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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: [email protected]
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.
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.