Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 31 August 2016

Fiscal rules should target the deficit, not spending

This jointly authored VoxEU piece on making the EU more resilient after Brexit that came out nearly two months ago has already had some unfavourable comment: Paul Krugman calls it timid, and Brad Delong does not like it much either. I want to pick out one particular idea, which I think is simply wrong and dangerous, and which I find it extraordinary that so many economists signed up to. Here is the relevant passage, in a section about the public finances.
“In most countries, the level of [government] expenditure – rather than the deficit – is the main problem. High expenditure makes it difficult to raise taxes and balance the budget, leading to dangerous debt dynamics. Thus, a focus on expenditure rules, linking expenditure reduction to debt levels, appears to be one of the most promising routes.”

Now this sounds to me like saying two things. The first is that the size of the state is too large in most countries. [1] The second is that we can use the need to bring government debt down as a way to correct that. It sounds to me exactly the policy that I accuse US and UK governments of following, although in their case the linkage is generally concealed. In this article it is suggested it should be explicit.

Whatever your views about the size of the state (including having no a priori view), it seems obvious that this is an intensely political issue. In contrast questions about the appropriate long run size of government debt are not so political, but more importantly they involve a completely different set of issues to those involved with the size of the state.

That is why policies or fiscal rules that aim to stabilise or bring down government debt focus on the budget deficit. It keeps the issue separate from the appropriate size of the state, and hopefully takes a good deal of the politics out of that issue. Linking the two issues makes it very easy to fall into what I call deficit deceit: saying we must cut government spending because government debt is too high, rather than because the state is too large. Even if that is avoided, associating the two sets back the cause of sensible debt management by needlessly politicising it.

That is why sensible fiscal rules target the deficit in some form, and allow how that deficit is achieved to be a political choice. I know this may seem obvious to me because I have written a lot about fiscal rules, but I would have thought the point might have also occurred to one of the economist authors of that article. When heterodox economists argue that the mainstream is hopelessly embroiled in the neoliberal project, they will be able to cite this article as evidence.


[1] You might say that, perhaps with certain European countries in mind, this is just a recognition that there is too much inefficiency and needless bureaucracy within government, rather than being a deeper statement of what governments should and should not do. If that is the case the authors should say so, but even then the coupling with debt control is problematic.

9 comments:

  1. I think a heterodox economist (and I refer here to economic historians, particularly those based outside the US and do not submit articles to journals like JEH) would say that targetting debt/GNP levels is nonsense and particularly targetting the numerator to bring the ratio down is nonsense because the debt levels across advanced countries are actually a symptom of another problem, and to understand it people have to look at the long run dynamics of capitalism for which its understanding neo-classical economics is pretty useless. The fundamental problems relate to globalisation, deindustrialisation, and rising inequality - including concentrations of capital, including productive capital. Once we put Model away and read the historical literature one might be surprised at how much we really do understand -and how much of this we have seen before, and how much could have been predicted. So I would say the mainstream profession is not so much embroiled in the neo-liberal project; its embroiled in preserving its model and this model-based approach to analysis - Glasperlenspiel- I think someone calls it. Some aspects of true neo-liberalism are actually good; these emanate from the Truman project which sees interdependence as actually minimising the prospects of conflict (although this has not always been proven correct). But what the US did after 1945 with the setting up of Bretton Woods and the Marshall Plan and encouragement of the Common Market in Europe was truly noble. Neo-liberalism argues that the US must take an international role. The problem was the liberal-neo-liberal project (both subsets of Idealism in Political Science) became captured by Monetarists, and owners of capital which somehow also captured the bureaucracy and governments. The training of modern economists - in terms of political economy, philosophy and history was simply not up to the level where it could properly challenge what was happening before the damage was seriously done. The foundations of neo-classical economics - individual optimisation and seeing a social system as a sum of individual parts - and a lack of desire to ask fundamental philosophical questions about whether this was actually true, made this apparatus and way of thinking too easily compatible with neo-liberalism.

    NK.

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    1. Actually, concerning macroeconomics generally and long run problems such as growth trends or the impact of high debt levels on said trends, the fundamental problem is that so few observation points are available. It has nothing to do with theoretical approaches or historical illeteracy, presumed or real. Identification hypotheses are always there, that you do it explicitly with econometrics or implictly as others do and if you try to work in plenty of relations between explanatory and explained variables, you quickly run out of informational content.

      It is hard enough with fluctuations where even more data is available.

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  2. I agree with the above article. And that’s why I particularly like a work (link below) by Richard Werner, the New Economics Foundation and Positive Money: it makes a clear distinction between strictly political decisions, which under their system are left entirely to politicians, and in contrast, the decision as to how large the deficit should be. The latter is a strictly economic decision which should be taken by technicians, i.e. economists (flawed as they may be).

    http://b.3cdn.net/nefoundation/3a4f0c195967cb202b_p2m6beqpy.pdf

    As it happens, the latter word advocates full reserve banking, but the existing bank system is actually compatible with the Werner/NEF/PM system.

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  3. Agreed. Wasn't groupthink amongst economists one of the issues identified after the crisis? If it wasn't: it should have been.
    Question for you, and bear in mind I'm speaking from the humanities...: do you think a non-ideological practice is possible given the institutional bias most economists are confronted with, whether that be the bias of banks and corporations or universities?

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  4. Both, deficit targeting and spending targeting can be decided by budget decisions only. (monetary policy affects the size of the deficit but luckily it does not consider such question when making a decision)
    Targeting deficit or government spending are choice between potentially less and more damaging policy. Targeting deficit is not a sensible aproach, it is just POTENTIALLY less damaging to economy.

    Only sensible policy considering the deficit and gov debt is employment policy and taxing savers more (those that do not need as much and do not spend their income(not spending all income is a tell that they do not need so much of it)) especially those with unearned income from paper assets and land.

    Keynes: "Look after the unemployment, and the Budget will look after itself."

    Anyone sugesting that deficit targeting is a sensible policy is contrary to Keyness and can not call himself x-keynesian.

    Both, deficit targeting and spending targeting can be done by budget decisions only. Budget decisions are finalized a year before deficits or government position is realized.
    Budget is adopted before deficit creation and some miniscule spending is added that increase deficits so, making a decision on budgets based on gov. spending would be proactive, while based on deficit would be reactive and that is its only potential in deficit targeting being less damaging.

    Anyone claiming that deficit targeting is a sensible aproach is anti-keynesian.

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  5. But the budget deficit is not under control of the government. Because when you cut spending by £x, tax and saving down the line reduces by £x. And when you raise taxes, the person further down the line who would receive your spending does not pay them.

    Once again - The level of government deficit is *caused* by the level of private net saving that occurs in the economy. That is the balance of people saving less the balance of people borrowing.

    The amount the government purchases - and therefore what it injects into that process - is largely disconnected from the process of saving and taxation. It will *cause* about 90% taxation and about 10% additional saving for every £1 spent depending upon the saving desires in the economy at the time.

    Moaning about government deficits *is* moaning that people have too much savings and are borrowing too little.

    Meditate on that fact for a while and you will see what a ludicrous groupthink we are caught in.

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  6. BTW my view is the only thing that will work is either a national 'Eurozone' government or breaking up the whole rotten thing.

    Once the UK leaves, there is more likelihood of other countries leaving if the problems are not fixed.

    What I am saying is your proposals are good but are more sticking plaster than a real fix.

    More likely the governments will "encourage" emigration (forcing people out) to maintain the "natural rate":

    http://qz.com/26644/why-22-percent-of-spaniards-wont-get-a-job-even-if-their-economy-booms/

    "If there's a shortage of workers, wages go up, forcing central bankers to tighten interest rates to combat inflation—in effect, increasing unemployment. In the US, this natural rate is estimated by US economists to be around 5%-6% (paywall). In Greece it is 15%, and in Spain it is 22%."

    Of course that has "decreased" now, but don't bet on the Eurocrats being sane. Plus it is not so much interest rates as austerity.

    Because it is "natural" to get screwed :)

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  7. this is an insane statement

    " High expenditure makes it difficult to raise taxes "

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  8. I think I'm paraphrasing Abba Lerner here but we could just focus on full employment and stable prices and let the deficit look after itself...

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