Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 7 October 2014

The mythical debt crisis

A constant refrain, from both the Conservative and LibDem party conferences, is how the current government saved the country from a crisis. Here is Osborne: “Four years ago, our economy was in crisis, our country was on the floor.” Or LibDem Danny Alexander: “We’ve seen the economy through its darkest hour ..” Now someone from outside the UK would immediately think Osborne and Alexander had got their counting wrong: the Great Recession was in 2009, which was five not four years ago. But of course they do not mean that little old crisis - they are talking about the Great Government Debt crisis. The only problem is that this debt crisis is as mythical as the unicorn.

The real crisis was the Great Recession. And if any politicians can claim to have saved the country from that crisis, it is Labour's Gordon Brown and Alistair Darling. They introduced stimulus measures (opposed by Conservatives) that helped arrest the decline in GDP. By 2010, which is when Osborne took over, the economy was growing by nearly 2%.

But surely there was a debt crisis in 2010? Indeed there was, in other countries. Crucially, these were countries that could not print their own currencies. This became apparent when interest rates on Greek debt went through the roof. Interest rates on UK and US government debt after the recession stayed well below levels observed before the recession. UK and US governments never had any problems raising money, for the simple reason that there was never any chance they would default.

So wrong time, wrong country, but also maybe wrong people. Consumers and firms in the US and UK did feel they had borrowed too much, or wanted to save more, as a result of the financial crisis. The personal savings ratio in both countries rose substantially, and stayed high for a number of years. But people need something to save, like government debt. Which is one reason why interest rates on UK and US government debt stayed low: although the supply of that debt increased, the demand for it was increasing even faster.

So why do we not hear Labour claiming that they saved us from a crisis - at least their crisis was real! Why do claims that the current government saved us from an entirely mythical crisis generally go unchallenged? Such claims are the equivalent to the Republican Congress claiming they saved the US economy. Welcome to the strange world of mediamacro. What the media should be doing, the next time this government claims it saved us from the Great Government Debt crisis, is to borrow a phrase from Jim Royle: crisis my arse!   


  1. Mediamacro created an Overton Window.
    And for targeted political reasons, Labour didn't feel it worth pushing that one open.
    Politics beats economics.

  2. I heard the BBC Feedback programme on the weekend discussing how to make foreign affairs stories easier for their listenership on Today, particularly the 35-54 age bracket. Nothing was said about economics.

    Why would Radio Four want to make things easier when, as someone just beneath that lower age, around 40% of my generation went to university?

    "The decline is spreading. We know that some universities have been constrained to lower their standards for entrants from comprehensives, discriminating against more the talented [sic] because they come from grammar or independent schools. We see how the demand for absolute equality turns into the new inequality. In the universities, which should be sanctuaries for the pursuit of truth, the bully-boys of the left have bean giving us a foretaste of what leftwing dictatorship would endeavour to achieve, actively cheered on by the casuistry of some members of the university staffs, cuckoos in our democratic nest, and by the pusillanimity of others, by the apathy of many and, I must add, by moral cowardice in public life. And since these universities are financed mainly by the taxpayers, only a minority of whom will have had access to them, it is the right of the public to pass judgment on how its money is spent. Whatever we may have thought fifteen years or so back, it is our right and duty to question, in the light of experience, the rapid expansion of the universities, and the belief that by increasing the number of undergraduates we necessarily multiply the benefit either to the young people concerned or to the nation."

    1974 Oct 19 Sat Joseph (Sir Keith) Speech at Edgbaston (“our human stock is threatened”),

    1. What does this have to do with the blog post?

    2. As soon as you combined 'left-wing' with 'dictatorship', I wrote you off as a swivel-eyed right wing nut. And, as for remaining behind a cloud of anonymity to spout your bile, two can play that game.

  3. SWL-

    The FFR is a policy choice, not a market result. The Fed is the reserve monopolist, they set the supply at whatever level corresponds to their target interest rate. Monopolist pricing should not be confused with market supply\demand.

    1. I'm not sure of the relevance of the US Federal Funds Rate on whether the fiscal policy decisions of a UK government helped avoid a debt crisis.

    2. Well, if you understand macroeconomics, then you would know that THE reason mainstream economists use for their Govt budget constraints mythology is that deficits will eventually lead to higher interest rates.

      Which is completely bogus. Sovereign currency issuing Govts (like the UK and US), are always in total control of their interest spending. SWL uses this line:

      "Which is one reason why interest rates on UK and US government debt stayed low: although the supply of that debt increased, the demand for it was increasing even faster."

      The interest rates are what they are because thats the policies of the Govt's, not because market forces led to low interest rates.

    3. A little QE also helps the increase in demand, of course.

  4. Cogent macroeconomics meets Royle Family - genius! If you can get a Blackadder quote in sometime that would really make my day.

    1. Perhaps I have a cunning plan to do just that

  5. As usual though, there were enough half truths to make the crisis story believable. IIRC there were a few jitters about UK bond auctions, there was also the Bill Gross "bed of nitroglycerine" comment as well as S&P Putting the UK's credit on negative outlook. The whole crisis story had a truthiness to it.

    Of course, since then UK Treasuries have moved downwards and Bill Gross has made an exit from Pimco. Media macro hasn't really looked back though.

    1. Bill Gross and S&P are hardly disinterested observers, of course, they have "services" to sell. Or is that the point?

  6. No debt crises? Try telling that to Rogoff and Reinhart. They'll send a hit man round to do you in.

  7. In October 2008 Krugman wrote a column asking if Gordon Brown had saving the world's financial system.

    Then a couple of months later Brown tried to use that line in the Commons, but misspoke and ended up saying "we not only saved the world..." which caused Cameron and the Cons to laugh.

    I really don't think Labour ever recovered and never tried to and take credit for saving the financial system again. People just weren't listening anymore. Maybe if they'd stuck to their catchphrases for several years like the coalition it could have made a difference.

    Now they find themselves in the strange position where they don't think they've got anything to apologise for, but don't have the guts to point out their role in preventing a crisis. It's their own fault for being cowards.

    Ed "too far too fast but we'll stick to the coalition plans" Balls has completely wasted the last few years.

  8. 1) I suspect Osborne would claim there was no sovereign debt crisis because his actions in his 2010 budget showed that the UK was serious about reining in a 10%+ deficit. Had he announced in May 2010 that he had no intention of raising taxes, nor of cutting government spending and was instead planning on borrowing an extra £10-20bn more on top of the £158bn deficit then what do you think would have happened to gilt yields ? Bear in mind yields had already risen from 3.2% to over 4% prior to the general election.

    2) There was no sovereign debt crisis but the crisis was expressed through the 25% collapse in sterling and the resultant imported inflation and collapse in living standards in an era of no wage growth. Of course a country with its own currency will never suffer a debt crisis but it will suffer a currency crisis.

    1. 1) It would not have made much difference, the rise in yields was not a global phenomenon not limited to the UK in anticipation of a global recovery. Had we stimulated, we may have managed to push the UK economy out of the liquidity trap in which case yields would be higher than they are now.

      2) Yes, the UK could have a currency crisis, although in 2010 the collapse of the pounds had already happened, it's hard to see why a lack of tightening or even mild fiscal stimulus on the scales we're talking would have caused a further collapse of the pound.

    2. I'd claim that we did have a currency crisis only it took place in 2008 and that its effects continued for the next 3-4 years. In 2008 the pound fell 20% against the Euro, 25% against the dollar and near enough 50% against Yen, Aussie dollar, HK dollar etc.

      The FX markets rightly realised that when the banking crisis hit the UK would be particularly badly impacted (due to greater reliance on banking & housing to drive the economy) and that therefore there would be massive borrowing needed for the forseeable future.

      Had whoever won the general election in 2010 (and remember all three main parties campaigned on "cuts worse than Thatcher's") decided not to cut spending or raise taxes and instead to add to the £156bn deficit then there was every possibility that the currency could have had a further major leg down.

      As it was the pound largely flat-lined at 1.5 to the dollar until recently and the UK suffered with a cost of living crisis as RPI inflation (largely imported inflation) ran at 4-5% whilst wages stagnated.

    3. 1) There was a slight increase in long term interest rates because the economy appeared to be recovering. If he had announced a delay in austerity to allow the economy to recover I think interest rates would have increased a little more for the same reason. But the UK as Greece is nonsense, because the UK was never going to default. Again, a simple and obvious fact that has completely escaped media macro, partly because their sources tend to come from the financial sector which has interests of its own.
      2) The depreciation seems to have been linked to the financial crisis rather than the debt crisis. It would only be a sensible response to the debt crisis if all that QE lead to a huge spike in inflation.

    4. 1) I'd agree that Osborne's "Greece-style" rhetoric in 2010 wasn't helpful (but he was a politician trying to win an election not an FT economic columnist trying to be scrupulously accurate) but I don't think anyone thought we were likely to default just that when you are running a deficit of 10%+ you can't be cavalier with fiscal policy.

      As it was the economy was growing reasonably strongly in 2010 and the OBR projections were that this growth would continue even with the austerity that was announced in May 2010 (tho issues like VAT rise weren't due to take effect for another six months). Had a Chancellor announced instead that there was to be no austerity the markets would have had every reason to think that the UK government was prepared to be cavalier about fiscal policy.

      2) I'm arguing that currency & debt are linked. With QE there is no chance of default and it is possible to keep yields low. However the downside is that the your currency takes an almighty hit. Which is fine as long as, unlike the UK, you don't import most of your energy, food & consumer products.

    5. 1) What does 'being cavalier' with fiscal policy mean. This is mediamacro talk. If you are not going to default or inflate debt away, then why worry about the deficit in the short term?

      2) Higher debt in itself does not hit the currency, if there is no chance of default. The nominal value of the currency depends on expected inflation and interest rates, and if higher debt has no impact on these, there is no reason for a depreciation.

    6. To answer both your points I'd argue that the markets did fear higher inflation would be the government's ultimate solution if it were to continue borrowing £100bn+ more than it raised in tax revenues annually.

      So a situation where a government is borrowing to fund current expenditure, even with a growing economy, and using QE to keep bond yields down it is likely to see an ever weaker currency.

    7. Shinsei: Re:Point 1 (not about the currency issue)
      To add to other explanations already made above, for the UK gilt yields are primarily driven by growth expectations, explained very well here:

      Again, Osborne was deceiving the electorate on a grand scale with the notion of austerity needed for fiscal 'credibility' to avoid spiralling borrowing costs.
      "borrowing an extra £10-20bn more on top of the £158bn deficit then what do you think would have happened to gilt yields?" They might have continued to rise as they did prior to the general election as growth prospects improved thanks to this extra £10-20bn of fiscal stimulus.
      But they fell, thanks to poor growth prospects due in large part to austerity measures which the OBR estimates cost the economy over £100bn in lost output. Strangely he doesn't mention that when referring to the mythical success of his 'long-term economic plan

    8. "the markets did fear higher inflation would be the government's ultimate solution"
      -Output gap too large. The UK was operating well below full capacity with GDP way below potential. No possibility of inflation (unless stimulus and QE continued beyond the point of 'full economic capacity'. This could not have happened anytime around 2010...its not even happening now in 2014.

    9. But growth didn't fall due to austerity measures. The OBR when it made its forecasts in mid-2010 took account of the negative impacts of a VAT rise, public sector pay freeze and fall in government capital expenditure and still thought the economy would grow at 2%.

      The two issues that caused growth to disappoint were both external and largely out of Osborne's control - namely the Eurozone crisis (and its effect on business sentiment) and the much higher than anticipated oil price (and its effect on UK utility bills & transport costs). The OBR (not to mention IMF et al) are pretty clear about this.

      And in the face of these negative surprises Osborne reined back on austerity (though without admitting so publicly) as I suspect most (especially here) would have thought sensible.

    10. Just noticed a mistake in my first comment "the rise in yields was not a global phenomenon" should read "the rise in yields was a global phenomenon".

      @Shinsei - I think the "cavalier with fiscal policy" argument is a problem here. Stimulus measures can be quantified reasonably well and be made conditional on certain circumstances, ultimately it's simply a question of what level government debt should be stabilised at, the idea that government debt might ultimately stabilise at a level 10% of GDP higher is not really going to scare the horses. The idea that the UK would go the full Mugabe is a fantasy.

      As for higher inflation, people who didn't believe in confidence faries but did believe in liquidity traps said this would not be a problem...and they were right. Even if some inflation were to occur as a result of overzealous stimulus, the risks of inflation are not particularly problematic, we know how to deal with them and for all the talk of how bad the 70s were, 70s levels of GDP growth would be a dramatic improvement on our current situation.

    11. @Shinsei

      1) "what do you think would have happened to gilt yields?"

      Surely, this is another example of mediamacro: the implication is that governments should be scared of bond markets.

      Nick Clegg was fond of comparing UK gilt rates with Italian bond rates -- but since OMT was announced in 2012 the Italian 10-year bond rate has fallen from ~7% to 2.3% now, almost identical to UK 10-year gilts -- despite Italian debt to GDP going up beyond 130%.

      As Flipchart Rick says:

      " It took intervention by the European Central Bank to bring Italian borrowing costs back down."

      Governments and central banks control sovereign bond rates, not markets.

      2) Was a 20% fall in Sterling a crisis? As Martin Wolf said back at the beginning of 2013: "Sterling is falling. Hurrah!"

    12. "Was a 20% fall in Sterling a crisis?"

      As it led to higher inflation, which wages have now lagged behind for six years, yes.

      In 2010 every party was proposing further fiscal retrenchment. What Osborne did, as opposed to what he said he would do, was almost identical to the Darling plan. Without that the fall in sterling would have been worse, and the 'cost of living crisis' worse still.

      As it was, we only had around 18 months of fiscal retrenchment anyway before Osborne called a halt to it (although you wouldn't know that if you read S W-L et al at that time). The UK's recent strong growth rate is probably higher because of the earlier flat period, so that the overall impact is close to nothing at all.

      Nobody at all thinks the UK can default, and the UK will never have difficulty raising money. That doesn't mean that there are no actual downsides to running a larger deficit: there are.

    13. you have a low inflation rate in England and it appears that you have had low productivity growth, which has a lot to do with the stagnation of wages. Without increasing productivity, firms would be squeezed trying to increase wages.

    14. Shinsei:
      Re: "But growth didn't fall due to austerity measures...The two issues that caused growth to disappoint were both external...The OBR (not to mention IMF et al) are pretty clear about this."
      The opposite is in fact true...both the OBR and the IMF (and the May2014 budget report) stress the enormous drag that austerity policies has had on a minimum calculated to have cost the economy £100bn in lost output (in isolation from the external factors which also contributed).

      SWL summarises the OBR view: "The OBR estimate that UK GDP in 2013 is about 1.5% lower as a result of fiscal consolidation, and the cumulated GDP loss due to fiscal tightening from 2010 to 2013 is a bit above 5%."


      What did you read to suggest the opposite?

    15. Simon, everyone but everyone accepts that if you tighten fiscal policy that will lower growth.

      Shinsei's point was that the reason growth disappointed (ie was lower than expected by the OBR and IMF at the time) was down to exogenous factors (the Eurozone and, more importantly, commodity prices).

    16. @Shinsei @SpinningHugo

      "Shinsei's point was that the reason growth disappointed (ie was lower than expected by the OBR and IMF at the time) was down to exogenous factors (the Eurozone and, more importantly, commodity prices)."

      That would have some logic if we accept the OBR/IMF forecasts as accurate. It could, however, be that they were simply inaccurate.

    17. Even if the OBR or IMF had factored in the negative impact of austerity when making their 2010 forecasts, they underestimated it ( they underestimated the size of the multiplier in fiscal consolidation when at the ZLB: the IMF has acknowledged this some time ago).

      Therefore, whilst exogenous factors had a negative impact on UK growth rates, the impact and drag on growth from austerity was much greater than forecast.
      Simply, the poorer than forecast growth of the UK economy was not just because of the two external factors mentioned by Shinsei. Austerity policies slowed it much further than expected, and the OBR, IMF and even the cross party body of MPs on the 2014 budgetary report acknowledge this).
      To suggest the UKs economy performed more poorly than forecast only because of exogenous factors flies in the face of all of the evidence, findings of independent economic studies/research and even the stated opinions of the OBR and IMF themselves.
      SH: If only it were true that "everyone but everyone accepts that if you tighten fiscal policy that will lower growth". There are still proponents of 'expansionary austerity" and that the governments austerity policies 'saved' the UK economy, not harmed it.

    18. @Spinning Hugo

      Was a 20% fall in Sterling a crisis?

      You say: "As it led to higher inflation, which wages have now lagged behind for six years, yes."

      Your stories are too simple. There are benefits as well as costs to a fall in sterling. S W-L is much better at explaining macro.

      Also, it's not only falls in the ex-rate that drive inflation. As Tejvan Pettinger says, "CPI-CT was lower than CPI during 2010 because tax increases, such as VAT, increased the headline CPI rate. "

    19. @SH: "so that the overall impact is close to nothing at all".
      Far from true... there are significant hysteresis effects which last for years afterwards to mention just one enormous impact of Osbornes fiscal retrenchment.

    20. Well, it is of course possible that there could have been some hysteresis effects.

      If there had been, what we would expect to see is longterm impact on employment.

      that is your claim is it?

      not impossible I suppose, but doesn't look very likely.

    21. " There are still proponents of 'expansionary austerity""

      There really are not Simon. Point me to who these people are.

      You make it too easy for yourself in thinking that those who disagree with you are fools. (Much the same is true of S W-L).

    22. @SimonReynolds

      - Of course I accept that other things drive inflation too.
      -Of course I accept that a fall in sterling has upsides as well.

      Does that mean that I accept that deficits don't matter very much as the UK cannot default and we don't have any problem obtaining finance?


    23. @SpinningHugo - I submit the following the following proponent of expansionary austerity.

      "And then two years ago in this very hall - when the clamour of our opponents was loudest and they insisted we should abandon that plan - we held our nerve and recommitted ourselves to the course we had set.

      Today I can report this to you: Britain is the fastest growing, most job creating, most deficit reducing of any major advanced economy on earth."

      The cause and effect is clear, we stuck to austerity, we have a growing economy.

    24. Don't be so silly.

      That is a politician doing what they all do: claiming the credit for a success which is nothing really to do with him.

      I was asking a serious question: who are these proponents of expansionary austerity? I know you can find some in the US, but in a UK context?

    25. hugo do you ever tire of trolling this blog

      you asked for a proponent and got one

      theres lots of posts on this very site about the proponents of expansionary austerity

      perhaps no true troll is as trolly as you

    26. SH:
      Re: Hysteresis
      “expect to see is longterm impact on employment. that is your claim is it? not impossible I suppose, but doesn't look very likely.”
      No, not necessarily an impact on unemployment numbers (as the current employment numbers do appear to show). But importantly these figures mask the nature and type of jobs that have been ‘created’ – the huge surge in lower skilled/lower paid part-time and zero-hour contract jobs, the ‘under-employed’ – Basically many workers who have lost their jobs since 2008 not able to go back into the same field, having to look at lower-skilled jobs with lower pay, so consequently reducing the long term productive potential of the economy as these workers ‘lose’ their previous skills – skills needed for more productive jobs in the future perhaps.
      " There are still proponents of 'expansionary austerity”…There really are not Simon. Point me to who these people are”
      A.Paterson beat me to it. Politically motivated or not, George Osborne remains a proponent (defn: a person who advocates a theory, proposal, or course of action). Because he is a liar does not mean he is not a proponent of expansionary austerity, as his recent verbal deceptions/falsehoods (speech) indicates.
      Otherwise, perhaps you missed SWL’s post in early January concerning the results of the FT’s survey of economists.
      Brief excerpts from it:
      Q. “Has George Osborne’s “plan A” been vindicated by the recovery?”.
      (ie. Adhering to austerity(Plan A), we have a growing economy.)
      Chris Giles and Claire Jones report that “A thin majority of 42 to 38 said the chancellor was “vindicated””.
      From academics. Here I counted just two clear Yes responses, from Patrick Minford and Mike Wickens.
      At least a dozen city economists gave a clear Yes….another quote: “The return of growth in 2013 … [is] an invalidation of the new [sic] Keynesian assertion that growth could not return during fiscal consolidation.”
      That’s over dozen SH.

      “You make it too easy for yourself in thinking that those who disagree with you are fools. (Much the same is true of S W-L).”
      No, I have and would never automatically think that those who disagree with me are fools. I know so little and learn so much from others who demonstrate how/why I am incorrect, causing me to re-evaluate my position and view. Don’t you do this?
      Only those who are consistently incorrect, forward their own opinions as self-evident truths - never supporting their claims with evidence; distort and mis-represent other people’s position in a pathetic attempt to avoid being seen to be wrong…sound familiar?
      Surely you must notice the difference in argument/writing styles – SWL (assertions are constantly backed with supporting evidence (as I try to when time allows), whilst you…well, why don’t you do this? Is it because the evidence so often refutes or casts serious doubt on your opinions and prejudices?

    27. Simon,

      Not one of those examples is of someone saying "tighter fiscal policy leads to higher growth' and the reason for that is that nobody believes that.

      That doesn't mean that there may be good reasons for tightening fiscal policy. There may well be, and doing so may well be vindicated..

    28. The evidence for "proponents of expansionary austerity" is there in black and white, even with a verbatim quote “The return of growth in 2013 … [is] an invalidation of the new [sic] Keynesian assertion that growth could not return during fiscal consolidation.”
      It cannot be any clearer than this, and I cannot understand why someone when presented with evidence which challenges (or in this case refutes) their assertions cannot then change their opinions. Its simply part of learning.
      (Not sure where that quote "tighter fiscal policy leads to higher growth' came from...I didn't suggest they would say this outright. Rather the focus was that austerity leads to growth..."expansionary austerity".
      Try not to speak on behalf of other people by saying "nobody believes that". You cannot argue that logically as its a generalisation. Ask yourself the question: "Do I know for sure that nobody believes that"? Your honest answer must be no - unless you know the minds of others of course. It is also written as a self-evident truth - again which you can't do. Worse, the evidence provided above completely refutes it as over a dozen individuals directly imply that austerity has led to growth, with the quote unambiguously spelling this out.

  9. Since we're on the subject of myths, perhaps the illusory 2% growth of 2009/10 deserves more attention. The majority of it can surely be explained by the £18-20 billion of income that HMRC estimates was brought forward to 2009/10 to avoid the additional rate of tax.

    1. There was nothing illusory about those growth figures, the bringing forward of tax revenues wouldn't have any bearing.

    2. I find your response completely inexplicable. Income equivalent to nearly 1.5% of GDP was brought forward to the year in which we had 2% growth, and it had no bearing?
      From the BBC:
      "The HMRC thinks that the total declared taxable income of those earning more than £150,000 a year slumped from £116bn in 2009-10, to £87bn in 2010-11."

    3. Tax revenue is not GDP, it's possible that the income that was brought forward meant the UK's fiscal position looked better than it actually was, it would not have boosted GDP though because it is complied from a much broader variety of sources.

    4. If you reread the section above, it is clear I am referring to income on which taxes are based, not tax revenue.
      The ONS uses the income estimate as one of its approaches for estimating GDP. One of the sources for income data is "administrative data from HM Revenue & Customs."
      It is beyond doubt that the 50% tax rate, announced a year in advance caused a major distortion to the total declared taxable income of those on incomes over £150,000 per year.

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