The case for a National Investment Bank

One of the policy proposals put forward in the leaked Labour Party manifesto last week was the establishment of a National Investment Bank (NIB) to facilitate £250bn of spending on infrastructure over the next ten years. There was no detail in the document about how this might be set up, but there is some merit to the idea if done properly and in this post I offer a look at how it might work.

It is important to be clear at the outset what it should not be. It should not be a conduit for monetary creation by the Bank of England – the so-called People’s QE plan proposed by Jeremy Corbyn when he took over as Labour leader in 2015. PQE essentially requires the central bank to buy the bonds necessary to capitalise such an institution. But this policy is fraught with danger primarily because it erodes the boundaries between government and central bank to an unacceptable degree. In the form envisaged, it allows government to force the central bank to create money to finance whatever projects it deems fit. Moreover, a policy which requires monetary creation on such a scale would also have potential inflationary consequences and no central banker worth their salt is ever likely to endorse such a plan.

That said, there is no reason why a NIB should not work. The UK has tried it before and it was remarkably successful though perhaps not in the way initially envisaged. The Industrial and Commercial Finance Corporation (ICFC) was set up in 1945 by the Bank of England with funding from major commercial lenders to provide capital to small and medium-sized companies. In order to free itself from the constraints of relying on the clearing banks for funds, the ICFC began to tap the market to raise capital. This had an adverse side effect in as much as it raised pressure to generate greater returns on equity, which in turn led to a shift away from longer term, less attractive returns which its core mission delivered, to shorter term higher return projects, which caused problems during times of economic downturn. But by the 1980s it had shifted focus to become a leading provider of finance for management buyouts and had expanded internationally. It became a public limited company in 1987, when the banks sold their stakes, and it was fully privatised in 1994.

Currently, the UK is the only G7 economy not to have an institution which provides finance to the SME sector. In Germany, the Kreditanstalt für Wiederaufbau (KfW) has supported industry since 1948 and in the US, the Small Business Administration (SBA) has operated since 1953. Admittedly, the UK government did dip its toes into the water recently when it established the Green Investment Bank (GIB) in 2012. But despite apparently being successful, it was sold to Macquarie Bank last month for a price (£2.3bn) less than the initial £3.8bn of capital injected by the government.

In an excellent paper commissioned for the Labour Party in 2011, the lawyer Nick Tott outlined the case for a NIB.  But just to show that the case was not party political, former MPC member Adam Posen made a similarly excellent case in a 2011 speech which suggested that not only was there a case for a NIB, but that there was a need for an “entity to bundle and securitize loans made to SMEs … to create a more liquid and deep market for illiquid securities.” The biggest question remains how to capitalise such an institution. The government could commit up to £5bn as initial seed capital – after all it put almost £4bn into the GIB – and it could issue another (say) £5bn of bonds backed by Treasury guarantee. In future years it could divert part of the income generated by National Savings and Investments (NS&I) which raised £11.3bn for the Exchequer in 2015-16 and has assets of £120bn.

Admittedly, this is pretty small scale stuff and would be in no way able to fund the £25bn per annum of infrastructure which the Labour Party is calling for. This is probably a good argument in favour of limiting the remit of such an institution to SME lending rather than big public infrastructure projects. That, after all, is what such institutions do in other countries. Moreover, as Tott points out, it “would need a wide measure of independence from government.” It cannot simply be an arm of government to finance all sorts of pet projects, otherwise those who brand it a return to 1970s-style profligacy will likely be proved right.

A NIB would have to be run along commercial lines. As Posen pointed out, “The existing banks will scream about the unfair cost of capital advantage such an institution would have, but ... since the major banks in the UK have benefitted from a too-big-to-fail situation, any disadvantage they have in funding conditions is offset by the funding advantage they have over smaller or newer financial institutions, which they have gladly accepted. [Admittedly] public sector banks do tend to underperform private banks in credit allocation, and do tend to erode private banks’ profits. Yet most if not all countries have ongoing public lenders of various types (even the US has the SBA), and their existence on a limited scale, while perhaps wasteful at the margin, does not lead to the destruction of the private-sector banking systems in those countries … Let us remember that the UK and other western private-sector banks did that themselves during a period of financial liberalization and privatization unprecedented in postwar economic history.”

There are good reasons why the UK needs to do something to raise investment. For one thing, it is about to lose its EU funding which will put a hole in the transfers to many of the English regions (places like Hartlepool, which were very much pro-Brexit, have received considerable funding in recent years). A more generic macroeconomic problem is that the rate of business investment growth has been below the rate of depreciation since the great recession. This is not an issue which gets much airplay in the big picture story, and I am not sure of the extent to which it represents a change in business behaviour or whether it is a measurement problem. But it means in effect that the UK capital stock is declining, which may be one explanation behind the slowdown in potential growth in recent years. The UK needs to raise its investment levels. Whether a NIB is the right way to go about it remains to be seen. But it is an idea which should not be dismissed out of hand.

High Labour costs

Four weeks from today, the main UK political parties will go head-to-head in an election we do not really need to have. No prizes for guessing that Brexit will be the key battleground on which it will be fought. But with changes in the leadership of all main parties since 2015, this really should be an opportunity to address many of the key economic issues which have plagued the UK over the last seven years. The lack of investment; the over-reliance on austerity and a chance to reset the terms of the EU debate which David Cameron got so totally wrong and which Theresa May is not helping to improve. One might have thought that by now, the parties would have their economic plans ready to roll in order to give us time to assess the issues. Well, not exactly. The Conservatives are not planning to publish their manifesto until next week, and the best we have from Labour is a leaked draft which was splashed all over the press, framed as a socialist document worse than the longest suicide note in history, as their 1983 agenda was dubbed.

If you actually read through the leaked draft of the Labour Party manifesto, rather than rely in the headlines which tell us how very socialist it is, there are some rather interesting ideas in there. Jeremy Corbyn, for all his many faults, is trying to fight an election on issues of fairness and responsibility. The key message is that the vast majority of the electorate has been squeezed since the financial crisis-induced economic collapse, and Labour wants to do something about rectifying it. Thus the plans outlined so far indicate more spending on the NHS and the creation of a National Care Service; the building of more new houses; the scrapping of university tuition fees and the reintroduction of student maintenance grants. Add in the prospect of establishing a National Investment Bank to facilitate £250bn of spending on infrastructure over the next ten years (which is not a bad idea and I will deal with it another time), and you have what sounds like a classic fiscal stimulus. I would use the phrase “pump priming” but Donald Trump has apparently just invented it. (“Have you heard that expression used before? Because I haven’t heard it. I mean, I just…I came up with it a couple of days ago and I thought it was good”).

There is just one tiny problem: The plan sounds horrendously expensive – and that is before we even talk about the renationalisation of rail and energy. Let’s start with education. The Institute for Fiscal Studies reckons that Labour’s Higher Education policy would raise the deficit by over £8bn (about 0.5% of GDP at current prices). Investing £250bn in infrastructure over a ten year period implies a boost equivalent to 1.5% of GDP per year. To secure the financing, taxes must inevitably go up. Labour has suggested that it will raise income taxes on those earning over £80,000 per year (the top 5%), though has not said by how much, and “will ask large corporations to pay a little more.”

Some back-of-the-envelope calculations suggest that there are 1.1 million taxpayers earning between £80k and £150k per year paying higher rate tax at 40%, and 0.3 million earning above £150k paying a 45% rate. This means that only 25% of all higher rate taxpayers earn more than £80k. We can thus take the HMRC’s tax rate elasticity multiplier which calculates the full effect of raising higher rates taxes, and assume a 25% efficiency rate compared to the full impact. Running through the numbers, each 1% rise in tax on those earning above £80k per year will yield around £0.5bn in revenue per year. If the tax rate is whacked up by 4 to 5 percentage points, we could thus fund the education costs. The ready reckoner also suggests that each 1% on the corporate rate will reap around £2.4bn per annum. Thus, reversing the planned 3 percentage point cut in corporate taxes by 2020 yields another £7.2bn over three years. A Labour government could even raise corporate taxes back towards 25% over (say) five years, yielding an extra £12bn by 2022. Adding up these numbers (an effective 8 percentage point rise in corporate taxes and 5 points on taxes for higher earners), we thus start to get close to the £25bn needed for annual infrastructure spending.

But funding the reprivatisation would be enormously expensive. A brokerage report by Jefferies in 2015 put the cost of renationalising the energy sector at £185bn (~11% of GDP). They also pointed out that “if a future Labour government restricted itself to just acquiring the UK assets of the big six generators plus National Grid, the cost would be £124bn.” I have no idea what renationalising the rail sector would cost but let’s say £60bn for the sake of argument. An increase of £184bn in public outlays would raise the debt-to-GDP ratio by 11% at one stroke. Even assuming this is not a problem, the markets would almost certainly demand a higher risk premium on gilts, so debt servicing costs would rise. But here is the kicker: Labour has proposed a Fiscal Credibility Rule which plans to reduce the current balance to zero on a five year rolling timescale (which sounds to me like a never-never rule), but also that the debt-to-GDP ratio be lower at the end of the parliamentary term than at the beginning. Nationalising rail and energy would blow a hole in that, but fortunately Labour proposes to suspend the operation of the rule so long as monetary policy is operating at the lower bound. So that’s all right then!

All of these numbers are back of the envelope calculations and in no way constitute a detailed analysis of the costs.  Although many commentators liken this document to Labour’s 1983 election manifesto, its 1974 document which called for “more control over the powerful private forces that at present dominate our economic life” was at least as damaging because the party was actually in government. Labour’s main failure in the 1970s was to recognise that the poor performance of the British economy was not due simply to the failings of the capitalist system: It was largely due to an insular view of the economic problems. It feels very much like we are at that point again today.

Vive la différence

Watching the acceptance speech by the new French president Emmanuel Macron yesterday, I must confess to a tinge of envy because it represented everything which is lacking from the UK scene. The French electorate decisively rejected the knee-jerk politics of division in favour of a more inclusive EU-friendly alternative whilst at the same time electing a man who, at 39 years old, is the youngest leader since Napoleon Bonaparte in 1799. At least for now, Macron represents hope for a more positive future. His election also breaks the recent trend towards right-wing populism, as represented by his opponent Marine Le Pen.

Here in the UK an election takes place in just over four weeks’ time and the choices on offer are nowhere near as palatable. Theresa May represents a continuation of the dogmatic opposition to the EU, with the prospect of the economy moving closer to the cliff edge that she claims to want to avoid. But the opposition offers no choice at all. Even accepting that Jeremy Corbyn probably does get a bad press from a media which is viscerally opposed to the Labour Party, he increasingly appears an ineffectual leader unable to rally centrist voters to his cause and who presides over a party which has slipped so far to the left as to be unelectable. The French, of course, had just such a candidate in the first round of presidential voting two weeks ago in the form of Jean-Luc Mélenchon and he trailed in fourth with less than 20% of the votes.

Over the weekend, the shadow Chancellor John McDonnell denied being a Marxist but did suggest that “there is a lot to learn from reading Das Kapital.” Whilst recognising the importance of Marx’s tract as a seminal work in the field of political economy, it is fair to say that from an economic viewpoint there is more to disagree than to agree with, but I’ll leave that for others to debate.  However, coming just days after Labour suffered heavy losses in local elections, losing 382 council seats across the country whilst the Conservatives gained 563, it seems that this is a message which the UK electorate does not want to hear. Labour does not have a positive message to sell the voters and with UKIP all but wiped out as a political force, losing 145 of the 146 seats it held, it is difficult to see the Conservatives winning anything other than a landslide victory at the general election scheduled for 8 June.

Quite what the Conservatives’ economic policy will look like is unclear, since it has delayed the publication of its election manifesto until next week. It is likely to maintain a pledge to reduce immigration but will almost certainly not repeat the mistake made in 2015 when it promised not to raise income tax, VAT or national insurance contributions. But as Jagjit Chadha of the National Institute points out, this election should be about more than just Brexit. Answers need to be found to the weakness of UK productivity for only this way will we finally be able to make some progress on the vexed question of stagnating living standards.

Of course, Macron will face all sorts of challenges to get the French economy back on track. Like the UK, fiscal issues will be high on the agenda with Macron planning to reduce the tax burden, including a reduction in the corporate tax rate from 33% to 25%, and to simplify the tax system. At the same time, he has promised to cut public spending to a still-high 52% of GDP (though on the basis of the European Commission’s data this is not exactly a high hurdle). The new president also plans to decentralise the labour market in favour of firm-level rather than collective agreements, and a gradual loosening of the 35 hour working week. As I noted a couple of weeks ago, the extent to whether he gets a mandate to push through his plan will depend on how much support he has in the National Assembly following June elections. He will have his work cut out.

Macron’s victory yesterday took my mind back 20 years to the election of another young left-of-centre politician in the form of Tony Blair. Blair was viewed across Europe as a breath of fresh air following the fractious Conservative government of 1992-97. He promised a third way in politics which involved a bit of state intervention and a lot of market forces, and offered hope to social democrats across the continent. He took over as UK prime minister at a time when the European economy was a lot stronger than it is today and he was obviously economically successful for a long time. But the story of how he came to be reviled by his own party should be a lesson to Macron. Today’s fresh face of optimism can just as easily become yesterday’s man. As former PM David Cameron once taunted Blair in 2005, “You were the future, once.” And now Cameron, too, lies on the scrapheap of history. Nemesis is never far away

Central banks: A balancing act

One of the issues which central banks are going to have to face up to at some point in future is the question of whether and how to reduce their balance sheets, which have been swollen by the huge purchases of financial assets under the QE programme. The balance sheet of the US Federal Reserve, for example, now stands at $4.5 trillion, which is roughly 25% of GDP compared to a figure around 7% at the start of the financial crisis, with the expansion comprised primarily of Treasury and Mortgage Backed Securities (MBS).

From the outset, central banks were clear that it was the stock of assets held on the balance sheet which was important for the purpose of injecting additional liquidity, not the rate at which they were purchased. This was because the purchase of bonds has a counterpart on the liability side of the balance sheet in the form of a credit to the banking system (excess reserves), representing the transfer of funds from the central bank to the seller of the bond. To the extent that the banking system creates liquidity as a multiple of the deposits in the system, this rise in banking sector deposits held at the central bank is what ultimately determines the pace of liquidity creation in the wider economy. The Fed ceased buying assets in October 2014. But as existing bonds matured so they ceased to be an item on the asset side. In order to prevent an unintended decline in the balance sheet, it was forced to rollover maturing securities which means that it is still actively buying assets, albeit on a smaller scale than previously.

But the Fed has indicated that it will ultimately shrink its balance sheet, and thus impose an additional degree of monetary tightening, but not until “normalization of the level of the federal funds rate is well under way.” Whilst markets are concerned about when this is likely to happen, a more interesting question is how rapidly it is likely to proceed. It is widely anticipated that the Fed will allow its maturing bonds to simply disappear from the balance sheet – a form of passive (or less active) reduction compared to the alternative of actively selling bonds. Ben Bernanke (amongst others) has argued that the Fed should simply aim for a given size for the balance sheet and allow the maturing of existing bonds to continue until the desired level is reached.

It is pretty likely that wherever we do end up in the longer-term, the balance sheet will not go back to pre-2008 levels. With Fed estimates indicating that demand for currency is likely to reach $2.5 trillion over the next decade, compared to $1.5 trillion today (and $900bn before the crisis), it is evident that the absolute size of the balance sheet in the longer term will be far higher than it was 10 years ago. In one sense, this makes the Fed’s task easier because it will not have to run it down so far. Indeed, in a nice little blog piece in January, Ben Bernanke reckoned that the optimal size for the balance sheet over the next decade is likely to be in the region of $2.5 to $4 trillion. If indeed the optimal size is close to the upper end of the range, it implies that the degree of reduction will be very small indeed, and would have little impact on markets which fear that a rundown of the balance sheet will result in a sharp rise in interest rates.

This absence of a dramatic reduction would be in keeping with past historical evidence. Analysis by Ferguson, Schaab and Schularick which looks at central bank balance sheets over the twentieth century, argues that prior to the onset of the financial crisis balance sheets relative to GDP were very small relative to the size of the economy compared to longer-term historical experience. They also note that “outright nominal reductions of balance sheets are rare. Historically, reductions have typically been achieved by keeping the growth rate of assets below the growth rate of the economy.”

Perhaps what this all means is that we should stop worrying too much about the potential impact of big central bank balance sheet reductions. But it does mean that a more permanent change in the conduct of monetary policy is about to take hold. Prior to 2008, central banks controlled access to demand for banking sector liquidity by regulating its price via the overnight rate. Now that liquidity is plentiful, both the Fed and ECB operate a floor system by controlling the rate they pay banks on reserves held with the central bank. As recently as November 2016, the FOMC described the current floor system as “relatively simple and efficient to administer, relatively straightforward to communicate, and effective in enabling interest rate control across a wide range of circumstances.”

Such a policy requires the banking system to be saturated with reserves and implies that the balance sheet may be about to assume a more important role in the conduct of policy as it becomes the tool via which bank reserves are supplied. So maybe central bank watchers will spend less time worrying about the policy rate in future and we will go back to the old-fashioned job of trying to predict how much liquidity central banks are injecting into the market. Now that takes me back a bit …

Dial it down

The rhetoric over the Brexit divorce has gone up by a few notches in the course of recent days. Leaked accounts of last week’s dinner engagement between Theresa May and Jean-Claude Juncker were splashed all over the German press at the weekend. Subsequently, the FT has calculated that the upfront cost of departure is likely to be in the region of €100bn whilst Theresa May today made the extraordinary allegation that “some in Brussels” did not want Brexit to succeed. It might be wise at this point to dial down the rhetoric before things get out of hand.

Dealing first with the politics (I know it’s dull but this whole debate is driven by it), there is little doubt that the European Commission was responsible for the leaks to the Frankfurter Allgemeine Zeitung. The details were too precise to be made up, and it is clearly designed to rattle the UK’s political cage in order to remind the government that it will not get everything it wants during the Brexit negotiations (if indeed, it gets anything at all). It is not very edifying but that’s politics for you.

As for Theresa May’s statement, she is right – except it is probably more accurate to say that “no-one in Brussels” wants Brexit to succeed. Why would they? We have known all along that the EU has no incentive to make life easy for anyone who wants to leave: If Brexit is a success the whole basis of the EU is threatened. If the EU is serious about holding together in the absence of the UK’s departure, of course it wants to see Brexit fail – to suggest otherwise is an act of incredible naïveté. The suggestion that there is any meddling in the election was, however, a step too far. In any case, this unnecessary election is all about the UK’s bargaining position regarding Brexit, so the PM’s comments were a bit rich.

Which brings us to the issue of divorce costs. I have referenced the work of the FT’s Alex Barker before, and I am indebted to his analysis of the data for an insight into where the EU’s increased bill comes from. Previously, the bill was estimated at around €70bn – a figure which included numerous questionable items. The extra €30bn is even more controversial, largely due to the demand for contributions to commitments planned for 2019 and 2020, which occur after the UK has already left the EU and which is estimated to cost between €10bn and €15bn. The EU is also believed to be demanding an upfront payment of €12bn to cover contingent liabilities rather than stumping up at the point when they arise. Finally, France and Germany are also believed to be doubtful that the UK has any entitlement to the EU’s assets – a move which is calculated to wind up the UK government.

It should be stated at the outset that the €100bn is a gross figure. If the UK is paying its full share of the budget beyond 2019, it will be entitled to its normal rebate. Once we add in farm subsidies and other items, it is expected that the final figure will be around the €65bn mark. Of course, like any good dealmaker, the EU is bound to start with a high figure in the knowledge that it will be beaten down, but the higher you bid the more chance of  getting a figure close to what you believe to be reasonable. The ratcheting up of pressure was likely also partly triggered by the recent UK government belief that it can legally walk away without paying anything at all, and this is the EU’s way of letting the UK know it is not in a strong negotiating position. After all, the UK will not get any form of trade deal if it refuses to pay anything (which, of course, the UK knows). More problematic still is that Michel Barnier, the EU’s chief negotiator, will not put a final bill on Brexit until the negotiations are complete – he simply wants the UK to agree on the methodology.

All told, this puts the UK in a difficult spot. David Davis, the UK’s chief negotiator, will not sign up to such a deal – and for once I have some sympathy. The UK will already be asked to contribute to the unattributed parts of the budget which have not been allocated on an accruals basis (the so-called reste à liquider payments), whose provenance is dubious. To deny the UK any claim on EU assets is morally indefensible, particularly since the UK is such a big net contributor to the EU budget. But to pay for budget commitments beyond the time the UK leaves is a red line. It’s like being charged in a restaurant for a meal you already don’t want to eat, but then you are being asked to pay for the next customer’s food as well.

The whole day has been one of high octane posing. As I have said before, there are deals to be done but if both sides continue to antagonise the other, the prospect of successfully concluding one will diminish. My advice would be to turn down the noise – no trade deal is ever concluded with anything other than a cool head.

Abbott without the Costello

For many years I have tried to keep politics separate from economics but these days it is virtually impossible, particularly when looking at UK related issues. Regular readers will know that I do not have a lot of time for the current UK government’s Brexit strategy. But, in the spirit of impartiality, never let it be said that I do not apply the same rigorous standards to the policies of all parties. This morning’s car-crash radio interview  by shadow Home Secretary, Diane Abbott, highlighted once again that it is not only the Conservatives who struggle to get their economic policies across.

In the interview, Abbott tries to explain how the opposition Labour Party plans to fund an expansion to the number of serving police officers. You really have to listen to the interview to do it full justice, but for the record I set out parts of the transcript below. 

Nick Ferrari (interviewer): Where will the money come from Diane Abbott? Good morning. 

Diane Abbott: The money will come from reversing some of the tax cuts for the rich that the Tories have pushed through. And the tax cut we're specifically identifying to pay for the 10,000 policemen is the cut in capital gains tax. 

NF: So how much would 10,000 police officers cost? 

DA: Well, if we recruit the 10,000 policemen and women over a four-year period, we believe it will be about £300,000. 

NF: £300,000 for 10,000 police officers? What are you paying them? 

DA: No, I mean, sorry... 

NF: How much will they cost? 

DA: They will cost, it will cost about, about £80 million. 

NF: About £80 million? How do you get to that figure? 

DA: We get to that figure because we anticipate recruiting 25,000 extra police officers a year at least over a period of four years. And we are looking at both what average police wages are generally but also specifically police wages in London. 

NF: And this will be funded by reversing, in some instances, the cuts in capital gains tax. But I'm right in saying that since Jeremy Corbyn became leader of the party, that money has also been promised to reverse spending cuts in education, spending cuts in arts, spending cuts in sports. The Conservatives say you've spent this money already, Diane Abbott. 

DA: Well the Conservatives would say that. We've not promised the money to any area, we've just pointed out that the cuts in capital gains tax will cost the taxpayer over £2 billion and there are better ways of spending that money. But as we roll out our manifesto process, we are specifically saying how we will fund specific proposals. And this morning I'm saying to you that we will fund the 10,000 extra police officers by using some - not all, but just some - of the £2 billion. 

NF: But I don't understand. If you divide £80 million by 10,000, you get £8,000. Is that what you are going to pay these policemen and women? 

DA: No, we are talking about a process over four years. 

NF: I don't understand. What is he or she going to get? Eighty million divided by 10,000 equals 8,000. What are these police officers going to be paid? 

DA: We will be paying them the average... 

NF: Has this been thought through? 

DA: Of course it's been thought through. 

NF: Where are the figures? 

DA: The figures are that the additional cost in year one, when we anticipate recruiting about 250,000 policemen, will be £64.3 million. 

NF: 250,000 policemen? 

DA: And women. 

NF: So you are getting more than 10,000. You're recruiting 250,000? 

DA: No, we are recruiting two thousand and - perhaps - two hundred and fifty. 

NF: So where did 250,000 come from? 

DA: I think you said that, not me. 

NF: I can assure you you said that, because I wrote it down.

It was shambolic and described by one journalist as the worst interview from a front line politician he has ever heard. There is, actually, a policy in there. Indeed, I have raised the issue of police funding in a previous post (here). But the whole affair gave the impression of a politician who was ill-prepared and a policy which was badly thought-out. I have done my share of media interviews in my time, and I know how easy it is to have a brain fade. But this is a politician seeking high office, trying to put across one of their key policies. Despite the fact that the apologists will say we should not allow the presentation to get in the way of the message, the fact is if a senior politician cannot prepare for a radio interview and get their facts straight, what chance would they have when faced with the difficulties of Brexit negotiations?

All this undermines the opposition’s case to be taken seriously at a time when the government is open to criticism on its track record in managing public spending, and will reinforce the media view that Labour cannot be trusted on key policy matters. Now more than ever, the UK needs effective government and a strong opposition able to hold it to account. On matters of economic policy, the government is getting off far too easily. The prime minister struggles to answer when pinned down on points of detail, but wriggles out of it by repeating to her interviewer that she will bring “strong and stable government.” It is the soundbite of the election campaign so far.

But it is a slogan, not a policy. Faced with the Scylla of the prime minister’s position and the Charybdis of Diane Abbott’s, it is hard to avoid the view that the electorate is not being well served by its politicians. Twenty years ago today it all seemed so different, when a freshly minted prime minister in the form of Tony Blair, marched into Downing Street promising to bring a fresh approach to government. Blair has come and gone, and is widely reviled - even by his own party. But his ability to communicate was first rate. The inarticulacy which characterises today's policy debate would simply not be allowed to stand.

Are we too complacent on interest rates?

One of the ongoing puzzles in the current conjuncture is why interest rates remain so low, despite the fact that the global economy has turned the corner. Indeed, central banks have recently been subject to widespread criticism for maintaining them at levels consistent with the emergency rates required in 2009 when the economy does not face anything like the same degree of danger. Despite the fact that the Federal Reserve has raised interest rates on three occasions since December 2015, yields on the 10-year Treasury note are still lower than in summer 2014 whilst UK 10-year gilts are trading just above 1% and 10-year Bunds below 0.4%.

Looking at the issue in a longer-term context, the standard approach in the academic literature is to point out that the neutral global real interest rate has fallen over the past three decades. A Bank of England Working Paper published in December 2015 highlighted that the long-term risk free real rate has fallen by around 450 bps in both emerging and developed economies since the 1980s.

The major factors which drive underlying long-term rates are expectations of trend growth and factors which impact on savings and investment preferences. The authors (Rachel and Smith) point out that the impact of a growth slowdown on lower rates is limited, accounting for less than a quarter of the total observed amount, and that the bulk of this can be attributed to changes in savings and investment preferences. Their key finding is that whilst there has been a sharp rise in saving preferences across the globe, desired investment levels have also fallen significantly. This is, of course, fully consistent with the savings glut hypothesis first postulated by Ben Bernanke in 2005. But Rachel and Smith go further by giving some quantitative estimates for the magnitudes of the quantities involved. Thus, they attribute 100 of the 450 bps decline in real rates to slower global growth; 90 bps to demographic factors and 70 bps to lower investment demand. All told, once they account for a number of other factors, they claim to account for 400 bps of the decline in real rates.

As an academic tour de force, this paper is an excellent and comprehensive overview of the factors driving rates lower. But it is not the whole story. A quick look at the data, compiled by King and Low in 2014 (chart), suggests that whilst there was indeed a sharp decline in the global real rate between 1990 and 2008 of around 250 bps, the last 200 bps has occurred post-financial crisis – a period when central banks slashed the short end of the curve to zero at the same time as they were engaged in huge asset purchases. In order to probe a little deeper, it is worth highlighting the concept of the natural rate of interest, postulated by Swedish economist Knut Wicksell at the end of the 19^th century. Wicksell argued that if the market rate exceeded the natural rate, prices would fall; if it fell below, prices would rise. Obviously, we do not know what the natural rate is but a quick-and-dirty method is to measure the difference between nominal GDP growth and the interest rate to assess the extent to which the real and financial sectors of the economy are misaligned.

In the UK, over the period 1975 to 2007, nominal GDP growth was on average within 30 bps of Bank Rate but since 2010 it has averaged a full 300 bps above, and similar deviations have been recorded in the US and the euro zone. This is not proof that interest rates are too low. After all, it is not as if price inflation is a problem for the global economy. But it does highlight the extent to which the interest rate on financial assets is too low relative to returns on real assets, which in turn has helped to propel financial asset prices to stratospheric levels. The concern is clearly that at some point asset markets will turn. But central banks will probably have no choice but to watch the bubble deflate because after having used a huge amount of monetary resources to pump markets up, they cannot realistically deploy more to cushion the fall.

Whilst I understand why central banks have been reluctant to raise interest rates so far – although the Fed is now grasping the nettle – I do detect a slight note of complacency. The fact  that (some) central bankers have justified their low interest rate policy on the basis of lower global equilibrium rates, without fully accounting for the fact that their actions have themselves pushed global rates down, strikes me as distorted logic. I am reminded of the situation a decade ago when many central bankers dismissed rapid growth in monetary aggregates as a problem not worth worrying about, when in fact it reflected the actions of banks to pump up their balance sheets. And we all know how that ended.