Brexit means…higher prices
Oct 13th 2016, 10:29 BY BUTTONWOOD
THE economic arguments for and against Brexit in the course of the referendum campaign were quite esoteric and confusing to the average voter. Similarly, sterling’s decline in the currency markets might seem like the kind of thing that only concerns City traders.
So the row that has broken out between Tesco, Britain’s biggest supermarket chain, and Unilever, the Anglo-Dutch multinational, has made the story concrete in ways that were not apparent before. Unilever wants to raise prices across a range of goods to reflect the fall in the pound, which has dropped from around $1.50 on the day of the referendum to less than $1.22 at the time of writing. Similar falls have been seen against the euro; indeed travellers who change their money at the airport are getting less than a euro per pound.
The row has centered on Marmite, a salty yeast-based spread that is loved by some, but not all, Britons including this blogger. (I have yet to meet an American who can stand it.) But Marmite isn’t the best example as it is made in this country. PG Tips, one of Britain’s favourite tea brands (pictured), is a better example; that is grown overseas.
So why did Unilever suggest an across-the-board price hike instead of targeting only overseas-sourced brands? It is not completely illogical. As you can see from its quarterly results, Unilever reports in euros. So even if the cost of producing Marmite has not risen because of the falling pound, the sterling proceeds of Marmite sales are worth less than before. It is thus not surprising that Unilever is trying to get that money back. Nor is it surprising that Tesco, trapped in a price war with discounters like Aldi and Lidl, is resisting. The only surprise is that the news has leaked out, largely it seems because Tesco is refusing to stock Unilever brands.
This can’t last for long and eventually there will be a compromise. Unilever will cut its price demands and Tesco will absorb some of the hit. But supermarket margins aren’t high and Britons will end up paying more, just as they will for petrol (the initial post-referendum plunge in sterling coincided with weakness in the oil price but now the latter has rebounded).
Of course, that is what devaluation (strictly speaking, depreciation) means. Britain’s exports are worth less (in foreign currency terms) and its imports cost more. This is a good thing for exporters only to the extent that they can gain market share via lower prices and that this volume boost is not offset by the greater cost of components (eg a widget-maker has to pay more for the metals that go into the widget).
In a recent column, Paul Krugman saw the pound’s fall as a necessary adjustment. But it is worth reading why he thinks that
In one of the models I laid out in that old paper, the way this worked out was not that all production left the smaller economy, but rather that the smaller economy paid lower wages and therefore made up in competitiveness what it lacked in market access. In effect, it used a weaker currency to make up for its smaller market.
In Britain’s case, I’d suggest that we think of financial services as the industry in question. Such services are subject to both internal and external economies of scale, which tends to concentrate them in a handful of huge financial centres around the world, one of which is, of course, the City of London. But now we face the prospect of seriously increased transaction costs between Britain and the rest of Europe, which creates an incentive to move those services away from the smaller economy (Britain) and into the larger (Europe). Britain therefore needs a weaker currency to offset this adverse impact.
Does this make Britain poorer? Yes. It’s not just the efficiency effect of barriers to trade, there’s also a terms-of-trade effect as the real exchange rate depreciates.
In other words, Brexit is a shock. And Britain needs to react to this shock by lowering its prices. That could be done by getting employers to cut wages in nominal terms but that would be incredibly difficult and would throw up all sorts of other problems (workers’ debts would still be fixed in nominal terms so could not be repaid). Better to let the exchange rate take the strain. The analogy is the euro crisis where, because of the single currency, Greece and Spain couldn’t devalue and had to take a painful hit to the real economy.
But as Mr Krugman says, Britons are still poorer. Brexit means not just Brexit but higher prices. Since wages are unlikely to rise to compensate, real disposable income will be squeezed; economists are talking of a 2.5-3% inflation rate next year.
Some will cite the 1992 example, when Britain left the Exchange Rate Mechanism, as showing that a weaker currency can be a good thing. But the great boon of 1992 was that it allowed the Bank of England to cut interest rates from their sky-high 12% levels. There is not such scope now (indeed, Brexiteers complained about the quarter point cut the Bank did make). Nor did the pound seem to be overvalued before the referendum vote either on our Big Mac index or, more scientifically, on the OECD’s measure of purchasing power parity, which suggested $1.43.
Will the Fed greet the next president with a recession?
Oct 13th 2016, 19:02 BY R.A. | WASHINGTON
IT WAS just a few months into the presidency of Barack Obama that America crept out of the Great Recession and into the current expansion. With just three months to go in his second term, Mr Obama seems likely to pass that expansion on to his successor. But what are they odds that she will make it through a four-year term without a brush with economic contraction? The Wall Street Journal polled 59 economists to get their view. They reckon there is a 60% chance of recession striking within the next four years. Is that a reasonable estimate? Let's consider a few facts about expansions and recessions.
1) This expansion is getting up there in years, by American standards... The recovery began in June of 2009, which means that we are currently in its 88 month. According to NBER, which maintains a list of historical recessions going back to the mid-19th century, the current expansion is the fourth longest on record. The third longest, at 92 months, was the great boom of the 1980s, which the Obama boom can surpass in March of next year. Then comes the 106-month expansion of the 1960s, and finally the Clinton boom of the 1990s, which lasted a full ten years. If it continues, the current expansion would become the longest in America's history in July of 2019, just over two years into the next presidential term.
2) But not necessarily by global standards. That's not quite right. A decade-long boom is still a long boom by global standards. It just also happens to be considerably shorter than the longest booms on record. A number of other rich countries have enjoyed expansions lasting much longer than ten years in their history. The Netherlands holds the record for longest expansion, at nearly 26 years, but Australia's current boom is closing in on the lead.
3) Expansions do not die of old age. You might think they ought to, but they seem not to. That is, according to a recent analysis of postwar business cycles, expansions in their 80th month are no more likely to end in the next year than expansions in their 40th month. The mere fact of having been around longer does not make a boom more likely to end.
But end they do, so what's going on? Booms appear to meet three sorts of demise. The first is a shock that policy-makers fail to offset entirely. Crisis might break out somewhere in the world, triggering a financial panic or putting a chill on spending and investment. If central banks and governments do not respond quickly enough and powerfully enough, the shock becomes a recession. The second death is something like euthansia: a recession brought on (more or less) intentionally in order to bring an overheating economy back to earth. The classic example is the Volcker recession of the early 1980s. The third death is like the second, but accidental. Since the victory over inflation won in the early 1980s, recessions have invariably come at the end of central-bank tightening cycles; central bankers attempt to merely prevent an episode of overheating but end up turning the screw one too many times.
Some economists would say, not without some justification, that these are all actually the same variety of end: death by tight monetary policy, motivated at least in part by concerns about inflation. Think about the Great Recession, for example. It came at the end of a Fed tightening cycle, which almost certainly contributed to the severity of the housing crisis. It was as severe as it was because of the shock of the financial crisis; but, the Fed underresponded to the financial crisis because soaring oil prices in the summer of 2008 kept inflation fears alive.
Whether one thinks the Fed was the arch-villain behind the Great Recession, or a hapless accomplice, or merely an ineffectual would-be rescuer, we nonetheless have a decent mental model for how the next recession will start. Some shock will probably play a role, policy will underrespond, and the decisive factor will be the vulnerability of an American economy kept from growing too explosively by a Fed hellbent on tightening. We learned this week that the Fed's decision not to raise rates in September was a very close shave indeed. That's pretty remarkable; after all, it has been years since the American economy has threatened to produce sustained inflation of 2% or more, and it certainly isn't red-lining now. Wage growth also remains tepid, and there are vulnerabilities galore across the global economy, from Brexiting Britain, to shaky European banks, to an unsteady Chinese economy. Despite all this, markets reckon the Fed will hike in December.
I think the American economy could easily avoid a recession over the next four years given the right macroeconomic policy. But the right macroeconomic policy, especially when so much of the world is stuck with near-zero rates, is to err on the side of faster growth and above-target inflation. Given that it is harder now than in the past to offset a spate of bad news or a drag on growth blowing in from abroad, it makes sense to keep a stronger head of steam than one might otherwise choose. That is not the way the Fed sees it, unfortunately. As a result, I'm inclined to agree with the Journal's economists; America is more likely than not to fall into recession during the next presidential term.
Really? But wouldn't we see some sign of economic trouble brewing if that were the case? No, we wouldn't. That's fact number four.
4) Recessions happen when you don't expect them. Or more accurately, you can't see them until they are right upon you. In the growth forecasts it makes every April, for example, the IMF has never once foreseen the onset of a recession in the next calendar year. Even in its October forecasts it only correctly anticipates a coming recession about half the time.
So deep was the Great Recession that American workers have only just begun to enjoy significant benefits, in terms of rising real pay, from the ongoing expansion. It would be a tragedy for those gains to be cut short prematurely. A careless Fed might land the country, and the next president, in just such a mess.
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