Monthly Archives: March 2012

The impact of quantitative easing

The Bank for International Settlements’ Quarterly Review featured two articles by one of the School’s PhD students, Jack Meaning, that dealt with unconventional monetary policies.

The first, published in December received international press coverage and was discussed on the front page of the Financial Times. Jack, with co-author Feng Zhu (BIS), estimates the financial market impact of the large scale asset purchase programmes carried out by the Federal Reserve and the Bank of England since the crisis, which have become more commonly known as quantitative easing. Using a range of methods the paper finds these programmes significantly lowered financial yields.

The second paper, published on 12 March, discusses the potential for further monetary stimulus via a ‘twist’ style operation in which the central bank sells assets at the short end of its portfolio to fund purchases of longer dated assets leaving the overall size of their balance sheet unchanged. By doing this the central bank can withdraw maturity from the privately available supply and twist the yield curve, lowering yields at longer maturities relative to the short end.

Using the US as a case study, the article finds significant potential for these initiatives, and more generally finds further support for asset purchases as a tool for monetary policy. However, it does raise issues of fiscal-monetary co-ordination.

These two articles form the basis of a forthcoming and more comprehensive paper on the effectiveness of asset purchases as a tool for monetary policy, which Jack will present at the Bank of England next month.

Budget tax changes could have mixed impact on growth, comments Kent economist

The School’s Professor Chris Heady, an expert on the effect of taxes on growth, says last week’s Budget could have mixed implications for growth.

He commented: ‘The public discussion of the recent UK budget is likely to continue focussing on the fairness of the budget, in terms of who gains and who loses. However, it is also important to assess its implications for growth, which is primarily driven by investment and productivity.

‘Recent work at the Organisation for Economic Co-operation and Development (OECD), in which I played a part before leaving for the University of Kent in 2009, analysed the effects of taxes on growth, investment and productivity using data from OECD countries since 1970. Its main conclusions were: there appears to be a ‘tax and growth ranking’ with recurrent taxes on immovable property (Council Tax in the UK) being the least harmful tax instrument in terms of its effect on long-run GDP per capita, followed by consumption taxes (and other property taxes), personal income taxes and corporate income taxes; lowering corporate tax rates and top personal income tax rates appears to increase productivity growth; investment appears to be increased by reductions in corporate tax rates.

‘These results suggest that the budget’s proposals to reduce personal income and corporate taxes and increase property taxes could increase growth in the UK.

‘However, the Chancellor’s decision to increase Stamp Duty Land Tax for high value properties is likely to be less good for growth than creating additional bands to Council Tax to ensure that high value properties attract more tax on an annual basis than less expensive properties. This is suggested by the first conclusion of the OECD study, which found that recurrent taxes on property are less harmful to growth than other property taxes (including taxes on the sale of property). The reason for this finding is that taxes on the sale of property – such as Stamp Duty Land Tax – raise the cost of moving. This harms growth by discouraging people from both moving to other parts of the country to find better paying jobs and moving into smaller houses when their children leave home (something that would lead to more efficient use of the housing stock).

‘Stamp Duty Land Tax suffers from two additional disadvantages. First, it is inequitable between people who live in houses of similar value if some people move house (and thus pay the tax) more often than others, perhaps for job-related reasons. Second, the amount of revenue from this tax relies on the level of housing transactions. The disadvantage of this reliance is illustrated by the case of Ireland, which was heavily reliant on such taxes, when the recent financial crisis struck and the volume of house sales was sharply reduced, leading to a damaging loss of revenue.

‘Council Tax is better for growth because it does not raise the cost of moving, is more equitable between owners of similar houses and generates more stable revenues, but it is unpopular. Much of its unpopularity arises from its visibility – in the form of an annual demand for payment – in contrast to the relative invisibility of personal income tax (which is mainly deducted at source) and both VAT and excise taxes (which are included in the quoted price of most goods and services). However, there is also concern about people who would have difficulty paying the tax from current income, so that they might be forced from their homes. The current system does provide some relief from Council Tax for people on low incomes but a more comprehensive system would be for the government to lend money to people who could not otherwise afford their Council Tax, securing the loan on the property – a sort of equity release provided by the government. The loan would be repaid with interest when the owner dies or sells the property. This way, people can be taxed on their housing wealth without being forced from their homes.’

Chris Heady is Professor of Economics and an International Research Fellow at the Institute for Fiscal Studies. He has undertaken consultancies for the World Bank, the National Radiological Protection Board, the Asian Development Bank, the Department for International Development and PricewaterhouseCoopers. He has obtained research grants from the (US) National Science Foundation, the Economic and Social Research Council, the World Bank, the Leverhulme Trust, the Foreign and Commonwealth Office, the Overseas Development Administration and the European Commission.

Should roads be privatised?

School’s expert on transport economics Professor Roger Vickerman comments on road privatisation proposals.

He said: ‘Prime Minister David Cameron has announced proposals to investigate ways of bringing private capital into developing and running Britain’s road network. The popular reaction to this was predictable: another example of selling off the nation’s assets and paving the way to mass tolling. But in fact this is nothing new. For years the Highways Agency has let both new road developments and major improvements to private contractors under the Private Finance initiative. Most users probably have not noticed the signs alongside some of our major routes indicating who actually runs the road on behalf of the Highways Agency. This has had the advantage of bringing forward schemes which would have been delayed if they had to wait for public funding. The contractor receives a payment – a ‘shadow toll’ – based on usage and paid for out of the taxes road users already pay. In fact these payments are increasingly smart as they make adjustments for road availability encouraging the contractor to maintain roads to a high standard and minimise disruptive roadworks. All the Cameron statement seems to envisage is that a wider range of potential investors will be invited to bid for ownership; the current ones are essentially the contractors who would bid to build the road anyway. If this results in a better road network then is there a problem?

Three issues arise. First, the road network needs to be planned as a whole so it is vital that there is a national roads strategy within which investors can bid to build the most profitable parts. Profitability here reflects the use of the road and use of a road reflects its importance to the regional and national economy. This would enable public money to be used to ensure adequate maintenance of the non-core network, the local roads with all the potholes. But the key need here is a strategy.

Second, any road strategy has to be part of a national transport strategy. We have heard a lot recently about high-speed rail and possible new airport runways (or even a wholly new airport off the North Kent coast); the problem with the debates on each of these is that they are too often held in isolation. Transport is not simply a set of competing networks; these networks have to be joined up as we rarely make a journey, especially a longer distance one, which does not blend together two or more modes of transport. Piecemeal development of our networks has led us to the situation we are in now in the UK with an infrastructure which lags behind our major competitors and has an adverse effect on both national and local economies.

Third, why such a paranoia about tolls and why such an adamant rejection of tolling by the Prime Minister? The problem with the current system of paying for the use of roads, which would not change under the current proposals, is that they fail the economist’s two major tests: they are inefficient and inequitable. We pay for roads through the annual vehicle licence and fuel taxes. In fact we pay rather more in these charges than is spent on the roads. But these charges do not account for how we use the roads so we pay broadly the same whether the road is in a congested urban area, a congested inter-urban motorway or a rural road. The variation in fuel consumption in these situations does not adequately account for the differences in total costs when we include the time of drivers in the costs. Rail users have to pay more for use of the network at busy times, and we know how airfares can vary according to pressure of demand, so why not road users? Is it right that we provide road capacity to suit the needs of all drivers regardless of the importance of their journey? Is it right that poor rural households pay the same in road related taxes to drive on uncongested lanes as rich urban households? And is it right that roads may be built at the expense of other uses of public funds. Of course any move to direct tolling would imply the need to reduce the other taxes currently used to fund roads.

What is the solution here? Once again we have piecemeal announcements about transport with an emphasis on headline grabbing issues about funding rather than a proper articulation of a national transport strategy covering all modes of transport. And that transport strategy should include clear statements about who should pay – it has been clear that the strategy for rail is to shift the burden more to the user, why not for roads? But first we need transparency about who pays and who benefits and then we might have a sensible and informed debate rather than the special pleading for rail commuters, the motorist etc.’

Roger Vickerman is Professor of European Economics at the University of Kent and Director of the Centre for European, Regional and Transport Economics. He is also Dean of the University’s Brussels School of International Studies.