Friday, 15 June 2012

Mansion House Myths and Excuses


                In his speech yesterday, George Osborne said this:

“Of course, there are those who argue we should not be reducing the deficit – we should be spending and borrowing even more. But that argument ignores a crucial fact: inflation in the UK has been significantly above the Bank of England’s 2% target since the end of 2009. That is due to a combination of commodity price shocks, the lagged effects of a lower exchange rate and a worsening underlying productivity performance, and it has very important implications for fiscal policy. Looking backwards it means that over this period looser fiscal policy would almost certainly have been offset by tighter, or less loose, monetary policy.”

This is an argument I have already discussed, but it is the first time I have seen the government use it. It is an improvement on those based on bond markets, confidence fairies, or expansionary fiscal contraction. Yet even if you buy it (which I do not think you should), the key phrase here is ‘looking backwards’.
                In judging policy, we should not look backwards. Lots of things are true in hindsight, whereas policy has to be made under uncertainty. Good policy should be as robust as possible to this uncertainty. In 2010, when additional austerity was announced, the government did not know that inflation was going to be unexpectedly high in 2011. So it cannot have known that the MPC would have been debating whether to increase interest rates in the spring of that year. A more likely outcome was that inflation would be falling and interest rates would be firmly anchored at their lower bound. As a result, high inflation in 2011 is a poor excuse for a bad decision.
                It was a bad decision because the government should, at the very least, have considered the possibility that demand was going to be weaker than they expected, and that monetary policy would be unable to do much about it because interest rates were at the zero lower bound. If they did not think about this possibility, it was irresponsible. If they did and took a risk, we are now experiencing the consequences.
                The Chancellor in his speech also quoted Mervyn King as saying that current UK policy was a “textbook response” to the current situation. I do not know where that quote comes from (it is not in the text of the Governor’s speech at the same occasion), so I will focus on what the Chancellor thinks. He goes on to explain:  “Theory and evidence suggest that tight fiscal policy and loose monetary policy is the right macroeconomic mix to help rebalance an economy in the state [of high indebtedness].” To which I can only say – no, not when interest rates are stuck at zero.
                Central banks get a lot of criticism: some justified, some not. When it comes to what monetary policy can do in a liquidity trap, they do not want to appear too pessimistic. But there is a danger of giving the opposite impression, which is that nothing much has changed except the way policy is implemented. I would much prefer them to be quite explicit about how much more uncertain Quantitative Easing is as an instrument, and that fiscal policy will have a much greater impact on demand as a result.
                Regular readers may think I’m beginning to sound like a record on this. Indeed, Jonathan Portes argues that the proposed new programme discussed yesterday by the Chancellor of government guarantees to support new house-building and infrastructure investment concedes the intellectual and economic argument.  To quote:  “The economic difference between the government borrowing from the private sector to finance investment spending, and the government guaranteeing the borrowing of another entity - with the government guarantee meaning that the lender has no more or less risk of non-repayment than if the money was lent direct to government - is marginal.” If the new investment happens, I would agree.
I also suspect that Mervyn King would not describe such schemes as pure monetary policy. He says: “But the long term nature of the lending and its pricing mean that the Bank could conduct such an operation only with the approval of the Government, as offered by the Chancellor earlier. So such a scheme would be a joint effort between Bank and Treasury. It would complement the government’s existing schemes, and tackle the high level of funding costs directly.” That sounds like code for this is also fiscal policy.
But why quibble. If measures of this kind allow the government to carry on the fiction that they are sticking to Plan A, and if it produces a recovery which it is then claimed has nothing to do with fiscal policy, should we mind? I think we should, because today’s myths have a danger of becoming tomorrow’s received wisdom.             
                   


5 comments:

  1. “tight fiscal policy and loose monetary policy is the right macroeconomic mix to help rebalance an economy in the state of high indebtedness..” I’ll translated into English.

    “When large numbers of numpties borrow too much, they should be rewarded with continued low interest rates (at the expense of ordinary frugal consumers who suffer from the above “tight fiscal policy”) so as to encourage the numpties to continue borrowing too much. Likewise the best cure for an alcoholic is to ply them with more alcohol.”

    Is that a fair translation?

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    1. What you're missing is that one person's borrowing is another's saving. Those "ordinary frugal investors" decided to lend the money to those borrowers; they'd complain more if they didn't get their investment back at all.

      The comparison with alcoholism is fatuous.

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  2. Sorry to begin by quoting a quote:

    "To quote: “The economic difference between the government borrowing from the private sector to finance investment spending, and the government guaranteeing the borrowing of another entity - with the government guarantee meaning that the lender has no more or less risk of non-repayment than if the money was lent direct to government - is marginal.” If the new investment happens, I would agree."

    Your "if" is a sound proviso.

    The difference is that the banks already hold extensive loan books, against which their new source of cheap capital can be arbitraged. It is likely that the net impact on new business written will be very much lower than the headline billions devoted to the scheme as the banks internalise the benefits of the lower cost of capital. If the government invested directly, then at least we could be sure that the first-round effects of the new capital was reaching ground level, and (possibly) directed towards projects with the greatest second-round impact.

    I fear that this initiative may prove to be one further case of economics not really understanding how finance operates.

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  3. Simon, the "textbook response" quote is from a Treasury committee session last year:

    http://www.publications.parliament.uk/pa/cm201012/cmselect/cmtreasy/uc1675/uc167501.htm

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  4. I'd like to note too the option of tax financed stimulus.

    We're concerned about government debt, and we're concerned about the great recession. Some people say the government can't deficit spend to stimulate because of high debt, and this is actually true in countries that can't borrow cheaply.

    So, you could raise taxes, especially on wealthier people with a high propensity to save, and then the government spends, invests, the money. We're worried that people aren't spending enough; this makes the money get spent. You tax a dollar from someone with, say, a 90% propensity to save; their spending goes down by 10 cents, and the government spends the whole thing, $1.00, hopefully on high return public investment. Private spending goes down by 10 cents, government spending goes up by $1.00, so total spending goes up by 90 cents, with not one cent added to the debt. It's sad that this is so rarely considered; the spending always has to be defict, because the right's billionaire financed propaganda machine has convinced so many that tax increases are always terrible for the economy, short or long term.

    Robert Shiller, wrote in 2010:

    It has long been known that Keynesian economic stimulus does not require deficit spending. Under certain idealized assumptions, a concept known as the “balanced-budget multiplier theorem” states that national income is raised, dollar for dollar, with any increase in government expenditure on goods and services that is matched by a tax increase.

    At: http://www.nytimes.com/2010/12/26/business/26view.html

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