycle - Growth in UK National Output Percent Annual percentage change in GDP at constant prices 6 6 5 5 4 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 -4 -4 -5 -5 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: UK Statistics Commission "Now in Britain, we are saying, as you know, that inflation is low, interest rates are low and we expect there to be growth. Gordon Brown, 27th January 2008 What type of recession? L, V or U? Real National Income for the UK Economy 325 325 300 300 275 275 250 250 225 225 200 200 175 175 150 150 billions Constant 2001 prices (billions) Gross Domestic Product at constant 2001 prices, source: Office of National 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Source: Reuters EcoWin Did rising inflation in 2008 cause the Bank to move too late? Economic Growth and Inflation Percent Interest UK Real GDPBase Growth andRates Consumer Price Inflation. annual percentage chang 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 6.0 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 6 Percent 5 6 5 Consumer price inflation 4 4 3 3 2 2 1 1 0 0 -1 -1 Real GDP growth -2 -2 02 03 04 05 06 07 08 09 10 Source: Reuters EcoWin -450 BP – a race to the bottom Base Rates Reach Historic Lows Percentage, since May 1997 base rates have been set by the Bank of England 7.0 7.0 6.5 6.0 6.0 5.5 5.5 5.0 5.0 4.5 Percent 6.5 LIBOR 3-Month Interest Rate 4.5 Bank of England Base Rate 4.0 4.0 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 05 06 07 08 09 Source: Bank of England Jobs cull – but (much) worse to come Unemployment in the UK Economy per cent of the labour force people aged 16-59 (women) / 64 (men), seasonally adjusted 11 11 10 10 9 9 8 8 7 7 6 Labour Force Survey 6 5 5 4 4 Claimant Count 3 3 2 2 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Source: Reuters EcoWin Consumer confidence has taken a hit Consumer Sentiment Expectations over next 12 months, % balance of optimists over pessimists Net balance 20 20 Own Financial Situation 10 10 0 0 -10 -10 -20 -20 Likely to make major purchases -30 -30 General economic situation -40 -40 -50 -50 -60 -60 01 02 03 04 05 06 07 08 09 Source: Reuters EcoWin With housing mired in a slump How much further will UK house prices fall? Index Halifax house price index, Seasonally adjusted data, monthly averages, 1983=100 650 650 600 600 550 550 500 500 450 450 400 400 350 350 300 300 250 250 200 200 97 98 99 00 01 02 03 04 05 06 07 08 09 Source: Reuters EcoWin And mortgages hard to find UK Gross Mortgage Lending 35.0 35.0 32.5 32.5 30.0 30.0 27.5 27.5 25.0 25.0 22.5 22.5 20.0 20.0 17.5 17.5 15.0 15.0 12.5 12.5 10.0 10.0 01 02 03 04 05 06 07 billions GBP (billions) £ billion per month 08 Source: Reuters EcoWin Equities take a pounding Is the Bear Market Over? Index Index of the UK's 100 leading shares - daily closing value 7000 7000 6500 6500 6000 6000 5500 5500 5000 5000 4500 4500 4000 4000 3500 3500 3000 3000 97 98 99 00 01 02 03 04 05 06 07 08 09 Source: Reuters EcoWin Business animal spirits head south British Chambers of Commerce Survey Net balance Survey on confidence over turnover going forward 70 70 60 60 50 50 40 40 30 30 20 20 10 10 0 0 -10 -10 -20 -20 -30 -30 -40 -40 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 Manufacturing Services Source: Reuters EcoWin And the ‘accelerator effect’ becomes negative Value of UK Capital Investment Spending 60 60 55 55 50 50 45 45 40 40 35 35 30 30 25 25 billions GBP (billions) Quarterly value of capital spending at constant 2003 prices, £ billion 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 Source: UK Statistics Commission UK manufacturing is in freefall UK Manufacturing Index of Production 110 110 105 105 100 100 95 95 90 90 85 85 80 80 75 75 70 70 80 82 84 86 88 90 92 94 96 98 00 02 04 06 millions Index of output 2001=100 (millions) Seasonally adjusted index of production, 2001 = 100 08 Source: Reuters EcoWin Despite the lower pound Dollar-Sterling and Interest Rate Differentials GBP/USD US dollars per £1, daily closing exchange rate; US and UK official policy interest rates (%) 2.2 2.2 2.0 2.0 1.8 1.8 1.6 1.6 1.4 1.4 1.2 1.2 7 7 6 6 Percent 5 5 UK Interest Rates 4 4 3 3 US Interest Rates 2 2 1 1 0 0 00 01 02 03 04 05 06 07 08 09 Source: International Monetary Fund Spare a thought for Japan Manufacturing Output in Japan Index Seasonally adjusted index of output, 2005=100 120 120 115 115 110 110 105 105 100 100 95 95 90 90 85 85 80 80 75 75 70 70 03 04 05 06 07 08 09 Source: Reuters EcoWin And Germany Germany - Industrial Production Index Seasonally adjusted index of production, 2000=100 125 125 120 120 115 115 110 110 105 105 100 100 95 95 90 90 85 85 97 98 99 00 01 02 03 04 05 06 07 08 09 Source: Reuters EcoWin Deflation is a key risk in 2009 Retail Price and Consumer Price Inflation in the UK Annual percentage change in the retail price index and CPI 6.0 6.0 Evaluation: 5.0 5.0 Percent All items retail price index (RPI) 4.0 4.0 3.0 3.0 2.0 2.0 1.0 1.0 Consumer price index 0.0 0.0 -1.0 -1.0 -2.0 -2.0 97 98 99 00 01 02 03 04 05 06 07 08 09 Source: UK Statistics Commission Was the decision by Brown to change the Monetary Policy Committee target from retail price index to consumer price index in 2003 a mistake? Especially if discounting spreads UK Non-Food Shop Price Index Index Index of Prices, December 2005=100 105.0 105.0 102.5 102.5 100.0 100.0 97.5 97.5 95.0 95.0 92.5 92.5 90.0 90.0 87.5 87.5 85.0 85.0 82.5 82.5 Dec 05 Mar Jun Sep 06 Clothing Dec Mar Electrical Jun 07 Sep Dec Furniture Mar Jun 08 Sep Dec 09 Hardware Source: Reuters EcoWin And commodity prices head lower The Economist Commodity Price Index Index of Prices 2000=100 325 325 Industrial Metals Index 300 300 275 275 250 250 225 225 All Commodities 200 200 175 175 150 150 125 125 Food 100 100 04 05 06 07 08 09 Source: Economist Commodity Price Index BoE survey suggests price pressures are falling – will this be enough for deflation? Bank of England Regional Agents Survey: Costs and Prices 5 Costs of imported finished goods 3.2 Net balance 4 Costs; material costs Manufacturers domestic prices Retail services prices 5 2.1 1.3 1.4 4 3 3 2 2 1 1 0 0 -1 -1 -2 -2 -3 -3 97 98 99 00 01 Costs of imported finished goods Costs; material costs 02 03 04 05 06 07 08 Manufacturers domestic prices Retail services prices Source: Bank of England The Global Backdrop Global GDP will shrink in 2009…making this the worst global downswing in the post-war period Growth in developing world will more than halve China slips below the 8% growth seen as a minimum target Japan suffers 4th recession in 12 years and manufacturing slumps back to 1971 levels Germany shrinks by nearly 2% Export-dependent countries hit by contraction in global trade Bright spots? Brazil, India, Poland China will need to rebalance Percent Annual Growth of Chinese Exports 60 60 50 50 40 40 30 30 20 20 10 10 0 0 -10 -10 -20 -20 00 01 02 03 04 05 06 07 08 09 Source: Reuters EcoWin And Japan moves into deficit Japanese Trade Balance 1.50 1.50 1.25 1.25 1.00 1.00 0.75 0.75 0.50 0.50 0.25 0.25 0.00 0.00 -0.25 -0.25 -0.50 -0.50 thousand billions JPY (thousand billions) Monthly balance of trade Yen trillion, seasonally adjusted 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 Source: Reuters EcoWin Monetary and Fiscal Policy – A Shotgun Marriage ‘Ease his pain’ – pulling every lever Policy rates have moved to the floor (0.5%) £75bn quantitative easing (March 2009) 25% depreciation of sterling over last 12 months Injection of capital into the banking system Government borrowing of more than 8% of GDP National debt that > 65% of GDP within 2 years Adding stabilizers to the cycle Stage 1: Estimate likely impact of recession on the UK’s GDP – say between 8 or 9%! Stage 2: Calibrate the likely impact of the policy stimulus Interest rate cuts: £12-16 billion or approaching 1% of GDP Fiscal policy: £20 billion or a bit above 1¼% GDP Huge Sterling depreciation to an open economy: 3% GDP BoE quantitative easing (impact unknown) Net effect – stimulus of more than 6% of GDP … So a contraction in UK of between 2 and 3% in 2009 – a bad recession – but it could (might still) be much worse Explaining a £120bn deficit Sharp fall in tax revenues (reverse fiscal drag) Bringing forward of capital spending Automatic stabilisers – higher welfare bill because of rising unemployment Bail outs of banks and selected industries Deliberate Keynesian style stimulus to demand Evaluation …. Uncertain size of the fiscal multiplier A fiscal tsunami – but who will pay? UK Government Spending and Taxation Measured as a percentage of national income 49 49 48 48 47 47 46 46 Government Spending Per cent of GDP 45 45 44 44 43 43 42 42 41 41 Total Tax Revenue 40 40 39 39 38 38 37 37 36 36 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 Total tax revenues as a share of GDP Government spending as a share of GDP Source: OECD World Economic Outlook Evaluation: Consider raising a counterfactual in your essays – what would have happened if there had been no fiscal stimulus. Borrowing and nationalisation UK Government Net Debt 750 750 700 700 650 650 600 600 550 550 500 500 450 450 400 400 350 350 300 300 98 99 00 01 02 03 04 05 06 07 billions GBP (billions) £ billion at current prices, monthly data 08 Source: Reuters EcoWin Is the Bank still independent? Nowhere to go on policy interest rates – liquidity trap reached? Inflation target is being ignored for now (will there be a change?) The key rate now is on government bonds - not the base rate Government committed to HUGE borrowing Will the Bank buy as many bonds as the government needs? Will the Bank be strong enough to tell the government to stop? For most people the base rate of interest is an irrelevance Look at the cost of unsecured credit Even if borrowing costs are low, can you actually get a loan? 0.5% - Does anyone pay this? The Cost of Borrowing Per cent, source: Bank of England 20.0 20.0 Overdrafts 18.0 18.0 Percent Credit cards 16.0 16.0 14.0 14.0 12.0 12.0 10.0 10.0 8.0 8.0 Mortgage rates 6.0 6.0 4.0 4.0 Base Interest Rates (set by BoE) 2.0 2.0 0.0 0.0 04 05 06 07 08 09 Source: Bank of England Borrow now – ask questions later? Yields on Govt Bonds and the UK Budget Balance per cent of GDP, data for 2009-10 forecast from the OECD 14.0 14.0 Interest rate on 10 year government bonds (per cent) 12.0 12.0 10.0 10.0 8.0 8.0 6.0 6.0 4.0 4.0 2.0 2.0 Fiscal stimulus 0.0 0.0 -2.0 -2.0 -4.0 -4.0 Cyclically adjusted budget balance (% of GDP) -6.0 -6.0 -8.0 -8.0 88 90 92 94 96 98 00 02 04 06 08 10 Source: Reuters EcoWin Evaluation: Is there evidence here of crowdingout? Do bond yields rise when borrowing increases? Keep a close eye on corporate bonds Percent UK Corporate Bonds, AAA Rated, Yield (%) 6.5 6.5 6.0 6.0 5.5 5.5 5.0 5.0 4.5 4.5 4.0 4.0 3.5 3.5 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 02 10 Years 03 04 2 Years 05 06 07 08 09 5 Years Source: Reuters EcoWin Risky Business Percent Spread of Yields on Corporate Debt, % 8.5 8.5 8.0 8.0 7.5 7.5 7.0 7.0 6.5 6.5 6.0 6.0 5.5 5.5 5.0 5.0 4.5 4.5 4.0 4.0 3.5 3.5 3.0 3.0 Jan Feb A Rated Mar Apr May AA Rated Jun Jul Aug 08 AAA Rated Sep Oct Nov Dec Jan Feb 09 BBB Rated Source: Reuters EcoWin The risk of corporate default is growing UK Corporate Credit Default Swaps Basis point Difference between corporate and government bond yields, per cent, in basis points 175 175 150 150 125 125 100 100 75 75 50 50 25 25 0 25 9 29 Mar-08 Apr-08 10 Years 0 9 19 3 3 May-08 Jun-08 5 Years 9 16 Jul-08 1 14 20 4 Aug-08 Oct-08 4 3 Feb-09 9 Source: Reuters EcoWin The (shotgun) marriage of macro-policy Monetary and fiscal policy are now joined at the hip Short term – appetite (demand) for bonds eases the problems of financing an eye-wateringly large fiscal deficit Good fiscal stimuli are timely, targeted, and temporary But there is no such thing as a free lunch Fiscal policy will need to be tightened There will be some crowding out of the private sector We cannot ignore the risk of resurgent inflation in a recovery Weak sterling poses a major credit (solvency) risk for the UK government – even if we are not (quite) an Iceland Looking for Green Shoots Financial market recovery is pre-condition Bank lending to commerce and property Getting through the 2009 corporate debt crisis Change in business & consumer sentiment Aggressive de-stocking might end Look for data on prices and profit warnings Impact of policy stimulus – note the time lags Lower commodity prices – impact on real income But unemployment will continue rising – a lagging indicator