Here’s a useful way of thinking about George Osborne’s new surplus target. Back in 2010 the Chancellor was committed, through one of his fiscal rules, to reducing Britain’s national debt by 2015. Today, the Chancellor has committed, through a brand new fiscal rule, to reducing Britain’s national debt by 2020.
I know that doesn’t sound quite the same as the version in the Chancellor’s speech, but that’s precisely what’s happening here. Achieving a surplus on the annual budget is precisely the same thing as paying back the national debt rather than adding to it. And today’s surplus target will replace the old “supplementary” rule on reducing the national debt – the one he ditched last year.
Now in fairness, the new rule he unveiled today is more stringent, in some ways, than the previous one: it involves reducing the national debt in cash terms (rather than as a percentage of GDP). All the same, it’s clear that, far from this being a new, pioneering, ambitious fiscal target, it is merely a rehashed, rebranded version of the Government’s old target. And, set against the fact that it’s more stringent, it’s also going to be met far later than the old one.
Moreover, it isn’t even as if the Chancellor’s new rule will involve any kind of change in his existing fiscal plans. Based on the current trajectory of Government spending, the Treasury is already heading for a surplus in the budget deficit by around 2019. So: eye-catching it may be, but the new surplus rule is hardly a game-changer.
More interesting, from an economic standpoint, is his commitment to “ensure that capital spending grows at least in line with GDP”. One of the major problems facing the economy in recent years has been the complete collapse in both private sector and public sector investment just when it was sorely needed. However, this was at least partly due to the coalition government itself, which (as most governments, including Labour, do) found that public investment was far easier to cut than benefits or the Health budget.
Now, don’t get the impression from all of the above that the Government is barking up the wrong tree. It’s certainly laudable for the Chancellor to be aiming to reduce the scale of the national debt. Britain, as you can see from the chart above, has faced annual deficits (eg an ever-increasing national debt) every year since the turn of the millennium. But, however the Chancellor dresses this up, it is simply another fiscal rule, there to replace the one he broke last year.read more
If you’ve been following the euro crisis over the past few years, you’ll doubtless recognise the chart above. It depicts unit labour costs – a measure of how much it costs to produce a given unit of economic output – in other words, it’s a yardstick of efficiency. The lower you are on the chart above, the more economic output you create for each pound/euro/dollar.
Why is this significant? Because if you’re sharing a currency and interest rates (as the members of the euro are), then you’d expect that over time the efficiency of your economies would converge. Otherwise you wouldn’t be getting the same bang from your buck in one part of the currency zone as you do in another. And, if you’re going to allow these disparities to endure, sure as night is day you will have to permit permanent transfers of cash from one part of the currency area (the efficient part) to another.
The euro crisis was a direct consequence of the enormous gap in efficiency between northern economies (well, mainly Germany) and the Mediterranean economies. You can see it in the chart above. The enormous deficits and debts which Greece, Spain, Portugal et al have suffered are a consequence of their wildly divergent capacity for generating economic output (for more on this see this previous post).
All of which is why the direction of travel on this chart (updated today by the OECD) is worrying. We are now more than three years on from the first Greek bail-out and although some countries (Ireland, Spain) have converged – their inefficiency has fallen and the gap between themselves and Germany has narrowed – others have not. In fact, Italy and France seem to be about as far from Germany in terms of economic efficiency as they have been since the start of the euro crisis.
There are, moreover, good reasons to suspect that the falls in unit labour costs of the most troubled, struggling eurozone nations (Greece, Ireland, Portugal and Spain) are overstated, partly since they reflect falls in employment rather than actual profound increases in their capacity to produce goods and services.
The simple lesson of the euro crisis remains the same as it was even before the worst of it began: either Germany will have to increase its costs through inflation, pushing up the dotted line at the bottom of the chart. Or the rest of Europe will have to reduce its costs, pushing down the rest of the lines. Or else Europe will have to work out a permanent means of transferring wealth from Germany to everywhere else. Or the euro will have to break up.
Simple as that.read more
There is no such thing as a perfect measure of housing affordability – after all no two homebuyers are the same. Some will be taking out enormous mortgages to part-finance their dream home. Others will be lucky enough to pay in cash. Some are buying as investment, others to live in the home.
However, perhaps the most broadly used measure is what’s known as the house price-earnings ratio. Very simply, you divide the average house price by the average earnings, and thereby learn how many years of a particular salary you’d need to buy a given home. While this doesn’t take account of the effects of interest rates, it at least gives you a yardstick against which to judge the expense or otherwise of a home.
It’s this metric that Mark Carney referred to this week when he told the Treasury Select Committee that although there were parts of the housing market that were picking up, across the country affordability levels remained relatively close to the levels in the early part of the economic crisis. The Bank of England Governor is right about the national picture – across England and Wales the average house price is now worth around six times the average salary. That’s down from the levels of 7-plus it hit before the crisis in 2008.
However, this overall figure masks an enormous range of differences throughout the country. We’ve done some analysis on this today, and the findings are quite astounding. First, a quick explanation of how we arrived at these numbers: we compared the average house price in certain regions of England & Wales (the Land Registry figures on different districts don’t extend to Scotland and Northern Ireland unfortunately) to the average salary of people living in that specific region. That final distinction is important: house prices in London are higher than elsewhere in the country, but then so are salaries. You only get a decent sense of the comparative expense of a home by comparing those who actually live in the area.
So, for instance, the median salary in Kensington & Chelsea was £41,315 at the midway point of this year. The average house price at that same point was £1. 19m. That equates to a price-earnings ratio of 28.9 times. To put this in context, the ratio in the borough has never been this high. The highest it reached before the crisis was 15 times; it has kept rising ever since. As you can see from the table below, it’s a similar story throughout London.
But although the figures are most eye-watering in London, this is not merely a phenomenon isolated to the capital. Prices in South Bucks and the Mole Valley (home to Leatherhead) are well over 11 times the average salaries locally. Prices in Ryedale in North Yorkshire are almost ten times local salaries. Throughout Britain (particularly, and perhaps predictably, in the commuter belt around London, and in towns where there are plenty of second homes) there are pockets where prices are well in excess of local salaries.
But elsewhere in England and Wales, prices are at far more affordable levels, with many regions of Wales and the North East having affordability ratios closer to three times – what would normally be regarded as a reasonably affordable level.
Now, to some extent, this disparity has always existed. House prices in certain smart parts of London have always been more expensive – even in comparison to local earnings – than in other parts of Britain. The point, however, is that the gulf has, suddenly, yawned wider to an alarming degree over the past few years. Looking at the way the house-price earnings ratio evolved over recent years in various parts of London, you’d struggle to spot the housing crash, for a simple reason: it never really happened in, prime London at least. As the markets slumped in 2008 and investors from around the world looked for alternative assets to buy (eg not bank shares), they discovered London property. Global quantitative easing, and the 25% depreciation of the pound, only made the play that much more attractive. In short, London property has become an asset class for global investors – in much the same mould as gold or bonds.
The problem is that at these kinds of levels it is becoming nigh-on impossible even for those who live within certain areas to afford the high prices of property. The upshot is that many will have to move elsewhere in order to find somewhere more affordable. Again, that’s not a new phenomenon, but the scale of the unaffordability in certain regions most certainly is.
It all raises the question, once again, of the wisdom of the particular formulation of the Chancellor’s new Help to Buy scheme. The policy will part-fund buyers’ deposits up to a purchase price of £600,000. This extremely generous ceiling implies that the scheme will be available for buyers within London, as well as outside. Quite why the Government should be subsidising a market which is already, in places, the most expensive in history (and by some yardsticks the most expensive in the world), is unclear.
You can read a news story and see a video report on this subject here.
The most expensive regions
Region House price/earnings ratio
Kensington & Chelsea – 28.9
Westminster – 19
Camden – 18.3
Hammersmith & Fulham – 17.5
Hackney – 15.1
The least expensive regions
Region House price/earnings ratio
Blaenau Gwent – 2.2
Hartlepool – 2.8
Merthyr Tydfil – 2.8
Kingston-upon-Hull – 2.9
Rhondda, Cynon, Taff – 2.9read more
Here’s something to dwell on: back in 2010, at the time of George Osborne’s first Budget, the Government was predicting that by this stage, midway through 2013, the economy would be almost 3% bigger than it was at the start of the economic crisis.
Instead, today Britain’s economy is still over 3 percentage points smaller than it was before the crisis. If you compare the shortfall to trend growth (in other words what Britons should have been earning were it not for the crisis at all) the gulf is almost 20%.
The statistics help explain why now even the Chancellor is referring to what’s happened over the past few years as “The Great Recession”. All that lost output means that Britain is considerably poorer than it was even a few years ago – after all, remember that GDP is merely a measure of the total amount everyone in the country is earning. This is important: it means that although Britain may well be “turning the corner”, as George Osborne said today, it may take some time before the feelgood factor returns.
It’s worth remembering this when considering the Chancellor’s economic strategy. For the first time in years, the economy seems to be showing some genuine signs of growth. The purchasing managers’ indices suggest economic output is running at the strongest rate since the late 1990s. All being well, that should equate to very punchy growth in the GDP figures when the Office for National Statistics publishes them. Moreover, unemployment looks like it may be on the way down.
This is all good news: however, none of the above is likely to put much of a smile on peoples’ faces. It will not make Britons feel richer – particularly when you consider that real incomes are currently at around the same level they were back in 2003.
That, I suspect is one of the reasons why the Chancellor remains very wary of declaring the end of the misery. “Turning the corner”, as Mr Osborne called it today, is very different to the full, lusty “green shoots” of recovery Norman Lamont talked about in the early ‘90s.
However, there is one way a Chancellor can give people the impression of being wealthy – even when they remain poorer than they were some years ago. You boost house prices. It is hard to escape the conclusion that that is the objective of the Chancellor’s Help to Buy scheme.
It is an economic illusion, of course: you can’t realise the extra value of your home unless you downsize or move to another country. But higher home prices might at least detract from the fact that actual real incomes are still so much lower than they were before the crisis.
There may not have been any new economic policy in today’s speech, but it is nonetheless an important one. From hereon his language will be the language of recovery. The question that still remains is whether he can generate a recovery that has a feelgood factor about it.read more
One thing became clear pretty soon into Mark Carney’s big speech today: the Bank of England Governor is much better when he ad-libs than when he reads from the script. The speech was a bit dry, a touch monotonous, and full of central-bankerese; but when it came time for questions from the floor, the Governor’s wisecracks had the audience here at Nottingham laughing and applauding – if not quite rolling in the aisles.
His response to one query about the future direction of interest rates (always a dangerous topic for central bankers) had something of the Groucho Marx about it: “Some are going to go up and others are going to go down.”
When a Citigroup economist asked a question, he asked: “Have you moved up here Michael?” before encouraging the audience of local businessfolk to pester him for a loan. Apparently wisecracks like this are a Carney stock-in-trade.
But the jokes serve an important function, beyond generating laughs: they usually kick in when he is trying to avoid answering the question.
Central bankers are paid to be enigmatic, not to give too much away. The problem is that Carney has been so enigmatic in his first couple of months in the job that markets, in particular, are finding it fiendishly difficult to judge him. His forward guidance policy, which many expected to usher in a new era of low interest rates, has, in fact, pushed the cost of borrowing (the real one in the markets rather than the rates the Bank itself sets) higher – not lower.
The issue is not the simple pledge at the policy’s heart – that the Bank will not consider raising rates until unemployment drops below 7%. It’s that traders are convinced this will happen sooner than the Bank is forecasting.
In one sense this is a “good news” story: another sign that the economy is healing faster than expected. The problem is that higher market interest rates feed, in turn, into the cost of personal loans and mortgages – though, as the Governor was keen to emphasise today – not all of them.
“Movements in longer-term market interest rates are certainly relevant,” he said in one important part of the speech, “but what matters most to you is what actually happens to Bank Rate, now and in the future. That is because the interest rates on 70% of loans to households and more than 50% of loans to businesses are linked to Bank Rate.
“And it is the Bank of England that controls that rate,” he added, perhaps a touch unnecessarily. It wasn’t the only part of the speech that gave the impression of protesting a touch too much: one section emphasised that Britain’s interest rates should not be unduly determined by those of the Federal Reserve in the United States.
When one discounts the central-bankerese, one does get the sense that Carney is slightly frustrated: frustrated that his landmark policy has been depicted (by traders) as a flop; frustrated that the Fed seems to have more leverage over UK interests than the Bank; frustrated that the Bank has been painted as powerless in the face of these forces. It isn’t the honeymoon he might have imagined when he took office.
However, in large part this owes itself to his own mixed messages. He has committed himself to low interest rates, but has inserted so many provisos that no-one quite believes him. He is pledging to loosen restrictions on banks, but, at the same time, promising to clamp down on mortgage lending if it gets out of hand.
In one sense, that’s pretty typical central banker behaviour – so what’s the problem? I suppose, that some in the markets expected Carney to blaze into Threadneedle Street all guns blazing and restart the UK economy with a monetary blitz the likes of which we’ve never seen before. That was clearly unrealistic – but then that’s markets for you.read more
I promised that yesterday’s blog would be my last on forward guidance. Alas it is not to be, because a friend has pointed me towards a detail which, up until now, I hadn’t quite appreciated.
It is this: even if the collective judgement of the Monetary Policy Committee is that the inflation “knockout” will not be reached, any of the nine individual MPC members will still be able to make their own call and, if they want, vote for a rate hike. To put it another way, even if the Inflation Report forecast is that neither of the inflation knockouts have not yet been breached, this still won’t stop MPC members making their mind up separately and voting for higher rates – in fact, it wouldn’t have stopped them from doing so this month(!)
The clause that explains this can be found on page 36 of the document the Bank published explaining its guidance [pdf] but here is a grab of the relevant paragraph:
This considerably undermines the messaging from Mark Carney last week – that “we won’t even begin consider increasing bank rate until the unemployment rate goes to 7%”. And this individual vs collective distinction is important: if the knockouts had been based on the collective forecasting operation entailed in the Inflation Report, it would have made it far more difficult for individual MPC members to vote in favour of hikes – their hands would have been tied.
Apologies if everyone else had already spotted this – but the distinction is an important one, and again helps explain why markets have been rather disappointed by the policy unveiled by the Bank.read more