Category: Uncategorized

The run up to the budget

October 20, 2022 229 Comments

The budget is now a crucial moment for this government. It has to demonstrate that there is a growth strategy, and show how decisions will be made to limit the downturn and point the economy to a better future. It is made more difficult by wanting to put up Corporation tax, making the UK a less attractive destination for inward investment and new jobs, and reducing company cashflows for new domestic investment by companies already here. Since the Chancellor spoke about reversing tax proposals various independent forecasters have been cutting their growth forecasts.

The government has placed itself at the mercy of OBR forecasts. The OBR needs to lift its current year forecast of the budget deficit which I said would be an understatement when they made it. It needs to update it for the extra spending the government has now committed as a response to the energy crisis. It needs to reflect for the following year the likely slowing of revenue growth as a result of economic downturn. The government needs to tell the nation that whatever it does borrowing will  be higher over the next year or so. The choice is whether to offer some offset to the hit to real incomes  from higher interest rates and higher energy costs in order to limit the downturn, or whether to end up borrowing even more  because the downturn is deeper and longer. It seems likely  the OBR will follow the Bank of England in predicting no growth and maybe a recession in 2023. The crucial 2025/6 year forecast which affects the budget judgement needs to be more realistic than last year’s deficit forecast. There will be a windfall on the debt interest programme given the way they state it. As inflation comes down so on their definition the interest programme falls sharply.

The government needs to review the list of projects to expand UK capacity listed in the Growth Plan 2022 released by the last Chancellor. Several important oil and gas field developments are missing at a time when we need to swell the domestic production  of fuels. This would boost revenues at home and cut carbon dioxide from transporting and liquifying imports. The road schemes need to be ones which increase capacity on main roads to allow people going to work in  vehicles freedom from so many traffic jams. They can then book an additional appointment in the day. They should add small modular nuclear reactors to the list where pump priming state investment could lead to a major new manufacturing activity to be privately financed with opportunity for exports.

The government needs reviews of regulations, licencing and subsidy regimes where they affect our ability to grow more of our own food, deliver more of our own energy and produce more of our own industrial products. Your ideas would b e of interest as to what a good Growth strategy should look like.

System Upgrades

October 19, 2022 17 Comments

Dear blog user,

The service provider I use for this website used Google Feed Burner to send you individual emails of the daily blog. Google have closed this down.

I am afraid the new system we are installing to replace the old one requires you to re-register. If you would like to, please put your email address into the ‘’free email alerts’’ box any time  from tomorrow ( Thursday 20th October ) onwards to continue to receive the email version.

Yours sincerely

John Redwood

What economic policy now? (written for Telegraph)

October 19, 2022 135 Comments
The abrupt decision to sack the Chancellor and to signal a 31% hike in business taxes was a bad idea. It leaves the government searching for more to fill its Growth strategy. The political debate over the growth strategy is now even more  fevered and not well informed. Critics of the tax cutting plans assume the borrowing levels that result will be too high, and lasered in on wanting to hike Corporation tax to correct the elusive number they use for the alleged excessive borrowing. They should wait to see the spending plans, and to read the government’s considered forecasts of what might happen to revenues and outgoings as a result of all the changes. The new Chancellor needs to work up convincing spending, taxing and borrowing numbers with OBR  assessment. The OBR need to get a lot better at forecasting deficits as they are so crucial to tax judgements.
It is clear that after two years of wild pessimism about likely borrowing by the OBR, this year their forecast for borrowing was too low. I have found myself having to disagree with  OBR forecasts three years running. The truth of the current situation is whether we raise Corporation tax or not, borrowing this year will be considerably higher than forecast. The main reason  is the cost of the energy package. All agree we need to do enough to help hard pressed consumers and businesses. Forecasting the cost of the current scheme depends on the gas and electricity price over the winter, which could ease the costs or could escalate them. Tweaking the scheme to limit all household consumers to the controlled price  for a specified amount sufficient for the average house could cut costs a bit, charge better off consumers with large houses more  on the extra fuel they burn, and be a further incentive to reduce fuel use. We need to be generous to those on low incomes but careful with overall spending on this package.
The choice we are making  is do we hike taxes  now with the likelihood that this would intensify the downturn and lengthen a possible recession, or do we provide more offset to the downturn through a mixture of financial support and tax reductions? Arguably we will have lower overall new borrowing if we offset some of the downturn than if we rush into tax rises. The economy is going to slow whatever taxes we set, as the Bank of England is determined to drive interest rates and mortgage rates up whilst the high energy prices are like a huge tax rise on all of us. The more we pay for energy the less we have to pay for other things, and the fewer jobs and incomes there will be supplying the discretionary items that many have to give up. As  mortgages are forced up so mortgage holders can afford less. Tax rises will deepen the downturn and slash the revenues as a result.
Amidst all the extreme argument there is some agreement. Most MPs agreed with cutting National Insurance as we do not need a higher tax on jobs at this juncture. Most MPs agree with the general principle of offsetting some of the impact of the energy price hikes to stop a worse downturn. The idea of a Growth strategy is still a good one. If the economy grows faster we get more revenue and have less spending on benefits as more people have better paid jobs and more are in work.
Instead of trying to undermine the Growth strategy the critics should be urging it on and demanding more action. We still await the details of the investments, regulatory changes, incentives, Enterprise Zones and the rest that it will need to boost our capacity, increase domestic energy and home grown food and expand industrial capacity. I want to see a bold set of measures, alongside a budget that tells me what the income is likely to be and what will be spent. Anyone who wishes our country well would want this too. Rushing to make the UK a less desirable place for businesses to invest and create jobs would not be a good start to such a strategy. When we know the whole package we can discuss its balance. We cannot afford tax rises, as these will worsen the downturn and cut the overall revenues.

My Conservative Home article on Treasury orthodoxy

October 18, 2022 181 Comments
So why did Kwasi Kwarteng and Liz truss campaign against Treasury orthodoxy?  And why did Liz truss then give a win to that same Treasury orthodoxy by sacking her Chancellor and imposing a business tax rise just as the fans of Treasury orthodoxy had always said?
         We cannot be sure. One of the strangest things was the absence of a definitive speech by either on what Treasury orthodoxy was, or why it was wrong. I think I know what they meant, but maybe my view was more conventional and restrained than theirs. The problem with challenging the establishment  without explaining why or what you replace it with was you could end up losing, devoid a clear alternative. Nor was it any good sacking a High Priest of Treasury 0rthodoxy , the Permanent Secretary ,without having a ready replacement who did know what you meant and what changes you wished to make.
          I have argued for some time that the Treasury and Bank are necessary institutions to impose discipline. The Treasury should do a better job at securing value for money in the many public services we do want, and at resisting demands for those extensions of state services which we cannot afford. The Bank needs to concentrate on its prime aim of keeping inflation down to 2%.  Both need to sharpen their models and forecasting abilities, as in recent years they have given bad policy advice based on worse numbers.
          The Treasury/OBR overstated the central government deficit by £121 bn last year. The very high number was used by Mr Sunak to justify unhelpful tax rises we did not need. Watching their model and forecasts over the years it has always had a tendency to understate revenues in an upswing and overstate them in a downswing, allied with an inability to see turning points in good time. They also do not credit revenue forecasts for some of the taxes  with sufficient Laffer effect when rates are lowered, inducing more taxable activity. How can a Chancellor make good decisions when revenue can be so wrongly forecast from existing taxes? They need to amend their models to recognise the sensitivity of revenues to rates of growth and to allow that some taxes provide more revenue at lower rates.
          The Treasury was at its worst over social care. It needed to make the  case that the state cannot afford to take on all the costs of residential stays for elderly people who can afford to pay for them out of their savings or  money released from selling their old home they no longer need or use. That has been our system for many years. Of course all healthcare is and should be free, but board and lodging is for most people with means a cost on their own resources. Instead the Treasury reached a compromise which did not guarantee to protect the full inheritance  for the children whilst entailing extra costs for taxpayers which led to the hated NI rise and social care tax. These were also  insufficient to pay for all the potential liabilities being unleashed.
           The Bank was far too optimistic about inflation. For much of 2021 as it was busy creating £150bn more to spend on depressing interest rates on bonds the Bank assured us inflation would stay  within the  2% target. Then as the year wore on it said any uptick would be transitory. As inflation prepared to hit 10% or five times target this year the Bank told us this was because of the unexpected Ukraine war hitting energy prices. So why then was inflation already at 5.5% or 2.75 times target before the war broke out? The Bank needs to take an interest in rates of change in money and credit. It does not believe that creating more money leads to more inflation, pointing out velocity of circulation or how frequently the stock of money is used can change as well. It should nonetheless be required to tell us if money and credit is growing quickly and provide a commentary if they think this is not inflationary to avoid them making the same mistake again.
           Which brings us to the question what should be the controls? There are currently three. There is the inflation control. This is crucial and needs to be better enforced. The government needs to adopt it as well as the Bank. As the government spends so much in the economy it needs to take the impact on inflation into account in all its actions. There is the target to keep interest charges down as a percentage of GDP or public spending. We need this, which should be based on the cash cost of interest payments made regularly to service the bonds. It should not include the extra eventual  repayments on index linked bonds which will in practice just be rolled over , nor should there be any credits for the big devaluation of repayments of nominal bonds brought on by the current high levels of inflation . Cash is what matters. There is then the Maastricht left over, debt as a percentage of GDP. This leads to bizarre decisions. As it relates to later years the figures will doubtless be well out given the poor forecasting record. Instead of this the tough inflation requirement which will constrain public spending and borrowing should be complemented by a growth target. I think 2% would be stretching compared to where we currently are, though this government has gone for 2.5%.
            What the PM and Chancellor seemed to be saying was they wanted to break out of the debilitating cycle of low growth brought on by high  taxes, heavy regulation and an anti enterprise culture. The world does not owe us a living and finally last year the proponents of the Orthodoxy discovered their luck had run out in simply printing more money and keeping interest rates too low. We certainly need a  new orthodoxy to replace that and to get on top of the inflation it has delivered. Growth is the way out. Growth does need lower tax rates, more investment, and a stronger spirit of enterprise. It also needs more control over spending, whilst ensuring great quality core services like health and education.

The Bank of England fights itself

October 17, 2022 132 Comments

The Bank of England has two major committees. The Monetary Policy Committee is currently wanting interest rates to climb ever higher and is willing to see mortgage and other longer term rates of interest hiked as well. They regret the big inflation that has taken place, though they blame the European war rather than their own ultra low rates and bond buying in 2021. They forget that inflation was already at 5.5% before the invasion started, 175% above target. They want to start selling the large portfolio of bonds they bought up over the last decade to take big losses on the  bonds and drive interest rates higher.

The Financial Policy Committee is responsible for orderly markets and avoiding financial crises. They have had to intervene in the last two weeks to temporarily reverse the MPC’s policy of selling bonds and hiking rates. They have warned that rates have risen too far too fats and bonds have been too depressed. This has led to issues for some pension funds and other owners of government bonds that has worried them .

This big split has led to some announcements that seem contradictory. We are told the MPC has great resolve to make money dearer to get rid of inflation, and that the FPC needs rates lower to cut the losses on bonds to ensure stability. In 2021 the Bank was united in wanting rates as low as possible and bond prices  as high as possible. In 2021 for a time the Bank was united in wanting to correct its 2021 errors by higher rates and ending bond purchases. More recently we have had the announcement of bond sales, promptly followed by the announcement of bond buying, to be followed by possible  bond sales shortly afterwards. No wonder the market is disturbed.

We need stability of policy and clear signalling of intentions. Why not say the Bank has no plans to sell any bonds all the time they are this depressed? They should give early warning of any intent to sell should bonds rise to a more acceptable level. They could do what Japan does and give indications of what they think a sensible level of 10 year interest rates would be. As the Bank owns around one third of all the gilts and is such a major player they can have great influence over the interest rates and bond prices. They need to use this influence for the Goldilocks rate – the rate that brings inflation down without causing a panic or deep recession.

Government bonds and mortgages

October 17, 2022 50 Comments

I have been in demand by MPs and the media to explain how the bond markets work. As daily we have front page news of movements in the price of bonds and therefore in the longer term rate of interest, let me have another go.

If a government issues some debt to pay some of its bills, it promises to make a regular fixed payment of interest on the debt. So, let us say it sells £10,000  of debt at 1% interest  to a bond buyer, as part of a much bigger issue . For ease of calculation let’s say it never promises to repay – there is some debt like that. Such irredeemable debts are similar in the way they behave to long dated debt, 50-70 year debt which is repaid at the end of the stated time. The UK has been issuing some 50-70 year paper which is a debt that only repays a long time hence.

If the Central Bank then decides to put interest rates up to 2% the owner of the 1% paper is being short changed but their interest receipts stay the same. If they want to sell their bit of the debt on as they can do in the bond market, they will find that the price of it has  halved. The buyer of the £10,000 bond will only pay £5000, as he wants a 2% rate and the £100 guaranteed interest payment stays the same, to give him 2% (£100 divided by £5000).

We have just lived through a period when the Bank of England has bought up £875bn worth of bonds, at ever crazier prices, taking the interest rate on them down to tiny amounts. Now they wish to drive interest rates up. They can do so by having the sole power to set the official short term rate of Bank rate which we know, currently now up to 2.25%. They can also do so by manipulating the price of bonds.

As the largest buyer of government bonds in recent years their  decision at the end of last year to stop buying them pushed the market down substantially and therefore longer term rates of interest up. On the Thursday before the Kwarteng Statement the Bank announced it would go further, seeking to reduce its holdings of government bonds by a chunky £80bn. The thought of the Bank selling bonds led to price falls as the Bank must have wanted. To get the longer term interest rates up they need to get the price of bonds down.

By the following Wednesday the bond market had fallen a lot. The decline was bigger in the UK than in other countries where Central Banks were also forcing rates up, mainly because in the UK a lot of pension funds had bought into funds that let them indirectly own more bonds than they had to fully pay for. As bonds fell they had to put up more money for these geared positions, forcing yet more sales to raise money for the calls. The ECB is not threatening to sell some of its huge holdings of bonds as it is worried what that  might do to their bond markets.

The Bank then decided this had gone too far and flipped from being a seller to being a buyer again of bonds to try to stabilise the prices. The Bank’s own pension fund has exposures to these vehicles. On Friday they changed again, ending buying with the possible threat of sales hanging over the market. It meant the market fell sharply after the announcement of a change of policy and Chancellor.

It is true some in the markets disliked the absence of forecasts and costings with the Chancellor’s measures, but as the gyrations in the week following show the main driver of bonds falling and then recovering was Bank of England action. The Bank can have a big influence on whether mortgage rates go up or go down. The commentary which sees the whole thing as a response to the mini budget is simply wrong. I have always wanted the government to set out costings and present spending and tax at the same time as is traditional.

 

Energy prices and markets

October 16, 2022 228 Comments

On Monday we will be asked in Parliament to approve a comprehensive set of powers for government to set maximum consumer prices for energy, to send large subsidies to energy suppliers who have to sell below cost and to remove surplus revenues from producers of electricity selling well above cost.

Of course we need to look after people who cannot afford their energy bills and need to offset some of the big hit to consumers generally. The energy price rise is like a massive tax rise.

We also need to be careful not to stop companies investing in new capacity or deter big users of power from seeking to improve their energy efficiency and reduce their use. We also need to keep the cost to taxpayers down where possible.

I would be interested in your thoughts on if there could be a cheaper and less all commanding scheme that would work?

 

You were right first time PM

October 15, 2022 185 Comments

The Prime Minister was right to want to keep the UK corporation tax rate at the lower end of the advanced countries tax table. We need to carry on attracting large investment  flows into our country and leaving domestic businesses with more of their profits to put into new investment.

It appears the PM has been persuaded to row back on this promise of her election campaign to “ensure economic stability”. I do not think this measure does that. After the 2.30 announcement yesterday  there was a sharp sell off in long bonds. Interest  rates on the 50 year paper rose by more than 0.4% or 40 basis points. As the PM’s critics wrongly think the UK bond  markets currently move on changes of government policy they need to explain why when the PM did the main thing they wanted the bonds sold off sharply. Maybe long bond movements in recent days have more to do with Bank of England management of the market.

Sterling was unchanged after the announcement instead of rising as her critics implied.

Instead of changing individual items in the tax proposals the new Treasury team needs to bring forward the spending proposals and show us forecasts of the deficit. We need a menu of tax and spend options with prices to influence and judge the full budget and fleshed out growth plan. The PM promised MPs a series of meetings and consultations over the next week preparatory to the full budget. These talks need the government to keep open tax cuts as well as increased spending on priorities and cuts elsewhere. If they have already taken the key decisions the talks are pointless.

I am all in favour of actions to get the deficit down.I have been forecasting a higher deficit this year than the £99 bn OBR budget estimate. To control it I would look first as the biggest change by far that the new PM has announced, the energy package. It should remain very supportive for people on low incomes, but there could be more burden sharing for higher earners who burn a lot more fuel.

Taxing times

October 14, 2022 339 Comments

Bizarre to hear the media and Opposition mobs out to pull down the PM by forcing her to tear up her pledge to keep the UK competitive on business tax rates.

As always the Opposition wants to do the EU’s dirty work to make us less competitive and get in the way of us attracting more business investment and more jobs.

The think tanks and forecasters who want taxes up tell us the deficit will otherwise be too big. If they have their way they will put us into a longer and deeper downturn which will mean a higher deficit, not a lower.

Over the last 2 years the OBR has massively over forecast the budget deficit and used these wrong forecasts to push a Chancellor into higher taxes. More accurate forecasting would conclude now that a lower business tax rate would be better for growth and for total tax revenue.

This year I disagreed again with the OBR deficit forecast. Unlike the two previous years when they massively overstated the deficit pushing the then Chancellor to tax rises, I thought this year they were too low. They will now need to increase forecast substantially. If we added tax rises to the big squeeze the Bank’s higher rates and the energy price surge is bringing we could well  end up with an even larger deficit. Making the downturn longer and deeper would cut tax revenues and increase benefit spending.

Onshore gas

October 13, 2022 159 Comments

The government has said it is considering allowing extraction of onshore gas in the UK subject to community consent and full  safety and planning controls.  Critics of this approach call it fracking, which is a description of some reservoir management techniques that have been commonly used in oil and gas wells for many years and have been accepted as safe. In order to sustain or increase pressure in some oil and gas deposits so the gas and oil flow to the surface it is necessary to inject agents, most often water, to increase pressure in the strata to move the gas on. There could  be low level seismic shocks from this process which produce little or no disturbance at the surface above the reservoir. These shocks are monitored and controlled, and are usually below the level of shock created by a bus going by on a nearby road, or felt near to a building site.

Producing more of our own gas would  be good for the environment and good for our economy. It would more than halve the CO2 output compared to relying as we do today on too much imported LNG gas. These imports need energy to compress, liquefy, transport and convert  back to gas which we do not need for home produced gas. Imported gas attracts large tax revenues which are paid away to a foreign country, whereas home produced gas would be taxed to help pay for local services. Home production brings well paid jobs . Home produced gas would likely to be sold as contract gas, avoiding the price spikes of buying gas on a volatile world market. It would ease our indirect dependence on Russian gas into Europe.

I also think it fundamental that work on such a gas well should only go ahead where the local community affected by it has given consent and participates in the revenue or uses some of the gas produced. I would not want a gas well close to a town or village in my constituency where the public did not wish one. The idea behind requiring community consent would be to encourage wells and drilling well away from homes. People should have the choice, and some may well wish to allow drilling a mile or two away from their home in return for payments from the producers. This policy is currently being consulted on and is not firm, so your ideas would be especially welcome.