Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday, 1 September 2014

Labour's austerity problem

One of the political/economic soap operas over the last year has been the UK Labour Party’s agonising over the perception of its economic competence. The story always starts with current polling data: either Miliband’s personal ratings or Labour’s rating for economic competence. It then often seeks to find the answer to these problems in the past: either the last years of the Labour government, or the first year of opposition when Labour was preoccupied with electing a new leader.

The latest example can be found in an article today by the Guardian’s chief political correspondent, Nicholas Watt. Here Gordon Brown’s call to invest rather than cut in 2009 is blamed, and this is contrasted with an alternative that would acknowledge the need to cut, but focus on the idea that cuts would have been fairer under Labour.

I know nothing about internal Labour politics, but it seems to me that what is going on here is confusion over what the right policy should have been, rather than how to frame it. I also suspect that what really puts the electorate off is when a political party appears confused or divided about a key aspect of policy. The taboo in Labour circles over mentioning the word borrowing is a case in point, which I made fun of before Ed Miliband fell into the same trap.

So what should Labour’s line have been? As it does not have a hidden agenda to reduce the size of the state, its line should have been based on sensible macroeconomics. As my paper with Jonathan Portes suggests, the policy should have been to avoid cuts and to invest while interest rates were stuck at ‘zero’. In other words, the recovery takes priority, and the deficit should be dealt with after the recovery has been assured. Sometimes translating good macroeconomics into simple messages can be difficult, but not in this case.  


  1. "it seems to me that what is going on here is confusion over what the right policy should have been, rather than how to frame it."

    As a matter of historical fact, that isn't right.

    Whatever the merits of a policy of avoiding cuts may have been, that was not Labour policy in 2010.

    So, Darling promised "cuts worse than Thatcher"

    And the 2010 budget projections envisaged immediate cuts in spending in the succeeding years. What Osborne actually did (as opposed to what he would say he would do) was almost indistinguishable from what Darling planned to do.

    Whoever had won in 2010 would have made cuts: that is the time of the electoral cycle when cuts occur. Perhaps they would have been less severe under Labour, but we'll never know (they weren't actually very severe anyway, the UK position was and is quite different from, say, Ireland or Spain).

    So, Brown's line about Tory Cuts v Labour Investment was, politically, daft as anyone numerate could see that cuts were coming whoever won. It was only a question of how deep they should be, and where they should fall.

    1. Exactly. My memory of events was Darling saying to the incoming Chancellor, "we are out of money, good luck."

      Labour's management of the economy under Blair/Brown was an unmitigated disaster.

    2. That was the outgoing Chief Sec to the Treasury's note to his successor (Byrne to Laws).

      It was a joke, and one that I think it was poor form to leak.

      S W-L has an argument when he claims that Labour's fiscal policy was not too loose pre-crash

      He (as usual) over eggs his case, but it is a useful corrective to the view that Labour was incompetent.

    3. I believe the note was intended as an in-joke between Byrne and his shadow Phillip Hammond, the arrival of an unexpected Lib Dem in office changed matters.

  2. The previous two commenters seem more than a little confused themselves! Simon is saying clearly that Labour's problem was not telling the wrong lie, but not realising what the truth was! And Darling, although not the sharpest tool in the Labour box, certainly wasn't responsible for Liam Byrne's infamous and idiotic note.

    In total agreement with you Simon on this one - commented on the Guardian piece:

    'His [Brown's] refusal to use the word 'cuts' in trying to frame the economic debate as investment versus cuts gave the impression we didn't understand that debt and deficit would have to be dealt with.' - Chuka Umunna

    As the vast majority of (non-shilling) economists would tell you, the 'dealing with it' through cuts has been disastrous, both in the UK and in the eurozone. The deficits and debt were never the primary problem but a symptom of an economy too reliant on rentiers and dubious financial tricks.

    The argument being made by Umunna and so many other dupes of idiot economics is, I am afraid, not that Brown should have been more honest but that he should have lied to gain votes from more practised liars.

    1. "The deficits and debt were never the primary problem but a symptom of an economy too reliant on rentiers and dubious financial tricks."

      Who created that problem? Even if they did not, they had plenty of opportunity to correct it. Where were the brilliant macro-economists and their Dear Model during this time?

    2. Read Mind the Gap in August 2002 in Krugman's NY Times blog. He lays everything out for you using Dear Model.

    3. To be fair, i live in the wrong Cambridge, and so I was much more aware of the macroprudential problems under Bush than what was going on in Europe. I was frankly surprised to realize that you guys had done as sorry a job as we did at managing our banking system.

  3. S W-L has an argument when he claims that Labour's fiscal policy was not too loose pre-crash

    Blair/Brown was a disaster. But I think its macro-economic policy blunders had more to do with monetary policy and financial regulation than fiscal policy.

  4. Oh well, we'll have to wait until the next Minsky moment then.
    Hopefully before May 2015.

  5. Simon,

    Speaking as a nit-picker who tries to find fault in your articles, I wish to querie the suggestion in your last para that stimulus has more justification when interest rates are low. Suppose those holding government debt demand 10% for doing so, and aggregate demand is inadequate. That’s not a reason to hold back on stimulus. In that scenario, the state should simply print money and spend it, i.e. combine fiscal stimulus with QE. Or even just implement QE without the fiscal bit.

    As long as the only cause of inflation is aggregate demand being excessive compared to aggregate supply, and assuming the latter QE (with or without fiscal stimulus) does not bring excess demand, then the above policy will not bring excess inflation. Ideally it would just bring the economy up to capacity.

    1. Its the preference for monetary policy rather than fiscal policy as a stabilisation tool that I talked about here

      and with which you disagree, although I did not understand why you though interest rate changes distortionary.

    2. I think interest rate changes are distortionary because they influence spending by just one type of household and firm: those with significant debts or stocks of spare cash. To be more accurate, and in the case of debts, it’s just those with SHORT TERM debts who are mainly affected. LONG TERM interest rates are relatively unaffected by central bank base rate adjustments.

  6. "...the recovery takes priority, and the deficit should be dealt with after the recovery has been assured.""

    Name three cases where that has happened in the past in any country- Salazar? But who else?

    1. US under Bill Clinton late 90s?

    2. Peter Walsh1 September 2014 23:42

      Not bad, but I said:

      Name three

    3. UK Labour Govt 98-2001.

      So with your Salazar that's three.

      Point is the meme "governments never deal with the deficit in good times" is a myth.

    4. Peter Walsh

      "governments never deal with the deficit in good times"

      well, hardly ever.

      It seems to be pretty difficult to name three - my mention of Salazar was joke since the price for Salazar - dictatorship - is clearly too high.

      But I sustain that the "myth" is more true than false, otherwise there should have been a flood of examples. Considering the number of countries and the number of governments since WWII, it seems to be more plausible to agree with Minsky that politicians try to combat recessions through inflationary measures with lasting effects. Actually, that is mainstream macro:

      Mankiw, Macroeconomics, 8th ed. 2013, Int.ed., p. 295:
      "There is no way to maintain full employment and keep the price level stable."

  7. "... the policy should have been to avoid cuts and to invest while interest rates were stuck at ‘zero’. In other words, the recovery takes priority, and the deficit should be dealt with after the recovery has been assured."

    I agree with your statement except for "while interest rates were stuck at ‘zero" bit. The interest rate is irrelevant to a government that is spending a fiat currency, which it can never run out of. The government "issues" the currency. Everybody else "uses" the currency. The government always spends before it taxes; not the other way around. You can only buy government, (mistakenly called) "debt", with currency the government has previously spent into the "users" (private) sector and has been "saved" by those "users". Taxes don't physically pay for anything. Once collected by HMRC, they disappear back into the cosmos from whence the government got in the first instance.

    Like wise, the government does not have to issue "debt" (Gilts) financial instruments; it chooses to do this, it is not a requirement of a fiat monetary system. Gilts are welfare payments for insurance and pension funds, just as DWP benefits are for the little people. Government spending could remain as "reserves" at the BoE (part of M0), exactly the same as QE is currently doing with little to no affect on the economy.

    No bunch of financial market bond vigilantes can take on a central bank in its own currency and win. If a country is dumb enough to use a foreign currency as a peg for its own currency and, foolishly borrows in that currency (Argentina); then you are a "user" of that currency and you will get shafted by the markets when you borrow.

    If you are dumb enough to join a currency union like the Euro-zone for instance, then again you are a currency "user" and you will get shafted by the markets when you borrow. Unless the ECB (the Euro "issuer") says it will buy unlimited quantities of your Euro "debt", at any price; with its bottomless pit of Euros.

    To let you into a very well kept secret, the size of your deficit and its aggregate, the so called "national debt" doesn't really matter. The governments debt is the private sectors savings. Eventually the private sector will pay it all back to the government in the form of taxes. Your children and your children's children won't be bothered by our debt, they won't be in a rush to pay it back either.

    Pounds Stirling and Euros are scores on the doors and that's all. No matter how many runs a batsman may get, the scoreboard will never run out of numbers to display that score. Likewise, we may run out of land but, we will never run out of acres to measure it with. That's what fiat money is and that's all it is. ATB Acorn.

    1. at the zero bound, you can spend a lot without having a problem with inflation; elsehwere, you cannot. So, unless you consider inflation as always tolerable, then there is a difference.

    2. Why the interests at zero condition? Because monetary policy is preferred to fiscal policy as a stabilisation tool: see

    3. Isn't inflation more dependent on capacity than the zero bound? At any interest rate, if I have spare capacity, an army of unemployed, or an army of under-productive - then I'm more likely to just sell more than raise prices. Especially in deflationary times.

    4. "Why the interests at zero condition? Because monetary policy is preferred to fiscal policy as a stabilisation tool" (SWL)

      Maybe you should rewrite Mankiw's textbook ( Ref Anon 13.30)?

      Or better still get people to read the General Theory and other forgotten or ignored economics.

  8. You will have a problem with inflation, if too much cash or credit is chasing too few goods and services; regardless of what the central bank's base interest rate is at the time. The natural rate of "bank rate" in a fiat currency economy is zero. When commercial bank "reserves" are higher than required for overnight "settlement" (as now with QE), there is no need for commercial banks to borrow, hence, you will get near zero interest if a commercial bank wants to lend it. The central bank is paying interest on "reserves" to maintain its current 0.5% base rate; it would colapse to zero if they didn't.

    Commercial banks do not lend "reserves" except to other institutions that have central bank reserve accounts (current accounts in UK terms) at the central bank. That is, reserves are not lent to households; there is no "money multiplier" to expand reserves into broad money supply (M3 money).

    Monetary policy is preferred to fiscal policy only by politicians. A politician can't be seen to be increasing the "deficit" and the "national debt"; it is not a vote winner among a populace that has been conditioned to think the government sector's finances are the same as a household, they are not. The UK government can spend new Pounds money into existence, as the "issuer" of the currency. Households are "users" of that currency, they can't "print" their own.

    Monetary policy can't rescue a balance sheet recession, only fiscal policy can do that. If you read the rules of "funding for lending" and "help to buy" you will see that the politicians went out of their way, with the BoE, to disguise a fiscal injection as a BoE monetary action. ATB Acorn

    1. Anonymous2 September 2014 00:41

      "Monetary policy can't rescue a balance sheet recession..."


      "...only fiscal policy can do that."


    2. "reserves are not lent to households; there is no "money multiplier" to expand reserves into broad money supply"

      Is that also true of excess reserves? After all, the baks can ask the central bank for cash instead of excess reserves.

    3. Anon1. Deficit spending by the government. You will have noticed that Mr Osborne was planning to have a zero primary deficit by next May. Looks like he will be deficit spending still at about £80 billion for 14/15. That, and a lot of PPI refunds and the like, are what is trying to lift the UK economy off the runway at the moment, while Households are still trying to pay down their debts. Mr Darling would have had us at this point about two years back.

      Anon2. It counts for all reserves, excess reserves are 98% of all reserves at the moment because of QE. Keep in mind that when the government spends it effectively spends twice. When it keyboards a pension payment into a commercial bank's client account, it also keyboards the same amount into that bank's "reserve" account at the BoE. The commercial banks balance sheet hence still balances. If the client goes and takes that deposit out of his account in cash, the BoE supplies the cash notes and debits the banks reserve account by the same amount. Balance sheet still balances.

      If the client has had a losing streak on the horses, he may keyboard the deposit straight to his bookies account at another commercial bank. During the day's bank "clearing", the client's bank has to transfer the equivalent amount of "reserves" to the bookies bank reserve account at the BoE, to make the balance sheets of both commercial banks balance again. ATB Acorn

    4. Anonymous2 September 2014 04:44


      Please give the details how deficit spending can actually rescue balance sheet recessions. Debtors will always have to reduce consumption (aggregate demand) until they have paid their debts or have them forgive (ie.g. through bankruptcy). How do you counterbalance that when a large proportion of the population has gone overly into debt?

      Anon 2:

      Your theory does not correspond to mainstream economics:

      Mankiw loc. cit. p. 607 and passim (e.g. p. 86, 92 f.):

      "Reserves: The money that banks have received from depositors but have not lent out"

      Excess reserves: reserves held by banks over and above minimum reserve requirements. Since they are not obliged to hold them, they can lend them out. Q.E.D.

      PS Your accounting is faulty: The government does not spend twice.

    5. Anonymous2 September 2014 13:53

      Anonymous2 September 2014 04:44

      Sorry - faulty citation:

      Mankiw, Macroeconomics, 8th ed. 2013, Int.ed., pages as quoted.

    6. As I haven't time to write, can I suggest you read Prof Bill Mitchell. Educational establishments, with a macroeconomics department. that is still using Mankiw, are to be avoided. .

      The Bank of England’s Quarterly Bulletin 2014/Q1, that Bill refers to is a must read for kids doing economics. "There was an interesting article – Money creation in the modern economy – which “explains how the majority of money in the modern economy is created by commercial banks making loans.”

      All the best Acorn.

  9. Simon,

    Spot on. I am disappointed in Balls ..I thought he had (ahem!).....


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