Macroeconomic stance, Departmental spending and Bank Capitalisation

More thoughts from the Treasury:

1 - NGDP Targetting.  Raised by Theo in the Ideal UK thread and promptly misunderstood by everyone there: NGDP targetting can be explained as having the Central Bank target the SUM of inflation and GDP growth.  That is, targetting nominal GDP (thus the name) rather than real GDP or inflation separately.

There is some belief that the Bank of England is engaging in a practical form of this already, as they haven't raised interest rates to combat the persistent high inflation that we've had through much of the recession - because to do so would likely choke off whatever growth there is.  This manifests the core tenet of NGDP targetting: increasing interest rates to reduce inflation is a very bad idea in a bust; reducing interest rates to increase inflation (demanded by a symmetrical target) is a very bad idea if the economy is already booming.  An NGDP target of 5% (for example) would aim as follows:

- GDP growth of 4%; inflation 1%

- GDP growth of 3%, inflation 2% (the implicit target during the Brown Years)

- GDP growth of 0%, inflation allowed up to 5% (to raise interest rates would be very foolish for the economy and high inflation erodes the value of debt - very useful when the "stabilisers" kick in and the cyclical deficit is therefore high.

It appeals on the grounds of elegance - it's a self-feedback mechanism on the economy and inflation.  I'd institute it promptly with the caveat that whenever one element (either real GDP or inflation) becomes greater than 80% of the sum, a meeting is held between the Governor of the Bank of England and the Chancellor in order to ensure the target is appropriate and no other action needs to be taken.

2 - Bank Capitalisation.  Often forgotten in talks of monetary policy (too often it is seen as a "one club golfer" strategy of manipulating interest rates) this is an element which is often left unmoved.  It is wise not to manipulate too many variables in any case and a little stability is never a bad thing - however the fraction of deposits retained looks as though it was incorrectly set at Basel II.  I would not change it during the recovery - we have enough of a liquidity issue as it is - but I would seek to reconvene the international financial ministers community to explore whether we need a consensus at a different level of capitalisation (for example, under Basel II, banks were required to keep capital of 8% against loans, but only 4% against short-term liquid securities and 1% against lending to sovereign banks: thus the ultra-willingness to lend to Greece (for example) during the boom and the shift from loans to securitised trades to reduce the amount of capital required and increase leverage was a rational response.  As it turned out, those securitised trades were poorly understood and a bloody bad idea!  Basel 3 (coming into effect 2013) won't help things as it stands).

3 - Departmental annual spending rollover.  A long-term bugbear of mine (ever since the first time I handled a large budget in the public sector) has been the handling of underspends against a budget: the budget is "punished" for inaccuracy by having any unspent funds withdrawn and the next years budget reduced by a corresponding amount.  Thus any late deliveries of goods or services can really screw you up and overestimating the requirements in one year can be fatal.  The standard reaction is that whilst overspends are regrettable, underspends are to be avoided like the Devil himself and every Department tries a lunge of last-minute spending in the Financial Year to consume their remaining budget (I know of one car park outside an Officers Mess in Lincolnshire that's bee resurfaced every March for decades ...).  My proposed solution is that any underspend gets rolled over into the next year's budget and the following budget is unaffected.  A Top Level Budget holder can voluntarily surrender any amount of budget at the end of the year in return for a bonus amount to be spread amongst his/her staff.