Ed Balls that is:
First he made the extraordinary claim that Britain could have gone the same way as Portugal if it were not for his deficit reduction plan. Leave aside the fact that Portugal is locked into the eurozone – so has no exchange-rate flexibility and the same interest rates as growing countries like Germany – or that Britain\’s debt is more long term than any advanced economy.
Osborne\’s logic is that if only Portugal had made cuts and tax rises on the scale and speed of his plan, it would not be facing this crisis. Yet Portugal has had austerity packages including two VAT rises in the last year. But just like Ireland and Greece, it has found that it does not matter how much the government cuts spending or raises taxes – if it cannot create jobs and growth, its deficit problem and the loss of market confidence will get worse, not better.
Well, possibly, but take that as being true. The UK is not in the eurozone, has contol of its own interest rates and most importantly, a currency which has depreciated by 25%.
Don\’t forget, all this fiscal expansion malarky depends upon ignoring the effects of the exchange rate upon the economy, the imports/exports lot etc.
When we include all of that we find that we\’ve actually alternatives. In the model (yes, the Keynesian model) fiscal expansion can substitute for those exchange rate changes: as exchange rate changes can substitute for fiscal expansion.
And don\’t forget, we\’ve just had a nice little report showing that fiscal expansion doesn\’t actually work in economies with flexible exchange rates….for changes in the exchange rate do the multiplier to death.
Which brings me to one of my favourite observations about macroeconomics. Umm, a favourite observation made by me that is. There\’s a rather large tendency to always be fighting the last war, as with Generals. Let\’s assume that all this Keynes stuff, the crude version of it, really does work in a world of fixed exchange rates.
But we\’re not in a world of fixed exchange rates, at least not in the UK we\’re not. So we really rather need to examine that assumption that because Keynes worked in 1950, 1960, whenever, whether it all still works today in these different circumstances. And as I say, there\’s been recent empirical research to show that it doesn\’t.
Which, if true (and of course, given that I know little about macroeconomics, this might not be true, but bear with me) would mean something really rather cute. That St. Maggie wasn\’t in fact correct that Keynesian economics did not work. But further, that she made Keynesian economics not work by allowing the currency to truly float and abolishing capital controls etc.
And isn\’t that fun?