Posts Tagged ‘Fiscal Policy’

21 May

A common eurozone bond

Posted by freethinkingeconomist in Uncategorized. Tagged: , , .

The Financial Times helps to resurrect an idea that CentreForum was cautiously plugging a year back. A  common eurozone bond:

would provide more accessibility to the markets, help stabilise the continent’s economies and, most importantly, lower the cost of funding, which in turn would ease the burden on taxpayers.Such a bond would create the scope for much larger debt issues, attract more international investors and challenge US Treasuries as the most liquid bond instruments in the world. It could even help to advance the euro’s case as a reserve currency as opposed to the dollar, although this would be in the very long term.

John Springford wrote about it 9 months ago (pdf), suggesting it as a means of sharpening the fiscal incentives to remain on the straight and narrow.   For ‘fiscal, straight and narrow, how not to’, google Greece. If more Eurozone countries were more disciplined in the GOOD times, then their ability to absorb shocks in the bad times would be enhanced, and the euro at less risk to disorderly outcomes.

The idea was that having access to centralised forms of borrowing – cheaper and more liquid as the quote above suggests – would be contingent on good fiscal behaviour.  Hence an extra incentive towards that behaviour – without the sharp and politically impossible system of fines that the Stability and Growth Pact had required.

However, the problems were also clear, and our suggestions correspondingly modest.  To engage in this when debt levels are rising precipitately would seem like a suggestion that Germany should just ride in and use its credit rating to help out the weak and profligate.   Futhermore (see Samuel Brittan today) fiscal deteriorations are often externally driven and forcing countries to change their financing arrangements in response to, say, a collapse in global demand may be difficult during the actual circumstances.

What I could never get my head around was the degree of fiscal control that a new entity would need.   If a new Eurozone Bond is to be a competitor with the US T-Bond, then surely it needs all of Europe’s credit standing behind it.   In which case, if Country A borrows from it, the name on the bit of paper is not A, it is EUROPE.  And in which case, how does EUROPE get the money back? Surely this involves a degree of central fiscal control of the EU over national fiscal powers – in which case, isn’t all the magic somehow within those arrangements?

Romano Prodi today writes of ‘a big step towards fiscal federalism in Europe‘ that “The only alternative to greater co-ordination of economic policies is dissolution of the euro”. To my ears he sounds rather keen on this:

the realisation that the Greek crisis presented an opportunity to take the inevitable steps towards economic governance that were not possible when the euro was created. This implies new institutions or bodies to monitor the budgets of member states, enforce fiscal discipline and impose punishments for repeat offenders of budget discipline rules.

A new eurozone bond sounds like a financial invention, but underneath it is a profound political shift, which I cannot see Germans swallowing.  Not everyone in Europe would agree with Prodi that “the ship of the European Union is sailing in the right direction”.  As Martin Wolf ceasely writes, a collapse in Eurozone Demand (which is now troubling markets across the world, including Asia) means inflating some economies while deflating others (as this letter reiterates).  But so far we are only getting the deflationary bit – the Germans insisting everyone be Germanic.

If anyone gets the chance to read the analysis from Afme, and can answer any questions about it, I’d be in their debt.  Pun intended.

17 May

Wresting back monetary control, surrendering fiscal

Posted by freethinkingeconomist in Uncategorized. Tagged: , , .

The big headline from Osborne’s first days at the Treasury is his setting up the Office for Budget Responsibility.  Stephanie Flanders describes the move here (she adds an observation about Osborne asking Mervyn King for permission to start cutting) and argues that this is not as significant as Brown giving away power over interest rates to the independent BOE in 1997.  Nevertheless, Ms Flanders sees this (current three man) operation as potentially a ‘hugely powerful force’.  John Rentoul is in no doubt:

the real issue is that the OBR will define government borrowing (clarifying the Private Finance Initiative and other off-balance sheet devices) and pronounce on what should happen to it in the coming years. Osborne and Laws would not be able, in practice, to ignore its rulings, provided that they are not patently unreasonable.

At a time when fiscal decisions will be as massively full of consequence as they have ever been, the word of an appointed three man committee may be too powerful for the new Chancellor to ignore.

The backdrop to this shift in power is the implicit assertion that Labour cooked the books.  David Smith does not agree, and LeftFootForward – run by Will Straw whom we should remember is not only son of a 13-year minister but also ex-Treasury himself – is rather outraged at the slight to the Treasury’s integrity. The FT writers at the Westminster blog meanwhile point out that ‘independent’ forecasters have their problems too, with a graph showing how evenly distributed have been the errors over the long period.

And as Dillow observes the latest revision revealed that Darling had been too PESSIMISTIC by £20bn or so.  All in all, my concerns about an OBR as expressed over a year ago in Fiscal Rules OK? are yet to be assuaged.

In the meantime, the opposite movement of power is taking place in the monetary sphere.  Politicians are recognising that in these difficult times the monetary steps we need become quasi fiscal.  Read Clive Crook today:

Monetary policy was thought separable partly because it seemed simpler: all you have to do is control interest rates. But in a crisis monetary policy gets complicated. Quantitative easing erases the line between monetary and fiscal policy altogether. When central banks support troubled borrowers, public or private, they expose themselves to default risk: again, fiscal policy by another name. Such interventions involve choices about who will be protected and who will pay. Those are, or should be, political choices.

Words that were largely prefigured in Credit Where It’s Due, where I used idea ‘restoring fiscal dominance’.

What an odd world for macro-policymakers.  With Merkel calling for balanced budget rules, and Osborne ceding some powers of suasian (i.e. embarrassment) to the OBR, we have technocrats or inhuman rules taking over fiscal policy, which in its turn is about to be ineluctably infected with the consequences of monetary policy.  Who is in control any more – if things go wrong, who do we blame?  What political structures do we need to manage accountability and to coordinate all these areas?  That is the biggie.

16 May

Crazy spending, or our lifeline?

Posted by freethinkingeconomist in Uncategorized. Tagged: , , .

To no great surprise, David Cameron has announced an immediate audit of the ‘crazy’ spending of Labour’s last years in power.  Politically, this no doubt makes great sense – “look what those idiots got up to” is perfect scene-setting for the blood-letting that will follow.  But what worries me is what sort of a narrative this tells of the crisis that has gone before – and how such a narrative restricts our future scope for action.

I’m rushing, so I’ll explain.   Look what Paul Krugman has found in the latest IMF report into the sovereign fiscal crises worldwide.  You will notice that it agrees with endless repeated polemics I launch on my slightly smaller blog:

what the report says is that there has been a fundamental deterioration in the fiscal outlook for advanced countries. Not only are they running up a lot of debt in the crisis, but — and much more important — they will emerge from the crisis with large structural deficits that weren’t there before. So spending cuts and tax increases loom.

No arguments so far.

where are those structural deficits coming from? It’s not interest on the debt: the IMF shows a large increase in primary (non-interest) structural deficits. So is it permanent increases in spending? No: the report shows that discretionary spending increases are a minor cause of rising deficits even in the crisis, and these increases will be reversed as stimulus winds down.

As I argue repeatedly, above all in A Balancing Act (see the pie chart), the revenue collapse was what finally revealed our massive deficits, the deficits that will characterise this premiership of David Cameron, and every subsequent premiership he might have.*

Why does all this matter?  Is it not just a matter for historians in what order things happened?  We are where we are: laden with debts and deficits.  Get over it, I hear you call.

But it does matter because the stories we tell of the past influence our future behaviour.  Consider the following crude account of how things happened:

  • We were going along nicely while the banks gambled madly
  • They made the economy collapse.
  • Governments responded by spending masses of money on two things.  Hundreds of billions on the banks (just read Peston)
  • And then this daffy thing called ‘Keynesianism’ encouraged that spendthrift Brown to go nuts with public money
  • Despite all this the economy has tanked by 6%, and is not growing well.  And we have a massive debt

Reading this, what would you conclude?  Well, that saving the banks and doing the Keynesian ‘splurge’ certainly left us with a debt, but only possibly helped the economy.  Next time, if we went badly into recession again, we should on no account repeat the same measures.

Which would be a terrible mistake.  The truth is that we did very little Keynesian spending indeed.  The government’s spending** did not rise very much (check out any economic reports).  The deficits happened because its ability to raise money was muellered by the collapse of the asset bubbles that fed it.  The states that were best able to do the Keynesian spending appear to have had faster recoveries.

I am not sure that I agree with Krugman in thinking this proves we need more spending, now; at some point, the risks of a sudden stop from the bond market just outweigh the benefit.   But we should be very careful that we don’t tell ourselves the wrong stories about the recent past.  We have a truly horrible fiscal situation.  Yes, cut the pay of highpaid civil servants.  But it was not the Labour government going crazy with Sir Humphrey that got us in this mess.  It was a collapse in nominal GDP, and revenues that are far too geared to an asset bubble.  Let’s get on with fixing that.

*amusingly, my working title for that piece was ‘The Cameron Inheritance’.  I was told off for begging the question – but they were 15% ahead in the polls.  Oh, how right the critics were …

**by which I mean its CONSUMPTION.  Look at the supplementary documents in the pre budget reports (table 1.12)

http://www.hm-treasury.gov.uk/d/pbr08_chartstables_501.pdf

and

http://www.hm-treasury.gov.uk/d/pbr09_chartstables.pdf

the figures for 2009 rose by just £20bn.

30 Apr

Latest CiF piece: for pity’s sake, shut up about Efficiency Savings

Posted by freethinkingeconomist in Uncategorized. Tagged: , .

Here it is.

30 Apr

If the answer is Helicopter Money, how do you sell it?

Posted by freethinkingeconomist in Uncategorized. Tagged: , , , .

Like I ranted yesterday, GDP is a very poor way of measuring how certain things are getting better.  And my absolutely favourite example is how the Internet has revolutionized the ability to interact with and eavesdrop upon thinkers and teachers – whom one would previously have had to ambush in some University corridor.

An example has arrived on this blog: Canadian Professor Nick Rowe of Worthwhile Canadian Initiative (an injoke for Canadians) clarifying some thoughts on this blog about where Fiscal Policy becomes Monetary Policy. In so doing, he links to a post of his from last year where the issues are first presented and then discussed in (what is for me) bewildering detail. Some but not all of the insights can be boiled down to this comment: ‘So if there’s no danger of inflation, on the margin, go ahead and print!’.

The question, however, is what you call that.  Vimothy – another clearly very learned fellow – has been getting stuck in on this question, writing this interesting paragraph:

A helicopter drop would be a fiscal operation with no offsetting bond issuance. It would place downward pressure on the CB’s target rate (which is why, in the MMT narrative, fiscal policy is accompanied by bond issuance–its an “interest rate maintenance account” in MMT jargon), but it would ensure that everyone is disabused of the notion that government borrowing funds its spending, and it would deny the bond market its corporate welfare

All of this interests me deeply, because I am meant to occupy that vital slice between monetary experts like Nick and vimothy, and the political class that needs to choose and also sell the right policies to their suspicious electorates.   My basic intuition is: if we are deeply below our Aggregate Supply curve, boosting aggregate demand is the answer – but how can we do this?  I.e. this is where I think we are – the dotted line:

(whereas supply side miserabilists like John Redwood think we are always at the vertical bit of the supply curve). I tried in ‘Credit Where It’s Due’, with my suggestions for things like the purchase of Covered Bonds (making mortgage lending cheaper); a National Infrastructure Bank; or even the straight purchase of banking equity (which could be just handed out to the public – that last idea is the closest I come to helicopter money).  But on this question of whether printing money and leaving it out there in the real economy is Fiscal or Monetary policy, I fudged the issue, with ‘quasi-fiscal’ or (borrowed from Nick) ‘fiscal dominance’.

So. Getting to the point.  First question: If you print money, and spray it out of a helicopter (without asking for it back later) what do you doing?  If the ‘spraying’ is just enabling the government to do the same things while issuing fewer bonds (bonds being: things you have to pay back, money being: stuff they don’t need to pay back), then it seems like monetary policy.  The shape of the government’s liabilities has changed, and future expectations of the money supply and NGDP have surely changed.

But this ignores the insight of note 11 of this IMF document: that this is a transfer to the public.  Those people standing under the helicopters see their asset position improve, surely?  If they are debtors, the extent to which their future indebtedness is going to weigh on demand is surely lessened.  ‘Hey Mom! I found a thousand pounds under the hedge!  We can go on holiday after all!’, and so on.   If you are convinced by Richard Koo’s analysis of Japan, then such balance sheet effects are surely critical.  Whereas the monetarist interest on changing people’s expectations of future economic demand can seem rather secondary if you have ASSETS/LIABILITIES of <1 …

Which leads to the second question.  Suppose we agreed we were in the situation above.  We agree with Nick (and Scott Sumner, and others), that this is absurd – we have a money printing press, surely that thing can boost aggregate demand somehow?  But how do you sell that idea to the public?  ‘We’ll spray money out of helicopters’ annoys those who don’t really need the money.  It also lessens discipline, to put it mildly: we have a political class that collectively dodges questions of spending cuts – and yet here I am, saying ‘Print money, spend it’ – a classic invitation to avoid thinking about hard things.

I am genuinely very interested in your answers.

28 Apr

#bigotgate distracts from important message: IFS very +ve for LibDems

Posted by freethinkingeconomist in Uncategorized. Tagged: , , , , , .

Prior to #bigotgate, I had hoped that the world would tune in, agog, to my take on the IFS’s take on the fiscal situation.  Fat chance now. (I think the best observation comes from my favourite tweeter.)

Anyway, back to business.  You will have read commentary such as this from the Guardian which tends to gather round one point: none of the parties have revealed anything like the scale of the cuts that are needed.  True, but realpolitik makes this impossible.  The first to reveal how many Sure Starts they will close/nurses they will fire/tax credits they will freeze will be victim to the other parties’ leaflets – and people don’t look at leaflets like they do an IFS report on all the parties plans, reading between the lines.

As Westminster Blog observes, parties can make spending pledges worth billions in just a matter of minutes; but eking from them a fraction of this in spending cuts is sheer murder, even when it is a mere dent. Staying shtumm is a no-brainer, politically.

The IFS is playing a blinder.  It cannot be ‘bought’ or leant on.  It still leaves me a bit mystified about what the Conservatives’ OBR would do.  Robert Chote’s remarks are all that most of us need to read. They have some very LibDem friendly highlights, or points of general interest:

On the overall shape of plans

  • [Conservative plans] would not make an enormous difference to the long term outlook for the public finances. The Conservatives would still end up borrowing £604 billion over the next seven years, just 6% less than Labour and the Lib Dems.

On its composition

  • Labour favours a ratio of 2 to 1 between spending cuts and tax increases, the Lib Dems 2½ to 1 and the Conservatives 4 to 1.

BUT

  • it is worth noting that when the last Conservative government faced the need for a big fiscal tightening in the early 1990s, we estimate that the ratio of tax to spending cuts was roughly 1 to 1 [so this surely makes the Conservative plans the least credible in terms of 'doability' (rather than attractiveness)]
  • When David Cameron said of the Liberal Democrat income tax cut in the first debate “It’s a beautiful idea. It’s a nice idea. We cannot afford it” that is a slightly odd accusation for a party advocating a net tax cut to make of one advocating a net tax increase.

On the scale of cuts

  • Labour and the Liberal Democrats would need to deliver the deepest sustained cuts to spending on public services since the late 1970s. While, starting this year, the Conservatives would need to deliver cuts to spending on public services that have not been delivered over any five-year period since the Second World War.

On Taxation

  • The Conservatives would make the pattern less progressive, reducing the losses of households at the top of the income distribution proportionately more than those at the bottom.
  • The Liberal Democrats would make the pattern more progressive, redistributing resources from the wealthy to middle-income households (though not the poorest).
  • Conservative plans would strength the incentive for many people to be in paid work at all, but would do almost nothing to encourage most existing workers to earn a bit more.
  • The Liberal Democrats would probably strengthen the incentive to be in paid work for more people than the Conservatives, as well as increasing the incentive for those earning less than £10,000 to earn more. But they would do more than the other two parties to harm incentives to work and save among richer households.

On complexity

  • The Conservatives would not improve matters. They would partially reverse what is probably Labour’s least bad tax increase and add new complexities and distortions of their own.
  • The Liberal Dem package would remove some undesirable distortions and inconsistencies of treatment. But their plan to restrict pension contribution relief is misguided.

Overall verdict: LibDem plans are more realistic and progressive than Conservative ones, leave the debt position roughly the same, distort the tax system less, involve deep spending cuts but unlike the Conservatives don’t involve breaking an all-time record.

I hope Nick reads this carefully before the Economy debate.  ‘I agree with the IFS’ …

What are the major Lib Dem weaknesses? (Gosh I am honest).  One is their double-taxation of higher rate pension contributions, which are called ‘fundamentally misguided’ here. But I am slightly more worried about their capital gains tax proposal.  Yes, I know Nigel Lawson did it first.  But a 50% rate for entrepreneurs is surely very damaging.  Does Luke Johnson go over the top in today’s column:

their Treasury spokesman Vince Cable, who claims to be an expert in finance and business, (although he has never actually dealt with a payroll in his life) expects entrepreneurs to take all the risk, and the government to take half the reward. At a stroke they would kill initiative, and send a massive signal to wealth-creators: do not invest here.

I take some small comfort from the fact that the Federation for Small Businesses does not mention it in today’s press release – nor in their manifesto.  But it would put me off being a risk-taker.

27 Apr

Online calculators rule

Posted by freethinkingeconomist in Uncategorized. Tagged: , , , , .

I’m sure most of you will have already played with the the FT’s online deficit buster.  So too has Adam Boulton, but when he asked Mandy to give some of his own brutal preferences, he got a prolonged smackdown, culminating in the undeniable “neither the IFS nor the FT are standing in this election”.

The point being …. what?   If I said, say, “The intergovernmental panel on climate change says the world is warming up” is this refuted by “the IPCC is not standing in this election?”  The FT and the IFS are calculators, and what Mandy seems to be saying is that ‘we don’t have to accept mathematics if we don’t want to’.  Labour’s strategy: to find a new kind of mathematics – perhaps based on restaurants?

I have banged on about this for ages – I even used ‘Elephant in the Room‘ in October.  Against this, how great a compliment is it that (via Flanders) the Liberal Democrats are the Least Bad?

In today’s report, the IFS estimates that the Conservatives would plan to cut spending by £57bn a year, in today’s money, by 2015-16. The Liberal Democrats would cut by £51bn by 2016-17, and Labour would need to find cuts amounting to £47bn by 2016-17 … None of the parties has revealed more than a fraction of what this would involve. True, the IFS thinks the Liberal Democrats are “slightly less bad” than the other parties in the amount of detail they have provided to the voters.

But in addition to this compliment, Chris Giles reports that “the IFS clearly likes the Liberal Democrat tax plans the best, calling their plans “far-reaching” and praising the reduction in distortions.”  This is precisely the point I was trying to make to Dan Roberts in the podcast – it is not about how difficult it is for analysts to work out the winners and losers from a tax change, but how easy it is for the users to use the tax system.  You and me, not the IFS’s eggheads, who love a challenge anyway.

Maybe all the parties are relying on Lloyds and RBS quintrupling in share price?  So far so good.

Finally, I don’t trust the look of the BBC’s swingometer – it only allows you to swing one thing at a time.  So I am beginning to build my own – see the link below.  Quick observation – is everyone listening – this voting system seems really unfair! I mean, so many of my bold inputs get a Lib Dem seat number of, say, 80, despite 28% of the vote.   Someone should be told!

Download beta spreadsheet

(seriously, this is very beta.  Allow macros.  Tell me of obvious howlers.  it has only Lib Dem COnservative Labour seats from 2005, no boundary changes.).

16 Apr

Martin Wolf hits several nails on the head

Posted by freethinkingeconomist in Economics. Tagged: , .

In today’s column.  Above all, the theme: Growth is what is needed to fix the finances.

Then he adds his voice to those arguing against the myth of the spending splurge:

the explanation for the sudden explosions in the share of public spending in GDP and the fiscal deficit is not that spending is out of control. It is, instead, that nominal GDP and tax revenue have fallen far below what was expected just two years ago. According to the 2010 Budget, public spending will be just 2.2 per cent higher this financial year than was expected two years earlier, despite the recession. But nominal GDP will be 9.3 per cent lower and tax revenues 18.1 per cent lower.

As I argued at tortuous length in my village anecdote.  You will note that MW has updated his approach since following Policy Exchange’s line last year, when he wrote:

How did this fiscal debacle occur? The answer lies far more in spending, forecast to jump by an astounding 8.4 per cent of GDP between 2007 and 2010

His mention of PX is in this piece. My irritation at people taking such a simple ratio take on spending is one of about 100 reasons that I wrote A Balancing Act.  I have always known that Martin Wolf understood this perfectly, and was mystified at him taking the PX line – and today’s column is proof that I was right.  So I am rather chuffed with this.

Wolf has other good advice today about how to boost investment, including from a much-praised PX paper by ex-FT writer John Willman. It is a good paper.   His column ends with this commentary on the NI controversy:

Finally, we have the question of how to tighten the fiscal position. I would have no problem with Conservative opposition to higher employers’ national insurance contributions, if they had not suggested that greater efficiency alone might replace it. With a need to tighten fiscal policy by at least £100bn (7 per cent of GDP), the UK must implement all the efficiency savings it can imagine, plus real-terms cuts to public sector pay bills and services, plus tax increases. The parties are determined not to discuss these realities. If politicians treat voters like children, the voters will throw tantrums when cuts come.

This is not just criticism of the Conservative position; it must count as criticism of any party who has found something nice to do and a way to fund it.  In a crisis, the bond market might just take the latter, and deny the leeway to carry out the former.  The same might apply to the Lib Dem raising of tax thresholds.  No matter that they are costed, the real world result might be: get rid of pensions reliefs soon, introduce a mansion tax now, and so on – and we will phase in your tax threshold increase as we think it can be afforded.

UPDATE: In a rush, I forgot to mention other nails he hammered:

The second qualification is that the country is not living beyond its means, to any significant degree; the government is. Not only is the current account deficit modest, but the UK’s net liabilities were only 13 per cent of GDP at the end of 2009. On a consolidated basis, the chief creditor of the UK public sector is the UK private sector, not foreigners

I pointed this out a few weeks back, criticising none other than Wolf’s FT colleage Chris Giles for saying Britain is borrowing too much.  As argued on the Long View, Britain is in debt to itself.  This is important, you know …

14 Apr

The people have the whiphand. But not in the way the Conservatives would like

Posted by freethinkingeconomist in Economics, Politics. Tagged: , , .

In case I have not mentioned it before, I am a liberal.  I find the idea of being reliant on the state for my future wellbeing disturbing, and intrinsically unsatisfying. I sort of expect others to feel the same.  Whether it comes from the right (see IEA comment thread) or left, I am repelled by the idea of being the toy of government forces.  This is one reason I found Labour’s manifesto video offputtingly self-congratulatory.

So I’m sort of attracted to the basic Conservative mantra: “it’s not about government, it’s about you”.  As the Guardian leader writes:

You do not have to buy in to everything that Mr Cameron says about his “big society” idea for providing better government through the empowerment of the small platoons to recognise both that this is interesting new political thinking, that it addresses an overmighty and inefficient central state about which no liberal should be indifferent

Of course, they are trying to make a virtue out of necessity – with a savage retrenchment in the offing, it had better be about you, because ‘we’ have the bond market to worry about.   But as a guiding philosophy it is a reasonably liberal one.  This does not mean it is guaranteed to work. As the FT leader observes “it is not self-evident that the government can actively build a “stronger society” that will volunteer more.”   Neither can we be sure that Conservatives would do any better than Labour; as Nicholas Timmins observes:

in the past 15 to 20 years some 30,000 or so new charities have been formed. The voluntary sector has slowly taken a larger share of public service provision. And Labour, like the Liberal Democrats, has been actively encouraging social entrepreneurs, providing resources for training, access to new forms of capital and legislating for the “Big Society Bank” that Mr Cameron now wants to use. About a third of council leisure services are already run by social enterprises . So the Tories can scarcely claim copyright for the idea.

Martin Kettle like me is not averse to the bigger idea, but the sheer gusts of optimism about how this will all pan out – which you can hear on the Guardian podcast - sounded loopy at times, given the paucity of real examples to work from.    He writes:

Personally, I like the sound of a lot of things in Cameron’s idea. … Yet looking at the day’s events again on the news bulletins last night, what struck me most about the Tory launch was that it all looked a bit disconnected from real life

You cannot blame the Tories uniquely for accepting the need for cuts but not spelling out the real pain they will cause; all the parties are playing this game.  Everyone is trying to sound tough, and realistic and optimistic – and these together produce an impossible trilemma.

But my major worry is still about macroeconomic stubbornness.  There is one way that the public already has the whiphand over the Government, and that is the one area where a Conservative government is determined to try to exercise rigid control.  And that is over the deficit.  As I have illustrated Excel-style, argued at length with Policy Exchange, pointed to through Dillow and Richard Koo’s slides, and can now quote to you from Martin Wolf today:

In the UK at least, the fiscal deficits are mirror images of private sector surpluses. Moreover, the direction of causality is from the latter to the former.

During a cyclical slump like this, most of the fiscal deficit cannot be chosen by George Osborne, his OBR, or anyone centrally.  As is observed in a quite brilliant post for Economists View,  the deficit is largely endogenous.  The great British Public – or rather the ‘private sector’ – is already in control here. The State cannot MAKE the private sector do particular things just by being virtuous. As Wolf reminds us:

The Panglossian view is that if the fiscal deficit were reduced, domestic private spending and the external balance would adjust automatically. But, with real interest rates on index-linked gilts at just 0.6 per cent, short-term interest rates at 0.5 per cent, yields on conventional 10-year gilts at about 4 per cent and weak growth of credit and broad money, this is a fairy story. The situation is entirely different from that in 1981, when the Tories tightened fiscal policy successfully in a recession.

The Conservatives, like Wolf and the Treasury and Everyone, wants a New Rebalanced Economy.  But whereas Labour produce a Budget that tries to favour investment, the Conservatives actually propose scrapping investment reliefs to fund a corporation tax cut – even though corporate profits are fine and tax levels not too bad.  They call for more manufacturing and green-ness, but as honest Ken Clarke admits there will be no aid for specific sectors and companies.  Their faith in laisser faire (well, apart from with immigration) is still strong: cut the deficit and all things will flower forth.   They still ignore demand problems – the Conservatives have never presided over a demand slump like this.   Read the BOE Agent’s survey:

Investment intentions remained subdued, as the significant margin of spare capacity, uncertainty about future demand and the restricted availability of credit continued to weigh on contacts’ spending plans.

Demand is the one thing the private sector has control over, and the problem is not the government being in the way.   Yet reducing demand from the government – regardless of economic conditions – is the one settled Tory policy that we can rely on – because they are hardcoded to believe in non-Keynesian effects.  Uhoh.

1 Apr

A spreadsheet to confound and ruin your holidays

Posted by freethinkingeconomist in Economics. Tagged: , , , , .

Here is the spreadsheet.

As with so many matters, this started with reading some Dillow post or other.  This is like some embarassing instance of an academic expanding 2 lines of poetry into a thesis.  But  Chris quite casually wrote:

And Keynesians would assent, because fiscal policy has little influence on the deficit as spending cuts reduce aggregate activity and hence tax revenue

That bit in bold is tantalizing, particularly if you are engaged in a fallacy-of-composition argument like the one you read on the post below between Andrew and I.   How can fiscal policy have little influence on the deficit?  Get real man.

But we saw it with Japan.  And so now I want to show it with figures.

The first Scenario shows how.  In this, households are determined to save 6% of GDP.  The government raises 15% of private sector income as taxes.  Then it determinedly spends just $150, which is what it would need in period 1 to have balance.   What happens?  For a Keynesian, GDP falls.  This iterates, until. by around period 15, we are in balance.  This is a bit like what Richard Koo found happened in Japan.

Because I am a spreadsheet UberNerd, I then mucked around to try other ideas.  In Scenario 2, business lower their investment mechanically to past falls in GDP, but increase when GDP increases.  This rule has faster growth once we hit the bottom, but still a net fall in GDP.

In scenario 3 I overwrite the second period with a Panic.

In scenario 4, because the government is determined to always borrow 18% and tax 15%, the spiral just keeps going down and down.  This is your Great Depression scenario.

My final favourite is scenario 5.  The government grows up, and allows a big deficit rather than demanding higher tax revenues in a recession. After the one year recession, the government runs a constant deficit.  But GDP growth is much higher, and things go into a self-sustaining upward spiral. This one might be termed Keynesian Over Optimism.

You will notice that at the end of the scenarios, you have the household asset position, and how much debt the business and governmetn sectors have.  Remember that government debt is just something someone else owns. At the end, you find the household sector has saved, and the business sector borrowed.

Have fun!

UPDATE:  Chris Giles has a nice go at those members of the business community: “Fully knowing there is a big and unresolved debate over the effect of fiscal policy on output at the moment, the business leaders show wonderful faux ignorance of it.”

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