Monday, November 24, 2008

British Stimulus Package

Gordon Brown has announced a stimulus package of 24 billion euros, including a decrease of the VAT from 17.5 to 15 percent. Since the UK GDP is roughly comparable to the French, this gives an idea of the order of magnitude that France should be looking at if it plans to go the Keynesian route. The 6 billion euros to be injected into the new French sovereign wealth fund falls well short, and Sarkozy, for all his activism, has been very guarded in saying exactly what he intends to do. But time is pressing. The rumors from Washington suggest a US stimulus plan on the order of $500 to $700 billion. Since US GDP is 6 to 7 times as large as the British or French, this is a good deal more ambitious than the Brown plan (which is only 1% of GDP, compared to 3-5% for the US). It's time for Sarkozy and Lagarde to get down to brass tacks.

ADDENDUM: Rumor has it that there will be an announcement of a European stimulus plan of 130 billion euros, or about 1% of EU GDP, on Wednesday.


kirkmc said...

How much effect will a drop in VAT have on the real economy? It's only a tiny amount, and will retailers pass it on to consumers? I think past experience suggests that they won't (as was largely the case in France when VAT dropped from 20.6% to 18.6%). Maybe the system is different in the UK, and it will get passed on, but as long as VAT is included in prices (as opposed to being added on, as sales tax is in the US), retailers are still going to sell things for round prices. They won't drop the price of a 99p item by 2p to make up for the difference, and the same is true for higher amounts.


Arthur Goldhammer said...

From a Keynesian standpoint, it doesn't matter much whether the retailer keeps the change or passes it on to the consumer. The retailer may use the extra income to stay afloat and thus preserve jobs, hire an additional employee, or increase inventory. Any of those uses would be preferable to passing it on to a consumer who simply banked it. The point of stimulus is to stimulate recipients to do what they wouldn't do otherwise: spend, invest, hire. You want to break out of a liquidity trap, that is, a situation in which people prefer to hold cash rather than consume or invest.

bernard said...


I suspect you are quite right.

British households are highly indebted compared to most European continental households. Their savings rates are low at the moment.

For these households, prospects are grim. First, they are facing a major increase in unemployment in the coming year, which will push them to increase their saving rate if possible. Second, they are facing negative equity (their dwelling is worth less than their mortgage amount) and prospects are that this will go further negative, which is a second reason to save. Third, they may reckon that prices would fall in the future (deflation anyone) and thus put off any major spending (new car etc) until price falls have occurred, which gives a third reason for their saving rate to go up.

The British government knows this of course and likely is not lowering VAT in the hope that this shows up in retail prices, but rather that this stays to a large extent within the production and retail chains, thus helping the high street to retain employees and not go bankrupt (circuit city anyone ?).

I believe that this is mainly an employement measure rather than a purchasing power measure.

Having said that, one understand better why France and Germany believe that this is not so well suited for their economies. In both countries, household indebtedness is much lower than in the UK and also is far from being as sensitive to short term rates. Also, real estate values are not falling in the same brutal fashion as in the UK, even though they are of course falling. Furthermore, finance and insurance are not as big parts of their economies. Finally, the saving ratios of households are high in France and Germany.

Arthur Goldhammer said...

Bernard, Thanks for that careful analysis. Indeed, France and Germany would be well advised to target infrastructure spending, but it's not at all clear that that's what they're planning. Sarko seems bent on a mission of economic patriotism, while Merkel seems still to be reacting to erupting crises rather than trying to plan one or two moves ahead. But more may emerge later this week.

kirkmc said...

It's true that with savings so high in France, the government should try and get people to spend rather than save. But since most people who save probably aren't cutting back on spending, and most people who can't afford to spend can't afford to save, it's a tough situation.

I have a feeling that we'll see more "revenue neutral" things, such as accelerated depreciation for business expenses. They did that some years ago - was it ten years or so? - for computers, and that drove up sales very quickly. They could do that for other investment, which would prime the pump for manufactured goods, helping sustain employment. I don't expect to see much for "rue de la Gare", if that's what you'd call Main Street here - the usual is an increased Christmas allocation (already announced), and other things that only help the lower to middle classes meet expenses, not get them to spend more.

bernard said...


Yes, the saving ratio of households is high in France, but that does not mean at all that it cannot be moved by policy. It has in fact fluctuated quite severely over the past 20 years. As a matter of fact, historically, fluctuations in savings ratios have been a more important determinant of cyclical developments than real income developments.

I for one registered a major success in the early nineties when I prognosticated the end of the 1993 recession through a careful analysis of likely household savings behavior given certain policy decisions. I was the darling of forecasting as far as the government was concerned at the time and had access to absolutely everyone (to quote Bob Dylan "things have changed"...). There is no question that the French or German government could influence households savings behavior at the moment, just likely not through VAT manipulation.

Arthur Goldhammer said...

Bernard, Let me take advantage of your expertise. The US stimulus plan has to take account of an enormous wealth effect in the US. This has two components. Household wealth has taken a huge hit from the decline in home values as well as from the decline in the stock market. France has a much lower home ownership rate, a smaller decline in housing prices, and a lower rate of stock ownership. Can you quantify these differences and suggest a reasonable stimulus for France in proportion to the size of the US plan? I've also been wondering about the comparison between this depression and the Great Depression. Stock ownership was much less widespread then. How much more significant will the wealth effect be as a result?

bernard said...

Well, I've seen today that the US plan might be 700 billion over 2 years, eg 2.5% of GDP each year. That seems to be the sort of range that Krugman suggested and he was, if I recall, making the point that it had to be huge and that there was massive uncertainty (better to err on the generous rather than on the stringy side).

You mention these wealth effects. Their econometrics even for the US are not quite settled (the "science" is 10 to 15 years old), that is we know that they have an impact, but is it really going to be 3p or 5p per dollar is not quite certain and, because we are talking about a huge decline in wealth, that uncertainty translates into large uncertainty about prospects: if we were talking a wealth decline of 100 billions, whether the impact on consumer spending was 3 or 5 billions would be immaterial, but here we are talking about multiplying 3 or 5p by a very large number indeed relative to household income.

In a country like France, first I am not quite sure that there are any good econometrics in this field. Second, we cannot translate what happened on the Paris Stockmarket (it is small anyway) into a households wealth decline: ownership of stocks is extremely internationalised (over 50% I think for CAC40 companies). What happened to non-sovereign bonds is more consequential as well as what happens to short term market instruments because that is where French households financial investments are mostly located. So I am thinking that from this angle we probably need a smaller stimulus plan (1%) than the US, especially if banks can be gently coerced to keep on lending. It is correct that banks were less leveraged thus less involved in financial fantasyland than others but here too, the sums are so huge anyway that one has to reserve certainties for hindsight times. Plus in previous financial crises (for instance Asia or earlier the savings and loans crisis), French banks were played as buyers of last resort by the US and the Japanese. The decline in housing prices is for the time being more gradual in France and the impact on households is contained because, to simplify, everyone is on plain vanilla 20 year mortgages fixed rates. Still of course, construction is grinding to a halt and support in this direction will probably be linked to the Grenelle de l'Environnement measures (support for green buildings etc...).

There however is a completely different angle to this: notwithstanding so-to-speak domestically generated woes, there will also be the international transmission of the economic slump: say the UK goes in the toilet, well the UK takes about fifteen percent of French exports, etc... So we have all these forces that are simultaneously reinforcing and they do suggest going for the larger number if possible (closer to 2% than to 1%).

My last remark would to stress again that there is massive uncertainty on prospects in 2009: if it is a recession, that's one thing, if we get into a deflationary mechanism, that's a completely different kind of cookie. And, there, European governments such as France or Germany should take full account of their incapacity to get money on the ground rapidly: there is a lag of a minimum of 10 months (not like the recent US tax rebate). What that means is that they cannot decide to do a little now and more later if the situation goes more towards the bad side than expected, because it will then be too late. They must take a leap of faith and do the deed right now and hope, if it turns out to be too much, that Trichet and Cie can close the bag fast enough for their credit standings.

I have not discussed monetary policy, but obviously we have still got 2 to 3 points to go if they want to. However, that is not very important because the transmission mecanism does not operate properly thees days and will not until the banking sector have absorbed their losses. This incidentally is why the ECB has not rushed to cut rates by a huge amount, but has expanded massively its balance sheet: to simplify they are doing huge quantitative easing and not bothering to try rate cuts. Well that's my understanding anyway but I could be wrong as we are talking about some arcane areas of monetary policy (as Krugman says, no one had bothered to study liquidity traps between the great depression and Japan in the late nineties, and if it wasn't studied, it wasn't taught either).

Arthur Goldhammer said...

Thank you.

Arthur Goldhammer said...

Bernard, re your thoughts on deflation and quantitative easing, see Jim Hamilton:

kirkmc said...

My economic knowledge is limited, but I think the biggest variable not mentioned by Bernard above is household debt in the US, especially credit card debt. First, this debt could be reaching a tipping point, as, with a bad economy, huge numbers of people default, leading to a crisis that could dwarf the housing crisis (at least according to what I'm reading). But the French don't have much credit card debt - in spite of what you see on TV about households with too much debt, it's very, very limited, and most people don't even use credit cards, they use debit cards. So the French won't be hit by such a problem. However, as Bernard pointed out, if the US and other countries go into a serious recession/depression, France will get hit in its exports. I don't know what the balance of payments is for France, but I don't think it's very good already, so further cuts in exports will have severe effects.

As for loans, Bernard said most French people have "plain vanilla 20-year fixed rate mortgages". I don't know how true that is; I've heard of lost of people getting ARMs recently. And more people opting for longer-term mortgages as well.