Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday 16 November 2014

Can we have our instrument back?

This is a rather long post about how one of the instruments of macroeconomic policy has been taken away, and replaced by a fetish about government deficits. It is not technical.

The latest Bank of England forecast has inflation returning to the 2% target by the end of 2017, which is in three years time. That is an unusually long time to be away from target. So what is the MPC proposing to do about this long lapse from target? Absolutely nothing. Tony Yates goes through all the detail, but remains mildly shocked. Much the same thing is happening in the US. In both countries the main discussion point is not what to do about this prolonged target undershoot, but instead when interest rates will rise. Two members of the MPC are voting to raise rates now! [1]

Cue endless discussion about whether the Bank or Fed think Quantitative Easing does not work anymore, or has become too dangerous to use, or whether the target is really asymmetric - 1% is not as bad as 3%. [2] All this is watched by a huge elephant in the room. We have a tried and tested alternative means of getting output and inflation up besides monetary policy, and that is called fiscal policy. We teach students of economics all about it - at length. But in public it has become like the family’s guilty secret that no one wants to talk about.

Once upon a time (in the 1950s, 60s and 70s) governments in the US, UK and elsewhere routinely used both monetary and fiscal policy to manage the economy. Governments did not stop using fiscal policy for this end because it did not work. Instead they found, and economists generally agreed, that when exchange rates were not fixed monetary policy was a rather more practical (and probably more efficient) instrument to use. They certainly did not stop using it because it caused the rise in inflation in the 1970s. That rise in inflation was the result of oil price shocks, combined with in many countries real wage resistance by powerful trade unions, and policy misjudgements involving both monetary and fiscal policy.

When, in the previous paragraph, I wrote ‘economists generally agreed’, I am talking about what could be described as the academic mainstream. However there were also two important minority groups. One, and the less influential, argued that the mainstream was wrong, and fiscal policy was better than monetary policy at stabilising demand. The other, often among those labelled monetarist, not only took the opposite view, but had a deep dislike of using fiscal policy. For example, many believed its use would be abused by politicians to increase the size of the state (and almost all in this group wanted a smaller state). For some there was the ultimate fear that politicians would run amok with their spending, which would force central banks to print money, leading to hyperinflation - we can call this fear of fiscal dominance. However, as I noted above, the rise in global inflation in the 1970s was not an example of fiscal dominance. I shall use the label ultra-monetarist for this second group: ultra, because it is not clear Friedman himself would be among this group.

These minorities aside, the mainstream consensus was that monetary policy was the instrument of choice for managing demand and inflation, but that fiscal policy was always there as a backstop. So, when Japan suffered a major financial crisis and entered a liquidity trap (interest rates fell to their Zero Lower Bound (ZLB)), the government used expansionary fiscal policy as a means of moderating the recession’s impact. At the time the results seemed disappointing, but following the experience of the Great Recession Japan’s performance in the 1990s does not look so bad.

The key event that would eventually change things was the creation of the Euro. For countries within the Eurozone, monetary policy was set at the union level, so to control demand within each country fiscal policy was the only instrument left. Unfortunately the influence of ultra-monetarists within Germany had always been very strong, and for various reasons the architecture of the Eurozone was heavily influenced by Germany. This architecture essentially ignored the potential use of the fiscal instrument. Instead the influence of monetarism led to what can best be described as deficit fetishism - an insistence that budget deficits should be constrained whatever the circumstances.

Within the Eurozone individual governments no longer had their own central banks who could in extremis print money. The worry among the ultra-monetarists who helped design the Eurozone architecture was that some rogue union members would force fiscal dominance on the union as a whole, so they put together fiscal rules that limited the size of budget deficits. This was both unnecessary, and a mistake. It was unnecessary because the Eurozone set up a completely independent central bank, and made fiscal dominance of that Bank illegal. It was a mistake because it completely ignored the issue of demand stabilisation for countries within the Eurozone - in practice it either took away the fiscal instrument (in a recession) or discouraged its use (in a boom [3]).

While the design of the Eurozone reflected the obsessions of ultra-monetarists within Germany, in the rest of the world the academic mainstream prevailed. So when the financial crisis hit, and interest rates fell to the ZLB across the globe, governments in the UK and US again used fiscal stimulus as a backup instrument to moderate the recession. The IMF, normally advocates of fiscal rectitude, concurred. The policy worked. But two groups were not happy. The ultra-monetarists of course, but also many politicians on the right, whose main aim was to see a smaller state, and who saw deficit reduction as a means to achieve that goal. Both groups began to warn of the dangers of rising government debt, which was rising mainly because of the recession, but also because of fiscal stimulus where that had been enacted.

What happened next was that the Eurozone struck back, although not in a calculated way. It turned out that it did contain just the kind of rogue state the architects had worried about: Greece. The fiscal rules failed to prevent excessive Greek government borrowing. Did this lead to fiscal dominance and hyperinflation in the Eurozone? - of course not, for reasons I have already given. But it did lead governments in the Eurozone to make a fatal mistake. What should have happened, and always does happen to governments that borrow too much in a currency they cannot print, is that Greece should have immediately defaulted on its debt. But instead Greece was initially encouraged to borrow from other Eurozone governments, perhaps because some countries worried that default might lead to contagion (the market would turn on other countries), but perhaps also because default would have hit commercial banks in the larger Eurozone countries who owned this Greek debt.

Eventually contagion happened anyway, and Greece was forced into partial default, although not until it had taken the poison of loans from other Eurozone countries which were conditional on crippling austerity. Equally important was the impact that Greece had on the use of fiscal policy in the rest of the world. Those ultra-monetarists and right wing politicians that had been warning of a government debt crisis used the example of the Eurozone to say that this proved them right. Many (but not all) economists in the mainstream began to believe it was time to reverse the fiscal stimulus, as did the IMF. 

From that point on, the idea that you could - and when monetary policy became ineffective should - use fiscal policy to stimulate the economy became lost. Even in 2009 it had been a difficult policy to sell publicly: why should government be increasing debt at a time that consumers and firms had to reduce their own debt? For those who had not done an undergraduate economics course (which included most political journalists), politicians of the right who said that governments should act like prudent housewives appeared to be talking sense. Greece and the subsequent Eurozone crisis just seemed to confirm this view. Deficit fetishism became pervasive.

Of course this about turn was just what both ultra-monetarists and politicians on the right wanted. The focus on government debt had an additional advantage in certain influential quarters. What had started out as a crisis caused by inadequate regulation of the financial sector began to appear as a crisis of the government’s making, which if you worked in the financial sector which had just benefited from a massive public subsidy was a bit of a relief. You could be really cynical, and say that austerity made room for another big financial bailout when the next financial crisis hit. 

But those with a more objective perspective watched the years after 2010 unfold with growing concern. There were no government debt crises in the major economies outside the Eurozone - instead interest rates on government debt fell to record lows. The market appeared desperate to lend governments money. The debt crisis was confined to the Eurozone. However austerity within the Eurozone, undertaken across the board and not just in the crisis economies, did nothing to end the crisis. The crisis only ended when the ECB offered to back the debt of the crisis countries. The offer alone was enough to halt the crisis, and interest rates on periphery country debt started to fall substantially. But austerity’s damage had been done, creating a second Eurozone recession. The fiscal policy instrument works, even when you use it in the wrong direction! Austerity delayed the UK’s recovery, and while growth was solid in the US, austerity there too meant that the ground lost as a result of the recession was not regained.

So those with a more objective perspective, including many in the IMF, began to realise the fiscal policy reversal in 2010 had been a big mistake. The world had been unduly influenced by the rather special circumstances of the Eurozone. Furthermore within the Eurozone the crisis that austerity had meant to solve had actually been solved by the actions of the ECB. It began to look as if austerity - in perhaps a milder form - had only been required in a few periphery Eurozone countries.

All this should have meant another policy switch, at least to end fiscal austerity and perhaps to return to fiscal stimulus. But deficit fetishism had taken hold. This was partly because it suited powerful political interests, but it was also because it had become the pervasive view within the media, a media that liked a simple story that ‘made sense’ to ordinary people. Politicians who appeared to deviate from the new ‘mediamacro consensus’ of deficit fetishism suffered as a consequence.

So as 2014 ends, we have at best an incomplete recovery and inflation below targets, yet central banks are either not doing enough, or have given up doing anything at all. A huge amount of ink is spilt about this. But if central banks really do believe there is nothing much they can do, with a very few exceptions they fail to say the obvious, which is that it is time to use that other instrument, or at least to stop using it in the wrong direction. Perhaps they think to say this would be ‘too political’. The media in the UK and US continue to obsess about government deficits, even though it is now clear to almost everyone with any expertise that there is no chance of a government funding crisis, so the obsession is completely misplaced. Within the Eurozone deficit fetishism has achieved the status of law!

There are some who say we cannot use the fiscal instrument to help the recovery, and get inflation on target, because debt will become a problem in 30 years time. It is as if a runner, who normally gets their fuel from eating carbohydrates but has run out of energy in mid-race, is denied a food with sugar (HT Peter Dorman) because a high sugar diet is bad for you in the long term. Others in the Eurozone say we must stick to the rules, because rules must be kept. But rules that create recessions with no compensating benefits are bad rules, and should be changed. Rule makers can make mistakes, and should learn from these mistakes. [4] It is perfectly possible to design rules that both ensure long term fiscal discipline, but which do not throw away the fiscal instrument when it is needed.

So every time someone writes something about what monetary policy could or should do to get inflation back to target, they should say at the outset that this goal could be achieved - in a more assured way - by a more expansionary fiscal policy. Political journalists who presume that more borrowing must be bad should get a severe telling off from their economist colleagues. For one thing that should now be clear is that rising debt since the recession has done no harm, but austerity policies that tried to tackle rising debt have done considerable damage. The 2010 Eurozone crisis was a false alarm. Macroeconomics needs to get its fiscal instrument back, and deficit fetishism has to end, but this is being prevented by an alliance between the political right, the ultra-monetarists, and I’m afraid the media itself.

[1] In the UK there is a certain irony here. When inflation was above target in 2010-13, most of the MPC was brave enough to avoid raising rates. Although they forecast that inflation would come back to 2% within two years, this forecast was met with considerable skepticism. Three members of the MPC in 2011 voted to follow their ECB colleagues and raise rates. Perhaps as a result, the Treasury wrote a paper in 2013 which said that on occasions like that (when inflation was above target in a recession) the MPC could be a little more relaxed about the speed at which inflation returned to target. The irony is that this latitude is being used (abused?) now, when inflation is below target and we are still recovering from a recession.

[2] Maybe in the US the target is asymmetrical - but shouldn’t be - but in the UK it is symmetric by law.

[3] In a boom, when fiscal policy should have been contractionary, budget deficits were low as a result of the boom, so the rules suggested no action was required.

[4] Equally those that lent money when they should not have lent money have to accept that they made a mistake.


  1. I understand all this (I think).You say something similar very often, but I do wonder to what extent you think it is true today in the UK (as opposed to the fact that it was true in the UK in 2010-2011, and is true today in the ez).

    So, I think we know that in retrospect the UK retrenchment was too swift in 2010, particularly in relation to investment spending. The misjudgment was caused by a failure to spot firstly (and most importantly) the rise in commodity prices that was coming and secondly the ez crisis. Osborne responded by halting "austerity", something commentators failed to point out until the impact of it became apparent. A case can be made (and often is) that given that the risks of cutting/not cutting were asymmetric, Osborne's error was a serious one. (Although, as it happens, the Labour government had also promised 'cuts worse than Thatcher, and any government if it is to going to tighten fiscal policy does so at the start of its term. Still it was Osborne who actually did it.)

    This year the UK will be growing at around 3.1%, next year around 2.4%. Now, it can be argued that this is just about par for the course considering the depths of the recession, but frankly compared to almost everyone else it looks pretty good. Our comparative trough to peak figures no longer look too shabby either. The UK's deficit is however, by histrocic standards during peacetime and by comparison with other economies, still very large: 6.5% of GDP.

    So, and this is a genuine question not a dig, given that the UK's growth figures look fairly reasonable, and the deficit very big, are you claiming we should run a looser fiscal policy just to target a 2% inflation rate? The reasons the rate looks to be so low are (i) a fall in commodity prices, especially energy prices and (ii) the slowdown elsewhere, especially in the ez (these are of course related), ie they are not really UK specific.

    So, whilst I can well see that there is a desperate need to run a looser fiscal policy in the ez, are you claiming the same for the UK (today)? If so, this looks to me to approach the MMT view that deficits don't really matter (at least in a country in control of its own currency) and that we should just target the things that do matter (inflation unemployment etc).

    No political party is, of course, proposing to run a looser fiscal policy than we currently are, the debate is about the degree of tightening that is required.

    1. there seems to be a lot of talk about wages not having kept up with inflation in UK media I read, even with GDP growth, this issue is not mentioned by SWL and I wonder why. Maybe because increasing inflation will drop living standards in the UK even more?

    2. One point you raise in particular puzzles me, (the second is more of contextual observation) though both are in the same paragraph.
      a) "Our comparative trough to peak figures no longer look too shabby either."
      - Even with the very recent upward revision/recalculation of UK GDP which brought forward the recovery time by 3 quarters, the UK still experienced by far the slowest recovery in 100 years, taking approximately 65 months. The next slowest was a tie between the Great Depression and that of the early 1980s which both took approx 48 months. ie. this latest recovery took about 40% longer than the previous worst of the last century.
      b) "The UK's deficit is however, by histrocic standards during peacetime and by comparison with other economies, still very large: 6.5% of GDP."
      Haven't checked 'other countries', but by UK historical standards figures of 6-7% are not unusual during/following a recession: 1975-76 almost 7% of GDP; and 1992-4 over 7.5%. But, as you say 6.5% is still a large figure, though its odd that deficit (and debt) mania didn't sweep the country in 1992-4 like it is now. (I'm not accusing you of being gripped by this false, politically/media manufactured non-problem, by the way).

    3. (a) If you look at the previous sentence it is clear that the comparison I was making was an with other economies this cycle, not our recovery from the depression 80 years ago.

      (b) These are false comparisons as you are comparing previous deficit highs with the current deficit. The high point of the deficit in this cycle was 11% in 2009-2010. 6.5% is very high when you realise this is not its worst point, but where we have got to after four years of retrenchment.

      I hope that helps.

    4. SH - I can't speak for SWL, but from my rather more basic analysis would say that yes the UK needs to loosen fiscally, it's not about the size of the deficit it's about raising aggregate demand.

      In a basic IS-LM analysis monetary loosening leads to lower interest rates, which then then leads to an increase in output. Interest rates (even in the UK) really don't look like they have anywhere to go at the moment so there seems to be little more that monetary policy can do, it looks very much like the classic liquidity trap scenario. The other policy tool available to us is fiscal policy, this raises both output and interest rates, normally the interest rate bit would be risky but given how low they are at the moment the risks are minimal.

    5. Point (a): OK, my were clearly comparing to other countries, but in doing so it still doesn't look very good at all for the UK, given that the economies most similar to ours - Germany and France - both experiened a similar slump in GDP to us (France especially), but both recovered to their pre-crisis GDP levels by Q1 2011, almost 2.5 years sooner than the UK. The USA got there a full 3 years ahead of the UK.
      Yes, compared to the periphery countries, our dire recovery looks not too shabby, but surely we can't meaningfully compare ourselves to these EU countries which are so different to ours economically, and of course unlike EU countries the UK has sovereignty over monetary policy and did not have stringent fiscal demands imposed upon them by other eu members.

      (b) No false comparison at all - you drew attention to 6.5% being very large by historic standards. My point was that levels of 6.5% and above are not unusual by historic standards.
      Secondly, I was not "comparing previous deficit highs with the current deficit.", given i'd written "figures of 6-7% are not unusual during/following a recession". ie. in that range. I then noted the high's, acknowledged 6.5% was still high (but not unusual), and used those figures to ask why there was no deficit obsession in those days.

    6. (a) Yes, if you stop in 2011 then Germany and France look better. To ignore the last three years seems a bit odd to me. If you take into account the period after 2011 and compare current position with pre-crisis peak you get

      US +7.7%, UK +3.4%, Jap -1.3% Ger +3.1%, Fra +1.4%, Spa -5.8%, Ita -9.4%, EZ -2.2%

      The trajectory for the next year looks like it will make the UK better still, by comparison with elsewhere.

      (b) I have dealt with this already. If you think comparing previous peaks with the position 4 years after peak is comparing like with like, I just disagree.

    7. a) Perhaps some cross-wires over terminology here?
      "Our comparative trough to peak figures no longer look too shabby either." Trough to peak means from the bottom to the top of the cycle...been as we are not at the top of the cycle (yet), I presumed (as you can see in my comments) that by the 'peak', you could only have meant the pre-crisis peak gdp level...hence how quickly UK returned to 'peak' in 2013, but compared to certain other countries who returned in 2010/11, this was still very poor. Perhaps you needed to clarify current position relative to pre-crisis peak, then it makes sense.
      b) Not comparing previous peaks to todays figure...they were above 6.5%. Just saying that following a recession high deficit/GDP figures in the region of 6.5% (whether that is the highest figure or not) are not unusual.
      Don't think this one needs any more of anyone's time!!

  2. An outstanding post. I only want to add two things. First, I guess the dominance of monetary policy over fiscal policy is also an expression of trickle-down economics still pervading the political sphere. The 'extra' money in this case goes from the central bank, to banks, then to businesses and then to people, IF the banks decide to lend it out. As far as I know, they are hoarding too much of it at the moment. Fiscal policy is more of a 'trickle-up' measure. Infrastructure programs go from the government to businesses to people and then to banks (in the form of deposits). The financial sector would very much like to keep its dominance, and so fiscal policy is not an option. I guess the imbalance between the financial sector and the rest of the economy is stronger in the UK than in many other countries (in Germany it's probably weaker than in many other developed countries).
    Second, Germany's "ultra-monetarism" is, again, a consequence of ordoliberalism. The central bank is supposed to keep the price level stable. That is its only job, that's what it's there for (according to ordoliberalism). Fiscal policy is not its job, but other institutions may well express their desire for fiscal measures (the unions, the car industry and other special interest groups). I think the problem is that Germany doesn't realize or doesn't want to accept (because it doesn't really care in the end), that other countries do not have this ordoliberal approach of creating strong institutions that balance each other. Without an equally strong civil society, german ordoliberalism placed into other countries is really just very regressive neo-classicism. And then it effectively creates an alliance with the monetarists. The Eurozone is suffering because of that alliance.

  3. “…mainstream consensus was that monetary policy was the instrument of choice for managing demand and inflation, but that fiscal policy was always there as a backstop.”

    There’s a problem there, as follows. A more or less constant deficit is almost inevitable, given 2% inflation and assuming the monetary base and debt are to remain constant relative to GDP (which they do roughly speaking in the long term). Reason is that given the latter scenario, the base and debt HAVE TO BE topped up constantly. And the topping up can only be done via deficits. (Plus economic growth adds to the need for topping up). That’s all basic maths or book-keeping: economics and politics has nothing to do with it.

    Ergo if the ratio of the size of the base to debt is X:Y, then long term, we are forced to use monetary policy and fiscal policy in the ratio X:Y. That is, for every £X of new base money printed and spent into the private sector, £Y of extra debt must be incurred….unless I’ve dropped a clanger.

    1. Prof. Wren-Lewis,

      Thank you for this comprehensive picture of the workings of your soul.

      What you want is: Back to Harold Wilson, but without the strong unions he was unable to control - they had to be emasculated by Mrs. Thatcher.

      My first reaction was: Are you serious? But you are, indeed, very, very serious.

      Others will be less so about you.

    2. "What you want is..."
      "But you are, indeed, very, very serious"
      Well done,there's nothing like a good old straw-man attack eh?
      Now try precisely addressing the actual points SWL makes and explaining why they are wrong and why you disagree with them, rather than ascribing a fictitious position to him which only exists in your mind.
      Given your comments you won't need to worry about anyone taking you seriously at all.

    3. Simon16 November 2014 15:24:

      I have always admired SWL's clarity of style. So how could you overlook

      "Once upon a time (in the 1950s, 60s and 70s) governments in the US, UK and elsewhere routinely used both monetary and fiscal policy to manage (!) the economy. ...."

      That's the instrument he wants back. And he thinks the Seventies are no counterargument:

      "... the rise in inflation in the 1970s. That rise in inflation was the result of oil price shocks, combined with in many countries real wage resistance by powerful trade unions (!), and policy misjudgements involving both monetary and fiscal policy."


    4. I because of "policy misjudgements involving both monetary and fiscal policy" when dealing with the inflation caused by the oil price shocks of the 1970s, we should not use fiscal policy to aid the economy now?
      Note "Misuse" of fiscal policy. There's nothing wrong with fiscal policy, as long as its not used at the wrong time, in the wrong way. The misuse of it in the 1970s and the particular economic circumstances of that decade has no bearing on whether it could and should be deployed in todays very different economic environment. So no, given the economic context of that decade compared to today, the Seventies are certainly no counter argument against calling for fiscal policy in the present.
      If we were experiencing the same economic and global environment today as we did in the 1970s, you'd have a point. But we're not.

    5. Simon17 November 2014 01:56

      I rest my case.

    6. Fascinating.
      Your wrong-headed argument is logically disproved by highlighting that current economic circumstances are not at all like the 1970s when there was indeed misuse of fiscal policy, thus showing that the experience of the 1970s provides little/no counter-argument against the use of fiscal policy today...and you believe your argument remains valid?

    7. Ralph Musgrave 16 November 2014 05:40

      In the EZ, the inflation target is 2% but deficits can be up to 3% (and even beyond in exceptional situations).

  4. I just typed 'fiscal stimulus' into BBC search engine, and the results cluster around 2009-11, with a few mentions this year relating to the far east.

  5. '' The worry among the ultra-monetarists who helped design the Eurozone architecture was that some rogue union members would force fiscal dominance on the union as a whole, so they put together fiscal rules that limited the size of budget deficits.''

    I think it was politicians (influenced by voter concerns), not economists, who wanted the fiscal rules. The reason was simple: surplus countries were afraid (and still are) that some day they will need to pick up the bill of the deficit countries with some form of fiscal transfers.

    ''It was a mistake because it completely ignored the issue of demand stabilisation for countries within the Eurozone - in practice it either took away the fiscal instrument (in a recession) or discouraged its use (in a boom [''

    that remains to be seen, you say yourself that results in Japan have been disappointing and the final outcome of policies in Japan is still unknown.

    ''The ultra-monetarists of course, but also many politicians on the right, whose main aim was to see a smaller state, and who saw deficit reduction as a means to achieve that goal. ''

    again, maybe you are talking UK and USA here, but this is not true for Europe. Political left in eurozone surplus countries want strict fiscal rules too, for reasons given above.

    Don't mix up politics in anglo-saxon and Northern European countries, they are completely different.

    1. Anonymous16 November 2014 06:44

      Thank for putting SLW right.

    2. There's nothing that really remains to be seen about 90s Japan. It may have looked disappointing compared to the growth of the US and Europe in the 90s but if we compare it with Europe now there really is no contest. Growth was slow in the 90s but it did happen, unemployment was around 4-5% which also looks good. It's also worth pointing out that withdrawing stimulus in Japan (as happened around 97) made things worse.

    3. Andreas Paterson 17 November 2014 03:39

      Your comparison presumes that both situations are comparable and that it is possible to judge who did better based on numbers.

      If in football team A beats team B 2-0 and team B wins 1-0 against team C, should team A then defeat team C with any certainty?

      Different situations, different circumstances. The comparisons with past recessions don't convince me at all because the conditions under which they occured are all different.

      It's fine to believe that austerity policies made things worse. It's not entirely improbable. But I find no convincing argument in such comparisons.

    4. Just how much similarity would you like? In both the current European situation and Japan's lost decade happened in the aftermath of a financial bubble bursting, the same is true of Europe at the moment; in both 90's Japan and present day Europe bond yields have dropped close to zero and in both 90's Japan and present day Europe we are experiencing low inflation. There are an awful lot of similarities between 90s Japan and present day Europe.

    5. Just one aspect: was technological progress in the compared eras the same?

    6. By 1990 Japan had caught up with the US so it could be considered a fully developed nation at the technological frontier, so not all that different most of Europe at the moment.

  6. I think the Germans have a number of reasons for not feeling the urgency. First: the german economy is still doing ok, partly due to the financial crisis that made money flee from the perifery to the 'center' of the Euro. Secondly: germans are still paying tax, clearly labeled as such, to build up east germany, and they are afraid they will need to do the same for all those perifery Euro countries. And this fear is still there. The 'northern' countries are afraid they will need to pay more tax to subsidise the south. Thirdly: Germany has a longer history of ordiliberilism, which means that they built institutions to stimulate the economy in ways that don't show up on the government balance sheet. A clear example is the KwF, a government bank that can create loans & money for developing the economy. Another example is the Feed In Tariff (FiT), to stimulate clean energy, but financed straight out of the electricity prices, not via government. Germany has many such financial tricks to keep the government balance sheet 'clean'. Other Euro countries don't have such structures .. and in principle the EU could provide some of this via the European Investment Bank. But strangely, germans are also afraid of the EIB taking more action. Because it would strengthen the EU central power, possibly reducing power at the level of countries.

    1. Very good point Brummer - thanks for raising it. These off central balance sheet items which cover government capital expenditure can almost be as large as the primary government account itself. An important reason why people need to understand country specific issues.

  7. Professor,
    Interesting piece but here are two comments.

    First you write about Maastricht being superfluous due to ECB independence, then conclude that even WITH Maastricht the ECB had to backstop Southern debt in order to stop havoc on the markets. Isn’t this a bit… errr… inconsistent?

    And I miss a key point from your argumentation. When a country consumes much more than what it produces, the difference being borrowed year by year, and productivity cannot rise enough to close the gap, then one would think consumption needs to decrease at some point. And then it would seem that fiscal stimulus is basically buying a country time for this inevitable adjustment process, and smoothing it of course. But it is not trivial to me that doing so is on mid term superior to having a shock therapy*. I don’t have the answer, but I wonder if it’s a fair argumentation to concentrate just on the short-term benefits without considering the mid term effects of fiscal expansion.

    *Just by way of example, gradual reforms vs. shock therapy was a much-discussed, highly controversial topic in Eastern Europe in the years after 1989 and the general experience there I think was more favourable to shock therapy.

    1. i also think that there is a time to pay down one's debts, but that time is when your country is back to full employment, not in the middle of a recession.

    2. rob sol17 November 2014 13:36

      How often do we have full employment?

    3. i always put my foot in the mouth when discussing europe, but we get pretty close to full employment most of the time in the US. By full, i mean approximating NAIRU, and by that standard, we got there for good periods under Bush, Clinton, and the 2nd Reagan term. These would have been great times to start paying down the debt. Unfortunately, as Dick Cheney said, Reagan taught the republicans that debt does not matter.

      about England and Europe, hey, I am an American who does not pay close enough attention not to make errors.

    4. once the B of E starts increasing rates, you should be getting pretty close to NAIRU

    5. rob sol:

      US unemployment was above 5,5 % most of the time since 1947, cf.

  8. maybe trying to exclusively use monetary policy to regulate the economy is part of what got us into this mess in the first place. Every time the economy stalls, lower interest rates to encourage people to borrow more... usually to buy increasingly expensive houses. That ended up working well, didn't it.

    1. When central banks lower rates, they lower borrowing costs for commercial banks. That doesn't only affect mortgages, first of all. Secondly, if you want to deal with housing markets and financial markets, you don't use monetary policy, you use macroprudential tools -- i.e., you regulate banks to make things like high risk assets less desirable to them.

    2. It was reasonably clear from former posts and now proven by this one that Simon Wren-Lewis is an adherent of micro-managing an economy (e.g. asking Austria, which has full employment, for fiscal stimulus because there is supposed to be an output gap).

      Now it is generally accepted that such micro-management, which was practised in the UK in the 1950s, 60s and 70s, was a dismal failure.

      Recommending a return to that is not convincing.

    3. @Anonymous17 November 2014 04:15 - I have no idea what you mean by micro managing the economy but I'm not sure how you can classify the 50s, 60s and 70s as a failure. The 50s and 60s are about the UK's best decades in history for economic growth and rising living standards in the UK, the 70s were disappointing but still gave us a 2% sustained rise in GDP per capita (IIRC).

      We can barely even dream of 70s levels of economic growth at the moment, let alone 50s or 60s levels.

    4. Would this 'dismal failure' be the period of Keynesian demand management using fiscal policy in the UK from the immediate post-war years right up until the 1970s, which resulted in the UK experiencing no recessions at all in this period (until the first oil-price shock)? The so-called 'golden years' of the UK economy?

    5. Beat me to it Andreas!
      Anon: Out of interest, do you refer/check the facts/evidence prior to would be impossible to refer to this period as a dismal failure if you did...or is it simply that it must have been a dismal failure because fiscal policy was the instrument of choice in that period?

    6. Simon17 November 2014 05:06
      "The so-called 'golden years' of the UK economy?"

      Different Anon here. The golden years were the golden years because of the levels of innovation and widespread distribution of today's common goods. Refridgerators, TV sets, automobiles, etc.

      Which is why Krugman's claims that "We can get down from these debt levels, we have done so before" is more than just a bit fishy.

    7. That might also be the case, but been as this is an economics blog I was referriing to the widespread, well documented notion of the "golden age".
      I don't normally refer to wikipedia, but its sumed up neatly on this page...

      I think I'll defer to Krugman's not so fishy claims and economic knowledge as opposed to someone who didn't even recognise the well documented name for the post war years expansion.

    8. - just noticed the spelling mistakes in that last comment, which was typed rather too quickly without reading it through...well, thats the official excuse anyway!

    9. Simon 17 November 2014 07:54
      "I think I'll defer to Krugman's not so fishy claims and economic knowledge as opposed..."

      Are you bowing to reputation instead of argument?

      "The golden years were the golden years because of the levels of innovation and widespread distribution of today's common goods. Refridgerators, TV sets, automobiles, etc."

      remains valid. And is the reason why Krugman's optimism regarding todays debt levels seems rather unfounded.

    10. As I wrote...his (Krugman's) not so fishy claims and economic knowledge, plus his analysis and explanations which time and again (not 100% of the time of course) prove to be correct. His predictions aren't too bad either...
      Hence I would defer to his interpretations rather than someone who didn't even recognise one of the most fundamental and best known terms to describe the economic period post WW2 up to the 1970s.
      I wonder if a man who has spent the past 40 years near/at the top of his field, living and breathing economics and surrounded by dozens of other experts in their respective economic areas; discussing ideas, scrutinizing theories and analysing world economic events and data has considered the reason you put forward at all? Probably not eh?

    11. "As I wrote...his (Krugman's) not so fishy claims and economic knowledge, plus his analysis and explanations which time and again (not 100% of the time of course) prove to be correct. His predictions aren't too bad either..."

      All of this irrelevant to me, sorry. I seriously don't care about reputation or past track record. In fact, I just pointed out the follies of taking past events and projecting them on the present.

      "Hence I would defer to his interpretations rather than someone who didn't even recognise one of the most fundamental and best known terms to describe the economic period post WW2 up to the 1970s."

      I have no idea where you got the idea from that someone didn't recognize any terms. I *also* have no idea where you got the idea from that the ability or inability to recognize a certain term has something to do with the ability to judge the current situation right.

      I wonder if a man who has spent the past 40 years near/at the top of his field, living and breathing economics and surrounded by dozens of other experts in their respective economic areas; discussing ideas, scrutinizing theories and analysing world economic events and data has considered the reason you put forward at all? Probably not eh?"

      Well, there are people who have done the same for 50 years and who think Krugman's theories are nonsensical and dangerous (Austrians, for example).

      Again, Noble prizes, titles, past track records, publications, none of this impresses me. If a randon man on the street says something that makes sense to me, then it does make sense to me. And if something Paul Krugman says does not make sense to me, then it does not make sense with me.

      And in this case it seems mightily fishy to me. I will give rest to the issue of standing, I have said my piece. If you have something to add to the actual issue of technological in the "golden years" not being comparable to todays saturated markets, feel free.

    12. Wow! where on earth to begin....on second thoughts, you'd better stick with the Austrians, they know they're stuff. Never mind their track record!

    13. I don't identify as an Austrian though. So, after your misunderstanding regarding the "golden age", now this. If people's statements were to be judged based on their track record, you would be in trouble by now. But don't worry, I am not holding it out against you.

      Your comments will continue to be analyzed individually for their merit.

    14. Note this is an Economics blog: I used the economic descriptor 'the golden age' when mentioning the period of growth and stability experienced post ww2 until early 1970s.
      The 'golden age' (of capitalism) is the correct term in this context and recognisable as such by anyone with even a basic grasp of economics/ economic history.
      As such, please explain my misunderstanding or misuse of the term 'golden age', as it appears to be perfectly appropriate to use this term when discussing the aforementioned period of growth between ww2 and early 1970s.
      Or were you simply ignorant of this term, and this is really a case of 'projection'
      given your complete misunderstanding of my use of the term?

      Luckily for you your comments won't be analysed for their merit otherwise there would be bad news coming your way on a regular basis.

    15. "As such, please explain my misunderstanding..."

      Sure. This here was your misunderstanding:
      "Hence I would defer to his interpretations rather than someone who didn't even recognise one of the most fundamental and best known terms to describe the economic period post WW2 up to the 1970s."

      "Luckily for you your comments won't be analysed for their merit otherwise there would be bad news coming your way on a regular basis."

      You're behaving immaturely, so I will step out of this conversation for now.

    16. Recall that this discussion began with you picking me up on the use/interpretation of the term 'golden years'. I then acknowledged your interpretation acknowledging "That might also be the case", then clarified with a weblink the economic meaning/context of this term.
      After a few other exchanges back and forth in which I pointed out your inability to recognise the common economic usage of the term, you then somehow state "after your misunderstanding regarding the "golden age"."
      Remember I have shown that I used in perfectly appropriately and in context, and that it was you who 'corrected' me as to why those post war years were known by that name.
      So again, please explain my misunderstanding of the term 'golden age'.
      I'd also appreciate it if you ceased projecting your own shortcomings onto me - notice how my "immature" comment(s) "Luckily fo you..." are directly based on your own previous comments - read your 03:20 post!)
      I do agree however that it is way over time to step away from this conversation, and wish you well...

  9. Krugman's recent post dealing with some of the issues here - "The unwisdom of crowding out" is one of his sharpest and best.

  10. ordoliberalism now seems to be the favorite name calling for Germany in the anglosaxon internet sphere.
    Sorry guys, but it's nonsense. Germany, like all North European countries, including France, have what's called a social market economy. Google it.
    Nobody in those countries uses the word ordoliberalism, it only makes you look ridiculous to start using that word for labeling economic policy in these countries.

    1. As a German, I like the term getting more widespread use. We're willing to pit our approach of Ordoliberalism against anglo-saxon approaches to running an economy. In fact, a clash of philosophies was entirely foreseeable.

      I am looking forward to it and am enjoying this here immensely.

    2. Anon 06.21, as an Englishman I agree. But it is important people understand what it is. For example in terms of primary accounts, these must be in surplus, but there are other government accounts which can be considered off-balance sheet that fund, for example, government capital expenditure.

  11. Prof. Wren-Lewis,

    I have left school a long time ago an for the past few years have become interested in macro again through blog reading. The thing is I have a doubt and want to ask you hoping you will be kind enough to answer it:
    You said that fiscal policy is not considered anymore a such a important tool, and that it should. But the problem is that, until where I can understand, monetary police works better in a context where government debt perspective is not pressuring interest rates.
    In other words, the capability that the government have to intervene in the economy through fiscal policy becomes more and more limited as government's capabilities of making monetary policy increases (up to a point where all the variables of economy must work as endogenous and quasi endogenous elements in the formation of interest rates).
    The problem is that if this is so, we must choose whether the problem is monetary policy itself or if it is about radical and simpletons (otherwise known as market agents LOL). What do you think and why do you think so?

  12. Dear Sir,

    you write:
    "For some there was the ultimate fear that politicians would run amok with their spending, which would force central banks to print money, leading to hyperinflation - we can call this fear of fiscal dominance. However, as I noted above, the rise in global inflation in the 1970s was not an example of fiscal dominance. I shall use the label ultra-monetarist for this second group: ultra, because it is not clear Friedman himself would be among this group."

    It's not just fear of hyperinflation. Germans do not want a soft currency that has to devalue relative to other countries repeatedly. Germans do not want a government that expands its debts endlessly. To Germans, these are all long-term sources of instability.

    That said, Germans are more flexible than some give them credit for. The Abwrackprämie of 2009, the original cash-for-clunkers, was fiscal policy. In fact, German history is full of fiscal measures to boost growth.

    However, where Germany differs is, as mentioned before, the seperation of concerns regarding tasks of important actors. It is not the government's job to take measures to achieve a certain inflation rate (in the medium term, which means several quarters). This is the task of the independent central bank. The inflation rate is not to be manipulated by the government to deal with unemployment. Instead, it is to be kept steady by the central bank. At about 2%. Numbers between 0 and 2% for a few quarters should be no drama for the economy either. (And, according to Prof. Sinn's latest remarks, neither are rates between 2% and 3% if they are boom-led and not artificially-driven up to realign the Eurozone and make Germany uncompetitive.)

    This way the central bank ensures stable conditions under which the government, labour unions and business associations can do their job without having to worry about the inflation rate. Ideally, the inflation rate is entirely taken out of the game this way.

    "These minorities aside, the mainstream consensus was that monetary policy was the instrument of choice for managing demand and inflation, but that fiscal policy was always there as a backstop."

    There is no difference to Ordoliberalism here. Surely, the government can do fiscal stimulus. Caveat: if it can finance it without the central bank. The German mainstream consensus is that fiscal stimulus is usually short-lived and supply-side reforms are more effective in the long run. Whether that is right or wrong is not for me to judge. But, indeed, fiscal stimulus is basically not off the table.

    It IS off the table when a government cannot finance it.

    "This architecture essentially ignored the potential use of the fiscal instrument. Instead the influence of monetarism led to what can best be described as deficit fetishism - an insistence that budget deficits should be constrained whatever the circumstances."

    Germans have been remarkably flexible here. And, looking at France's deficit numbers, one might wonder if they have not been too lenient.

    "Greece and the subsequent Eurozone crisis just seemed to confirm this view. Deficit fetishism became pervasive."

    one reason for that was that it became apparent that southern banks was soaked up with bad debtors.Spain did end up soaking a lot of debt, after all. Nobody knew how much it would be and you really can't sell that in this situation Spain should take on even more debt to stimulate the economy.

    "The crisis only ended when the ECB offered to back the debt of the crisis countries."

    Bond spreads went down but that does not mean the crisis ended.

    "There are some who say we cannot use the fiscal instrument to help the recovery, and get inflation on target, because debt will become a problem in 30 years time."

    In Ordoliberalism, governments do not engage in inflation targeting.

  13. " The policy worked."

    Only in so far at it was a beggar-thy-neighbour strategy. Your proof that the policy worked is to compare the better results of those who enacted the policy with those who did not; but that's exactly what you would expect from a beggar-thy-neighbour strategy. If *everyone" uses the same beggar-thy-neighbour strategy, no one is better off.

    1. Fiscal stimulus is a beggar thy neighbour policy? When I hear beggar thy neighbour I think of tariffs, currency devaluations or industry specific subsidies, none of which seemed to be the case for the UK's stimulus (mostly a VAT cut) or ARRA in the US.

    2. Andreas it can also mean export reliant GNP growth (rather than one through domestically supported AD). But still, I think it is ridiculous to call Germany's policy beggar-thy-neighbour, certainly in terms of its objective, although it MAY be an effect.

    3. True, although I'm assuming (Anonymous@17 November 2014 06:24) is quoting the original post which refers to stimulus in the UK and US.

  14. Just to state an important event which macroeconomists seem not to have noticed: the eurchf is testing its floor again at 1.20. Now maybe the SNB is going to be willing to add to its stock of euro instruments by selling more chf, in order to maintain the floor. If the SNB does this then you can consider Switzerland to have joined the euro by stealth because the only thing it will have left on its balance sheet will be euros. And if at last the SNB holds back, then you can expect a few years of crisis, as every central bank and every currency outside the USD and the EUR are picked off and attacked by the market for its profit - and this will include the JPY and GBP. So you can winch about the euro all you want, but if this scenario does come to pass, I for one will be happy to belong to the euro.

    1. I don't get this. If there was a sudden for these currencies leading to a rise in GBP or JPY, surely the central bank could just intervene in a similar manner to the SNB and by foreign reserves. If they decide to sell up UK assets and reserves then this would lower the currency making the UK (or Japan) more competitive.

      This just seems to be another desperate attempt to defend the terrible record of the euro on the flimsiest of justifications.

    2. The SNB should be smart enough to sell their CHF against Gold or Euro denominated stocks and not against worthless Euro.

      The gold initiative is coming to Switzerland.

    3. Spotted a typo, should read "If there was a sudden demand.."

  15. "Can we have our instrument back?"

    No you little rascall, with a world drowning in debt that instrument is a big no no.

    1. As folks are keen to point out, world net debt is exactly £0.

    2. The very instrument that used correctly i nthe right economic circumstances can stimulate demand, raise national income, growth and decrease improving the fiscal position for government and result in lower deficits and a greater chance of paying down national debts?
      The fiscal position and debt of many eu economies is presently worsening in the absence of an alternative policy instrument to monetary policy (as well as numerous other issues related to the common currency area).

    3. Simon18 November 2014 02:19

      So what proof have we that present governments will follow the right fiscal policy if SWL is not made philosopher-king?

    4. "As folks are keen to point out, world net debt is exactly £0."

      Great! Let's expand my debts by a factor of a trillion - world net debt will still be exactly £0. Or might distribution of debt matter after all? What if world net debt is 0 and still lots of gross debt can't be serviced?

    5. So I was being a little facetious, of course the distribution of debt does matter but we need to seriously consider the options available to us. If we believe that an awful lot of our economic problems are down to a lack of aggregate demand (which I most certainly do) then we need to consider a way of raising this demand. Monetary policy is not looking all that effective right now so that leaves fiscal expansion, to do that we need something that will move the IS curve to the right.

      So, from our Y=C+I+G identity we need to raise one of C, I or G. Now, raising any of these would increase debt in one way or another, but of the three G seems like the best option as it's directly under government's control and the new debt that would be issued would be sovereign debt which is available at low interest rates and that ultimately central banks that could intervene should the worst happen.

      Sovereign debt is still low by historical standards, so debt financed fiscal expansion seems like by far the best option.

    6. Strange. Why ask me for proof of this? I merely pointed out the need/usefulness of fiscal policy when monetary policy is constrained/ineffective at the ZLB.

    7. That's wasted on the trolls Andreas...

    8. Simon18 November 2014 04:59

      Because you were so eager to believe that the crises of the seventies were the product of faulty fiscal policy. How about producing proof for that (since SWL doesn't)?

    9. ''As folks are keen to point out, world net debt is exactly £0.''

      and this is the economic dogma that got us into the financial crisis

    10. Hey folks net debt inthe world his always "0" because for every debtor there is - I hope you smart undergraduates guess it by now - well yes a "creditor".

      Net it and it will always be "0".

      I just hope you will never make it out of university or what ever you call it and stay locked in your ivory tower.

    11. Anonymous18 November 2014 06:22
      Where did I state "the crises of the 70s were the product of faulty fiscal policy"?
      If you re-read my previous comments relating to this much further up the page, I very clearly and simply note that fiscal policy was *used inappropriately in response to* the economic crises which were largely caused by the oil price shocks, making a bad situation worse still. This of course is completely different to believing that "the crises were the product of faulty fiscal policy". No-one has saidor inferred that anywhere on this blog...(except you of course).

    12. Which is why the other Anon alluded to the perils of fiscal policy, when he wrote:
      "So what proof have we that present governments will follow the right fiscal policy if SWL is not made philosopher-king?"

      A rhetorical question, of course.

    13. Simon18 November 2014 16:39


      Can we possibly come to agree if you look up

      That is the version of history which I share, and that is why SWL seems largely wrong to me.

    14. Thanks for the link which I've had a quick read over (p.1316). Just to clarify, is each section of this book written by (or excerpts from) the individuals listed in the bibliography at the end of each section (which I note is Nigel Lawson and one other in this section)?

    15. Simon19 November 2014 08:02

      The book is called

      Europe Since 1945: An Encyclopedia, Band 2
      ed. by Bernard A. Cook

      Lawson only seems to be about the Thatcher years.

    16. Had a chance to read over the page linked (P.1316) and to cut a long story short was very suprised, since much of the key observations relating to UK economic performance as a result of policy appears totally bizarre in the sense that it is not supported at all by independently published historical economic data.
      To keep it to some brief excerpts: "continued slow growth...further the 1940s-50s..."
      But the evidence shows with the exception of the odd year there was very strong growth in these decades (averaging over 3% p.a, sometimes over 4%, with inflation falling after 1951-2 and remaining below 5% thereafter (which was low for this era, but not so today).

      "methods used to encourage investment and *economic growth* in an effort to micromanage the economy...*none of these were successful*...kept *inflation high*..." before mentioning 'stop-go' policies and moving onto the 70s.
      In this period (1950s to early 1970s) in the era of 'stop-go', UK economic growth rates, though fluctuating (due to stop-go) were often exceptional, averaging over 3% for the 1960s, often over 4 or 5%, only once falling briefly (in 1958). Similar to the previous decade, inflation remained low, below 5% for the 60s, until the last few years of the 60s when it rose. Then came the 70s of course...

      Whilst is very fair to question the political use and especially timing (for elections) of fiscal policy over the period, and the fluctuations as a result of these 'stop/go approach', I cannot reconcile the narrative in the book describing "low growth" and being unsuccessful in encouraging growth, plus "further/high inflation" to he actual economic data and evidence. Reading the page you provided paints a very bleak picture of the UK economy over the whole period, but now explains you initial comment about the "dismal failure" of policy in the 50s, 60s and 70s.
      Please don't take my word for it. Here's just one link which provides the relevant economic data for the period:

    17. Simon:

      Thank you for the link.

      Allow me to quote:

      "1951-1964: the period of ‘stop-go’

      This period was dominated by Keynesian ideas, in particular the use of
      fiscal policy to achieve a high level of demand, low unemployment and1964-1970: the balance of payments and the failure of

      It has been disputed whether policy succeeded in stabilizing the
      economy. It has been argued that the timing of policy was
      frequently wrong and that this made fluctuations worse.........

      1964-1970: the balance of payments and the failure of

      Planning came tonothing because the government found itself having to introducerestrictive policies, inconsistent with the plan’s targets. There were
      other problems, such as an over-optimistic target for productivity

      ...growth remained lowand unemployment remained high,..........

      1970-1974: U-turn and dash for growth
      The period was one of rising inflation..

      Inflation was never controlled,........

      1974-1979: responding to the oil crisis

      ...........The main problem was that the rise in unemployment and the rise in
      inflation called for different policies: the supply shock was both
      ‘deflationary’ and ‘inflationary’. Contractionary fiscal and monetary
      policy would have made unemployment worse, whilst expansion
      would have made inflation worse.
      Inflation increased during 1974-5, reaching 25-30 per cent per annum
      (the exact figure depends on what price index and what period is
      taken). Unemployment rose and output fell, this leading to an
      improvement in the balance of payments.

      ...............British performance differed from that of similar economies in a
      number of ways: (a) the recession of 1974-5 was longer lasting; (b)
      inflation was much higher in the UK than in most similar
      economies; (c) the recession of 1980-1 was much more severe than
      elsewhere, because of the behaviour of sterling in 1979-80..."

      Is there so much of a difference? Both texts seem to indicate that Government actions then were not very bright.

      If you and SWL now ask for government action of a type then current, that means that both of you are optimistic about modern governments' qualities. Now that is a matter of opinion.

      What I miss is a detailed discussion of the tradeoffs of such policy, esp. of the disadvantages of inflation (not hyperinflation) as longterm effect and the little likelihood of reducing it in the short term.

    18. Yes, as I mentioned before it is very fair to question and criticise the way fiscal policy was deployment - especially the timing of it which was highly politically motivated for elections, resulting in the exaggerated fluctuation in GDP during the period. However, use of this policy (recall monetary policy was all but non-existent as an instrument then), despite the fluctuation thus lack of ‘stability’ but no recessions) still resulted in the very good and often excellent economic performance between 1950-1970 as indicated by overwhelmingly positive growth rates, low inflation and low unemployment - which the info I sent you clearly illustrates and describes - and hence my original reference to the 'golden years'. Yes, it goes pear-shaped in the 70s, but this was after the golden years of course and was not the period in question (so I’m not sure why you included the information relating to the 70s and 80s above)
      Therefore, with reference to the book you sent me, the question is how and why does the author describe a very negative picture of UK economic performance in the golden years period (1950-1970), using terms “slow growth, unsuccessful growth, further and high inflation etc” specifically for this era, when the evidence clearly indicates the complete opposite? I cannot reconcile this discrepancy, but am interested to know if you can.
      You are right to say we can certainly criticise the deployment of fiscal policy during the 70s, but that is true given the economic context and circumstance of the time. We are not in anything like the same situation – in fact the opposite with very low inflation and monetary policy ineffective due to interest rates at the ZLB. Therefore the other policy available and favourable given the very low borrowing costs is fiscal policy…but SWL explain that part. Of course we must be wary of the downsides of this approach, but given present economic circumstances these appear to be far outweighed by the need and upsides of such an approach.
      Anyway, its been constructive and interesting, but I’m still totally baffled as to how the author describes the UKs economic performance (GDP, inflation etc) as poor. I would genuinely like to know if you also think the data similarly indicates a ‘dismal failure’ of policy, now that the data is to hand. ( I think policy could have been deployed better, especially timing wise)
      PS.(I notice the author provides no references or supporting evidence in his narrative, which can often be a tell-tale sign of an attempt to mislead and political motivation, but that is conjecture on my part.)
      PPS. For a similar example, I posted a link from Chris Dillows on the other blog post which illustrates ‘fiscal deception’ and is worth a look over.

    19. Simon20 November 2014 04:14

      I looked up your latest link, and Chris Dillow says:

      *What's more, uncertainty reduces gilt yields because investors seek out safer assets; it is this, more than confidence in fiscal policy, that explains why long-term interest rates are low*. This makes government borrowing more affordable."

      Econ 101 says that higher risk (uncertainty) makes bond yields higher. Of course, Econ 101 may be wrong (Macroecon 101 is actually not very convincing), but I doubt that - it seems more plausible that he's talking nonsense.

    20. I think you're misunderstanding Chris here, what he's describing is the choice investors might make between a safe and risky assets. In times of uncertainty investors choose safe assets like government bonds because they don't want to risk losing their money, in times where the outlook is less risky people feel more comfortable risking their money for higher returns.

    21. What about that authors claims from the last comments I asked you about?

      I think you've taken the notion of uncertainty and risk out of context and not made the necessary distinction between 'uncertainty' and 'risk' in relation to:
      (1) The global economy
      (2) Government fiscal solvency and their ability to service their debts
      Each of these has a very different impact on yields. One down, the other up respectively.

      1. Dillows talks of the global economic downturn 'uncertainty', making investors seek safer returns in gilts (thus lowering their yields) as other investments (stocks) become riskier and interest bearing accounts become less attractive (paying such low interest rates).
      - So here we are talking about risk and uncertainty to the global economy.

      2. However, the risk and uncertainty which causes bond yields to rise refers to the risk/uncertainty of a government being unable to service and honour its debts such that potential purchasers of gilts may be at risk of not getting their money back.
      - So here the risk and uncertainty (you mention in relation to ECON101) is very different from that in (1), as this one refers to the ability of a government to honour their debts and thus greater risk in relation to government solvency, not the global economy.

      So there is a need to distinguish between ‘risk/uncertainty’ in terms of:
      i) global economic downturn – which sends gilt yield lower as investors flood into gilts in the absence of other ‘safe’ places, causing the price of gilts to rise, and the yield to drop (given the inverse relationship between price and yield).


      ii) government finances brought into serious question – which send gilt yields higher due to higher risk of default

      There can of course be a mixture of these, plus other effects, making it difficult to predict a rise/fall in gilt yields.

      Hope this helps – if only to show he is not talking nonsense at all + macro101, whilst it often simplifies the real worlds using models, is more often than not very convincing.

    22. Andreas Paterson20 November 2014 07:37
      Simon20 November 2014 07:44

      I take that back about Chris Dillow.

    23. Simon20 November 2014 07:44

      Thank you for your willingness to discuss details.

      Criticisms of British economic policy from 1950 to 1980, which I share, are based on Britain' low growth rates compared not only to Germany but to France.

      From the text you yourself quote

      "Between 1966 and 1980 the UK was overtaken by
      West Germany, France and Japan.
      ❏ The UK was overtaken, in terms of GDP per head, by West
      Germany in 1966, France in 1972 and Japan in 1980. The
      equivalent dates based on earlier, non-PPP comparisons were
      1959, 1965 and 1972 respectively. The use of of PPPs rather than
      exchange rates to make the comparisons makes Britain’s position
      look better compared with other countries."

      The same in

      "As Table 1 shows, Britain’s growth performance has been the most
      stable of the major economies - but also the lowest. It is this relative
      growth under-performance that has been the nub of the dissatisfaction with
      the UK’s record. It is an undeniable fact that the UK has lost ground over
      the past century to the US, its European neighbours and Japan in terms of
      economic expansion.

      In particular, the relative under-performance against European countries
      such as Germany, France and Italy was seen as an especially serious issue.
      At the political level the key question that came to a head under the
      Thatcher government in the 1980s was whether the UK’s relative decline
      must be accepted or whether it could be resisted and reversed.
      the UK performance in the 1950-1980 period is
      indicative of relative economic decline, as broadly similar economies in
      Europe developed output per head that substantially exceeded the level of
      the UK without any obvious advantages in resource endowment,
      geographic size or location."

      Of course, things have changed. As David Kern says in Rozenbergs:

      " In the past 15 years, however, the UK economy has performed relatively
      well compared with its industrial peers, particularly in Europe. "

      The problem we are discussing are the "Golden years" or "Trente glorieuses" when the whole world grew, but Britain less.

      Can we agree on that?

    24. The problem we were discussing began with you claiming "micro-management, which was practised in the UK in the 1950s, 60s and 70s, was a dismal failure", using the book page you sent as the source of your views and confirmation.
      This view has been shown, by the evidence, to be untrue - particularly the findings of the book regarding the performance of the UK economy. We de agree that policy implementation (stop/go) was less than desirable. But to be described as a dismal failure would have surely meant poor UK economic performance in the period, whereas in fact it was some of the best. The argument was not about UK performance compared to other countries, and neither was it in the book you sent. But yes, "the whole world grew, but Britain less" is something we can obviously agree on as the evidence support this assertion.
      Evidence however does not support the assertions of the author of that book and the notion of 'dismal policy failure'. The era of the 'golden years' in the UK under the less than perfectly implemented Keynesian demand management policies still produced the most outstanding years economically for the UK, even if they were not as outstanding as compared to France/Germany (but this comparison was not part of the debate originally remember).
      I think we’ve done this to death…but I still cannot understand how that author from the book you sent reached their conclusions on UK performance – just read it again and incredibly there is no mention of anything positive happening in the UK economy in the period, only negative. How is that possible? I suspect the hand of a politician – Lawson in this case!

    25. Simon21 November 2014 04:02

      I cannot resist having the last word. It is:

      Yes, dear.

      After all, the whole thing started wih a joke about Harold Wilson.

    26. Thats a shame. And I thought progress had been made - agreeing that policy wasn't executed in an optimal way, and the Chris Dillows misinterpretation.
      Saying that the author's descriptions in that book portray a misleading and often inaccurate picture of the UK economy would in no way discredit you, only the author of those inaccuracies himself.
      The last word really should be left to JM Keynes, as recounted by Paul Samuelson, and is something I adhere to: “When my information changes,I change my mind. What do you do?”

    27. Because I'm the kind of person who is interested in this kind of thing, I've crunched a few numbers on GDP per capita from Angus Maddison's data.

      In 1950 the UK had by far the largest GDP per capita, France's GDP/capita was 75% that of the UK, Germany's was 56% of the UK. Growth of GDP per capita in each decade was as follows:

      50s (France 43%,Germany 99%, UK 25%)
      60s (France 54%,Germany 40%, UK 25%)
      70s (France 29%,Germany 30%, UK 20%)
      80s (France 20%,Germany 13%, UK 27%)
      90s (France 16%,Germany 19%, UK 24%)

      In the post war years France and Germany caught up to the UK, overtaking it by 1970. In the 70s both France and Germany surge ahead, in the 80s the UK comes back overtaking Germany but not France. In the 90s the UK continues to surge ahead almost catching France (although the UK does not overtake France until 2002).

      A lot of this could be seen to bear out the claims that in the 50s and 60s the UK's record was unimpressive, although it's worth bearing in mind that during this period Germany and France were playing catch up terms of technology and so on.

    28. A good point Andreas, though the international comparison wasn't originally the root of the debate, I think its fair to say both Anon and I agreed (how could we not given the figures) that the UK s golden years were'nt as golden as France or Germanys. But golden they still were - despite what that page in the book said, and only 'unimpressive' when compared to other countries - though this still needs careful evaluation as your last sentence touches upon in explaining the more impressive GDP growth per capita figures of France and Germany. Whilst of course the UK economy,infrastructure, industry suffered greatly as a result of War, the greater destruction and devastation suffered by Germany and France meant they were starting the post-war period from a much lower base/ the gains and 'bounce back' to be made from such a low economic level and 'the catch-up effect' would be greater for these nations as millions of workers and vast amounts of capital and infrastructure are repaired/rebuilt/ put to more productive efforts than war usage and generally brought back into play, together with the help of allied finance (Marshall Plan), equipment, manpower, expertise and technology. This too applies to the UK, but crucially not from such a 'low base' as other countries, making improvements in GDP (per capita) not as impressive as theirs.
      An even more extreme example is Japan post WW2, or for different reasons the economies of SE Asia in later decades which are classic examples of the catch-up effect.
      This is a much simplified version of events, with many other contributory factors helping to explain faster/slower growth rates of various countries. And as already mentioned, the implementation/timing of policy in the UK appears to have room for improvement, though it still resulted in some of the best economic performances as measured by GDP, infltion and unemployment for the UK during that century. The 1970s, other than noting that was when it went all wrong, together with the following decades was never part of the discussion, but it all makes for interesting study.

  16. Krugman re-tells a jibe on his blog this week. "There are two types of German economist: those who haven't read Keynes and those who haven't understood Keynes."

    I thought it was a bit over the top. Then I read the comments on this page.

    1. The next thing Krugman will be telling us is that Japan is a victim of Abe's austerity.

    2. "I thought it was a bit over the top. Then I read the comments on this page."

      There are German economists who comment in here?

      As for Krugman's quote, it is a bit void of content. It merely expresses his conviction that Keynes was very right. Let's move on.

  17. @03:04: Krugman is against higher taxes now, who knew, anything to save keynesian economics!

    1. This is not difficult to understand, if we take total demand (Y) to be equal to the sum of consumption (C) plus investment (I) plus government spending (G) minus taxes (T). We can write this as Y = C + I + G - T, anything that makes Y bigger is fiscal expansion, anything that makes Y smaller is fiscal contraction so A rise T lowers output, a cut in T raises output, equally a cut to G lowers output and a rise in G raises output.

      If our concern is about low output levels then we want to avoid policies that are contractionary, such as tax rises, this is why Krugman is against a sales tax rise in Japan. If we want to address other issues beyond simple economic output then we might want to adopt a bit more nuance.

    2. Whoa, then we've got a solution!! Let's double, no, let's triple G! And let's eliminate T altogether! Y takes off!

      Jesus H. Christ, my four year old daughter would cry aloud upon the intellectual quality of this.

    3. Why only triple? Let's go a 100-fold! Debt is no problem!

    4. No, because that would cause inflation. 100% of government spending is eventually returned to the treasury, excluding net savings and imports (money sent abroad) Think of it like buckets- every transaction you lose some in VAT, income tax, corporation tax, etc.
      You have to spend before you tax, where do you think money ever came from?
      The national debt just represents national savings plus net imports.

  18. Ok one more try. Forget your undergraduate equations. Public debt (and with it perceived but unrealistic "private domestic wealth") is growing faster and faster.

    Central banks have got a point in pressing interest rates to "0", so that the public debt does not fall prey to the hilarious effect of compound interest, but we are already on a level of debt that is > 100% of GDP in most developed countries.

    And now the big question: What did us get to > 100% of GDP - I guess you don´t wanna know - but it is called "deficit spending" (your beloved "instrument").

    This fact will (c.p.) someday disgustingly show up in the "-G" or "+T" of your smart equations (but not only for one period but decades).
    The other (I think better) option is to "net it out to 0" which is equal to destroying the "domestic wealth" of the nation.

    Lucky will be those that do not hold any public debt and consider it to be their "private wealth".

    1. Many Keynesians are unwilling to admit that piling public debt is indicative of either
      a) using public consumptively (aka waste, aka bribing voters) or
      b) repeat malinvestment, defined here as investments that don't amortize themselves in the long run. You build new roads and bridges but it does not lead to an increase in tax revenue that justifies the initial expenses.

      Of course, there are also cases c) like Spain which took its banking sector's bad debt on its balance sheet but this is rather exception than rule and does not really make things better.

      Without such mismanagement of credit being given, public debt would probably hover around the 30% to GDP (in times of great technological breakthrough perhaps more because it is a time for investment).

    2. So I should forget all my IS-LM equations because a of the scary debt monster, no thanks. It's surprising how readily "undergraduate" macro is dismissed by people who don't really seem to understand it.

      I've not mentioned debt up to this point because at this moment I think it's importance is secondary, 100% of GDP is a large number but it's been a lot higher in the past. The UK doesn't have a problem either issuing or servicing it's debt right now so there's no real urgency and should a problem arise their are ways of dealing with that debt.

      The reason why I'm focusing on output rather than worrying about debt is that at this moment output looks low. We currently have low inflation, virtually zero growth in wages (I believe they're starting to pick up) and low yields on government debts. All these indicators would seem to point to a depressed economy with output well below it's potential. This is important because tax revenues depend on the level of output, raising output will also raise tax revenues which will help to close the deficit, we want to keep pushing output up until the point that it looks like that output might start to be inflationary and we need to start raising interest rates. Once we hit that point we can start to talk about balancing the budget with tax rises and spending cuts.

    3. Andreas Paterson19 November 2014 06:20

      IS/LM has nothing to do with it.

    4. IS/LM has nothing to do with what?

    5. Andreas Paterson19 November 2014 07:2

      You said

      So I should forget all my IS-LM equations because of the scary debt monstermonster, no thanks.

      That's my answer.

    6. If you have a decline in marketable technological innovation, any guesstimation regarding output might be unreliable. The economy will return when a wave of fresh products that everyone must have will hit the shelf.

    7. Government spending can be spent unwisely, good point. Also it can invested in long term good for the future, like flood defenses.
      By worrying about 'running out of money' the UK government is harming the future of our children and grandchildren by failing to invest in things we need.

  19. Ok Andreas, if you are talking UK matters here I do not care. You are free to do whatever you want on your pound-island as long as you pay the bills being sent to you by Brussels because you were so successful in working your IS-LM.

    On the other hand I am really trying hard but just can not come up with a "technological innovation" creating "must haves" that came from the UK in the past 30 years.

    Let me think, ok the milkman has been driving electric early on but since then all that is left seems to be "financial dangerneering" ...

    The ugly German

  20. I'm not sure what point you're getting at here, if I want to judge a country's economic wellbeing I think it's generally worth looking at the economic stats like GDP, unemployment and so on rather than drawing up a list of technological must haves. However, if you'd like a list I'll start with the world wide web, I can also point to ARM(CPUs), JCB (Construction Machinery), Rolls Royce (Jet Engines), Jaguar Land Rover (Cars). There is thankfully far more to the British than financial "engineering".

    I get the impression you think I'm down on Europe, this really isn't the case. I do however object to certain policies coming from the EU and it's various associated organisations at the moment. I'm also against the euro, because I think it it bad for it's member nations. I look at it's short history and I don't see any gains from adopting it and can now see a host of negative consequences, especially for Portugal, Ireland, Italy, Greece and Spain. Italians are no richer now than they were in 1999, Greece and Spain have 25% unemployment. These are economic problems on a a similar scale to those of the great depression.

    I'm not down on Europe, I'm more frustrated at it's inability to actually recognise the scale of it's problems and do something about them. I should add at this point that I'm not ecactly happy with the way the UK government have handled things either.

  21. Andreas Paterson20 November 2014 02:44

    You are quite right to be against the euro. Germans were against it because they realized that it would not work without political (fiscal) union. If the other countries had only followed German advice.....


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