Opinion: Clutching at straws

I have spent the day clutching at a couple of straws.

Last week in the tractor factory Nick Clegg appeared to confuse the ‘deficit’ with the National Debt when he said, “We have a moral duty to the next generation to wipe the slate clean for them of debt. We have set out a plan – it lasts about six or seven years – to wipe the slate clean to rid people of the deadweight of debt that has been built up over time.”

It sounded like a fail in GCSE Economics. But suppose he wasn’t mistaking the policy to eliminate the structural deficit by 2017 for a moral crusade to wipe the slate clean by removing the deadweight of the National Debt, all £1,300 billion of it.

At the other end of my straw was the realisation that Nick Clegg might have become an extreme Market Monetarist and was revealing his plan to re-establish Nominal GDP back to its trend line, even if that meant buying in the whole of the National Debt in the mother of all quantitative easing exercises.

Now, wait a minute before you pile in with the derision. We have already bought in roughly a quarter of the National Debt with the QE so far and our head is just above the water. That lot is sitting in a computer in the Bank of England as a figure owed by the Government to the (nationally owned) Bank of England. It is just a press on a delete button to wipe it clean, so why not go the whole hog, hoover up the rest and press delete. Could that be Nick’s intention?

Madness you say. Think of the criticism he would receive from the Telegraph.

Until, that is, you read a piece on Monday by the Telegraph’s senior economics commentator Ambrose Evans-Pritchard entitled, World Edges Closer to Deflationary Slump as Money Contracts in China. The gist of Evans-Pritchard’s argument is that we are on the verge of another shock similar to that of 2008/9. Whereas then, the BRICs were able to keep the world economy afloat (just), this time the BRICs are in the mire too.

The situation in China, India and Brazil makes scary reading. Writes Evans-Pritchard, “My fear has always been that the credit cycle in the Rising World would blow itself out before the Old World has safely recovered, or reached “escape velocity” to use the term in vogue”. And the second straw? The stock market fell by 2% today. Pundits pointed to Europe, but just suppose the market is responding to similar fears expressed by Evans-Pritchard. Greece and its politics have surely been factored in. The election and the aftermath can’t have come as a shock to anyone. In fact, says I, grasping at the second straw, Syriza and the Greek people probably have it right. Greece is too important for Germany to allow it to fail. Faced with a Greek exit or renegotiation, the Troika will blink before the Greek people do.

In pursuit of extreme monetary stimulus, Evans-Pritchard is all for loading the helicopters tonight, “sovereign central banks have the means to defeat any depression thrown at them by launching mass purchases of assets outside the banking system, working through the classic Hawtrey-Cassel quantity of money mechanism until nominal GDP is restored to its trend line.”

“The problem is not scientific,” he continues. “A world slump is preventable if leaders act with enough panache. The hindrance is that the Euro Tower still haunted by Hayekians, and most G10 citizens – and Telegraph readers from my painful experience – (and Lib Dem Voice readers from mine, B le B) view such notions as Weimar debauchery, or plain Devil worship. Economists cannot command a democratic consent for monetary stimulus any more easily today than in 1932.”

In 1932 they couldn’t print gold. In 2012, the ECB, the Bank of England, the Bank of Japan and the Federal Reserve can print Euros, pounds, yen, and dollars.

Nick, don’t let me down. You can eliminate the whole of the National Debt and you may have to. But more importantly you will be saving future generations from the legacy of a preventable depression. Winter is coming early if you don’t.

* Bill le Breton is a former Chair and President of ALDC and a member of the 1997 and 2001 General Election teams

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  • Richard Dean 15th May '12 - 11:26am

    That is one hugely tempting Delete button! But there might be a couple of complications. The tractor factory stunt was intended as a communication to the electorate, most of whom probably don’t have GCSE Economics. We need to speak the people’s language.

  • We’ve reached a point where there are so many downside risks that we have to consider extreme action, such as loading up the proverbial helicopters. However, I have my doubts that this will work: playing around with currencies is not the same as restoring faith in the future and it is precisely that which is lacking. The last time we were in a recession, we received liftoff from the arrival of new technologies, e.g. internet for the general public and the World Wide Web. What do we have that could provide a similar spurt of creativity and optimism? Bio-technology? 3D printing? It’s difficult to see. Until we can summon up things which offer promise, it’s unlikely that people will believe that what is to come is superior to what we’ve left behind; it’s a recession of the soul as well as the wallet, and much more difficult to cure.

  • Trevor Stables 15th May '12 - 12:45pm

    After over 30 years being a member of the Party, I’m actually enjoying supporting (at least from an armchair) our Party being in Government with all the trials and tribulations that inevitably brings.
    One thing is troubling me though, ” Banking and the Banks”…..most people I speak to are really worked up and angry with the way the Banks are perceived to be getting away with blue murder.

    Not only are small businesses suffering badly through lack of lending but the general rip off of retail customers continues.

    During a long recession the public are being charged very high overdraft fees, alarming credit card rates and even the predominantly state owned LloydsTSB/Halifax this month are increasing mortgage rates when the base rates haven’t moved!

    This behaviour would be disgraceful during a financial boom but in the present circumstances it is also a slap in the face for the great British Public that have bailed out the Banks and as a result piled up the public debt.

    There will be those that argue the Banks need to refrain from lending to build up their balance sheets to protect them from another Banking crisis, well nearly £300 billion has been made available through quantitative easing so that Banks could sell assets and paper to build up their balance sheets. Alas this has done nothing to stimulate the real economy and foster economic wellbeing in the wider community, indeed many economists believe this has merely starved small and medium sized businesses of available bank lending.

    Last week watching BBC Question time I was struck by similar but more cogent arguments made by Lord Matthew Oakeshot. Quite frankly, I am very surprised that Lord Oakeshot’s expertise and clear headed views are not be being utilised by the Government.

    European Banks in mainland Europe are continuing to lend at a fraction of what British Banks are doing. Why are the European Banks able to do this while British consumers of Retail Banks are so poorly served? “Leave it to the market !” cry the Tories, well this approach has had its chance and need is for more direct intervention and leadership by the Lib Dems..

    This whole issue of direction of banking and the lack of real affordable lending needs to become an acid test for the LIBDEMS continuing in the Coalition, this will engender huge public support for the Party if only, we grasp it and really become associated with being on the side of the public who are being ripped off by the retail banks.

    “Action this day”, Churchill once said and it’s time the Party called this situation to order and obtain a better, fairer deal for the public. as stimulating Recovery would be aided by forcing the Banks to lend and lend at reasonable rates in line with Eorope, the Government have the shareholding power and our Ministers in the Government should drop their perceived timidity now.

  • David Allen 15th May '12 - 1:28pm

    Basically, we’ve all been out on a bender. We are suffering from a great big hangover. And here we are, all arguing about how best to get over it.

    Angela Merkel thinks that the morally correct solution is a cold shower and a twenty-mile run. Well, that isn’t going to help anyone feel better or recover faster.

    The Greek Syriza think that the hair of the dog solution is the thing to go for. Well, they may not manage to get their hands on any more booze, and if they do, it may not help them much.

    The centre-left think that, since the previous two guys have gone for blatantly irrational solutions which merely pander to their prejudices, therefore the good guys ought to be able to win the political contest by coming up with something more rational, whether it is Obama’s stimulus, or QE, or the Green New Deal, or whatever. I fear they are also wrong. There just ain’t any rational solution to a hangover. It will stay around with you for ages, and there’s nothing to be done about it!

  • jenny barnes 15th May '12 - 1:50pm

    It all depends on what you think the problem is. If you think the problem is that all the growth in the western economies in the last 30 years has gone to the global corpocracy (aka 0.01%) leaving the rest of us trying to live on borrowed money, it might be different to if you think those borrowings were in some sense unjustifiable.

  • Richard Dean 15th May '12 - 2:09pm

    Why not just print money?

    Modern banks are no longer places where money is kept, but places through which it moves, getting transformed on the way. Lots of small depositors put money in long-term savings accounts and this gets transformed it a one-time loan payment to a business. The business uses the money to make operating profits and pays the money back in bits over the long-term just in time for the bank to pay back the small depositors when they want their money back. A big bank has many such flows, and the art of modern banking is to balance them and make a bit of a profit too.

    When a bank gets a haircut, it no longer receives flows from the defaulter, and this means that the flows through the bank no longer balance. Some customers are going to get less interest on their deposits, and loans get harder to get. This means that the customers are paying the haircut. It slowly restores the balance, but takes a long time.

    The simple solution would seem to be to reinstate the flows that the defaulter defaults on. By doing this, none of the flows are disrupted, which means crucially that there is no effect at all on the economies that depend on those flows. No need for any inflation to result from this, and no need for a credit crunch. How to do the reinstatement? Simply print the money. Just enough to keep the flows in balance. The printing need have no other effect.

    So I wonder why this is not done? Or perhaps it is? Of course steps would need to be taken to avoid repetition, but the present agonies of Greeks and non-Greeks seem excessive as a deterrent. Perhaps there is a sound economic argument not to do it, and I wonder what it might be?

  • Borrowing went up because In banking terms debt looks like profit until people stop paying it back. Everyone knew that house prices were too high, that wages weren’t stable enough and that the bubble would burst eventually. The way out of this crisis is not more of the same. and it certainly isn’t going to be resolved by making work less stable and less rewarding.
    Also we’re kind of ignoring how much of the banking system was involved in criminality. The banks didn’t just become too big to fail they became too big to take to task. Part of me suspects that in the end a lot of this debt will simply have to be written off and that politics should be about improving the average punters lot, not trying to turn them into more efficient wage slaves and better profit yielding debt peasants.

  • The problem is excess non-government sector savings and what to do about them. Excess non-government savings brought about by feelings of uncertainty generate the paradox of thrift. They cause a depression by eliminating spending.

    A credit system can have this condition because banks buffer, so you end up with a value that Modern Monetary Theory (MMT) calls ‘net-savings’ which is more properly called ‘non-government savings net of investment’.

    As uncertainty increases investment goes down and savings goes up, increasing the excess savings value.

    The choice then for government is to confiscate those excess savings through taxation, let the economy shrink naturally (causing massive unemployment and destruction of capital – bad and good), or accommodate those excess savings by spending and running a deficit (essentially offer the non-government sector a savings account with government – whether national savings, bank reserves, government bonds or even newly printed cash for storing under a mattress).

    It’s very difficult to determine whose savings are excess – because we have intermediary facilities called banks. So taxing the excess savings away is problematic. Taxation is just as likely to destroy actual private sector spending, and in itself seems to generate further uncertainty – after all you are increasing taxation in a slump. It’s very likely to be pro-cyclical.

    The MMT approach is to accommodate those savings with counter-balancing government deficits (eliminating the problem of whose savings are the issue), get the economy going and increase taxation/decrease government spending if necessary *during a boom* when it is more acceptable. However if you design the automatic stabilisers properly (such as with a job guarantee scheme) that will handle the counter-cyclical backoff more elegantly and acceptably.

  • Richard Dean 15th May '12 - 3:09pm

    @Joe Bourke. Where are those savings? If they are in banks, aren’t the banks either using them to support their reserves, or lending them? Are they really sitting there doing nothing but wilt? And if they are, then taxing them might have a desired efect (the LVT argument?). I’m just ignorant and interested, that’s all. I have no money (or property) myself.

  • Richard Dean 15th May '12 - 3:30pm

    One way to identify static money might be through a company’s accounts – it is presumably what appears on the Balance Sheet as “Cash in Bank and at Hand”. One way to get it moving would be to put a tax on “Cash in Bank and at Hand”. Companies would move it out to avoid the tax – maybe into Fixed Assets, which means investment in the means of production. There’d maybe need to be new auditing procedures to check that such moves are real. Would it work?

  • Richard,

    a big chunk of the multi-nationals UK profits and cash piles seem to be going into overseas investments and foreign currency holdings according to this report UK firms are spending – but their money is going abroad.

  • Richard.

    This guy seems to advocate taxing of cash piles Tax the corporate cash mountains

  • Richard Dean 15th May '12 - 7:02pm

    @Joe. That’s very useful information, thanks. This really isn’t a savings crisis at all, then, it’s just that we’re losers in the global competition for investment. I imagine China and India, with their huge populations, present such large opportunities for profits that there’s virtually nothing we can do to attract investors back.

    Maybe we should all move there? Seriously, there must be skills we have that can be useful in those huge economies, and China might not notice even a million people moved there from the UK. Another way: a programmer or consultant or telephonist can work in the UK and deliver products via the Internet to companies abroad. Another: freight costs are negligible, and allow cheap Chinese goods to be sold world wide. Can we do the same in reverse? Are there things we can make here that can be useful for foreign economies and that they can’t make enough of?

    Does the crisis reaaly mean that our entire lifestyles must change in these sorts of ways? After all, others have done it to us, why can’t we do it to them?

  • Andrew Suffield 15th May '12 - 7:59pm

    So I wonder why this is not done? Or perhaps it is?

    My understanding is that this is more or less exactly what quantitative easing is doing.

  • Bill le Breton 15th May '12 - 8:28pm

    Exactly Andrew.

    It is very good of you all to contribute, but I did think I’d get a battering for suggesting that before we are out of the whole (or liquidity trap) we might have to use QE to a scale as great as the entire national debt.

    And what did everyone think of the Evans Pritchard piece? Are the ‘Rising’ economies going into a period of deflation?

    Richard, my worry about the Clegg clanger is not so much that he obviously doesn’t really understand the true objective of his deficit reduction policy, it was as much the religious fervour of his remark. As I have said before, there is a Puritanical reaction to debt that moves it out of rational analysis in many cases. Austerity has been enveloped in the sacred. Debt is profane … as you Durkheimians would say.

    On banking – why ‘tax’ when you can charge banks (rather than pay them interest) for ‘storing’ money at the Bank of England. At present they receive a risk free payment for not lending.

    Did anyone hear the story from Portugal about Pingo Doce’s 50% discount marketing campaign: http://en.wikipedia.org/wiki/2012_Rush_to_Pingo_Doce ?

  • Tony Dawson 15th May '12 - 9:13pm

    @Bill le Breton

    “…my worry about the Clegg clanger ”

    My worry is more about the Osborne-Alexander soup dragon.

    I enclose a still from a recent Cabinet meeting. 🙂


  • Richard Dean 15th May '12 - 9:17pm

    @Bill le Breton. When the time comes, I nominate you as the person to push the “Delete QE” button. It will possibly be the biggest deletion in history. Indeed, the TV rights alone might pay be able to pay off the QE, making the ceremony self-funding.

    In the meantime, charging banks for overnight deposits does seem a good idea – may make them slightly more willing to inter-lend. Why is the BofE not doing it? Are Puritans really uncomfortable about debt? Others certainly are, hence Islamic banking in which actual ownership of an asset is shared between a bank and “borrower”. Over time the borrower pays the bank and more and more ownership is transferred until the bank has all the money and the borrower has all the asset. Could this be a way forward?

    Wikipedia associates Durkeim with suicide, and two of his four forms of suicide seem particularly apt…

    >Anomic suicide: reflects an individual’s moral confusion and lack of social direction, which is related to dramatic social and economic upheaval
    >Fatalistic suicide: the opposite of anomic suicide, when a person is excessively regulated, when their futures are pitilessly blocked and passions violently choked by oppressive discipline

    But none of the four are for me thanks!

  • Keith Browning 15th May '12 - 10:27pm

    I was in a store with the Pingo Doce’s 50% discount. I went in to buy a carton of milk and came out with nothing. The queue was about an hour long. They chose a day when most people didn’t work, and people who had to work were paying friends 20 euros to purchase goods.

    It was interesting what people were buying. Mostly dry goods or things that stored well. Rice, olive oil, UHT milk, tins of anything were probably favourite. No-one seemed to go for top end luxury foods. People were stocking their larders for a rainy day.

    It seemed like a good idea in a country where people are struggling.

    What it does show that poor people will spend money on sensible things and rich people will squirrel it away in the Virgin Isles not spend it on Virgin oil.

  • Bill le Breton 16th May '12 - 6:23am

    Fascinating, Keith. Interesting how you ‘priced’ your time.

    But … Let’s not get carried down a false trail:

    QE is not designed to reduce the National Debt.

    The argument is that although the Government has ‘created’ this new money, because it has a policy of destroying an equivalent amount when recovery occurs, it does not lead to the changed behaviour it is designed to achieve.
    The only way of changing behaviour is to make the creation permanent. That would only occur if the ‘delete’ button was used and reversal believed to be impossible.

    Why would anyone want to debase the currency?

    The argument is that when it is known that the pound will buy fewer goods and services tomorrow consumers will spend it today – passing the money on as quickly as they would a hot potato.

    Has it been done before?

    Yes – Shortly after being inaugurated in the spring of 1933, FDR one month later passed Executive Order 6102 (outlawing the hoarding of gold). All gold had to be surrendered to the Federal reserve for $20.67.
    To obtain gold for foreign exchange, US citizens then had to buy it from the Fed for $35 – FDR had deliberately debased the value of the dollar by (by my reckoning) 37.5%.

    What was the effect? Industrial production rose 57% in his first four months of office, prices having risen sharply.

    Could it be done now?

    Yes, but it would require co-ordinated activity by central bankers.

    What is stopping this? A fifty year mindset that inflation is the enemy. And especially the overhang of a particularly bad experience in Germany that influences its monetary policy today and influences the policy of the European Central Bank.

    This is about the price level, not the debt level.

  • Paul Murray 16th May '12 - 7:27am

    Evans-Pritchard recently described the Greek electorate as suffering from “cognitive dissonance” – they want to remain in the Euro but also want their debt to be cancelled.

    He has also repeatedly referred to the visceral fear of hyper-inflation that lies behind BuBa policy and the German constitutional ban on fiscal transfers: “No permanent treaty mechanisms shall be established that lead to liability for the decisions of other states”. This is a clear ban on Eurobonds.

    The real issue here is the Euro itself. It seems to me that just like the current Greek electorate, its creators suffered from “cognitive dissonance” – they convinced themselves that monetary union would not require fiscal union. It’s hard enough in this country to convince people in Surrey that their tax money is well-spent in regeneration projects in Tyneside – how much harder is it to convince the people of Finland that their taxes (and accumulated wealth) should be used to cancel the debts of the “feckless Greeks”?

  • Richard Dean 16th May '12 - 10:08am

    @Paul Murray. Is it perhaps the others that suffer from “cognitive dissonance” – by wanting the Greeks to remain in the Euro but also wanting their debt to be paid?

  • Bill,

    support for your debt cancellation proposal from an unusual quarter Bond Vigilantes.

  • Richard Dean 16th May '12 - 4:28pm

    This is what a friend says,

    The financial services sector values stuff on the basis of what it expects to happen to prices in the future. If QE has to be paid back, that has an implication for the future that affects current prices of stocks and debt. The consequence of using the Delete button would be that the pre-deletion prices (striictly, the pre-publication prices) no longer match the post-deletion future, so prices would adjust. The adjustment would be exactly equivalent to the QE that was deleted, but it would occur in the free economy, and so be uncontrolled – with all the chaos that that might cause.

    If this sounds mystifying, I agree! I have no way of explaining it.

  • Bill le Breton 16th May '12 - 8:06pm

    Richard, that is exactly right, but the comment that it would bring chaos is just prejudice. It will result in increased aggregate demand. But, because QE can be reversed, (and the bank of England says it will be) the market expects it will be reversed and so does not ‘spend’ or ‘invest’ expecting interest rates to rise as it is clawed back in the future. It has to be permanent to affect behaviour NOW.

    A break up of the Euro will be hugely deflationary. Which is the point made by Evans-Pritchard … and at a time when deflationary pressures are mounting within the BRICs.

    Joe, Interesting to see those Bond Vigilantes contemplating the possibility.

    If things are as dire as my own prejudices believe then it will happen. Until then, these are my thoughts on NGDP targeting:

    It was interesting that in the Hutton/Cable interview Cable’s commitment to NGDP targeting seemed to be as a result of a fear that the currency would lose the competitive advantage of its depreciation before export growth had come through. He saw NGDP target-setting succeeding as via the exchange rate.

    That was probably at £/Euro 1.8. We are now at 2.5. Cable’s concerns have come true and are getting truer by the day.

    I expect that a debate is going on within the Lib Dem leadership on NGDP targeting.

    Huhne was too ‘backdated’ (as the Roger Daltry would have said) to ‘get’ the concept. But he is no more. Does Laws get it? I really hope so, but have no confidence he will.

    The eyes of Clegg and Alexander would glaze over at the thought of having to get their heads round it. But both would look to Laws.

    I don’t see anyone in the DPM team that would be open to the idea.

    That leaves Cable and Laws as the only hope. Again, the point is that this is about the price level, not the debt level, and I am not sure that Laws will accept that as, if it is not the debt level, it doesn’t serve the ideology of reducing the size of the state.

    To see the best way forward you have to be pragmatic about the size of the state and unprejudiced about inflation. That is an alient mind set in 2012.

  • Bill,

    interesting review from Martin Wolf Fiscal and monetary policy in a liquidity trap

    What is the correct approach to fiscal and monetary policy when an economy is depressed and the central bank’s rate of interest is close to zero?… I can identify three macroeconomic viewpoints…. The first is the pre-1930 belief in balanced budgets and the gold standard…. The second is the religion of balanced budgets and managed money, with Milton Friedman’s monetarism at the rules-governed end of the spectrum and independent inflation-targeting central banks at the discretionary end. The third demands a return to Keynesian ways of thinking, with “modern monetary theory” (in which monetary policy and central banks are permanently subservient to fiscal policy) at one end of the policy spectrum, and temporary resort to active fiscal policy at the other.
    In this note, I do not intend to address the first view…. I also do not intend to address Friedman’s monetarism… [or] “modern monetary theory”…. This leaves us with the respectable contemporary view that the best way to respond to contemporary conditions is via fiscal consolidation and aggressive monetary policy, and the somewhat less respectable view that aggressive fiscal policy is essential when official interest rates are close to zero.
    Two new papers bring light from the second of these perspectives…. McCulley… and… Pozsar… [and] J. Bradford DeLong… and Lawrence Summers….
    McCulley and Mr Pozsar puts the case for aggressive fiscal policy. The US, they argue, is in a “liquidity trap”: even with official interest rates near zero, the incentive for extra borrowing, lending and spending in the private sector is inadequate…. [L]arge swathes of the private sector became over-indebted. Once asset prices fell, erstwhile borrowers were forced to reduce their debts… “debt deflation”… “balance-sheet recession”, coined by Richard Koo of Nomura. That is what Japan had to manage in the 1990s. This is how the McCulley-Pozsar paper makes the point:
    deleveraging is a beast of burden that capitalism cannot bear alone. At the macroeconomic level, deleveraging must be a managed process: for the private sector to deleverage without causing a depression, the public sector has to move in the opposite direction . . . by effectively viewing the balance sheets of the monetary and fiscal authorities as a consolidated whole. Fiscal austerity does not work in a liquidity trap and makes as much sense as putting an anorexic on a diet. Yet ‘diets’ are the very prescriptions that fiscal ‘austerians’ have imposed (or plan to impose) in the US, UK and eurozone. Austerians fail to realise, however, that everyone cannot save at the same time and that, in liquidity traps, the paradox of thrift and depression are fellow travellers that are functionally intertwined.
    Confronted by this line of argument, austerians (a term coined by Rob Parenteau, a research associate at the Levy Economics Institute of Bard College), make three arguments:
    1. additional borrowing will add heavily to future debt and so be an unreasonable burden on future generations;
    2. increased borrowing will crowd out private borrowing;
    3. bond investors will stop buying and push yields up.
    In a liquidity trap, none of these arguments hold….
    McCulley and Pozsar:
    held back by concerns borne out of these orthodoxies, . . . governments are not spending with passionate purpose. They are victims of intellectual paralysis borne out of inertia of dogma . . . As a result, their acting responsibly, relative to orthodoxy, and going forth with austerity may drag economies down the vortex of deflation and depression….
    The conclusion of the McCulley-Pozsar paper is, in brief, that aggressive fiscal policy does work in the unusual circumstances of a liquidity trap, particularly if combined with monetisation. But conventional wisdom blocks full use of the unorthodox tool kit. Historically, political pressure has destroyed such resistance. Political pressure drove the UK off gold in 1931. But it also brought Hitler to power in Germany in 1933. The eurozone should take note.
    Remarkably, in the circumstances of a liquidity trap, enlarged fiscal deficits are likely to reduce future levels of privately held public debt rather than raise them. The view that fiscal deficits might provide such a free lunch is the core argument of the paper by DeLong and Summers….
    In normal times, with resources close to being fully utilised, the multiplier will end up very close to zero; in unusual times, such as the present, it could be large enough and the economic benefits of such expansion significant enough to pay for itself. In a liquidity trap fiscal retrenchment is penny wise, pound foolish. Indeed, relying on monetary policy alone is the foolish policy: if it worked, which it probably will not, it does so largely by expanding stretched private balance sheets even further…. [T]he absence of supply constraints means that the multiplier is likely to be large. It is likely to be made even bigger by the fact that fiscal expansion may well raise expected inflation and so lower the real rate of interest, when the nominal rate is close to zero…. [M]oderate hysteresis effects of such fiscal expansion, via increases in the likely level of future output, have big effects on the future debt burden…. [T]oday’s ultra-low real interest rates… suggest that monetary policy is relatively ineffective….
    This is a very powerful result. It rests on the three features of the present situation: high multipliers; low real interest rates; and the plausibility of hysteresis effects…. [T]he expansion would continue to pay for itself even if the real interest rate were to rise far above the prospective growth rate, provided there were significantly positive multiplier and hysteresis effects…. Are such numbers implausible? The answer is: not at all. Multipliers above one are quite plausible in a depressed economy, though not in normal circumstances. This is particularly true when real interest rates are more likely to fall, than rise, as a result of expansion. Similarly, we know that recessions cause long-term economic costs. They lower investment dramatically…. Again, we know that high unemployment has a permanent impact on workers, both young and old. The US, in particular, seems to have slipped into European levels of separation from the labour force…. Indeed, we can see hysteresis effects at work in the way in which forecasters, including official forecasters, mark down potential output in line with actual output: a self-fulfilling prophecy if ever there was one. This procedure has been particularly marked in the UK, where the Office for Budget Responsibility has more or less eliminated the notion that the UK is in a recession. Yet such effects are not God-given; they are man-chosen. They are the product of fundamentally misguided policies.
    This is an important paper. It challenges complacent “do-nothingism” of policymakers, let alone the “austerians” who dominate policy almost everywhere. Policy-makers have allowed a huge financial crisis to impose a permanent blight on economies, with devastating social effects. It makes one wonder why the Obama administration, in which prof Summers was an influential adviser, did not do more, or at least argue for more, as many outsiders argued.
    The private sector needs to deleverage. The government can help by holding up the economy. It should do so. People who reject free lunches are fools.

  • Bill le Breton 17th May '12 - 6:54pm

    Martin Wolf has a considerable reputation, Joe.
    Let’s list six Liberal Democrats who should read this article …
    I still think that it is pragmatic in the circumstances to try both monetary and fiscal stimulus provided the politicians instruct the MPC not to nullify the fiscal stimulus – ie set them a new target for the price level (if not for NGDP growth).
    And as I have been arguing for nearly four years now, they are co-joined in the way the PSBR is financed.
    If we are going to fall out with outr partners in the EU, then we should do it over bank loans to the public sector.

  • Richard Dean 17th May '12 - 6:56pm

    ‘Tis the season of long comments! This paper confuses me – if “The private sector needs to deleverage”, then why do people say that firms are sitting on huge cash mountains? Excuse my ignorance, and distrust of apparently free lunches. I also wonder if the liquidity trap is as solid as people make out, but that would be another question,

  • Bill le Breton 17th May '12 - 9:23pm

    Richard, I think this is how it can be explained: firms are on a spectrum – the most indebted are paying down debt, the most cash positive are finding low risk uses for that cash – on deposit. Net effect, loans are falling. Does that help?

    If MV=PT=Aggregate Demand, the reduction in money supply (without a change in the Velocity of money ) leads to reduced aggregate demand, which in its turn discourages investment … and onwards and downwards.

    Change in Money Supply = PSBR + change in the stock of bank loans to the private sector – change in stock of non bank private sector loans to Government (gilts) + O (the overseas impact on the money supply.

    If you reduce the PSBR at the same time that the stock of loans to the private sector is falling, Money supply must fall and with that (velocity constant) AD falls. So, austerity just makes matters worse.
    Wolf and others above are describing this.

    Besides lack of demand failing to excite the entrepreneurial juices, some suggest that there is a dearth of investment opportunities. Either way, the firm that pays down debt leads to the destruction of money and the firm that does not borrow, does not lead to the creation of money.

    The GOvernment must step in if output is not to keep falling. If the government borrows from banks, it avoids the bond market. The Government gets its services and infrastructure and tax reductions.

    Any inflation encourages people to spend today as their money would buy less tomorrow. Firms predicting this stimulation in demand increase capacity, eventually replenishing stocks and buying new capital goods.

    Escape velocity is reached.

  • toryboysnevergrowup 17th May '12 - 10:22pm

    On Greece and the other PIIGS one point that is not being recognised is that those countries have already experienced substantial falls in their levels of real wages – they have already had much of the pain that those followers of neoclassical economics who complained about their lack of competitiveness said they had to go through. The response of the same people, and the speculators, that they need to have a further dose of medicine through being forced out of the Euro and by being made to devalue their currencies just strikes me as a combination of their pig headedness about their economic theories and vindictiveness. And of course what will these ideologues be asking for next – when any devaluation does not produce instant results and in the short term makes things even worse (remember the old J curve and the 18-24 months required for the benefits of devaluation to come through).

    To be honest the Greeks are being perfectly sensible in asking for both an end to deflationary fiscal policies and no further cut in real wages caused if they were to leave the Euro. Perhaps a little medicine needs to be given to the bond traders and hedge fund managers looking for speculatory gains from others misery.

  • Richard Dean 17th May '12 - 10:26pm

    @Bill le Breton. Thanks, yes and no, but that’s just me. Your explanation is good, thanks. Please excuse me if I continue to misunderstand!

    If the indebted firms are paying down debt, and the cash-rich ones are depositing the cash with banks, then banks should be in good shape, and getting better. Unless the problem is far far worse than we have ever been told, the banks should be able to start lending to non-indebted, non-cash-rich and new businesses, and there should be a recovery. If the banks are instead buying government bonds, why can’t the government increase bond prices to encourage banks to lend elsewhere? This doesn’t look like the liquidity trap to me – it looks more like HMG wanting the banks’ money due to fright about its own upcoming commitments.

    Sorry if this is utter nonsense. Thanks for the macroeconomics lesson in advance, the book I’m reading on it is so boring! I haven’t asked about O(verseas impact) – that may be next!

  • Bill le Breton 18th May '12 - 6:32am

    Morning Adrian and others.

    JUst caught a snip of the Prime MInisters speech yesterday in which he apparently called for more monetary stimulus! If true this is great news. But someone should tell him that he is the prime minister. The GOvernor of the Bank of England’s phone number is in his cell-phone memory. Tell him! and do it publically so the market and business world hears him. But whewre oh where are the Lib Dem leaders on this – could/should have nbeen calling for this all along.

    Toryboys nevergrow up. If Greece leaves the Euro then the subsequent devaluation will result in a lot of very cheaply priced Greek firms and the GOvernment’s privatisation programme will then be in a firesale of cheap assets too. I happen to think that the sell off in markets could be the speculators building up cash to ‘cash in’ on these cheap assets.

    Richard, how many good investment projects are there out there? See above. Why risk gearing up or buying into something which could lose you money – remmber the quote from Will Rogers in the 1930’s ‘I am more concerned about the return of my money than the return on my money. ‘ So keep it ‘dry’ somewhere safe – even under your bed and wait … five years on there could be some real bargains – (this is not my thinking you understand, but a cartoon of what is going on).

    Also the B of E is speaking with forked tongue. How can Banks lend and keep their balances sheets strong at same time? Why should they risk lending to start ups when they can deposit spare cash at B of E and charge those who do want to borrow massively inflated fees?

  • toryboysnevergrowup 18th May '12 - 10:09am


    I suspect that most of the speculators wouldn’t probably be interested in buying Greek Government assets but just in closing off their short positions so that they can realise their ill gotten gains to spend elsewhere – possibly funding futher short positions in an other of the PIIGS.

  • Richard Dean 18th May '12 - 11:58am

    @Bill le Breton. Good Morning. Aren’t some of the profits from lending to business used to re-capitalize? But I suppose if you are certain that Greece will not default, you re-capitalize quicker by lending to Greece and raking in the huge interest payments. Or if you’re unsure about Greece, you lend to Spain and still re-capitalize quicker, and once you;ve re-capitalized you continue to make a better profit than from business lending. And who is doing all this bad stuff to them which hurts us too? The City of London! What’s the solution?

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