Opinion: You can’t have ‘growth’ without ‘austerity’

Amid the current maelstrom of gossip, speculation and forecasting concerning the British economy, a number of myths have developed.

Principal among them is that the coalition’s economic plans for this parliament contained ‘only’ cuts, with no concern for achieving growth.

The issue of whether fiscal consolidation itself can be a driver of growth is one I aim to address further below, but first I want to debunk that myth.

The economic plans, outlined by the coalition in 2010, made clear that the first half of the parliament would contain the bulk of the ‘cuts’, while, in the latter period, capital spending would increase to help deliver growth.

Perhaps the greatest contribution made to modern economics by the great Liberal J.M Keynes was his highlighting the importance of certainty in an economy. Many times in history this has been misapplied by governments, who simply used it as a license to spend money, give a short term boost to the economy, and store up problems for future governments to deal with.

However the memory of tough times, and realization that the growth seen in the economy is as a result of a temporary government initiative, means real confidence, what Keynes called the ‘animal spirits’ of the people, is not increased. Another reason why massive spending doesn’t necessarily increase confidence, is that sharp increases in government spending can lead to inflation, as the spending is financed by borrowing, which can weaken the value of the currency, making imports more expensive. Thus, even if the economy is doing better, people won’t feel better off and so won’t feel more confident, and will constrain their spending, tipping the economy back into negative territory.

Keynes advocated austerity been applied at the right time, believing that balanced budgets are a long term obligation of governments.

One advantage of the clear and definitive austerity programme of the coalition is that market participants knew when and on what scale the cuts would happen and could adjust accordingly. This increases certainty and allows policy makers to understand the true state of the ‘real’ economy, i.e. at level demand without the impact of artificial stimulus.

The second advantage of austerity as a prelude to growth, is that it should help to maintain lower borrowing costs. This means that when the borrowing occurs to enable growth later in the economic cycle, it will be at a lower rate, helping to keep inflation low and ensuring that the growth, achieved by the economy as a result of the infrastructure spending, is not swallowed up by the costs of repaying the borrowed money, which is usually acquired on international markets, with the repayment essentially being money leaving the country, not contributing to increased domestic demand.

We have the UK’s borrowing costs hitting a record low, while Nick Clegg has been able to announce infrastructure spending in accordance with the coalition agreement.

Labour has consistently embraced cuts, but their ‘cut later’ strategy would damage the economy. The markets would be skeptical of cuts ever happening, keeping borrowing costs and inflation higher than necessary, while domestic market participants, who may have the capacity to spend because they haven’t suffered a ‘cut’, will choose not to spend as they anticipate cuts are coming. By announcing and frontloading the cuts, the coalition got the bad news out of the way in one go, while Labour’s longer term ‘drip drip’ approach increases uncertainty. This means demand is reduced, without the deficit being reduced. This is something I discuss in greater depth here.

By announcing and frontloading the cuts, the coalition got the bad news out of the way in one go, while Labour’s longer term ‘drip drip’ approach increases uncertainty.

We live in interesting economic times, with many orthodoxies to be challenged, but the concept of austerity and investment being two sides of the same coin to achieve growth is as true today as it was when Keynes minted it seven decades ago.

* David Thorpe was the Liberal Democrat Prospective Parliamentary Candidate for East Ham in the 2015 General Election

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38 Comments

  • mike cobley 28th May '12 - 2:01pm

    Ah, I see. So the Coalition policies consist of this, this and this, while Labour would have done that and that; the Coalition is doing all these things, where Labour would have done all t hose things over a longer period.

    What an encapsulation of the narrowness of permissible debate, as reflected, of course, in the media wherein no other solutions or critiques are allowed to be taken seriously.What a crashing failure of imagination and the critical faculty.

  • I love that link to why Labour’s policy would increase the chance of a double dip recession. This article really does have to be read in the context of the author’s other contributions to Libdemvoice for full effect.

  • Richard Dean 28th May '12 - 2:39pm

    I wonder whether it might be a bad thing, rather than a good one, that the UK’s borrowing costs have hit a record low? What about the costs of damage done as a result of reducing governemnt investment or spending? Perhaps there is some intermediate level of borrowing where the sum of the two costs is least?

  • @Richard, you might find Martin Wolf’s column in the FT on a more nuanced reading of our low borrowing costs quite interesting. http://blogs.ft.com/martin-wolf-exchange/2012/05/12/the-journey-towards-becoming-japan/

  • And on what that means for the coalition’s economic policy:
    http://www.ft.com/cms/s/0/5853d1c0-9ea9-11e1-9cc8-00144feabdc0.html#axzz1wAivLafS

  • David Thorpe 28th May '12 - 2:59pm

    Thanks for the comments all.
    Just to clarify-I dotn think the coalition have gotten everything right-nor have Labour gotten everythingw rong. The eurozoen sovereign debt crisis means that the best laid plans of either side would be blown off course by now. Thats whyw e have a double-dip recession- thats why the eurozone countries which announced their cuts(ireland) are not in recession-while those who waited are.
    There is also an argument that we had the stimulus before the growth-i.e. under gordon brown, he certainly argues in his book that the stimulus happened on his watch.
    I think hesright about that-however, through no fault of brown-the stimulus money wqas used not to directly stimulate demand-which is what a keynesian would do-but to prop up demand by rescusing the banks.
    This meant that we had a worst of both worlds sceanrio-huge deficit-no extra demand-that unprecdented sceanruio l meant the coaltion had a quite unique economic problem, many hard critics on the right and left have tried to treat the problem within an orthodox framework, and it shouldnt be.

  • Richard Dean 28th May '12 - 3:13pm

    @Aaron. Very interesting. So the low bond price is an indication that business is not investing? The lower the bond price, the more damage is being done?

  • Here is a section ofthe recent Bank of England report on the subject:

    “Gilt yields remain close to historically low levels. Domestic and international factors are both likely to have depressed yields. Domestically, the MPC’s asset purchase programme and expectations that official interest rates will remain low have reduced gilt yields. The current level of yields could also reflect expectations of weak output growth in the longer term: the implied cost of government borrowing for five years in five years’ time is also close to historically low levels, largely reflecting low real rates. Internationally, persistent concerns about euro-area periphery countries have contributed to strong demand for sovereign bonds — including those of the United Kingdom — that are perceived as more liquid or carrying little credit risk. That is also likely to have contributed to the current depressed level of gilt yields.”

    As Jontahan Portes notes, the domestic factors stem form economic weakness, not strength. And he argues that although our low credit risk is a factor that helps, it wasn’t ever really a massive issue. We look good now more because the Eurozone countries are so comparitively bad.

    You might like his blog with other posts as well:

    http://notthetreasuryview.blogspot.co.uk/

  • I have to say, even commentators at the Telegraph are getting exasperated with Cameron’s simplistic spin that low borrowing costs are a sign of successful coalition policy!

  • Alex Sabine 28th May '12 - 3:56pm

    David, I agree with much of your basic argument, including the point that it makes sense to ‘get the bad news out of the way’ and lay out a full audit of the public finances, and the measures required to sort them out, which is broadly what the coalition did in 2010. However it isn’t the case that the cuts are being front-loaded.

    “The economic plans, outlined by the coalition in 2010, made clear that the first half of the parliament would contain the bulk of the ‘cuts’, while, in the latter period, capital spending would increase to help deliver growth.”

    Not really. The original June 2010 fiscal plan featured discretionary spending cuts that were fairly evenly spread from 2011-12 onwards, but tax increases that were heavily ‘front-loaded’.

    While the overall aim was a roughly 80:20 split between cuts and tax rises, this would not be achieved until the very end of the plan, and in the early years the government planned to rely on tax rises to do nearly half the work. Thus, the ratio of cuts to tax rises was projected to rise gradually from 57:43 in 2011-12 to 77:23 by 2015-16. See the June 2010 Budget Red Book p15: http://cdn.hm-treasury.gov.uk/junebudget_complete.pdf.

    The latest plans, as modified in last year’s autumn statement and tweaked very slightly in the most recent Budget, envisage a similar profile for the balance of the fiscal tightening, with the net tax increases now nearly complete and the bulk of the spending cuts still to be done.

    You’re right that the capital spending squeeze was always going to be eased in the second half of the Parliament. Both Labour and the coalition planned to withdraw the ‘stimulus’ injections of capital spending of 2008-09 and 2009-10, with big cuts in the early years of the consolidation tapering off to a real-terms freeze after 2014. All parties planned to front-load the capital cuts, presumably because this is simply easier to cut than current spending. But the cuts in non-investment spending were back-loaded, which has indeed been the case under the coalition with current spending continuing to rise in real terms.

    The Treasury figures I’ve cited are based on so-called ‘discretionary’ policy changes – ie they are relative to a baseline in which departmental spending grows in line with inflation, and in which no measures are taken to restrain the growth in welfare spending. In other words, the baseline assumes that welfare spending would continue to rise in real terms, and any welfare changes are counted as ‘cuts’ even if they are, strictly speaking, simply reductions in planned increases. Equally, this approach counts the savings in debt interest costs that result from the fiscal tightening as ‘cuts’, even though the actual debt interest bill continues to rise. So this way of measuring the cuts is relative to an ‘unchanged policy’ scenario if you like, not a scenario in which public spending remains constant in real terms (let alone cash terms). Likewise, tax receipts are assumed to grow in real terms and the figure for tax rises is based on the revenue yield from specific tax-raising measures like the rise in VAT from 17.5% to 20%.

    If, instead, we look at the raw numbers for tax receipts and spending totals, we see that higher taxes have accounted for almost all the fiscal tightening that has happened so far.

    Tax receipts have grown from £514 billion in 2009-10 to £570 billion in 2011-12. Correcting for inflation (ie converting to 2009-10 prices), tax receipts in 2011-12 were £544 billion. So tax revenues have risen by £30 billion per year in real terms.

    Pubic spending has increased from £670 billion in 2009-10 to £696 billion in 2011-12. Correcting for inflation (ie converting to 2009-10 prices), the level of public spending in 2011-12 was £664 billion. So overall public spending has been trimmed by £6 billion.

    In cash terms the entire fiscal consolidation is being achieved through higher taxes, not lower spending. (This continues to be the case all the way to 2016-17.) In real terms we have had £30 billion in higher revenues and £6 billion in lower spending, so thus far the ratio of cuts to tax increases is 17:83. Under current plans, there will be a gradual increase in the contribution made by spending cuts over the coming years, but they will still be less significant in closing the fiscal deficit than higher revenues.

    So whether you call this a cuts-based consolidation or a tax-based one is heavily dependent on your choice of baseline. But on any measure the government has front-loaded tax rises while pursuing a much more gradual approach to spending cuts.

    @ Mike Cobley: “What a crashing failure of imagination and the critical faculty.

    It certainly takes a huge leap of imagination to believe that there is some magic solution (outside the bounds of permissible debate, presumably) by which a £150 billion budget deficit – and the highest structural deficit in the whole of the OECD and all EU member states, as ours was in 2010 – can be tackled without cutting spending or raising taxes sooner or later.

  • LondonLiberal 28th May '12 - 4:11pm

    @ David Thorpe “The eurozoen sovereign debt crisis means that the best laid plans of either side would be blown off course by now. Thats whyw e have a double-dip recession- thats why the eurozone countries which announced their cuts(ireland) are not in recession-while those who waited are.”

    Ireland is in recession, though: http://www.tradingeconomics.com/ireland/gdp-growth

    Also, i find it unsurprising but rather sad that libdems now seem to be saying what i despaired of governments in the past saying; namely that, when something bad happened when ‘the other lot’ were in power, it was the other lot’s fault, but when it happened and we were in power, it was foreigners’ fault. Hence the global recession was all labour’s fault, but the weak economy since 2010 is the eurozone’s fault. Thus at no point are we to ever question the bonkers neo-liberal orthdoxy of the Conservative Party and that creed’s backers in the libdems: David Laws, Danny Alexander
    and Nick Clegg.

  • LondonLiberal 28th May '12 - 4:17pm

    @ Alex sabine
    “It certainly takes a huge leap of imagination to believe that there is some magic solution (outside the bounds of permissible debate, presumably) by which a £150 billion budget deficit – and the highest structural deficit in the whole of the OECD and all EU member states, as ours was in 2010 – can be tackled without cutting spending or raising taxes sooner or later.”

    When the economy is shrinking you surely need to raise taxes or cut spending by a greater relative amount to ensure the same saving, don’t you, though? So a policy of spending on capital investment that produces growth in the long term from the effect of the project as well as growth in the short term from the jobs being created and taxes paid broadens the tax base meaning that tax rises can be more evenly spread and less punitive?

  • Keith Browning 28th May '12 - 4:32pm

    As a regular visitor to North Portugal (real Portugal) I can report the economic problems are having an interesting effect. During the past few months many of the vacant building plots, that have sat abandoned for many years have suddenly spouted major building projects – all privately funded and all aimed at the higher end of the housing/apartment market. I counted over 10 at my last wander round the town, with some now close to completion.

    This must be aimed at the Portuguese market because there are few ‘foreigners’ in the place.

    One can imagine labour costs are low at the moment and a good deal could be made with the suppliers of materials, but what it does say is that the men with decent amounts of money in the bank are transferring it into bricks and mortar as rapidly as they can. I’m not sure how this would be viewed by those who preach austerity but as a casual observer it makes for interesting viewing in a country that is struggling to get a grip of its finances.

  • jenny barnes 28th May '12 - 4:48pm

    Thirty three years of neo liberalism has resulted in the biggest financial and economic crash since at least th 1930s. Solution – more neo liberalism. We have unemployed resources, why can’t we put them to work? The markets, believe it or not, are a social construction, not reality.
    This is class war, and the 1% are winning.

  • Dave,

    The social market foundation have recently published a report aimed at combining fiscal credibility and growth.Osbornes Choice

    The summary is as follows:
    In November the Office for Budget Responsibility (OBR) substantially downgraded the UK’s growth prospects. As a consequence, it indicated the need for a further £15bn of annual tightening by 2016-17 to fill a larger permanent fiscal hole than was previously anticipated.

    The UK’s growth problem has three parts: weak aggregate demand; reduced supply capacity; and sluggish productivity growth. All of these need to be tackled simultaneously. The difficulty is that with Government and households seeking to pay down debt, and the UK’s main export market in the doldrums for the foreseeable future, there is little incentive for firms to invest their surpluses. Unless a way can be found to unlock private investment, the adjustment in public spending will inevitably happen through continued economic slump. This would raise concerns among investors about the UK government’s ability to handle its debts.

    Nevertheless, there are also risks to investor confidence of the additional government borrowing to boost output that many advocate. Getting public borrowing under control and on a clear path to sustainability is essential given the febrile state of sovereign debt markets. In this context, the need for a further £15bn of tightening raises questions about where this money will come from.

    So, in the wake of the OBR’s autumn assessment, the Government’s fiscal strategy is now vulnerable on two fronts:
    • the prospects for growth are increasingly poor, putting greater pressure on plans to cut the deficit, yet there is no apparent strategy to boost it; and
    • deficit reduction credibility after 2015 is weakened since
    they have decided to wait until shortly before a general election to set out where the extra £15bn of tightening will come from.

    In these testing economic conditions, careful stewardship of the public finances is essential. In response to these problems with the current strategy, the Chancellor needs to set out a plan that will achieve three goals at the forthcoming Budget.

    First, the plan must strengthen the Government’s deficit cutting credibility; second it must boost economic output now; and third it must expand the growth potential of the economy for long-term prosperity. The current political debate emphasises the trade-offs between these goals. This paper instead highlights the synergies between them and sets out a strategy to achieve all three.

    The growth debate is highly polarised and over-simplified, focusing on questions like what impact ‘more or less spending’ in aggregate will do to output, and treating all changes in spending or taxes as equally beneficial or damaging for the economy. In reality, the impact of fiscal policy on the level of output and its future growth depends on how public money is used, and varies enormously between policies.

    This polarised and simplified debate implies that the three goals set out above are incompatible. In reality, by focusing more on the composition of the spending and taxation, rather than the size or speed of cuts, it is possible to achieve all three simultaneously through judicious microeconomic policy. There are legitimate debates around whether additional,unfunded fiscal stimulus is necessary and/or viable. This paper deliberately does not take a view on that discussion but instead restricts itself to the narrower question: what can be done to boost the economy without borrowing more? The inevitability of a further £15bn of fiscal tightening by 2016-17 creates the opportunity for a potent growth strategy within existing borrowing plans. The Government should:
    • Identify the sources of the required £15bn now, targeting policies known to have a low or negative impact on economic output.
    • Do so with an eye to using microeconomic policy to unblock imbalances within the UK household sector, to encourage households with the capacity to sustain demand to increase their consumption.
    • Make those cuts from April 2012, shifting the saved £15bn to credibly temporary policies with a large positive impact on output and longer-term growth, for each of the four years from 2012-13.

    This paper makes the case for five specific growth-friendly consolidation measures that fit these criteria, and which would account for the vast majority of the required tightening. These include:
    • Halving higher rate tax relief on pension contributions, saving around £6.7bn annually.
    • Capping maximum ISA holdings at £15,000, saving around £1bn per year.
    • Rolling Child Benefit into the existing tax credits system, saving some £2.4bn each year.
    • Cutting Winter Fuel Payments and free TV licenses to better-off pensioners, saving 1.7bn per year.
    • Scrapping free bus travel for the over 60s, saving around £1bn annually.

    Recycling £15bn per year raised through such measures into infrastructure capital spending from 2012-13 would return the capital budget to around £63bn in that year, just short of the level it was planned to be at for that year at the time of the 2008 Budget.

    Based on OBR estimates of the impact of similar policies, it is possible to estimate that finding the £15bn now and using it to boost capital investment would raise output by around £10bn in each of the next three years, and around half that level in year four. It would also have a material impact on the supply side of the economy since infrastructure investment lowers costs to firms and households, encourages complementary investment by companies, and substantially reduces the scarring effect of unemployment.

    Putting this in the context of the current debate, the SMF plan would yield a fiscal stimulus twice as large as a reversal of the January 2011 VAT rise, suggested by Labour, but without adding a penny to the deficit. A VAT cut to 17.5% would, by contrast, involve borrowing an extra £12bn to £14bn each year. The SMF plan would be three times more effective than an unfunded increase in the personal tax allowance to £10,000 from this April, which would cost around £9.5bn. It’s time move beyond a damaging political debate that starts from the position that boosting the economy in the short-run, expanding its long-run potential, and trengthening investor confidence are incompatible goals. Both the Government and the Opposition characterise their respective approaches to the fiscal debate as the only viable option. But Osborne’s choice need not be a Hobson’s choice.

  • The problem with the Austerity part of the equation is that it is only really being imposed on those in the average to low income bracket. I see no austerity at all at the top. No tax increases, no move on inheritance, more funding for opt out schooling, less for the schools most people go to and the complete collapse of any notion that “we are all in this together”. It’s carrot and stick Conservatism. A carrot for us and our backers , the stick for for everyone else. We are even being forced to take ideas like regional pay seriously, not because of pragmatism, but because Northerners don’t vote the right way. Sure, you can sell austerity as a nation saving devise but it has to be seen to be fair and hit everybody.

  • Alex Sabine 28th May '12 - 5:03pm

    The UK’s low bond yields (not prices, as there is an inverse relationship between the price and yield) almost certainly reflect some combination of (1) investor confidence in the deficit reduction plan, (2) the UK being a relative safe haven from the eurozone crisis because we have an independent currency, (3) the effect of QE in driving down yields, and (4) expectations of weak output growth and subdued inflation. It is difficult to disentangle these or say which is the most important factor.

    The Bank of England’s asset purchase scheme has clearly been a big factor in driving yields down. The fact that yields have fallen for Germany (despite being in the eurozone) and for the US and Britain suggests that there is something in the ‘safe haven’ explanation. On the other hand, I take Martin Wolf’s point that Britain and the US have seen yields decline despite continuing massive deficits, and in the US context without a credible long-term fiscal plan. But then of course the US has reserve currency status, so again safe havens come into play; Japan is a unique case because it finances its government deficits through huge domestic savings.

    If you look at the bond market spreads within the eurozone, it’s quite clear that the countries with the biggest fiscal problems (Greece, Ireland, Spain, Portugal, Italy) are the ones facing high market interest rates. Even France’s yields are running at nearly double Germany’s. So the markets are distinguishing between the eurozone members on the basis of credit risk in a way that they simply haven’t for most of the life of the euro. (Indeed this cheap credit was part of the problem that encouraged some members to go on borrowing sprees in the good times.)

    Non-euro members that are heavily exposed like Sweden and Denmark have German-type rates (below 1.5%) despite their GDP being almost flat. Denmark has a relatively small fiscal deficit while Sweden is actually running a budget surplus.

    Try telling Greece (or Spain, or Italy) that low bond yields are a sign of failure. Clearly, beyond some point, ‘distress’ levels of yields reflect market concern about sovereign risk. Equally, it would be simplistic to say the lower the bond yields, the better. When the economy recovers we would normally expect bond yields to rise. To avoid some unpleasant debt dynamics this means we need to get the deficit and stock of debt down to manageable levels.

  • The point has been made before, but to maintain demand (as well as for social equity in the most unequal society that post Thatcher and Blair Britain has become) the tax rises should have been of a more progressive variety than relying mainly on VAT, ie income or wealth tax rises. It is very creditable to start to try to reduce current levels of tax evasion and avoidance, but I have this nasty feeling that without further additional staff, HMRC is going to find the predicted figures for additional income difficult to achieve. Benefit and Tax credit cuts will have reduced demand even more. I know that what Alex says, that cuts are still largely to be made, but that is not what you would imagine working in public services, where job cuts and pressure arising from services starting to fall apart in both education and health are leading to potentially disastrous situations. Goodness knows what will happen when the cuts “properly kick in”. And if anyone uses that disingenuous argument about “we’re only returning public spending levels to 2007 level”, I shall swear! They are only there because of extra resources used to mitigate recession. It is likely that per capita spending is returning to levels last seen when the Liberal Party was in Govt, ie totally unacceptable in a modern society.

  • David Allen 28th May '12 - 5:37pm

    Alex Sabine said:

    “It certainly takes a huge leap of imagination to believe that there is some magic solution … by which a £150 billion budget deficit … – can be tackled without cutting spending or raising taxes sooner or later.”

    So it might seem. However:

    Suppose you are Farmer John Bull, you buy 10 £10 bags of chickenfood each year, and you get 100 eggs to sell. You find that you can only sell an egg for 60 pence, so there you are, stuck with a budget deficit of £40. If you continue the same policies next year, you will stick with the same deficit.

    So you try the “raising taxes” approach. You ask £1.00 each for your eggs, which your maths predicts will enable you to break even. None of them sell, so you find to your woe that your deficit has increased to £100.

    Next you try the “cutting spending” approach. You only buy 6 bags of chickenfood, which your maths also predicts will enable you to break even. All your chickens starve, no eggs are produced, and again your deficit (£60) is higher than the £40 deficit which Farmer Balls has achieved by blithely ignoring the problem.

    Help! Real life is all too complicated for us masters of the austerity universe! It seems that thumping the tub about how seriously you care about the deficit, and prescribing yourself the nastiest tasting medicine you can find so as to prove how serious you are, may merely make things worse!

    Perhaps all the smart-alec politicians who think that a simple ideological approach will work should read Joe Bourne’s piece above. I have no idea whether the specific proposals from the SMF are perfect . I’m pretty sure we do need to think and plan to their level of rigour and detail.

  • Keith Browning 28th May '12 - 6:18pm

    Part of the problem is that the money keeps ending up with the middle men and never with the people who will kick-start the economy. The middle-men are the banks and they have been the receivers of a variety of funds that are supposed to get us out of this mess. Instead of distributing it to the ‘people’ who will spend it in the UK they either use it to feather their balance sheets or lend it to investors who then use it in projects in growth economies in the Far East. Neither of those outcomes helps the UK populus one jot.

    Give the money directly to the people and they will spend it in a more dynamic way and circulate it very quickly.

    Raise the tax threshhold to £20,000 and reduce VAT to 15%. Rich and poor all benefit equally and if nothing else it will put a smile on everyone’s face.

  • Bill le Breton 28th May '12 - 6:24pm

    David,
    It’s worse!

    In your ‘economy’ above, by my calculation, there is only £60 in the economy to buy your eggs. What happens if next year someone has burnt ten of these, then, there would only by £50 and you’d have to sell you eggs for 50p each.

    The trouble besetting the UK economy is insufficient aggregate demand.

    The Monetary Policy Committee of the Bank of England is managing CPI at 2% (ignoring supply side shocks). So, any more or less deficit spending will not change aggregate demand. The Bank will neutralize any change, so long as that remains their target.

    How are they doing? Change in Aggregate Demand for the first quarter of 2012 was 0.2% annualized (i.e. change in money GDP was 0.2%). The deflator was 1.5 so annualized real GDP was minus 1.2%. That is the real cost of the inflation target.

    UK money supply figures are falling as you would expect from these figures. Interest rates are unusually low. These are all signs that monetary policy remains far too tight – self destructively too tight. And because everyone expects it to remain tight and therefore aggregate demand weak, we are remaining cautious and timid in all we do.

    This inflation target is acting like the Gold Standard did in the Great Depression. You have to leave it if aggregate demand is to rise. Today that means changing the target set for the Bank of England and publically committing to a new target and telling the Bank of England to hit that new target by whatever means necessary – and tell the markets that this is what they can expect – a totally determined approach to reaching that figure.

    If it exceeds that target it can trim back by the amount of the excess next year, but on pain of dismissal the target must not be undershot.

    (Result, next year we have £70 in the economy and eggs will be expected to rise to 70p each, so people will buy them now before the prices rises – and you will breed some more chickens, and buy that new hen shed and more hen food in anticipation of the higher demand for eggs.)

    But whilst everyone remains fixated on deficits the Bank of England, like some NS-5 from I Robot, will continue its deadly commission.

    It’s monetary policy that has to change.

  • Paul Murray 28th May '12 - 7:26pm

    There was an excellent article in the Telegraph by Roger Bootle yesterday. He makes some extremely important points – they are not “opinion” or “party politics” – they are simply matters of arithmetic.

    Bootle notes the double-dip and determines that the majority of it is caused by a fall in consumer spending – it accounts for 3% of the 4% drop in GDP since 2008.

    This can be explained by a number of factors: VAT and tax increases reduced disposable income by 1.5%; sterling has devalued, increasing the cost of imported goods; commodity prices (especially oil) have increased; and the UK’s consumers – who ran up dreadfully high levels of unsecured debt in the last decade – have been paying down debt.

    So we are in a double-dip recession primarily because consumer spending has fallen since 2008.

    In fact, GOVERNMENT spending has actually caused a 0.5% increase in GDP relative to 2008.

    Consumers are retrenching. They are reducing their use of credit and are trying to live within their means. If that results in a small GDP fall is it really such a bad thing? What is the value of GDP growth if it comes from ever-increasing indebtedness?

    Bootle finishes by noting that inflation is likely to fall sharply later this year. I should imagine that this will create scope for further QE as well as an increase in disposable income.

    We may well be “bottoming out” in the UK. As for the Eurozone…

  • Richard Dean 28th May '12 - 7:53pm

    If I had money, I’d have a few options

    One would be to invest in industry. I’d expect a return from growth G, since I would’t be anle to seel even one extra egg if G=0. I also want a return that took accpount of inflation I. Of course therecould be a risk R of losing everything, so my expected return would be G+I-R

    Another option would be to buy bonds witha yield B. Of course there is a soverigh risk S of losing everything, so my expected return from bonds would be B less S.

    Which do I do. If my retrun from investing in business is more than from bonds, I invest everything in business. If bonds are better, I nvest everything in bonds. So the only way that bonds and industry can coexist is if the expeceted returns from them are equal. This means that

    B – S = I + G – R

    Re-arrnging gives me a bond yield B of

    B = I + G + S – R

    Now David Cameron is proud that B is low. What does it mean? Well it might mean people have confidence in the government (S is low) or it might mean people think industry is very risky (R is high, making B low). Or it might mean that people expect low growth, or even negative growth (G small or negative).

    So actually it doesn’t seem to be anything to shout about at all. But waut, Mervn is my friend. He’s hard at work keeping I low. Oooops, but he’s doing it by reducing the money supply, so making G low too!

    Can someone lend me a brain please?

    Now Greece has high bond yield because S is high – everyone knows the Greek government has a high probablity of default. Keeping G low seems to keep B low too, but is this what we want? I wonder what R is?

    Then again, I’m really only an amateur at this game. Perhpas one of my signs is wrong? But at least I do believe I am now able to rival the lengths achieved by Alex, Joe, and occaisonally Bill and others!

    Maybe I should just put the money under granmas’s bed?

  • Paul,

    Roger Bootle spells out more specific recommendations on economic policy here Ministers spoilt for choice on where to direct pump priming-investment

    “The key should be to get the private sector spending more on investment. If that requires a bit more public investment spending to prime the pump then so be it. The markets would understand a limited and carefully constructed plan to get the economy moving. By contrast, if the economy continues to flatline, preventing public borrowing from falling, they may not be forgiving at all.

    There is no shortage of things for the Government to look at: the barriers to increased housebuilding, including the availability of land and the role of land banks on housebuilders’ books; the hurdle rate used to assess investment projects; the investment policy of the privatised utilities and the role of regulation in affecting it; the cost of energy and the role of its own policies in increasing it; the possible introduction of road pricing; a National Investment Bank; a decision on a new London airport or a third Heathrow runway; a major relaxation of labour laws.”

  • Richard Dean 29th May '12 - 12:26am

    Why does it have to be a London airport? Why not Liverpool, Newcastle, Birmingham, Bristol, Carlisle, Cardiff, Edinburgh? And an HS rail network that is not a star centred on London?

  • dudes,
    You aim for a better world. What we are seeing here is that capitalism sucks so you might as well make countries nice to live in.

  • Bill le Breton 29th May '12 - 6:58am

    Well said Richard.

    Just as the trouble with much of EU and ECB policy is that it is centred on the needs of Germany, so, much of UK policy is set to deal with London and totally unsuited to the rest of the country. If HS2 then, indeed why not HS3, HS4, and HS5. We shall never be able to buy a new train set more cheaply than now.

    And here’s another thought: what about financial reforms that concentrate on penalising unused assets – e.g. tax the land banks, charge banks interest for keeping money ‘safely’ tucked away at the Bank of England and give everyone a clear reason to believe that the ‘day after tomorrow’ everything is going to be dearer, so penalizing Richard and the all the others for keeping their cash under the bed.

    To this end you might like to read this interesting post, Competitive Devaluation to Save the Euro Zone http://leftoutside.wordpress.com/2012/05/22/competitive-devaluation-ftw/

    Roughly; if the UK used QE to buy Euro Bonds our currency would depreciate against the Euro. If the EU used QE to buy Japanese bonds, the Japanese used QE to buy US bonds and the US used QE to buy UK bonds, (because everyone can’t devalue against each other) all the countries would actually be devaluing against the price level.

    It has the same effect as FDR’s Executive Order which increased the price of gold overnight; probably the most effective thing that he did in his first 100 days in office. It gets people spending now and convinces firms that they need to gear up for that increase in demand.

  • Paul Reynolds 29th May '12 - 8:12am

    Blimey. A really technical debate. However, I thought that the aim was to reduce debt rather than spending per se, so that debt service costs and tax burdens on the econony could be reduced – and resilience to shocks increased. Feeble stuctural and public administration reforms have meant that spending reductions are more paunful than they need to be. In addition this means that state investments are much less positive in effect and much more expensive than they need to be. Given that, debt reduction is a necessary but insufficient condition for growth. Commercial sector reforms and major reforms in the economic role of the state are needed to result in ‘sufficiency’ in reforms. Sadly our self-congratulatory civil service elite know little of this subject matter.

  • Richard Dean 29th May '12 - 10:06am

    @Paul. Wouldn’t those aims be rather crazy?

    Alice borrows 10, buys a chicken for 5, feeds it for 5, and sells its eggs for 15. Net gain = 5 for a debt burden of 10.
    Berti borrows 20, buys 2 chicken for 10, feeds them for 10, and sells their eggs for 30. Net gain = 10 for a debt burden of 20.

    So Berties does better with a higher debt burden. That’s business, and we haven’t even started on economies of scale yet!

    Then again, I am so poor that I pay no tax. My neighbour pays 50% on an income of a million. Who pays more tax and who is better off?

    If the cost of resilience is more than the cost of the shocks it protects against, isn’t it better to have the shocks?

  • Richard Dean 29th May '12 - 10:12am

    @Paul Reynolds. Surely not?

    Alice borrows 10, buys a chicken for 5, buys feed for 5, and sells the eggs for 15. Gam=5, debt burden=10
    Berti borrows 20, buys 2 chickens for 5 each, buys feed for 10, and sells the eggs for 30. Gam=10, debt burden=20

    So berti does twice as well as Alice, with twice the debt burden. And we have’nt started on economies of scale yet.

    I am so poor I pay no tax. My neighbour pays 50% on an income of a million. Who pays more tax and who is better off?

    Is resilience worth while if it costs more than the shocks it protects against?

  • Richard Dean 29th May '12 - 10:14am

    Gam –> Gain. (Failing eyesight!)

  • Bill le Breton 29th May '12 - 12:50pm

    Stop Press: In the New York Times, Paul Krugman has named Nick Clegg as the number one obstacle to an essential change in economic policy: http://krugman.blogs.nytimes.com/2012/05/28/britains-trap/

    The Nobel Prize winner points to an FT article by Martin Wolf in which Wolf shows why the Coalition should change economic policy and drafts a speech for the Chancellor.

    Wolf then writes, http://blogs.ft.com/martin-wolf-exchange/2012/05/28/#axzz1wD09fFUP that although this may be embarrassing for the Coalition there is no reason why the citizens of the UK should suffer from its mistake indefinitely.

    But significantly goes on “There is, however, one interesting alternative to reconsidering fiscal policy. It would be to change the remit for the Bank of England, to focus on nominal GDP, instead of inflation.”

    Watch his space at the FT, He intends to examine the advantages and disadvantages of that possibility in a future post.

  • david thorpe 29th May '12 - 2:09pm

    Thanks for the comments all

    @ Jenny Barnes-Im not a Neo-Liberal-and tories generally arent either, thats why the are called conservaticves-they dont like liberals-the only neo-liberal senior tory arguably is ken clarke-and hes very unpopular among his colleagues!
    Labour under Blair were neo-liberal.
    Thatcher pursued many policies which neo-liberals would like, but many which they wouldnt.
    They last thing we need now is neo-liberalism, new labour pursued it and it failed. This government are spending billions to craete demand-exactly the opposite of what a neo-liberal government would do. #
    On the broader issues-in my day to day job..I report on macroeconomics-and everywhere from singapore to swede…central banks are coming back with the same message-the eurozone crisis is damaging gorwth in their copuntries, so the idea that it couldnt damage it in the UK-whatever the government do-is nonsense of the highest order.
    Labours policy would have led to a double dip with or without a eurozone crisis-the coalitions wouldnt have if the euro crisis hadent happened.
    Witness the following-the germans introduced stark cuts straight away-and that country is not in recession-ireland the same. greece and spain delayed-and both are in recession.

  • The de long/summers paper that Martin Wolf basis his comments on in the FT, makes a compelling argument for fiscal stimulus when interest rates are close to zero and surplus capacity exists in the economy Fiscal policy in a depressed economy and concludes that in these circumstances a temporary stimilus will very likely be self-financig.

    In the conclusion to the report, they discuss the issue of fiscal stimulus on long run fiscal consolidation and the potential impact on interest rates:

    ..if countries that have committed themselves to short-term deficit reduction as a down payment on a move to long-term sustainability find that “if growth slows more than expected… [they are] inclined to preserve their short-term plans through additional tightening, even if hurts growth more” then the fear is that fiscal austerity will be counterproductive because “interest rates could actually rise [even] as the deficit falls” if “growth falls enough as a result of a fiscal tightening.

    ..the risks of short run fiscal stimulus having adverse effects on long-run credibility will be greater in settings where government debt already carries a significant risk premium. Clearly, it will be larger when there is evidence that deficit fears are impacting on stock market valuations and on investment decisions. But even in the absence of such evidence, there is always the risk that market psychology can change suddenly.

    ..expansionary fiscal policies may operate to call forth a more expansionary monetary policy response by, for example, raising the credibility of commitments to monetary expansion after the economy has recovered, or increasing the extent of debt monetization in the short run.

    ..if fiscal policy is self financing it will be desirable to use as an instrument once it is recognized that (i) with uncertainty about multipliers diversification among policy instruments is appropriate as suggested by Brainard (1967), (ii) expansionary monetary policies carry with them costs not represented in standard models (including distortions in the composition of investment, impacts on the health of the financial sector, and impacts on the distribution of income), and (iii) the historically-clear tendency of low interest rate environments to give rise to asset market bubbles.

  • Richard Dean 30th May '12 - 12:46am

    @Joe. That’s a very heavy, 52 page paper! Maybe I will read it in detail tomorrow. I suspect the “psychology” aspect can be understood in terms of effects on perceptions of risk factors S and R. These factors surely depend on the markets assessment of government’s assessments and consequent policies. If the market judges that austerity has gone too far, the result may be an increase in perceptions of soverign risk S that more than offsets the effects of decreased growth G.

  • jenny barnes 3rd Jun '12 - 10:24am

    I’m pleased to see the Krugman post referenced above. It’s a pity that we’ll be spending the next 3 years rerunning policies that failed in the 1930s; one can only hope that whatever replaces this government in 2015 will have a bit more sense.

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