There is an important balance to strike. How much is ‘any amount’?  Well, a billion or so out of global FX might not hurt much.  $100’s of billions out of every area of finance – as the Robin Hood People want – would surely be devastating.  Utterly insolvent banks – you would have thought that the last 3 years has taught us something about that having consequences.

So the point should be to move the debate over to where it is conducted along grown-up evidence based lines, as I think Lord Turner is capable of.   Not everyone involved in this debate is so capable.  So instead of:

“How much shall we take from Evil People to do Good Things, given that there are No Bad Consequences and that the people who disagree with me are clearly evil and corrupt or stupid?”

we move to:

“Transaction taxes can raise money and lower liquidity.  At what level could they be set so that the liquidity lost is not harmful or if harmful is made up for by the money raised?”

Much more boring.  Not sure it will attract the quantity of luvvies that the Robin Hood Tax campaign has…  But, as a brilliant young friend of mine has shown in a Hume quote (private email):

“There is not a more effectual method of betraying a cause, than to lay the stress of the argument on the wrong place, and by disputing an untenable post, enure the adversaries to success and victory”

Incidentally it would also help if some of the people in the debate recognised that Corporations are not People.  The tax on Corporates then fall on employees, shareholders, and so on.  Read Tim’s post on this.

I am off for personal reasons today, so argue amongst yourselves ….

But in Britain Lacks a clear Fiscal Exit Strategy, the criticism is subtly different.  Detail, and timing, are separate issues.  This in fact the FT’s line:

The possibility of fragile recovery argues in favour of contingent plans. It does not mean there should be no plans at all. The government could, for example, plot to reduce the underlying deficit while outlining temporary stimulus measures that could be deployed were growth to fall short.

As they write later, it is crazy to suspend all discussion of how the diminishing pie be split up, just because we don’t know if 2011 will grow by +3 or -1%.   In their words, “Is the government really planning to use schools and hospitals for demand management? Will hip replacement operations now be used as stabilisers?”.   No.   You don’t want to suddenly mess around with 3-year plans in response to one-quarter growth figures – one of the many reasons for criticising those who insisted on future spending plans being cut immediately when the recession engulfed us 18 months ago (the other minor reason being: you’d turn -6% GDP into -10%).

So what should the government do?  In a sense, it is asymmetric; we want a Treasury committed to devoting money to debt reduction if things go well but not if things go badly.   This why I agree with the FT’s call today to use (the bulk of) positive surprises to revenues/lower spending for debt reduction, not more goodies.  This could buy a lot of credibility.  And it looks like we have just such a surprise to the deficit happening now: see the Times story.  Unfortunately the Times is probably right that this is seen in Downing Street as ‘money to be played with’.

Things get better than expected –  bank the difference.  Things get worse than expected – let the public balance sheet absorb it.  This is strikingly similar to something I called for 9 months ago in A Balancing Act:* to hypothecate better-than-expected revenues from certain streams towards the debt reduction, not permanent spending increases.  That is the sort of prudence-in-advance that might convince bond market investors that this government will not splurge the good times, without a commitment to ****up the economy if things get worse (aka ‘The Tory Plan’).

If only Brown had done this over 1997-2006 we might have far more in the kitty for fighting recession now.     That is the real criticism that should be aimed at Labour, not some mad spending splurge in the last 3 years.

*p52 “Tying the government’s hands”

and yet the Pound is up.  From the $1.50 level to $1.54.  Nothing spectacular: just enough to confirm my hunch that this is not “tories down, sell the pound’.     The sort of dumb stuff that Tory newspapers were and are desperate to believe.

Although FT Alphaville have every reason to pick on him, it was not just Jim Rogers.  Every saloon bar economist thinks that you can go from 1. not remembering what the UK produces (read Policy Exchange’s recent report on manufacturing) to 2. assuming the pound should fall.

Why is the pound up?  Perhaps the unemployment figures – stronger economy, stronger finances, safer gilts (gilts are also up today).  Perhaps the mildly hawkish BOE minutes. It is not likely to be eurozone strength: they have weaker prices than since the Euro was brought in.    Nor inflation in the US, which is still kinda missing.   Though if the UK is going to outgrow both these it might be good for the pound, it might just as easily translate into even more export weakness, more QE, and the other direction.

Unsurprisingly, though dismayingly for armchair political pundits determined to use their rules of thumb to dictate messages linking the Pound to Political Weakness, I think the direction of sterling is something to do with economics.  I have no idea where it is going, but don’t think it will be much to do with the latest gossip about Liberal Conservative alliances, no matter how well informed.

“seriously damages the rest of the world. Most of the world’s large economies are stuck in a liquidity trap — deeply depressed, but unable to generate a recovery by cutting interest rates because the relevant rates are already near zero. China, by engineering an unwarranted trade surplus, is in effect imposing an anti-stimulus on these economies, which they can’t offset.”

Given that Krugman got his Nobel for trade policy, this is extraordinarily provocative, and has provoked some tit-for-tat with Ryan Avent of the Economist (start it here).   But both of them agree that it is in China’s interests to devalue revalue. Avent writes:

He should respect China enough to know that its leaders understand that RMB appreciation is in their interest.

Whatever clever tricks you can play with monetary policy (and Advent is probably right that the zero-bound need not bind – see also Credit Where It’s Due), it seems preferable that the surplus nations spend to the deficit ones. I agree with Richard Koo on this one: no matter what current or expected future rates are, if you think you have too much debt relative to your assets, you want to save to pay it down.  Models that don’t include the balance-sheet positions are incomplete.  (This is a flaw in my Credit Where It’s Due paper.) Martin Wolf’s passionate column today is all about this, begging the surplus nations to adopt some common-sense.

The balance sheet is a factor that I find Professor Sumner dismisses too easily; he seems not to see how if one part of the economy determinedly pursues savings, then output may fall.  His comment says it all: “Less consumption doesn’t mean less output, just different kinds of output (investment and exports.)”  That seems extraordinarily complacent.  If households save suddenly, why would businesses invest?  If every Western household wants to save, why do exports rise?

I believe that he is similarly misguided when attacking the idea that a remnimbi appreciation may boost US production.  His EconHistory counter-example is Japan; in 1971 Japan had a big surplus.  Its currency has increased in value from 390 to 95 to the dollar.  But it still has a surplus.  Ergo, currency values don’t do the trick.

Scott Sumner is one of the very brightest people writing about anything today, and so this is not aimed at him.  But it strikes me that there are good ways and bad ways of reducing imbalances, and that by altering the terms of trade between two blocks, you can ensure the good way takes place.    To illustrate this, consider these two tables.  They consider two idealised economies: the US signifies deficit nations, and Chermany the surplus.  For simplicity they are the same size.*

and

(the embarassingly crude 30 minute spreadsheets are here)

In the first example, the US starts off spending 80% of its GDP on its own stuff, adn 30% on Chermany’s.  It gradually works this down, by a simple rule (spend 80% of the previous year on US stuff, and a diminishing proportion on Chinese).  The key variables are Chermany’s (it is the dog not the tail).  It is programmed to increase consumption of both by 6% per annum.  As a result of these actions, we get a good equilibrium, with high growth in both areas, and the trade deficit falling.

In the bad way, the Chermans keep their currency at such a level that they consume only 20% of their GDP on US goods.  They grow their own consumption at 4%.  Because Cherman goods remain cheap, the US keeps spending 30% of their GDP on them. Their trade deficit remains high, and growth low.

So observing a continuing trade deficit is no proof at all that the right things have not happened.  That growth between the US and Japan continued for 20 years after 1971 suggests to me that the devaluations were the right thing.  What would have happened if the Japanese had kept their currency at 300 to the $?

In fact, if the bad way had continued, at some point there might have been a crisis – you know, like that 2008 crisis – where the capital being used to support US consumption is withdrawn for some reason.  Then the US might slow its consumption rapidly.  In this scenario, I have it dropping to 75% of GDP on its own stuff, and trending down the Chinese stuff:

As you can see, the US goes into recession, and the Chinese growth slows too.

I’m still on Wolf’s side here.  Where I am not so sure is whether the Chinese understand what is in their interests, as Avent implies.  But I agree with him that ignoring the political ricochets from punitive actions is unwise.  We need to send Wolf over to China, stopping off in Berlin on the way.

*It makes no fundamental difference.

You will be familiar from earlier posts of his (e.g. this one) that GDP can be disaggregated into expenditure components (consumption and investment and net exports), and also income components (wages, taxes, profits, others).   Ultimately, the weird and counterintuitive magic of macroeconomics is that these two need to be brought to equal one another. (Though note: the two are often far apart – see the Economist). It is this sort of insight that causes Nick Rowe to rant* with some justification about the misplaced use of microeconomic techniques in macro.  Certain homespun wisdoms of micro-thinking just don’t work on a macro level.  A classic example is: if you want to have higher savings, then have lower consumption.  It don’t always work that way.

A (very bright) friend noticed that blogpost, and questioned the theory that ‘the government does not control how much it borrows’.    Without being snarky and saying “if they get to choose this, they have made some rather uncontrolled choices in the last 2 years”,  I tried to summon the logic of a naive Keynesian like me into a sentence, and made a hash of it.  So I have tried drawing pictures instead.

This is for my own education as much as anything; I often blurt things out without seeing them through.  It does not constitute a prediction about what will happen if the government cuts now; as a model, it is grossly oversimplified, leaving out prices and the variable behaviour of the various actors (state, households, businesses) in the picture.   It can be extended.

The basic point I have been trying to explain to myself is that GDP as determined by expenditure needs to be brought to equal GDP as determined by income.  This is a picture of how it might happen in equilibrium:

(updated; thanks Ben and Luis below)

In this simple world, I leave out the transfers that government sends straight back to households; I just net them out (see this report).  Government consumption tends to be 20% of so of GDP, not the same as government spending.  For simplification, I assume that businesses reinvest all their profits.  The savings relationship is therefore between households and government: the households save 50, and the government has a deficit of 50.

Now, let’s see what happens in disequilibrium.  The government decides to run no deficit at all.

Now we have a problem: the GDP demanded is now insufficient.  A demand shock: the government has lowered what it wants to spend, and nothing has risen to take its place.   Please note: in that single sentence is buried and second-guessed all of the macro argument, including the possibility of non-Keynesian effects.  If business was investing too little because something about that government spending of 200 was bothering it (it was taking too many resources, bidding up wages, threatening future insolvency, raise interest rates), then the equalization would come through, say, investment increasing.  But in a slump the presumption from a hardline Keynesian is that this does not happen.**

So how is this disequilibrium resolved?  In the Keynesian-depressive account, by GDP falling, household incomes falling, probably unemployment rising and government revenues falling, so the government is forced to run a deficit.  Like this:

Now things match up again.  Household spending has fallen, in order to keep their desired level of savings at 50.  Taxation has fallen – like it does in a recession, much harder than the GDP fall.  Government spending has risen – driven by the GDP fall.  So the government is forced to run a deficit of …. 50, the very deficit it tried not to run.   The situation is just like the first picture – but GDP is 5% lower.

Again, let me reiterate: this is not a prediction about what will happen, just an explanation for my own edification and hopefully some of yours of the logic behind the Keynesian insight.  All of the real macroeconomic meat is in the arrows, not the numbers; how particular relationships make those numbers go up and down.  If I steal a moment tonight, I will post some alternative possibilities.

Does it makes sense?

*I mean rant as nothing but a compliment.  Please read his post.

**And, anyway, even if it did, it would return the same result: what the government chooses is not the point; it is the private sector’s decisions that determine the outcome.

In the meantime, I am working on something else, which will have many many pictures in it.  Admit it: you prefer them to a thousand words.

• a levy on monocles, classic cars and children called Tristan
• A polo tax
• stamp duty to be extended to transactions involving the exchange of eligible daughters for land and titles
• a penalty for shouting “Come on Tim!” at any sporting event whatsoever.

The money raised is going towards buying free books for sixth formers.

But the policy has been passionately condemned by those on the Left, who attack it as ‘a slap in the face of the poor’ and ‘just another example of how these neo-liberals types choose regressive policies at the drop of a hat’.  They fail the test of fairness, says a blog, and will stop at nothing in their mad quest to get the Gini coefficient up to 1.  Or even higher.

In a long policy report, some wonks have shown how more middle class kids get to sixth form.  Devastating bar charts demonstrate how this give more money to those middle class people.  And since they are middle class, that means, you know, wearing barbours, private school, obsessing about organic food, all that stuff that proper people loathe. Not the sort of b*****rds we should be helping, obviously.

The think tank calls on the Liberal party to abandon its poor-hating, rich-loving ways and instead use this money, that has just been found somehow let’s not ask how, on something really worthwhile, like the policies of another party altogether.

————————

OK I may be exaggerating a little.  But – as Alix is tweeting endlessly to Will - if you can choose which part of a policy proposal to leave out, anything can look regressive.  I think we share similar objectives here. This policy may have its flaws: efficiency bought for political clarity, issues with undermining pension investing.  But it doesn’t really deserve an attack from the point of view of unfairness.

In fact, you can see it as well in the US case, from Paul Krugman’s recent post on the Chinese WaterPistol:

where he comments:

The US private sector has gone from being a huge net borrower to being a net lender; meanwhile, government borrowing has surged, but not enough to offset the private plunge. As a nation, our dependence on foreign loans is way down; the surging deficit is, in effect, being domestically financed.

What is the tail, what is the dog? Policy Exchange sometimes imply that a government spending boom is what has is caused our problems.  I have written too much about this to bore you with my responses.   My view is that revenues collapsed; in cash terms, it is unambiguous that this is what separates the l0w-deficit plans from the high-deficit outcomes.  So the collapsing private economy is the dog, and the public deficit the tail.

On the subject of dogs and tails, one of the articles Chris links to makes a funny point about interest rates.   It says:

I don’t just mean that interest rates influence how much we save and invest. They also influence “animal spirits” – low interest rates can engender optimism about the future and hence contribute to investment booms.

I know that Chris knows this, but I’ll make the point anyway, because Scott Sumner taught me to: interest rates reflect supply AND demand for investment funds.   So, of course, a government/central bank can influence the rate by promising to supply funds cheaply for yonks.  Knowing this can cause finance officers everywhere to borrow funds with more confidence, knowing that they are safe from a future liquidity squeeze throwing them out of a job and onto some perp-walk into Congress.

But the level of rates also reflects how much people want to invest.   This demand-side is the bit that worries me, and this last graph is an excellent illustration of the issue.  It shows what people think the inter-bank borrowing rate will be in December 2010 (take the number off 100; a rising graph means falling rates).  The trend is upwards – people think rates are going to stay weak, and they think this because they think the economy will be weak:

You may complain that rates are set by the Bank. This graph is just a reflection of what the market thinks the Bank will do.  But in December 2010, the Bank will be looking forward two years, mashing together expectations of future growth, inflation and so on into one grand view about what it should do with rates.  This graph is a view on a view, all of which amounts to the strength of the economy in the next few years.

So I agree with Chris – obviously – that we need loose money.  But at the end of all this, low rates will be a sign of failure.  Loose money, and persistent indications from the financial markets that they are falling over themselves to get and use some of the stuff, is what we need to see to know that 2011 will be OK.

“Consider Capital Gains at 0/18% rather than Income tax at up to 50%”

“Utilise a range of appropriate investment notes to provide potential for tax-efficient returns, without necessarily risking your capital”

Andrew Rodger, Stonehage executive director, said: “The stated intention of the government was to increase tax from resident non-doms and simplify the regime. Our survey shows that the rules are unattractive and that non-doms are leaving the UK or not arriving any more, resulting in a tax loss for the Treasury within a relatively short time.”

However, it turns out that complexity and uncertainty are the big issue – “the confidence of the ultra rich could easily be regained, however, with an extensive simplification of the tax rules and a pledge not to alter the system again in the near future”.

What I found weaselly was that all we have seen is a slowdown in arrivals, and some departures.  Nondoms are still, it seems, arriving in the UK, but just at a slower rate.  Their numbers have been growing at a 4% pace; now that might be slower.  The other weaselly implication is that the Treasury did not expect some change in behaviour.   No, they did.  From a sub-article:

Preliminary figures from Revenue & Customs show that 4,200 people paid the charge for the 2008-09 tax year. That compares with the Treasury’s 2007 forecast that almost 4,000 individuals would pay the charge, a further 14,000 would start paying UK tax on offshore income and – over the long term -almost 3,000 non-doms would choose to leave the UK.

The ones that leave are likely to be those for whome 30k makes staying a marginal decision.  Not the very richest, I would think. Though who is rich?  Let us consult Simon Heffer. Not the people paid over 150k per annum; no – they are the ’so-called’ rich, people that Labour has fooled us into thinking are rich.  Since 99% of the population is below that level, the answer seems to be the rich do not exist.  So stop making a fuss about them.