"So, there are six cardinal colors: yellow, red, orange, green, blue, and purple.
And there are 3,000 shades.
And if you take these 3,000 and divide them by six, you come up with 500.
Meaning that there are at least 500 shades of The Blues."
H20 Gate Blues, Gil Scott-Heron
When faced with a complex systems of inter-related equations, economists are used to undertaking perturbation analysis in order to understand relationships. To do this, we shock the economic system and trace out the effects on certain variables. We may be in interested in whether the system is stable; does it return to equilibrium in the dynamics of how variables respond, or jump from one resting point to some other? David Cameron’s decision to hold a referendum and then Britain’s decision to “Leave” the European Union has certainly shocked our economic and political settlement. The question is whether this shock has revealed something about the system or has acted to undermine its fundamentals.
The collective response was a palpable emergence of the blues in many metropolitan quarters. How could the country have become so fragmented that those with frustrated expectations could out-vote those who were willing to maintain the status quo? And subsequently measures of economic and political uncertainty have rocketed. We neither know what kind of trading regime for our goods and services will obtain post-Brexit, nor do we know when any deal might be struck (when it is, the financial sector may undergo a sharp contraction). We also do not know very well the preferences of Theresa May’s new Cabinet and do not have an especially effective Opposition. The economy’s immediate response to Brexit has been to go into a tailspin: measures of consumer confidence, business investment and house prices have fallen sharply. Indeed, as a further sign of the blues, people are turning to holding notes and coins, with the growth rate in those holdings considerably greater than that of income. As all serious economists warned: the vote to the leave the EU will increase significantly the probability of a recession.
Accordingly, the standard levers of stabilisation policy are being pulled. George Osborne’s fiscal charter that required a budget surplus by the end of this Parliament has been dropped and the Bank of England has provided forward guidance about looser monetary policy. We can therefore expect some more public debt to be issued and for Bank rate to nudge down, as well as some more purchases of government and corporate bonds. But there is limited room for manoeuvre: despite a growing economy since 2010, we have continued to run fiscal deficits and seven years of Bank rate at 0.5 per cent signals anything other than normality.
What should we do? Financial market prices provide an important clue. The exchange rate is down nine per cent and bank share prices are down by eight per cent and yet government bond yields are down, meaning that the present value of claims on future tax payers has gone up. Financial prices have reduced the risk faced by international firms, whilst warning that our banks look rather vulnerable, and also given a prompt to the UK government that there is a significant world appetite for (relatively) safe assets. A further clue is provided by the intellectual journey taken by policymakers since 2007-8, in that less attention has been placed in the average but more on dealing with the tails of the distribution. This point has been pursued by the Financial Policy Committee of the Bank of England, which has tried to set capital and liquidity requirements in such a manner that large shocks are less likely to affect the economy. It may now also time for the Treasury to re-consider how it manages risk through the type and quantity of public debt that it issues.
When there is the kind of uncertainty we are currently experiencing, the issuing of public debt can reduce overall risk in the economy. Yields on debt from nation states that have existed for a long time are pretty near zero and, despite downgrades from credit reference agencies, UK debt is trading at hardly any interest rate carry cost, for example, 30-year debt is trading at just over 1.5 per cent. Let me put this into context: if interest rate costs can be put to one side, then £1 of debt issued today is an ever smaller fraction of future income, because income tends to grow in the very long run. This means broadly that in ten years £1 of debt is more like 67p, in thirty years 31p and in 50 years 14p. Indeed if we issued century bonds at near zero interest rates, they would cost around 2p to payoff in 2116. Bonds of longer maturities than 50 years and also bonds that pay interest rates proportional to GDP growth may help. The government should now issue bonds and use the money to develop long term investment projects that yield a rate of return for those parts of the country that felt the Left Behind Blues.
And there are 3,000 shades.
And if you take these 3,000 and divide them by six, you come up with 500.
Meaning that there are at least 500 shades of The Blues."
H20 Gate Blues, Gil Scott-Heron
When faced with a complex systems of inter-related equations, economists are used to undertaking perturbation analysis in order to understand relationships. To do this, we shock the economic system and trace out the effects on certain variables. We may be in interested in whether the system is stable; does it return to equilibrium in the dynamics of how variables respond, or jump from one resting point to some other? David Cameron’s decision to hold a referendum and then Britain’s decision to “Leave” the European Union has certainly shocked our economic and political settlement. The question is whether this shock has revealed something about the system or has acted to undermine its fundamentals.
The collective response was a palpable emergence of the blues in many metropolitan quarters. How could the country have become so fragmented that those with frustrated expectations could out-vote those who were willing to maintain the status quo? And subsequently measures of economic and political uncertainty have rocketed. We neither know what kind of trading regime for our goods and services will obtain post-Brexit, nor do we know when any deal might be struck (when it is, the financial sector may undergo a sharp contraction). We also do not know very well the preferences of Theresa May’s new Cabinet and do not have an especially effective Opposition. The economy’s immediate response to Brexit has been to go into a tailspin: measures of consumer confidence, business investment and house prices have fallen sharply. Indeed, as a further sign of the blues, people are turning to holding notes and coins, with the growth rate in those holdings considerably greater than that of income. As all serious economists warned: the vote to the leave the EU will increase significantly the probability of a recession.
Accordingly, the standard levers of stabilisation policy are being pulled. George Osborne’s fiscal charter that required a budget surplus by the end of this Parliament has been dropped and the Bank of England has provided forward guidance about looser monetary policy. We can therefore expect some more public debt to be issued and for Bank rate to nudge down, as well as some more purchases of government and corporate bonds. But there is limited room for manoeuvre: despite a growing economy since 2010, we have continued to run fiscal deficits and seven years of Bank rate at 0.5 per cent signals anything other than normality.
What should we do? Financial market prices provide an important clue. The exchange rate is down nine per cent and bank share prices are down by eight per cent and yet government bond yields are down, meaning that the present value of claims on future tax payers has gone up. Financial prices have reduced the risk faced by international firms, whilst warning that our banks look rather vulnerable, and also given a prompt to the UK government that there is a significant world appetite for (relatively) safe assets. A further clue is provided by the intellectual journey taken by policymakers since 2007-8, in that less attention has been placed in the average but more on dealing with the tails of the distribution. This point has been pursued by the Financial Policy Committee of the Bank of England, which has tried to set capital and liquidity requirements in such a manner that large shocks are less likely to affect the economy. It may now also time for the Treasury to re-consider how it manages risk through the type and quantity of public debt that it issues.
When there is the kind of uncertainty we are currently experiencing, the issuing of public debt can reduce overall risk in the economy. Yields on debt from nation states that have existed for a long time are pretty near zero and, despite downgrades from credit reference agencies, UK debt is trading at hardly any interest rate carry cost, for example, 30-year debt is trading at just over 1.5 per cent. Let me put this into context: if interest rate costs can be put to one side, then £1 of debt issued today is an ever smaller fraction of future income, because income tends to grow in the very long run. This means broadly that in ten years £1 of debt is more like 67p, in thirty years 31p and in 50 years 14p. Indeed if we issued century bonds at near zero interest rates, they would cost around 2p to payoff in 2116. Bonds of longer maturities than 50 years and also bonds that pay interest rates proportional to GDP growth may help. The government should now issue bonds and use the money to develop long term investment projects that yield a rate of return for those parts of the country that felt the Left Behind Blues.
