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Economic and Strategy Viewpoint - August 2019

The fiscal fix?

  • Recent moves in the US and UK show that fiscal policy is coming back into vogue as politicians try to boost growth whilst bond yields are low. It may be the best response to a world economy hampered by geopolitical risk and policy uncertainty.
  • IMF analysis suggest that both countries have some scope to ease fiscal policy, although the US may have used much already.
  • Meanwhile, despite substantial fiscal space, the eurozone has eschewed expansionary fiscal policy. This may change given the slowdown, but in the meantime the combination of loose money and tight fiscal policy is helping the euro win the currency war.

What lies behind the recent weakness in US inflation?

  • The US economy continues to add jobs and unemployment is at its lowest for fifty years, but core inflation has surprised to the downside over the past three quarters.
  • Our bottom-up approach reveals that, while cyclical inflation components are still responding to changes in economic activity, the slowdown in oil prices and in non-oil import prices have been responsible for the recent weakness in US core inflation.

Why weaker sterling has failed to turbocharge the UK economy

  • Despite the sharp depreciation in the pound the UK has made little progress in "rebalancing its economy".
  • Two reasons help explain why. First, UK productivity growth has been appalling, allowing unit labour costs to rise and erode the competitive gains from the fall in sterling. Second, most UK exports are produced by large multinationals that can price their goods and services in overseas markets. They have kept prices unchanged and boosted profits over export volumes.
  • If the pound falls far enough, eventually exports will rise, but the costs in terms of higher inflation, lower purchasing power, and the destruction of the value of savings would be devastating.

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Economic and Strategy Viewpoint - August 2019 18 pages | 485 kb