It is easy to criticise Rishi Sunak’s Summer Economic Statement for not doing enough. The Chancellor had a difficult task to assess what size of economic stimulus would be effective.
His main aim was apparently to create jobs for those who had lost them or will be losing them soon. But the Statement.is very disappointing because it doesn’t deal with the realities of the situation for lots of businesses. Social distancing is very likely still to be in place after October, so it just will not be possible for many businesses to provide their services to as many customers as before lockdown.
He should have included a new coronavirus staff retention scheme (turnover based). It should have provided a proportion (say 80%) of the difference between the takings of a business in a month compared to the relevant month in 2019, for businesses that can demonstrate that because of social distancing they can’t deal with the same number of customers.
Rishi Sunak reported that £4.6 billion of consumer debt has been paid off and households have increased their bank deposits by £25.6 billion. This means there is the potential for more than £30 billion (about 1.5% of last year’s GDP) to be spent into the economy when households have confidence restored.
With an economy valued at £2000 billion I believe the maximum economic growth per year with which the UK can normally cope is about £60 billion. Therefore an economic stimulus of £30 billion at this stage is about right.
Instead of allocating up to £9.4 billion for his Job Retention Bonus scheme, I think Rishi Sunak should have used the amount to increase all working-age benefits such as Universal Credit, Family Tax Credit, Jobseekers Allowance and Employment and Support Allowance by £20 a week, the same value as his temporary increase of Universal Credit and Family Tax Credit in March. This would have targeted the money to the poorest in society who are most likely to spend it and to the areas where more of these people live. Giving employers £1000 per worker retained is not going to do much to encourage them to retain the most marginal workers, and will do very little if anything to increase demand in the economy.
A lot of the £5.6 billion for infrastructure projects is not new money and includes maintenance projects. £900 million is for shovel-ready projects in England in 2020-21 and 2021-22. But some of this, maybe the majority, will not be spent until the next financial year. We must hope that most of the £5.6 billion will go into the areas worst affected by job losses.
The £1 billion for public-sector bodies including schools and hospitals to fund energy efficiency and low-carbon heat upgrades is a good idea, as is the £2 billion Green Homes Grant to make homes more efficient. 100% grants for the poorest and 2/3rds for the rest are good rates.
£2.1 billion for his Kickstart scheme and £1.6 billion for apprenticeships targeted towards young people should be useful, though I think the minimum hours of work per week should be 30, not 25. With more than 700,000 people leaving education this year it may not be sufficient. I would also have targeted retraining schemes for those being made redundant in the aviation industry and aircraft building industry, and have piloted a Job Guarantee Scheme in north-east England for 40,000 people, which I think would cost about £210 million.
The VAT cut for hospitality, accommodation and attractions will slightly increase demand in these sectors, but if instead of a 5% cut VAT had been halved I think the effect would be double. The Eat Out to Help Out scheme costing half a billion is more of a gimmick or headline-grabber than a useful economic measure.
The temporary cut in Stamp Duty on property purchases is not being targeted and will go to those who are in work and can already afford the costs of moving. Its benefits are greatest for those people who can afford a property valued over £500,000.
Generally, this economic statement provides money for those who already have plenty and not to people who have had their incomes slashed by becoming unemployed. It provides a small economic stimulus which should result in some new jobs, and will help some young people avoid the dole, at least temporarily. He could have offered more assistance to over 25s who have been made unemployed, and by giving more money each week to those of working age not in work could replace some of the spending power lost through redundancies.
* Michael Berwick-Gooding is a Liberal Democrat member in Basingstoke and has held various party positions at local, regional and English Party level. He posts comments as Michael BG.
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125 Comments
It used to be the case that the government disliked unemployment, and provided support for those who had lost their jobs. The economy changes all the time and jobs in older areas go. It looks like this change in the world is going to hammer aviation and tourism, hospitality and entertainmnets. But there will be other jobs, eventually. However, this government seems to want a desperate starving army of the unemployed, who will be prepared to take insecure, low paid, rubbish jobs … I’m not really surprised.
Having just attended the first hustings of the leadership campaign, that arranged by the Social Liberal Forum, I feel sure that both the leadership candidates would sympathise with the conclusions of the author, that the Chancellor should have done better in his effort to save jobs and distribute necessary income supplements.
I asked a question, would Ed and Layla put relief of poverty in Britain at the head of their commitment if elected, and would they support the proposal for a new national Social Contract in which this would be the first of five pressing requirements?
Ed answered enthusiastically, yes, said Beveridge was an inspiration to him and as leader he would look at a national Social Contract. Layla said poverty was the reason why she had become a Liberal, , the cruelty of the Tory government will be exposed, and she thinks there will be a social contract.
However, I think Michael and I – proposers of a national Social Contract – will need to emphasise, as Michael does in this article, that poverty should be first tackled by upping benefits, which will also help the economy by increasing people’s spending power. And we can also point out to our prospective leaders that the Social Contract proposal very much focuses as well on the pressing questions of jobs and housing, both of which Ed Davey especially emphasised.
Thank you for this analysis Michael which confirms that the Tories are primarily trying to keep those parts of the economy going which will benefit their friends and donors. They are trying to keep their new voters happy by saying they will build, build, build and chucking large numbers of virtual pounds around, but, in fact, as Jenny says, they want most people to have insecure low paid jobs. The problem is that the consequence of the gig economy is that most people won’t be able to afford to spend the money they want us to in order to rescue the economy through private purchases. The public investment they are promising is pathetic in comparison to the New Deal, but unfortunately not many people will realise that.
“The temporary cut in Stamp Duty on property purchases is not being targeted….Its benefits are greatest for those people who can afford a property valued over £500,000.”
Leyla Moran has pretty much said the same thing. But you’re both missing the point. Politicians like to say they’d like housing to be more affordable. But do they really? JoeB thinks high property prices are an accidental side effect of the unfair nature of land ownership and will be corrected by the introduction of a LVT. Yes, land ownership is unfair but a LVT won’t do much to correct the problem.
This government is much more worried about a crash in property prices which will almost certainly take the wider economy down with it too. Therefore Rishi Sunak doesn’t rally care that he’s putting money in landlords’ pockets. If it will at least help keep property prices as they are – he’ll be a happy chappy. My expectation, even before the Covid problem arose, was the property bubble would continue to deflate as we’d already seen start to happen in London. So it probably won’t be enough. We’ll see.
Your back of envelope calculation to justify a £60 billion stimulus isn’t valid. It ignores the need to meet the 2% inflation target, it ignores the extent of spending and saving in the private sector, whcih may or may not continue as is when the lockdown ends, and the likely deficit in the current account which will need to be covered somehow.
You’re right about the half price meals offer being largely a gimmick though.
The furlough scheme has been successful in heading off mass layoffs during the Pandemic. This second phase is about supporting the reopening of the economy and the third will be about rebuilding.
The £2bn kickstart scheme (a larger version of Labours future jobs fund)that provides six-month work placements for 16-24-year-olds is very welcome and ideally can be extended to a permanent national job guarantee scheme that would allow local government, social enterprise organisations and charities to offer long-term employment and training contracts.
The policies in this summer statement were the phase aimed at supporting a return to work. The temporary stimulus measures are targeted on the hardest-hit sectors of the economy with a VAT cut on leisure and hospitality spending from 20% to 5% for the next six months. It appears unlikely, however, that this sector will have recovered by 2021 not least due to the burden of unpaid commercial rents on which the moratorium on evictions comes to an end in September.
Many of the longer-term decisions will come in the autumn budget and spending review. It seems likely that the scale of the short-term stimulus measures needed to help the economy restart, rebuild and renew will need to be greater still by then. The longer-term spending review will also need to address the unmentioned phase four of the Chancellor’s plan i.e. the tax rises and possible spending cuts that will be implemented to bring the deficit back to more normal levels. While the Chancellor may well adopt the politically more palatable Augustinian solution and proclaim that he will be virtuous, but not yet. It is only in later years that the cost of this Pandemic wlll begin to hit home for those fortunate enough to have avoided unemployment. The IFS expects tax rises to begin in 2022.
The costs of delivering health, pensions and social care are only going to rise and the pressures on other areas of public spending are not going away. Our party leadership would be well advised to set in train a proper, transparent review of how we should be setting tax strategy for the future, with a remit to identify economically efficient and equitable changes that can raise some serious cash. The Mirrlees review is the obvious place to begin.
Tax strategy? 50p/litre on road fuel. Encourages active travel, electric cars, public transport, discourages Co2 particulate and nox emissions, saves money on building roads, discourages unnecessary driving.
Tax strategy? 50p/litre on road fuel. Encourages active travel, electric cars, public transport, discourages Co2 particulate and nox emissions, saves money on building roads, discourages unnecessary driving.
Jenny,
fuel duty would be an obvious place to make a start as too is the under-taxation of capital gains and allowances like entrepreneurs’ relief. The way that council tax impinges far more heavily on those living in modest homes in the north than on the inhabitants of mansions in Kensington and Chelsea has to be addressed. There’s a lot of money in pension tax relief. Unfortunately for Mr Sunak, his predecessors have already raided the pensions of seriously high earners. To get much more, he would need to start hitting those on somewhat more modest incomes: those, for example, on between £50,000 and £80,000 whose income tax bills Mr Johnson pledged to reduce when standing to be leader of the Conservative party. That might not go down well when pension annuities are at all time lows. A more palatable change might be the introduction of an alternative minimum tax into the tax structure for very wealthy non-doms. This is estimated to raise £11 billion according to the LSE http://www.lse.ac.uk/News/Latest-news-from-LSE/2020/f-June-20/Reform-UK-tax-to-rebuild-post-COVID-19-public-finances
Key findings of LSE report:
– The average person with more than £2 million in taxable income had an EATR (Effective Average Tax Rate) of only 40 per cent: for someone at £2 million this represented a tax saving of £140,000.
– The average person with £10 million in taxable income and capital gains had an effective tax rate of just 21 per cent: less than the rate that would be paid by someone on median earnings of £30,000.
– Effective tax rates vary considerably among the richest: one in four receiving above £100,000 paid the headline rate on earnings of up to 47 per cent, but one in ten people with total remuneration over £1 million paid just 11 per cent: a lower EATR than someone earning £15,000.
– Low tax rates on dividends and gains almost exclusively benefit investors and business owners rather than employed or self-employed earners.
– There is a lot of tax revenue at stake:up to £20 billion could be raised if all taxable income and gains were actually taxed at the existing headline rates applicable to earnings.
– An Alternative Minimum Tax that required everyone earning more than £100,000 to pay at least a 35 per cent tax rate on their income and gains could raise around £11 billion. This is equivalent to 2p on the basic rate, or 5p on both the higher and additional rates.
Joseph, do our existing tax policies follow the advice of the Mirrlees review? Please remind us – though as you suggest the review of taxation policy is not imminently needed. What will be urgently needed is pressure for a general increase in benefits. I should imagine it has been a shock to more than a thousand people suddenly unwaged to find how little even the enhanced Universal Credit gives them each week. Particularly pitiful has been the plight of care workers on zero-hours contracts choosing between continuing to work even if beginning to feel ill rather than try to live on sickness benefit. Both humanity and economic need – the need to increase demand – require benefit increases, and, of course, our policy of a shorter waiting time for first payments, because people may well have nothing to live on meantime.
Just to note that I understand Michael was going to attend the South Central hustings this evening, so would not be able to reply to queries and comments with his usual celerity.
Katharine,
Sir James Mirrlees https://www.theguardian.com/politics/2018/sep/24/sir-james-mirrlees-obituary was known for his work on optimal taxation theory and advocated a strong and well-funded welfare state. He chaired a comprehensive review of the UK tax structure over five years. The conclusions published in 2011 included:
“The UK tax system is costly and inequitable, and is “ripe for reform in ways that could significantly increase people’s welfare and improve the performance of the economy”,
“the rate structure for income tax should be simplified and merged with NI, while a single integrated benefit should be introduced to replace all or most current benefits.”
“The zero rate of VAT applied to many goods and services is “an expensive and highly inefficient” way of helping people on low incomes. For example, charging a reduced rate of VAT on domestic fuel consumption “effectively subsidises energy use and encourages carbon emissions”. The review recommends VAT should be applied to nearly all spending to reduce complexity and avoid costly distortions to consumption choices (and that other taxes and benefits should be more progressive).
“Stamp duty land tax, which is paid when buying a home, should be abolished, and council tax reformed so payments are “fully proportional to house value and based on up-to-date values”. This would effectively be in place of VAT on housing consumption”
“in addition to the tax relief available on Isas and pensions, standard bank and building society accounts should be completely tax-free, but interest earned above the “normal” rate of return on savings (typically the rate that can be earned on gilts) or other risky investments should be taxed as earned income.”
“…an allowance for corporate equity should be introduced to ensure equal treatment of equity and debt-financed investments, only profits above the “normal” rate of return should be taxed, and the tax treatment of employment, self-employment and corporate-source income should be aligned.”
Mirrlees said “…the UK system falls short of the ideal in costly and inequitable ways. It discourages saving and investment, and distorts the form they take. It favours corporate debt over equity finance. It fails to deal effectively with either greenhouse gas emissions or road congestion. The revenue it raises, and the redistribution it does, could be achieved in less costly ways.”
I usually find that I at least understand the thinking of economists, such as Sir James Mirrlees who were around in the more Keynesian 60’s, even if I don’t fully agree them.
These quotes are from his Wiki entry:
“The behavioural effect is the effect that the behavioural change induced by the tax change would have on government revenue, at the initial tax rates. Raising taxes will discourage labour supply, and this will lead to lower tax revenue as a result; so for a tax increase, this is negative.”
This means: If you put taxes up people will want to work less.
“The welfare effect is the effect that the tax change has on the social welfare function by changing individual’s utilities. For a tax increase, this is negative.”
This means: If you make social benefits more generous people will want to work less.
These are points which need to be borne in mind, but usually aren’t, when discussing making welfare benefits generous enough to take people out of poverty.
I notice that this article (below) in the Guardian says:
“In many ways Mirrlees was constantly attempting to reconcile the internal dialogue between what he described as his left-wing heart and his right-wing mind.”
So Katharine and Michael might want to be slightly wary of anyone who claimed to have a “right-wing mind” 🙂
I would argue, though, that an observation that people don’t work unless they have to was more realistic than right-wing per se.
https://www.theguardian.com/politics/2018/sep/24/sir-james-mirrlees-obituary
This was Sir James Mirrlees obituary in the economist https://www.economist.com/finance-and-economics/2018/09/06/sir-james-mirrlees-a-nobel-prizewinning-economist-died-on-august-29th
“…he realised that the question of how to solve poverty in the developing world was “what really mattered”. That meant a career studying economics.”
“Higher rates for higher earners were thought to promote equality. But they also risk productive workers cutting their hours, because their extra effort is taxed at a higher rate. ”
“A paper published in 1971 presented his neat mathematical model. If governments want more productive people to work harder, they must choose tax rates that incentivise them to do so. Data run through his model suggested that a flat marginal rate of 20% would be optimal. As a lifelong Labour voter, he had “expected the rigorous analysis of income-taxation in the utilitarian manner to provide an argument for high tax rates”. Instead, it provided some of the intellectual justification for flattening income taxes across the West in subsequent decades.”
“Economists who have pored over more detailed data now think that the highest earners could bear higher marginal rates without being put off doing extra work.”
In his 2011 report Mirrlees confirmed the Laffer curve effects writing:
‘…at some point, increasing tax rates starts to cost money instead of raising it. The question is, where is that point? Brewer, Saez, and Shephard (2010) addressed precisely this question for the highest-income 1%. Their central estimate is that the taxable income elasticity for this group is 0.46, which implies a revenue-maximizing tax rate on earned income of 56%.29 This in turn (accounting for NICs and indirect taxes) corresponds to an income tax rate of 40%.
We do not know with confidence what the revenue-maximizing top tax rate is. But governments do not have the luxury of stopping there: policy must be decided, so, in the absence of compelling evidence, they must take a best guess. The Treasury’s best guess is that the 50% rate will raise some revenue. That is certainly not impossible, but it is certainly uncertain.”
Tax and spending policy is likely to split the Conservative party in the coming months and years. The Sunday Telegraph reports that Sunak plans Brexit tax cuts to stimulate the economy next year. “Rishi Sunak is preparing to introduce sweeping tax cuts and an overhaul of planning laws in up to 10 new “freeports” within a year of the UK becoming fully independent from the EU in December,”
The Sunday Observer, however, carries a piece from former Treasury Minister David Gauke https://www.theguardian.com/uk-news/2020/jul/11/david-gauke-tax-rise-must-pay-for-covid-19 warning “…Sunak will have to order steep tax rises to plug a £40bn gap in the public finances caused by emergency spending during the Covid-19 crisis.”
“Last night other senior Conservatives said publicly and privately that prime minister Boris Johnson and his chancellor would have to be honest with the country about the pain ahead, and spell out how to bring borrowing under control this autumn to calm the markets.”
“The Tories now face acute political and economic dilemmas. With the Johnson government committed both to “levelling up the country” and avoiding increasing taxes where possible, something will have to give, Gauke says, if a sterling crisis is to be avoided. “Once we are through the economic shock … the government will have to fill this gap with tax increases or spending cuts,” he says.
This comes on the back of criticism from senior Conservatives last month of John Major’s call to boost social care, permanently house rough sleepers and end reliance on foodbanks https://inews.co.uk/news/sir-john-major-conservative-government-social-care-rough-sleepers-food-banks-457543
Sir John told BBC Radio 4’s Today programme that he wanted to see borrowing first and then taxes rise to pay for a “greater role” of the state in areas like social care after the pandemic. “None of this is easy for any Government of any political ideology but it seems to me that is going to be inevitable that the Government take a greater role in the future in terms of social care simply because there is no one else who can do it.”
“The attractions of very small government are always ideologically obvious but the practicalities from where we are at the moment is that the Government is going to have to take a lead in policies that deal with many of these social problems.”…
Meanwhile, the Labour party is complaining about the government wasting money on subsidising employment with Sunak’s £1000 per worker job retention scheme. Funny old world isn’t it.
Thank you everyone who has commented.
Katharine,
Both Ed and Layla are talking the talk but they have not mentioned poverty in their top three things. ED has Greener, Fairer and more Caring with an emphasis on social care. Fairer could mean anything. Layla has Education, Environment and the Economy.
We should not get hung up with only supporting tax changes if supported in the 2010 Mirrlees Review. I don’t think anyone has made a comparison between what he thought was needed ten years ago and what we have as our policies today.
Peter Martin,
I expect no government would want house prices to drop by large amounts because of the amount of debt secured via mortgages on houses. As you say falling house prices could take the rest of the economy down with them.
I am not sure there has been any decline in house prices. The latest ONS figures (https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/housepriceindex/march2020) state, “UK average house prices increased by 2.1% over the year to March 2020, up from 2.0% in February 2020, average house prices increased over the year in England to £248,000 (2.2%), Wales to £162,000 (1.1%), Scotland to £152,000 (1.5%) and Northern Ireland to £141,000 (3.8%),” and “London’s average house prices increased by 4.7% over the year to March 2020; this is the largest 12-month growth London has seen since December 2016”.
I did mention the level of consumer spending that has been announced. I would expect the government to already be planning to increase expenditure to cover cost of living wage rises and general price prices. The stimulus is the extra amount outside of that needed for inflation.
Joe Bourke,
You set out what might be Rishi Sundak’s thinking. However, he has made a huge mistake in not having a new worker retention scheme for those businesses who can’t deal with the same number of customers as they did before March.
I agree more is likely to need doing to stimulate the economy in the autumn. There is no need for any tax increases or public spending cuts at the moment. They will only be needed once the economy has at least reached it pre-Coronavirus level and/or if inflationary pressure is developing.
The 2010 Mirrlees Review states that the Council Tax is “regressive relative to its base—the more the house is worth, the less as a proportion of the value is paid in council tax”. I suggest a flat percentage of the value of each property. Mirrlees thought a 0.6% flat percentage on property values would raise about the same income as the Council Tax when he wrote.
Jenny Barnes,
Increasing the duty on petrol is not a good policy. It would be better to encourage people to buy electric vehicles rather than make car travel more unaffordable for the poorest in society. I like the idea of giving people money for their old cars if they buy a much more energy efficient one. We have some good policies in our policy paper passed last autumn – ‘Tackling the Climate Emergency’ https://d3n8a8pro7vhmx.cloudfront.net/libdems/pages/46346/attachments/original/1564404765/139_-_Tackling_the_Climate_Emergency_web.pdf?1564404765
“Increasing road fuel tax is not a good policy “
Oh yes it is.
My side of the theatre can shout louder than your side.
The poorest in society can’t afford cars. It’s the rich riding round in their 4 tonne canyoneros who will pay most. If you’re really concerned about the poorest, the increased tax take could be spent on a very small UBI.
“…Sunak will have to order steep tax rises to plug a £40bn gap in the public finances caused by emergency spending during the Covid-19 crisis.”
More household economic thinking. If anyone doubts the validity of the term ‘neoliberalism’ they need look no further than this article for confirmation.
There is no “gap”. If the economy starts to overheat, and there is an inflation problem, spending cuts and tax rises will be in order. If it doesn’t they won’t.
What could be simpler?
@Jenny Barnes
You are obviously too young to remember, or perhaps you have already forgotten, the fuel tax protests of 2000:
https://en.wikipedia.org/wiki/Fuel_protests_in_the_United_Kingdom
It is not difficult for even a small group of determined people to bring the economy to a halt by blockading oil refineries. That protest was over relatively small fuel tax increases, far smaller than what you are advocating. Actions speak louder than words as Gordon Brown quickly found.
Transport today is 14% of CO2 production. This CO2 output is going down at only 4%/yr and is the worst environment problem we have.
The solution is a very rapid movement to Electric (only) Vehicles.
To get this to happen we have to openly and reliably deliver the fuel, electricity, to the EVs. This means a huge infrastructure of charge points – at homes, in the street and across our road network.
By 2035 there will be 10 million EVs on our roads. Most EVs charge at home, so we need 10 million home chargers. Only longer journeys (say 200 miles or more) you will need to Rapid charge on your way or on your way home. This means 2 million Rapid charge points, about one charge farm every 30 miles.
So the change from Internal Combustion Engines (ICE) to EV is a huge revolution.
And we need to get on with it. It means building 1 million new charge points per year for the next 10 years.
Joseph, thank you for explaining the Mirrlees thinking and your other information on taxation. I hope that there will indeed be a proper review of our party’s tax strategy for the future, begun at Conference with the full engagement of our new leader. But whether tax rises or tax reductions are desirable, and clearly there are balances to be struck, I agree with Peter Martin that neither needs consideration at present.
However, Peter, regarding your earlier comment derived from the consideration of Mirrlees (though I think wrongly), that ‘if you make welfare payments more generous people will want to work less’, I think on a purely superficial level that could be true. I was struck by a comment by my friendly Cockermouth newsagent, who said that some workers now on furlough (probably referring to one of her own staff) ‘are very content to have 80% of their wages paid for doing nothing!’ Yes, I can see that. But this is a temporary payment in this health crisis, like others in which there are winners and losers – among the latter of whom are the freelancers and lately self-employed and other would-be workers who have fallen through the Chancellor’s safety net.
The temporary measures have nothing to do with the fact that people of working age who are obliged, temporarily or otherwise, to take welfare benefits need the rates to be sufficient for them to live at the poverty level. I was very glad to read that John Major wants an end to reliance on food banks, and I hope that becomes part of our own party policy.
Jenny, I think that to suggest the poorest don’t have cars unfortunately brings into play that illiberal discussion of what poor people are entitled to – you know, suggestions like ‘They’ve always managed to afford their X-boxes’ or ‘Look at how much they spend on fags!’ Please let’s leave the discussion of essential social needs to the Office for National Statistics – after all, a poor family may need a car to carry a frail or disabled member about, or to visit to look after them, especially if they live in rural areas.
I wish I could pay more attention at this important stage — but my house is now on the market. BUT with reference to ideas of Benefits and UDI, may I have the cheek to draw everyone’s attention to MMT. The title must be, as well as apt, jocular, for these initials for Magic Money Tree are also, and pointedly, those of Modern Monetary Theory.
It is called ‘Modern’ but I hope it will soon change to “Current”, since that I trust is and will be the truth, for it resembles what was “Taken for Granted” in the mid-Sixties, at Bristol if not at Oxford (of which I knows nowt, but the influence of PPE on Tories). It is what renders all that discussion, of whether we could possibly afford UBI, seem to miss the point.
Please all quickly acquaint yourselves, if this new to you, withh MMT. It instantly confounds the Conservative “MMT” and all that hideous ‘Austerity”. And please forgive my simple minded impudence.
Michael BG,
yes, as long as social distancing has to continue, the Chancellor may well have to think again in the autumn. It is, however, not simply inflationary pressure that necessitates tax financing. It is the potential for freefall in the exchange rate. Exchange rates are subject to market sentiment and supply and demand, rational or otherwise. And as Keynes said: “the market can stay irrational longer than you can stay solvent. The effect of introducing emergency capital controls to stem a market-driven run on the pound is explored in this article https://www.independent.co.uk/news/business/comment/capital-controls-uk-economy-brexit-labour-corbyn-pound-sterling-banks-nationalisation-a8738296.html
The non-bank financial sector is exposed to a collapsing commercial property sector. This shadow banking sector is as vulnerable as the banks were in 2008 to maturity mismatches. QE alters the behavior of individuals operating in financial markets and that this can lead to speculative bubbles and financial instability i.e. a repeat of the 2008 credit crunch on top of this pandemic. As Keynes said of the consequences for the real economy when financial markets do not function well: ‘When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.’
In the 1990s and 2000s, UK 10-year bond yields (adjusted for inflation) averaged over 4%. As a pension fund, if you compounded this out, funding future retirement benefits was straightforward. However, in the 2010s, the real yield has collapsed to 0.15%. Worse still, since 2017 the real yield has been negative. Now the compounding accelerates against pension funds.
Of course, many pension funds, especially in the public sector with its defined benefits, have diversified into private equity and other riskier investments. The trouble with these are that their returns are falling too. In the end, public sector workers and others will need to increase their contributions to make up for any shortfalls. Add a disruptive Brexit to the mix and there are very serious long-term structural issues to be dealt with in the comprehensive spending and borrowing review this autumn, long before the economy is anywhere near a return to pre coronavirus levels.
@ JosephB,
“It is, however, not simply inflationary pressure that necessitates tax financing. It is the potential for freefall in the exchange rate.”
You’d only get “freefall” if there was a high inflation rate. The price of a Macdonalds burger in the UK is never going to be that much different from what it is in France or the USA. Yes there are some differences but they aren’t huge. Just why these difference exist is connected with such matters as minimum wage legislation and agricultural policy.
But you have to make up your mind on what you want to do. If you want the pound to have a set value against the euro or the dollar you have to say so. There are advantages to doing that. Industry knows where it stands. I’ve seen how a wildly varying currency can wipe out manufacturing industry in Australia. When the Aus$ was valued at well over a US dollar, around 2012, Aussie industry became hopelessly uncompetitive.
Otherwise stop prevaricating and decide to let it float. Letting it float means letting it vary. It means you have to have confidence that, ultimately, the value of the pound will be determined by the performance of the UK economy. That’s the confidence we should be aiming to build. Our own confidence. We get on with the job of steering and growing the economy and we don’t keep asking the currency speculators what they think of the job we’re doing.
We let them fight against each other on the forex markets. That way they are taking money off each other and not the UK govt.
@ Roger Lake,
“it (MMT) resembles what was “Taken for Granted” in the mid-Sixties”
Only to a very limited extent. We were on a fixed exchange rate system then so there was much more justification for the distinctly non-MMT arguments that JoeB now makes. See exchange above.
MMT is specifically the economics of a non Gold standard free floating currency.
Peter Martin,
we don’t have a high inflation rate now, but we do have a declining exchange rate relative to other developed economies. The reasons are explored in this article Why sterling has fallen off a cliff – and will probably keep going down
The author concludes: ” ..until [an] escape route becomes more palpable, speculators are likely to keep betting against the pound.”
This is why setting out a credible routemap for economic recovery and stabilisation of debt levels is of such importance and why David Gauke speaks of avoiding a sterling crisis in his Observer article.
Part of the route map is the tax financing of permanent current spending as projected in the comprehensive spending review scheduled for this Autumn and the cost and sourcing of debt financing for investment while maintaining a stable price level. Richard Murphy, himself an advocate of MMT, makes the points https://www.taxresearch.org.uk/Blog/2018/11/09/modern-monetary-theorists-need-to-take-a-long-and-hard-look-at-how-they-are-campaigning-if-their-case-is-to-be-won/
“modern monetary theory does not eliminate exchange rate risk. It still exists. That is in large part because most exchange rate risk has nothing whatsoever to do with government economic action. It is created by political risk, as has been the case with the substantial down-rating of sterling since the Brexit referendum took place; or it is created by external price shocks… or it can arise because of short-term speculation. if a government believes that it can create money without limit, then it is fundamentally wrong. Likewise, if it thinks it can spend without taking into consideration the limit of available resources within the economy itself and ignores entirely the impact upon imports then the use of MMT can, and usually will, have a downward impact upon the balance of payments and the long-term value of the currency. ”
“MMT has not got its head around tax. It largely ignores its social functions, the tax gap, why it is important, and why tackling tax abuse is a fundamental task of government. That is because far too many MMT proponents think the government can simply print money instead of taxing. And that is not true. MMT cannot, in my opinion, function without an effective tax system.”
“…however good MMT might be as an explanation of an aspect of the economy, it does not answer all questions and is no substitute for sound political judgment. “
Jenny Barnes,
I think it is not liberal to try to change people’s behaviour by putting taxes on things. (I am happy that increasing fuel duty is no longer party policy.) It should only be used when there are no alternatives. And there are alternatives to increasing fuel duty. There are many places in the UK where having a car is necessary and not having one can restrict a person’s choices. Liberalism should be about ensuring people have as many choices as possible. I think our policy of phrasing out diesel and petrol cars plus my idea of giving financial assistance to change are much better.
Peter Martin,
The quote “…Sunak will have to order steep tax rises to plug a £40bn gap in the public finances caused by emergency spending during the Covid-19 crisis” is from David Gauke in the Sunday Observer not me.
I like the idea that the government should get the economy right (full employment and near to 3% economic growth) and should not worry about the exchange rate.
Antony Watts,
You are correct building lots of electric vehicle charge points will be needed.
Joseph Bourke,
Lots of economies have higher and will have higher levels of national debt that the UK so it is likely there will be no decline in the value in the pound. However, for those people who think we should manufacture more a decline in value of the pound should stimulate more UK based manufacturing.
You seem to want higher interest rates. Most economists see low interest rates as a good thing.
@ Michael BG “I think it is not liberal to try to change people’s behaviour by putting taxes on things”.
Does that mean you’re opposed to taxing tobacco, sugar and also to the minimum pricing of alcohol, Michael ?
Whenb one person’s behaviour includes riding round in a Canyonero burning immense quantities of fossil fuel I think it’s entirely liberal to want to defend my right to live on a habitable planet. Changing their behaviour by deploying Stingers on the roads might be a little extreme, but an increase in taxation seems entirely reasonable to me. Or should we just ban fossil fuel cars straight away? As was done with smoking on the tube?
@Jenny Barnes
“I think it’s entirely liberal to want to defend my right to live on a habitable planet.”
Seconded.
” Or should we just ban fossil fuel cars straight away?”
Not practicable. A significant number of people do actually need to get around by car/van etc. – lack of suitable (or any) public transport, carrying equipment for work purposes, disability etc. And as I pointed out in some other thread a while back there are well over 30 million fossil fuel cars and light vans in use – we can’t make electric vehicles quickly enough to replace them all in a short timescale.
But no-one really needs the worst gas guzzlers – Bentleys, Ferraris, Hummers etc.
JoeB,
Saying that MMT doesn’t eliminate the exchange rate risk is no different from saying it doesn’t eliminate the inflation risk. No one says it does – at least not in the absence of the Job Guarantee. We’d both agree that UK inflation has been too high in the past. Its been higher than its been in the USA. That’s fundamentally why the pound is now worth much less than it used to be in terms of US$ on the forex markets.
If the speculators take their money out of ££, which is what seems to be your worry, then the capital account will be less in surplus than it was. This means the current account will be less in deficit. The two have to balance. This in turn means the Government’s deficit will very likely fall too. Isn’t this what neoliberals are supposed to like? So what’s the problem?
As Michael BG points out: “You seem to want higher interest rates. ” So if we do that more overseas lenders will want to lend us money. But, aren’t you supposed to dislike the idea of borrowing too much? If so, you should be pushing for rates to be as low as possible.
The Bank of England has two main responsibilities. Firstly, to support the government in maintaining macroeconomic stability i.e price stability ( inflation target) and subject to that, to support the government’s economic objectives including those for growth and employment. Secondly, to maintain stability in financial markets including the money, capital and foreign exchange markets. Monetary policy trys to achieve macroeconomic stability; and the stability of financial markets is maintained by providing liquidity insurance (i.e. the lender-of-last-resort function), the work of the Bank’s Financial Policy Committee (FPC) and Prudential Regulation Authority (PRA). Macroeconomic stability is unlikely to be realised unless there is also financial stability which includes relative exchange rate stability.
The BofE’s inflation mandate emphasises the importance of price stability in achieving macroeconomic stability, and in providing the right conditions for sustainable growth in output and employment.
A persistent low-interest rate environment is associated with low growth prospects and distorts the effective functioning of financial markers inflating assets like real property and financial securities while eroding the value of money savings and pension incomes. That effectively redistributes income to wealthier investors while wages stagnate and pensioners have to eke out whatever savings they may have without any return on savings.
Macroeconomic stability is, of course, also affected by the fiscal and supply-side policies.
Unemployment is the issue to be faced now. The current fiscal expansion will be unlikely to reverse the downward trend in investment demand, if it aims solely at supporting existing economic activities or consumption rather than stimulating new investments, R&D or structural reforms. To bolster potential growth, it is important that public spending supports private investments and productivity by creating growth-enhancing conditions, e.g. by spending on green infrastructure projects, public housing and skills training that would create permanent jobs for the future and aid in moving the economy to its zero-carbon targets and better, higher paying employment.
David Raw,
I am not against taxing tobacco, sugar or alcohol or petrol. As I wrote, when there is no alternative but increasing prices to change behaviour I accept it. I understand that the minimum pricing of alcohol is a successful policy, but I still feel uneasy about it. I am much happier with high levels of tax on tobacco (as they had an influence on my giving up smoking).
Jenny Barnes,
I support our party policy to ban diesel and petrol cars and small vans in 2045 and the sale of new ones in 2030. As I wrote I think people should be given a grant if they buy an electric vehicle and remove their own less energy efficient vehicle from the road. If a particular car uses too much petrol then ban its sale but don’t increase the price of petrol so only the richest people can afford to have and use one.
Joseph Bourke,
Please can you provide the evidence that persistent low interest rates leads to low growth rates? Economic theory states that when interest rates are low businesses will borrow to invest and this increases production.
Indeed it is not enough for the government just to increase aggregate demand, it also needs to try to increase production which is much harder to do. Changing the conditions for some green market is one way to do this which has been successful in the past. I believe there is a role for the government to encourage a particular business to setup in a particular area. Spending on infrastructure also increases the demand for things to go into it and this extra demand should encourage more investment and more production.
@ Joe B,
Thank you for telling us all about the BoE’s monetary responsibilities. There’s about 150 words or so. You then mention the Govt’s role in saying “Macroeconomic stability is, of course, also affected by the fiscal and supply-side policies.” An order of magnitude fewer.
And this is indicative of where we are now and the economic problems we face. There’s been far too much emphasis on monetary policy, ie leaving it all to the BoE , and nowhere near enough on the Govt’s essential role. It can’t go on. This ‘monetarism’ has to stop now. We don’t want the abolition of cash and ever lower interest rates extending into the highly negative.
@ Michael BG,
“Economic theory states that when interest rates are low businesses will borrow to invest and this increases production.”
This is only a part of it. Anyone investing in a new factory, for example, will create lots of overheads for themselves. The conditions have to be right and the idea that Govt can hand over nearly all the responsibility for creating those conditions to a group of bankers is just so absurd that it’s surprising that anyone could have taken it at all seriously in the first place. But as Orwell once remarked “One has to belong to the intelligentsia to believe things like that: no ordinary man could be such a fool.”
@David Raw. 12/7, 9.05
I too approve of tax on tobacco, sugar, etc., and like MichaelBG I consider it illiberal. I call this the Liberal Paradox. Rather like the whole “Free Speech/Hate Speech” thing. Bit of a nuisance, really.
An old canard is a dead bird, perhaps a Norwegian Blue.
The population of Gibraltar want to retain the status quo
Spain’s possessions in North Africa should bereconsidered by the UN.
Michael BG,
the evidence that persistent low interest rates is associated with low growth rates is the experience of Japan over the past three decades and the equally low growth of developed economies since the financial crisis despite ultra-low interest rates. This article explores the issues https://www.globalpolicyjournal.com/blog/11/05/2020/why-low-interest-rates-will-not-help-recover-economy.
“… traditional monetary measures to stimulate the economy actually do more harm than good. They contribute to rising inequality, for lower interest rates benefit mostly the wealthy, who already have large financial holdings, and hurt middle-class families and retirees who depend on their investments and savings for a living.”
“…low interest rates have contractionary consequences: monopolization of the economy, slowing growth in productivity, and rising inequality. Low interest rates, as a result, cause more pain to the economy than they do good.”
“Pension funds and other financial institutions, unable to profit from negative inflation-adjusted yields on government bonds, invest in the stock market, leading to the overvaluation of asset prices there and a potential bubble. ”
“Low rates also lead to the misallocation of capital by encouraging healthy companies to undertake unproductive projects and, importantly, facilitating the development of so-called “zombie” companies, entities that are artificially maintained by cheap borrowing but that will be a drag on economic growth in the long run. All these changes are accompanied by rising debt levels and higher leverage.”
“Low interest rates, by spurring the growth in consumption, reduce national savings. In turn, the reduction in national savings directly contributes to the current account imbalances, in particular, trade deficits and subsequent fiscal deficit.”
“…they are actually counterproductive and damage the economy by causing market concentration, fueling asset bubbles and unproductive investment, and increasing trade deficits and debt.”
The remit of the Bank of England in maintaining financial stability includes ensuring the effective operation of financial markets in intermediating the supply and demand of finance between savers and borrowers. If savers and pension funds cannot earn a return that is at least equivalent to inflation, then confidence in financial markets is eroded and people look elsewhere, such as the residential property market or gold, for a store of wealth.
Chris Cory,
there was a time when putting up taxes on beer and cigarettes was considered by Labour politicians as an attack on the working classes by Champagne swilling, cigar-chomping Tories. Times change. Now we call them sin taxes. The paradox is the higher they go the less revenue is collected as consumption falls off – the so-called ‘deadweight loss’ of taxation. Jenny Barnes is right about fuel tax. This LSE article argues it is all about
electoral incentives http://www.lse.ac.uk/GranthamInstitute/news/why-the-uk-government-has-frozen-fuel-duty-again/
“Taxing petrol and diesel is one of the most important policies governments can use to combat climate change. Fuel duty has not increased since 2010. During this period the volume of traffic has grown, producing more air pollution and greenhouse gas emissions. The Institute for Fiscal Studies has calculated that the failure to raise fuel duty in line with plans originally set out by Chancellor Alistair Darling in 2009 now costs the Treasury around £9 billion a year. The UK’s Committee on Climate Change recently recommended that that the fuel duty freeze be ‘reconsidered’ if the country is to be on track to meet the fourth and fifth carbon budgets.
Given its myriad benefits, both current and future, why does the Government continue to freeze fuel duty (even when wholesale costs have fallen dramatically)? it is all about electoral incentives.”
“While politically expedient, the strategy is myopic. Focusing solely on the short-term monetary costs of fuel duty ignores its significant benefits, now and in the future. Indeed, fuel duty should be thought of a policy investment that transforms short-term costs into much larger long-term benefits – importantly, climate change mitigation.”
“In addition, the annual announcement that fuel duty will not rise in line with the escalator policy creates further policy uncertainty that can have a negative impact on investors and companies that are developing more fuel-efficient and electric vehicles. It is hard to reconcile the annual freeze in fuel duty with the need to rapidly decarbonise the UK’s transport sector.”
“If governments around the world are serious about decarbonisation they must show more political leadership, which at times means taking political risks.”
@ Joe Bourke “there was a time when putting up taxes on beer and cigarettes was considered by Labour politicians as an attack on the working classes by Champagne swilling, cigar-chomping Tories”. I’d be fascinated to hear your evidence for that comment, Joe.
I don’t think King James 1 was a member of the Attlee Cabinet when he initiated the first ‘tax for health reasons’ and raised tobacco tax 40-fold from 2 to 82 pence per pound, making tobacco more expensive than silver.
However, I remember back in September 2014 Ed Miliband was met with a storm of protest from the UK tobacco firms at a Labour plan to tax them more to pay for the NHS. “Tobacco industry calls move ‘unjust’, arguing that total tax paid on each cigarette packet in Britain is already 86%”. The Guardian 23/9/2014.
In fact it was the retired Mrs Thatcher and Kenneth Clarke who went to work for British American Tobacco for more vthan a few bob…… and, of course I remember both Paddy and Charlie K. were smokers, to the point where the BBC reported :
‘Kennedy caught smoking on train’ – BBC NEWS news.bbc.co.uk › uk 6 Jul 2007 – Former Liberal Democrat leader Charles Kennedy has been “spoken to” by police for smoking on a train.
Peter Martin,
Liberal democrat economics is firmly entrenched in Keynesian macroeconomic theory and advocates countercyclical fiscal policies that act against the direction of the business cycle to stimulate employment and stabilize wages during economic downturns. Taxes are raised to cool the economy and prevent inflation when there is sufficient demand-side growth. Monetary policy is also used (where appropriate) to stimulate the economy in the short-run by reducing interest rates to encourage investment. The exception occurs during a liquidity trap (as has been the case since 2009) when increases in the money stock fail to boost output and employment.
Governments should intervene in markets to solve problems in the short run rather than wait for market forces to fix things over the long run. This does not mean adjusting policies every few months to keep the economy at full employment. Governments cannot know enough to fine-tune successfully. Monetary and fiscal policy can be effective in increasing output in the short run but in the longer run, expansionary monetary policy leads to inflation only or exacerbates inequality and the potential for secular stagnation in an aging population.
Keynes diagnosis of recessions and depressions remains the foundation of modern macroeconomics and the remedies are largely unchanged – expansionary stimulus in the short-run, fiscal contraction as demand recovers, and financial stability over the long run underpinned by full-employment.
As to budget deficits that is encapsulated in Keynes enduring advice “Look After unemployment and the budget will Look After Itself'” That is best achieved with a combination of job guarantee programs and productivity-enhancing investment in skills develpment and infrastructure.
David Raw,
James 1 relationship with Parliament, in particular the amount of money he needed for his court, were far from harmonious. He left his son, Charles 1, two political treatises, The True Lawe of Free Monarchies (1598) and Basilikon Doron (1599), in which he expounded his own views on the divine right of kings. There was nothing with respect to economic justice in these writings.
For where we are today, the IPPR commission on economic justice is a useful guide and makes a wide-ranging series of recommendatios worthy of consideration https://www.ippr.org/files/2018-10/cej-final-summary.pdf:
” Many of the causes of the UK’s poor economic performance – particularly its weaknesses in productivity, investment and trade – go back 30 years or more.
Economic justice needs to be ‘hard-wired’ into the way the economy works.It is not sufficient to seek to redress injustices and inequalities simply by redistribution through the tax and benefit system. They need to be tackled at source, in the structures of the economy in which they arise. These include the labour market and wage bargaining, the ownership of capital and wealth, the governance of firms, the operation of the financial system and the rules that govern markets.
Our 10-part plan includes far-reaching but achievable measures to:
• promote ‘ investment-led growth’ by raising public investment, holding down house price inflation and reducing the incentives that currently favour short-term shareholder returns over long-term productive investment
• rebalance the economy through ‘new industrialisation’, away from an over-dependence on the finance sector towards a more diverse array of manufacturing and other innovative, export-oriented industries, located right across the country
• give workers greater bargaining power, making it easier for trade unions to negotiate on their behalf to achieve higher productivity and to share its rewards fairly through better wages and conditions and reduced working time
• pursue ‘managed automation’, accelerating the adoption of new technologies across the economy and ensuring that workers share in the productivity gains and are helped to retrain
• promote open markets which reduce the near-monopoly power of dominant companies
• spread wealth more widely in society, both by widening ownership of capital and through fairer forms of wealth and corporate taxation.”
@ JoeB,
“the evidence that persistent low interest rates is associated with low growth rates is the experience of Japan over the past three decades and the equally low growth of developed economies….”
“is associated with” isn’t the same thing as “leads to” which is what Michael BG asked. It is much more likely that low growth rates “leads to” low interest rates as central banks follow the conventional wisdom of relaxing monetary policy in a bid to stimulate a flagging economy.
“Liberal democrat economics is firmly entrenched in Keynesian macroeconomic theory and advocates countercyclical fiscal policies that act against the direction of the business cycle to stimulate employment and stabilise wages during economic downturns”
I might have agreed with you before the experience of Coalition with the Tories. Seeing Lib Dems meekly follow the economic austerity line as directed by George Osborne caused more than a few of us to doubt that.
“Look After unemployment and the budget will Look After Itself”
This sounds a catchy thing to say but just what does “look after itself” mean? Does it mean that it will always be at least in balance? It can’t do. If the private sector have nearly all got jobs but are spending less than they earn someone has to be in deficit. Unless we suddenly become like Germany that isn’t going to be the overseas sector. So it has to be government.
Is it Joe or Joseph – and is that how you get so many bites at the cherry ? Still no justification of your comments on fags,booze and the Labour Party though. Just a ramble through a four hundred year old constitutional theory.
James V1 (as he was here) on the divine right of kings may have inspired Charles 1 to lose the monarchy by a short head, but his ideas were way out of kilter (sic) with popular feeling in Scotland. As James’ tutor George Buchanan suggested, (supported by the Kirk) a monarch should rule in accordance with some form of social contract with the people.
A social contract ? A moral there somewhere for the Lib Dems – and their less than inspiring leadership do.
Our local MP is a Conservative who does not seem to accept that we are having a drought in the southeast of England and is therefore not pushing for piping from areas of surplus in the northeast England, although he does know why the surplus was created for chemical industries which are not currently needed.
David, I do enjoy your witty comments ! – and it’s fascinating to know that James V1 had a tutor (I presume, a Scot), wise enough to recommend him to think in terms of having a social contract with his people. As our Prime Minister seems bent on kingly powers for himself, perhaps be may yet at least learn about noblesse oblige , which might be a slight improvement. Meantime, I want our party Leader, he or she, to lead in promoting a policy so far not understood by our esteemed Federal Conference Committee in its lordly powers, of promoting the same proposal as that which the seventeenth-century Scottish tutor wisely suggested to his king, namely responsibility of the ruler to put right the national wrongs. Which our party could and should be shouting about, from now until it is heard and acted upon.
Peter Martin,
ultra-low interest rates and low growth are associated. As with most economic relationships, it is an iterative one or circular feedback loop rather than a dependent relationship. The reasons that very low-interest rates have contractionary consequences are outlined in the global policy paper linked above.
The need to reduce the level of deficit was a view held across all the main parties in 2011. Ed Balls as Labour’s shadow chancellor pointed out that in government he had published one of the most detailed programs of spending cuts produced by any cabinet member https://www.theguardian.com/politics/2011/jan/21/ed-balls-accepts-need-for-deficit-cuts. There appears to be a general consensus across the parties today, at least for the present, that there should be no cuts in public service spending in any event and that targeted tax increases can wait until economic and employment growth is well underway.
Look After unemployment and the budget will Look After Itself means exactly what it says. Unemployment had declined from 8.1% in 2011 to 5% by 2015 and had reduced to 3.8% last year with the current spending budget in balance at that point. The deficit was financing investment spending, borrowing was at its long-run average and spending as a % of GDP had returned to its pre-crisis level of 40%. That is a good indication that to significantly increase the level of public service and welfare provision (including health and social care, schools and policing local government support and benefits) when the economy returns to operating at near capacity will require a higher proportion of public spending relative to GDP. That in turn will need a higher level of taxation to deliver and sustain public provision as the economy stabilises. Significant deficit financing will still continue to fund the high levels of infrastructure spending and public housing development required to address productivity improvements and affordable housing provision. That should be uncontroversial. When the economy is operating near capacity, tax increases are required, not to contain inflation (that can be done with staggered reversal of QE) but to reallocate resources from the private sector to the public sector.
@ Joe B,
As Sukhayl Niyazov says in the article you referenced “Low interest rates, according to mainstream economics, are beneficial for economic growth.” Any sensible discussion on the limitations to this concept has to include the downside of debt deflation but he can’t bring himself to do this. There’s no mention of it. That would take him much too far away from the main flock and risk the label of heterodoxy. So he sets out to find some other obscure and less convincing reasons. He ends up saying ” For in today’s day and age, simply lowering interest rates will not help the economy; it is the time for more active measures.” This is what a MMT economist would say too. But he wouldn’t want anyone to think his reasons were the same.
Let’s just suppose, for the sake of argument, that we did all agree that the government’s deficit had to be cut. How would we do it? The popular view is to treat the government’s finances as a household. So we cut spending and raise taxes. But you and I know that doesn’t work. The governments finances aren’t like a household. If the government cuts its spending it cuts its income. The economy tanks and there are more demands for government intervention and even more spending. Raising taxes only worsens the problem. Big mistake by the Coalition to try that.
So what else can we do? How did we achieve the occasional budget surplus in past times? They happened during credit booms. If everyone else is borrowing more the Government has to be borrowing less. The sectoral balances have to balance. So how about trying to create another one? To some extent that was still possible in 2011. There was some scope for lowering interest rates and that’s what happened. The debt bubble was reinflated. It worked for a time. Well enough to get the Tories re-elected. But it isn’t a long term fix for the economy.
@ Joe B,
“Look After unemployment and the budget will Look After Itself means exactly what it says.”
You mean like ‘Brexit means Brexit’ ?
I would say that ‘If we look after the economy both the exchange rate and the budget deficit will look after themselves’.
‘Looking after itself’ is a handy phrase at times!
Peter Martin,
Looking after employment means introducing job guarantees at local authority/SEO/Charity level or similar support programs and maintaining public investment at levels at least comparable with the OECD average. At full employment, current spending (including depreciation) should be financed by tax receipts and investment spending financed by long-term bond issues.
If current spending is not tax-financed when the economy is operating at full capacity then that is an indication that the level of taxation needs to be increased to support ongoing public service provision with a greater focus on wealth taxation. Without adequate taxation there is likely to be inadequate levels of investment in infrastructure and housing development.
That is the proper role of government in the economy – the efficient provision of high-quality public services; redistribution and welfare; long-term investment in infrastructure and the maintenance of relative stability in the price level, exchange rate, employment levels and financial markets.
Economic growth over the long-term is a function of innovation, technological progress, skills development and public infrastructure. Both monetary and fiscal stimulus are neutral in the longer-term. Stimulus is a necessary short-term mitigation of economic shocks or automatic stabilisers that smooth fluctuations in the course of the business cycle. Stimulus cannot, however, substitute for the fundamental drivers of growth or address economic justice.
As the IPPR writes in their report “Economic justice needs to be ‘hard-wired’ into the way the economy works.It is not sufficient to seek to redress injustices and inequalities simply by redistribution through the tax and benefit system. They need to be tackled at source, in the structures of the economy in which they arise. These include the labour market and wage bargaining, the ownership of capital and wealth, the governance of firms, the operation of the financial system and the rules that govern markets.”
@ JoeB
“At full employment, current spending (including depreciation) should be financed by tax receipts and investment spending financed by long-term bond issues.”
There’s a few problems with this rule-of-thumb. So some questions:
1) What about when we don’t have full employment?
2) The definition of current and investment is quite arbitrary. If the Government spends to educate a child or restore the health of a sick person is that current or investment?
3) If the government sells bonds, under your rules, they can use the money for investment. If potential buyers keep the same money in a safe, or even in short term Govt deposits, the Government cannot use it. But what’s the effective difference?
4) If a Govt has to either raise its money in taxation, from those who already have it, or borrow it long term, again from those who already have it, where does new money come from to fuel a growing economy? Are you saying a currency issuer shouldn’t actually be a currency issuer?
And, yes, I do understand the inflationary implications if a Govt overdoes it.
Peter Martin,
1. Since the end of the last recession, UK unemployment has more than halved at a time when the total economically-active labour force has also grown. This can be attributed to a market-driven downard adjustment in real wages.
Barriers to reducing unemployment below the levels seen pre-pandemic include: Significant regional differences in unemployment and employment opportunities; structural long-term unemployment (people out of work for a year or more); Housing affordabaility is a barrier to people being able to move in search of fresh work; skills shortgages – structural unemployment due to the mis-match of skills to jobs. Job guarantees are likely required to address these issues.
2. The definitions of current and capital spending are set-out in the National accounts framework. The national accounts identify two types of asset within the economy. The first of these is non-financial assets and includes fixed assets (such as buildings and vehicles), valuables, inventories, and non-produced assets (such as land). The second type is financial assets; these include currency holdings, bank deposits, ownership of shares and loans (from the point of view of the lender).
3. All public spending is eventually financed by taxes. Longer-term borrowing allows for smoothing of tax collections over time and repayment of nominal debt with lower value currency.
4. Most of the money in the economy is provided by the commercial banking sector in response to demand for money that increases with the level of growth in economic activity.
Ultimately, if you want Scandinavian levels of public service provision you need Scandanavian levels of taxation to finance them as this article argues https://www.peoplespolicyproject.org/2019/02/24/whats-the-point-of-modern-monetary-theory/?mc_cid=de24d48234&mc_eid=7bf858b250. To quote Jonathan Portes “one thing is absolutely certain. The claim that MMT means that a future government can dodge hard choices about how to pay for decent public services is just plain nonsense.”
@ Joe B,
Lets just take it one a time.
@ Joe B,
Lets just take it one at a time. I think this is the only chance of getting a straight answer.
Are you saying that spending on children’s education is?
a) all counted as an investment b) Only the bricks and mortar in the school building
@ Joe B
Another one at a time question:
“Most of the money in the economy is provided by the commercial banking sector”
Does the Govt accept this money in payment of taxes? a) yes b) no
Peter Martin,
I understand that you run a company, So you know what an asset is. In accounting terms an asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Human beings are not controlled by the entity in this case (government) and cannot be classified as assets. They are free to go anywhere they please and the principal purpose of modern education is a social benefit to facilitate self-learning and self-realisation, not an economic purpose perse.
State Assets are recorded in the whole of government consolidated accounts (WGA) and summarised on page 16 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/803751/WGA_2017-18_WEB_1.pdf
“The headline results in WGA 2017-18 show income of £760.9 billion, expenditure of £814.8 billion. After financing costs are taken into account, the net expenditure for WGA is £212.4 billion. On the Statement of Financial Position, WGA shows total assets of £2,013.8 billion, and liabilities of £4,579.2 billion.”
Yes, the government does accept bank money for payments of taxes. Most money in the economy is in the form of bank deposits and these deposits are the source of payment of taxes. These are the ways you can pay your tax bill https://www.gov.uk/pay-self-assessment-tax-bill – direct debit, online transfer, debit card, cash payment at your bank or building society, by cheque etc. Tax payments are made to the HMRC account with Barclays bank.
As noted in this brief summary https://neweconomics.org/2012/12/where-does-money-come-from
“Fiscal policy does not in itself result in an expansion of the money supply. Indeed, the government has in practice no direct involvement in the money creation and allocation process.”
@ Joe B,
So you are saying that spending on children’s education isn’t counted as investment? And that an educated workforce isn’t an asset to the country?
Well OK but please make sure that everyone understands this when you are talking about investment because they are usually aren’t interested in accountancy definitions. They are interested in the government investing in education and they don’t mean the bricks and mortar of schools.
“Yes, the government does accept bank money for payments of taxes.”
So you mean it separates out all the money according to its origin?
So what would it do with, say, Barclays bank money if Barclays went bust?
Peter Martin,
the education departmental budget includes both current spending for wages, goods and services as well as capital spending on land and school buildings. The services of teachers and current spending are consumed by the current cohort. The investment in fixed assets is available to house and educate future generations. The current generation of taxpayers bear the cost of current spending. Future taxpayers bear the cost of future benefits from enduring infrastructure including depreciation of the fixed asset amortised over their useful lives.
Money is fungible. As regards tax payments, these at first go into bank accounts of HMRC (payment in bankmoney) and are thereafter transferred in bigger amounts to a treasury transaction account with the central bank (payment in reserves). In any case, the money spent on taxes continues to circulate through ongoing government expenditure (the reserves in the interbank circuit among the banks, the bankmoney in the public circuit among nonbanks). The respective reserve balances are not deleted. Reserves are only deleted in the case of bank reserve payments to the central bank itself; as bankmoney is deleted by nonbank payments in bankmoney to a bank. By contrast, the reserve balances in a government transaction account continue to exist and circulate in government payments to whosoever.
Tax payments are an inflow of means that serve continued funding of government expenditure, most often together with additional debt taken up. Public expenditure spends the inflow of money from taxes and debt, but does not of itself create money except when it makes use of the BofE ways and means account. Expanded government demand for credit is, however, likely to trigger money creation by the commercial banks on behalf of investors in gilts, jut as expanded credit demand from finance, companies and private households does.
If Barclays was to go bust it would be subject to the UK’s bank recovery and resolution regulations. In most cases its loan assets and deposit liabilities would be taken over by other banks or recapitalised and its existing shareholders and possibly bondholders would absorb the brunt of the financial losses.
@ Joe B,
“The current generation of taxpayers bear the cost of current spending.”
The current generation bears ALL the cost of ALL government spending. Whether you want to call it current or capital is neither here nor there. The cost is in the allocation of available resources which are finite in number. So if we allocate resources to building a bridge which will last for a couple of hundred years we can’t do something else with them which we could have done otherwise.
” Future taxpayers bear the cost of future benefits…”
Like we can go forward in time and ask them for a contribution and then bring it back to the present. It would have to be a contribution in real resources to be of any use. Their money would be of no help at all.
We have benefitted from the efforts of previous generations. We haven’t had to pay anything for the network of railway lines built by Victorian engineers. We haven’t had to bear any of the cost of construction. They did it entirely on their own. We can’t go back in time to give them a helping hand. We do pay for the maintenance. Does it matter if it’s called current or capital spending? Not in the slightest. Its just an arbitrary division.
The major infrastructure assets are roads, rail, water and sewage, ports, power plants, land and buildings. Most infrastructure is financed by new long-term borrowing. Infrastructure assets are continually renewed refurbished and replaced at the end of their useful life. These costs together with interest costs on debt and repayment of maturing debt not rolled over are tax-financed after the initial construction. Other costs are incurred by current consumers, but are paid for after the benefits have been consumed e.g. decommissioning costs of nuclear power installations and pension liabilities that accrue during the working tenure of public sector employees. Whether construction is financed by borrowing (deferred taxation) or leasing as in PFI contracts for hospitals and schools – it is as the services are consumed that the tax financing is required.
Domestic resources are a limiting factor in the pace at which new infrastructure can be delivered. The UK has held talks with China over giving Beijing’s state-owned railway-builder a role in constructing the troubled HS2 high-speed link. The China Railway Construction Corporation (CRCC) has said it can build the line in just five years at a much lower cost than is currently forecast. Swathes of Britain’s energy, transport and utility networks are now run by companies owned by other European governments.
Chinese and French companies are scheduled to develop new nuclear power plants that will be paid for by higher electricity charges. So yes, whether long-term borrowing or lease contracts generate future economic benefits is an important consideration in the management of public finances.
Infrastructure investments should be evaluated based on the value for money they provide to taxpayers. Secondly, fiscal targets should be amended to permit additional borrowing for public infrastructure projects that pay for themselves through increased income (whether tax revenue, user charges, rents or sales proceeds) or through reduced costs or acquisition of land. This should prioritise much needed transport improvements and social housing construction that currently have to compete for funding resources, even though they could actually improve the government’s overall financial position. It should also enable capital investments that will benefit the taxpayer by reducing running costs to be moved closer to the top of the queue.
Joseph Bourke,
What you say is Liberal Democrat economics is really your economics. I don’t recall the party passing any economic policies since Coalition days when it kept passing policies in support of the Conservative economic policy of the Coalition government. Please can you post links to any policy motions or policy papers we have passed on economic policy since the 2015 general election.
I like the idea that the government should achieve full employment and the government budget will look after itself.
I don’t think negative Quantitative Easing should be the method used to reduce inflation, tax increases can do it much quicker.
There is no real reason why all current spending has to be financed by government revenue even when there is my definition of full employment and certainly not at what you consider is full capacity. The economy never actually reaches full capacity just as it never reach the point of equilibrium.
@ JoeB,
So called Govt borrowing is NOT deferred taxation. You know very well it isn’t. Its a neoliberal myth. Using taxation to “pay off” debt is ultra rare. A comparison with Hen’s teeth, and what rocking horses don’t produce much of, springs to mind!
You’ve still not explained where Govt money comes from in the first place. The idea that it’s created by Barclay’s bank and somehow becomes Govt money after we have paid it in taxes to the Treasury is just more of the nonsense that you’re peddling.
It’s an IOU. The government can create and spend as many as they like. They don’t have to tax and they don’t have to borrow. But just because they can doesn’t mean they should. As always the real resources available in the economy are the crucial factor in deciding the fiscal and monetary mix.
@ Michael BG,
Joe BG is dreaming if he thinks he can see negative QE happening any time soon. Negative QE would be the process of the BoE selling Govt bonds into the market so the buyers would be paying the BoE rather than the Treasury. Why would the Treasury, which owns the BoE, want them to do that?
They might, but only if they had so much tax money coming in that they decided that it didn’t look good! So they’d spin some yarn about paying off debts. It would be a way of pushing up longer term interest rates and they would be hard pressed to think up a reason to explain to the public why they’d deliberately want to increase Govt borrowing costs.
Peter Martin 15th Jul ’20 – 5:16am
?? Or just get lucky ??
Examples are
1) North Sea oil and gas
2) Arms sales to Saudi Arabia and their neighbours
3) better use of solar energy
4) Invent a medicine to control the virus
5th Jul ’20 – 7:10am
Peter Martin 15th Jul ’20 – 5:16am
5) Sell property in Hong Kong
Michael BG,
Liberal Democrat economic policy is encapsulated in the manifesto we all campaign on: https://www.libdems.org.uk/plan. On Public finance s it writes:
“A good government should responsibly manage the nation’s finances: taking advantage of opportunities to borrow to invest in key infrastructure while making sure that day-to-day spending does not exceed the amount of money raised in taxes. The Liberal Democrats are the only party who will manage the country’s finances properly. The Conservatives are pursuing a Brexit that will wreck the economy for a generation, making it impossible to sustainably invest in public services. Labour will waste billions nationalising utilities – spending money that could be used to improve them just to bring them under state control. Our plan for the future is built on responsible management of the country’s finances: stopping Brexit and using the increased revenue from a bigger economy to invest in services and using the money that Labour would waste to tackle the climate emergency and invest in transport and energy infrastructure. ”
Andrew Bailey, the governor of the Bank of England has advised that a reversal of QE should come before lifting interest rates https://www.cityam.com/bailey-bank-of-england-will-reverse-qe-before-raising-rates/. “When the time comes to withdraw monetary stimulus, in my opinion it may be better to consider adjusting the level of reserves first without waiting to raise interest rates on a sustained basis,” Bailey said he did not want high Bank of England purchases of government bonds to become a long-standing scenario “Elevated balance sheets could limit the room for manoeuvre in future emergencies,”
Peter Martin,
it has been explained to you many times how money is created and the BofE site is as good a placec as any to review that https://www.bankofengland.co.uk/knowledgebank/how-is-money-created “Most of the money in the economy is created, not by printing presses at the central bank, but by banks when they provide loans.” If you need further explanation read the New Economics foundation article above https://neweconomics.org/2012/12/where-does-money-come-from thst quotes J K Galbraith “The process by which banks create money is so simple that the mind is repelled. When something so important is involved, a deeper mystery seems only decent.”
Both the US and UK increased or maintained very high levels of taxes after the war and ran budget surplus in the late 1940s as military spending was cut back to pay down elevelated levels of debt after 1945. While we are likely to maintain elevated levels of debt for several decades in the wake of this pandemic or at least as long as interest rates can be kept at historically low levels; It seems equaly likely that taxes will increase to fill the current spending budget black hole as the economy begins to recover with a review of capital gains tax as a first step https://www.independent.co.uk/news/uk/politics/rishi-sunak-capital-gains-tax-review-ots-uk-a9619576.html
The conclusion in the People Project Policy article linked above (as in Richard Murphy;s blog) seems a reasonable assessment “MMT seems to…deploy misleading rhetoric…deceiving people about the necessity of taxes in a social democratic system…”
Much is made of aggregation and the circular flow of funds in macroeconmics. In a simplified model of an economy there is the government, a single landlord, a single bank, a single shareholder and a single firm that produces all goods and services needed (food, sheler, clothing, utilities etc) and households. The factors that combine to produce the goods and services we all consume are land (provided by the landlord), plant, machinery, inventories and know-how (provided by the shareholder) and labour (provided by households).
The money used as a medium of exchange is created by the bank (owned jointly by the landlord and shareholder) There is no need for paper currency or reserve accounts. The bank simply issues credit that creates deposits, facilitates payments and accepts deposits in the form of rents, dividends and wages that the firms pays out. The Landlord, shareholder and households transfer part of their income to the government to enable the provision of public services and welfare services as required to maintain the health and oroductivity of the working population.
What is evident is that the size of the economy is determined by the quantity/quality of the goods and services produced by the firm that brings together land, labour and capital for these purposes. The firm must allocate a share of what is produced to the Landlord, shareholder, households and government based on what is demanded by each and their relative bargaining stength. The banks function is to ensure that there is an adequate supply of money in the economy to facilitate the efficient exchange of goods and services produed between the economic agents and to act as an intermediary between borrowers (firm. some households and government for investment spending) and savers (Landlord, shareholder and some households).
In a modern monetary economy there are a multitude of economic actors (not least the foreign sector) and money creation plays an important behavioural role in incentivising production, consumption, investment and savings but the basic microfoundations remain unchanged. Sustainable prosperity requires both the efficient allocation of real resources and an equitable distribution of value created among the factors of production. The monetary system facilitates the first and progressive taxes that allocate resources to the government for the provision of public services facilitate the second.
@ Joe B,
Maybe it’s not so quite so simple as JK Galbraith makes out. Frances Coppola takes issue with Guardian writer Zoe Williams, who also quotes the BoE paper, but also comes to the same misunderstanding as yourself. Incidentally, I wouldn’t put it quite the way FC does but she seems to understand the mechanism well enough.
If she’d been responding to what you’d written she be saying “Sadly JoeB did not understand it..”
We were originally discussing the difference between the government money spends into the economy and the money the government takes out in taxes. Neither of these involve bank created money. You’ve mentioned payment of taxes in terms of bank reserves ie Govt money so I can only conclude that you do already know this. Yet you’ve said the Government will accept bank money. This is true only in the sense that they know they can exchange it for the bank’s reserves to finalise the transaction.
So does than mean you’ve been disingenuous and want to obfuscate the issue to protect yourself from awkward questions?
Like where government money really does come from before it is available to be collected in taxes?
https://www.forbes.com/sites/francescoppola/2017/10/31/how-bank-lending-really-creates-money-and-why-the-magic-money-tree-is-not-cost-free/
“In a simplified model of an economy there is the government, a single landlord, a single bank, a single shareholder and a single firm that produces all goods and services needed (food, sheler, clothing, utilities etc) and households.”
It may be simplified but it’s also incorrect. The government itself is a bank. Combine the Treasury and BoE to see that. And you’ve totally missed out our overseas trading partners who cannot be ignored. The money that the commercial bank creates, as explained in the previous comment, is neither spent into the economy by Govt nor taken out in taxation.
Joseph Bourke,
You have not provided either a motion or a policy paper setting out our party’s economic policy. The manifesto is never agreed by conference but only by Federal Policy Committee. What you have posted from the manifesto is not what you had posted earlier and you haven’t stated where any of it was agreed by a Federal Conference. My view is that we as a party need to reject the idea that the government has to ensure that day-to-day spending does not exceed the amount of money raised in revenue, especially now with the Coronavirus crisis. This is a hang-over from the failed economic policy of the Coalition government. In 2010 we didn’t have this economic policy, we were advocating a small economic stimulus in 2010 and said we wouldn’t start removing demand from the economy until the economy was growing strongly enough to cope.
According to the UK Public Spending.co.uk website the UK’s deficits/surplus in the late 1940’s were:
1946 deficit £ 2.27 b
1947 deficit £1.99 b
1948 surplus £10 m
1949 surplus £450 m
1950 deficit £630 m
So out of five years the UK ran a small surplus for one year and a medium sized one for another one. Together these two years are less than just 1950’s deficit.
I have in the past pointed out on LDV how few years since 1950 the UK has had a government budget surplus.
Michael BG,
Policy paper F30: A Stronger Economy and a Fairer Society https://www.libdems.org.uk/f30_a_stronger_economy_and_a_fairer_society is what underlies the LibDem Manifesto:
Conference in particular welcomes its proposals to:
1. Finish the job on the deficit and balance the books by:
a) Aiming to balance the structural current budget by 2017/18.
b) Setting a course to reduce debt as a share of national income.
c) Making deficit reduction fair by ensuring high earners and the wealthiest pay their share, including through the introduction of a banded Mansion Tax.
d) Setting new fiscal rules to balance the budget while allowing borrowing for productive investment.
e) Increasing public spending again in line with the growth of the economy once the budget is balanced.
The 2019 manifesto is highlighted above and was by far the most socially progressive of the three main parties. . The 2017 manifestos were asssesed by Oxford economics https://www.businessinsider.com/economic-impact-uk-manifesto-election-policies-2017-5?r=UK
“”The more expansionary fiscal plans of Labour and the Liberal Democrats would boost both demand and supply, yielding stronger outturns for GDP growth compared with the Conservatives. By the end of 2021-22, the level of GDP is 1.9pp higher under the Liberal Democrat plan than under the Conservatives’ proposals, while under the Labour approach, real GDP would be 1pp higher than under the Conservatives’ proposals.”
No one in the party leadership (or any other party as far as I am aware) has suggested that day-to-day spending should be dependent on money raised in revenue during the Coronavirus crisis. That would be a rejection of the Keynesian tradition that underpins the Liberal Democrat economic approach.
What is suggested (as per the policy paper) is that public finances are put on a sustainable basis in the long-term future and that defecit reduction should be made fairer by ensuring high earners and the wealthiest pay their share of taxes and that borrowing should be targeted at productive investment, particularly in housing and green infrastructure.
Peter Martin,
if you want to understand how the monetary system actually works then you you should read what people who actually design and operate that system have to say about it i.e. central bankers and treasury officials. Hyman Minsky was one such person who understood how money was created in the commercial banking sysyem and the destabilising impact it had on financial stability. Most economists make an initial effort to accommodate MMT bloggers and point out where they get it right and where they go wrong until they get fed-up responding to cult-like behaviour. This piece is a case in point pointing out the good and bad (Monetary crankery) https://blog.usejournal.com/whats-wrong-with-mmt-a41e10c7203b and makes some effort to suggest how MMT adherents might be able to work on developing a coherent theory that is actually applicable to the real world.
As othere have noted, MMT has its own peculiar language, so the same words do not have the same meaning as in most normal economic debate. That is what brings you to state such absurdities as your comments above – that the government doesn’t need to tax or borrow to fund its spending or that people don’t pay taxes using bank deposits. To understand what you are taliking about you have to go back to the writings of the MMT guru- the bond trader Warren Mosler.
it is as Jonathan Portes (Professor of Economics, King’s College London) has said https://www.prospectmagazine.co.uk/economics-and-finance/nonsense-economics-the-rise-of-modern-monetary-theory, along with virtually every other credible economist, regardless of economic school of thought, “a mixture of the tautological, the obvious and the tendentious.” and “…one thing is absolutely certain. The claim that that MMT means that a future government can dodge hard choices about how to pay for decent public services is just plain nonsense.”
“Setting new fiscal rules to balance the budget while allowing borrowing for productive investment.”
Where is the theoretical justification that this is even desirable, or possible, for a country like the UK?
By that I don’t mean a reference to someone else who thinks it might be a good thing to aim for too. I mean an analysis of what the sectoral balances would have to look like. An analysis of what would happen if there were either too much or too little capital inflow. An analysis of what policy we would have to adopt on the exchange rate. An analysis of what the implication would be for levels of unemployment, interest rates and the inflation rate.
Superficially it all sounds plausible. But are you and the Lib Dems happy with ‘superficial’ ?
Incidentally it can be done without causing too much discomfort. If that’s what everyone genuinely wants. It will mean setting an artificially low value for the pound relative to the euro, as Denmark does with its Krone. But give a bunch of neoliberal economists and politicians the task of doing it and it will be the austerity economics, and worse, of the Coalition years all over again.
Peter Martin,
the theoretical justification can be found in any number of writings by modern Keynesian economisdts like Paul Krugman, Vince Cable, Martin Wolf, Jonathan Portes, Simon-Wren Lewis, Thomas Palley, Joseph Stiglitz and others.
A good place to start in understanding the interaction of politics and economics (without which there is little point to the study of economics) is here https://www.libdems.org.uk/beyond-brexit-booklet
“In a wide-ranging set of essays on Britain’s future, Vince Cable casts his party not at the centre of the tranditional left-right axis, but as the leading proponent of a values-based politics, which is open, inclusive and outward-looking, not closed or narrow-minded.
He examines how liberals should respond to the ‘age of identity’ and proposes an ambitious program of radical reform.
In a thoroughgoing analysis, he warns about the growing inequalities of income, wealth and opportunity that are fuelling populist movements. His prescription for change embraces reforming capitalism; tackling the power of the tech giants and harnessing their potential; changing the tax system; investing in public and private housing; infrastructure and the green economy; and achieving a revolution in lifelong learning.
Together these changes will help individuals take control in a more meaningful way than Brexit could achieve, particularly through establishing new rights for workers in the ‘gig’ economy, creating opportunity for young people, dispersing power from the centre to communities, and fixing the broken model of UK parliamentary democracy.
He challenges liberals and social democrats to avoid eulogising the past, and instead to prepare the country and its citizens for the 2020s.”
@ Joe B,
You can read up on whoever you like, and whatever neoliberal theory you like, but in the end you need to accept that if you want a export based, balanced budget based, economy like Denmark’s you have to do what the Danes do and fix your currency at an artificially low level. In Physics we would call that a practical observation such as when we’re observing the behaviour of the climate or a distant astronomical object. It’s not always possible to do controlled experiments. But theory has to fit observations. It can’t be the other way around.
On the question of monetary theory: It is also an observed fact that Govts spends Govt money into the economy and takes out Govt money in taxation. I suppose if Govt wanted to open up an account at Lloyds bank and use Lloyds bank money I suppose it could. But it owns its own bank called the Bank of England so doesn’t need to. The govt’s deficit or surplus is all accountable in terms of BoE money, sometimes called reserves.
So your introduction of commercial bank money into the discussion is a red herring. You are like Zoe Williams of the Guardian. As Frances Coppola says she’s got hold of the wrong end of the stick on how banks create money. Either that or you’re wanting to muddy the waters for everyone else.
Peter Martin,
You conflate fiscal operations and monetary operations. The New economics foundation explains clearly how money is created https://neweconomics.org/2012/12/where-does-money-come-from and correctly conclude “Fiscal policy does not in itself result in an expansion of the money supply. Indeed, the government has in practice no direct involvement in the money creation and allocation process.”
It is the monetary operations of the BofE that can create what is defined as money in the form of bank reserves via its asset purchase facility that swaps one form of interest-bearing debt (bank reserves held on deposit with the BofE) for another form of interest-bearing debt (government bonds).
The majority of the liquidity required to combat this crisis is created and provided by the commercial banks in the form of loans to business with government guarantees to support it. Government spending on direct grants and tax relief is financed by a combination of borrowing existing or new investor savings with banks and pensions funds as well as the utilisation of excess reserves by banks to purchase newly issued bonds to replace the bonds they have exchanged for reserves.
The flow of that money in the economy supports existing private sector debt payments and maintains asset prices on which bank lending is collateralised. With the economy in lockdown only a fraction of that support relates to aggregate net spending on essential goods and services with most discretionary spending on travel, hospitality, retail and leisure services curtailed. That support is necessary to contain a damaging debt deflation.
In many ways, Covid 19 was the catalyst for a recession that was predicted by the inversion of the yield curve last year and the stress in the US repo market last September https://uk.reuters.com/article/uk-usa-fed-repo-tools-explainer/explainer-repo-is-wall-streets-big-year-end-worry-why-idUKKBN1YR0F4#:~:text=WHAT%20IS%20THE%20WORRY%20OVER,four%20times%20the%20Fed's%20rate..
As to how this global economic recession pans out and its impact on the trade deficit, it is worth recalling J K Galbraith’s quip “that economic forecasting exists to make astrology look respectable,” The trade deficit may well come down if imports contract more than exports, bringing the current account closer toward balance.
The only thing we can say for sure is that there is a serious unemployment crisis underway that will need to be addressed over a number of years without exacerbating the environmental degradation that is seeing record temperatures in the Arctic circle https://www.bbc.co.uk/news/science-environment-53415297
@ Joe B,
You might want to open your eyes. In the UK we use the pound. In the USA its the dollar. In Japan it’s the Yen etc etc. So to say that its all down to private banks is clearly ignoring reality. If the private banks created money in the way you’d like us to all think they do why wouldn’t they standardise on the euro or the US dollar?
Did you understand the point Frances Coppola was making in her criticism of Zoe Williams? Even if you don’t agree with it? Zoe Williams has read the same BoE paper you always recommend but still hasn’t understood what it means according to FC. What is your reply to FC’s criticism ?
Peter Martin,
both Zoe Williams and Francis Coppola agree that money (bank deposits) is created when banks lend and bank deposits constitute by far the greatest proprtion of money used in the economy.
Coppola says “the money created by central banks requires a government guarantee. The dollar is backed by the “full faith and credit of the U.S. government.” And central banks are mandated by governments to maintain the value of the money they create. That’s what their inflation target means.”
This is correct. Under the Bretton Woods system that faith was provided via a peg to the US dollar that in turn was underpinned by gold. In the era of fiat currencies that faith is provided by the governments committment to maintain the value of money. It does that by funding its spending with taxes and by borrowing in the financial markets so not to create excess money supply.
“So, faith in money is, in reality, faith in the government that guarantees it. That in turn requires faith in the future productive capacity of the economy. As the productive capacity of any economy ultimately comes from the work of people, we could therefore say that faith in money is faith in people, both those now on the earth and those who will inhabit it in future. The “magic money tree” is made of people, not banks.”
This is also correct. Money is debt and debt carries ‘real’ service costs. It obtains its value from the real economy in which it circulates and is used as a medium of exchange and store of value. Government uses taxation and borrowing of savings to reallocate real resources from households and firms for public purposes, Without the underpinning of real resources money has no value.
If a country is consuming more resources than it produces then it begins consuming its accumulated store of real assets and the real exchange value of its currency tends to fall over time. If a country is consuming less than it produces than the convere applies. It begins to accumualte overseas assets and overseas earnins and the real exchange value of its currency tends to appreciate. If interest rates are allowed to find their own level through price discovery, then imbalances should even out over the longer-term with a period of trade deficits in some years offset by a period of trade surpluses in other years. If the central bank is artificially lowering interest rates then balances can only correct with continued exchange rate depreciation.
@ Joe B,
You are being evasive as usual. You aren’t explaining why Frances Coppola criticised Zoe Williams for getting it all wrong in her explanation.
You’ve latched on to the point of “Banks Creating Money” in order to minimise the Govt’s role in the money creation process, and so mislead to suit your own political purpose. The quote you make of “the government has in practice no direct involvement in the money creation and allocation process” is clearly not true.
In the early days money was measured as an amount of gold or silver. Because of the inconvenience this involved, both the government and other banks, if they were allowed, could issue promissory notes guaranteeing that their note was a pound of silver or they too had created money.
As the system evolved the use of precious metals was discontinued so the Govt’s pound was just its IOU. Just as before, others would issue their IOUs which used the Govt’s IOU as a measure. So in Australia they use an Aussie Dollar, an IOU and the monopoly issue of the Aussie govt. The Australian govt initially creates the Aussie Dollar and NOT the Aussie commercial banks. They just follow suit.
Peter Martin,
there are numerousexplanations linked above of where MMT goes wrong
https://blog.usejournal.com/whats-wrong-with-mmt-a41e10c7203b
“MMTists often like to position themselves as the only ones to properly understand the ‘operational realities’ of modern monetary systems. Ironically, many of the claims made by MMTists on this topic are misleading at best. One common rhetorical tactic that I’ve noticed they employ is to use the term ‘government’ in a way that’s different typically from how it is used in mainstream economics. When they say ‘government’, they tend to include the central bank — hence the ‘government’ here includes consolidating the treasury and the central bank into one entity, effectively ignoring or assuming away any independence the central bank may have.
This allows them to make assertions such as that money is created by government spending, or for instance that government spending is “self-financing”. What’s even more confusing is that some supporters will often use the ‘treasury’ and ‘government’ interchangeably, despite the terms meaning very different things, and then essentially claim that even the treasury creates money when spending, which is definitely false, which I’ll get to later.
From these premise they are able to make further dubious semantic claims, such as that taxes and borrowing don’t actually “fund” government spending at all, and that the true purpose of taxation is to remove excess high powered money from the economy — in other words, taxes and borrowing are monetary policy operations. I argue, is that it’s doubly wrong: it’s wrong both in a nominal operational sense and it’s wrong in a ‘real’ resource sense.
…the central bank does still operate independently. When the government wishes to spend, it cannot simply demand funding from the central bank directly or even indirectly — it has to engage in borrowing and taxation without assuming any particular quantity of bonds will be purchased by the central bank. What MMTists will say here is that treasury and central bank will ‘coordinate’. From here, they make the most bizarre claim in my opinion, which enables them to maintain the ‘taxes/borrowing not funding spending’ claim — they argue that the purpose of taxes and borrowing during this sequence of events is merely to ‘drain reserves’ from the system.”
The BoE is owned by Govt so there is no reason to not consider it a part of government. It’s all quite logical.
But why the jump to another topic? I asked you about FC’s criticism of Zoe Williams which strikes me as criticism of the way you’ve got the wrong end of the stick too. Don’t you have any opinion on that?
These two guys from Cambridge Uni are also very aware of how misleading the phrase “banks create money” can be. The end by making the same point I’ve often made:
“If banks were indeed able to create money out of nothing, why would we need to bail them out?”
https://voxeu.org/article/banks-do-not-create-money-out-thin-air
There is one exception. The govt/central bank as the currency issuer. Everyone else has to be in the black. ie have net assets. The Govt’s role is to hold the liabilities and exist in the red.
Peter Martin,
the first sentence of the article you link to is “In contemporary societies, the great majority of money is created by commercial banks rather than the central bank.” This is precisely the point that has been consistently made in these comments.
As the New Economics article notes ” central bank reserves do not actually circulate in the economy, we can further narrow down the money supply that is actually circulating as consisting of cash and commercial bank money.”
“Physical cash accounts for less than 3 per cent of the total stock of money in the economy. Commercial bank money – credit and coexistent deposits – makes up the remaining 97 per cent of the money supply.”
These bank deposit are what is used in the real economy and what is underpinned by the productive capacity of the economy, Reserves held with the BofE allow banks to keep a liquidity buffer to settle inter-bank payments and do not circulate in the real economy https://www.bankofengland.co.uk/markets/bank-of-england-market-operations-guide.
The governments consolidated balance can be seen in the Whole of Government accounts. This includes the assets and liabilities of the BofE. On the Statement of Financial Position at 31March 2018, WGA shows total assets of £2,014 billion and liabilities of £4,579 billion i.e. a negative net worth of 2.565 trillion based on market values at the time.
The financial net worth of UK households was estimated at circa 10.4 Trillion in 2018 split relatively evenly between propery and financial assets (imcluding pension funds) https://www.ons.gov.uk/economy/nationalaccounts/uksectoraccounts/bulletins/nationalbalancesheet/2019#:~:text=The%20UK's%20net%20worth%20reached,per%20person%20in%20the%20UK.
Joe Bourke,
You have failed to provide any motion or policy paper passed by Federal Conference since the 2015 general election. ‘A Stronger Economy and a Fairer Society’ was the pre-2015 manifesto passed in the spring of 2015 while we were still in government with the Conservatives.
Quoting an organisation commenting on our 2017 manifesto is not providing evidence that the policy was agreed by members at a Federal Conference since May 2015.
It is accepted by almost everyone that during the Coronavirus crisis the government should not have a balanced budget or even have day-to-day spending equal to government revenue. What is needed is for this to be accepted for all time. The rules of economics don’t change because of a crisis. The rules if they are true work during all situations.
I think that when it is suggested that day-to-day spending must equal government revenue and government capital spending does not have to be funded from revenue a fudge is being made. Behind this idea is the knowledge that government spending does not have to equal government revenue, but because of the myth that government finance is like a households it is claimed that capital spending can be funded from borrowing, just like households have mortgages and businesses borrow to invest.
As you know in the circular flow of income there are Leakages – Saving (S), Taxes (T) and Imports (M) and Injections – Investment (Business Investment) (I), Government Spending (G) and Exports (X). When the economy is in a state of equilibrium Leakages will equal Injections. It makes no difference what the government spends its spending on.
Michael BG,
“The rules of economics don’t change because of a crisis.” Yes they do. A crisis requires a counter-cyclical policy to offset debt deflation.
“The rules if they are true work during all situations.” The opposite is the case. As Keynes argued: “the boom, not the slump, is the time for austerity.”
” It makes no difference what the government spends its spending on.” It makes all the difference in the world. Borrowing to invest so as to expand the nation’s income at a time of private sector weakness is a widely accepted principle. Without investment that enables an increase in productive capacity the decline in productivity simply continues and stagnation sets in.
The resolution foundation in its review of party manifesto’s last year https://www.resolutionfoundation.org/publications/rewriting-the-rules/ concluded:
“These new approaches are welcome, given the need for such spending on priorities from housing to tackling climate change.”
“Fiscal rules are technical frameworks …are important for government’s running of our public finances, and for having a sense of where we are heading as a country.”
“…the country is mainly heading for much higher investment spending – and higher borrowing as a result. This is necessary, but not sufficient – we also need a much more serious debate about ensuring it’s spent on the right priorities and in the right ways. That is the task whoever wins the coming election.”
@ Michael BG @ JoeB,
Michael is quite right. The rules of economics don’t change because of a crisis. If you’re driving your car and a child steps out into the road, you need to react hard and fast. Normally you’d have more time and wouldn’t have to do anything too dramatic. The rules are the same. It’s just a matter of degree.
So it doesn’t make any sense to rule out even a moderate deficit in more normal times but then to abruptly change to having a huge one when we have a crisis.
“the boom, not the slump, is the time for austerity.”
Did Joe remind Nick Clegg and David Laws of that when they were getting it all wrong and losing most of your electoral support? MMT takes pretty much the same line. It’s the danger of inflation during a boom which is the reason for being more cautious.
” It makes no difference what the government spends its spending on.”
It makes a difference inasmuch as if the Govt needs to match available resources with spending. This can take some time to adjust. So it couldn’t magic up enough doctors and nurses recently when they were needed simply by spending more. But it really didn’t matter if building workers were building temporary hospitals, which presumably aren’t counted as investment, or permanent ones which presumably could be.
In both cases there is a requirement to use exactly the same resources and so there is exactly the same inflationary/reflationary impact in both cases.
I’m still amused that Joe thinks future generations can somehow give us a hand with our capital spending. All we have to do is create bonds for them to pay off! But they won’t mind doing that because they can see the bridges and roads we’ve built with ‘their’ money. But they will mind if they think we’ve frittered it away on their and their parents’ education. This means somehow they’re effectively travelling back in time to pay our bills!
@ JoeB,
You can’t understand and describe the meaning of an article by just reading and quoting the first sentence. If you’d read a little further you’d realise that Rendahl and Freund weren’t simply writing another article on how “the banks create money”. They were writing about how many people, such as yourself, have a misunderstanding about what this actually means.
They explain just why banks can’t do that in quite the same way as a good counterfeiter might be able to.
You might want to go back and read it again. Especially the story of how two friends in a pub create their own money to pay for their drinks.
Peter Martin,
In the UK all money is designated in sterling measures and virtually all money is held in the form of bank deposits i.e. debt. Reserves are simply sterling deposits that banks hold to facilitate the clearing of paymemts. If you like riddles here is one:
“It’s a slow day in some little town……..
The sun is hot….the streets are deserted.
Times are tough, everybody is in debt, and everybody lives on credit.
On this particular day a rich tourist from back west is driving thru town.
He stops at the motel and lays a $100 bill on the desk saying he wants to inspect the rooms upstairs in order to pick one to spend the night.
As soon as the man walks upstairs, the owner grabs the bill and runs next door to pay his debt to the butcher.
The butcher takes the $100 and runs down the street to retire his debt to the pig farmer.
The pig farmer takes the $100 and heads off to pay his bill at the feed store.
The guy at the Farmer’s Co-op takes the $100 and runs to pay his debt to the local prostitute, who has also been facing hard times and has had to offer her services on credit.
She, in a flash rushes to the motel and pays off her room bill with the motel owner.
The motel proprietor now places the $100 back on the counter so the rich traveler will not suspect anything.
At that moment the traveler comes down the stairs, picks up the $100 bill, states that the rooms are not satisfactory, pockets the money & leaves.
NOW,… no one produced anything…and no one earned anything…however the whole town is out of debt and is looking to the future with much optimism.”
These transactions have made no change in any of the parties’ NET wealth. True, at the beginning each resident has a $100 liability. But each also has an offsetting financial asset of $100. At the end, they all have neither. So the $100 bill acts as a clearing mechanism. This is what bank reserves facilitate.
When it comes to the economy there isa lot of misleading rhetoric put about and dressed up in the guise of the rules of economics.
The simpleast way to cut through all the guff is to look around to see what works and what does not for developed economies.
For Liberal Democrat values that is best represnted in the Scandanavian model that is based on a strong welfare model and a record of financial stability i.e. counties such as Sweden, Norway Finland, Denmark,
The worst models are represented in the inequality and widespread deprivation that exists in great swathes of the USA or the economic stagnation that has beset Japan for three decades.
For several decades we have attempted to model the UK on the US economy and since the financial crisis we have been following the path tread by Japan since the early 1990s.
In looking at where things have gone wrong for Japan we can get some insight from this former executive managing director at the Institute of International Finance https://www.atlanticcouncil.org/blogs/new-atlanticist/do-deficits-matter-japan-shows-they-do/
“there is no free lunch in running large public deficits and building up debt. Japan has paid heavily for its high public sector debt through slower economic growth brought about by net household and corporate lending. The United States will need to get control over its debt, holding a public debate to build social and political support for a difficult reform and reprioritization of the US federal budget. This will need to be done to both deal with the consequences of massive public debt as well as meet the urgent need to repair and upgrade the human (healthcare, education and training, basic social safety net) and physical (transportation, clean and sustainable energy, broadband digital access) infrastructures of the country. The COVID-19 pandemic and widespread protests for social justice have dramatically showed the need for this new investment, but with the public sector debt burden already sky high, there will be no easy way out.”
As a party, we will need leaders that can articulate and deliver real solutions to difficult problems as we tackle this deep recession. Leaders that can carry the UK public with them in a fast changing world where the next crisis is just around the corner; whether that be economic crisis, environmental disaster or military confrontations.
@ Joe,
The story would work just as well with a counterfeit $100 bill. Theoretically if everyone was able to get together they could have crossed off their credits and debits against each other and that’s what they, in effect, were doing.
If you want a Scandinavian model then, as I’ve said previously, you can’t have a free floating currency. You’d need to have the pound fixed at somehwhere near 85% of its free market value. Norway exports its surplus capital via a SWF. Denmark fixes its currency against the euro. Sweden has a managed exchange rate. Finland uses the euro. The first three all act to keep their currency from becoming too expensive. With Finland it is questionable if they went into the euro at the right level. With the relative demise of Nokia -maybe not. They’ve had problems adapting.
The problems for the world economy is, of course, that not everyone can act to keep their currency at a lower level than market value to benefit their export industries.
Peter Martin,
Sweden targets inflation and not the exchange rate https://www.riksbank.se/en-gb/press-and-published/notices-and-press-releases/notices/2019/ingves-inflation-target-and-floating-exchange-rate-have-worked-well-in-sweden/#:~:text=The%20weakening%20of%20the%20krona,growth%20in%20the%20Swedish%20economy.&text=In%20Sweden%2C%20the%20Government%20decides,should%20be%20fixed%20or%20floating.
” a floating exchange rate means that its value is freely determined on the market. A choice has to be made, and with an inflation target, movements in the exchange rate are unavoidable. The Riksbank cannot stabilise both inflation and the exchange rate.”
Denmark targets its exchange rate and conducts monetary policy to maintain its peg with the Euro https://www.nationalbanken.dk/en/about_danmarks_nationalbank/frequently_asked_questions/Pages/Denmarks-fixed-exchange-rate-policy.aspx#:~:text=Denmark%20conducts%20a%20fixed%20exchange%20rate%20policy%20to%20ensure%20low,for%20low%20inflation%20in%20Denmark.
” the sole purpose of Denmark’s monetary policy is to keep the krone stable against the euro. Danmarks Nationalbank is independent in its conduct of monetary policy and neither the Folketing (Parliament) nor the government can determine the formulation of monetary policy. This gives a clear division of responsibility for economic policy. The government ensures that fiscal policy and all other economic policies support a stable economy. Stability-oriented fiscal policy is also essential in relation to maintaining the fixed exchange rate policy.”
The Nordic model is underpinned by universal benefits that act as automatic stabilisers in times of stress and Internationaly competitive businesses that generate significant foreign exhange earnings. In Sweden’s case these include firms that produce high value-added products in major world markets, such as Volvo, Scania, Electrolux, Aga, ABB, AztraZeneca and Ericsson.
The UK, like Sweden, targets inflation. However, inflation is not the problem at present. It is unemployment. Ed Davey has advocated a £150bn green coronavirus recovery plan over three years.
“Specific ideas include a green jobs guarantee, giving people training in new, environmental industries such as renewable energy, insulating homes and rewilding projects, paid at least the national living wage. Another pledge would be for at least 80% of energy to be from renewable sources by 2030.”
Joe Bourke,
Government capital expenditure does not increase productivity. Building houses, roads, railways and airports do not increase future production. They produce things and increase demand in the economy and are the best way of increasing demand because they can be targeted to a particular area or sector, unlike tax cuts which are spread across those in work and across the whole economy.
Its not really possible to separate out inflation and the exchange rate as “targets”. Sweden has been running negative interest rates until very recently which has been a clear signal that it doesn’t want any inflow of capital which could push the exchange rate higher. It’s not correct to say that Denmark only wants a stable exchange rate. Yes it does want that, but it wants a stable rate at much lower than its free market level.
Most countries in Europe have quite a different attitude to currency levels than we do. We want ours to be as high as possible. The Europeans are generally more more inclined to want to keep their exporters happy by having a lower valued currency. Germany, Holland and Denmark are probably the main offenders on the mercantalistic index. Sweden, even if they are paying much more attention to their currency level than they might be wanting to publicly admit, certainly aren’t the main offenders.
Peter Martin,
the published article from the Danish National Bank tells you how it keeos the Krone stable against the Euro.
“Denmark participates in ERM 2 at a central rate of 746.038 kroner per 100 euro. Because of the high degree of convergence, Denmark has concluded an agreement with the ECB on a narrow ERM 2 fluctuation band of +/- 2.25 per cent. This means that the krone can only fluctuate between 762.824 kroner per 100 euro and 729.252 kroner per 100 euro. Since the late 1990s, Danmarks Nationalbank has, in practice, stabilised the krone at a level much closer to the central rate. The krone’s central rate against the D-mark and then against the euro has been unchanged since January 1987.”
Similarly, the Swedish National Bank makes their poisition clear “a floating exchange rate means that its value is freely determined on the market. A choice has to be made, and with an inflation target, movements in the exchange rate are unavoidable. The Riksbank cannot, and should not, stabilise both inflation and the exchange rate.”
II is Riksbank’s view that “the system we have had since the mid-1990s has been very positive for the Swedish economy and there is good reason to assume that it will continue to be so.”
Michael BG,
major infrastructure investment typically has long lead times and as such cannot easily be deployed for short-term stimulus spending. This is why acceleration of maintenance projects like pothole funds are often favoured for cyclical demand management. The maintenance of good quality infrastructure base is, however, an essential component for expansion of supply capacity in the economy https://www.pwc.com/gx/en/issues/economy/global-economy-watch/prioritise-public-infrastructure-investments.html#:~:text=In%20the%20long%2Dterm%2C%20infrastructure,more%20efficient%20and%20increasing%20productivity.
“The long-term benefits of infrastructure investment are supported by the literature. For example, there are estimates that one extra dollar spent on infrastructure in Canada could increase GDP by between $2.46 and $3.83 in the long-term, discounted to present value terms. But this money does need to be spent effectively to realise these gains.”
@ Joe Bourke,
I’m sure I could find some estimates to suggest that spending $1 on education and training increases GDP by much more than $3.83. But would that change your opinion that such spending shouldn’t be considered as an investment?
There aren’t many countries around the world which have the ‘open to all’ economic model we’ve chosen. ie Low tarriff barriers. Freely floating currencies. Free movement of Capital etc. They are essentially the “Anglo” countries.
The figures below are the latest available. Mainly from 2017.
Country, Current Account (trade) deficit, Govt Budget Deficit
Australia -3.1% ,-1.7%
Canada -2.9%, -2.0%
United Kingdom -4.4%,-1.1%
United States -2.5%, -4.6%
New Zealand -3.7%, 0.7%
So any country running this model should expect to have a deficit in trade and a Govt budget deficit to support it. If money leaves the economy to support a trade deficit then the Govt needs to put in even more money in to keep the “money supply” topped up and keep the economy ticking over. At the time only the USA was doing that. This is an indication that all the other countries were too heavily dependent on private sector borrowing. This will mean there is a lurking debt deflation problem which will likely soon become apparent as we emerge from the Coronavirus lockdown.
This is a what we expect to see from the more mercantilistic European economies. A large trade surplus and close to a balanced budget. The difference in the figures represents the net savings of the private domestic sector.
Denmark 7.25% , −0.6%
Germany 8.2%, 0.7%
Sweden 4.5% , 0.9%
The currency doesn’t float in Denmark or Germany. They have cheaper currencies than they should have. So these figures are what we might expect.
But what is going on in Sweden? Have the Swedes really got an Anglo style model? If the currency is supposedly free floating why doesn’t the krona rise to at least equalise exports and imports as the textbooks suggest it should? Is it really as free floating as the Swedes would have us believe?
Peter Martin,
In the economic literature there are two distinct theories concerned with the linkage between budget deficits and the current account deficit. The first theory is based on the traditional Keynesian approach, which postulates that the current account deficit has a positive relationship with the budget deficit. This means that an increase in budget deficit will lead to a current account deficit and a budget surplus will have a positive impact on the current account deficit. The increase in the budget deficit will lead to domestic absorption and, thus, increase domestic income, which will lead to an increase in imports and widen the current account deficit.
This twin deficits hypothesis is based on the Mundell-Fleming model which asserts that an increase in budget deficit will cause an upward shift in interest rate and exchange rate. The increase in interest rates makes it attractive for foreign investors to invest in the domestic market. This increases the domestic demand and leads to an appreciation of the currency, which in turn causes imports to be cheaper and exports costlier. However, the appreciation of domestic currency will increase imports and lead to a current account deficit).
Conversely, the Ricardian Equivalence Hypothesis (REH) disagrees with the Keynesian approach. It states that, in a setting of an open economy, there is no correlation between the budget and current account deficits and hence the former would not cause the latter. The assumption here is that current consumption depends on expected lifetime income, rather than on the current income as proposed by the Keynesian model. The permanent income hypothesis developed by Milton Friedman in 1957, states that private consumption will increase only with a permanent increase in income. This means that a temporary rise in income fueled by tax cuts or deficit-financed public spending will increase private savings rather than spending (as has happended in Japan). As private savings rise, the need for a foreign capital inflow declines. In this situation a current account deficit will not occur.
In practice, it seems to depend on the country#s individual situation and level of confidence among consumers and the business community. Hene, Keynes overriding emphasis on stimulating business investment and reviving ‘animal spirits’ during recessions.
@ Joe B,
” This means that a temporary rise an increase in budget deficit will cause an upward shift in interest rate and exchange rate. in income fueled by tax cuts or deficit-financed public spending will increase…”
“…. an increase in budget deficit will cause an upward shift in interest rate and exchange rate. ”
You’re always telling me that if you see two things happen you can’t infer that one caused the other. But here you are…
In any case an increase in the budget deficit will mean that there is more money swilling around unspent. So we’ll see a decrease in interest rates as the owners look for a home yielding some return. Isn’t this what happenened after the GFC? High deficits and falling interest rates.
The external deficit has to equal the sum of the deficits of both the government and the private sector. So there is a relationship involving three factors.
Peter Martin,
an upward shift in interest rate and exchange rate resulting from an increase in budget deficit is an assertion of the Keynesian based Mundell-Fleming model http://www.bankpedia.org/index.php/en/114-english/m/23303-mundell-fleming-model-encyclopedia#:~:text=The%20Mundell%2DFleming%20Model%20(MFM,the%20Keynesian%20IS%2DLM%20model.
It is a hypothesis than can be observed in certain circumstances, but doesn’t always hold (e.g. as in Japan) Hence, the alternative hypothesis – the Ricardian Equivalence Hypothesis (REH) – disagrees with the Keynesian approach.
Generally, however, the higher the level of deficit driven growth the higher the level of interest rates. If interest rates are held down by central bank monetary policy, then typically the exchange rate will adjust instead and begin to spur imported inflation. If inflation cannot be cooled with monetary policy (because interest rates have to be kept down) then taxes have to increase. If interest rates are allowed to increase with growth then a greater proportion of public spending is absorbed by higher debt service costs on an elevated stock of debt.
Either way you end up back where you started as the article argues https://nymag.com/intelligencer/2019/01/modern-monetary-theory-doesnt-make-single-payer-any-easier.html “Whether you take a Keynesian view or an MMT view, if the government spends more, it’s likely going to need to tax more, sooner or later.”
@ Joe B,
You might want to open your mind to the possibility -even likelihood – that Mundell, Flemming and Ricardo are all wrong.
The Ricardian “The assumption here is that current consumption depends on expected lifetime income ” sounds like total nonsense. That’s probably because it is!
This reminds me of something that Steve Keen quoted as an example of the absurdity of some conventional models. I can’t find the reference at the moment but his quote suggested that there were infinite horizons involved. In other words if people could see the government spending too much they would cut back their spending to be able to afford the higher taxes that would come later and not just for themselves but their descendants too.
It’s all BS but apparently some economists use it in their models!
@ Joe B,
“Whether you take a Keynesian view or an MMT view, if the government spends more, it’s likely going to need to tax more, sooner or later.”
And you think this a bad thing, right?
Why might we be suggesting higher spending/lower taxation? In more normal times, because we have unsold goods and services. Unemployment is too high and output is lower than capacity. We don’t have enough after-tax spending power to buy what’s potentially available. So we need to increase government spending and perhaps reduce taxes to increase total spending power and help clear the shelves of unsold goods and make use of potentially available but unused services.
And why would we want to increase taxes? Not for the government to get money to spend. We know it doesn’t work that way. We increase taxes, or cut govt spending, only when our spending power is too high, unemployment is very low, and the shelves are starting to become empty due to our excess spending power. We might have an inflation problem.
So the statement ‘if the government spends more, it’s likely going to need to tax more, sooner or later.’ in fact is saying, ‘Higher deficits/spending today, when unemployment/underemployment is high, will cause it to go down. We might then need to raise taxes to cool down an overheating economy.’
And the problem with that is…..?
Peter Martin,
the answer is in the article:
“there is a reason to believe an MMT approach would not lead to better management of the economy in the long run: The fact that it calls for raising taxes to control inflation when the economy is strong. It is hard enough to sell voters on the idea of raising taxes in order to provide them valuable services. Now we are supposed to tell voters that taxes aren’t for financing the government, but we need to raise them anyway so we don’t overshoot an inflation target?
“The strong argument against MMT is precisely the one you made, that tax increases will be potentially difficult to carry out. The contractionary piece of that might not be followed in practice because it would be very unpopular.”
“…contrary to the views of some MMT scholars and most MMT enthusiasts in the political sphere — he believes that consistently implemented MMT would call for smaller budget deficits in the long run than a traditional Keynesian approach.
“… Warren Mosler, one of the founders of the movement, says interest rates should be set permanently at zero. Without the interest-rate lever, once MMT policymakers achieved their goal of an economy at full employment, the tool they’d have to use to control inflation is a very unappealing fiscal one: tax-financed budget surpluses.”
“None of those countries that have single-payer health care needed MMT to make it work. They did it the conventional way, by taxing the public. Maybe that’s a sign that that’s the best way to implement such programs. Or maybe it just reflects the fact that you’d still need to tax the citizenry to implement single-payer health care, even with an MMT worldview.”
If you want to have the kind of strong welfare programs that are prevalent in the Nordic counries and Northern Europe then you need to emulate their fiscal and economic policies including their levels of taxation.
Fiscal policy does not have to be that difficult. You start with the basic proposition
“Look After unemployment and the budget will Look After Itself”.
You look after employment by maintaining an aggregate level of loan financed investment in excess of current spending (inclusive of depreciation) of circa 3% of GDP and having in place a nationwide job guarantee scheme. Current spending is tax-financed. Normal fluctuations in the business cycle are smoothed via automatic stabilisers including the job guarantee program. The sectoral balances are simply the outcome. If the deficit on current spending is more than +/-1%, or the overall deficit is more than 4%, then fiscal adjustments are made to future budgets to increase or decrease tax levels as necessary. In this way, budgets can be based on the need to ensure that public services are delivered as required over a parliamentary term and the social security safety net maintained at adequate levels. Spending decisions are made first based on need and the levels of taxation required to finance those spending decisions follow. The benefit of stable public finances is that when an economic shock such as the financial crisis or this pandemic throws the economy into a deep recession, you will have the credibility in financial markets and fiscal space to do whatever is necessary (including monetisation of debt when required) to restore economic stability. That is an advantage unavailable to most developing countries or even constrained modern economies like Argentina, Lebanon or Turkey cannot.
@ Joe B,
“the boom, not the slump, is the time for austerity.”
Do you remember quoting Keynes at me? So we really aren’t saying anything different – except we probably wouldn’t use the word austerity. We’d say it was sensible regulation of aggregate demand. But whatever terms were used we’d both have the problem that many voters would want to know why the government wasn’t prepared to use all the tax money that was coming in if we needed to cool things down a little.
In the 60s, it was quite normal for the govt to compare the economy with a car. So we’d need to press on the accelerator or apply the brakes to slow things down. If everyone understood then they’d understand now.
“there is a reason to believe an MMT approach…”
MMT is just that. A theory of how a modern monetary system works. There’s no gold. No precious metals any longer. Either it’s right or it isn’t. So, if it’s right, we can’t not have an MMT approach. If we do apply austerity, contrary to Keynes’s advice, at the depth of a slump MMT will correctly predict the outcome.
“….. would call for smaller budget deficits in the long run…..”
Possibly we will see smaller deficits but this remains to be seen. It doesn’t really matter what they are providing the economy is running well. It’s more likely we’ll see them rise if everyone becomes better off and wants to save for their retirement.
/cont
“Warren Mosler, one of the founders of the movement, says interest rates should be set permanently at zero.”
When he first said it, this would have raised more than a chuckle in “respectable” economic circles. So why have they since followed his advice and kept them close to zero for so long? Once they’ve been this low for long enough we may as well just get used to the idea that they’ll stay there permanently.
The North European model may work for Northern Europe. Nearly all the Northern European countries (except us in the UK of course!) run substantial export surpluses which creates the conditions that taxes need to be high to remove the money that comes in to the country. This is to prevent inflation as per standard MMT theory. It’s not to “pay for” social programs. The personal culture in Germany is very much to save rather than to borrow. It is this saving which creates the fiscal space for Governments to spend more without taxes having to be even higher than they are.
If the Germans suddenly became more like us it would be interesting to see what would happen. They’d have to run a budget surplus of around 10% or so just to keep things as they are. Either that or, more likely, they would have to slash their social spending.
Joe Bourke,
The PWC article states, “In the short-term, building or upgrading transport or energy networks, for example, can boost aggregate demand through increased construction activity and employment”.
The effect on supply is much more difficult to determine. The example they give is better transport facilities increasing labour mobility which they say could make the labour more efficient. I assume by employing people who already have the skills. It could instead just mean it is easier to employ people because it takes less time to travel to work. A business therefore produces more by employing more people. Improvements to transport would improve distribution and this can benefit businesses but it does not directly improve production or productivity, the business still has to take action to do this. The PWC article states that a project has to meet certain criteria to have an economic benefit – there has to be a need for it and it must give an economic benefit!
When there is an economic stimulus that increases aggregate demand both domestic demand increases and so do imports. Therefore there is no need for an increase in the interest rates or the value of the currency for there to be more imports and an increase in the balance of trade deficit. You have also pointed out that the central bank may not increase interest rates. Therefore the Mundell-Fleming model does not reflect what happens in the real world.
Under these conditions, government deficit, economic stimulus, more domestic production and consumption and more imports you assert that the currency will decline in value. This would only happen if the economic theory that the value of a currency falls when there is a balance of trade deficit was true. We know that what can happen instead is that the demand for the currency can be maintained because foreigners invest in the country.
Joe Bourke,
You start from the correct place and then go awry. Government economic policy should be to look after unemployment. They aim for a level of unemployment and they stimulate economic growth (I believe within the 3% annual maximum) to achieve it.
What is the aggregate investment level and why does it have to be 3% of GDP?
I have already pointed out there is no requirement for current spending to have to be financed from government revenue.
The so called “automatic stabilisers” are not large enough to actually bring the economy back to full employment in a short period of time. I thought we had rejected the idea that the economy somehow magically reaches full employment.
There is no reason why it is bad for the current spending deficit to be over an arbitrary 1%, or for a total deficit of 4% to be a bad thing. (Please point out why having deficits above 4% between 1992 and 1996 were bad things. I don’t even remember anyone being bothered at the time. It seems to me they were clearly needed after 2007. To advocate not having them would have meant more unemployment and a longer recession.) We don’t have working-age benefits provided at adequate levels and you will have to go back a long time to find a time when we did.
It is a fallacy that the UK government needs the credibility of the financial markets and it can build it by following the wrong economic policies to try to please them. We are not Greece.
@ JoeB,
“Look After unemployment and the budget will Look After Itself”.
OK we can all agree with this in principle. You keep saying, though, that we need to apply a rule that the kind of spending which you arbitrarily define as current should be matched by taxation and growth can be supplied by the kind of spending which is arbitrarily defined as investment. Road and railways, are examples usually cited.
This seems rather dated thinking. The current lockdown has, for example, demonstrated that many of us could work much more efficiently if we didn’t have to travel so much. The digital infrastructure is already in place to do that and the improvements we’ll need aren’t likely to be anywhere near as expensive as building HS2.
So we should be looking to work smarter rather than harder. Shipping millions of workers in and out of the major cities is hard work that is often quite unnecessary and has major environmental impacts. If we didn’t do it our need for ever increasing energy use would diminish too. So a move to green thinking would be beneficial all round. We should be aiming to provide employment near where people live and, at least part of the time, actually in the home itself.
Michael BG,
this is the 2010 manifesto (prepared by economists like Vince Cable) that brought the LibDems back into government after a 65 year hiatus and that was prepared two and a half years after the 2007/08 financial crisis
https://www.markpack.org.uk/files/2015/01/Liberal-Democrat-manifesto-2010.pdf/ From page 14:
“…dealing with the defi cit. The health of the economy depends on the health of the country’s fi nances. Public borrowing has reached unsustainable levels, and needs to be brought under control to protect the country’s economic future.
A Liberal Democrat government will be straight with people about the tough choices ahead. Not only must waste be eliminated, but we must also be bold about finding big areas of spending that can be cut completely. That way we can control borrowing, protect the services people rely on most and still find some money to invest in building a fair future for everyone. We have already identified over £15 billion of savings in government spending per year, vastly in excess of the £5 billion per year that we have set aside for additional spending commitments. All our spending commitments will be
funded from this pool of identified savings, with all remaining savings used to reduce the deficit.
We must ensure the timing is right. If spending is cut too soon, it would undermine the much-needed recovery and cost jobs. We will base the timing of cuts on an objective assessment of economic conditions, not political dogma. Our working assumption is that the economy will be in a stable enough condition to bear cuts from the beginning of 2011–12. ”
There are difficult times ahead that will require competent management of the public finances by the treasury and central bank. You cannot expect ordinary people to vote for a party that does not have the basic competence to understand the importance of financial markets to the health of the real economy. And as last year’s election results for Labour has shown, they will not. Now is the time to use financial markets to halt the downturn. When the economy is stabilized the recovery will take careful management over a long period of time.
Keynesian economics is about stimulating and sustaining private sector business investment and reviving so-called ‘animal spirits; Until you understand that you will never understand how living standards are improved for society as a whole.
Peter Martin,
a transparent fiscal framework plays an important role in maintaining the financial stability that is essential to a functioning economy. When interest rates are kept close to zero prices are distorted, particularly house prices and equity markets.
Overheating in the economy comes from two principal sources. Firstly, excessive credit creation, particularly in financing investment in the existing stock of property. And secondly, excessive spending by governments in an effort to stimulate consumption in supply-constrained economies reliant on imports. The latter can be controlled by the adoption of fiscal rules and the former can be controlled with monetary policy. If interest rates are held at zero, then monetary policy is no longer effective and you only have tax increases or reversal of QE to dampen the inflationary effects of excessive credit creation in housing and equity markets. That has been a major cause of rising inequality over the past decade.
Central banks were made operationally independent as part of the institutional framework to give financial markets confidence that governments would not resort to inflationary expansions for short-term electoral gain.
When that independence is overridden, as it has been in Erdogan’s Turkey, that confidence is lost and the currency begins to rapidly deteriorate. In extremis, the economy can collapse as it has in erstwhile relatively healthy economies like Lebanon or Venezuela.
Investment in infrastructure does of course incorporate digital infrastructure including the rollout of highspeed broadband across the country and 5g mobile networks. But as Ed Davey has outlined the big investments are in the transition to a green economy particularly in power generation. This is where the imperative lies in the coming decades.
Joe Bourke,
Please provide the list of the names of the people on the 2010 manifesto working group who drafted the manifesto? I don’t think it will include the name of Vince Cable. You are correct Vince did agree with the mistaken consensus that there would need to be cuts sometime after 2010. Experts can be wrong. We all, if we can, should look at the theories and make our own decisions, not slavishly follow one person’s theory or solution.
You also quoted the part of the manifesto which states cuts should not be made too soon. No matter what timescale was given the premise behind this is that “cuts” should only be made when the economy is strong enough to cope with them.
On page 21 we stated, “To boost the economy and create jobs for those who need them, we will begin our term of office with a one-year economic stimulus and job creation package.” Unfortunately, we ditched this correct economic policy to support the wrong one of the Conservative Party, cutting before the economy was strong enough. This is why it was reported we had a double dip-recession for the last quarter of 2011 and the first of 2012.
I do understand that for economic growth we need businesses to produce more and this mostly means they should invest more. Keynesian economics is about managing aggregate demand. To increase it when it is too low so businesses will invest to produce more to meet this increased demand and to decrease it when it is too high to remove inflationary pressure from the economy.
Joe Bourke,
Economic theory states that when interest rates are low, businesses will invest. That is one reason why financial stability is important to the economy. Another is that businesses don’t like rapid changes because stability allows them to make long-term decisions with a high level of confidence. We didn’t need these mythical financial rules in the past and we don’t need them now. Especially as history shows that the rules are broken once the government has a change of mind and so are worthless.
If a government has created inflationary pressure then it can remove that pressure from the economy by increasing taxes or cutting the economic stimulus or a combination of both.
If I were to advocate a fiscal rule it would be – the government will ensure that any increase in government spending will not increase the forecast of economic growth to above 3% when the multiplier is taken into account. (The reason for 3% is that it is close to the historical average. And a growth rate of over 3% has been difficult to maintain for any length of time since 1949. Therefore the government should not try to maintain a growth rate above 3%.)
@Michael BG
When launching the 2010 manifesto Nick said:
“We have scrutinised public spending line by line, and found the savings we need to pay for all of our priorities as Vince explained.”
The idea that somehow the 2010 manifesto happened without Vince agreeing to it is nonsensical.
Michael BG,
a fiscal rule framework was introduced by Gordon Brown when he made the Bank of England independent and has been part of treasury economic planning ever since. The Resolution Foundation https://www.resolutionfoundation.org/publications/totally-net-worth-it/ set out a framework that was largely adopted by both Labour and Libdems at the last election:
– A Net Worth Objective: to deliver an improvement in public sector net worth as a share of GDP over five years. This would incentivize prudent investment decisions to address the long-term challenges facing the UK.
– A Structural Current Balance Target: to achieve a cyclically-adjusted public sector current balance of 1 percent of GDP (and no less than -1 per cent) over five years. This requires the government to keep receipts and day-to-day spending in broad balance but would also allow it the to borrow to invest; and
– A Debt Interest Ceiling: to ensure the proportion of revenue spent on debt interest does not exceed 10 percent. This would ensure that the overall debt burden remains sustainable at all times by taking account of not only the level of debt but also what it costs to service.
– An ‘escape clause’: to recognise the need for more active fiscal policy given the constraints on monetary policy, the net worth and structural current balance targets would be suspended if the economic outlook deteriorates significantly. These rules would be reinstated as the economy recovers ensuring a credible fiscal framework even if downside risks crystallise.
The annual average budget deficit has been 3.4% of national income since 1970 https://commonslibrary.parliament.uk/research-briefings/sn06167/#:~:text=What%20are%20the%20trends%20over,of%20national%20income%20since%201970.
“The IMF – who use a slightly different measure of governments’ net borrowing – report UK government borrowing of 2.1% of GDP in 2019, higher than the European Union average of 0.6% but below the average for advanced economies of 3.0% of GDP. UK borrowing in 2019 was also below the average amongst the G7 group of advanced economies of 3.8% of GDP.”
So a target deficit of 3% to 4% of GDP is certainly consistent with historical experience and other advanced counties while providing for more active fiscal policy when economic outlook deteriorates significantly, as it has with this pandemic and allowing for the vagaries of economic forecasting.
Michael,
there is a strong correlation between real economic growth that increases the demand for money and higher interest rates, basically tracking each other. The reason investors will accept low interest now is that following a short bounce back from the recent steep declines, both growth and inlation are expected to remain low for the foreseeable future.
The OBR and BofE put the UK medium-term growth rate at around 1.5%. If the UK were to achieve consistent real growth of 3% with inflation of 2% i.e. nominal growth of 5% over an extended period of years, that would imply much greater returns on equity investments and bank base rates of at least 3%, if not higher. What do you think an increase in interest rates to that level would do to mortgage holders, indebted businesses, and the burden of interest costs on much higher levels of public borrowing post-pandemic?
“there is a strong correlation between real economic growth that increases the demand for money and higher interest rates”
The assumption behind this assertion is that interest rates are determined by the market. When demand is high they rise. When demand is low they fall. The economic mainstream likes to ignore reality and pretend that what they remember reading, many years ago, in their undergraduate economic textbooks actually happens in the big bad world. They’ve even read that Government borrowing can force up interest rates too. The fact that it doesn’t actually happen that way doesn’t seem to bother them too much.
Anyone who has studied what really goes on in the economy can see that the main influencer of interest rates has been the Government/BoE. There’s no secret about this. Short term rates are decided by a vote of committee. Longer term rates are determined by a combination of open market operations and QE. And it’s not just peculiar to the UK. This is the way it happens just about everywhere.
Maybe in 50 years time we’ll actually see this written down in new textbooks. But its a slow process.
“a fiscal rule framework was introduced by Gordon Brown when he made the Bank of England independent and has been part of treasury economic planning ever since. ”
Yes, this is the problem. Rules don’t age very well. What might have seemed a set plausible rules in the 90s wasn’t a set of realistic rules in the 00s. It wasn’t just in the UK. The fashion at the time, worldwide, was to have lots of rules for public sector finance but hardly any rules at all for the private sector. So, surprise surprise, when the GFC hit in 2008 there was much scratching of heads because, in the main, everyone had been sticking to the public sector rules. So that wasn’t supposed to happen!
The USA was largely responsible for the GFC but because they were much less wedded to the notion that “The Rules Must Be Obeyed” they made a relatively much better recovery post 2008 than here in Europe. We weren’t quite as good as them but not quite as bad as mainland Europe though. They really did have a problem. They discovered that the rules which were hard wired into the EU treaties were unworkable. So all the things that central banks weren’t supposed to do, had to be done to save the euro. To get around the problem, there needed to be some creative interpretations of European laws, and rules, to say the least!
So the conclusion of all this is that Governments shouldn’t create a rod for their own backs by creating rules when they don’t need to. Just a one or two simple rules will do, If it works. Do it. If it doesn’t work then don’t do it!
Peter Martin,
interest rates are determined by the market for borrowing. In setting bank base rate the BofE is responding to market driven trends and sentiment https://www.libdemvoice.org/who-gains-from-rishi-sunaks-summer-economic-statement-65304.html#comment-536638 You don’t need to read a textbook, the BofE has simple explanations of the purpose of its operations on its site. When borowing and spending slows the bank will react to the slowdown by reducing interest rates.
“During the financial crisis of 2008, people reduced their spending and many lost their jobs. We had to cut interest rates to really low levels to support spending and jobs. Over the past few years, our economy has needed interest rates to stay very low as we recovered from the global financial crisis.”
This is the BofE reacting to the market and lowering interest rates as a consequence. When spending recovers and demand for borrowing picks up the bank will similarly react to these changes in the market by increasing its base rate in an effort to influence other interest rates in the market.
Those who have actually studied what really goes on in the economy find that nominal GDP growth drives increases in imterest rates https://www.sciencedirect.com/science/article/pii/S0921800916307510
The authors test the interest-rate-economic-growth hypothesis. They analyse the relationship between three-month and 10-year benchmark rates and nominal GDP growth from 1957-2008 in four of the five largest economies in the world: the US, UK, Japan and Germany.
The results of their study debunk one of the oldest and most popular hypotheses of monetary economics. They find that nominal interest rates are consistently positively correlated with growth. The correlation between GDP growth and the three-month interest rate was as high as 0.8 for Japan over the 50-year period. Also, the study finds that it is GDP growth which affects short-term and long-term interest rates in all four countries. That is, interest rates follow GDP growth, not the other way round. This is the first study to systematically examine the relationship between nominal interest rates and nominal GDP growth in several major economies.
@ Joe B,
“interest rates are determined by the market for borrowing.” ???
Two questions:
1) When then does the Monetary Committee of the BoE meet up regularly to determine what the Bank Rate should be? It is now 0.1% as per their last decision
2) Why have QE? If the Treasury wants money why don’t they just get whatever they can from the sales of their bonds as they normally do? Methinks it’s because they know this will force down longer term interest rates and so they’ll get a better price.
Correction: Should be 1) Why then ……
@ Joe B,
PS The ECB do exactly the same thing. Left to the workings of the market, Italian and Greek bonds, would yield very high rates of interest because of the risk of default. So the ECB intervenes at a certain level to purchase them, lowering their effective interest rate, and so tries to stabilise the euro.
By no stretch of the imagination is this “responding to market driven trends and sentiment”. In fact, just the opposite. It is trying to counteract them.
Peter Martin,
there is a wide range of market interest rates. Those available for secured mortgage loans and to larger companies; rates applicable to car loans and other asset-backed lending; small business loans and personal loans at close to double-digit rates; and much higher rates such as credit cards (17%), store cards (29%) and payday loans at several hundred percent APR’s.
The MPC sets bank rate based on whether market demand for borrowing is considered consistent with the banks inflation mandate and its secondary objectives of supporting spending in the economy and stability in financial markets.
If the bank’s interventions and or fiscal stimulus are successful (and that is a big if) then demand for borrowing increases and interest rate rises follow. If the bank seeks to hold interest rates at zero when the economy is in a sustained growth phase it is quite likely that increased demand for borrowing will generate inflationary pressure.
Both tax increases and expenditure cuts can be and often are politically difficult. Increasing taxes when household finances are already under-pressure from inflationary price rises in housing costs and elsewhere is likely to impede growth and impact poorer households disproportionally unless carefully targeted to avoid deadweight effects e.g. with taxes on higher-value properties. Cutting economic stimulus means spending cuts (austerity). This is particularly difficult if the initial stimulus was substantial increases in welfare benefits and is not feasible in many areas of public spending already under stress including health, pensions and Universal credit, education, local government, etc.
In the current circumstances, public borrowing and monetary policy are aimed principally at preserving the supply capacity of the economy and supporting displaced workers to allow for a recovery as and when the impact of the virus subsides. Further fiscal stimulus measures to support aggregate demand, will most likely come in the Autumn budget.
Economics is not called the dismal science without good reason. There are no free lunches. There are winners and losers with every policy choice. But then to govern is to choose. That requires making political judgments in maintaining a sustainable mixed market economy that combines universal basic services with aspiration, equality of opportunity and environmental constraints.
@ Joe B,
The point is that the Govt/ BoE is a currency issuer so if it intervenes in the markets in the way it does then you can’t say that interest rates are determined by the market. Now, of course we all know that we can’t expect to pay Bank Rate when we borrow to buy a car. There’s an addition which is essentially an insurance against default. Or even worse than that if loan sharks are involved. But that doesn’t change anything. The Govt/BoE is a market leader and not a follower. Or a rule maker and not a rule taker.
Why is the BoE so keen to follow MMT advice and have interest rates almost at zero if they are such a bad thing?
Asking the BoE to use its interest rate capability to regulate the economy is stupid idea! Interest rates are always going to be lowered to try to cure the debt deflation problem that was previously created by having interest rates too low when that private debt was being created. Anyone with any understanding at all could have foreseen we’d end up where we are now.
Look, I wouldn’t mind if interest rates were fixed at something other than 0%. Maybe 2% or 3% would be just fine. But the Govt/BoE should decide what they want them to be and keep them there. They should only change them in exceptional circumstances. Instead, they should use fiscal measures to regulate the economy. That’s what they’ll be forced to do anyway but probably at close to 0% interest rates.
Hywel,
Our spokesperson in a particular area are included in the policy working group which produces the policy paper. They are not all included in the manifesto producing working group. So they have influence but don’t actually write the manifesto, which is signed off by the Federal Policy Committee. As Vince was not in the coalition negotiating group it is very likely he was not in the manifesto writing working group. As we believe in open government it is surprising we don’t know whether Vince was a member or not!
Joseph Bourke,
Even before 2008 I thought there was criticism of Gordon Brown because he was fudging his fiscal rules so he could say he hadn’t broken them!
UK growth was 2.9% in 2014 and this should be achievable again. Between 1993 and 2007 the average was 2.98%. When economic growth declines interest rates should decline and when economic growth rises interest rate should increase, but this doesn’t always happen. In 1995 economic growth fell to 2.5%, but the bank rate went from 6.13 to 6.63 in February and not dropping to 6.38 until December 1995. In 2004 economic growth fell to 2.3% while the bank rate was increased to 4% in February, 4.25% in May, 4.5% in June and 4.75% in August.
You seem to be saying a growth rate of 3% would be a bad thing. It would be a good thing if the economy can cope with it, without inflation increasing dramatically. If interest rates increase because more businesses want to borrow more to increase production and it is profitable this is a good thing. With economic growth government revenue will increase.
I recall the Coalition increasing VAT by 2.5% I don’t recall they found this hard to do. It just was the wrong policy. Increasing interest rates like increasing income tax reduces aggregate demand. It might be argued that interest rate increases will affect more people who had difficulty with coping with the increase than a targeted income tax increase. The income tax increase might be lower because it affects more people than an interest rate rise which might have to be higher affecting fewer people to remove from the economy the same amount of demand.
Michael – Vince literally stood up and told people how all the savings had been identified at the Manifesto launch.
The idea that the Manifesto happened without the Shadown Chancellors agreement is utter nonsense. And if you consider the standing Vince had in the party at the time (he was substantially more popular than Nick pre-debates and the ‘battlebus’ had a joint ‘Nick & Vince’ pic on the side) it’s even more nonsensical.
You may have some good points to make but this one is just a rubbish one.
@ Michael BG,
“When economic growth declines interest rates should decline and when economic growth rises interest rate should increase…..”
This is the mainstream view. Sometimes known as New Keynsianism. Should really be Not Keynesianism. The idea is that monetary policy can be substituted for fiscal policy in regulating the economy.
“….but this doesn’t always happen.”
You’re right. It hasn’t always happened. If it has, the downward movements have been bigger than the upward ones. That’s why we now have ultra low interest rates. There’s a fundamental flaw in monetarist theory. It’s not the level of interest rates per se which determines economic activity it’s the rate of change. Encouraging everyone to borrow more doesn’t make them any better off in the same way as would a fiscal stimulus. It is instead bringing forward future spending ability which appears to create the same effect albeit temporarily.
But you can’t keep doing that forever, especially if there is a requirement to repay which there always is in the private sector. You run out of positive interest rates to reduce! Mathematically, you could continue to create the same effect by going further and further into the negative but does anyone really think this is a good solution?
Hywel,
Perhaps you have misunderstood what I originally wrote. I wrote, “Please provide the list of the names of the people on the 2010 manifesto working group who drafted the manifesto? I don’t think it will include the name of Vince Cable.”
It seems that I was mistaken and that Vince was on the Manifesto Working Group. Here is the list (I request Joe to provide) as published when the pre-manifesto was published:
Danny Alexander MP (Chair)
Dr Vincent Cable MP
Nick Clegg MP
Edward Davey MP
Dr Richard Grayson
Jeremy Hargreaves
Susan Kramer MP
David Laws MP
Steve Webb MP
I am really surprised at how many MPs there are on it and how few non-MPs. I expected there to be more non-MPs than MPs on this group. Looking at the 2001 manifesto it seems that an MP was responsible for most sections which would mean more than 14 people were involved in drafting it!
However, while Vince is likely to have supported our economic policies there is no still way to know if he actually wrote any of it, or how much was written by the three members of staff working on it. I never said Vince had no influence on what was in the manifesto or that he opposed what was in it. I was only pointing out that we cannot know if any of the words in the manifesto were actually written by Vince.
Peter Martin,
What you say is called New Keynesianism and seems to be monetarism has a role to pay in managing the economy. Maybe this is why Joe Bourke thinks a fiscal stimulus should only be used during a recession and not during a slowdown. If the money supply is increased by too much it can cause inflation. We now know it is possible to increase it by huge amounts and for inflation not to get out of control!