Carney calls for RPI to be dropped

Change retail prices index of inflation, says Mark Carney

Philip Aldrick, Economics Editor

January 31 2018, 12:01am, The Times

• Banking

Mark Carney, the Bank of England governor, said RPI had “known errors” and should be phased out over the next decade

Mark Carney has called for the government to scrap the retail prices index of inflation used to set the interest rate on student loans, rail fares and on £400 billion of government debt because it has “known errors”.

The Bank of England governor is the most senior figure to suggest abolishing RPI since the Office for National Statistics revealed five years ago that there was an error in the equation used to produce the monthly figure.

A change could save taxpayers £5 billion in lower interest on the national debt every year, equivalent to about a penny off income tax. Commuters and students would also be spared higher rail fares and loan costs.

Economists and campaign groups have been calling for the inflation index to be changed since RPI was stripped of its national statistic status in 2013 for falling short of international standards. The ONS estimated that a bias in the equation meant that RPI was being overstated by 0.6 percentage points.

Mr Carney said “most would acknowledge [that RPI] has no merits” and “it would be better not to further embed RPI in contracts”. Moving to a new system could take “seven, eight, ten years” to give markets time to adjust, but he added: “We would not want to be in this position ten years from now.”

He also suggested that the consumer prices index or its alternative version, the CPIH, replace RPI. Mr Carney said: “It would be helpful to have just one public-facing cost of living measure.”

CPI is currently 3 per cent, CPIH is 2.7 per cent and RPI is 4.1 per cent. If RPI was replaced by CPIH, it would imply a £5.5 billion annual saving on the £400 billion of index-linked gilts.

The Campaign for Better Transport has calculated that commuters to London from a dozen cities would have saved £200 on average had rail fares been updated by CPI since 2014. Student loans are charged at 6.1 per cent because of the added RPI, even though the Bank’s interest rate is 0.5 per cent.

Any change would have to be handled sensitively because many holders of index-linked gilts are pension funds that are managing the retirement savings of millions of people.

Ultimately, abolishing RPI would be a decision for the chancellor. Mr Carney told the Lords economic affairs committee that wages were picking up and “there is a prospect of a return of real income growth later this year”. He added that the strength of the global economy and certainty about Brexit would release business investment in 2019. The upbeat comments suggest that the Bank may signal that an interest rate rise is imminent in its economic outlook next week.

China & Trade

Very useful insights for the final topic in the course, globalisation & trade. What will Mrs May walk away with following her visit to China?

Mrs May mustn't be naive about China; this is the most protectionist economy on the planet

• JEREMY WARNER

30 JANUARY 2018 • 8:41PM

65

China plans hugely to expand global trade with its One Belt, One Road initiative, but is this not just imperialism in modern form?

What does Theresa May hope to achieve from her trade mission to China? As ever with Mrs May, it is not entirely clear.

There will certainly be contracts aplenty, some of them possibly genuinely new ones, as well as the familiar fodder of recycled old ones; this is always part of the publicity seeking furniture of such visits. 

But at a time when the US President, Donald Trump, has vowed to get tough on trade with China, what’s her overarching purpose here? Does she back Trump’s complaint, or is she merely on the scrounge for potential Chinese windfalls from Trump's impertinence? 

Her predecessor, David Cameron, started off badly with China; rather than focus on trade, he chose to highlight China’s shameful record on human rights, and then, horror of horrors, he rubbed salt into the wounds by agreeing to meet the Dalai Lama.

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The Chinese leadership’s fury could be heard all the way from Beijing.  The subsequent grinding of gears as the UK Government’s approach was put violently, and humiliatingly, into reverse, was almost deafening. There would be no more meetings with Tibet’s spiritual leader.

The next several years were to be defined by a great “kowtow”. Goodies and plaudits were showered on Beijing as if no country were as important to our economic future as China. We would trade the Renminbi in the City, support China’s efforts to set up an Asian alternative to the World Bank and International Monetary Fund, and we would cede the future of our nuclear energy industry to state controlled Chinese suppliers. A new “golden age” in relations between the two countries was declared.

Yet the payback from all this atonement has been far from obvious. Yes, our exports to China have grown strongly, but so have everyone else’s, and compared to other major economies, they remain quite small.

As far as I’m concerned, all trade is capable of economic good, even when it results in a deficit. My faith springs from the classical, English economists, Adam Smith and David Ricardo, and the law of “comparative advantage”. Once described as one of the most counter-intuitive ideas in economics, the concept holds that if someone else can produce things more cheaply and efficiently than you can, you are better off buying these things from them and focusing on stuff you are good at.

Trump’s gripe with the Chinese is that they are not in fact better at the things they sell to America, but abuse the rules of the game to engage in mercantalist practice and unfair trade.

His assault on the established norms of trade is multi-faceted. He’s attacking specific Chinese imports with tariffs, he’s interfering with the mechanics of the World Trade Organisation by blocking key appointments, he’s pulling out of newly negotiated free trade agreements such as the Trans Pacific Partnership, and he is threatening to kill off the long standing North Atlantic Free Trade Association. For the time being, his threats are more bluster than substance, but his message is clear; free trade by all means, but it must also be fair trade.

With China in particular, his complaint is more than justified. This is a country that talks free trade, and has grown increasingly rich and powerful on its bounty, but practices something different. Currency manipulation to gain competitive advantage? Guilty as charged. State subsidy and a planned economy that in key sectors is entirely free of usual market disciplines? Guilty. Tariff and non tariff barriers to trade? The European Union doesn’t come anywhere close. Intellectual property rights? Forget it. They are stolen with impunity. Media, old and new? No access whatsoever. I could go on.

There will be much talk in Beijing this week of China’s “One Belt, One Road” plan to revitalise ancient trading routes, with its promise of $1 trillion of infrastructure spending, but what honestly is the purpose of this ambition? Very simple; it’s about extending Chinese commercial power and political influence. As I say, all trade is good, but use of trade for imperialist ends is as old as trade itself.

I’m not arguing here that Trump’s tough cop approach to China is necessarily the right one. Gentle persuasion through existing, international rules based frameworks may in time yield better outcomes. And it is in any case much easier for the US, the world’s largest economy, to stand up to Beijing than it is for Britain, with its comparatively small and very open economy. 

But there is no doubt that things have to change. Today’s international trading system was built for a bygone age of largely equal Western economies. It has not coped well with the arrival of billions of souls from the developing world. Globalisation has proved a boon for them, lifting hundreds of millions out of poverty, but it’s advantages to the West are far less obvious.

For many, it has looked like a one way street, an immense transfer from us to them of technology, jobs and wealth. In the early stages of Chinese development, there may well have been an altruistic and geopolitical case for such assistance, similar to that provided seventy years ago by the Marshall Plan to a war ravaged Europe.

But that time has long gone. Countries that plan to send manned missions to Mars no longer require a helping hand. The playing field must once again be leveled.

Forget China, globalisation, and trade, it is often said. They are not responsible for the Western malaise in living standards. Rather, it is the advance of machines and technology.

As brilliantly demonstrated by the economists David Autor, David Dorn and Gordon Hanson in their paper, The China Shock, this is only partially true. Alongside the much heralded consumer benefits of expanded trade are substantial adjustment costs and distributional consequences, they found. “Adjustment in local labor markets is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences”. As China moves up the value chain, these effects threaten to shift beyond already affected basic industries into the wider economy.

I do hope Mrs May is listening as she begs bangles from China to substitute for the ties of the European Union. All trade is ultimately beneficial, but when it is neither free nor fair, it can also be destructive.

Hugely important article on Europe - may or may not be entirely valid (a lot of speculation about the future) but crammed full of useful analysis you can use in essays. Daily Telegraph 4th January:

Eurozone’s fleeting boom is an illusion - Britain won't remain the sick man of Europe for long

• AMBROSE EVANS-PRITCHARD

Brexiteers must hold their nerve. By a twist of timing, the eurozone is briefly basking in economic glory while Britain languishes in relative stagnation.

It is an illusion of the economic cycle, magnified by Europe’s elastic snap-back from a needlessly severe recession. The EMU sorpasso over recent months looks more meaningful than it really is, yet it is inevitably creating confusion and will colour Brexit talks at a crucial juncture.

We can all agree that the UK economy has long been mismanaged. It needs a radical shift from consumption to investment if it is to avoid falling further behind the US and the rising powers of Asia. But one problem that it does not face is being left behind by the eurozone in any lasting sense.

OECD analysts think the region’s economic speed limit is around 1pc. The eurozone has been able to grow at well over twice that rate in recent quarters without running into trouble only because it has had a legacy output gap to cover. The UK is far ahead in the cycle.  

The European Central Bank has turbo-charged recovery by running an extreme liquidity experiment, with interest rates at minus 0.4pc, or minus 2pc in real terms.

It has been buying €60bn (£53bn) of bonds – down to €30bn this month – pushing its balance sheet to 41pc of GDP, much further than the US Federal Reserve ever dared to go. It has bought €130bn of corporate debt in a direct intervention in the credit markets.  

Fiscal austerity has given way to net stimulus. Spain, Italy and France have all been flouting EU spending rules. If this heady cocktail cannot produce a catch-up boom, nothing can.

Yet this burst of growth is ephemeral unless the eurozone uses the opportunity to grapple with its own dysfunctional pathologies – rigid labour and product markets, non-performing loans, zombie companies, warped welfare incentives – and to reestablish the currency union on workable foundations before the next crisis hits. Little of this has happened. 

The IMF’s Article IV report on the eurozone for 2017 is one long indictment of structural paralysis. “Unresolved legacy problems are holding back a stronger medium-term outlook. Risks are large and policy buffers remain thin,” it said.

Poul Thomsen, the IMF’s Europe chief, says the fundamental picture is getting worse. Intra-EMU divergences are becoming more extreme. Those countries that had the poorest productivity growth at the launch of the euro are falling even further behind. “The gaps in real per capita income levels have widened rather than narrowed,” he said. 

Germany’s real GDP is 14pc higher than its pre-Lehman peak, while Italy’s GDP is still 6pc below and will not recover its previous output until the “mid-2020s” – amounting to two Lost Decades. What is extraordinary is that these two countries are still trying to share a currency union, given their starkly contrasting fates, and the lack of any sign that this is will ever self-correct. 

Brussels admits that the eurozone’s slump from 2008-2015 was so deep that it crossed into hysteresis, the point where "cyclical unemployment becomes structural" and causes lasting damage to job skills and economic dynamism. Hysteresis is why austerity policies become inherently self-defeating if pushed beyond the therapeutic dose. They lower trend growth rates decades ahead, making it even harder to bring debt ratios back under control.

Youth jobless rates peaked at 56pc in Spain, and are still 38pc today. The shock was so profound – and went on so long – that a whole cohort of Spanish youth went through their twenties without ever holding a durable job, with subtle macro-economic effects. Variants of this occurred in Italy, Greece, Portugal, and to some extent in France. 

There have been episodic bursts of reform in southern Europe and France – usually less than advertised – but the OECD still thinks the currency bloc is so sclerotic that it will hit capacity constraints long before it has reached what would be considered full employment in Anglo-Saxon states. In economic parlance, the "Nairu" floor for unemployment is 8.8pc, exactly where the jobless rate is today. The output gap has essentially closed, and in Germany it is long past closing.     

The eurozone boom therefore contains the seeds of its own demise. The stronger the recovery now, the sooner it hits the buffers, and the sooner QE will have to end. ECB board member Yves Mersch warned this week that Frankfurt must be “very careful not to act too timidly and too late, and to fall behind the curve”.

This brings Italy into uncomfortable focus. ECB has bought €319bn of Italian debt and is essentially covering the Italian budget deficit. This has compressed bond yields sufficiently to head off a debt compound spiral. It has been a life-saver but it has not restored self-sustaining viability. The public debt ratio remains stuck above 130pc of GDP, at the outer limits for a country with no sovereign currency. 

Italy must refinance debt worth 17pc of GDP next year without obvious buyers. Italian banks and foreign funds have been systematic sellers, rotating the proceeds into accounts in Germany or Luxembourg in what amounts to slow capital flight.

“The end of QE does not frighten us,” says the defiant Italian finance minister Pier Carlo Padoa. Yet it will certainly frighten bondholders if it coincides with the election of a radical anti-euro government in March. The Five Star movement of Beppe Grillo leads the polls at 29pc, while the ruling Democrats are in slow collapse. Five Star is no longer calling for the restoration of the lira but its manifesto flouts the basic rules of monetary union.

Spain is in better economic shape, to the extent that it has clawed back competitiveness by slashing relative wages in an "internal devaluation". But this should not be mistaken for good health. Productivity has not recovered. “Much of the post-crisis growth has been in lower-skill, lower-productivity sectors,” said the IMF.

My guess is that bond yields in both countries will spike high enough by mid-2018 to cause heartburn, and this time Germany will be in a less accomodating mood with the anti-euro Alternative fur Deutschland commanding 94 seats in the Bundestag, and snapping at chancellor Angela Merkel’s heels.

The ECB’s policies are becoming more intolerable for Germany by the month. Negative rates are destroying the business models of the local savings banks that fund the Mittelstand backbone of the industrial economy. QE has pushed the Bundesbank’s net credits through the ECB’s internal Target2 payments system to €880bn. It is becoming a backdoor "transfer union" without democratic consent.

The economy is overheating. The IFO confidence index has reached the highest level since 1969. The Bundesbank expects 2.5pc growth next year, twice the German speed limit, describing it as “clearly above the production potential”.

“It is very clear that monetary policy is too expansionary for Germany by any rule you care to use. The lesson of the past is that the longer this momentum goes on, the more dangerous it becomes, and I see a lot of dangers,” said Professor Clemens Fuest, head of the IFO Institute.  

The ECB’s Mario Draghi can push Germany only so far. If he tries to stretch QE even longer to buy time for Italy and Spain, he risks further eroding – and ultimately losing – German political consent for monetary union. Yet what Germany needs is incompatible with what the Latin bloc needs.  

IMF officials fear that sooner or later one country will be hit by an asymmetric shock, revealing the EMU system is as unworkable as ever

IMF officials fear that sooner or later one country (Italy) or region will be hit by an asymmetric shock, revealing that the EMU system is as unworkable as ever. There is still no fiscal union, and Germany is unlikely to offer Mr Macron much beyond the symbolism of a eurozone finance minister with no budget. The banking union lacks the genuine backstop needed to avert a repeat of sovereign/bank "doom-loop" that almost engulfed EMU in 2012. 

 Such a brutal denouement is a story for the next global downturn, not a looming threat for this year. What is likely to become clear in 2018, however, is that boom conditions are much harder to handle than the sluggish Goldilocks growth of early recovery. Deep rifts within monetary union are becoming visible again. The removal of the ECB shield may prove very painful for high debtors. 

So if you think Britain looks like the crisis child of Europe right now, just wait a few months. Rivals abound.

Very useful article about nationalising the railways

Very helpful for you to have some strong arguments against nationalisation; arguing for it should be simple, it is harder to muster stronger arguments against. Here are a few you can use to add depth to that side of an essay:

The Folly of re-nationalising the railways - January 3rd CapX

Rail fares have just gone up again, by an average of 3.4 per cent. Add to that the industrial action that has plagued Southern Rail and other operators and it’s hardly surprise that a recent poll found that 75 per cent of Britons support renationalising the railways. This, however, wouldn’t just fail to deal with the problems that have passengers so angry. It would make things even worse and be grossly unfair.

The train-riding commuter tends to be better-off than the average Brit, generally travelling from leafy suburbs or the countryside into well-paid jobs in cities. This means that the majority of Britons travelling to work by car or bus subsidise wealthier railway passengers, a fact that is often forgotten by the politicians and policymakers who live in London (or commute in on trains), where there are more plentiful public transport options.

On the continent, rail fares are cheaper because the taxpayer subsidy is much higher. This may suit those of us who have experienced “cheap” rail travel on holiday in Europe, but European taxpayers are footing the bill. The logic of the British system is that it is fairer for someone using a service to pay more for it than those who don’t (or can’t).

There is still a taxpayer subsidy in the system thanks to chronic under-investment during the bad old days of British Rail, which left the network in a parlous state, with many lines closed.

That investment is starting to pay off. Just look at the redevelopment of King’s Cross and London Bridge. There would be much more of this if it were not for the UK’s true rail scandal, HS2. Electrification of the lines and signals upgrades in the South-West and North-East have been stopped indefinitely to make the sums add up for a £104bn white elephant that refuses to die.

Nevertheless, signalling improvements and other upgrades means that Britain now has the safest trains in Europe, and punctuality and journey speed are much better than they were under British Rail.

One of the major criticisms from those who want to see renationalisation is that dividends to shareholders come at the expense of the money available for investment. But those payments equate to only 13p per journey and, as a new Taxpayers’ Alliance report shows, half of train operators did not pay any dividends to shareholders in 2015-16. Added to the fact that the number of passenger journeys has increased every year since privatisation (except during the recession in 2009-10) and the overall picture looks very different to the one painted by those nostalgic for the bad old days.

Another bogus argument for renationaliation doing the rounds today was the example of East Coast. The fact that the service was taken into temporary public ownership is often cited as proof that it would work with the entire network. But, as Sebastian Payne of the Financial Timespointed out, Directly Operated Railways paid less than half the track access charges than its predecessor.

No one wants to pay higher fares, especially when there are no seats available for the long slog into work. But the evidence shows that on the whole we are pretty pleased with the rail network. The latest National Rail Passenger Survey shows overall satisfaction at 83 per cent with only 6 per cent dissatisfaction. Of the 38 categories on which passengers are surveyed, only three had a higher proportion of dissatisfaction than satisfaction: availability of WiFi at stations and on trains being two, and the other being the availability of power sockets. The most unpopular operator? The strike-riddled Govia Thameslink Railway, whose franchise has an unusual structure as it uses a management contract under which fare income does not go to GTR, which instead receives a management fee. In other words, the “most nationalised” operator scored the lowest levels of satisfaction.

Another argument made is that Railtrack, Network Rail’s predecessor, was fully privatised and made a hash of things – so the pseudo-privatised system we have now should simply go back into public ownership. But the evidence clearly shows that the government doesn’t do particularly well when tasked with important jobs like buying rolling stock – take, for instance, the 2014 National Audit Office report criticising the procurement of Intercity Express and Thameslink rolling stock, the first time the Department for Transport had led such a programme since the days of British Rail.

Hand-in-hand with calls for renationalisation come support for trade unions. ASLEF and the RMT have made commuting into London on Southern Rail, as I do every day, very difficult. Continuing industrial action has nominally been about the “safety” of commuters if train guards are to be phased out, but these concerns have evaporated since Southern agreed to a 28 per cent pay increase (taking their basic pay to £63,000 for a four-day week). Small wonder 25p in ever £1 spent on the railways goes to staffing costs.

There is still much that can be done to improve the experience of rail commuters, beyond curbing the power of these trade unions. Extending platforms and stations to accommodate longer trains would help, as would more intelligent signalling. And the harsh peak/off-peak dichotomy should be replaced by a tiered costing system to smooth the demand on the first off-peak trains.

Richer people should pay for the privilege of living in leafy Surrey or Regency Cheltenham, but those of us who commute because we are priced out of living near where we work represent a failure of housing policy and should be helped. Our major commuter-receiving cities are much less dense than Paris, Tokyo or New York, and liberalising planning laws so that more of us could live nearer where we work would ease some of the worst routes.

But whatever the merits of these improvements, one thing is clear: renationalisation would be a massive, costly step backwards from the improvements that have been made in the last 25 years.

James Price is Campaign Manager at the Taxpayers' Alliance