Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 4 February 2015

Going for balance

The Green Budget analysis just released by the IFS contains a lot of material. (For a very reasonable summary, see this from the FT.) One point that a number of papers have picked up is, to quote the Independent, that the UK “Coalition’s fiscal plans for the next Parliament imply the largest dose of austerity anywhere in the developed world”. Actually the analysis appears to come from the IMF’s World Economic Outlook forecast. Here is a chart of the IMF's estimated and forecast structural budget deficits for a number of countries as a proportion of potential GDP.


The extent of additional consolidation planned for the UK beyond 2015 is clear. It is important to note that structural balance (zero on this chart) is not in any sense a neutral position. It means that debt to GDP will be falling as long as GDP is growing. That is what Germany is currently doing, and France is aiming for, while both the US and Japan are only going for a roughly stable debt to GDP ratio.

As I have emphasised many times, the critical issue is not whether it is desirable to gradually reduce net government debt as a percentage of GDP (I think it is), but when you try to do this. Theory and evidence clearly tell you not to try during a liquidity trap, when interest rates are stuck at their Zero Lower Bound. This will waste a great deal of resources, and cause unnecessary hardship. In my recent VoxEU piece, I argued that real GDP in 2014 could have been up to 4% higher in the US, UK and Eurozone if government consumption and investment had followed a fairly neutral trajectory, rather than being cut back substantially.

That result did not come from assuming some outrageous multiplier, but largely reflects the extent of austerity already undertaken. Compared to that neutral path, government consumption and investment were between 10% and 15% lower by 2014 in those countries or country blocs.

One explanation for the extent of austerity is that it represents political opportunism by those who seek a smaller state. Now I know that some do not like to entertain such thoughts: they think to suggest such things indicates a lack of political balance. However as I discussed here, there seem to be compelling reasons to at least explore that possibility. If we do, then the size of these cuts in spending are important, because they clearly show that - for the moment at least - opportunism has been remarkably successful in its own terms. By this measure the size of the state has been substantially reduced by making deficit reduction the number one macroeconomic priority.

This is in turn important because it influences the lessons to draw from this experience. To a macroeconomist, losing up to 4% of GDP a year is a huge cost. Such a cost might be excusable if it had been required to get inflation down from some high level, but instead it has lead to inflation well below target. The obvious question to ask therefore is how to avoid such costs happening again. If the basic cause has been political opportunism, and that opportunism has been successful in its objectives, then it seems highly likely that it might happen again the next time we have a major global recession. If that is the case then macroeconomists need to rethink how policy is made after major recessions. In the meantime, if political opportunism is what is driving policy, we will see in countries like the UK how far that opportunism can be pushed.


21 comments:

  1. It is even more than political opportunism in the UK. It looks more like it was preplanned - but never mentioned before the last election.

    ReplyDelete
  2. It is even more than political opportunism in the UK. It looks more like it was preplanned - but never mentioned before the last election.

    ReplyDelete
  3. Hi, I'm a Canadian College student and I just started a new Economics Journal. I would love to get some feedback if possible, check it out here: http://www.csbusinessreview.com/our-journals/

    ReplyDelete
  4. Simon describes the FT article he refers to in his opening sentence as “very reasonable”. Having read it, it seems to me to be a classic bit of macromedia.

    The article’s second para says “Britain’s fiscal position is in some ways worse than Greece’s: whereas Athens has a small primary surplus, the UK runs a deficit of closer to 3 percent…”. So what’s the problem with a large deficit as long as interest on the debt is near zero? Are we supposed to cut that deficit and watch unemployment rise (an outcome which Simon rightly deplores)?

    Later, the FT article says “The Conservatives could hit their target of a surplus with cuts of £12bn..”. Having any particular figure in mind for the deficit or surplus in the future is daft because no one knows what stimulus for example might come from an EZ that gets its act together (or doesn’t). And no one knows what will happen to domestic UK consumer and business confidence in two years time.

    ReplyDelete
    Replies
    1. SWL / Ralph. Have a read of Bill Mitchell, probably the best explanation of a fiat money system I have read yet.
      http://bilbo.economicoutlook.net/blog/?p=30110#more-30110

      Acorn

      Delete
    2. Anon, I follow Bill's blog, but he's a bit verbose. That article is 3,800 words. I can explain why deficits are inevitable with a tenth that number of words.

      Delete
  5. Im glad that you have finally peered far enough out of yr ivory tower to see that the reasons for the coalition's economic policy have very little to do with sophisticated macroeconomics and a lot to do with putting all of that lovely traditionally state sector spending into the hands of their chums and benefactors. Society is being dismantled and flogged off. No coincidence that the Tories' 2015 election budget is vastly bigger than last time.

    ReplyDelete
    Replies
    1. ...and benefits have to be reduced in line with the reduction in wages/working conds, otherwise people in low paid crappy jobs (i.e. most people!) wouldn't bother going to work!

      Delete
  6. I wish I could shout this -- You should not cut taxes for the wealthy class so you then need to borrow the same foregone cash from them.

    I am a liberal democrat, Hill, WH staffer formerly, National Academy center director background person, not some balance-the-budget, shrink self-govt's capabilities, extremist. Yes, it is true that govt borrowing costs are low but the tax mix is completely wrong.

    OK, support aggregate demand. Ok to borrow to finance spending that supports aggregate demand or to finance a many-year asset owned by the public. OK, cut taxes to support aggregate demand - but the taxes being cut should be the ones that improve the spending capacity of those with the higher propensity to spend.

    So if you feel that govts should have deficits as a policy goal for economic reasons, please advocate to change the tax mix first, for the same economic reasons.

    SWL I doubt you or many believe the purpose of govt is to concentrate wealth or income. So please advocate for a revenue system that complements the economic reasons, instead cut payroll taxes or lower-bracket income tax definitions and rates, tax cuts that complement the economic reasoning.

    Please stop defending deficit spending if it is based on borrowing from the wealthy classes (the small group of people who are able to trade in the financial markets or even buy govt bonds themselves directly).

    Can I get you FIRST to say something like this in your columns before you go on to advocate a policy of having deficits.


    ReplyDelete
    Replies
    1. Your have things in the wrong order, priority one should be getting the economy off the zero lower bound and back to normality, the tax mix is more of a long run debate. We can plan how we fine tune the future budget balance, but that really is something that we should properly approach after we've made it off the ZLB.

      As an example look at Japan's recent consumption tax rise, it was predicated on the kind of thinking you advocate and it turned out to be an economic disaster.

      Delete
    2. the rich are not getting a whole lot richer by buying government bonds. If they want to do so; let them. I am not terribly liberal but think that a stimulus when the economy is firing below its potential is a good idea.

      Delete
    3. Andreas P - I know SWL said that the theory and evidence says we need to get off the ZLB before we try to balance budgets. The article was focused on balancing budgets. The point I am making is about how you go about reaching balance or some other goal, and this is first a tax system issue because we are doing it the wrong way by raising VAT on top of tax cuts for those in upper brackets. I have no idea why the ZLB makes any difference here as I am not saying that we remove more money from the bulk of the people via taxation. I said shift tax burdens based on propensity to spend while you keep govt spending above the prior equilibrium, so to speak. Of course borrowing rates/costs are low, so common sense tells you that you can borrow too, just don't borrow the money from the class of people whose taxes you have cut.

      Delete
    4. Rob Sol - I think I was clear about the policy of support for aggregate demand. I said make the tax policy a complement to this by shifting taxes on the basis of propensity to spend. Its a rhetorical device to talk about a single purchaser, in the aggregate this class or group of people have portfolio needs that has them buy govt debt - if they have the money to do this because you cut their taxes - it beggars common sense to do that, but it is worse because in the aggregate you forego a tax bill and substitute a tax bond - a double your money increase in net worth. Why would we do that?

      We believed in some rationale for this before, the economic reasons now are support for aggregate demand.

      Delete
    5. A: it makes sense to cut taxes of people who have a high propensity to spend during a severe recession/depression; those people are poor. It makes no sense to cut taxes on rich people who have a low propensity to spend. And it probably makes sense to tax the rich and have the government spend that money as the rich will not spend it. Sure.

      Delete
  7. This comment has been removed by the author.

    ReplyDelete
  8. This final paragraph from the summary in the IFS work is very poor. It reads:

    “Had the March 2010 Budget plan instead been retained, taxes would have been lower and spending higher than they have been. This would have offered greater support to household incomes and made it easier to deliver public services. But it would have resulted in significantly more borrowing and would only have deferred, rather than avoided, the need for greater fiscal consolidation.”

    First, the IFS make the ever popular assumption that a bigger deficit means a bigger debt. It doesn’t: a deficit can accumulate as more debt OR MORE base money. And of course the stock response by the untutored whenever the words “print” and “money” appear in the same sentence is “inflation”. Well if the economy is well below capacity, which is when deficits are implemented, then a bit of money printing WON’T be inflationary, as long as we don’t do a Robert Mugabe.

    Second, a bigger stock of debt or base money in private hands does NOT NECESSARILY mean that “consolidation” is needed: it won’t be needed if the private sector is willing to hold those assets at a zero or near zero rate of interest. And creditors worldwide currently seem to have a big appetite for zero yield assets. Moreover, if creditors are NOT SUPPLIED with the safe assets they want, they’ll try to save so as to acquire them, and we get Keynsian paradox of thrift unemployment.

    But if interest rates DO RISE significantly, then consolidation will be needed. But that does not mean lower “household incomes” and poorer “public services” as the IFS implies above. If the private sector has what it thinks is an excess stock of debt, and it is thus charging government an excessive rate for holding those assets, all the state needs to do is to is to print money and buy back some debt. And as to any inflationary effect, that can be countered by raised taxes: i.e. grabbing base money off the private sector. As long as the deflationary effect of the latter equals the above inflationary effect, GDP stays the same, so there’s no adverse effect on “household incomes” or “public services”.

    To keep things simple there, I’ve assumed a closed economy. Obviously the effect of internationally mobile holders of UK debt is different to the effect of domestic holders, but taking account of those “internationals” doesn’t change the argument much.


    ReplyDelete
    Replies
    1. That IFS paragraph is nonsense. The IFS continues to peddle the neo-liberal myth that sovereign fiat currency issuing governments, have to "borrow" money. Likewise with the "fiscal consolidation". Can we get this straight. The UK Treasury can never run out of Pounds Sterling; because, it is the monopoly issuer of that currency. You can't get Pounds from anywhere other than the UK Treasury and its wholly owned Bank of England (they are one and the same in reality).

      There is no invoice denominated in Pounds Sterling that the UK Treasury can't pay. There is no interest payment due in Pounds Sterling, that the UK Treasury can't pay. There are no "bond market vigilantes" that can try and out-gun the BoE in Pounds Sterling, and not get slaughtered in the process.

      The only metric that HAS to be watched 24/7, is that "spending", both public (government) and private sector (commercial bank credit lending); does not push any particular sector of the economy, beyond its capacity to supply its goods and services and induce inflation. Properly targeted fiscal controls (taxation for instance), in each sector can control such inflation; acting as the brake pedal. Economy wide, sledgehammer, "Bull in a China Shop", monetary interest rate controls, would be redundant or "in emergency only".

      Acorn

      Delete
  9. It's always nice to read something new. Nice work guys. Thanks for letting me learn like this.
    <a href="https://www.greeneconsults.com>cfp courses</a>

    ReplyDelete
    Replies
    1. This comment has been removed by the author.

      Delete
  10. ". Such a cost might be excusable if it had been required to get inflation down from some high level, " Only if that were costing you more than 4% of GDP. Which I doubt that inflation would do that.

    ReplyDelete
  11. > One explanation for the extent of austerity is that it represents political opportunism ...

    A simpler explanation is to be found in the low inflation figures. Bondholders want low inflation in order to prop up the value of their fixed-income assets. They will bribe and bully politicians to make this happen. A "small state" isn't an ideological issue for them, it's a very direct and selfish way to increase the value of their assets. Low inflation, and even deflation, will make them richer and they will stop at nothing to arrange it.

    Deflation is good for them, even though it's terrible for the rest of us. We need to flip these incentives around. NGDP level targeting is one possible solution to this incentives problem; it would ensure that the only way to keep inflation down would be to push growth up, and therefore the bondholders would be lobbying in favour of growth instead of against it.

    ReplyDelete

Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time.