February 8, 2008 | posted by Michael Baxter in UK economy | comments (1) |

Yesterday, the Office for National Statistics dug out the biggest spanner it could find, and hurled it right into the midst of the government’s fiscal workings. As a result, one of the two central planks of Gordon Brown’s approach to government borrowing was left in tatters.

Is it time for our Gordon to sip on the hemlock? Well, maybe not. Maybe, it is all just down to an accountancy quirk, and it doesn’t really matter. Mind you, while we are being asked to look kindly on this apparently meaningless breaking of one of Gordon’s rules, we might equally ask, if this is just an accountancy quirk we are talking about, why does it exist in the first place? In any case, surely, the government should be subjected to the same measures and constraints that are applied to business.

But, even after taking that into account, Gordon’s cunning might in any case come to the rescue. It appears he could just about stretch logic, and claim that the existing definition of his fiscal rule no longer applies.

You may recall, Gordon Brown defines his prudency by two yardsticks. First there is his golden rule, this is the one which says government spending on current account items must balance over the course of an economic cycle. So, it’s okay to go out and spend, providing it is paid back before the cycle ends.

Now, Gordon, as is his wont, played around with this, so that he has always been able to show the rule had been adhered to.

He played around with the timing of the economic cycle, for example.

Also, at one point, when some analysts were saying the rule was about to be broken, he took one of those sharp intakes of breath of his, and said “No”; spending should be balanced over the course of a cycle as a percentage of GDP – not in absolute terms. This was a subtle but important point, as in an economy which is growing, GDP will be much greater at the end of an economic cycle – therefore, borrowing at the end of the cycle which recently ended might have been greater in terms of pounds, shillings and pence than savings at the cycle’s beginning, but as a percentage of GDP, it was the other way round.

The Office for National Statistics also reclassified spending on road maintenance as a capital item, thus removing this from the current account.

Put all that together, and yippee, the golden rule stayed golden.

Moving forward, it seems a much bigger problem exists with this rule. After all, we have been enjoying the fruits of an impressive economic boom – unemployment has been down, corporate profits, and therefore corporation tax, has been high, and thanks to the consumer boom, VAT receipts have risen sharply.

Despite all this, year-in year-out, government borrowing to pay for current account items has been greater than the government originally predicted.

If the economy is now set to go through a sharp slowdown, then just at the time when the economy needs a boost from government spending, it appears government finances will be looking terribly stretched.

So that’s bad news for the golden rule.

Fort that reason, a number of economists have been calling for the golden rule to be scrapped altogether.

It does seem that the Dubya Bush government has the right idea, with its $146bn tax rebate. When a country’s consumers are highly indebted, slashing the rate of interest may not be an effective way to kick-start the economy. It is what Keynes once called “pushing on string.” Instead, goes the argument, the government needs to boost the economy with a fiscal stimulus.

So that seems to mean the UK needs a boost from the government, just at the time when its finances are tight.

But, and here is the really bad news, Gordon has his second rule: the sustainable investment rule. This is supposed to mean that overall government debt must never be more than 40 per cent of GDP.

Well, this has now gone horribly wrong, thanks to Northern Rock and Gordon’s erstwhile friends at the Office for National Statistics (ONS). For yesterday, our official compiler of statistics announced that Northern Rock is now a part of the public sector.

Gordon and Alistair might have been able to avoid using the “n” word, but as far as the ONS is concerned, Northern Rock’s mountain of debt has been nationalised.

The finances did, however, get a boost though, with the ONS’s  inclusion of the Bank of England debt within the public sector too.

In fact, as the Institute of Fiscal Studies (IFS) explained this morning, “The ONS and the Government agreed as long ago as 2003 that the Bank of England should be classified as part of the public sector, but this had not yet been done. The ONS has decided to do so now to avoid ‘an unnecessarily complicated and potentially misleading’ presentation of the transactions between Northern Rock and the Bank.”

So what does it all mean? The IFS put it this way: “The reclassification decisions mean that the debts of Northern Rock and the Bank of England (minus their short-term financial assets) will be added to public sector net debt. The latest available data suggest that reclassifying Northern Rock will increase public sector net debt by roughly £100 billion (around 7 per cent of national income), while reclassifying the Bank of England will reduce public sector net debt by around £2 billion (0.1 per cent of national income).

“Public sector net debt stood at £536.5 billion (37.7 per cent of national income) in December, so the reclassification will probably increase public sector net debt to around 45 per cent of national income. “

Public sector net debt rises sharply in the short term because the measure of debt used for the fiscal rules is net of short-term financial assets, but not long-term financial assets. Crucially this means that the increase in debt is not offset by the value of Northern Rock’s mortgage book. When Northern Rock or its mortgage book is sold, this should offset a large part of the increase in public sector debt. It is even conceivable that the net debt will end up lower than it started.

So does it matter? The IFS put it this way: “Taxpayers have provided a direct loan of around £25 billion (via the Bank of England) and guaranteed some other creditors of Northern Rock, estimated at around £30 billion, to ensure that savings deposited at Northern Rock remain risk-free from the point of view of savers. Therefore in principle the total potential exposure of the taxpayer is around £55 billion (or 4 per cent of national income). But in practice all or most of this exposure should be recoverable from the sale of Northern Rock’s assets, in particular its mortgage book.”

In other words, sure, the statistics say the sustainable rule has been broken, but the reality is different.

And yet, it seems to us that if we can dismiss this idea of including short-term debts but excluding long-term assets from the analysis, why divide the accounts in that way in the first place? Investors are used to comparing a company’s short term assets with debts – that is considered the prudent way. Why should the government be different?

But fear not, it turns out that Gordon once said the definition of the sustainable investment rule will be re-examined in the next economic cycle – a cycle that has now begun. So all our Gordon has to do is re-arrange his mirrors, pump out some smoke, and all is well anyway.

February 7, 2008 | posted by Michael Baxter in UK economy | comments (1) |

It’s that time of the month again today. By the time you read this you will probably know whether rates have stayed on hold or been cut. There is even an outside chance the Bank of England will cut rates by more than a quarter of a per cent – although it seems unlikely.

The arguments for and against the change have been rehearsed here many times – but maybe they are really distracting us from the real issue.

Maybe instead we should be looking at a far more significant debate which is beginning to take on a new traction, and say that actually the key to seeing the US and UK through the credit crunch lies not in playing with interest rates – but rather with tax breaks for the poor.

And in eliciting support for this view we can call up one incredibly credible witness. ( I am incredulously intrigued - Ed)

Keynes, the greatest economist of the 20th century, said there are times when monetary policy just doesn’t work.

If consumers are already in debt, if asset prices are too high, then the last thing you need are measures to encourage more borrowing. Many argue that by doing this, you are merely sweeping today’s dusty problems under the bed, creating the risk they will return in the future.

Keynes would argue, though, that there are times when encouraging borrowing to get an economy moving, is about as effective as “pushing on a string.” It was one of the great man’s most-famous quotes, and it seems as relevant today as when he said it.

Keynes instead said the answer was to give a boost to the poor – tax breaks, and job creation.

Keynes himself was a man who seemed to propose policies that these days are considered to be socialist, but with his condescending way, and public school manner, never really endeared himself to the people he wrote so brilliantly in favour of supporting.

But right now, the debate is re-playing itself in the US.

As you know, George Dubya’s big idea – well it probably wasn’t his idea – was this massive $146bn tax break to US citizens. Under the plan, 117 million US individuals will receive a rebate of around $600, while married couples will be getting around $1,200.

It is a bold move. If the Brown government took a similar action, then our PM would be accused of blatant electioneering with the tax system. But, the measures taken are what Keynes would have recommended.

But, some people in the US felt the Bush plan didn’t go far enough, and yesterday a Democrat idea for handing out $157bn, but geared more to the poorer families (and in particular pensioners and disabled veterans) was discussed and finally narrowly rejected in the US House of Representatives.

Meanwhile, in the UK there is a growing debate on what the government should do. It is clear that government finances are strapped. A growing number of economists believe Gordon Brown will break his golden rule this cycle. If the Office for National Statistics decided to include government guarantees to Northern Rock in national debt, then the accounts will look even worse.

Yet it seems we are heading for a position when the economy needs tax cuts – especially tax cuts aimed at the poor – who traditionally have lower savings ratios – to get the economy moving.

Don’t be surprised if, ultimately, the golden rule is changed. This is increasingly looking like a meaningless measure – but cut through it all and the real problem facing the UK is that government borrowing was too high in the years of plenty. There is real danger we are about to pay the price for that.

January 31, 2008 | posted by Michael Baxter in UK economy | comments (2) |

Alistair Darling would need to announce fresh tax increases worth about 8 billion in this year’s Budget to keep public sector debt below the Government’s self-imposed ceiling, and to bring about the improvement in the public finances over the next five years that the Treasury wants to see, or so says the Institute of Fiscal Affairs (IFS).

The IFS has worked out its own – green budget – and even it is only slightly right; the Government seems to be stuck between the devil and the deep blue sea.

“Over the next five years,” says the IFS “to cut borrowing and comply with its self-imposed fiscal rules, the Government is planning to increase the tax burden to a 24-year high and cut public spending to an 8-year low as a share of national income. This would involve the Government taking 48 per cent of the proceeds of growth (the extra real income generated by the economy) in tax and other revenues over the next five years, up from 45 per cent under Labour to date and 30 per cent under the previous Conservative government.

“But we fear that tax revenues will not grow as strongly as the Treasury hopes, as the impact of the credit crunch and a weak outlook for profit growth depress Corporation Tax receipts and as weaker share and property prices reduce Stamp Duty revenues.”

The IFS concludes, “We expect the Government to have to borrow more than 40 billion this year, next year and in 2009-10. We expect public sector net debt to hit the Government’s ceiling of 40 per cent of national income in 2009-10 and to rise to 41.2 per cent by 2012-13. The Government would also break its golden rule (to borrow only to pay for investment) over the new economic cycle, unless that cycle lasts at least a decade.”

But all that is counting without Northern Rock. A possible decision by the Office for National Statistics to put Northern Rock on the public sector balance sheet would probably add 100 billion or 7 per cent of national income to public sector net debt, easily breaching Gordon Brown’s ceiling of 40 per cent of national income – although the eventual impact will be much smaller once Northern Rock’s mortgage book is sold.

And that’s the problem. In the US, the government is planning to give $150bn back to the taxpayer. But in the UK, we are still paying for the last round of fiscal expansion.

The idea behind Gordon’s golden rule is that it’s okay for the government to borrow in the lean years, providing it pays back in the years of plenty. The snag is, the economy, it appears, had developed the habit of relying on government spending. We staved off recession earlier this decade, in part thanks to Gordon’s spending. But, what happens if the next big threat comes along while you are still getting over the last one?