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The Great Unravelling Macro policy-making in uncertain and turbulent times Geoff Riley, Head of Economics, Eton March 2009
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The Great Unravelling
Macro policy-making in uncertain and turbulent timesGeoff 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
Annual percentage change in GDP at constant prices
The Cycle - Growth in UK National Output
Source: UK Statistics Commission
76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
-5
-4
-3
-2
-1
0
1
2
3
4
5
6
Pe
rce
nt
-5
-4
-3
-2
-1
0
1
2
3
4
5
6
"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?
Gross Domestic Product at constant 2001 prices, source: Office of National
Real National Income for the UK Economy
Source: Reuters EcoWin
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
bill
ion
s
150
175
200
225
250
275
300
325
Co
nst
an
t 2
00
1 p
rice
s (b
illio
ns)
150
175
200
225
250
275
300
325
Did rising inflation in 2008 cause the Bank to move too late?
UK Real GDP Growth and Consumer Price Inflation. annual percentage chang
Economic Growth and Inflation
Source: Reuters EcoWin
02 03 04 05 06 07 08 09 10
-2
-1
0
1
2
3
4
5
6
Pe
rce
nt
-2
-1
0
1
2
3
4
5
6
Consumer price inflation
Base interest rates
Real GDP growth
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
Pe
rce
nt
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
Base Interest Rates
-450 BP – a race to the bottom
Percentage, since May 1997 base rates have been set by the Bank of England
Base Rates Reach Historic Lows
Source: Bank of England
05 06 07 08 09
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
Pe
rce
nt
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
Bank of England Base Rate
LIBOR 3-Month Interest Rate
Jobs cull – but (much) worse to come
people aged 16-59 (women) / 64 (men), seasonally adjusted
Unemployment in the UK Economy
Source: Reuters EcoWin
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
2
3
4
5
6
7
8
9
10
11
pe
r ce
nt
of
the
lab
ou
r fo
rce
2
3
4
5
6
7
8
9
10
11
Claimant Count
Labour Force Survey
Consumer confidence has taken a hit
Expectations over next 12 months, % balance of optimists over pessimists
Consumer Sentiment
Source: Reuters EcoWin
01 02 03 04 05 06 07 08 09
-60
-50
-40
-30
-20
-10
0
10
20
Ne
t b
ala
nce
-60
-50
-40
-30
-20
-10
0
10
20
General economic situation
Likely to make major purchases
Own Financial Situation
With housing mired in a slump
Halifax house price index, Seasonally adjusted data, monthly averages, 1983=100
How much further will UK house prices fall?
Source: Reuters EcoWin
97 98 99 00 01 02 03 04 05 06 07 08 09
200
250
300
350
400
450
500
550
600
650
Ind
ex
200
250
300
350
400
450
500
550
600
650
And mortgages hard to find
£ billion per month
UK Gross Mortgage Lending
Source: Reuters EcoWin
01 02 03 04 05 06 07 08
bill
ion
s
10.0
12.5
15.0
17.5
20.0
22.5
25.0
27.5
30.0
32.5
35.0
GB
P (
bill
ion
s)
10.0
12.5
15.0
17.5
20.0
22.5
25.0
27.5
30.0
32.5
35.0
Equities take a pounding
Index of the UK's 100 leading shares - daily closing value
Is the Bear Market Over?
Source: Reuters EcoWin
97 98 99 00 01 02 03 04 05 06 07 08 09
3000
3500
4000
4500
5000
5500
6000
6500
7000
Ind
ex
3000
3500
4000
4500
5000
5500
6000
6500
7000
Business animal spirits head south
Survey on confidence over turnover going forward
British Chambers of Commerce Survey
Manufacturing ServicesSource: Reuters EcoWin
89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
-40
-30
-20
-10
0
10
20
30
40
50
60
70
Ne
t b
ala
nce
-40
-30
-20
-10
0
10
20
30
40
50
60
70
And the ‘accelerator effect’ becomes negative
Quarterly value of capital spending at constant 2003 prices, £ billion
Value of UK Capital Investment Spending
Source: UK Statistics Commission
88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
bill
ion
s
25
30
35
40
45
50
55
60
GB
P (
bill
ion
s)
25
30
35
40
45
50
55
60
UK manufacturing is in freefall
Seasonally adjusted index of production, 2001 = 100
UK Manufacturing Index of Production
Source: Reuters EcoWin
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
mill
ion
s
70
75
80
85
90
95
100
105
110
Ind
ex
of
ou
tpu
t 2
00
1=
10
0 (
mill
ion
s)
70
75
80
85
90
95
100
105
110
Despite the lower pound
US dollars per £1, daily closing exchange rate; US and UK official policy interest rates (%)
Dollar-Sterling and Interest Rate Differentials
Source: International Monetary Fund
00 01 02 03 04 05 06 07 08 09
0
1
2
3
4
5
6
7
Pe
rce
nt
0
1
2
3
4
5
6
7
UK Interest Rates
US Interest Rates
1.2
1.4
1.6
1.8
2.0
2.2
GB
P/U
SD
1.2
1.4
1.6
1.8
2.0
2.2
Spare a thought for Japan
Seasonally adjusted index of output, 2005=100
Manufacturing Output in Japan
Source: Reuters EcoWin
03 04 05 06 07 08 09
70
75
80
85
90
95
100
105
110
115
120
Ind
ex
70
75
80
85
90
95
100
105
110
115
120
And Germany
Seasonally adjusted index of production, 2000=100
Germany - Industrial Production
Source: Reuters EcoWin
97 98 99 00 01 02 03 04 05 06 07 08 09
85
90
95
100
105
110
115
120
125
Ind
ex
85
90
95
100
105
110
115
120
125
Deflation is a key risk in 2009
Annual percentage change in the retail price index and CPIRetail Price and Consumer Price Inflation in the UK
Source: UK Statistics Commission
97 98 99 00 01 02 03 04 05 06 07 08 09
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
Pe
rce
nt
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
Consumer price index
All items retail price index (RPI)
Evaluation:
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
Index of Prices, December 2005=100
UK Non-Food Shop Price Index
Clothing Electrical Furniture HardwareSource: Reuters EcoWin
Dec Mar Jun Sep Dec Mar Jun Sep Dec Mar Jun Sep Dec05 06 07 08 09
82.5
85.0
87.5
90.0
92.5
95.0
97.5
100.0
102.5
105.0
Ind
ex
82.5
85.0
87.5
90.0
92.5
95.0
97.5
100.0
102.5
105.0
And commodity prices head lower
Index of Prices 2000=100
The Economist Commodity Price Index
Source: Economist Commodity Price Index
04 05 06 07 08 09
100
125
150
175
200
225
250
275
300
325
Ind
ex
100
125
150
175
200
225
250
275
300
325
All Commodities
Industrial Metals
Food
BoE survey suggests price pressures are falling – will this be enough for deflation?
Bank of England Regional Agents Survey: Costs and Prices
Costs of imported finished goods Costs; material costs
Manufacturers domestic prices Retail services prices
Source: Bank of England
97 98 99 00 01 02 03 04 05 06 07 08
-3
-2
-1
0
1
2
3
4
5
Ne
t b
ala
nce
-3
-2
-1
0
1
2
3
4
5 Costs of imported finished goods 3.2Costs; material costs 2.1Manufacturers domestic prices 1.3Retail services prices 1.4
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
Annual Growth of Chinese Exports
Source: Reuters EcoWin
00 01 02 03 04 05 06 07 08 09
-20
-10
0
10
20
30
40
50
60
Pe
rce
nt
-20
-10
0
10
20
30
40
50
60
And Japan moves into deficit
Monthly balance of trade Yen trillion, seasonally adjusted
Japanese Trade Balance
Source: Reuters EcoWin
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08
tho
usa
nd
bill
ion
s
-0.50
-0.25
0.00
0.25
0.50
0.75
1.00
1.25
1.50
JPY
(th
ou
san
d b
illio
ns)
-0.50
-0.25
0.00
0.25
0.50
0.75
1.00
1.25
1.50
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?
Measured as a percentage of national income
UK Government Spending and Taxation
Total tax revenues as a share of GDP Government spending as a share of GDP
Source: OECD World Economic Outlook
90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
36
37
38
39
40
41
42
43
44
45
46
47
48
49
Pe
r ce
nt
of
GD
P
36
37
38
39
40
41
42
43
44
45
46
47
48
49
Total Tax Revenue
Government Spending
Evaluation:
Consider raising a counterfactual in your essays – what would have happened if there had been no fiscal stimulus.
Borrowing and nationalisation
£ billion at current prices, monthly data
UK Government Net Debt
Source: Reuters EcoWin
98 99 00 01 02 03 04 05 06 07 08
bill
ion
s
300
350
400
450
500
550
600
650
700
750
GB
P (
bill
ion
s)
300
350
400
450
500
550
600
650
700
750
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?
Per cent, source: Bank of England
The Cost of Borrowing
Source: Bank of England
04 05 06 07 08 090.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0
Pe
rce
nt
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0
Mortgage rates
Base Interest Rates (set by BoE)
Overdrafts
Credit cards
Borrow now – ask questions later?
per cent of GDP, data for 2009-10 forecast from the OECD
Yields on Govt Bonds and the UK Budget Balance
Source: Reuters EcoWin
88 90 92 94 96 98 00 02 04 06 08 10
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
-8.0
-6.0
-4.0
-2.0
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0Interest rate on 10 year government bonds (per cent)
Cyclically adjusted budget balance (% of GDP)
Fiscal stimulus
Evaluation:
Is there evidence here of crowding-out? Do bond yields rise when borrowing increases?
Keep a close eye on corporate bonds
UK Corporate Bonds, AAA Rated, Yield (%)
10 Years 2 Years 5 YearsSource: Reuters EcoWin
02 03 04 05 06 07 08 09
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
Pe
rce
nt
1.5
2.0
2.5
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
Risky Business
Spread of Yields on Corporate Debt, %
A Rated AA Rated AAA Rated BBB RatedSource: Reuters EcoWin
Jan08
Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan09Feb
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
8.5
Pe
rce
nt
3.0
3.5
4.0
4.5
5.0
5.5
6.0
6.5
7.0
7.5
8.0
8.5
The risk of corporate default is growing
Difference between corporate and government bond yields, per cent, in basis points
UK Corporate Credit Default Swaps
10 Years 5 YearsSource: Reuters EcoWin
Mar-0825
Apr-089 29
May-089 19
Jun-083
Jul-083 9 16
Aug-081 14 20
Oct-084
Feb-094 3 9
0
25
50
75
100
125
150
175
Ba
sis
po
int
0
25
50
75
100
125
150
175
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
