Labour, SNP, Greens: could they do business together?

Every week in the run up to the election there’ll be a “noise of the moment”. Last week’s was the idea of a Labour-SNP coalition.

Nicola Sturgeon toured the newsrooms assuring journalists there was no way she would go for this – but at the same time setting out her price for it: namely, £180bn fewer spending cuts (or 0.5 per cent of GDP per year) over a five-year parliament. Labour’s people are similarly insistent: it’s not on, and nobody’s talking.

However, given the polls currently suggest Labour is unlikely to win an outright majority, and given the high likelihood of a Blairite challenge to Milband’s leadership if he fails to win,  it would make sense for the Labour leader to look for coalition partners to his left.

Miliband’s own political soul, which often struggles to find temporal embodiment, is to the left of what the party currently says and promises.

But “anchoring a coalition to the left” is, after all exactly what David Cameron did as he tried to complete the modernisation and liberalisation of the Tories in office.

Plus there is the Syriza factor. Syriza’s victory in Greece has visibly enthused the SNP and its new left-leaning members; and for those in Labour it has not enthused, it has slightly terrified them. There is no prospect of a Syriza-style party in Britain emerging before the election. But the Green surge and the ever present threat that Labour’s biggest trade union, Unite, could walk away from the party and start its own, have focused Labour minds.

What few realise is that there is a ready made fiscal programme for an SNP-Labour (and if they want it Green) coalition – and it was quietly outlined in the green budget produced by the Institute for Fiscal Studies on 4 February.

This graph shows that, on the central projection from the Office for Budget Responsibility, what the next government would have to do to hit three targets over the next five years: balance the current budget, balance the overall budget (including infrastructure spending); and run a 1 per cent surplus.

Cast your eye over the middle bar and you will see the official script for the general election laid out: Labour wants to do the blue bit; the coalition aims to do at least the purple bit, and according to current plans also the green bit, in order to run a surplus.

Now move your eye up to the top bar. This is a projection based on figures from Oxford Economics, which is the most happy clappy of all forecasters when it comes to the UK’s potential growth. It shows what happens if there is much better growth than currently expected.

In this scenario, the amount of austerity you would need in order to meet Labour’s target of a current budget balance by 2019 is zero. Yes, zero. You would not have to do any more austerity at all. That would more than meet what Nicola Sturgeon has asked for. So what are the chances of the UK growing much faster than expected?

Seasoned observers of fiscal policy know that is the wrong question. All fiscal policy is made against realistic projections – of growth, public spending and tax income. The coalition was forced to do much harder and longer austerity because the OBR suddenly revised its growth projections downwards (by re-estimating the size of the so-called output gap).

If the OBR – or an OBR 2.0 – were to revise its growth projections up again, this would be very interesting for those in British politics who want less austerity. So the smart question is: what are the chances of the OBR being asked to look at a different growth model?

Currently the OBR is obliged to use the same growth model as the Treasury, which looks for “spare capacity” indicators – like idle machinery. Whereas a firm like Oxford Economics uses something called “production function” measurements – trying to estimate the amount of land, labour and capital in the economy.

Oxford Economics’ method led them to state that, despite the economy growing rapidly over the past 12 months – at around 3 per cent, they think – its capacity to grow also grew. Oxford’s projection is an outlier, but it would have been keenly noted by the ranks of special advisers and policy wonks at the launch of the green budget, which their UK chief economist fronted.

Here’s why: in the first months of the coalition the incoming government convinced the newly created OBR that its austerity policies would actually allow the rebalancing of the economy and a rapid return to growth. On this basis, it green-lighted the toughest austerity policy for two generations, only to admit – after 12 months – its projections were wrong.

Simply on the basis of that episode, I conclude there is every chance that an incoming government of Labour (or Labour plus SNP) could convince the OBR, and indeed the Treasury, that a new micro-economic growth strategy, again aimed at rebalancing the economy and boosting demand, could push reality close to the Oxford Economics scenario.

The only example we have of in incoming government’s relationship with the OBR is that the OBR gives them the benefit of the doubt. If Ed Balls were to give the OBR permission to use different models, the whole debate would loosen up anyway. Ditto if the Treasury was obliged to listen to Labour-friendly economists like those of the National Institute of Economic and Social Research, who also question the current output gap methodology.

And there is a new factor in play: deflation. Deflation is haunting the eurozone and – though the Bank of England does not fear true deflation here it has warned of the possibility of interest rate cuts and zero price growth (while also warning that the next rate move will probably be upwards).

It makes sense if you think the UK is immune to the true deflation threat present in Europe, but has implications for the £375bn quantitative easing programme.

The bank’s old stance was that, as the economy recovered, it would raise interest rates before starting to sell off some of the bonds it bought under quantitive easing. Rates would start at 0.5 per cent and go up.

Implied in Mark Carney’s statement last week is that he could cut interest rates first if inflation remains below target – so the rises might start from 0.25 per cent instead. What that means for QE nobody knows, but it might make sense – if you feared deflation – to extend it for longer, or even increase the amount. Carney assured his audience at Davos that the UK “has the means” to boost inflation to 2 per cent within two years.

However all Carney’s current moves are designed against the bank’s existing monetary policy target – which is 2 per cent inflation and permission to do £385bn of QE. But the bank’s targets, and its QE policy, are actually set by the Treasury.

As we go into the election, it’s important to keep the mantra in your head: monetary policy has fiscal impact.

Buying government bonds to the tune of 12 per cent of GDP helps the government finance itself, whatever you say or do. And it also, overtly, means that the bank is using cheap money to counteract the downward impact of austerity on growth.

Now Labour has a traditional blind spot on monetary policy. Over the years I’ve heard Labour politicians talk obsessively about spending cuts and tax rises, but say not a word about monetary policy. It was this that lay behind the famous comment of an ousted Labour minister in 1932, after Britain left the gold standard, to the effect that: “We didn’t know you could do that.”

But the SNP and the Greens think very unconventionally about monetary policy.  During the #Indyref, the SNP argued for Scotland to share sterling, with the Bank of England managing monetary policy in a way that would accommodate the different fiscal policy of an independent Scotland.

When QE was first introduced the SNP’s Treasury spokesperson, Stewart Hosie, repeatedly questioned whether it would not plunge the UK into a Japanese style deflation/stagnation pattern, and called for parliamentary scrutiny over the policy – ie overt political control. Thus, inside SNP thinking, there is certainly the predisposition towards setting the bank a different, more overtly expansionary remit.

As for the Greens, they want to scrap fractional reserve banking and institute a national money supply issued by the bank, which becomes the “national monetary authority”. So let’s say they are no strangers to unorthodox monetary thinking.

While Labour is tight lipped and ultra-orthodox at present, it is entirely possible to imagine the common ground of a Labour-SNP-Green coalition, or a “supply and confidence” type arrangement as follows:

–       (i) a new OBR growth projection, justifying a revised deficit reduction plan, with little or no extra austerity in the next parliament
–       (ii) a revised Bank of England mandate to expand QE and use it in a more targeted way, as in the USA and now Europe, to boost growth; plus harder political pressure on the bank to get inflation at or above 2 per cent
–       (iii) a pledge (as the coalition gave in 2010) to rebalance the economy to achieve a rapid swing towards the kind of growth that boosts the Treasury’s coffers, pulls more people into paying income tax, and boosts export earnings, also justifing point (i).

If you think this sounds very far from what the politicians are saying now you are right. If you suspect they might be thinking about it, you are also right.

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