After the financial crash, the Tories persuaded the public that they were the only party who could be trusted with the economy. Osborne’s message went something like this:
“Labour crashed the economy. They did this by spending too much, borrowing too much, and letting the budget deficit get too large. In order to create a strong economy, we need to get the deficit down. And the only way to do this is to implement spending cuts until our deficit reaches zero again.”
This narrative was a huge political success. Even now that we have a new Chancellor, and a supposedly new approach, the Conservatives still hold onto the reputation of being the only economically sensible party, built on the foundations laid by so-called Osbornomics. The problem is that it is absolute nonsense.
Their economic narrative is flawed in three ways.
1) Labour’s spending didn’t crash the economy. The economy crashed because there was a global economic meltdown. In response to this, Labour bailed out our banks, and made other investments to stimulate growth, leading to the large budget deficit. This approach was not loony-left economics. Many Governments of different political leanings did the same thing, including George W Bush – a right wing American President. The credit crunch led to the budget deficit. Not the other way around.
2) Austerity is not the only way to eliminate the deficit. A budget deficit is the difference between what the Government spends and what it takes in through taxes. One way to try to get the deficit down, is to cut Government spending. But if these cuts make people poorer, then those people will pay less tax, potentially widening the deficit again. Another approach is to invest in the economy, make people wealthier, and hence raise more money in taxes. The idea that pure austerity is the only way to eliminate a budget deficit is a fallacy.
3) Having a budget deficit of zero is not a requirement for a healthy economy. The Conservatives have successfully pedalled the narrative that money spent by the Government must equal money received by the Government in any given year. But this totally disregards the principle of investment. Borrowing money can be entirely sensible, if that money is then invested in an area which brings economic benefits down the line. Take mental health for example. If we were to borrow a large amount of money to invest in mental health, we would make that money back, because good mental health treatment allows people to contribute to the economy again, rather than living on welfare. This is without even mentioning the huge human suffering that this investment would alleviate. But it’s so hard to push for this perfectly sensible investment, because the Tory economic narrative says that borrowing money is irresponsible, and the public will no longer allow it.
The Lib Dems must fight against this economic message. It does a great deal of harm, and gives the Conservatives an undeserved reputation as the only party who can be trusted with the economy. But Osbornomics was a lie. The Tory message is flawed. And Labour did not crash the economy.
* Ben is a Councillor in Sutton, and the Vice Chair of the Environment & Transport Committee at Sutton Council. He has been a member of the party since the 2015 election, and used to work for the Sutton Liberal Democrats as a volunteer organiser. Ben now works for a charity promoting the greater use of Restorative Justice in the criminal justice system.
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125 Comments
Thank you. I see the message that Labour Crashed The Economy repeatedly from Liberal Democrats, and it enrages me, because New Labour’s economics were never my problem with them.
Having a budget deficit of zero is not a requirement for a healthy economy.
No it isn’t!
The way to look at the problem is to consider that money originates with government spending. So, logically, the spending has to come first, otherwise there is no money in the economy to pay taxes that governments levy or buy the bonds that govt sell.
Then money returns to the government in taxation. The difference between what has originally been spent into existence, and what comes back as taxation revenue is, in any one time period, the deficit.
So, again logically, the government can’t consistently receive back in taxation more than it spends. It’s just not possible. It has to be in overall deficit.
While admitting the truth, eventually, is always welcome the anger many will feel at the Liberal party for their disgraceful and disasterous role in concretising and fascilitating this march toward societal ruin will be long lasting. Its good to have some support in the long climb back towards economic and political sanity but for many trust will be a hard thing to build. An end to the characterisations of Corbyn & McDonnell’s economics as any further Left than tradditional Social Democratic fare would be a start.
@Ben Andrew
“Osborne’s message went something like this:
‘Labour crashed the economy. They did this by spending too much, borrowing too much, and letting the budget deficit get too large. In order to create a strong economy, we need to get the deficit down. And the only way to do this is to implement spending cuts until our deficit reaches zero again.'”
I’m not sure that Osborne said all of that, actually, although I’m sure he said some of it.
For instance he may well have said “In order to create a strong economy, we need to get the deficit down” and I don’t know anyone who would disagree with him if he did.
In order to avoid Straw Man concerns, Ben, is there any chance of you linking to things Osborne actually said rather than what (probably) the Labour Party said he said?
” I don’t know anyone who would disagree with him if he did [say we need to get the deficit down] .”
Maybe we could go out for a drink? You’d know me then!
Following on from what I said above, it follows that the difference between what government spends and what it receives back in taxes is the amount of money that everyone else some hangs on to. ie Saves!
So, you may not know anyone, yet, who thinks the deficit doesn’t need to be reduced but you will, I would guess, know plenty of people who think we should all save more.
It’s one and the same thing. No difference at all!
@Andrew Ducker
“I see the message that Labour Crashed The Economy repeatedly from Liberal Democrats”
Really? “Repeatedly”? Are you quite sure about that?
1) “The economy crashed because there was a global economic meltdown.”
There is always a global economic meltdown, either; present, past, or coming. They received an economy in 1997 in tip-top condition, and then proceeded to ratchet up spending based on specious assumptions about future growth projections.
2) “Another approach is to invest in the economy, make people wealthier, and hence raise more money in taxes.”
No, everyone tries to make people wealthier, so the other approach is to raise taxes. Unfortunately for wishful new-laborites Britain has never had the recognised a sense of collective community that permits taxation north of 45% of GDP. Labour had already increased tax as a proportion of GDP to the outer bounds of historic norm, so they had no room to maneuvre when the bad times arrived.
3) “Having a budget deficit of zero is not a requirement for a healthy economy.”
Sadly for you, you have a mountain to climb as far as public trust goes when it comes to golden rules promising borrowing only for investment. Remember the assurances that Gordon’s nascent tax-credit empire would only cost a few billion per year, well, i remember it sprawling into an uncontrollable labyrinth that cost many times that amount. “Pull the other one!” will be the public response.
@Simon
The reason I said “Osborne’s message went something like this” as opposed to giving a verbatim quote from a speech, is because this is a narrative that he and the Tories were pushing non-stop for literally seven years. It was it’s relentless repetition which allowed this message to become so firmly lodged in the public mind.
If there’s any individual part of that message which you do not think was party of the Conservative narrative – then please do flag it up.
@Peter Martin
” ‘ I don’t know anyone who would disagree with him if he did [say we need to get the deficit down] .’
Maybe we could go out for a drink? You’d know me then!”
Are you seriously suggesting that a deficit of £150,000,000,000 a year (which is what the Coalition Government inherited in 2010) was sustainable? Even Labour, to give them credit, wanted to get that down In order to create a strong economy.
Incidentally, when you and Ben say “Having a budget deficit of zero is not a requirement for a healthy economy” I’d totally agree with you, it’s just that it’s another Straw Man argument.
I thought the Lib Dem position is that Labour was negligent during a time of plenty in their oversight of the financial sector (Tories were for even more laissez faire) and that they abandoned Keynesian restraint at this time (spend in a downturn, save in the upturn).
Other than that, I agree with Simon that it is mostly Labour who are saying that they are accused of having “crashed the economy”. Even articles like this reinforce this rather misleading, but pervasive message. So far as a message goes it is an own goal.
Nonetheless the Tories may very well actually crash the economy, an unforced error, in which case past crashes will have less significance.
Of course Fannie Mae and Freddie Mac – despite being US supporters of George Bush in 2008 – were also known to be prominent members of the Brown Cabinet according to Clegg/Alexander.
As to what the Lib Dems said in government – time after time they trotted out exactly the same Osborne/ Cameron litany about Labour crashing the economy. Any search of Hansard of the comments of Clegg at deputy pm questions and Alexander at Treasury questions will reveal countless nuggets of this.
@Martin
“and that they abandoned Keynesian restraint at this time”
If that is the Lib Dem position then it is a hypocritical as the Tories, given that both the Tories and the Lib Dems had an identical commitment to Labour in keeping the national debt below 40% of GDP in their 2005 manifestos. There was nothing from the Tories or the Lib Dems saying that the debt needed to be paid down further from the increased tax revenues and nothing saying that spending needed to be more restrained.
The ‘Labour were reckless with public finances’ narrative only began to be formulated after the event.
@Ben Andrew
“The reason I said “Osborne’s message went something like this” as opposed to giving a verbatim quote from a speech, is because this is a narrative that he and the Tories were pushing non-stop for literally seven years. It was it’s relentless repetition which allowed this message to become so firmly lodged in the public mind.
If there’s any individual part of that message which you do not think was party of the Conservative narrative – then please do flag it up.”
Thanks, Ben. In terms of a part of the alleged Tory message that I have particular doubts about I’d refer to this:
“And the only way to do this (i.e. to get the deficit down) is to implement spending cuts until our deficit reaches zero again.”
I’m not aware that Osborne (or the Conservatives) ever said that. I think it was always stated that it was a combination of growth and spending cuts that would get the deficit down.
The more important issue is why you think that Lib Dems should defend Labour. I happen to think that some of the economic criticisms of Labour by the Conservatives are unfounded, although many are well-founded. It’s just that the alleged Tory criticisms aren’t always what the sort of people who post comments on the Guardian website claim them to be.
But, when Labour are now led by people like Corbyn and McDonnell, do you really think that defending Labour’s economic record is the right thing for Lib Dems to do? Even in Sutton?
The issue is not that New Labour crashed the economy; as Ben rightly says they were not responsible for the global banking bust. No, New Labour’s failure was to claim that they had ended ‘boom and bust’ as the quotes below illustrate.
https://www.theguardian.com/politics/2008/sep/11/gordonbrown.economy
While preaching fiscal prudence, Gordon Brown as Chancellor continued to fudge his figures by repeatedly extending the end point of the economic cycle so that he could carry on running a deficit. As long as the banks were providing large amounts of Corporation Tax for the Treasury, this deficit appeared manageable but the crash of 2008 exposed it. As Warren Buffett famously said of the crash “Only when the tide goes out do you discover who’s been swimming naked.”
Ben also might have done better with point 2) of his posting, had he admitted that you can also reduce a budget deficit by raising taxes. This seems to be a taboo subject for Liberal Democrats these days, but to deny this is to accept that a Tory Chancellor always knows what the right level of taxation is. 1p on income tax for education was one of our strongest policies, yet no-one seems to want to discuss the trade-off between taxation and the level of public services.
Actually during the leaders debate Nick Clegg said
“This is the man who was part of the Government who said no boom and bust in our economy and crashed our economy,” He challenged Mr Miliband to apologise explicitly for the financial crisis.
And speaking on LBC Radio
” IT was verging on the bizarre that the Labour Party thought they had anything to teach anyone about the banks because they are single handedly responsible for the biggest collapse in our banking system in the postwar period.”
It is refreshing to see an article on LDV admitting that Labour did not crash the economy, it was a worldwide banking crisis.
I don’t recall that being the message that some LDV contributors were giving though during the coalition years
In response to the Great Depresiion in the US in the thirties, Henry Ford doubled his workers wages. His business friends were aghast apparently saying , why didn’t you use your money to invest in more efficient mahines and sack some workers? His reply was’ “Machines don’t buy cars”. As I have tweeted earlier, Welfare cuts = cuts in aggregate demand = recession/depression.
What is needed is an alterntive economic system that reduces income inequality at source. Susan Kramer already has in her possession the ideas that could bring this about
This is a pointless article, its just normal politics that the Party in charge gets the benefit of booms & the blame for crashes, unfair but normal. Labour made it worse for themselves with all the nonsense about having “abolished boom & bust.” That suggested a combination of arrogance & stupidity, just what you dont want from a Government.
On the Economics, debts cost money to service, surpluses make money: it really is as simple as that. In the long run it makes sense to get rid of debt & build surpluses. That is worth saying because in the short run their is always stuff that needs money, the temptation is always to leave debt to the future.
We did a huge disservice to progressive economics and politics by siding with Osborne on austerity and blaming Labour for the crash. It was the banking sector, the pinnacle of our unequal economic system, not Gordon Brown and a few spin doctors. About time we look to the cause of the problem and identify the evils of capitalism, otherwise we’ll never come up with real solutions or connect with lost Liberal voters again.
It is an inescapable fact that the Bankers and other financial institutions bought about the collapse in Western economies and continue to do so to this day. But encouraging bank mergers, failing to apply surplus monies at infrastructure at an earlier date and a completely laissez faire to the financial services industries was an error of massive proportion. No Labour didnt cause the financial collapse but contributed to it. If I can example one area which I found particularly nonsensical was the PFI initiative which will cost this country billions to extricate itself
The economy was in a very precarious position in 2010. We had the threat of going the route of Eire or, even, Greece if we weren’t careful. Reducing public expenditure was an agreed stance: both the Lib Dems and Labour supported making cuts in the campaign, the arguments were about how much, when and where, not whether.
The “Labour ruined the economy” was of doubtful veracity (although Vince did warn them!) and of limited relevance: we were in a hole and the point was not to attribute blame but to get out of it.
And get out of that hole we did. It wasn’t pleasant, it wasn’t pretty and we didn’t avoid all the pitfalls but by 2015 the Coalition had brought a measure of stability and put us in the position were the next parliament could be about easing up a little, investing a bit more and trying to get some of the benefits down to those hardest hit by the downturn. In other words, crisis managed: let’s look forward.
Unfortunately the electorate didn’t want to know, the Lib Dems got kicked out and the Tories were left on their own to take austerity to be a long term plan rather than a short term neccessity.
As far as trusting with the economy goes, though, this pales into insignificance next to Brexit. Brexit will damage the economy and hard Brexit will damage the economy catastrophically. Continued austerity shows we disagree with the Tories about the best way forward on the economy. Brexit shows they simply cannot be trusted at all on the economy. Neither can Labour, with their sudden enthusiasm for Brexit and opposition to continued membership of the single market.
Arguing about austerity, fiscal stimulation, quantitative easing and the like when looking at a hard Brexit is like arguing about fuel consumption as you steer towards a cliff.
Only the Liberal Democrats can be trusted with the economy.
So a few things to clear up:
1) Do the Lib Dems support the Tory economic narrative? Not always, but many Lib Dems do, and few do enough to attack it. Matt is spot on with his examples.
2) Why should we defend Labour? We should certainly feel free to attack Labour’s economic policies where appropriate, as some of you point out, but we shouldn’t allow this Tory lie to survive. First of all because it’s misinformation, but second of all because it seriously harms our interests. We don’t want an electorate who believe that the Tories are the only sensible economic option, or that borrowing money is economic suicide. Because, as I said, this is a huge road block in our crusade for policies like large investment into mental health services.
3) Am I strawmanning the Tory message? No, absolutely not – that is the message which they have pushed for 7 years. They wouldn’t necessarily say it in as plain terms as I did in my summary, but that was the narrative. Just look at almost every PMQs between Cameron and Milliband, where Cameron would attack by saying something along the lines of. “we’re clearing up the mess that we inherited, and that’s why we have to eliminate the deficit with austerity, and fast.” Another example that comes to mind is the leaders Q&A in 2015 – watch from 8:40-9:45 “Ed Milliband wants even more borrowing, even more spending, even more debt, all of the things which landed us in this mess in the first place. I never want us to go back there again.” Stone cold liar. https://www.youtube.com/watch?v=7q2E1SNspYs.
And in response to Simon – yes they wanted to stimulate growth, of course, but the policy which they were defending the entire time was rapid austerity, in order to eliminate the deficit. They were arguing that rapid austerity would stimulate growth and help to eliminate the deficit (a seriously dodgy argument) but the ultimate method which they were defending was the “cut cut cut and eliminate the deficit” approach.
4) Can we reduce a deficit by raising taxes? Yes, certainly, I should have mentioned that.
I understood at the time that we were claiming that Labour had risked the economy (not ‘crashed’ the economy) through not challenging the culture of de-regulation and through trying to institutionalise a system where high tax yields from an overheating economy funded a relatively high level and sometimes unwise targeting of spending on the public sector, that made ongoing investment to fund infrastructure etc through the downturn more difficult, and possibly ruled out a quicker recovery.
However, we seemed to say (pre-2010) that Labour had done some of the right things, late, to address the crisis, and that this should be respected.
By contrast, I understood the Tories as saying that Labour had always been simultaneously overspending and over-taxing, and that this was always bad, and that doing the right thing in the crisis was irelevant. They also neglected frequently talking about what had caused the crisis, deliberately downplayed the global factors and by omission therefore implied that labour had caused the crisis.
By dint of two factors – 1) that our message was more nuanced, and 2) that incidents like the ‘no more money’ letter, combined with poor discipline in rhetoric from our leading ministers, seemed to merge the two arguments – our message was lost, or perceived as being the ‘same’ as the Tory message.
Our rhetorical emphasis on the defecit – which was shared with Osbourne, although our proposals about how to address it were markedly different – meant it was too easy for people to assume and allege that we believed overspending caused the crisis.
The public did not and does not differentiate between ’caused the crisis’ and ‘worsened the impact of crisis’.
The other issue – for me – was the longterm dualist political perception (going back years…) that Tories ‘always’ criticise Labour for financial incompetence, and Labour ‘always’ criticise the Tories for unnecessary cuts. (People tended to resolve this during the Blair era by assuming that there was an element of truth on both sides, thereby hoping for a world in which no cuts were necessary and no-one makes mistakes because nothing unforeseen happens).
So when we stood alongside a Tory minister, proposing cuts, and criticising Labour for financial incompetence, it was much, much too easy for people to assume that all the cuts we were proposing were inherently bad (and to be honest, some of them were), and to forget that we had already pointed out that Labour had been panicking and making unnecessary and cruel cuts themselves. Cutting and criticising Labour was what Tories did. When we did what they did (whatever the difference of detail), we had ‘become’ Tories. This concept, once established, was capable to being transferred to a whole range of other policy areas.
What Labour under Miliband did not realise was that by indulging this dualism as a tactical tool, they handed Corbyn the future leadership of the party and were undermining the concept of social democracy. (Because all cuts to spending=compromising-your-principles=Tory=bad).
I agree with the author apart from one important detail. The New Labour government was part of the neoliberal concensus that supported light touch regulation of the financial sector and this was a major contribution to the 2008 recession. Prior to the 2010 general election the British economy was starting to grow again and I think we should have continued the Labour policy at the time. Osborne’s policy brought the economy to a shuddering standstill and I opposed it which was why I was one of a handful of Lib Dem members who attended the special conference who voted against the Coalition. It was Nick Clegg’s decision to put David Laws in the driving seat on economic policy – and later Danny Alexander and not Vince Cable and I think that was a choice based on ideology. David Law’s book on the Coalition shows that Vince Cable was clearly sidelined. John Maynard Keynes remarked on the paradox of thrift which is well described by the author in this article.
“Labour did not crash the economy” is true in the sense that had the Tories been the government then exactly the same things would have happened.
How can I be so confident in saying that? Because during the build-up to the crisis while Northern Rock and RBS were engaged in dangerous business practices and we had an economy whose growth was largely dependent on consumer spending and increasing house prices (does that sound familiar?) both sides attacked Vince Cable as a Cassandra for pointing out the risks of a collapse.
But in the year or so before the last General Election, opinion polls regularly showed that the public had absolutely no confidence in Liberal Democrats as custodians of the economy. Polls would typically show just 3% or 4% of voters thought the Lib Dems had the best economic policies, even when the party itself was polling at 10% or so.
I see no point in revisiting the reasons why the party in coalition and during the 2015 GE failed to fully utilise its most credible economic spokesperson. But I’m afraid it is now probably too late for the Lib Dems to salvage anything. Cable is no longer in parliament and the party has no crediblity in these matters.
@Simon Shaw,
You ask:
“Are you seriously suggesting that a deficit of £150,000,000,000 a year (which is what the Coalition Government inherited in 2010) was sustainable?”
That’s £150 billion in case you are wondering whether I appreciate the magnitude of the number.
That was quite exceptional as after the the population largely stopped borrowing and started saving and the GFC.
But I’d just ask you if you appreciate that the Government’s deficit has to equal everyone else’s surplus? And if you appreciate that a criticism of the Government’s deficit is also criticism that everyone is saving too much.
The big savers are our overseas trading partners who, in aggregate, sell us more than they buy and save the difference. If you are worried about that you’d have to welcome the recent fall in the value of the pound which should go some way to reducing the trade imbalance.
Labour moved bank regulation from the Bank of England to a new organisation, the FSA.
The FSA failed to regulate bank lending, allowing banks to lend too much, at too low interest rates, to projects which were too risky.
Whilst the directors of the banks are firstly responsible for controlling their lending, the regulator’s sole job is to stop bad lending and didn’t. Labour has to accept responsibility for taking bank regulation away from a competent Bank of England and passing responsibility to a new, incompetent FSA.
Why bother defending the Blair-Brown governments that even Labour is not defending now? We should live mainly in the present and the near future. David Cameron gambled on an EU referendum and lost. The result is an upcoming crisis that will affect the UK
as soon as Wednesday 23 November 2016. The message to young people is VOTE!!! It is your future !!!
Bankers get a lot of the blame for the financial crisis and deservedly so, but there were very large numbers in an unregulated market in financial derivatives based in Mayfair.
British Conservative politicians are supposed to support sound money, but Republicans in the USA ( before Trump) no longer do. Their objective is to weaken the federal government so that an incoming Democrat President is severely constrained in what he or she can do. Both Bill Clinton and Barack Obama inherited economic crises of this kind. Bill Clinton left a large surplus which George W. Bush proceeded to spend by cutting taxes for the rich and invading Iraq.
John Maynard Keynes was a brilliant economist, but his advice was not always taken. After World War One he said that defeated Germany could not afford to pay reparations. In 1929 the Liberal Party in the UK fought a general election saying “We can conquer unemployment” because governments can borrow at times of deficit if they repay at times of surplus. That election was also affected by the enfranchisement of women aged 21 to 30. After World War Two Keynes was sent to the USA to ask for financial help so that the UK could a welfare state including a National Health Service that Americans did not have themselves. They were reluctant. The work was exhaustingly achieved but cost him his life. Universal health care in the USA was achieved by the Obama presidency, but is now at risk.
@ Richard
You ask “Why bother defending the Blair-Brown governments that even Labour is not defending now?”
The simple answer to that question is that any Govt whether it be the Lab B-B or the Tory Thatcher govt should only be criticised when they get it wrong. The deficits run by both weren’t that different. Thatcher’s were a little higher.
If we consider the UK as whole, running a current account deficit, then we can see that someone in the UK has to fund that deficit by borrowing. Now, for any particular level of trade deficit, if we think the Govt borrowed too much then it must follow that we think everyone else in the UK borrowed too little. But do we? Are we that logical?
Of course, the other option would be to have devalued the pound to reduce that trade deficit. Is that what we think the B-B govt should have done?
Laurence Cox’s (21st Nov ’16 – 11:24am) post above is absolutely spot on.
While other factors were at play (light touch regulations, over exposure of markets to bad debt) Labour still bare significant responsibility for trying to put off the basic economic truth that economies run on cycles. you cannot avoid the boom bust cycle. It is impossible. As Laurence says by brown massaging the figures and delaying the downturn, the effect was we were in a much worse place to be hit when the down turn came (due to too high government debt at the top part of the cycle giving no room for government borrowing when needed at the bottom end).
Really good post by Laurence.
the clever thing Osborne did was to make out that he/the Tories were going for full out austerity/deficient reduction. this reassured the debt markets, stablised the pound and kept liquidity while….. actually not implementing full on hard core austerity. He was much closer to Darlings economic plan than is often said.
clever give perception of one thing, while doing what was actually required.
@Peter Martin – “So, again logically, the government can’t consistently receive back in taxation more than it spends. It’s just not possible. It has to be in overall deficit.”
Of course it can. The amount of money in circulation is massively more than Government spending in any one year. Governments can and do run surpluses, sometimes for years at a time. And when a Government runs a surplus it usually uses it to pay back debt i.e. it meets it’s obligations to give money back to someone. This doesn’t take it out of circulation – it just puts it back elsewhere to be invested or lent to someone else.
The 2007–2012 global financial crisis was an unintended consequence of Margaret Thatcher’s 1986 “Big Bang”. UK investment banks, previously very cautious with what was their own money, had merged with high street banks putting depositors’ savings at risk and forced US banks to follow suit….
Not my words, but those of Nigel Lawson; Thatcher’s Chancellor at the time…
Ben’s previous article was excellent so I was surprised to read this, which I think misses the mark.
Of course Labour didnt cause the global financial crisis, and I dont know anyone who said they did (even crazy Tories!) What they did do was make it much worse for us than it should have been, and much worse for us than it was for most other comparable countries. If people want to call that “crashing our economy” then that’s hardly a lie – it’s a slogan no different to countless others. Or perhaps this is all really an argument about the semantic difference between “crashed the economy” and “ruined the economy”?
Let’s look at the facts:
Labour ran a deficit of nearly £50bn during a boom (over-spending and under-taxing simultaneously) – which meant a structural deficit of nearly £80bn at that time! They also failed to take any action at all to cool private debt growth or the insane rises in house prices between 2005-8, when Vince Cable was warning about debt growth. Keynes, remember, said that debts should be paid down during booms (to ensure counter-cyclic spending, and take money out of a heated system) not that deficits were always good.
And on top of that, Gordon Brown’s financial deregulation and balancing of the entire economy towards financial services made our economy extremely vulnerable to exactly the kind of crash that occurred. Have we forgotten that in 2004 he told an audience of bankers that “in budget after budget I want us to do even more to encourage the risk takers”? When in 2008 he just kept repeating that “we’re well placed to weather the storm” in fact the opposite was true.
Paul Murray makes the critical point that if it had been a Tory govt we would have said exactly the same thing. It wasn’t being anti-Labour – it was being anti-incompetence.
And we actually did very well to start the repair of the mess that the Labour Party left the economy in and leave this country with the strongest growth of any comparable economy over several recent years.
To the people who are saying that Labour made the crisis worse by not building up a surplus during the good years, I probably agree. And we should certainly argue that point. But that is not what I’m focusing on here.
My deep concerns are that the public’s view of the economic story since 2008 is pretty much summarised by Osborne’s message: “Labour borrowed and spent so irresponsibly that they crashed the economy and now we need to clear up the deficit so that it doesn’t happen again.” To those of you, like mark, who say that that wasn’t the Tory message, I very strongly disagree! Osborne might have fudged it a bit when directly asked “did labour cause the global economic crisis” (there’s only so much you could get away with lying to someones face before 2016) but they did everything in their power to push the narrative that this was all labours fault, and the public have bought it. I’d point you to the clip from the leaders q&a which I posted above. Cameron doesn’t say “labour crashed the economy by borrowing too much” but he heavily heavily implies it. Most people have a very basic understanding of economics (because it’s so complicated and boring and they don’t tend to invest the time to developed nuanced economic views). And the simple one line which I think most people have in their minds about economic logic is “labour crashed the economy by spending irresponsibly and the Tories cleared it up by cutting the deficit with austerity.”
This view point is a *disaster*. And I’m not writing this to defend labour, they can defend themselves if they want to. I’m writing this because the public having this view of borrowing and spending is very damaging to our priorities. Mental health is one example I mentioned above of where borrowing to invest would be a good idea – this also applies to childcare, prisons and many other areas. But it is very difficult to advocate these things when the Tories can turn around and say “wheres the money coming from?” and if the answer is borrowing then the public mood is against you at once.
I genuinely believe that more people think that the deficit caused the crash than that the crash caused the deficit. This is a very serious problem, and creates an over paranoia about borrowing to invest which helps no one but the Tories.
I think the most important point here is that we should not be talking about Labour at all. Labour are no longer in the same game as us, they have abandoned mainstream Politics, for us they no longer matter.
Look at the current Polling average on “Britain Elects”. Labour seem to be doing OK on 29% but we are coming up to mid-term when The main Opposition is usually ahead. Currently Labour are 13% behind. Compare that with 5 years ago, at the same point in the last Parliament when Labour were around 3-4% ahead of The Government & then remember that come The Election in 2015 they were 7% behind. Comparing the 2 cycles its not unreasonable to suggest that in 2020 Labour can expect to be 20-25% behind The Tories. In short Labour can expect to come in around 20% of the vote.
There is no point attacking or defending Labour, they are on the way out.
@ Nick Baird,
You don’t seem to understand what a govt surplus is. It’s just money that the government receives in taxes that goes into the shredder or the digital equivalent. ie The delete button! The pound is an IOU of govt so it can’t repay debts by handing out its own IOUs to someone else. It can only reduce its debt by destroying its own IOUs.
So if you leave your estate to “pay off” the govt’s debt, the numbers just get deleted in the Govt’s computer which reduces govt debt.
@Cllr Mark Wright
” Keynes, remember, said that debts should be paid down during booms”
This would be for the special case when there is no net saving occurring in the economy -over the course of a business cycle. If we divide net saving into saving by the domestic and overseas sectors then:
Govt Deficit = Domestic Saving + Trade Deficit.
The Govt cannot do much about its own deficit when the trade deficit is as significant as it is. (George Osborne discovered this the hard way) . It can reduce it somewhat by encouraging us all to borrow more which means the first term becomes negative.This tends to happen naturally in the upswing part of the cycle.
David Raw
The blaming of the erstwhile pairing you allude to , they being not people , but well intentioned lenders to the lower paid to become home owners , founded by FDR, played into the hands of the right in the US, to no avail with Liberals like me , or many .The bankers or non profit motivated , whoever, may have all had about the same level of blame attached in some eyes , not mine. If Fannie and Freddie got rich but Mr and Mrs Average got homes, good ! I lost mine and Mr. Blair and Brown gave no help !
There were enough signs of overheating in the economy in the years leading-up to the crisis to have warranted a much more cautious approach to public spending on working tax credits by the government of the day. The massive increases in consumer debt in the noughties and accelerating housing bubble were both strong indications of looming trouble, as Vince Cable was warning. Gordon Brown chose to dismiss these warning signs in the lead-up to the 2005 election and in the build-up to the crisis.
To Labour’s credit, when the crisis came, they did act decisively in implementing a Keynesian approach and maintained public spending in the face of collapsing tax receipts to head-off a major depression. But then so did virtually every other government of all political stripes.
Osborne had to back-track on his plan for eliminating the deficit in one parliamentary term after a relatively short period of time and where we have ended up is pretty much in line with the plan Alistair Darling set-out in the 2010 election.
Deficits do matter. As debt levels grow, an ever greater proportion of tax receipts are required to pay interest on those debts. In recent years this has been mitigated by historically low interest rates, but that era may be coming to an end. As debt service costs increase it becomes ever more difficult to reduce deficits and to allocate adequate spending to needed public services and welfare.
As Einstein once said – “Compound interest is the eight wonder of the world. Those who understand it – earn it, those who do not – pay it.”
@ Joseph Bourke,
“Deficits do matter. As debt levels grow, an ever greater proportion of tax receipts are required to pay interest on those debts.”
Deficits matter if they lead to overheating in the economy which can cause inflation. That’s all. End of story.
Interest on loan payments doesn’t come from tax revenues. In fact it is questionable whether we can consider what is normally termed government borrowing to be borrowing. If I borrow a bag of sugar from my neighbour I can issue him with an IOU for the sugar. If I want to borrow more sugar then I can issue him another IOU with a promise to pay him back more sugar that I borrowed.
But I can’t borrow back my own IOUs. Government can’t borrow its own IOUs either. All it can do is swap one type of IOU for a different type of IOU. It can choose whatever interest rates it pays on those IOUs. The payment comes, of course, from the mechanism of issuing new ones. The UK government, unlike the French government which doesn’t have its own currency, can issue as many as it likes.
@Peter Martin
The UK Government ran budget surpluses between 1988 – 1990 and 1998 – 2001, despite your claim of their impossibility.
During those years, the Public Sector Net Debt went down.
@Nick – Peter has some unorthodox views on deficits and has argued them here many times. I’ve given up arguing with him!
I 100% agree with Mark Wright’s analysis (5.32). Labour were complacent and incompetent with the economy and contributed to the crisis enormously by their loose economic policies. We did the right thing to start to help sort the mess. We should be proud of this, not apologetic.
Is it right that in the last 40 years budget surpluses were run in only five years? Despite the largess handed to us via North Sea Oil? And yet some will only blame Labour for not basing their economic policies on Keynes?
Remarkable, simply . . . . . remarkable !
Peter,
inflation is precisely what we have seen for the past 15 years – not so much in consumer prices or wages where the effects have been offset by globalisation, but in asset prices – principally stocks and property. This has led to the situation where housing costs are absorbing more and more of wage income each year. This trend was evident long before the financial crisis hit.
Prior to the financial crisis the house price inflation was fuelled principally by the avalanche of new money supply arising from the creation of private credit by lending institutions. Since the financial crisis it has been sustained by central bank intervention in the form of near zero interest rates and quantitative easing.
Holder’s of government and private debt (via interest payments) have a call on the future economic value created by UK businesses and workers in the same way that landowners have a call on economic value produced via economic rents. This is Piketty’s argument in “Capital in the 21st Century” where he argues that we are seeing a return to the kind of inequality not seen since before the first world war.
Just to emphasize this one more time – the point of my article is NOT to defend Labour’s entire approach to economics. The headline might be misleading in this regard.
My point is that the Tory economic message which I summarize at the start of the piece is extremely dangerous and has been swallowed by most of the public. I think we need to fight against this narrative, not to clear Gordon Brown’s name, but so that we can achieve more of our prioriites looking forward.
@ Cllr Mark Wright
I don’t remember hitting the height of an economic cycle in the years 2005-08, this is because I measure the height of the economic cycle by the level of unemployment. There was a small dip in 2004-05, but after that it was rising above 5%. It would have been silly of the government to reduce the deficit while unemployment was rising.
If the coalition had not made such deep cuts in 2010-12 but kept to Darling’s spending plans our economy would be bigger now and the costs for people would have been reduced. The blame for this must lie at the door of David Laws, Nick Clegg and Danny Alexander.
@ Joseph Bourke
The National Debt has increased nearly every year since 1692 and rarely since 1946 been reduced (c 1949, 1957, 1988-91, 1999-2001 and any decrease has been very tiny http://www.ukpublicspending.co.uk/spending_chart_1692_2020UKb_16c1li011tcn_G0t). The reason this increase in National Debt is not a problem is because of economic growth and inflation which keeps the debt servicing costs proportional.
@ Simon Shaw
According to UKpublicspending the National Debt in 2009 was £769.69 billion and it didn’t reach above £1500 billion until 2015.
Michael,
Interest costs on public debt have doubled since the financial crisis to 49 billion, more than the entire defence budget. That is in a period of historically low interest rates. They are projected to reach 60 billion by 2010 or around 7 to 8% of government spending based on a continuing low interest, low growth and low inflation rate environment. We will get updated OBR forecasts on Wednesday.
If we are preaching financial prudence and forward planning then preparing for the management of a future rise in interest costs is a necessary element of economic planning.
correction – projected to reach 60 billion by 2020
I’m glad you’ve said this.
That’s not to say that everything Labour did was perfect, but it was just a bit too convenient for opposition parties to blame them during the election campaign, and to keep that message going in the aftermath. These lies became so embedded, that even Labour themselves gave up on trying to challenge them, as the media just scoffed at them when they tried.
I have many issues with Corbyn, including his own inability to recognise much of the good work his predecessors did in power, but he did at least challenge this presumption that the global financial crash was all the fault of the UK Labour party, and I think that’s part of his appeal.
@Nick Baird,
“The UK Government ran budget surpluses between 1988 – 1990 and 1998 – 2001, despite your claim of their impossibility. During those years, the Public Sector Net Debt went down.”
I said they were impossible overall. ie sustainably. But yes, if the Govt creates a credit boom as Nigel Lawson did in the late 80’s and we also had with the dotcom boom of the late 90’s then it is possible to generate a surplus for a year or two. But what follows credit booms? Is a surplus such a good idea?
@ Cllr Mark Wright “Peter has some unorthodox views on deficits and has argued them here many times. I’ve given up arguing with him!”
They aren’t so unorthodox and are becoming less so. I’m pretty much of the PK persuasion. Prof Steve Keen who’s the head of the Economics Dept at Kingston Uni in London is very much on the same page as myself. Steve warns that its private debt and deficits that is the problem for the UK economy. Not public debt.
I’d also recommend reading the late Prof Wynne Godley. He made the very simple observation (although I’m not sure if he was the first) that if the Government is in surplus then everyone else must be in deficit. Of course it sounds much better if politicians to call for the Govt to be in surplus than it does for them to want everyone else to be in deficit.
Is that such an unorthodox view? Maybe it is. But is it wrong? That’s the important question.
@JoeBourke,
Yes you’re right about asset price inflation in the UK. There’s really only three ways to stimulate the economy and keep it moving at close to full capacity:
1) Persuade the private sector to borrow and spend more by de-regulating and lowering interest rates every so often. The neo-Keynesian approach that we are all so used to. So it’s hardly surprising we have an bubble in the property market. What comes next though? We can’t lower interest rates any further.
2) Go for export led growth. This means devaluing the pound substantially and that’s not going to be a popular line. Only the Germans seem good at running an export surplus continually! But we can’t all be Germany. Germany works ‘cos there is only one Germany. Housing is much more affordable there though.
3) Go back to fiscal management. The Government spends what is needed to maintain economic activity. That means not worrying about our deficits quite so much. Or not worrying at all really!
So these are the options. There really aren’t any others.
Only the Germans seem good at running an export surplus continually! But we can’t all be Germany. Peter Martin
How many years have Germany been able to maintain a budget surplus…
Perhaps we have something to learn…
I broadly agree with the post, but just two points. Labour did share responsibility for the crash because like the Clinton administration, they responded to the wheedling of banks and pet academics by deregulation. The government and the Bank of England were caught by surprise. They should not have been. Secondly, while I agree that borrowing, especially for infrastructure, can be healthy and a huge opportunity was missed in the first year or two of the coalition because of Osborne’s narrow vision and our weak response, we should start thinking about this: borrowing is sustainable because long-term economic growth can be assumed. What if it stops, thanks perhaps to global warming?
I just love hearing how Vince Cable foretold the crash as if, somehow that absolves the rest of the party for NOT seeing it coming…Vince has always been a ‘bit of a maverick’ and gets more wrong than right…I note his part in the Royal Mail sell-off scandal is glossed over..
I also note that, during our ‘love-in’, the party kept well away from mentioning how, just months before the crash, Osborne promised less regulation of the financial sector and proposed spending more on public spending than did Labour….
It was Labour’s misfortune to be in power when the crash happened; deficits and surpluses would have made little difference…The UK was, with the US, the major player in finance and, as such, got hit the hardest….
Post crash, Brown acted quickly and effectively; I wonder what Osborne’s response would have been?
Perhaps the most remarkable fact of government policy right now is the turnaround expected from and signalled by Hammond, to a policy of borrow and spend to invest, thereby boosting the economy. This is because of the crisis caused by Brexit, which is expected to be very bad indeed, and so the government has adopted this policy as the solution.
Yet for the last 5 years they applied exactly the opposite policy, or at least tried to, of austerity, cutting back on spending and borrowing. This was justified by the dire financial situation of the economy, which is now the same rationale for the opposite policy.
There are a liited number of explanations for this. One could be simply incompetence by the Osborne/liberal alliance. A more sinister one, and frankly much more likely, is that the last government never believed its own propaganda about the seriousness of the national situation. Labour fixed the problem and the economy was recovering when lib/con took over. They applied austerity, and the economy crashed, and ever since applied as much austerity as they could get away with. Now, in a genuine crisis, they have formally accepted a need for stimulus.
The truth is that con/lib did not impose austerity to fix the economy, it caused the opposite, but insted they did so furthering the conservatives policy of reducing the size of government. It was a convenient excuse for cutting all manner of state services. Well thank you libs for assisting this fundamental turnaround in national policy.
David Pearce writes above, “The truth is that con/lib did not impose austerity to fix the economy, it caused the opposite, but instead they did so furthering the conservatives policy of reducing the size of government. ”
I would add that they did so to destroy the Labour Party by destroying its credibility on economic policy. In so doing they not only delayed the recovery but made it harder to introduce policies that would prevent Lost Decades (a la Japan).
Keynes famously wrote, ‘the ideas of economists and political philosophers, both when they are right and when they are wrong are more powerful than is commonly understood.’
The ideas of Keynes were disproved as wrong and rejected in the 1970s. From at least 1980 there were no longer any academic ‘Keynesians’. The ‘wrong’ ideas of Keynes exerted their influence through and among politicians and journalists, fed as they were on the story of how Keynes identified the causes of the Great Depression and through fiscal policy ended the Great Depression.
By 1980 all economists were monetarists. One lot emphasised the role of the quantity of money in controlling the economy and the others (leaving the Austrians aside) emphasised the role of interest rates and their management in controlling the economy – these latter called themselves New Keynesians possibly for sentimental reasons, but have allowed politicians to hang on to their wrong ideas.
Anyone who believes that Keynsian policies delivered the Great Moderation are wrong.
Ben Andrew:
Peter Martin: Asset sales are also relevant to national debt. Tories criticised Gordon Brown for selling gold reserves, treating the issue in isolation. The Thatcher governments sold North Sea oil at $18 a barrel and watched as the price soared to $100 dollars a barrel.
Labour criticised the Tories for selling council housing stock at large discounts and not replacing it. These things are easily explained.
Printing money electronically (Quantitative Easing) is more difficult to explain satisfactorily, as was the introduction of the widely distrusted paper money (now plastic).
The only way Labour could have offset the worst of the crash would’ve been by regulating the City of London and investing in modern manufacturing as a more worthy focus of the economy. Unfortunately, Blair and Brown weren’t going to do that. Dave and Osborne would’ve made things even worse.
The case against Labour is that in a period of economic growth they continued to run deficit budgets. Consequently, when the crash in confidence in transatlantic banking (to which Labour’s poor regulation contributed) came, then the UK was not in a good position to apply Keynesian remedies to the resulting recession.
Labour have managed to write “global financial crisis” into history, but in reality only the USA, the UK and countries whose economies were closely linked to those two suffered badly.
“Labour crashed the economy” may not be strictly factual, but it is useful shorthand for their poor management. Potentially disastrously, May and Hammond seem intent on resuming the same path.
Do people agree that the Tories have used the financial crash to make the public extremely averse to borrowing money, even if it is used for investment? And if so, do you agree that this is concerning and that we need to address it?
Frank Little 22nd Nov ’16 – 12:33pm…The case against Labour is that in a period of economic growth they continued to run deficit budgets. …
More of the, ‘Failing to fix the roof when the sun shone’, nonsense…A fixed roof is little use against a tornado….
The financial/banking world was awash with cheap money, interest rates were low and the world was on a spending spree…The only way to have curbed the excess was to hike interest rates; impossible for the UK to do alone…
As for, “Labour have managed to write “global financial crisis” into history , but in reality only the USA, the UK and countries whose economies were closely linked to those two suffered badly”?????
A cursory look at a world map of GDP, following the crisis, would show that is not the case; countries as diverse as Argentina to the USSR were in, or near, recession….
@Roland,
The reason that Germany can run a budget surplus is because it runs an export surplus.
Govt Surplus= Export Surplus – Private Sector Savings
But not all countries can run an export surplus. It just isn’t arithmetically possible!
So if countries balance their trade, the govt will always be in deficit if the private sector save more than they earn.
@Frank Little
The case against Labour is that in a period of economic growth they continued to run deficit budgets.
Why shouldn’t they have? Again, as above, it’s just arithmetic. If there is a trade deficit, then the govt can only be in surplus if the private sector is spending more than they are earning. ie they are net borrowing.
@ Joseph Bourke
In the 1920’s over 8% of GDP was spent on paying the interest on the National Debt this is much worse than the approximate 6% you are referring to (based on National Debt being 80% of GDP). However I don’t know where you get your figures from, but according to a commons library document (figures from the ONS and OBR) debt interest payment are forecast to be about 2.3% of GDP by 2020/21 being 3% c 2011 and over 3% c 1995-98 and above 4% c 1984-86. (For 2015/16 it was only 2.4%) After taking account of quantitative easing the figures are even lower about 2% (researchbriefings.files.parliament.uk/documents/SN05745/SN05745.pdf).
@Peter Martin
You have an annoying habit of pulling equations out of the air. I see what you are getting at but you need to explain where they come from.
@ Peter Martin
I have looked Wynne Godley up on Wikipedia and there is an interesting graph for the USA (https://en.wikipedia.org/wiki/Wynne_Godley#/media/File:Sectoral_Financial_Balances_in_U.S._Economy.png) showing government deficits, private sector savings and current account balances. There does seem to be a relationship between private sector savings and government deficits but the role of current account deficit (show as positive) does not seem clear. I think this theory makes sense.
However looking at the 2010 line the government deficit is -10 and savings and current account balances are about 4.5 not 5. Therefore they do not balance each other out, which I think the theory would predict as they should balance out at zero. (In my 2010 example they are at -1.) I don’t understand why the theory is wrong, because if the -1 was from foreign investors in the national debt I think these should show up in the balance of payments.
@Michael BG,
Yes I have come across the same problem. I can only suggest that the data isn’t as good as it should be. It’s not possible, of course, for the US govt to know every international transaction that occurs, especially as many of them will be highly illegal!
The Goto guy for sectoral balance analysis in the UK is Neil Wilson. He’s very approachable and he would readily give you his opinion:
http://www.3spoken.co.uk/2016/04/uk-sectoral-balances-q4-2015.html
@Richard Underhill
“Asset sales are also relevant to national debt.”
The so-called “National Debt” is just a monetary thing. The USA has $18 trillion worth of debt but the USA government has real assets which are incalculably high. Land, Buildings, Mineral reserves, Radio Spectrum, Fishing Rights etc. Then there is the right to levy taxes on the big players like Microsoft and Amazon. How much is that worth?
So if we included a notional dollar value of all those real things on a balance sheet the USA is nowhere near bankrupt. That idea is just nonsense. I don’t know what that figure would be but it would be orders of magnitude more than any so-called debt the US govt might have. They really don’t need to borrow money from China to pay their way!
Ben Andrew: Yes, I think we desperately need to address this and make the case for long-term investment alongside responsible budgeting. The fact that progressive voices calling for limited state intervention are often dubbed ‘hard left’ shows how far we’ve gone in the wrong direction, particularly since the crash.
@ Peter Martin
Neil Wilson’s graph looks a perfect fit. It is a shame he hasn’t put up the figures and percentages it is based on, especially after saying it was hard for him to get them.
If we think about this relationship and start off with simple model. It makes perfect sense that the government deficit equals the amount saved in the economy, if we assume that the amount saved is that part which is saved but not borrowed by others to invest. As I have already stated if the government finances some of its borrowing from foreign investors then this part of the balance of payments would need to be included. The problem area is to do with the balance of payments. According to this theory when government spending is in total balance and there is a balance of payments surplus there must be a negative being saved. I don’t understand why this would be the case. Even if we say that “a negative being saved” means more is invested than saved I still don’t understand why this would be the case.
The Tories won the last GE for a large part on the dual message of “Labour crashed the car” and “labour will be in Scotland’s pocket”. Such misinformation and divisive language should be stood against by a liberal democratic party who should believe that more factual campaigning and more representative electoral systems leads to better elected officials and a better country.
Michael,
the % quoted is a % of total government spending not GDP. Government spending is circa 37% of GDP.
The debt accumulated after the 1st world war had a significant impact on the economy in the inter-war years. The UK government technically defaulted on its obligations when it failed to repay war debt to the USA following the ending of reparation payments by Germany; and again when it reduced the contracted interest on government debt from 5% to 3.5% in 1932, giving bondholders at the time what is these days described as a haircut. As always, those at the bottom of the pile were the worst effected. Austen Chamberlain, as Chancellor, cut the already meagre unemployment allowance that so many were depending on by 10%, as part of his budget measures to restore the credibility of the public finances.
When confidence in the UK economy hit another low point in 1976, a sterling crisis ensued. The Callaghan government found itself unable to refinance its debt. The IMF were called in to rescue the public finances with swingeing cuts to public spending and exercised effective administrative control of UK domestic policy for several months.
Maintaining confidence in the economy is the key. Overseas investors shy away from sterling investments if a slide in the value of the currency is a looming prospect.
@ Jeff and Michael BG
I’l try to answer both your questions together. If we divide up the economy into sectors then it must follow that the surplus of any one sector must be matched by the deficits of the remainder. In other words: all the surpluses (or deficits) sum to zero.
So if we consider 3 sectors: Govt (G) , Private Domestic (PD) and Foreign (F) then it must follow that
GS+PDS+FS = 0 (GS = Government surplus. PDS = Private Domestic Surplus or Private sector net savings, FS =Foreign Surplus)
If we want to talk about deficits then the Government Deficit = -GS
FS = – Trade Deficit
So its just a matter of working out what you need to say and working out the right equation. Although some economists would prefer the term identity to equation.
@ MichaelBG
You say: “…when government spending is in total balance and there is a balance of payments surplus there must be a negative being saved.”
Ok lets make GS=0 There is a balance of payments surplus so that must mean the FS is negative. So PDS must be positive. So there is a positive not a negative being saved.
@ Joseph Bourke
I thought there were plans regarding German reparations – Dawes and Young and they only stopped following the banking crisis of 1931. Austen Chamberlain was Chancellor of the Exchequer 1903-05 and 1919-21, and Neville Chamberlain was Chancellor of the Exchequer 1923-24 and 1931-37. Therefore it was Neville not Austen who reduced interest on the war debt from 5% to 3.5% by buying back the 5% and offering them replacements at 3.5% linked to a 1% tax-free bonus. Denis Healy has written that the UK did not need the IMF money. This was because the Treasury got the forecasts wrong. I think that the sterling crisis of 1976 was caused by Denis Healey following bad Treasury advice. I can’t believe you think that the National Government was following the correct economic policies in 1931.
@ Peter Martin
Unfortunately you have not really made anything clearer. However I do accept I was wrong and if there is no government deficit or surplus and there is a trade surplus and so F is negative therefore S is positive. This is because as explained on the Wikipedia page for Wynne Godley on the USA graph there is a note “Foreign represents -1*Current Account Balance (i.e., a positive is a trade deficit or capital surplus)”.
You have not explained why if we are exporting more than we importing it follows that more is being saved than invested.
I did wonder if there is a link to Keynesian theory (Injections = Leeks)
Investment + Government + Exports = Savings + Taxes + Imports
I + G + X = S + T + M
Rearranged using algebra
(G-T) + (X-M) = (S-I)
If G-T = 0, then (X-M) = (S-I)
The theory then states as injections = leeks therefore
0 = (S-I) – (G-T) – (X-M)
For some reason G and T are reversed giving
0 = (S-I) + (T-G) – (X-M)
Then “X-M … the formula is subtracting this amount, we graph the inverse (*-1) so it appears as a positive number in the graph.”
(https://commons.wikimedia.org/wiki/File:Sectoral_Financial_Balances_in_U.S._Economy.png).
Therefore this theory does make sense.
Wynne Godley and the Levy Institute as he notes in this 2007 paper http://www.levyinstitute.org/pubs/sa_nov_07.pdf base their economic analysis on Keynesian principles. Sectoral balance analysis is used to identify significant changes in accounting identities in the national accounts. It does not of itself give any answers as to why sudden shifts occur but points to areas for further investigation.
This analysis holds that when there is excessive demand in the economy this will be evidenced by high levels of private sector borrowing (net dissavings) and corresponding government surpluses. In the UK prior to the financial crash we saw a massive build-up in levels of household debt (both consumer and mortgage debt), accelerating trade deficits as imports continued to grow, relatively low business investment and a continuing government deficit. The analysis would suggest that government spending at the time (particularly on redistribution via tax credits) should have been financed by higher corporate and income taxes rather than increased borrowing.
In the aftermath of the crisis as net dis-savings turned into net savings the government rightly allowed high deficits to continue for a time to allow time for the economy to recover. However, as the trend turned again towards a decrease in private sector saving and increase in household debt the sectoral analysis would point towards a need for a fiscal tightening that seeks to eliminate the structural deficit such that as the economy returns to full capacity (circa 5% unemployment rate) the budget is brought back into balance. Inflation and economic growth can then begin to reduce the national debt as a % of GDP back towards more sustainable levels until the next slump comes.
Michael, yes Neville Chamberlain not Austen.
No I do not think that the economic policies of 1931 were the right approach. The point, however, is that the level of debts and deficits matter (even based on wrong treasury forecasts as Dennis Healey complained) because they ultimately lead to a loss of confidence that often as not results in the implementation of austerity measures to restore market confidence in the public finances.
@Michael BG
I like to try to understand these kinds of issues in words rather than the mathematics so I would say that if the government is exactly balancing its budget it is neither saving nor borrowing. So if we are then importing more than we are exporting it must be the private sector which is doing the necessary borrowing. If we are exporting more than we are importing then it is the private sector doing the saving.
Prof Bill Mitchell is very keen on sectoral balances and often uses them in his quizzes.
See for example: http://bilbo.economicoutlook.net/blog/?p=31901
You’re right that the national accounts equations are the right way to analyse the problem mathematically but it’s easy to get a sign wrong if you aren’t careful.
(I – S) + (G – T) + (X – M) = 0
So if G-T = 0 and X>M then it must follow that S>I
The take home message that anyone who might not follow all this is that the government’s budget deficit can never be considered in isolation. Trying to reduce the Govt’s budget deficit, by reducing spending and increasing taxes (like VAT), at the same time as the country is running a trade deficit will only depress the economy and won’t do much at all for the Govt’s deficit.
Joebourke,
“….to restore market confidence in the public finances.” </em
This is an erroneous argument. The Govt is a currency issuer. It can spend what it likes and create any amount of money it likes. Note that 'can' doesn't mean 'should'! The constraint is inflation. If Government overdoes the spending, and underdoes the taxation, we get too much inflation. That's about it really!
The "markets" don't lend to the National Government in the way they (as say a commercial bank) might lend to a local council. The council is not a currency issuer and does need to be credit worthy to secure a loan from the bank. The National Government in no way requires any money that Barclays, Lloyds or anyone else may wish to lend to them.
They can 'lend' money to the Govt for safe keeping if they wish but they aren't going to make much money by doing that.
@Michael BG
I like to try to understand these kinds of issues in words rather than the mathematics so I would say that if the government is exactly balancing its budget it is
neither saving nor borrowing. So if we are then importing more than we are exporting it must be the private sector which is doing the necessary borrowing. If we are exporting more than we are importing then it is the private sector doing the saving.
Prof Bill Mitchell is very keen on sectoral balances and often uses them in his quizzes. Just Google {Billy Blog}
You’re right that the national accounts equations are the right way to analyse the problem mathematically but it’s easy to get a sign wrong if you aren’t careful.
(I – S) + (G – T) + (X – M) = 0
So if G-T = 0 and X>M then it must follow that S>I
The take home message that anyone who might not follow all this is that the government’s budget deficit can never be considered in isolation. Trying to reduce the
Govt’s budget deficit, by reducing spending and increasing taxes (like VAT), at the same time as the country is running a trade deficit will only depress the economy and won’t do much at all for the Govt’s deficit.
Joseph Bourke 22nd Nov ’16 – 8:23pm………….Maintaining confidence in the economy is the key. Overseas investors shy away from sterling investments if a slide in the value of the currency is a looming prospect…………..
That resonates, not just with 2007/8, but with 2016/17…
Peter,
governments and those advocating/developing government policy have to live in the real world. I understand the basic premise of modern monetary theory and agree that money supply in the economy is increased by government spending and decreased by taxation. Even though we live on a Island, we are part of and dependent on a system of International trade and finance that works around basic common standards. One of these is perceived creditworthiness. An issuer of fiat currency like the UK can always issue more currency/bonds but the purchasing power of that currency has to be maintained or a spiral of inflation/currency devaluation ensues.
When high levels of inflation are present in the economy (as in housing bubbles and asset price inflation generally) this should be an indication that the money supply needs to be reduced via greater taxation not expanded by increasing the volume of government debt issues.
This was the basic problem with labour policy pre-crisis. Not that working tax and child care tax credits were the wrong policy (they go in the right direction) but that they were not funded higher levels of tax to redistribute income from higher earners to lower earners. This was a political decision by labour, but proved to be not good economics.
I’m hoping that this Autumn Statement might change things!
@ Peter Martin
Sometime you just have to show the equations. I think going back to the Keynesian equation regarding injections = leaks and explaining your position from there is a way to get people like Mark Wright to understand you are not just making up your words but they are based in economic theory and if they take the time they can understand why your theory makes sense. I don’t think you were being very successful in convincing people that a government deficit = balance of payments deficit when savings and investments are equal.
@ Joseph Bourke
As you know I do not accept that 5% unemployment is full capacity and that 2004 was the height of the economic cycle when unemployment dipped below 5% because inflation was only 3.5%. Reducing unemployment below 5% and reducing the number on employment and support allowance would assist in reducing any government deficit. When private sector savings are negative and continue to move in that direction the government should only stop increasing the deficit and possible reduce the deficit a little. However it does not matter if the growth in the economy is caused by negative savings or government deficits or a mixture of both.
If we both accept that the government should have increased the deficit to reduce unemployment and grow the economy when the interest payments were 8% of GDP in 1931, I find it strange that you are arguing that having interest payments of only 2.4% of GDP means that a government should not increase the national debt if the economy is not at full capacity.
It seems that you might be advocating increases in taxation because of the rise in house prices and assets. A much better policy would be to increase the supply of both houses and assets to bring their price down.
It seems that governments worry too much about “confidence” and if they worried less about it and did not over-act to a perceived loss of confidence the economy would work better for the people. We have a reduced pound because of lack of confidence in the UK economy and Philip Hammond is increasing the deficit above what it would have increased because of the slow down. He at least is doing the right thing unlike George Osborne.
@ Joseph Bourke,
I don’t think we are too much in disagreement. You are quite right to say: “but the purchasing power of that currency has to be maintained or a spiral of inflation/currency devaluation ensues.”
We can perhaps discuss what a reasonable inflation target might be. I’d prefer maybe something more like 3-4% than the current 2% but I can understand the case for a lower target.
We might differ slightly on “perceived creditworthiness”. I really don’t understand how the credit rating of the UK govt can be anything other that AAA+. It cannot possibly default on any loans it makes in its own currency. If the ratings agencies mean inflation risk they should say so. But the UK has had a good rating previously when inflation has been much higher. The UK doesn’t really need to borrow any money in any case. If overseas buyers didn’t buy gilts the capital and current account would still balance – just as they do now.
If we weren’t net selling gilts, if we couldn’t, we wouldn’t be accumulating more debt.
Isn’t that what we are supposed to be aiming for?
So we can’t have it both ways. We can’t say we want to reduce our debt and at the same time worry about our creditworthiness !
Quantum physicists suggest that there are multiple universes. Having read this piece I felt I might have fallen into one of them. Who said what and how many angels on the head of a pin.
Yes, the banking crisis was the catalyst, but the ability of each country to withstand the crisis is directly related to that nations financial stability. As stated many times, a Keynesian approach means that you run a surplus when the economy is buoyant. We didn’t and therefore we were already running a deficit when the global economy dipped and tax revenues fell. Result ? £1.6 trillion national debt. Is any of this actually contentious ?
Basic problem, Labour tries to run a Swedish style welfare system with American levels of tax. Parties of the left need to treat the public like adults. If you want first rate education, health care, welfare and investment, then you have to pay more tax. You don’t know, people might actually vote for it.
@ Chris Cory
“As stated many times, a Keynesian approach means that you run a surplus when the economy is buoyant.”
This is simply not true.
If everyone else is saving then the government needs to be spending. And that can happen when the economy is buoyant. Keynes knew this as well as anyone. The economy couldn’t have been more buoyant that it was during WW2 yet the Govt ran a large deficit to pay for the war effort. Inflation was largely kept under control by a compulsory savings scheme advocated by none other than Keynes, himself!
The big savers aren’t us in the UK. They are the big exporters who only spend a proportion of what they earn selling us stuff. They save the difference.
“The coalition are cleaning up the mess we inherited from the previous Labour government” and “Labour caused the crash” are two statements with very different meanings. I only really saw Lib Dems in the coalition years saying the first one, though anti-Liberal news sources liked to pretend otherwise.
@ Chris Cory
“As stated many times, a Keynesian approach means that you run a surplus when the economy is buoyant.”
Yes something like this is often said. However if we assume that Keynesian economic policy is being used to achieve full employment. We should conclude that when the economy has reached full employment the government’s target should change to trying to keep the economy at equilibrium at this level. What this mean in Keynesian terms is:
Investment + Government + Exports = Savings + Taxes + Imports
I + G + X = S + T + M
Which can be also expressed as
0 = (S-I) + (T-G) – (X-M)
Therefore for a government which is pursuing Keynesian economic policies to run a surplus it has to believe that the economy is at full capacity. After 2004-05 unemployment was rising and therefore the government should not and did not run a surplus.
http://1.bp.blogspot.com/-kLgOVHK3Dj8/UX9sgjXg20I/AAAAAAAAAcY/3iAvbut0VfA/s1600/unemployment-percent-79-12.png has a graph based on ONS figures showing unemployment only dipped below 5% in 2004-05.
Whether the government should have been reducing the deficit in 2004-05 will depend on whether you thing 5% unemployment is full capacity, which I do not.
Jen
A couple of seconds googling turns up “Labour was the party that crashed the British economy” – a direct quote from Nick Clegg. There’s mountains of this stuff if you care to look.
I don’t know how much any of this matters now. The next crash is coming and we are in far worse shape to deal with it than we were in 2007.
AndrewR – I tried that but can only find it as an attributed quote without any context. See also the Guardian front page circa 6 years ago pretending that he’d said the Lib Dems were a party of the Right.
@AndrewR
“A couple of seconds googling turns up “Labour was the party that crashed the British economy” – a direct quote from Nick Clegg. There’s mountains of this stuff if you care to look.”
That sounds remarkably like the comment from Andrew Ducker above, over three days ago, when he said:
“I see the message that Labour Crashed The Economy repeatedly from Liberal Democrats.”
In response I asked him “Really? “Repeatedly”? Are you quite sure about that?”, but have still received no amplification.
So as you are saying “there’s mountains of this stuff if you care to look” perhaps you could justify your comments instead?
@Jen
You can find it in Hansard – https://hansard.parliament.uk/
@Simon Shaw
Sorry, not playing today.
Having tried, perhaps with some limited success, to get everyone to think laterally on the subject of debt and deficits, and understand that they can’t be considered in isolation, I should add that Labour are at least partially guilty for crashing the economy.
Their sin? Allowing too much private debt in the economy. They would have done better if they’d allowed less and had MORE public debt to compensate.
@Cllr Mark Wright. How’s that for an unorthodox view? It has to be right when you think about it though. If you can think about it.
There’d be no point discussing issues like these if the orthodox was as correct as you assume. If the mainstream had it right there wouldn’t have been any crash. The euro would be a resounding success and the Brexiteers would now be licking their wounds after being soundly beaten in the referendum. That is if anyone had seen the need to call one!
@ AndrewR
Thanks for the link to Hansard.
@ Simon Shaw
I did a search and it came up with five times when Nick Clegg said things that mean he was blaming Labour for the crash and one for Danny Alexander.
https://hansard.parliament.uk/search?searchTerm=labour%20crashed%20the%20economy
Michael BG 24th Nov ’16 – 10:36pm….
I’m just off to bed but have been amused by you, AndrewR and AndrewD trying to get any kind of a straight answer from Mr. Shaw..Most of us gave up ages ago.
Good luck; but, frankly, you’ll have more success ‘bottling fog’
I’m afraid that Ben is mistaken in falling for Labour’s spin that it was nothing to do with them that the economy crashed in 2008. For many years up to 2010, all political parties, once in government had a simple aim, and it was “Keep the good times rolling”. They knew that if keeping the feelgood factor (especially in the year to 18 months up to a general election), was vital to win the next time. Hence all the economic manipulation with giveaway budgets towards the end of a parliament, were focussed on this aim, and it worked. If they got it right they won again, if they didn’t, they lost.
Margaret Thatcher’s government in the 1980s created huge giveaways to people with tax cuts; underpriced privatisations of Gas, electricity, water etc; changing the law to allow Building Societies to demutualise; even allowing councils to underfund their pension funds were all done to stimulate the feelgood factor. Earlier than that in the 1960s the infamous Barber Boom under Ted Heath, was another example. Of course Labour were just the same but generally not quite so successful at it. Indeed the one occasion when a government did the right thing was in 1970 when at a time of good economic figures, the then Labour Chancellor, Roy Jenkins, chose a fiscally neutral budget in the run up to an election which Labour lost later that year.
Part 2 (sorry)
So when Labour took power under Tony Blair and Gordon Brown in 1997, they followed the standard formula. Relatively cautious in the first few years and then stimulate a boom before the election. Again it worked, but each time it got harder. Lax regulation of the City (normally a hallmark of Conservative governments) was the norm; adopting the economically illiterate PFI initiative; and the repeated redefining Gordon brown’s “Golden Rule” so that prudence would come, just not this year were just three examples. So this, coupled with Labour’s substantial increase in benefits (or tax credits as many were called to hide them from view) led to a massive increase in the deficit to £100b, only camouflaged by the unsustainable boom in property and property based financial instruments, which they chose to believe would just go on and on.
Vince and others elsewhere saw the folly in this, and pointed it out, but were derided in parliament, and ignored by those making a quick buck.
So yes Labour did their bit to crash the economy and they did do this by spending too much, borrowing too much, and letting the budget deficit get too large. Of course other factors also drove it including an unwillingness to regulate properly (worldwide), and many voters’ belief, again worldwide, that economic success could be produced by magic by brilliant chancellors, who were in fact simply pumping up the bubble ever more in a never ending drive to get themselves re-elected.
@expats
“I’m just off to bed but have been amused by you, AndrewR and AndrewD trying to get any kind of a straight answer from Mr. Shaw..”
I think you have misread postings above. It was I who asked the two Andrews to provide some factual justification for vague generalisations that they made. Neither of them did so, although thanks to Michael BG for assisting.
So it was I who was trying to get a straight answer here from the two Andrews.
I am more than happy to give a “straight answer” if asked, and, for example, have done so in the last day or so on another thread in response to Michael BG https://www.libdemvoice.org/what-to-expect-from-the-lib-dems-in-response-to-the-autumn-statement-52545.html
@ David Evans
“a massive increase in the deficit to £100b”
This only happened because of the financial crisis. The deficits were:
(£ b.)
2002-03 26.7
2003-04 31.5
2004-05 43.6
2005-06 41.1
2006-07 36.6
2007-08 40.5
(researchbriefings.files.parliament.uk/documents/SN05745/SN05745.pdf).
@ Simon Shaw
“I am more than happy to give a “straight answer” if asked, and, for example, have done so in the last day or so on another thread in response to Michael BG”
Thank you Simon, I needed a good laugh as I can’t remember when I last had one. Thank you.
I am not sure that you know what giving a straight answer is. It is clear that in the thread you link to I am unhappy with your failure to admit you were mistaken. Here again you have failed to admit that Liberal Democrats did often say that Labour had crashed the economy. The six times I found and two occasions that matt quoted must qualify as Andrew Ducker’s repeatedly even if not AndrewR’s mountains.
@ Michael BG,
Yes you are quite right to say that the deficit only increased because of the crash. But why did the crash cause the deficit?
The answer has to be that the deficit has to equal whatever everyone else saves.
Thankfully we don’t live in the kind of society where saving isn’t allowed. If I want to go down to the pub and spend a few pounds that’s fine. If I want to buy some premium bonds then that’s fine too.
But my going down to the pub will mean that the Treasury will take in revenue from in alcohol duty and VAT. The wages of the staff will be paid from what I spend and there’ll be income to the taxman in terms of Income tax and NI.
My buying premium bonds will put the govt greater into debt!
So which is better for the country?
@Simon Shaw
Let me google that for you
Look at the first result. There are actually at least 3 times in hansard where Clegg claimed that Labour crashed the economy. Put a little effort in, mate.
@ Peter Martin
“The answer has to be that the deficit has to equal whatever everyone else saves.”
This is not true. What is true is:
Investment + Government + Exports = Savings + Taxes + Imports
I + G + X = S + T + M
(G-T) = (S-I) + (M-X)
Therefore if G-T provides a deficit then the gross amount saved and balance of payments must equal it.
Perhaps it would be better to put some figurers in the equation.
8-4 = 4-2 + 4-2
4 = 2 + 2
4 is the size of the deficit; 2 is amount saved and 2 is the balance of payments surplus.
Therefore you can see from the equation that for your statement to be true the balance of payment must be in balance.
However what can be said, is that if a person spends their money rather than save it, some of it will assist the economy.
@ Michael BG,
I don’t disagree with the national account equations you are using and there really is no conflict between using them and my statement that the government deficit (G-T) is what everyone else saves.
(M-X) is Imports – Exports. This is what our overseas trading partners save.
(S-I) is Savings – Investments. ie the Net Saving of the Domestic Private Sector.
Another way of looking at it is to consider the creation of new currency. The Govt FIRST spends the currency into existence then later gets back SOME of what it has created in taxation revenue. The difference is what everyone else (including overseas trading partners) has somehow hung on to. ie Their net savings.
@ Peter Martin
“there really is no conflict between using them and my statement that the government deficit (G-T) is what everyone else saves.”
Apart from it not being true.
If we assume that our balance of payment surplus is just another countries deficit we have:
M-X = -2
(I-S)+ (G-T) = -2
Therefore it is possible that this is entirely the surplus of savings over investments, but it might be because in that country taxes are greater than government spending, or a combination of both. (This would work if we saw this “country” as the rest of the world.)
Why do you make these false claims, when it would be so easy to add “when x is zero” (where x is the third part of the equation you are not interested in)?
However if you made it clear you were talking about the whole world you could say –
The total of all the countries of the world’s government’s deficit minus the total of all the countries of the world’s government’s surplus equals the total of everyone’s savings minus their investments because the balance of payments of all the countries in the world must balance.
@ Michael G,
I don’t believe we are in disagreement, just that there is some confusion over terminology.
You, yourself, have given me this equation (26/11 12.03am) :
(G-T) = (S-I) + (M-X)
Which in the terminology I’ve used means:
Government Deficit = Net Savings of Private Domestic Sector + Net Savings of Overseas Sector.
I can’t see what’s wrong with that!
The important thing, especially for anyone arguing against the Govt running a budget deficit, to remember is that nothing can be taken in isolation. There is a section in the link below called “Austerity in the view of the sectoral balances approach”
Google {wiki Sectoral Balances}
@ Peter Martin
You have three elements but M-X is not “Net Savings of Oversea sector”, it is the balance of payment deficit or surplus and as my previous post pointed out this does not HAVE to equal the rest of the world’s savings minus investments.
I assumed you knew this but just could not be bothered to be accurate, and my question was I don’t understand why you can’t just be accurate and so you can get your point over without anyone disputing what you are writing. I assumed that you wish to challenge people’s thinking and not get into a long debate to get the equations on sectoral balance right.
The Wikipedia piece under Austerity in the view of the sectoral balance approach is also not taking into account the balance of payments.
Is (M-X) or Imports -Exports the “Net Savings of Oversea sector” ?
If a country as a whole sells us something then they get paid in pounds. So what does that country do with those pounds? It can either spend them on buying something from us, or it can save them, in cash, or by buying up gilts or other securities.
So it’s spend or save. Are there any other options?
The drawback of the sectoral balance approach is that it ignores money. Money may be neutral in the long run but it isn’t in the short run.
David Evans lists the deficits during that part of the Great Moderation post the dot.com bust. Monetary easing immediately after the bust was very successful. There was no Great Recession, but there could have been.
2 questions arise, why was there no Great Recession after the dot.com bust but there was one after the US housing crisis? Having survived the dot.com bust why did western monetary policy remain accommodating whilst aggregate demand was growing above trend?
The answer is because of inflation targeting. When, following recovery from the dot.com bust, monetary policy should have tightened it couldn’t because it coincided with (good) deflation from globalisation. Because inflation remained around 2% the central banks didn’t tighten.
Then, when aggregate demand started to fall in 2007, as a result of the housing bust, that is when (ceteris paribus) demand disinflation would have cause inflation to fall below 2% and triggered easing, commodity inflation caused counteracting cost inflation and central banks refused to lower interest rates (even as aggregate demand crashed).
Central banking and inflation targeting caused the Great Recession.
@ Peter Martin
“So it’s spend or save.”
This is why the money received from exports can be either spent or saved and therefore these funds are not foreign savings. Therefore M-X does not HAVE to equal “Net Savings of Oversea sector”. This illustrates the point I am making, your points can be lost because you seem not to be able to help yourself in presenting them inaccurately. I was trying to be helpful because it seemed that you tried to present your ideas before but were not getting your point over, therefore I was suggesting that you ALWAYS present the three items and specify which one you are assuming is zero. I do not see much point in trying to convince you any further that you should follow my advice.
@ Bill le Breton
I didn’t see David Evans post any actual UK government deficits. However I did post them for 2002-08, which might include the end of the dot com bust. The UK bank rate was reduced from 6% to 4% c 2000-03 and from c 5% to 0.5% 2007-08. Therefore your proposition is not convincing. Perhaps more details with dates are needed because you have presented it in a very general sense.
Michael – it may have been you who posted those figures.
I think you should look very closely at when the Bank of England lowered its rates in response to the start of the Great Recession. They were very slow to move.
Here is how slow the Bank reacted:
Juky 2007 they actually RAISED rates to 5.75% !
Collapse of Northern Rock September 2007
No reaction by Bank of England until December 2007 when rates lowered just .25 to 5.5%
Then waited until Feb 08 for another .25% cut to 5.25
It was Aoril 08 before a cut to 5%
October 08 cut to 4.5%
So when Lehmans collapsed in September 2008 rates were still 5%!!!!! and when the Bank of Scotland was rescued the rate was 4.5% !!!!!
And then it took them nearly a year , yes a year of collapsing nominal and real GDP to cut in gradual steps to 1% in Feb 2009.
Of course by this time there were huge fears of deflation and general collapse. And real interest rates as opposed to nominal interest rates were perhaps negative 4% !!!!
The damage had been done!
The really interest figures to look at are the collapse in nominal GDP
@ Michael BG,
Yes it is either spend or save. I thought you might say the pounds could be exchanged for dollars or euros but that’s just transferring the pounds to someone else who has to make the same spend or save decision.
But look at it from the POV of those countries who are net exporting to us. Germany, China, Singapore and others. They aren’t spending all the pounds they earn. The difference, between what they spend and what they earn, is what they choose to save.
@ Bill le Breton,
“The drawback of the sectoral balance approach is that it ignores money. Money may be neutral in the long run but it isn’t in the short run.”
This isn’t correct. The monetary easing that creates a credit boom , for example, shows up as a deficit for the PDS and smaller deficits or larger surpluses for everyone else.
“2 questions arise, why was there no Great Recession after the dot.com bust but there was one after the US housing crisis? Having survived the dot.com bust why did western monetary policy remain accommodating whilst aggregate demand was growing above trend?”
There was a mini recession after the dot.com bubble collapsed but so mild that no-one really noticed. As one bubble burst Governments on both sides of the Atlantic and in countries like Australia and NZ too eased monetary policy deliberately to stoke up a new credit boom in housing. The GFC of 2008 was the result of two bubbles collapsing. The delayed effect of the dot.com boom and the collapse of the housing bubble -especially in the USA.
Australia managed to escape the effects of the GFC, largely because the Chinese took it upon themselves to create their own credit boom and went crazy buying up as much coal and Australian iron ore as they could ship over.
If the PTB could have thought of a new bubble to create to temporarily avert the GFC , I’m sure they would have created one. But they’d run out of options. As interest rates are just about zero and can’t be lowered any further that’s the end of the line for neo-Keynsiansim (should be NOT Keynesianism) in any case. Although there is the crazy notion of abolishing cash and having negative interest rates that is being discussed in some circles.
Peter, people thought dot.com bust was to create a very deep recession. It didn’t because it was met with appropriate monetary easing. But, once aggregate demand was back on track and beginning to ‘overheat’, cost cuts from globalization (good deflation) obscured the need for monetary tightening.
My reply to Michael demonstrates how slow the monetary authorities were to ease monetary policy in 2007 – again, they were misled by inflation – this time they feared inflation from commodity price rises and failed to cut interest rates hard and fast enough on 07/08 … because they were governed by an inflation target instead of keeping their eye on nominal GDP.
They raised interest rates in 2007! At year end 2007 the Bank of England policy rate was 5.5%. This told investors that ‘this time’ they weren’t going to ease and they immediately began a competitive deleveraging (and a dash for cash) that not only destroyed money it put a huge break on the velocity of exchange (the demand for money to hold) … result? NGDP crashed. In that situation all three Parties supported the resulting budgets until June 2010.
@ Bill le Breton, I would guess that you’d categorise yourself as being of more of a monetarist persuasion? I do remember we had an interesting but inconclusive discussion on a posting that I’d written called “What is monetarism and what happened to it?”.
Monetarism, as it was initially advocated by leading Thatcherites of the time like Sir Keith Joseph, quickly morphed into interest-rate-ism. There is really no argument form those of a more conventional Keynesian persuasion, like myself, that the use of interest rate variations doesn’t has a role to play in the regulation of aggregate demand but in recent times we’ve seen far too much emphasis on that.
Which is why we’ve created asset bubbles and the busts that inevitably follow when they they bust. IMO.
@ Bill le Breton
Your comments are always worth reading. Thank you for providing more details (even if not internet links). As I expected with more details your point is convincing.
Michael, thanks for kind words. I get my info on interest rate changes from the Bank of England here http://www.bankofengland.co.uk/boeapps/iadb/Repo.asp . But I thought you’d use this too, so didn’t link to it. The Bank also publishes monetary aggregates and the Office for National Statistics provide spread sheets on changes to NGDP.
I shall try to answer Peter’s point above, which my give you more info on my views.
Best wishes, Bill
Peter, I’m heavily influenced by monetarism and have been since the early 1980s. At school in the 60s and at university in the 70s we were taught Keynesian economics and the M=P or MV=PT (as it was then, now MV=PY) was ridiculed.But in the early 1980s I was lucky enough to spend time with David Gowland then teaching at York but who had prior to that been in No 10 advising Callaghan on monetary policy.
The logic then was inflation was principally caused by increases in the money supply resulting from part of the PSBR (as it was called then) being funded by borrowing from private sector banks. ie You paid for teachers and nurses and bridges and roads by sending them a cheque which they presented to their bank which present it to their account at the bank of England and hey presto money had been created. Hence control of the money supply was seen to come from control/reduction of Government spending and the avoidance of monetary financing of the PSBR. This began to happen under Labour so Keith Joseph was a side show in all this.
Those politicians of the Liberal persuasion did not like government services being used as the means of defeating inflation. Friedman was seen as the bad boy. They argued for prices and incomes policies. The Tories focused a lot on controlling certain monetary aggregates but unsuccessfully. But Howe did give the game away a few times when he mentioned that his budgets would lower the growth of Nominal GDP. Of course the Americans were doing this too. It worked. Everyone became monetarists.
There was then a new breed (called New Keynsians) who seemed to reply heavily on the preferred tool of interest rates and inflation targeting for controlling aggregate demand – and the Great Moderation followed. But globalisation brought first disinflation and the subsequent rise in commodity prices both of which ‘fooled’ inflation targeting central banks.
The monetarist (Friedman’s) explanation of the Great Depression was accepted, but this acceptance never went as far as Liberals who still hero worshipped that part of Keynes’ work suggesting that Government spending had solved the GD and had cured all subsequent Recessions. It has made the Liberals and the Liberal democrats blind to the potential for NGDP targeting to provide optimal non-inflationary growth. So there was never a chance of Liberals understanding the cause of inflation nor of deflation nor of booms and busts.
I have serious doubts about these things called ‘bubbles’ – especially housing bubbles. What we saw in the Noughties were frauds – loans fraudulently ‘sold’ to those who couldn’t afford them and then these loans parcelled up and sold to financial players as safer than they were. There were also frauds in the way properties were valued to support mortgage applications. But banks are still taking legal action over these against valuers.
But say in London, and in many other places, the asset – the house or apartment – has risen in value. So, first, housing stock has risen in response to demand (perhaps not enough, but more than would otherwise have been the case) and, second, homeowners who had to borrow have the asset rather than purely ‘cash’ purchasers – so ownership has been more widely spread than would otherwise have been the case.
Thankfully there were far fewer repossessions than in previous times, the major hits were taken by bank shareholders (which include pension owners) and tax payers. So the burden has been widely shared. We have all paid for the frauds – which obviously were the result of criminal activity and negligent regulation. The relationship between social costs and benefits are more finely balanced than might be thought.
Bill,
I don’t believe the equation MV=PT or MV=PY has ever been ridiculed. But, we have to understand what it really means and the assumptions that monetarists make when they (including you?) talk about the link between the money supply and inflation.
M is the money supply, V is the velocity of circulation, P is the average price associated with a transaction and T ( to use the older version) is the number of transactions. If money supply increases, then if all other things remain equal, the price will increase too and we’ll have inflation. But “other things remaining equal’ is nearly always a bad assumption.
The evidence is that the velocity of circulation is far from constant. The number of transactions isn’t constant either. If we have recession T will fall too. T will rise if the economy is stimulated – but not overstimulated.
A better way to look at the problem is to consider total spending in the economy. If the GDP of the UK is £2.1 trillion then it needs £2.1 trillion of spending to keep it going. £2.2 trillion if we allow for 2% inflation and 2% growth. No Government can know just what everyone else will spend so it has to spend more if everyone is spending less and vice versa.
If we look at the economic history of the UK in the 60’s and 70’s it is easy to see that mistakes were made. There was rarely more than 2% unemployment. This was largely concentrated in areas like Northern Ireland and the North East of England. There was virtually no unemployment in the prosperous SE of England. It was hardly surprising there was an inflation problem. Government should have better targetted its spending. It may well even have headed the troubles in NI had it done so!
To throw out sensible economics, though, in favour of the nonsense spouted by the monetarists really was throwing out the baby with the bathwater!
Peter, This is not deliberately being picky, but in your example the country’s nominal GDP looks to have risen by 5% – (using GDP rather specifying whether this is NGDP or RGDP is always confusing) – or are you suggesting that bthe Government wants NGDP to rise by 5% next year ie it sets a target of NGDP rising at 5% pa?
This is therefore Government policy and we know that the ‘independent’ central bank has to deliver that policy but at the same time keep inflation expectations to 2%. (There are issues about giving a central bank a dual target, but … let’s go on)
If markets believe the central bank is extremely efficient at delivering its mandate(s) they will assume that aggregate demand (NGDP) will continue to grow at 5% next year. It knows that the Bank of England will use its powers to create or destroy base money or/and to influence private sector borrowing to deliver that 5%.
Really, there is no need to change fiscal policy. Monetary policy will deliver the 5% increase in NGDP (though we cannot be precise about the split between a real GDP increase and the level of inflation), however, firms will invest accordingly to replenish stocks and replace worn out capital. And fix wages with all this in mind.
The money supply will increase accordingly as firms and consumers borrow from the private sector banks, thus increasing the money supply . (This is exactly the position our old friend MF advocated ie. not zero growth in the money supply but a constant increase sufficient to keep inflation expectations anchored – and this is where everyone was until 2008).
In fact during the great moderation the UK economy grew with NGDP growing at 5% pm and delivering 2% inflation and 3% growth in RGDP.
Bill,
I think I was just rounding the numbers. But, in case anyone is still following our conversation, I should say that NGDP is nominal Gross Domestic Product. RGDP is real GDP. Or NGDP is RGDP + Inflation.
So a rise of NGDP of 4% could be be a rise of real GDP of just 1% plus 3% inflation or vice versa, or any combination that we might imagine.
I think what you have said in your last comment is largely true.
“during the great moderation the UK economy grew with NGDP growing at 5% pm and delivering 2% inflation and 3% growth in RGDP.” Although I’m sure you’d agree that it is difficult to know whether any stimulus to the economy will deliver growth or inflation. If we get both in equal measure then maybe we aren’t doing too badly?
You still seem hung up on the idea that it is the job of the central bank to deliver growth and/or the right amount of inflation. But, we are at what many Keynesians call the “zero-bound”. That’s always going to happen when too much emphasis is placed on the variation of interest rates to control the economy.
In other words, yes, a reduction in interest rates is a stimulant to the economy. It encourages more borrowing and hence more spending. Nothing to do with the money supply. But the debt that accumulates later acts as a depressant. So we then have to have another stimulus to overcome this. Inevitably we soon arrive at the zero bound.
I would argue that we should decide what we want interest rates and inflation to be and, instead, use mainly fiscal measures to control the economy. I’d favour maybe 2% for interest rates and the slightly more for inflation.
The reason for wanting a slight amount of inflation is to introduce an element of use-it-or-lose-it in a currency’s value. It’s that desire to save, amongst the rest of us, which means that the government’s debt can seem to get out of control.
Peter, hope you are still able and willing to scroll back to this. This may be a short cut to it https://www.libdemvoice.org/labour-did-not-crash-the-economy-52516.html#comments
Here’s a last thought. You write, “You still seem hung up on the idea that it is the job of the central bank to deliver growth and/or the right amount of inflation. ”
Not quite – I think it is the task of an efficient central bank to provide a stable growth path for NGDP or money National Income. And that it should do this by compensating for any undershoot or overshoot in the next time period ie bygones are not bygones – or level targeting.
Evidence suggests that in Western Economies when this level growth in NGDP is around 4.5% or 5% the economy delivers 2% inflation and between 2.5 and 3% growth in RGDP.
People and firms know where they are ie their expectations are anchored.
If you target inflation the central bank is mandated to respond to demand led inflation with the same action as supply led inflation.
You may be interested in this paper https://www.mercatus.org/system/files/Beckworth-Eurozone-Crisis-v1.pdf which shows how when the ECB failed to follow this in 2008 and later in 2011, the Euro crisis followed.
If you don’t provide some growth and a just distribution of the benefits of that growth you get extremism. On that we are surely agreed.
Bill,
Yes of course. That’s what’s happening now. We aren’t getting the growth we were used to prior to 2008 and that’s causing social unrest. The vote for Brexit is a part of it . It may be possible to have a no-growth economy at some time in the future- but we haven’t figured out how to make that work just yet.
You’re probably right that if the BoE and other central banks had acted differently the GFC may not have happened when it did. But there’s still a fundamental problem if interest rates are the only control lever used to try to regulate the economy. You’re right also that monetarism started under the Callaghan government. It’s just that Mrs Thatcher was more forceful in her approach in that direction. I remember she jacked up interest rates to about 16% just as I was buying my first house, and just after my wife had to give up work when our eldest son was born. I’ve never quite forgiven her for near bankrupting me!
But since then the trend in interest rates has been steadily downward. Regardless of how well the central bank ran it policy we’d always end up where we are now with interest rates at just about zero.
You’re still not answering my question about how to stimulate and regulate the economy now that interest rates are just about zero. They can’t be lowered further.
@Bill le Breton
I suppose the thread has gone a bit stale now but I couldn’t let this go by without comment:
“Anyone who believes that Keynsian (sic) policies delivered the Great Moderation are wrong.”
That’s true in a way. True Keynesians wouldn’t have relied solely on central banks and inflation targetting. But that doesn’t mean we don’t know why these policies were relatively successful, albeit for a short time.
Central banks would “adjust” interest rates to regulate the economy. Lower interest rates encouraged more lending which created more spending. The snag was that the adjustment was always in one direction. The neo Keynesians started off with double figure interest rates and for 25 years or so, through a combination of deregulation and the constant lowering of interest rates managed to keep the economy ticking over reasonably well.
But, what now? You can’t keep lowering interest rates for ever!
Peter- just seen your latest two comments with its challenge, “how to stimulate and regulate the economy now that interest rates are just about zero”?
We have just had from the bank of England a significant piece of monetary loosening, so perhaps it should be a case of waiting to see how this plays out.
But what would I have done in 2008/9 when the Bank of England dithered and cut rates gradually down towards zero nominal rates (I don’t believe in the ZLB) and talked up the prospect of deflation?
When you get down to zero I would have reversed the policies that beat inflation in the early 1980s. They then stopped Governments financing deficits by deficit financing. The point about not sterilizing deficit spending is that it leads to increases in the supply of money.
So I’d have a communications strategy that said that nominal GDP growth was too low, that the Government in partnership with the central bank would embark on a period of government spending on infrastructure, a certain proportion of which would not be financed by taxes or sale of gilts.
The central bank would target in the first instance an increase in NGDP growth to 7% and after a couple of years allow this to settle down to 5% growth each year by means of reducing the qty of unsterilized government deficit. as the private sector’s own investment initiatives took over its part in the necessary money creation and with it increasesin aggregate demand needed to maintain NGDP growth at 5% – by which time nominal interest rates would be high enough to play a part in how the central bank delivered its target of NGDP growth of 5%. (NB To be able to gauge future NGDP growth the CB would create a market in NGDP futures.)
Once individuals and markets had grown convinced that growth rates (of NGDP) over 5% would be met with interest rate rises they would be less likely to take out new borrowings when NGDP was > 5%. Ditto when NGDP growth rates fell below 5% they would know that monetary policy would be loosened to make investment projects attractive again.
In a small downturn, firms would be worried that if they refrained from investment, their competitors would not and they’d lose their share of that 5% growth next year. This level targeting system becomes largely self-correcting.
@ Bill le Breton,
” the Government in partnership with the central bank would embark on a period of government spending on infrastructure, a certain proportion of which would not be ”
This sounds very much like the “People’s QE” that people like Richard Murphy were writing about a year or so ago and seemed to be taken up with some enthusiasm with the Corbyn team before they got cold feet.
It would seem that we may not be in such disagreement as I thought.
I’d just make the point though that we shouldn’t have waited so long for the co-operation between the central bank and government. In fact, we shouldn’t have waited at all. The regulation of the economy has always to be a a matter of joint responsibility. I’d give most of that responsibility to government who could then advise the central bank on the monetary policy they expected which would be complementary to their fiscal policy.
In other words, we don’t want the government and central bank to be fighting each other. In recent years I believe we’ve see a fiscal policy which has been too tight and the central bank, the BoE, has tried to compensate by having a monetary policy which is too slack.
PS I’m still not happy at looking at the problem in terms of “money supply” though. The mere existence of money is financially neutral. It’s the spending of money which has an effect.