Saturday, 19 January 2013

MPC new man does nothing to lift the gloom...

Ian McCafferty gave his first public speech as an MPC member yesterday. I found it faintly depressing, which doesn't mean it wasn't interesting. It's just that the policy prescription for the UK is wrong.

The most interesting part of Ian's speech was about the labour market. His contention is that with a shortage of skilled labour, and with more flexible wages, we have seen downward pressure on wage growth  at the same time as employment has held up far better than expected in this downturn. hence very weak productivity. Certainly, the growth of the bonus as a part of annual compensation for more workers, has provided scope for compensation to go down as well as up, and the notion that we have seen companies keep people on while cutting wages is plausible and supported by the data  - at least in the private sector.

Ian moved on to talk about exports - which have grown over the last decade, but by less than some had hoped since the financial crisis, given the pound's fall. His view is that companies used the pound's fall to boost profit margins rather than export volumes to some degree, perhaps as a way of financing labour hoarding. I have a permanent bee in my bonnet about the idea of using the pound to re-balance the economy because when I look at UK exporters, I don't see ones where a small move in the pound boosts volumes much. If BAE is the country's biggest exporter r then I am not sure the number of fighter jets they sell is affected much b the currency. Likewise Cosworth's car engines, Dyson's vacuums, or Westland's helicopters. The UK moved out of the most price-sensitive industries years ago. The notion that the weak pound improves (sterling) revenues from exports more than the volume of exports, makes lots of sense. And if we want to improve our export performance, we need to export more to big growing markets - like China  to whom we sell less than we do to the Belgians; for goodness' sake. See ONS data here:

So far, I have an image of an economy which has 'used' a weaker pound to help profits, and reacted to weaker demand by cutting worker compensation, rather than  cutting jobs. As the speech moved on to QE, the verdict was, largely, that most companies have taken advantage of the fall in funding costs to sort out their balance sheets rather than to increase investment and economic activity. This is true in the UK and in the US and in Europe, so no controversy here. Companies pay back expensive short-dated debt, and borrow for longer, and at lower rates. This works well for big companies and especially ones with access to the bond market  Less well (as in, not well at all) for small and medium-sized companies. The view is that it would be good to find a way for these smaller companies to access the capital market. Once upon a time, they could, to a greater degree  - banks lent money, and the loans were re-packaged in the form of CLOs. The death of the structured credit market, and the increased capital requirements placed on the banks, and (let's be fair) the stupidity of the senior management of  banks in abusing what could have been helpful technology,  have all put paid to that.

The funding for lending scheme is intended to help get money to borrowers other than the bond-issuing big companies. It has worked, it seems to me, better in terms of helping the mortgage market than the corporate sector. That's good, but again with a caveat. The government and the MPC want the mortgage market to recover. But there is a general hue and cry to avoid house prices rise any further (at least in the South East). But on a small, easily flooded island with a rapidly-growing population and very little room to build new homes, increased availability of funds to buy homes will inevitably push prices up. Maybe the FLS should be focused outside the South East, but more than anything, I wish there were clarity on the topic. Do the Government and MPC  think increased household indebtedness is a good idea and if so why? Are they relaxed about rising house prices, as long as house building picks up? Once you get into the business of micro-managing the economy, especially when you try and micro-manage with monetary policy (or use 'More targeted measures than QE' to drive growth, to use Ian McC's phrase), you inevitably run the risk of policy mess.

The MPC is going to fiddle around trying to find ways to help the economy. It is also going to go on worrying about inflation. The persistently high level of inflation has several causes; part of it comes down to the pound's weakness. Part, shared with other countries  is related to food prices and the weather. A really big part though comes from fiscal policy. We have required many (most) utilities to increase investment since they were privatised and allow them to raise prices irrespective of competition in order to finance it. So the price of water, electricity, gas, transport, etc. all go up faster than inflation. Government austerity then pushes up the cost of local services as cash-poor local government reacts to decreased central funding. There are no competitive pressures standing in the way of these price increases. And there absolutely nothing that monetary policy can do about except drive deflation in the rest of the economy to compensate.

Because the MPC is still worried about persistent inflation  and because the fret that if/when growth picks up there will be more inflation (my guess us that given there was inflation works in the UK  there'll be less), we will continues to see current policies left in place. That is, the pound will be talked down, rates will remain at zero, the government will raise taxes and cut spending. As the economy stagnates, the corporate sector (which pays lower taxes than the household sector) will try and maintain profit margins and revenues  Employment will hold up but wages won't and consumer spending will remain weak, as will tax revenues. This could all go on for a depressing long time before economic recovery gathers any momentum....

So thanks, Ian, I enjoyed the speech, but it left me rather gloomy.....

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