Britain's fiscal stimulus
A shot in the arm
The government of Britain announces tax cuts designed to boost the economy
BRITAIN'S contribution to a global effort to add a shot of fiscal adrenaline to ailing industrial economies was delivered by Alistair Darling, the chancellor of the exchequer (finance minister), on Monday November 24th. He produced an emergency winter budget, which had been preceded by a deluge of leaks, to the House of Commons. He is notorious for the tranquillising effects of his oratory but this event, at least, stirred significant excitement.
The scale of the giveaway certainly sounded impressive. The centrepiece of the fiscal package was a big reduction in the main rate of value-added tax (VAT), which is charged on most goods and services, from 17.5% to 15%. This will take effect from the start of December and last until the end of next year at a total cost of £12.4 billion ($18.5 billion), equivalent to 0.8% of annual GDP.
The busy Mr Darling, keen to contrast Labour’s willingness to intervene to support the economy with the opposition Tories’ reluctance to endorse tax cuts financed by extra borrowing, had much else to give away. There was a package of measures to support small businesses, including a deferral to April 2010 of a planned increase next spring in the small-firm corporation tax rate from 21% to 22%. He also dipped into the public purse to help pensioners and families with children.
The chancellor had to make some further amends for the upset caused by Gordon Brown’s last budget when it came into effect this spring and put over 5m families out of pocket. That had prompted a £2.7 billion unfunded tax relief for basic-rate income taxpayers, which was announced in May. Mr Darling made this help permanent and more generous at a cost of £3.6 billion next year.
Taking all his measures together, the chancellor is injecting an extra £9.3 billion into the economy in 2008-09 (the fiscal year runs from April to March) of which he had already announced £3 billion since his spring budget; rising to £16.3 billion in 2009-10, of which £1 billion had already been announced. That adds up to new measures worth £21.5 billion, of which £3 billion consist of planned capital spending being brought forward from 2010-11.
That may sound a big boost, but because it is spread over two years it is less so. Mr Darling’s policy announcements since his budget in March will ease the fiscal stance by 0.6% of GDP in 2008-09 and by 1.1% in 2009-10. As a result Britain is still heading for a painful recession, despite the government's fiscal stimulus.
The reason why the Treasury was unable to do more was clear from the borrowing forecasts that Mr Darling unveiled. Although these include his new fiscal measures they were still breathtakingly high, as George Osborne, the Tory shadow chancellor, immediately pointed out. This year borrowing will double to £78 billion, and it will then jump to £118 billion in 2009-10. In relation to GDP, it will rise from 2.6% in 2007-08 to 5.3% this year and to 8% in 2009-10, the highest in records stretching back to 1970. Furthermore, net public debt (using the Treasury’s measure, which excludes the liabilities of nationalised banks such as Northern Rock) soars from 36% of GDP in 2007-08 to 57% in 2012-13, again the highest over the past 40 years.
So big a deterioration in the public finances cannot be blamed on the downturn in the economy. In fact, Mr Darling’s growth forecasts, while slashed from his whistling-in-the-wind predictions earlier this year, were still quite optimistic: the Treasury’s central forecast is for GDP to decline by 1% in 2009 and to bounce back by 1.75% in 2010. By contrast, the IMF thinks that the economy will contract by 1.3% next year. Rather, the worsening state of the public finances reflects the particular shape of this recession as the Treasury loses two of its big moneyspinners over the past decade, the buoyant tax revenues from the financial sector and the property market. As a result the cyclically-adjusted budget balance will reach 7.2% of GDP next year.
Conscious of the need to retain the confidence of the financial investors who will have to finance the flood of new borrowing, Mr Darling set out plans to bring Britain’s books back into order once the economy starts to recover. These include tax rises on the well-off, with a politically significant though fiscally insignificant increase in the top rate of income tax from 40% to 45% for people earning over £150,000. More important, the chancellor is raising social-security contribution rates and most significant of all public spending growth will be yoked back. Underpinning his projection of a return to budgetary health is a helpfully high assumption about how fast Britain’s underlying growth rate will be after the dust has settled.
Hanging over Mr Darling’s fiscal statement was the prospect of a general election, which must be held by June 2010. The task of fiscal consolidation will fall to a new government. Almost certainly that government, whether it is Labour or Tory. will find that more harsh fiscal medicine is needed to restore Britain’s public finances to sound health.
Nov. 24 (Bloomberg) -- Barack Obama today unveiled an economic team steeped in fighting crises and likely to push for an unprecedented government role in reviving growth and stabilizing the financial system.
New York Federal Reserve Bank President Timothy Geithner was picked for Treasury secretary, former Treasury chief Lawrence Summers will be White House economic director and Peter Orszag, head of the Congressional Budget Office, will be in charge of assembling President-elect Obama’s budget.
“Obama has picked a very strong troika to pull the sled,” said Peter Wallison, a Treasury general counsel in the 1980s and now a fellow at the American Enterprise Institute in Washington.
They’re going to need all their skills, and coordination, to get ahead of a financial market meltdown that has confounded outgoing President George W. Bush’s policy makers. First up: putting together and passing a stimulus package that may run to $700 billion or more, in an attempt to head off millions of job losses as the credit crunch freezes the economy.
“We do not have a minute to waste” because the economy is “trapped in a vicious cycle,” Obama said at a press conference announcing his team in Chicago today. “We have to make sure that the stimulus is significant enough that it really gives a jolt to the economy.”
Chief Economist
Christina Romer, a University of California, Berkeley, professor, will head the Council of Economic Advisers, and adviser Melody Barnes will be domestic-policy council director, Obama said today.
Obama’s program will be far larger than the $175 billion package of tax cuts and stepped-up government spending he proposed just a month ago. Some of his advisers, and Democratic Senator Charles Schumer of New York, have suggested a figure of $700 billion. Bush’s February stimulus was just $168 billion.
Obama declined to put a number on the stimulus today, saying it will be up to his economic team to provide a recommendation. “It’s going to be costly,” he said.
The incoming administration may also enlarge the $700 billion financial-rescue fund enacted last month. It may surge to perhaps $1.2 trillion, said Martin Baily, who served as White House chief economist under Clinton and is now at the Brookings Institution in Washington.
Paulson Plans
Outgoing Treasury Secretary Henry Paulson already plans a new program to aid consumer-finance companies, signaling he may request from Congress the remaining half of the funds.
Summers, in a Bloomberg Television interview last month, urged “extraordinary steps” to ensure the flow of credit and address the cycle of mortgage foreclosures. He will take on a wide-ranging portfolio at the White House, coordinating economic policy across the administration.
Summers, 53, will also be positioned to take the helm of the Federal Reserve in 2010 when Chairman Ben S. Bernanke’s term ends. Geithner may stay on at the New York Fed until Obama takes office Jan. 20.
For Bernanke, today’s designations mean a shift in his ties with Geithner, who until now has been his top lieutenant on Wall Street. Any perception that Obama wants him replaced could also undermine his authority.
Still, any decision on the Fed chairman post is likely a year away, leaving time for Bernanke to build on his increasing outreach to Democratic positions -- and for any opposition to Summers to emerge. Summers, now a Harvard University professor, has repeatedly stirred controversy that has affected his career; he was forced out as Harvard president in 2006 after clashes with the faculty.
Accelerated Action
Obama has shifted gears as the economic crisis mushroomed. Initially inclined to steer clear of influencing policy while Bush was president, Obama indicated Nov. 22 that his team might start working with Congress on a stimulus program now. That would make it more likely it could be signed soon after he takes office Jan. 20.
The stimulus package will act as a down payment on Obama’s longer-term proposals to cut taxes for the middle class, improve the country’s infrastructure and lessen U.S. dependence on foreign oil, according to his radio address Nov. 22.
“We’ll put people back to work rebuilding our crumbling roads and bridges, modernizing schools that are failing our children and building wind farms and solar panels,” Obama said.
Stocks Rally
Investors gave the Geithner pick a vote of confidence, driving the Standard & Poor’s 500 Stock Index up 6.3 percent from its lowest level in 11 years on Nov. 21. The index gained another 6.5 percent to 851.81 today in New York.
“Tim is a strong and decisive leader and a consummate problem solver, and has the strong support of the business community,” said General Electric Co. Chief Executive Officer Jeffrey Immelt, who also sits on the New York Fed’s board. “Tim manages complex issues with sharp analysis and common sense, and is a great listener who considers a variety of perspectives in developing policies.”
Obama’s team will need to avoid the type of internal squabbling that characterized the early years of the Bush administration and which could delay speedy action to counter the economic travails facing the country. Both Geithner, 47, and Summers had been in the running for Treasury secretary, people close to the Obama camp said earlier this month.
“It’s certainly not going to be Nirvana, but policy making never is,” said Michael Barr, who worked with Geithner and Summers at the Treasury in the 1990s and is now at the University of Michigan Law School in Ann Arbor. At the same time, “a strong president is best served by a strong series of team members and that’s what Obama is getting.”
Fannie Mae, Freddie Mac
Bush’s team began the crisis seeking to avoid government intervention, then oversaw an intrusion into the financial system unprecedented since the Great Depression. Yet even after seizing mortgage financers Fannie Mae and Freddie Mac, taking over insurer American International Group Inc. and creating the $700 billion financial-rescue fund, the financial turbulence has morphed into a global recession.
Since the Nov. 4 election, reports have shown the jobless rate climbed to 6.5 percent in October, the highest level since 1994, with retail sales and consumer prices plunging the most on record. Fed policy makers now anticipate the economy will contract through the middle of 2009, with private analysts forecasting the worst recession in at least a quarter century.
David Axelrod, who will be a senior adviser to the president, left open the possibility that Obama will refrain from repealing tax cuts for the wealthy right away -- as he suggested he would do during the campaign. Instead, he may allow them to lapse at the end of 2010 when they are scheduled to expire under current law.
‘On the Road’
“The main thing right now is to get this economic recovery package on the road, to get money in the pockets of the middle class, to get these projects going, to get America working again,” Axelrod, Obama’s chief strategist during the campaign, said in an interview with “Fox News Sunday” yesterday. “That’s where we’re going to be focused in January.”
Summers has already advocated a massive stimulus package, saying it needs to be “speedy, substantial and sustained” to counter the forces buffeting the economy. He’s also played down concerns about what’s shaping up to be a record federal budget deficit, arguing that demand for Treasury securities currently far outstrips supply.
The stimulus program won’t be the only thing swelling the deficit. Obama has said he wants to do more to help homeowners who are facing foreclosure and the loss of their houses. The big three automakers -- General Motors Corp., Ford Motor Co. and Chrysler LLC -- are seeking assistance from the government.
Robert Rubin
Geithner and his onetime mentor Summers were top advisers to former Treasury Secretary Robert Rubin when the Clinton administration tapped a government fund to rescue Mexico from default in 1993-94. Later, they corralled banks into extending financing to South Korea, and worked with the International Monetary Fund to prop up emerging markets during the 1997-98 Asian financial crisis.
“There were two people who could make fun of Larry: Bob Rubin and Tim -- one from above, the other from below,” said Jeffrey Shafer, who served with Geithner and Summers at the Treasury from 1993 to 1997 and who is now vice chairman of global banking for Citigroup Inc. in New York.
Geithner has, along with Paulson and Bernanke, been one of the top decision-makers in handling the current crisis. He helped lead the rescue of Bear Stearns Cos. in March, the ultimately unsuccessful attempts to prevent a Lehman Brothers Holdings Inc. collapse in September, and the subsequent takeover of AIG.
Citigroup Shares
A collapse in Citigroup shares this month may leave what was once the nation’s biggest bank next on the list of casualties.
It will be up to Geithner in his role as Treasury secretary to try to make sure that the flood of securities coming from the U.S. government doesn’t spook America’s foreign creditors, including those in China and the Middle East, who may be already worried about what they see as an unprecedented borrowing binge.
That’s a part for which the former Treasury undersecretary for international affairs is well suited. Geithner has studied Japanese and Chinese and has lived in East Africa, India, Thailand, China and Japan.
“He is a substantive and savvy negotiator on the international scene, understands the substance and nuances well, and knows the key players,” said Mohamed El-Erian, co-chief executive officer of Newport Beach, California-based Pacific Investment Management Co, which runs the world’s biggest bond fund.
At the New York Fed, Geithner’s departure will leave a gap at the central bank’s main link with Wall Street. Among potential leading candidates to succeed him is Kevin Warsh, a Fed governor who previously worked at the White House and as an investment banker with Morgan Stanley.
Economists React to Obama’s ‘Dream Team’
President-elect Barack Obama’s selection of Christina Romer to chair the Council of Economic Advisers drew praise Monday from many of the nation’s top academic economists, who see her as part of an incoming “economics dream team” needed to quickly enact policies to help the struggling U.S. economy.
“I think she’s the perfect pick for the job,” said Jeffrey Frankel, a professor at Harvard University’s Kennedy School of Government who previously spent 20 years at the University of California at Berkeley with Ms. Romer and her husband, David, also a prominent economist. In a Chicago news conference, Mr. Obama also confirmed the appointments of Timothy Geithner as Treasury Secretary and Larry Summers as director of the National Economic Council. The president-elect named Melody Barnes, formerly Executive Vice President for Policy at the left-leaning Center for American Progress, to be Director of the Domestic Policy Council.
“He’s assembled a dream team,” Mr. Frankel said.
The CEA typically has been lead by academics with a prowess for economic theory, such as Martin Feldstein and Ben Bernanke, now chairman of the Federal Reserve. It’s one of a trio of positions central to the president’s decision-making, though not necessarily one of great influence. By appointing Mr. Summers as his right-hand man, Mr. Obama has signaled that he’ll have the final say.
Ms. Romer is widely seen as one of the top economic historians in the world, a handy expertise as the U.S. grapples with an economic downturn. Both she and her husband currently serve on the National Bureau of Economic Research’s business cycle dating committee, the official arbiter of the nation’s recessions. Ms. Romer is one of the nation’s two leading experts — the other being Mr. Bernanke – on the U.S. economy during the Great Depression.
The similarities between Ms. Romer and Mr. Bernanke (she and her husband also took over the NBER post he vacated) have some wondering whether she – and not Mr. Summers – is being groomed as a future chairman of the Federal Reserve. Mr. Bernanke’s term expires in 2010 and during Mr. Obama’s first year in the White House, he will have to decide whether to reappoint the Fed chief.
“The CEA’s definitely been used for that in the past,” said Justin Wolfers, a professor at the University of Pennsylvania’s Wharton School of Business. Another possibility, Mr. Wolfers said, is that Ms. Romer’s husband, David, could wind up serving on the Fed’s board for a couple of years and then be considered for chairman.
George Akerlof, who won the Nobel prize in economics in 2001 and is also a professor at Berkeley, said via email that his colleague’s appointment was “superb” and added that “The Obama Administration is off to a great start in putting together an all-star team to tackle the economic crisis.”
Peter Temin, who was Ms. Romer’s thesis advisor at the Massachusetts Institute of Technology, called her “terrific” and noted that her thesis topic — which questioned whether the economy really had stabilized in the postwar period – was “ahead of its time.”
He noted that the position of CEA chairman isn’t necessarily one of great power, and her role in the administration will largely depend on how forcefully she exerts her influence. “I don’t think she and Larry Summers will have any problem in getting along,” he said. “But the question is who will prevail?”
Nov. 25 (Bloomberg) -- Asian shares rose as a rally in raw materials lifted commodities producers and a U.S. government rescue of Citigroup Inc. shored up confidence in the world’s biggest economy.
BHP Billiton Ltd., the world’s biggest mining company, soared 12 percent in Sydney, the most since 1987, after oil and copper jumped more than 5 percent. Posco, Asia’s third-largest steelmaker, jumped 9.4 percent in Seoul. Resona Holdings Inc., Japan’s No. 4 listed bank, climbed 7 percent as Japan’s market resumed trading following a holiday yesterday.
“Investors are pleased with the Citigroup rescue and the subsequent rally in U.S. shares,” Mamoru Shimode, chief equity strategist at Deutsche Bank AG, said in an interview with Bloomberg Television.
The MSCI Asia Pacific Index added 2 percent to 78.42 as of 9:20 a.m. in Tokyo. More than 20 shares climbed for each that retreated on the gauge as all 10 industry groups posted gains.
Japan’s Nikkei 225 Stock Average rose 4.7 percent to 8,281.36. Panasonic Corp. led gains after the Yomiuri newspaper said the company may buy a majority stake in Sanyo Electric Co. at less than the stock’s current price.
South Korean and Australian indexes rose more than 5 percent.
About half of stocks in Asia trade at below their book value as almost $1 trillion in credit losses and writedowns battered financial firms and dragged the global economy into recession.
U.S. Rally
U.S. stocks surged yesterday, with the Standard & Poor’s 500 Index rising 6.5 percent. That capped its biggest two-day rally since 1987, after the U.S. government decided to protect Citigroup from losses on troubled mortgages.
Citigroup received a government support package which injects $20 billion of capital and shields the bank from losses on $306 billion of mortgages, commercial loans and other securities. The bank’s stock soared 58 percent yesterday, rebounding from last week’s 60 percent plunge.
Crude oil for January delivery climbed 9.2 percent to $54.50 a barrel in New York yesterday, the biggest one-day jump since Nov. 4 as the Citigroup rescue plan bolstered confidence banks will loosen lending and demand for raw materials will increase. Copper futures for March delivery rose 5.9 percent.
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