Opinion: Pick your horse in the grand recovery stakes

Moody’s, the US credit ratings agency, has put the UK on negative outlook, threatening the country’s triple A status. This came the day after three other organizations had also made their views known.

The CBI predicted that the UK would avoid a double-dip recession, the services firm BDO published the results of a survey suggesting turnovers were continuing to fall and the Chartered Institute of Personnel and Development reported that employers were more likely to lay off staff.

It is now four and a half years since the uncertainty of the credit worthiness of banks and hedge funds that were holding sub-prime mortgage-backed securities caused a ‘credit crunch’: time enough, surely, to have data to compare the differing policies and contrast the performances of some key nations.

Over at The Faint of Heart Marcus Nunes has done just that for the US, the UK, Australia, France, Sweden and Poland, which like the UK remains its own currency issuer outside of the Eurozone and has put in a very interesting performance in the Grand Recovery Stakes.

On the left hand side of the diagram below are three countries in which their respective central banks made it possible for Nominal GDP (the red line) to rise roughly in line with its pre-2008 trend.  In Poland there was hardly a pause.  In Australia NGDP leveled briefly before resuming course (note Australia stimulated its housing market with subsidies for first time buyers).  In Sweden policies that initially saw NGDP decline were reversed.

In all three ‘thoroughbred’ countries Real GDP (the blue line) continued to grow as NGDP rose.  The response of real growth in Sweden, declining as NGDP declined and rising when once NGDP resumed its course, is especially striking.

The story in the US, the UK and France is of central banks (the ECB for France) allowing their NGDPs to decline and not afterwards regain its earlier trend rate of increase with the effect that real growth has barely regained the pre-shock levels four years on.

Nunes then went on to plot the ratios of Government Spending to GDPs.

Here, the three leading ‘horses’ have chosen different paths. Sweden endeavoured to reduce the ratio significantly, whilst Poland allowed it to grow.

In conclusion, fiscal policy, Plan A or Plan B or whatever, was far less important than Plan M – where M stands for a monetary policy that appears to be practicing nominal GDP level targeting.

If this policy is a crucial factor in recovery in countries like Poland, Australia and Sweden (all of which have adopted differing fiscal policies), why is there so little attention paid to it here?

Over at The Money Illusion, in part 1 of this post the market monetarist, Scott Sumner, offers this explanation:

… monetarism looks so out of touch with reality for many people with feet firmly planted in the real world.  They see some “obvious” problem like a housing bust, which really is a problem.  It’s capable of reducing R(eal)GDP growth by say 1%.    Then they see a demand-side recession follow soon after.

They see no sign of tight money (recall that rates are low.)  So they can’t imagine how this mysterious “tight money” could have caused the recession.  But as we saw with Australia, if the central bank keeps N(ominal)GDP growing (at least in terms of two year averages) then RGDP can hold up pretty well, despite a big drop in exports.  Australia had the growth slowdown (as opposed to decline) that we (the USA) and the Europeans should have had, if we’d been following a NGDP level targeting approach.

At the very least the first part of Sumner’s post should be essential reading for Liberal Democrats.  It may be counter-intuitive to believe that it is nominal spending that determines real outcomes, and not fiscal stimulus, but then Liberals are in their element countenancing the counter-intuitive and supporting the outsider.

* 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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  • Andrew Suffield 16th Feb '12 - 6:07pm

    He is suggesting that the variation in economic growth between these various nations is unrelated to the question of austerity/stimulus, and is more to do with monetary policy.

    Fascinating, if true. Can somebody volunteer a couple of nations to experiment and find out if it is? It would be a worthy contribution to science.

  • Bill le Breton 17th Feb '12 - 9:38am


    The Market Monetarist prescription is a NGDP level targeting approach. For example, if the level was set at 5% with the intention of achieving 2% inflation and 3% real growth and in a year the out turn looked to be 4% the following year’s target would be 6%, or if 6% the following year’s target would be 4%. Importantly, this would have to be an overt policy, known and understood by all as it rests on expectations, which would themselves respond to signals read for an enhanced market for ‘treasury inflation protected securities’.

    MMs do generally believe that fiscal stimulus is ineffectual (that the multiplier is zero). Their reasoning is that the central bank will read the fiscal stimulus as inflationary and tighten monetary policy in pursuit of their inflation target – nullifying the fiscal stimulus.

    Ultimately these are political decisions. This is why I believe they should be addressed, debated, decided in the political field. At present politicians obsess over small variations in fiscal policy and leave monetary policy to central bankers (in most cases the central bankers who oversaw the mess in the first place).

    It was interesting to hear King this week predict 1.2% real growth in the year to come. As he also thinks inflation may fall towards 2% by the year end, then one may presume that the ‘hawks’ on the MPC will be trying to set monetary policy to achieve nominal growth of 3.2% – urging a tightening if that target appears to be being exceeded. Perhaps they are suggesting that capacity has been so reduced over the recession that this is all that the economy can deliver.

    There would be much space within the debate for arguing the target level of NGDP increases and, if fiscal and monetary policy was under unified control, debate over the combination of fiscal and monetary policies needed to achieve it.


  • Andrew Suffield 17th Feb '12 - 1:52pm

    Ultimately these are political decisions.

    I think that the question of whether or not a statement is true is one that is best not left to politics. Factionalisation over facts is rarely productive.

    Politics should be about what we are trying to achieve, not which religion we should use as a substitute for evidence.

  • Bill le Breton 17th Feb '12 - 8:24pm

    Thank you Louise.

    Andrew, I like some accoutability when power is being exercised. The central bankers got it very wrong, not just running up to 2007, but, when the shock arrived, they took far too long to loosen monetary policy. 6 months after Lehman’s before slashing rates was derelict and they should have been sacked for it. Ditto those members of the MPC who were calling for interest rate rises 8 months ago.

    Liberal Eye, I know where you are coming from with your views on Australia and they did have the advanage of exporting raw materials to China, but in the early days these too were affected.

    It is pretty clear that the E in PPE was more like an exercise in learning classical Greek 100 years ago than anything relevant to experience post 1975. Perhaps we would have a very different perspective on economic policy if those cabinet ministers had read economics at say Warwick or York.

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