EC-111 British EconomyRecent UK Macroeconomic

TrendsDr Catherine Robinson

F26, Richard Price BuildingOffice Hours: Mondays 10.30-11.30 and Thursdays 9.30-10.30

Appointments: c.robinson@swansea.ac.uk

Week 4:1 2

Margaret Thatcher (1925-2013)

Week 4:1 3

Today…We begin from 1997-ish

Focus on the changes that the New Labour Government brought in Institutional changes Policy focus

What did the UK look like? Employment, prices, balance of payments, economic

performance?

What about macro policy? After leaving the ERM, what filled the void?

Week 4:1 4

Post ERMFor the rest of Europe, it was business as usual

A strong belief in a stable European currency, pegged to the German Deutschmark

Not all plain sailing; Spain had to devalue also but remained in, Italy left and then rejoined

For the UK, a medium term framework was still viewed as important Successful because it influenced expectations A clear-cut policy stance allows for planning

A belief that stable and predictable policy will lead to longer term prosperity

INFLATION TARGETING

Week 4:1 5

Inflation targeting continued

1995 – 2.5% inflation became THE target

Bank of England required to produce a quarterly report – the Inflation Report Contains charts, forecasts and general information on the

performance of the economy : Money, interest rates and exchange rates Demand and output The labour market Costs and prices (Monetary policy) Prospects for inflation Minutes from MPC meetings

The first real Inflation Report of the Labour Government is still available online: http://www.bankofengland.co.uk/publications/inflationreport/ir97aug

.pdf Subsequent ones are also available…here’s the link to the latest… http://www.bankofengland.co.uk/publications/inflationreport/ir13feb.

pdf

Week 4:1 6

Week 4:1 7

New Labour innovationsElection in May 1997 saw:

Hangover hair….

Bank of England independence

Week 4:1 8

Bank of England Independence

1998 Bank of England Act Made the Bank accountable to parliament and the wider

public – (NOT the government) In extreme circumstances, the government can instruct the

Bank for short periods of time

Responsibility to set interest rates

Creation of the Monetary Policy Committee Who set the interest rate

Objectives of the BoE: To deliver price stability To support the government’s economic objectives for

economic growth and employment

Week 4:1 9

But the Chancellor still sets the parameters..

Identifies the target inflation rate in his annual budget statementCurrently set at 2% (previously 2.5%)Too low inflation seen as a problem as much as too

high….take now for example

The MPC – June 2011

Week 4:1 11

Current MPC (2013)Sir Mervyn King, Governor

Charles Bean, Deputy GovernorPaul Tucker, Deputy Governor Ben Broadbent Spencer Dale Paul FisherDavid MilesIan McCaffertyMartin Weale

Week 4:1 12

Monetary Policy Committee

Experts in the field of economics and monetary policy

Independent

Each member has a vote to set the interest rate at a level they think will best achieve the target level of inflation

One person, one vote

Treasury representative sits in May discuss issues, but doesn’t vote To ensure the MPC is fully briefed on current fiscal policy and other

aspects of government policy Feeds back to the Chancellor

Meet monthly, but receive Bank briefing throughout

Half-day meeting – pre-MPC on the Friday before the setting

Week 4:1 13

Meetings2-day meetings

Begin with an update of recent economic data

Identify issues for discussion

Day 2 – MPC members explain their position

Governor puts his favoured view to the meeting One which he thinks has the greatest degree of support MPC vote Minority view has an opportunity to clarify their position

and their preferred outcome – minuted Interest rate decision announced at 12noon the following

day

Week 4:1 14

Public accountabilityMinutes are published a fortnight later

Highlight all the different views and votesBlanchflower was in favour of cuts before the

financial crisis hit…

Committee has to explain its actions regularly to parliamentary committeesEspecially the Treasury Committee

Week 4:1 15

Missed targetIn the event of the target being missed by more

than 1 percentage point (either way), the Governor has to write an open letter to the ChancellorTo explain why inflation is where it is and what the

Bank plans to do about it

The MPCs job is to maintain price levels without creating undue instability within the eocnomy

Remit letters

Week 4:1 16

..and fiscal policy? to support monetary policy

Required because of the convergence criteria from the Maastricht Treaty, for fiscal policy for monetary union

EU Stability and Growth Pact PSBR should not exceed 3% of GDP Total public debt should not exceed 60% of GDP

Whilst not binding, the UK was comfortably meeting these criteria by the mid 1990s

Not especially pro-European, more consistent with the passive fiscal policy of the ‘monetarists’

Week 4:1 17

New Labour Innovations Two fiscal rules:

Share the burden of public spending fairly between current and future tax payersNo bias against investment spending if policy had to

be tightenedKeep public finances on course to be sustainable

THE GOLDEN RULESUSTAINABLE INVESTMENT RULEEnshrined in the 1998 Finance Act

Week 4:1 18

1998 Finance Act ‘Code of Fiscal Stability’

Any government must spell out how it intends to run fiscal policy and publish twice yearly forecasts illustrating how the setting of policy at any given time is consistent with its approachGrowth in importance of macro modelling

Up to the government whether to set itself operating rules and to decide if they’ve been kept

No penalty if missed though

GOLDEN RULE Government will only borrow to fund investment Tax revenues should equal or exceed current spending Future taxpayers should only be asked to repay debt from

which they are likely to benefit – fairness provision

Week 4:1 19

Golden rule continued…It limits current (not overall) spending

Reducing incentive for policymakers to make cuts in public investment when spending plans have to be cut

Traditionally, government cuts have fallen on the investment rather than current sideWhere genuine economies are more likely to be

made

Week 4:1 20

Sustainable investment rule

Public sector debt should be kept at stable and prudent levels

Public sector net debt must be below 40% of national income (at the end of every fiscal year of the current economic cycle)

When a government borrows to fund an investment project, it effectively taxes in the future to fund borrowing costs

Sets a ceiling on funding today’s investments by tomorrow’s taxpayers

More fair?

Week 4:1 21

In summaryHas it worked?

Well, Chancellors 1993 until 2007 were very capable of prudent economic management

Exceptional global economic stability over this periodRemit letter stating action was not required until 2007

Is inflation the key to stable macroeconomic policy?

A role for expectations?

And in the cold light of the financial crisis?

Week 4:1 22

And since the coalition?Last month, the Chancellor, George Osborne,

changed the remit of the MPCOffers them a little more flexibility in targetsSo far, no noticeable change in the MPC’s behaviour..

Despite some dissent, they have chosen to keep things the same this month

A (significant) minority wanted to introduce a further QE round

They forecast inflation as being around 3% mid-year and highlight threats from the Euro Zone crisis and the government’s fiscal squeeze

Yesterday’s unemployment figures for the UK showed a rise from 7.8 to 7.9%

Week 4:1 23

Tomorrow…Focus on the supply-side a bit and explore what

has been happening to productivity since the 1990s

US productivity miracle

The current productivity paradox

Next week: macro policy since 2007: the financial crisis

Week 4:1 24

ReferencesWealth of information on the Bank of England

website:

The Monetary Policy Committee: 10 years onThey have good working papers too, although

quite technical

Barrell, R. and M. Weale (2003) ‘Designing and choosing macroeconomic frameworks: The position of the UK after four years of the Euro’, Oxford Review of Economic Policy, 19 (1), 132-148.