How a spreadsheet error has wrecked the world economy… or not

An economics student has overturned a key finding in the economics literature on the relationship between high public debt and low growth, the BBC reports.

While it remains clear that heavily indebted countries grow more slowly, Reinhart and Rogoff’s particular finding that growth drops sharply when debt reaches 90% of GDP appears to be in error.

We should of course be greatly relieved because the national debt stood at 90% at the end of 2012 (source). So we are now, like it or not, in the 90%+ danger zone of slower long term growth. To avoid this would have required much less borrowing growth and more austerity since 2008 than we have seen.

But clearly this revelation shifts the balance of the risk of too much austerity against the risk of too little. Whether this changes the debate at all remains to be seen, and I expect we will hear much argument over how much or little government policy has depended on this one paper. “The theories on which the chancellor based his cuts policies…” spins the Guardian.

The idea, however, that we have austerity because of “theories” is fairly risible. We have it because there is a massive and unsustainable deficit. There are no anti-austerity positions that exist in any depth greater than the slogan. There are faster austerity and slower austerity positions, each with their own risks, and the sober debate is all about where to strike that balance.

So I leave you with the sober as ever Economist

Firm conclusions on thresholds are elusive. A 2010 IMF paper turns up “some evidence” of a 90% threshold; a 2011 study by the Bank for International Settlements identifies a threshold of 85%. But another IMF analysis published in 2012 found that “there is no particular threshold that consistently precedes sub-par growth performance.” The costs of even moderately slower growth can quickly add up, however: Ms Reinhart and Mr Rogoff warn that the average debt overhang lasts more than 20 years.

The latest dust-up does nothing to answer the question of causation. Slower GDP growth could be the cause of a rising debt load rather than the result. Ms Reinhart and Mr Rogoff acknowledge in their academic work that this conundrum “has not been fully resolved”, but have sometimes been less careful in media articles. This is perhaps their biggest mistake. The relationship between debt and growth is a politically charged issue. It is in these areas that economists must keep the most rigorous standards.

* Joe Otten was the candidate for Sheffield Heeley in June 2017 and Doncaster North in December 2019 and is a councillor in Sheffield.

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  • Good article Joe. For reference there are other academic papers ( which make the link between high debt and low growth – whether it’s 80%, 90% or 100% is missing the point somewhat.

    These are the full changes in data from 1945 to 2009: even when revised, median growth in countries with 90%. Hopefully this displays well:

    Reinhart & Rogoff Herndon, Ash & Pollin
    Debt/GDP Mean Median Mean Median
    90 -0.1 1.6 2.2 NA

    Of course, this data doesn’t determine whether the link is causal, or in which direction (low growth may well be causing high debt, and not the other way round). But Reinhart and Rogoff never claimed to make a causal link, just a statistical one.

  • The data hasn’t displayed well, but it’s in an FT article here if anyone is interested.

  • One quick point: according to the budget, public sector net debt was 75.9% GDP at the end of March. That’s probably a better number to use than the Maastricht figure. It projects (optimistically?) debt will peak at 85.6% in 2016/17.

    And it does not “remain clear that heavily indebted countries grow more slowly”. Aside from the fact that the world is too complex for such simple economic rules, as Alex says it may be fairer to say “it’s clear that countries with slow growth rack up heavier debts”.

    And it doesn’t really affect the big argument about whether the best way to reduce our deficit and debt is – in the short-term – fiscal consolidation or growth. A large part of our “massive” deficit is down to the economy underperforming. And as even R&R suggest, it’s not the size of the debt that matters, but its size relative to the size of the economy.

  • Good title Joe.

    I think it would be misleading to interpret Reinhart and Rogoffs findings as evidence that can underpin policy decisions. The austerity debate is essentially a political one. In the UK, mainstream economic science would support the observations of the IMF Chief Economist, Oliver Blanchard, for a slower pace of fiscal consolidation as per Paul Krugman and Richard Layard’s MANIFESTO FOR ECONOMIC SENSE.

    I think the issue of causation probably runs both ways and will vary according to a country’s situation. Countries such as the UK, US and Japan with their own fiat internationally traded curencies will experience lesser effects than Eurozone countries or those with dollar pegs.

    It is reaasonable to assume (and it can be observed) that there will be policy effects arisig fron high levels of debt or more particularly debt service costs. If high proprtions of the national budget are being absorbed by interest costs and there is a lack of capacity for investment in economic infrastructure you would expect that to slow economic growth. Coversely, the UK has historically carried much higher levels of puiblic debt in the aftermath of the Napoleonic wars and World War II, while still able to maintain steady growth.

    I think Jedibeetrix points the way (although I would aim for a 40% of GDP tax take with the introduction of a Land Value Tax) when he says:”Sod the theories, I want continued [spending] austerity equivalent to 1% of GDP year on year until government spending returns to the level of taxation that the British public has seen fit to tolerate. That varies year by year as new measures are brought in, avoidance catches up with it, and old measures retired, but by and large the degree to which we’ll accept the government parting us with our money has trended around 38% of GDP.”

    How we get from here to there I think was best articulated by Samuel Brittan The harmful myth of the balanced budget .

    Brittan suggests “a threefold division of the national budget. The first would be normal current expenditure, such as spending on teachers or soldiers, which would be always covered by revenue. The second would be a capital budget some of which governments could borrow, but strictly at market rates of interest.

    The third section would be a stabilisation fund which would inject purchasing power when depression threatens and remove it during periods of inflationary pressure. It would not be confined to the traditional public works but could include any types of public spending and also tax remissions. This approach would help to distinguish economic arguments about fiscal stimuli from political arguments about the size of the state.

    This third section could best be financed at zero or low interest rates by advances from the central bank, as it would be a respectable form of the helicopter drop. The threefold division could perhaps be policed by a body such as the Office for Budget Responsibility. And in the background there needs to be a national policy goal such as a nominal GDP objective. Nit-pick these ideas as you like, they are more promising than everlasting austerity and slump.”

    I think the stablisation fund could be established as a form of ‘UK special drawing rights’ i.e. non-tradeable non-interest bearing intra-government debt whos purpose and use was limited to the financing and subsequent repayment of automatic stabilisers to support demand during recessions and to cool demand when the economy has reached capacity and is overheating.

  • Andrew Suffield 21st Apr '13 - 8:30am

    The second most important thing to know about the Reinhart/Rogoff paper is that the error discovered, while embarrassing, doesn’t have a very significant impact on the results of the calculation. The numbers you get at the end are roughly the same.

    The most important thing to know about the Reinhart/Rogoff paper is that it never told us very much in the first place. It clearly shows that over the past few decades, countries with high levels of debt also have low levels of growth. That proves nothing: economies are massive things with many hidden variables and lots of other global effects over that time period, and nothing in the paper helps to sort them out. It’s an interesting paper for economists and it’s completely irrelevant to economic policy decisions. People who are making political decisions on the basis of this kind of non-evidence need to be stopped.

    Here is a detailed discussion of why most macroeconomic data is terrible and not very useful:

    Also, I repeat once again: the UK government is spending more money than at any time before 2009, even after adjusting for inflation, and the spending keeps increasing year on year. This is not austerity by any definition. We’re not even remotely close to following the policy which Reinhart/Rogoff have been espousing. The US government is talking about austerity; ours is talking about slowing the rate at which spending is increased. Tory and Labour pundits both want you to believe that austerity is happening in the UK. Look at the numbers instead – it’s not!

  • Paul In Twickenham 21st Apr '13 - 9:31am

    People here have mentioned the “correlation is not causation” or “post hoc ergo propter hoc” critique. I have long held the view that the way that economics is used by politicians has the hallmarks of a cargo cult. If you’re not familiar with cargo cults, then you might find it interesting to read the wiki article:

    Richard Feynman applied the term to science, and gave the (now paradigmatic) example of Millikan’s oil drop experiment. Millikan was a great scientist but he got the experimental procedure wrong and came up with the wrong result. But his reputation was such that when people attempted to replicate the experiment, they selected outliers that were closest to Millikan’s results and ignored the more accurate results. As a consequence, over time the accepted experimental result slowly drifted towards the true answer.

    The quoting of scientific-sounding data allows politicians to give the impression that there is an objective basis for what are essentially subjective views. R&R provide “academic” evidence for Paul Ryan’s agenda in the USA, and are name-checked by George Osborne in defence of “plan A”. And the academics are in turn made complicit in the political agenda by either tacitly or (as in R&R) explicitly supporting the politicians who have previously mentioned them. And the mutually-reinforcing “authority” of the speakers means that (as with Millikan) dissenting voices find it hard to be taken seriously.

  • Ken Palmerton 21st Apr '13 - 12:10pm

    Academic economists and polititians are looking for causality ?

    Dont make me laugh.

    “causality” is looking them in the face, and they dont dare acknowledge it.

    Debt is caused by borrowing at interest. And no sovereighn State needs to borrow. Unlike an indevidual, the State has a DUTY to supply its citizens with a secure, adequate, and debt free medium of exchange.

    Our legislators are scoundrels and cowards for not looking at the possibility.


  • Michael Parsons 21st Apr '13 - 12:54pm

    Might it not just be that, convinced by voodoo economics that State debt is like household debt and needs “paying of” by cutting the money supply, then the actions of politicians in cutting back spending as State debt increases cause an apparent correlation between high “debt” levels and lower GDP growth? Or/and that politicians relying on finance from the finance industry (that gets a rake-off from debt-bondage) are more than predisposed to please their money-masters, whose contributions far outweigh anything done by mere voters?

  • @ Michael Parsons

    Government spending is not the money supply, fiscal and monetary policy are different things.

    No debt is being “paid off” the rate on increase is slowing.

  • @ Geoffrey Payne

    I don’t see that Joe saying that it is a political decision is dismissing anything.

    And “argumentum ad verecundiam” is not big and not clever. If you have a case to make, make it.

  • Paul Marshall 21st Apr '13 - 8:46pm

    Two important resources for all, in relation to the anti-austerity position being nothing more than a slogan:

    First, we assess the problem:
    How Money is Made / Created: Ben Dyson Explains the Debt Crisis

    Second part of the argument can’t happen yet because not enough people are aware of the situation, but there is a brainstorming event planned in June called the People’s Assembly which already has a sign up list of all kinds of organisations, economists, journalists

  • Paul Marshall 21st Apr '13 - 8:46pm
  • Eddie Sammon 21st Apr '13 - 8:58pm

    Michael, how is state debt not like household debt? The only difference is the government think they can constantly remortgage the debt; however one day the buyers might not be so keen and in that case bond prices would crash (they are at record highs at the moment) and interest rates would soar.

    If you think they aren’t the same because we can print money then well, that just causes inflation, which usually has a disproportionate effect on the poor.

    I don’t care how many economists spout the virtues of money printing, economics is not a science and in my book money printing or quantitative easing is just plain cruel. And cowardly.

  • Eddie Sammon 21st Apr '13 - 9:55pm

    The only alternatives to austerity are lowering interest rates, borrowing to invest and printing money (this includes temporary money printing such as quantitative easing). The problem with the first option is that the base rate is already below inflation, which means the Bank of England is losing money on its lending. People will say, ahh, but the revenues from growth will make up for it! But this was the theory that caused the financial crisis in the first place – easing monetary policy is not a risk-free solution to producing growth.

    The second option of borrowing more to invest is a more attractive one, but again it is not risk free. We should only borrow more to invest if there is a fantastic opportunity. We should not be making mediocre investments for the sake of making them.

    The problem with printing money is that it just devalues the currency, which causes inflation. People will say that it can increase confidence, but instilling people with a false sense of security is also a recipe for disaster. Regardless, it’s cruel to fixed income pensioners.

  • Eddie Sammon 21st Apr '13 - 10:00pm

    Sorry I forgot about supply side fiscal policy (tax cutting). Again, this can work but once again not risk free. There are other solutions, but there are no magic growth trees.

  • Michael Parsons 21st Apr '13 - 10:58pm

    Don’t be hoodwinked, my friend!

    Stop and think: when the State uses tax receipts to “reduce debt” that debt is only a bank book-entry. Using tax to remove such bank entries simply means the money disappears: a repaid “loan” doesn’t go anywhere, it just ceases. It is the equivalent of calling in cash and burning it, is it not? It reduces the money supply – which is what austerity is dong to pour services, is it not? Curtailing the growth of “debt” reduces money availability similarly.

  • Michael Parsons 21st Apr '13 - 11:14pm

    Edie Sammon

    You need to look at an economics text book section on macro-economics to see why. And the section on banking: look at the bank credit multiplier and the creation if money by banks out of nothing (by declaration: it is called fiat money), which they then charge interest on! This is a simple description of how the system works, and to whose advantage – not some strange revolutionary innovation. So the State (which underwrites the banking process at present) needs to confine its guarantees to retail banking only, and use its own State credit-creation for direct physical local investment – once that is established private investment begins again because demand rises – but not before, as poor old Osborne is finding out
    It is surprising that these elementary pieces of economic description seem so obscure to many.

  • Eddie Sammon 22nd Apr '13 - 1:10am

    Commercial banks cannot create their own money! If a bank receives £1,000,000 through quantitative easing then the reserve system means it can lend out £900,000 (approximately), not £10,000,000! They can’t print their own money and lend it to customers! I’m sick of this charlatan nonsense!

  • Paul Krugman and Richard Layard in their Manifesto for Economic Sense make the following key points:

    “There must of course be a medium-term plan for reducing the government deficit. But if this is too front-loaded it can easily be self-defeating by aborting the recovery.A key priority now is to reduce unemployment, before it becomes endemic, making recovery and future deficit reduction even more difficult.

    …many Western policy-makers are inflicting massive suffering on their peoples. But the ideas they espouse about how to handle recessions were rejected by nearly all economists after the disasters of the 1930s, and for the following forty years or so the West enjoyed an unparalleled period of economic stability and low unemployment. It is tragic that in recent years the old ideas have again taken root. But we can no longer accept a situation where mistaken fears of higher interest rates weigh more highly with policy-makers than the horrors of mass unemployment.”

    These are not the sterile arguments of statistical correlation, debt thresholds and bond yield curves, but are rooted in the purpose and application of economics to improving the lot of the general population in the tradition of ‘political economy.’ They argue a case, on the basis of cause and effect, in which mainstream economists offer the public a more evidence-based analysis of our problems.

    Automatic stabilisers reduce tax withdrawals and maintain current government spending levels to a large degree but large contraction of capital spending has a multiplier effect on demand throughout the economy.

    Investment in Infrastructure and housing provision is an important element in both addressing longer-term structural problems in the UK economy and supporting the delivery of an industrial strategy. Such investment has the added benefit of being able to provide a fiscal boost to demand at a time when government borrowing costs are at historic lows.

    The only conclusion that I can come to is that a wiser chancellor, of whatever political stripe, would be employing these very arguments and presenting them as part of his party’s political commitment to reduce unemployment, revitalise the British economy and reduce the government deficit in the medium-term.

  • Paul in Twickenham 22nd Apr '13 - 7:51am

    @Joe – by a “wiser chancellor” I assume that you mean someone like Keynes: “When the facts change, I change my mind. What do you do, sir?”. I think the problem here is one of political capital.

    Osborne (and Alexander, and Clegg, and Cameron) have expended so much political capital in supporting austerity that any change in position, no matter how small, will be viewed as political weakness and jumped on by Labour.

    It’s been widely observed (e.g. by Kamal Ahmed in yesterday’s Telegraph) that the IMF were supportive of Osborne’s plans when they visited 2 years ago, but are now critical of those same plans. But of course a politician cannot react to a volatile situation (“Events, dear boy”, and all that) without looking er… “weak”.

    Yet in this time of “austerity” the government has launched a mortgage assistance programme that it is now widely accepted will not encourage new house building, but will expand the property bubble (and put the UK government on the hook when it collapses) just in time to give Conservative core supporters a warm fuzzy feeling as house prices surge.

    So in my view Osborne will not change course for fear of looking weak, yet he will risk the economy to win a few votes.

    What a disaster!

  • Peter Watson 22nd Apr '13 - 8:14am

    @Paul in Twickenham “So in my view Osborne will not change course for fear of looking weak, yet he will risk the economy to win a few votes.”
    If only there were another party in government, a “partner” perhaps, who could point out these things to Osborne and the public, and influence the decisions of the Chancellor.

  • Andrew Suffield 22nd Apr '13 - 8:27am

    It reduces the money supply – which is what austerity is dong to pour services, is it not?

    Well, no! Because austerity is not happening according to your definition here. The debt is increasing, and the money supply is increasing with it.

    So, given that the current government is doing exactly what you say it should be doing, should we assume that you are enthusiastically supporting Osborne’s policy?

  • Michael Parsons 22nd Apr '13 - 8:41am


    “Paying off the debt” would wipe out the economy by removing money-supply: austerity that attempts to do part of that, or even fails, has a partial destructive effect: so yes, that is what we see. The fact that the Clegg-Cameron policy is voodoo economics (i.e. does not work) does not make it any less destructive and dangerous, just as applying lily-water to cure sore eyes would still be blinding, medically speaking as well as ineffective. Crank remedies are not always neutral in their outcomes.

  • Eddie Sammon 22nd Apr '13 - 1:19pm

    Michael, the debt is real, it needs to be paid off. I am not saying we need to be in a position where we have no debt, but we must always be in a position where we can pay it off if we had to. From looking at the government’s accounts ending March 2011, I can see that public sector liabilities are £2,421 billion compared with assets of £1,228 billion – we are effectively running a negative equity government, which also has a £94 billion budget deficit.

    Those who advocate printing money seem to be blissfully unaware to the plight of fixed income pensioners, who are having their life savings eroded away, some of whom are freezing to death.

  • Bill le Breton 22nd Apr '13 - 1:21pm

    Fiscal austerity? Budget Deficit circa £120 billion
    Growth? Zero, or as good as.
    Inflation/growth expectations? 10 year gilt 1.73%
    Conclusion – it’s monetary austerity!
    Demand for monetary assets > supply of monetary assets
    Increase supply of monetary assets
    Reduce demand for monetary assets through raised expectations of increasing nominal incomes.
    Is this being done anywhere?

  • Eddie Sammon 22nd Apr '13 - 1:40pm

    Bill, the braver thing to do is to read my criticisms of printing money and see that it is not a magic solution. Too many people are running around with money printing blinkers on thinking they have found treasure.

  • @Eddie
    You are simply never going to understand anything about economics if you can’t understand that a country is not like a household. When a household ceases to exist its financial situation needs to be resolved and any outstanding debts repaid but a country just doesn’t cease to exist in that way. We have had a national debt for 350 years. Why do you think it suddenly needs to be paid off? All that is required is that we are able to service it on reasonable terms. That means that at some point we want a falling debt to GDP ratio. How we get there is a matter of debate. It is of course always within the means of a government to pay off the total debt, for example it could just impose a one-off wealth tax, but it is very difficult to imagine a scenario in which that would be necessary or desirable.

  • Andrew R,

    “It is of course always within the means of a government to pay off the total debt, for example it could just impose a one-off wealth tax, but it is very difficult to imagine a scenario in which that would be necessary or desirable.”

    Do you mean like this proposal from an unlikely quarter Donald Trump Proposes a Tax for the Rich/One time levy on net worth would pay off entire national debt

  • Eddie Sammon 22nd Apr '13 - 3:05pm

    Andrew, I understand economics. I said “I am not saying we need to be in a position where we have no debt, but we must always be in a position where we can pay it off if we had to.”

    This is similar to what you said, basically that we can’t have too much debt. Where we differ is probably the fact that I do not like our debts being greater than are assets; this is because it leaves us vulnerable to an increase in interest rates.

  • Eddie Sammon 22nd Apr '13 - 3:08pm

    our, not are, assets sorry, I never usually make that mistake!

  • Eddie Sammon 22nd Apr '13 - 3:17pm

    No chancellor should be happy with having public liabilities greater than public assets. A prime example of this problem is public sector pension funds, where there money just isn’t there to pay for them, so we have to borrow more and get further in debt than we already are.

  • Eddie,

    “From looking at the government’s accounts ending March 2011, I can see that public sector liabilities are £2,421 billion compared with assets of £1,228 billion – we are effectively running a negative equity government, which also has a £94 billion budget deficit.”

    The reported deficit in the Whole of government accounts is basically equivalent to the unfunded public sector pension liabilities Whole of government accounts: what’s the financial health of the UK?

    The government runs most UK public service pension schemes with no fund on a pay as you go basis. As such, the government must ultimately supply the monies needed to finance cashflows to pensioners. Net annual expenditure on the PAYG public pension scheme is equivalent to the amount spent on paying cash benefits less contributions made by public sector employees. As and when contributions received fall below the cost of making pension payments, the government must finance this shortfall through current expenditure.

    Borrowing for investment in tangible assets that generate future income streams, whether that be economic infrastructure that supports growth in the tax base or social housing that generates rents does not bring about a deterioation in the net asset position.

    Conversely borrowing to fund cyclical tax shortfalls or increased social security payments in a downturn will exacerbate the negative net asset position in the short term. This type of cyclical funding may well be better furnished by temporary money creation to expand output to the point where the econony is running close to capacity. It is only when the government tries to increase the money supply/public sector spending against the cap of supply constraints (as it often has done in the past) that domestic inflation risks begin to develop.

    What we seek from government is intelligent and skillful management of the multiple variables of the economy while maintaining stability in the administration of public finances. We seem to be a long way from delivery of what we seek at present.

  • Michael Parsons 22nd Apr '13 - 5:22pm

    Still puzzled by this wisdom.
    I think money concealed in “tax havens” amounts to trillions of dollars in places such as the British Virgin Islands etc. Abolish these by force if necessary and we have no “debt”?

    But even more: debts without assets or counterparties characterise the global banking system , which creates money at will and without limit and is bankrupt, kept afloat by grabbing cash from pensioners and via governments, including supposedly protected private deposits. For proponents of active intervention b y the State as the instrument of the people’s will for a just redistribution to be lectured on rectitude and debt settlement is tiresome. None of the proponents of “debt repayment” schemes can even begin to explain how any nation or any prosperity would survive if “debts” were repaid by surplus budgets, or even their accumulation further slowed by smaller “deficits”.

    Money creation is not a strange quirk or failing of Government, it is its basic monetary power, and one wrongly exercised currently by gigantic private corporations that need to be brought back under public control; and which do not (unlike States) have power to tax and so meet their obligations, except b y the so-called “tax” of contrived scarcity through monopoly conspiracy, and by the purchase of political power through the party system, parachuting in their executives into major government roles.
    Perhaps the answer to this network of fraudulent debt might be revolutionary democracy? The removal of oligarchy? Isn’t that what we are supposed to be about?

  • Paul in Twickenham,

    “What a disaster”

    Business Insider online magazine agrees with your assessment The Biggest Economic Experiment Of The Last 5 Years Has Ended In Disaster

    The general consensus seems to be that austerity has failed. The IMF’s Chief Economist, Oliver Blanchard argues that Osborne is “playing with fire” and that he should “decrease the speed of fiscal consolidation.”

    David Blanchflower, economist and former member of the Monetary Policy Committee is a bit more explicit. “Almost everything this government says; do the opposite … I would just say, anything they ever say, my default position would be do the opposite.”

  • Eddie Sammon 22nd Apr '13 - 6:21pm

    Printing money is not a magic solution to our problems. I accept the argument that it might help through improving perceptions, but I still think it has been a net negative. I understand the increasing money supply argument, but I think that just leads to currency wars.

    Debt does have to be paid off, but it can be paid off with new debt. However this does not mean we can have unlimited amounts of debt or pay them off by printing money.

  • Eddie,

    “The second option of borrowing more to invest is a more attractive one, but again it is not risk free. We should only borrow more to invest if there is a fantastic opportunity. We should not be making mediocre investments for the sake of making them.”

    The economist article Infrastructure Bunged up:Why Britain doesn’t build goes into some of the issues and notes:

    “Although big projects like high-speed rail turn ministers’ heads, smaller ones are collectively crucial. Prosaic schemes, particularly those involving maintenance and repairs, could provide large benefits to the economy, and quickly, with little planning hassle. “Give councils money to fill the holes in the road,” says Tony Dolphin of IPPR, a think-tank. “And improve signalling on the railways.” The £170m that the Department for Transport has made available to local authorities for “pinch-point funding” is a step in the right direction. Sir John Armitt, who was commissioned by the Labour Party to lead a review of long-term infrastructure planning, advocates “hundreds of school and hospital extensions” that local people can get behind.

    The success of the London Olympics shows that Britain can build infrastructure punctually if the money and the will are there. And in things like water management and broadband provision, the country is well served. But dithering is all too often the main activity, as the rows over airport capacity in the south-east show. The government could start by selecting a few projects—say four of the top 40—and doing all that is needed to get the diggers out of the garage. It is easy to cut infrastructure projects that have not started and from which benefits have not been felt. Time to show some commitment.”

  • Eddie Sammon 22nd Apr '13 - 6:29pm

    Printing money also increases food prices, which starves the poor around the world – forget about domestic demand!

  • Blanchflower in his comments to Business Insider has advocated the following measures:

    – Immediately reinstate £20 billion in infrastructure spending, that they cut” and put it towards building homes, schools and so on.
    – Completely reverse austerity” – cut the value added tax (VAT) by five percent, reduce payroll taxes.
    – Give companies incentives to hire and invest.
    – Set up a small business bank to get money to small and medium businesses.

    These measures by themselves may not be the whole answer and there may be no easy way out of a prolonged period of slow recovery, but the key point is that made by Krugman and Layard ” At the very least we should not be making things worse by big cuts in government spending or big increases in tax rates on ordinary people. Unfortunately, that’s exactly what many governments are now doing.”

    The first priority has to be to reestablish confidence with sustainable real growth in earnings on the back of major public investment. Only then can we realistically take the necessary tax and spending measures to tackle the deficit in public finances and the trajectory of public debt.

  • Paul In Twickenham 22nd Apr '13 - 7:46pm

    @Joe – Hurrah for Blanchflower’s point #1. I would dearly love to be proven wrong, but I simply do not believe that Osborne (who has also acted as Conservative election campaign co-ordinator) would be willing to countenance measures that increase housing stock and hence drive property prices down (see my earlier comment).

    I would suggest one other infrastructure priority – make a firm decision to secure electricity supply in this country and act on it!. Frankly I don’t care if it’s renewables, nuclear, thorium or some mix of all of these – but the government needs to stop prevaricating. I can think of nothing that is more likely to result in civil unrest in this country than if all the lights go off when people turn the kettle on to make a cuppa in the middle of Corrie on a cold winter evening about 5 years from now.

    Housebuilding, securing energy supply, updating the railway network… we need a 21st century Brunel or Bazalgette, and we need a government with the wisdom and courage to enable it all. I have low expectations…

  • Eddie Sammon 22nd Apr '13 - 8:54pm

    @Joe, I agree the government have other options available.

  • Andrew Suffield 22nd Apr '13 - 9:05pm

    Printing money is not a magic solution to our problems. I accept the argument that it might help through improving perceptions, but I still think it has been a net negative.

    To point out the obvious – printing money has been tried, by this government and the previous one. As the complainers in this thread are so eager to point out, growth has not occurred, so this has not worked. One can but wonder why they are suggesting that more of the thing that hasn’t worked will work better.

    (I don’t believe there is any achievable government policy that will significantly improve upon the current situation, and there’s certainly no evidence to support any claims for one, but there clearly do exist policies that could make it worse – Greece has proved that. Consequently I would suggest that this is not the time for radical economic experiments along the lines proposed in this thread.)

  • @ Michael Parsons

    I was going to respond to your earlier comments explaining how you have misunderstood, starting with the difference between stock and flow.

    However when I read:

    “I think money concealed in “tax havens” amounts to trillions of dollars in places such as the British Virgin Islands etc. Abolish these by force if necessary and we have no “debt”?”

    I realized it wasn’t worth it. Just best to let you sit in your tin foil hat and rant. Using force as you don’t like a self governing state’s tax arrangements is the sign of someone who has already lost their grip on reality.

    And just in case as you plot your invasions of foreign lands I though I would help you with some tax havens you could start with:
    Hong Kong

    Good luck with your plans for world domination. As none of us will notice your attempts at a coup I would suggest that as their response will probably be to put you in a mental hospital I would avoid trying the Chinese and go for the Swiss as they probably have nice views and pleasant staff.

  • @ JoeBourke

    Blanchflower is a parody of himself now. Some targeted versions of the infrastructure spending and tax cuts would help but not on the scale he advocates. Adding complications to the tax system is not helpful to small businesses.

    The small business bank idea is terrible, governments are not good at running businesses (and the UK government is particularly bad) as shown by the middle to latter part of the 20th century. What is more likely to be effective is relying on new technologies that allow effective peer to peer lending, seed funding models and genuinely “local” lenders. However laws and regulations are not written from the point to trying to let new innovations develop. There are good consumer protection reasons for why some rules exist but there are threats to some of the innovations to some firms of lending that could help grow the economy.

    Confidence is key but I don’t see that most of the “Political” economists offer solutions that will deliver that but some tax cuts and tax simplifications combined with some limited targeted infrastructure spending could move in that direction but not an even larger splurge than we have already seen.

    Business confidence does not come with a belief that the government has no idea about responsible spending and creates vast future liabilities.

    The other factor has been the speed at which the workforce are able to re-skill, there are number of things that could be done on that front some tax, some spending, some cultural. The speed at which the work force can adjust to newer opportunities is key to dealing with economic re-adjustments.

  • Eddie Sammon 22nd Apr '13 - 10:52pm

    I have a feeling that some of these big name economists begin to sell themselves out and start writing provocative articles that nobody serious listens to. In fact, I’m pretty sure of it.

  • Eddie Sammon 22nd Apr '13 - 10:55pm

    Krugman also seems to have vested interests with the Democratic Party, so he would write against cuts and tax rises on ordinary people.

  • Michael Parsons 22nd Apr '13 - 11:43pm

    Hi psi!

    Stock of what money? Accumulated and perhaps illegal bank liabilities backed by what?

    See the continuing reports on massive money- laundering scams. Regulatory concern is growing at the highest levels:-
    BRUSSELS (Reuters) — The so-called shadow banking system, blamed by some for aggravating the global financial crisis, grew to a new high of $67 trillion worldwide last year, a regulatory group said on Sunday, calling for tighter oversight of nonbank institutions like hedge funds, private equity firms and other investment companies.
    The report by the Financial Stability Board appeared to confirm concerns among policy makers that shadow banking is set to thrive beyond the reach of a regulatory net that has been tightening around conventional banking.
    The board, a task force from the world’s top 20 economies, also called for greater regulatory control of shadow banking.
    “The F.S.B. is of the view that the authorities’ approach to shadow banking has to be a targeted one,” the group said, pointing to current lax regulation of the sector. “The objective is to ensure that shadow banking is subject to appropriate oversight and regulation to address banklike risks to financial stability,” it said.

    There is nothing outlandish in arguing that the State should resume control of money creation and direct it for the growth of employment and production. If you lpopok at the liquidity preference curve you will see how increases in money-supply end up with lower interest rates and massive transfer of funds to idle balances (or inflated property and land values). In the absence of State action the major UK corporations are holding amounts equal to about half UK GDP in idle balances.
    There is nothing weird in arguing that tax should be collected and extradition arranged ; there is something weird when reparation fines for £millions imposed by our courts on several crooks and swindlers in UK remain uncollected. The people deserve justice in these matters. Why do you oppose that? Why do you resort to bluster to dodge the issues?

  • Michael Parsons 22nd Apr '13 - 11:55pm


    Just to make it clear, the following accountancy report might interest you:-

    Large industrial corporations are accumulating cash…

    However, there is one part of the economy that has not been living beyond its means. The corporate sector is accumulating cash at an astonishing and accelerating pace and acting as a major drag on the rest of the economy, keeping it close to stall speed. It is hard to see any strong revival in the economy until companies start to release this cash by spending more on acquisitions, investment or dividends.

    It is interesting to take a look at the current conjuncture from a cash-flow perspective. The the net amounts earned or spent by each of the main sectors of the economy in the last two years, ideally each balance would be close to zero. What stands out is the government financial deficit or net borrowing, which pumped £147 billion into the economy in 2010 and a further £122 billion 2011. But these massive figures were largely the consequence of cash being drained out of the economy and indeed out of the Exchequer by the private sector. The biggest drain was the company sector, which sucked a hefty £72 billion out of the system in 2010, and a further £80 billion 2011. And most of this cash is being hoarded, not spent or invested. Non-financial companies increased their holdings of currency and bank deposits by £48 billion in 2010 and a further £82 billion 2011, taking the total to £754 billion, a staggering 50% of GDP.
    It is not difficult to see how companies find themselves in this cash-rich position. Globalisation has dramatically increased the power of capital over labour, with workers at the bottom of the pile and even the ‘squeezed middle’ coming under huge pressure. This has been most apparent in the US where companies continued to post record profits right through the downturn. In the UK, companies have been swimming in cash while consumers have been drowning in debt.
    …but they’re not investing.

    Stocks and flows eh?

  • jenny barnes 23rd Apr '13 - 9:16am

    Eddie sammon: ” I understand economics.”
    I would suggest you read Lipsey’s Positive Economics, as you clearly don’t.

  • @Psi: While I concur that Government run projects have a habit of going belly up in the UK, Government backed business and development is something we should get behind because as Germany showed, companies are more willing to gamble on new ideas and innovation, when it is not solely their money on the line.

    @Burke: A good point, our Government, probably due to over centralisation, has always been too focused on the big projects, leaving so many things like rail maintenance to fail by the wayside. This in some industries and areas is at a critical breaking-point.

    With regards to debt, I think may be if someone explained to Eddie the differences between debt and deficit that would help move that debate along somewhat. Well, it would at least move it to a position where you debating actual Government policy as opposed to something no one is proposing.

    With regards to printing money, I hate to say it because I am clearly putting myself against people who have a far better understanding economics than myself, but while printing money is indeed not a new idea, that does not necessarily make it a good one.

  • Psi,

    there is some common ground between Blanchflower and another political economist – Vince Cable.

    With respect to the scale of infrstructure spending that might be appropriate, Vince Cable: a turning point in politics? Vince Cable says:

    “It partly depends on the scale. If you are talking about under 1% of GDP [roughly £14bn], that is hardly going to shake the world. It depends on how you do it – giving local authorities powers to build council houses seems to be a bit of a no-brainer. It can be done quickly. There is the capacity there and it directly helps the sector of the economy that faces the greatest weakness, which is construction, glass, cement, bricks, many of which are in serious trouble. That is quite different from spending vast sums of money on new infrastructure.”

    He accepts that nothing is without risk. “As long as there is nervousness around the place people will worry because there is this confidence effect. Animal spirits are very difficult to quantify. You have to respect colleagues in the treasury who worry about these things, but objectively it’s very difficult to see what the problem is.”

    In his New Statesman essay When the facts change, should I change my mind? he references Reinhart and Rogoffs research saying:

    “The banking system hardly rates a mention in the General Theory: not surprising, as the British banking system, unlike America’s, was stable in the 1930s. To seek precedents for the present position, we need to look at early-19th-century Britain or the recent experience in Japan. A seminal paper by Carmen Reinhart and Kenneth Rogoff suggests that financial crises are typically followed by slow and difficult recovery.

    Furthermore, the damage inflicted on the banking system has severely impaired credit flows, especially to small and medium-sized companies and to infrastructure project fin – ancing. The money transmission mechanism has been badly disrupted, which blunts not only monetary policy but also fiscal policy, by reducing the income multiplier and accelerator by which demand is translated into increased production and investment. Any reliable escape route from the crisis has to have a plausible mechanism for boosting credit to business, especially SMEs. That is why I am working in the government to launch a state-backed business bank and promote non-bank finance.”

    In the concluding paragraph of his essay, Vince comments:

    “On the balance of risks, there is no “right” or “wrong” answer. There is no theoretically correct solution: rather, a matter of judgement – which incorporates a political assessment of which risk is the least palatable. There is a body of opinion arguing that the risks to the economy of sticking to existing plans are greater than the risks stemming from significantly increased and sustained public investment targeted at those areas of the economy where there are severe impediments to growth (housing; skills; infrastructure; innovation). But this is also too crude and binary a characterisation of the position; the government has carried out considerable policy reform in these areas, not least in my own department, the fruits of which take a while to mature. The balance of risks remains a matter of judgement.”

  • Eddie Sammon 23rd Apr '13 - 5:31pm

    Oh come on guys.

    @jennybarnes: please don’t resort to unsubstantiated personal criticisms because you disagree with someone.

    @LiberalAl: strangely you have said I don’t understand the difference between the debt and the deficit, what evidence do you have for this? Do you understand the difference between a liability and a debt?

  • Eddie Sammon 23rd Apr '13 - 5:44pm

    Clearly a debt falls under liabilities, but liabilities include much more such as future pension purchases, or payments for assets. Just in case you want to nitpick over every sentence I say.

  • Bill le Breton 24th Apr '13 - 10:12am

    Andrew Suffield,

    The Bank of England has been conducting £375 billion worth of unconventional monetary policy (Quantitative Easing) over some time. It has bought a very narrow group of assets.

    Why do you think that this is sufficient to conclude that “printing money has been tried, by this government and the previous one. As the complainers in this thread are so eager to point out, growth has not occurred, so this has not worked. One can but wonder why they are suggesting that more of the thing that hasn’t worked will work better”?

    That is hardly a scientific statement. You are guessing. What would have been the cost of not doing this? What might the effects have been of buying a wider range of assets? What if the Quad had set a target for nominal income growth and said it would conduct asset purchases until that target had been reached?

    The US and now Japan have announced and are conducting open ended unconventional monetary policy, on a considerable scale, with the assets to be purchased defined much wider than those purchased by the Bank. Their target for their policy includes growth as well as price level.

    A central bank of a fiat currency can achieve any level of nominal aggregated demand that it wishes. That the Bank of England continues to achieve a very low level of aggregated demand in the economy and continues to reinforce expectations of continuing low levels of growth in aggregate demand is evidence that their monetary policy is too tight.

    The longer we delay in following the US and Japan the greater the long term damage to our economy and our social capital – a toxic mixture of long term unemployment and rising debt.

    As Balls is on record that he wants the Bank of England to hit a 2% inflation target (i.e. marginally tighter than post-budget Coalition policy) the UK looks set, whatever the result in 2015, to endure at least 7 more years of stagnation – truly a lost decade: 2010 – 2020.

  • Michael Parsons 24th Apr '13 - 11:03am

    Why us so-called “printing money” by the State, directed at national regeneration, so bad compared to the endless generation of fiat currency by unregulated large private corporations directed at their choices (which are not in any way governed by “price discovery” or the general good are they?) Are we not talking about a power struggle for control of the creation and use of money between the private oligarchy versus the democratic State which should be emerging? Isn’t it time to grow up and look not at positive economics but at the contributions of the sociology of economics and the externalities and institutional profiles that govern decisions? The idea that bank directors(for example) make rational scientific judgements was shown to be foolish way back when Pareto wrote his General Sociology! Let alone any accounts of the profound wisdom of the Fred the Shreds of this world, or the absurdities of marginal utility and community indifference curves or gains from “free trade” in a world of fixe-up prices and Libor rates, political bargaining and currency wars.

  • Eddie Sammon 24th Apr '13 - 11:41am

    Bill, printing money simply devalues the currency, which causes inflation.
    Michael, private corporations cannot “print money”.

    If either of you can’t see the above then you are both incredibly stupid.

  • Paul in twickenham 24th Apr '13 - 12:29pm

    @Eddie – Michael is making a very important point and is certainly not being stupid. Banks create money ex nihilo through debt issuance that must be repaid by”real” money that is earned through the productive effort of borrowers. A discussion of the morality of fractional reserve banking seems somewhat orthogonal to the matter in hand but the point about the dubious practices of the banking sector are well taken.

    As Bill points out, economics is not a science. All too often it resembles a set of feuding religious cults. I disagree with Bill’s enthusiasm for Abenomics as I believe it will ultimately lead to currency wars that will spread out from SE Asia. But I think (as I have often noted here) that the UK’s QE efforts have been a charade. We now have vast amounts of liquidity giving the semblance of life to the corpses of the banks while vital and valuable infrastructure projects gather dust.

  • Malcolm Todd 24th Apr '13 - 1:09pm

    Eddie Sammon
    “Michael, private corporations cannot ‘print money’.”

    A question for you: when you borrow money from the bank, where do you think the money comes from? If you think the answer is “From the money deposited by other customers”, then brace yourself for the truth: you’re wrong. It doesn’t.

    If the bank agrees to lend you, say, £10,000, it does that by creating an entry in your bank account — a credit of £10,000. That’s it. That simple. You can now go out and spend that money. You have, of course, promised to pay the bank £10,000 plus interest over a period in the future — but that doesn’t change the fact that you have money now, from the bank, from the bank’s simple act of saying “Here is the money.”

    If that’s not “printing money” — in this age, when the vast majority of transactions involve electronic transfers between bank accounts and no physical cash changes hands — then I don’t know what is.

  • Malcolm – yes, but … its not quite that simple. AIUI there are ratios between deposits and loans that have to be maintained.

  • Eddie,

    The high priest of Monetarism and scourge of inflation, Milton Friedman, in a 1948 paper, A Monetary and Fiscal Framework for Economic Stabilityput forward a proposal according to which the government would run a balanced budget only at full employment, with deficits in recession and surpluses in economic booms. Friedman proposed that all government spending would be paid for by issuing government money (currency and bank reserves); when taxes were paid,this money would be “destroyed” . Thus, budget deficits lead to net money creation. Surpluses would lead to net reduction of money.

    His proposal to combine monetary policy and fiscal policy, using the budget to control monetary emission in a countercyclical manner would have eliminated private money creation by banks through a 100% reserve requirement–an idea he had picked up from Irving Fisher and Herbert Simons in the early 1930s–hence, there would be no “net” money creation by private banks. They would expand the supply of bank money only as they accumulated reserves of government-issued money.

    Friedman believed his proposal would result in strong counter-cyclical forces to help stabilize the economy as monetary and fiscal policy operate with combined force: deficits and net money creation when unemployment exists; surpluses and net money destruction when at full employment. Automatic stabilizers are not sufficiently strong to offset fluctuations of private demand. Friedman would have had government deficits and, thus, net money emission so long as the economy operated below full employment.

    In Friedman’s proposal, tax rates would be set in such a way so as to balance the budget only at full employment. . Essentially, Friedman’s proposal is to have the budget move countercyclically so that it will operate as an automatic stabilizer. And, indeed, that is how modern government budgets do operate: deficits increase in recessions and shrink in expansions. In robust expansions,budgets even move to surpluses . Yet, we usually observe that these swings to deficits are not sufficiently large to keep the economy at full employment.The recommendations of Friedman to operate the budget in a mannerthat maintains full employment are not followed. Why not? Because the automaticstabilizers are not sufficiently strong, there are fears of starting an inflationary cycle or sparking a rise in interest rate, eventhough the economy is operating well below capacity.

    To build in sufficient countercyclical swings to move the economy back to full employment government spending and tax revenues must be strongly cyclical–spending needs to be countercyclical (increasing in a downturn), and taxes pro-cyclical(falling in a downturn). One way to make spending automatically countercyclicalis to have a generous social safety net so that transfer spending (on unemployment compensation and social assistance) increases sharply in a downturn. Alternatively, or additionally, tax revenues also need to be tied to economic performance–progressive income or sales taxes that move countercyclically.

    Much of the debate around economics we have had since the financial crisis was also undertaken in the wake of the great depression. Economists and policy makers learned their lessons and got it right for a couple of decades, but as time passed and memories of the 1930’s faded the old habits and flawed ideas returned bringing us to where we are today.

  • Eddie Sammon 24th Apr '13 - 2:54pm

    You can’t make the world rich by printing money and I’m not discussing it with the usual suspects any further.

  • “And, indeed, that is how modern government budgets do operate: deficits increase in recessions and shrink in expansions. ” Except for when Gordo and Balls were in charge.

  • Bill,

    I think Paul in Twickemham might be right about Japan when he says Abenomics may ultimately lead to currency wars that will spread out from SE Asia.

    The guardian analysis Japan’s QE will leave its workers out of pocket with lower quality of life argues:

    “Any prescription needs to based on a diagnosis of the ailment. The primary cause of Japan’s long crisis is a fall in investment. In cash terms the Japanese economy has fallen by ¥53tn from its peak, a fall of 10%. The decline in productive investment on the same basis is almost exactly the same at ¥54tn. The slump in investment accounts for the entire fall in nominal GDP. Because of deflation the economy has not declined in real terms, but instead has grown at a snail’s pace. The investment strike by Japanese firms has led to their hollowing out and a hollowing out of the entire economy. This explains why the electronics giants and others are in crisis.

    Radical monetary policy does not address the investment strike. Instead, its first effect is to increase the price of financial assets, stocks, bonds and perhaps even property prices. There is a hope that it will also lead to a persistently weaker yen, which would make Japan’s exporters more competitive. This is not guaranteed, as speculative money also flows into Japan precisely because of rising financial asset prices. But currency devaluation alone can only ever be a beggar-my-neighbour policy, and advanced industrialised countries like Japan cannot sustainably compete on price. They are forced to compete on quality and value-added, which requires investment.

    It is a stated aim of policy to generate consumer price inflation. Yet no Japanese policymaker is proposing that wages should have a matching rise. If the policy is successful it will be highly damaging to living standards as inflation eats away at pay levels. A combination of increased asset prices, lower real wages and a weaker currency will boost profits. This is the real aim of policy, following the sudden lurch lower of Japanese profits in 2011.”

    If we thought that we had learnt anything from the travails of the 1960s and 1970s, it was that monetary expansion in the medium and longer run does not bring faster, sustainable growth. If anything, the opposite is true; faster inflation, at any rate beyond some threshold, deters growth. The long-run Phillips curve is vertical. It was on this analytical basis that the case both for Central Bank independence and a specific inflation target was made.

    Monetary stimulus is a short-term tool and in Japan’s case more about combatting the threat of deflation and whay is perceived as an overvalued yen. It is not a subsitute for structural and labour market reforms , industrial strategy and trade liberalisation that can get Japanese companies once again making the kind of investments in technology and innovation that formerly propelled them to the top of the economic league table.

  • Bill le Breton 24th Apr '13 - 8:16pm


    Paul and I, elsewhere, have agreed to differ on whether the devaluations of the Thirties were competitive and mutually destructive or just the result of countries getting their monetary policy right at different times and providing the impetus out of depression, as I would argue.

    If country A sets it monetary policy to best manage its aggregate nominal demand and as a result its currency depreciates its economic recovery will lead to more more imports from as well as exports to country B than would have occurred had its economy continued to stagnate under the effects of overly tight monetary policy. The quality of life in B as well as A improves.

    If B judges that it’s growth in aggregate demand is affected adversely it has only to ease its monetary policy. Result, both countries see growth, trade between both increases and we know the benefits of more international trade – it was the foundation of the Liberalism of Cobden and Bright. It is recession that imperils international trade not recovery.

    It is difficult to see how fifteen years of stagnation in Japan and the increase of their debt to GDP to 200% is better for ‘workers’ than a period of sustained growth of 2% in their incomes. Nothing improves the debt:GDP ratio more than growth – and vice-versa as the Quad are discovering.

  • Bill le Breton 24th Apr '13 - 8:23pm

    Forgot to point you all to this piece from 2009

    As Barry Eichengreen writes, “What mattered (in the 1930s) was that one country after another moved to loosen monetary policy because it no longer had to worry about defending the exchange rate. And this monetary stimulus, felt worldwide, was probably the single most important factor initiating and sustaining economic recovery. ”

    Japan’s lead today echoes the lead taken by Britain in the 1930s. Then, those that recovered best were those who were quickest to follow Britain.

  • Bill,

    I have never really considered there was a significant economic recovery in the 1930’s, just a climb out of severe depression and devestating rates of unemployment back to the meagre conditions that prevailed in the 1920’s and not even that in the North and South Wales. Unemployment was over 3m (20% of the workforce) in 1933 – two years after coming off the gold standard. The rest of the 1930s saw a moderate economic recovery stimulated by private housing. Unemployment fell to 10% in 1938. GDP did not return to pre-WW1 levels until 1938/1939, several years after rearmament had began.

    Professor Crafts article referencing this era and the early eighties is instructive Returning to Growth in the UK. On our current situation he comments:

    “If radical changes to monetary policy (price level targeting/higher inflation) are ruled out and fiscal consolidation continues, the implication is that reforms to supply-side policies have to play a significant part in any attempt to stimulate growth. The ‘good news’ is that there are plenty of evidence-based reforms that can strengthen the UK’s growth performance by improving horizontal industrial policies which have left much to be desired in the last 30 years. These include repairing a serious infrastructure shortfall (Kamps, 2005), institutional reforms to deliver higher quality schooling and improve cognitive skills (Hanushek and Woossman 2009), reforming taxation to reduce corporate taxes and expand the VAT base (Mirrlees et al. 2011), and addressing the massive distortions created by the land-use planning system which undermine the potential productivity gains from successful agglomerations (Cheshire and Hilber 2008). The ‘bad news’ is that these policy choices are very much exposed to government failure, are subject to implementation lags, and have their effects in the medium- and long-term.

    If there is one area that could deliver short-term stimulus and long-term efficiency gains, as in the 1930s, it is surely private house building. The evidence suggests that draconian planning restrictions mean that the stock of houses is three million below and real prices are 35% above the long-run free market equilibrium (Hilber and Vermeulen 2012). The welfare gains from some relaxation of these planning rules are huge and the employment implications of steadily addressing the housing shortfall could be considerable – building 200,000 extra houses per year might employ 800,000. This would require addressing issues of housing finance and incentivising local communities to want development because they can benefit from it and builders to believe that delaying construction would not be profitable (Besley and Leunig 2012). In principle, this could be achieved very quickly but, sadly, it is not politically acceptable so the Chancellor of the Exchequer may find himself in the role of Mr Micawber for a while longer.”

  • Michael Parsons 25th Apr '13 - 12:34am

    Thanks to Paul and Joe et al for reminding us that (as I said)the private banks create money and there are schemes to try to deal with this constructively. The undergraduate- textbook dream of a self-regulating monetary system or market-economy system is a dream and no more than a dream. A simple example: if an economy is specialising in an over-supplied product or one where it is “less efficient” devaluation via monetary outflows from a payments deficit simply increases the local-currency reward for that industry and does not correct the poor specialisation. This is where active government policy allocating resources to the depressed middle and working class needs comes in to play: debt cancellation, welfare support, rate and rent controls, investment in locally-based industries, direction of resources, exchange control etc. -there are tons of possibilities of varying attractiveness: the point is the private market economy has no in-built resilience, no log-run ‘normal’ full-employment equilibrium that it targets itself on. As I wrote above, with all that cash in idle balances still the big corps. do not invest…. and people’s lives or time once wasted are gone forever, not like unused physical resources or equipment that can be moth-balled and then switched on again. That is why austerity is unacceptable as well as being mistaken.

  • Bill le Breton 25th Apr '13 - 9:29am

    Joe, that Guardian article is unbelievably dumb. First the author declares that monetary expansion in the medium and long term doesn’t bring faster growth. Well that’s the whole argument of monetarists and of course not what market monetarists or the Japanese Government is suggesting. What they do argue is that in the short term monetary stimulus does have an effect on growth as firms sensing or expecting an increase in effective demand gear up to meet that demand. And they have the capacity in a recession to do this without pressure on wages. The short term and the long term aggregate supply curves are very different.

    The author clearly has no idea of the hot potato effect which is central to the argument for monetary stimulus.

    Crafts is very useful on lessons from the 1930s, as of course are Freidman and Swartz, who were the first to see that the cause of the Great Depression was tight monetary policy designed to prick the stock market bubble going on too long and too far. The Thirties like Japan’s lost decade were a series of over eager tightening stiffling repeated recoveries.

    There are strong arguments for investment in housing and other forms of infrastructure – and tragically political vanity is delaying their adoption – but you cannot predict or control the effects of such fiscal stimulus unless you factor in what the accompanying monetary policy is.

    As Professor Wren-Lewis writes here: “Fiscal multipliers are bound to depend on what monetary policy is doing. In principle monetary policy can offset the impact of fiscal changes on output, but if monetary policy is constrained in some way, it cannot. So any empirical study of the impact of fiscal policy must control for what is happening to monetary policy. I have often written about why high debt may be damaging to growth, but these effects work through raising real interest rates, or discouraging labour supply. It just seems foolish to apply them to a situation where real interest rates are unusually low, and output is hardly constrained by a shortage of labour.”

    The key concept evading too many is that it is in the PSBR that monetary policy and fiscal policy meet. You do not have to fund the PSBR in the gilt market. We could initiate a building programme (or any fiscal programme) and fund it through private bank lending to the public sector. Increasing the money supply, and placing the increased demand in the hands of those employed to construct the programme.

    Leaders have only to overcome their fear and their political vanity.

  • Bill,

    Simon Jenkins at the Guardian takes an opposing view to his colleague If Abenomics works, Britain’s leaders will look like monkeys . The title remined me of that old Japanese proverb “Saru mo ki kara ochiru. ”
    Literally: Even monkeys fall from trees – Meaning: Anyone can make a mistake.

    Jenkins says:

    “George Osborne should abandon the tribal morality of austerity and, like Japan, print money not for banks but for people.” Trouble is that is not what Japan is doing. Their QE is largely the same as the Uk’s i.e. buying of Japanese governments bonds in the secondary market.

    I am not sure I follow your reasoning when you say “You do not have to fund the PSBR in the gilt market. We could initiate a building programme (or any fiscal programme) and fund it through private bank lending to the public sector. Increasing the money supply, and placing the increased demand in the hands of those employed to construct the programme.”

    The gilt market is largely government borrowing from private banks and other financial institutions. It does not itself increase the money supply (bank deposits) merely transfer deposits from investors/financial institutions to the suppliers of goods and services paid by the government. The government would need to spend money into the economy that it has newly created (not borrowed from banks) to idirectly increase the money suppy i.e. use QE to fund direct spending or to make direct loans to the private sector (If the legal constraints of EU agreements can be got around as they have with the current QE arrangements).

  • Michael Parsons 26th Apr '13 - 12:04pm


    Sounds weird to me.
    Money borrowed from the private banks is an increase on the money supply(=bank debt). Banks issue money by adding it to their books and so promising to pay even though they have no real assets (except a few bank buildings and some equipment), since between them they have re-hypothecated any initial cash deposits.
    As to the bond market, it is sustained by QE granted at almost zero rates which the banks grab and lend back by buying bonds, so as to make a turn – sustained as long as their hold on the government and regulators can be used to “keep interest rates low for expansion” i.e. keep up bond prices and boost property prices and rob savers too: watch them unload the gilts on to pension funds and local authorities etc. as soon as interest rates look like rising and so bond-markets collapse!
    Of course the government needs to spend directly on employment and public works to resolve the current financially-induced collapse – and of course that means breaking the EU monetarist dogma – the sooner the better.
    Of course fiscal ;policy is the answer – along with ending all government insurance support for the non-retail banking sector, splitting “investment banking” from banking proper, ensuring the big losers can’t grab our retail deposits to try to cover their losses as the B o E now proposes to allow.

  • Michael,

    would agree with your prognosis “Of course fiscal policy is the answer – along with ending all government insurance support for the non-retail banking sector, splitting “investment banking” from banking proper, ensuring the big losers can’t grab our retail deposits to try to cover their losses as the B o E now proposes to allow”

    I am not getting my head around Bills suggestion yet “We could initiate a building programme (or any fiscal programme) and fund it through private bank lending to the public sector. Increasing the money supply, and placing the increased demand in the hands of those employed to construct the programme.” How would that be different to borrowing from private banks via government bond issues? Is it not just a different form of loan contract?

    Increasing the supply of money(M4) held by the non-government sector is effected by any of the following:

    1.Printing more notes – Seignorage.
    2. BofE electronically creating money to change their own bank reserves. Done under the policy of quantitative easing.
    3.A net increase in lending of money by private Banks to the non-government private sector.
    4.BofE buying government securities. i.e. Central Bank paying people in return for bonds. If the Central Bank buy Government securities (or corporate bonds) People who were holding the bonds have more money to spend. Banks see illiquid assets become liquid. Therefore, in certain circumstances this can lead to an increase in the money supply. However, it depends on whether the bond purchases are sterilised or ‘unsterilised’. Unsterilised means they create money to buy bonds.

    I am not seeing what is the purpose of funding the PSBR through borrowing from the Private bank sector as against the gilt market. The level of government spending would not change in any way as a result. Syndicated bank loans are a funding vehicle that are normally only used in the public sector by emerging countries that have not yet developed a sovereign bond market. Maybe Bill will elaborate further on how the mechanics of this could work for the the UK.

  • Bill le Breton 26th Apr '13 - 4:08pm


    Sorry to have missed this until now, Joe.

    Raising funds to fiance the PSBR through the sale of gilts sterilizes the process. As you say, the money created by Government spending is then destroyed as gilt purchasers have their deposits ‘destroyed’ in return for Treasuries. Money Supply Unchanged.

    However, let us assume that the Government orders and buys an estate of 500 homes from the house builder Persimarclays. It pays for these homes with an electronic transfer drawn on its account at the Bank of England. Persimarclays account at Royal Lloyds is credited. Royal Llords has a liability, but to match this Royal Lloyds account at the Bank of England is credited (money created by the Central Bank). The Government’s account shows a liability (but it does not finance this through the sale of gilts)

    The commercial bank, Royal Lloyds, has effectively lent the Government those funds and will receive interest on its account at the Bank of England. The Money Supply has increased by the cost of the 500 homes. Builders have made profits and will be encouraged to build more. Construction workers will have been employed and be purchasing goods and services. There will be an additional 500 social homes.

    It is a relatively recent phenomena to fully sterilize government borrowing. Which when the economy is running at full capacity is sensible – but in the present circumstances the monetary expansion increases output, raises confidence and produces the positive expectations that are needed to get people spending and firms investing.

    We would be defying Maastrict to do this – but that should go down well with our Coalition partners. It is QE but not as we know it Joe. Fiscal expansion and a matching (facilitating) monetary expansion.

    Why don’t central bankers come clean on this possibility – because they think that once politicians relearn this they will continue its practice after the output gap has been closed/after the natural rate of unemployment has been reached.

  • Bill,

    I see where you are coming if newly created loans are used to finance government expenditure that would not otherwise be undertaken. . It might even be a neat way around the constraints of the Maastricht treaty for deficit funding without increasing borrowings. IF QE to infinity is not a breach of the Maastricht treaty, then I am not so sure this would be either, particularly if there was a stated intention to repay bank loans with bond issues at some future point.

    There is a paper on this by a Professor Werner from University of Southampton Wener Euro Solution/a>

    Although this is primarily directed at the Eurozone problem, he argues that a switch in funding by bond issues to bank lending , which he calls ‘enhanced debt management’ . has a number of major advantages:

    1. The borrowing rate is substantially lower. Governments receive, according to Basel banking regulations, the lowest
    risk-weighting (zero). Thus they can borrow from banks at their favoured-client rate, which is the prime rate. The
    prime rate has been substantially lower than the sovereign bond rate throughout this financial crisis. In the
    case of Italy, we estimate that about E10bn can be saved in the next two years alone on lower interest charges.
    Furthermore, governments will deal with stable borrowing rates that are fixed throughout the loan contract period
    (say 3 years). Movements in the bond market become far less relevant.

    2. The banks do not have to mark these loans to market. Moreover, they are not affected by downgrades from credit rating agencies. This severs the vicious negative feedback loop between banks and governments. At the same time,
    however, the banks can use these loans fully as collateral with the ECB for funding, as the ECB’s announcement
    of 8 December 2011 makes clear.
    3. Instead of a negative feedback loop, there is now a positive feedback loop: banks will be happy to lend to governme
    nts, for one, because sovereigns carry a zero risk weighting according to BC BS rules. This means that banks will need
    zero new capital to back these loans.
    4. The main business of banks is to lend, but they are not lending to the rest of the economy due to their risk aversion. Thus they do not generate earnings to retain and rebuild their balance sheets. Through my enhanced debt management, banks will rapidly grow their balance sheets and earn decent income. Instead of primary market bo
    nd underwriters, such as Goldman Sachs, earning large fees in cosy relationships with semi-privatised public
    debt management agencies, banks will be the beneficiaries of this business.
    5 Despite the above major advantages, which alone would make this a no-brainer, the single most important advantage of switching public funding to loan contracts from banks has not yet been mentioned: it will boost domestic
    credit creation – turning bank credit growth from zero or negative growth to positive growth (of about 3% in the case of Italy). This will increase demand and the money supply, ending the current debt deflation spiral, and generate
    nominal GDP growth, in the case of Italy between 3% and 4% above the growth otherwise possible. (This is th
    e result of our empirical nominal GDP model based on our Quantity Theory of Credit).

    I am going to have to think about that last point a little more, which I assume is why you consider this an approach pursuing. , It is ceratainly an interesting take o the problems.

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