Summary

Llewellyn focused their talk on the current recession, and the road to recovery. Following WWII, the G7 grouping had comparatively steady GDP growth with no significant falls for 60 years. This was due in large part to the post-war reconstruction, “catch-up growth”, and the now-larger share of government in the economy. However, the pace of growth steadily declined, the result of a range of factors including demographics, demassification, underspending on infrastructure, increased concentration in industry and inequality. Most recently, economies have been hit by two huge negative shocks to GDP, and the length of the recessionary episode that will follow the second, coronavirus one, is likely to be measured in years, not months. The historical experience of recessions is that typically it takes 3-6 years for GDP to get back to its pre-recession level. And it can take even longer: Italy has still not recovered to where GDP was in 2007. So, history suggests that G7 GDP is likely to re-gain 2019 Q4 levels only by around 2024. Once economies begin to recover, moreover, they will still face issues - low rates of GDP growth and productivity growth, and prolonged low real rates of interest, with investment weak relative to available savings. Llewellyn then discussed fiscal policy, which after being eased in most countries between 2008 and 2010 was then tightened, then to be followed by a progressive easing which culminated in the dramatic expansionary fiscal response to the COVID pandemic. Fiscal policy can have powerful effects. The ‘super multiplier’ captures two dimensions of investment; firstly, the initial investment expenditure gives rise to successive rounds of expenditure throughout an economy, multiplying the initial impulse. Then, secondly, it boosts productive capacity, permitting a further expansion of demand. The size of the initial income-expenditure multiplier depends on a variety of factors, including the stance of monetary policy, the degree of spare capacity in the economy, the rates of saving and taxation, and the propensity to import. This basic income-expenditure multiplier is usually 1.0-1.5x; and for UK green investment, this number is probably close to the upper end of the range. The super multiplier depends both on the size of the income-expenditure multiplier and the efficiency of investment. The IMF and OECD value the super multiplier in the range of 2.5-3.0. Fiscal expansion has been encouraged by low interest rates, with bond yields at historical lows, the result both of an excess of savings over investment, which determines the ‘real’ rate of interest, and unconventional central bank policies, which determine the nominal rate of interest. Most advanced economies have had low debt service costs relative to GDP (<2%), and so this has not been a major consideration for most advanced economies, but then came the skyrocketing deficits in 2020. Normality is unlikely to come for a long time, and only slowly, even without taking into account the impacts a second wave may have. Llewellyn considered different ways countries might look to reduce debt-to-GDP ratios, for example extending fiscal austerity and running primary budget surpluses, defaulting, or generating inflation. However, these all come at great cost economically and socially. The best method by far is achieve real increases in GDP. In practice large debt rises are rarely addressed without some form of default. For some countries this takes the form of explicit default through a negotiated exchange of debt or restructuring. A more subtle form of default is financial repression. This can come about as the result of implicit or explicit interest rate caps, or through regulation or direct ownership or extensive control of financial institutions. Financial repression is more politically appealing, not least because the pain from adjustment can to some extent be concealed. Llewellyn then discussed aggregate demand. Economic resources are usually scarce: but unusually not so at present, not scarce. So, in order to support spending in the economy in these current exceptional circumstances governments do not need to borrow or raise taxes. Instead, the central bank is able to finance this expenditure, whereby the public sector is obligated only to itself. Central-bank-financed monetary expansion would also be more potent than quantitative easing. Monetary finance can take many forms; QE or yield curve control combined with fiscal expansion; cash transfers to government; haircuts on existing central bank-held debt; and central bank cash transfers to households. However, there is a potential moral hazard issue: monetary finance could open the door longer term to irresponsible inflationary policies. Avoiding this requires robust checks and balances to reduce moral hazard, including a transparent and robust institutional framework to certify when the conditions are met and, even more importantly, when they no longer hold.

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