Ministers have been sounding a gloomy tone recently and it's not just because of the eurozone crisis. Work by the Financial Times using the Office for Budget Responsibility model suggests that the structural deficit is £12bn higher than previously thought, a slippage of 25 per cent.
It seems that the level of spare capacity in the economy, both in terms of plant and labour (with the right skills mix), is lower than was previously thought. I would add a note of caution here as spare capacity is more difficult to forecast than most economic variables.
What this would imply is yet more spending cuts or tax increases, but politically that is not viable given the sluggish growth in the economy which, according to the Bank of England, would have tipped into recession but for quantitative easing. What the Bank also admits that QE has pushed inflation higher than it would have been by 0.75 to 1.5 per cent. Of course, inflation also reduces the real value of the debt.
In any event we aren't going to see value added tax go up to 22.5 per cent which is what would be required to plug the gap. But it is does show how difficult will be for the Government to meet its structural deficit target and have some good economic news by the time of the next general election.
Showing posts with label output gap. Show all posts
Showing posts with label output gap. Show all posts
Monday, 19 September 2011
Friday, 20 May 2011
Walking the tightrope
Both the Government and the Bank of England are walking a tightrope in terms of economic policy at the present time. The Bank is (quite properly) a relatively secretive institution, even if much more transparent than it was in the past and I am not claiming to have any special inside knowledge.
However, there are concerns by observers of the Old Lady that inflation has got baked into the cake. Electricity prices are expected to go up by 10 per cent in the summer and gas prices by 15 per cent, the latter driven by liquified natural gas demand from Japan.
It could be argued that increasing interest rates would actually do very little to drive down inflation and would impact on consumers by pushing up mortgage rates. The Bank does consider, however, that inflation will eventually diminish because there will be no further VAT rise; no further fall in sterling; and (hopefully) no big rise in energy prices.
Exports have been largely driven by sterling depreciation. It is particularly a matter of concern that imports by businesses resoponding to Bank surveys have not been affected at all despite a 20 per cent rise in their cost. Imports are predominantly intermediate ones suggesting that no domestic substitution is occurring. However, it is possible that the rate of growth in imports may have been slowed down.
The consequences of an unprecedented fiscal contraction in the UK economy have yet to be seen. However, big corporates do have tons of cash they could spend. Employment intentions are picking up, but a lot of it is part-time and self-employed.
There have been substantial differences on the Monetary Policy Committee (MPC), although these will diminish with the departure of ultra inflation hawk Andrew Sentance who even seemed to question the Bank's forecasts. Sentance's argument is in essence that it is really all about global imbalances rather than UK domestic conditions and the former will persist.
More generally, the differences on the MPC reflect considerable uncertainty about risks. Some members of the MPC are concerned about the credibility gap in terms of constant overshooting of the inflation target. People are arguably more concerned about growth and employment than inflation.
At the moment there is an unprecedented monetary expansion and at some point this will have to stop. However, there is believed to be some concern in Bank circles about the fragility of the economy and downside risks.
The Bank has in effect admitted that the output gap (slack in the economy) is smaller than thought and this means that any expansion may see limited productivity gains and create inflationary pressures. It is unfortunate that the output gap is one area in which data is less reliable, but it is evident that some physical capacity has been destroyed for ever. There are also some signs of skill shortages appearing, especially in engineering.
One uncertainty is the sterling exchange rate. Bank thinking is to prefer the current rate, but a mild appreciation seems likely. In any event it cannot be managed.
Growth has been driven by larger firms, but business has never been better at the company owned by one of my children and her husband. New workers have been taken on and the order book is full. However, they were not receptive to the idea of a chat with the Bank's regional agent.
However, there are concerns by observers of the Old Lady that inflation has got baked into the cake. Electricity prices are expected to go up by 10 per cent in the summer and gas prices by 15 per cent, the latter driven by liquified natural gas demand from Japan.
It could be argued that increasing interest rates would actually do very little to drive down inflation and would impact on consumers by pushing up mortgage rates. The Bank does consider, however, that inflation will eventually diminish because there will be no further VAT rise; no further fall in sterling; and (hopefully) no big rise in energy prices.
Exports have been largely driven by sterling depreciation. It is particularly a matter of concern that imports by businesses resoponding to Bank surveys have not been affected at all despite a 20 per cent rise in their cost. Imports are predominantly intermediate ones suggesting that no domestic substitution is occurring. However, it is possible that the rate of growth in imports may have been slowed down.
The consequences of an unprecedented fiscal contraction in the UK economy have yet to be seen. However, big corporates do have tons of cash they could spend. Employment intentions are picking up, but a lot of it is part-time and self-employed.
There have been substantial differences on the Monetary Policy Committee (MPC), although these will diminish with the departure of ultra inflation hawk Andrew Sentance who even seemed to question the Bank's forecasts. Sentance's argument is in essence that it is really all about global imbalances rather than UK domestic conditions and the former will persist.
More generally, the differences on the MPC reflect considerable uncertainty about risks. Some members of the MPC are concerned about the credibility gap in terms of constant overshooting of the inflation target. People are arguably more concerned about growth and employment than inflation.
At the moment there is an unprecedented monetary expansion and at some point this will have to stop. However, there is believed to be some concern in Bank circles about the fragility of the economy and downside risks.
The Bank has in effect admitted that the output gap (slack in the economy) is smaller than thought and this means that any expansion may see limited productivity gains and create inflationary pressures. It is unfortunate that the output gap is one area in which data is less reliable, but it is evident that some physical capacity has been destroyed for ever. There are also some signs of skill shortages appearing, especially in engineering.
One uncertainty is the sterling exchange rate. Bank thinking is to prefer the current rate, but a mild appreciation seems likely. In any event it cannot be managed.
Growth has been driven by larger firms, but business has never been better at the company owned by one of my children and her husband. New workers have been taken on and the order book is full. However, they were not receptive to the idea of a chat with the Bank's regional agent.
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