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This is interesting

The new official analysis, based on a report from the International Monetary Fund (IMF), showed that Britain was running a so-called structural deficit of 5.2pc in 2007 – far higher than the 2.5pc initially stated by the IMF.

That\’s from the same IMF numbers that everyone is using to show that deficit spending is the cure to our ailments I assume?

And it\’s really most unKeynesian to be running a deficit of that sort of size at the top of the longest boom in modern history, isn\’t it?

Indeed, it rather adds weight to my contention that Keynesianism doesn\’t work. Not necessarily because deficits in slumps don\’t work (upon which I reserve judgement for this point_ but because policitians will never run the associated surpluses in the booms. That just isn\’t what the incentives are and thus not what will happen.

27 thoughts on “This is interesting”

  1. this line of thinking *can* take one ultimately to the Islamist/Salafist argument that democracy is inherently unworkable because all politicians lie or make false promises in order to attract votes; therefore anyone asking your vote is unfit to receive it, and so we must have a theocratic dictatorship.

    Personally, I’m with Friedman on this – the only way to stop the lying bastards misallocating your money is to reduce the amount they take off you

  2. @Flatcap: ‘the only way to stop the lying bastards misallocating your money is to reduce the amount they take off you’


    Tax avoidance – it’s the new democracy.

  3. Many economists are Ivory Tower types: Keynes, however, was a Man of Affairs. So it’s odd that he overlooked the problem that the half of his preferred policy wouldn’t, in reality, be effected. Or perhaps it’s not odd and his policy was just a lash-up intended to be a temporary solution to a particular state of play. In which case the Keynesians are very silly boys.

  4. the same IMF numbers that everyone is using to show that deficit spending is the cure to our ailments I assume?

    are you referring to the recent IMF mea culpa concerning the size of the multiplier? if so, that describes the relationship between changes in government spending and taxation, and changes in the deficit. If the multiplier is sufficiently large, one might raise spending or cut taxes, without increasing the deficit. Or vice versa, cut spending without cutting the deficit.

    The multiplier does not tell us about the impact of “deficit spending”

  5. Act I ally some governments can run surpluses, both Australia and NZ ran significant surpluses in the period 2004-2008 say (varies a bit, but around then) which did leave them in a better place to start the downturn.

    Mind you some of the governments since then, especially in Australia, have rather flashed that benefit around and run up huge deficits that wipe out the earlier savings. And largely showing that deficit spending doesn’t really help, the temporary minor boost being rather offset by the looming necessity to repay some of the borrowings at some time.

  6. the looming necessity to repay some of the borrowings at some time.

    Not in the slightest. Don’t you keep up to date with the pronouncements of the world’s wisest simpleton? He declared, 12 Oct iirc, that governments don’t need to repay debt. So, therefore, that must be true.

  7. ….Mind you some of the governments since then, especially in Australia, have rather flashed that benefit around and run up huge deficits that wipe out the earlier savings…..

    Which brings us to the next problem, both parties in a two party system must be signed up to both parts of Keynes or it doesn’t work.

  8. The OBR increased its estimates of the size of the structural deficit because of the size of the UK output gap as reported by the IMF in its Article IV review.
    The OBR generally is “supply pessimist” according to the IMF’s definition (see p.5), so is assuming that the real output gap is small and the rest is froth and bubble that cannot be recovered.

    This has absolutely nothing to do with the IMF’s “mea culpa” about fiscal multipliers. All the IMF is saying is that if the multiplier is higher than they had originally assumed, fiscal consolidation will have a larger negative impact on the economy. The OBR had based its growth forecasts on the IMF’s multipliers, and in its report issued yesterday it admitted that it got its growth forecasts very wrong. But it stops short of accepting that the reason for this significant error is the use of IMF multipliers. There are other possible causes too, such as persistent high inflation and weakening exports.

  9. Yup, surpluses and deficits will never be symmetrical because any finance minister running a surplus will be under a dual pressure to spend on “desirable” causes/projects and to cut growth-damaging taxes.

    But we do have a way of accommodating this. It is called inflation. In the EU,US, UK the target rate of inflation is about 2 per cent, not zero. Politicians who set these targets are clearly not going to say that some inflation is needed to allow for the long-term inflationary effect of embedded fiscal deficits but if we cut through the more detailed arguments, that is really why inflation targets have to be positive.

  10. Tim’s point about politicians never running “associated surpluses in a boom” is a good point. On the other hand the deficit in 2007 he points to didn’t actually cause excessive inflation. Had inflation really looked like getting out of hand, politicians / Bank of England would have acted, wouldn’t they?

    You could argue the deficit contributed to the property bubble, but virtually no one thought there actually was a serious bubble. So no one acted.

  11. On Outsider’s point at 10, if you have growth and inflation, do you really need surpluses in the good times (ie actual net repayment in nominal terms)?

    Can’t you use interest rates to deal with inflation, and if debt/govt spending increases more slowly than GDP for a while, that’s solvency sorted?

    Simple explanations please.

    Tim adds: one way of looking at it is that no, you don’t. The debt from the spending in the bad times will be eroded by inflation and will become less important as the economy grows.

    But that ain’t what the theory is, not really. What the theory really is is that wise and omniscient politicians will boost the economy with judicious spending in times of deficient aggregate demand. And also restrain the economy by judicious extraction of aggregate demand in the booms.

    That second don’t happen. As soon as politicians realise that’s what they’re doing (ie, they are running a budget surplus) then they piss it away. For that is the incentive that politicians are presented with.

    Now, I am not sure at all that Keynesianism works at all. But if it does, if it really does, then it fails in the sense that political incentives are never to rein in the booms.

  12. If you can bring yourself to answer Chris Dillow’s post on this, I’d be very interested. I’ve seen the Financial Balances argument before, and how if the private sector is engaged in large scale net saving, then the public sector has little option but to be in net deficit. What I haven’t seen so far is a repudiation of this argument, which appears to imply that Gordon Brown’s hand was forced between 2002 – 2007, as opposed to the “conventional” wisdom that he engaged in a ruinous and avoidable spending spree.

    Waiting with bated breath ….

  13. SimonS

    There is evidence that private sector savings do increase when public deficits increase. What is not clear is the direction of causation – do the savings cause the deficit or vice versa?

    If you think the private sector’s saving forces the government to run a deficit, then as you say Gordon Brown had no choice but to run a deficit (or improve the trade balance). If you think the private sector was saving more because they knew they would have to pay for the deficit through higher taxes at some point, then Gordon Brown was engaging in a ruinous and avoidable spending spree. You pays yer money, you makes yer choice.

    Both of these are respectable economic arguments, by the way. The former is Modern Money Theory’s sectoral balance: the latter is Ricardian Equivalence.

    I may have a go at Chris’s post myself. Could be fun.

  14. Tim, thank you for having a go in simple terms.

    “But that ain’t what the theory is, not really. What the theory really is is that wise and omniscient politicians will boost the economy with judicious spending in times of deficient aggregate demand. And also restrain the economy by judicious extraction of aggregate demand in the booms.”

    But are you falling into the trap of treating “Keynesianism” as some kind of sacred tract? (Some followers do, IMHO, eg Skidelski). Yes, doing things by fiscal stimulus might not be perfect, but are you really saying that “wise and omniscient politicians” (or central bankers ) should do nothing to stimulate/reduce demand? Interest rates should stay the same, at all times?

    As before, please keep it simple.

    Tim adds: My using “wise and omniscient” is just me being hyperbolic. But Keynesianism does indeed require a great deal more detailed knowledge of the economy and also their taking the correct actions at the correct times than other macroeconomic management methods.

    Don’t get confused between interest rates and fiscal measures (ie, spending and taxing). The second is really the Keynesian part. Everyone agrees that moving interest rates around according to exconomic circumstances is a good idea. It’s the Keynesians who go on to say that playing around with tax and spending is a good way to further manage the economy. My basic objection to this idea is that I don’t think we end up with politicians bright enough or informed enough to do this properly, even if in theory it does work. Further, the incentives politicians face mean that even if they were bright enough and informed enough they would still get it wrong.

  15. SimonS: I had a go at Chris Chris Dillow’s argument a year ago (this isn’t the first time he’s made it). Most of his stuff is very good, but I think this point is wrong.

    Luke: you’re right, you don’t actually need surpluses, so long as your deficit is on average modest. (I think Dillow had a good post about this a while back.)

  16. PaulB

    I would go further and say that persistent fiscal surpluses are irresponsible and even immoral, since they amount to taking money from the private sector that is not needed to pay for goods and services. To my mind the only justification for running a surplus would be if the public debt is unsustainably high and the sovereign risks being shut of markets – but a nice burst of inflation would do the job just as well.

    The sectoral balance shows that if the public sector is in surplus, the private sector must be in net debt. The Government’s own forecasts in 2010 showed an increase in private sector debt (particularly households) arising from its planned deleveraging. Which of course explains why the Government is so anxious to get banks lending. If banks won’t lend, the private sector can’t take on more debt, so they will cut spending and/or default on existing debt instead.

    Tim, we have moved on from the days when you had to run a surplus to depress aggregate demand (if indeed those days ever existed). Nowadays, that’s what interest rates are for.

  17. PaulB

    The government does not have to “pay off” existing debt at all. All it HAS to do is service it. If it chooses to reduce the debt burden, therefore, it must do so with the explicit agreement of its electorate, since they will have to pay more in tax than the cost of the services they will be provided. Debt is incurred by PREVIOUS electorates, remember – not the present one. So:

    – Running fiscal surpluses to reduce debt when the electorate has not agreed to that course of action is immoral

    – Attempting to run fiscal surpluses to reduce debt when the economy is in recession is both irresponsible and immoral. Achieving them is probably impossible (good luck with that, Greece)

    – Personally I would regard running fiscal surpluses when the debt burden is sustainable as irresponsible. The question is what level of debt is “sustainable”. These days that is not a simple question. Government debt is widely used as a “safe asset” for investment and as collateral in the financial system. Because of this, highly-rated governments now need to have quite high levels of debt.

    You have to see government debt for what it now is – simply another form of money – and address its management in the same way. Withdrawing government debt from the economy has the same deflationary effect as reducing the money supply. This post from macroresilience is instructive on the changing nature of government debt:

  18. But if the then government had chosen to continue reducing debt after 2001, it would have been able to implement a major economic stimulus starting in 2008. Wouldn’t that have been a good thing?

    I agree that there are good reasons to run a substantial gross debt. But net debt need not be so large.

  19. PaulB

    I don’t accept that for a currency-issuing sovereign high net debt prevents economic stimulus. That wasn’t true in 2008 and it isn’t true now. If the economy requires stimulus it should have it, regardless of the net debt level.

    You should not dismiss the sectoral balance problem. If you reduce net debt, you reduce private sector savings – which would have made companies (since it was primarily corporates that were saving) less able to withstand the financial crisis. Like America, we might have had to bail out non-financial corporates.

  20. I don’t disagree with you about the stimulus in theory, but in practice the government didn’t have the courage. I think that at a lower debt level it would have done.

    If it was necessary to maintain gross debt levels after 2001 then the government could nevertheless have run a surplus and used it to invest overseas: if it had no better ideas it could have bought US government debt.

  21. The lack of courage argument is just silly. Political paralysis through fear. Really, what do we elect politicians for?

    I think running a surplus and NOT using it to pay off debt is just about the worst thing a government can do. Government surplus consists of confiscated private sector savings. The private sector is perfectly capable of investing its savings itself. It doesn’t need government to do it for it. And as for investing the surplus overseas – no, absolutely no. Why should people and businesses in the UK give up their savings to fund investment in the US?

  22. @Luke 12/15
    Bringing in “Keynesian” stimuli actually complicates the issue needlesly. Even if you are a trying to operate a Friedman policy of just relying on the built-in stabilizers (tax revenue versus unemployment benefits without policy changes) to damp economic cycles, the same applies.
    If you don’t allow the natural surpluses to accumulate during booms, there is an upward ratchet in borrowing and demand.

    The simple equation is that if the (multiannual moving average) gdp rises more that the (multiannual moving average) fiscal deficit as % of gdp, the debt burden falls but if gdp growth is lower than the fiscal deficit the debt burden rises.

    If you use interest rates to curb private sector growth to offset the fiscal deficit, all you do is reduce the average gdp growth rate so that does not work.
    If you manage STEADY inflation at a non-lethal level such as the consensus 2 per cent then the simple equation becomes that bit easier to hit. Inflation reduces the real value of accumulated debt, to the extent that it is not index-linked.
    So, if I have got this right and not made a bloomer, the debt burden only rises if trend growth + inflation is < the average fiscal deficit %. So in the UK the debt burden would not rise if the moving average fiscal deficit across the cycle were less than, say 3.75 per cent. It would actually need to be somewhat lower than that to allow for index-linked debt, not that it is going to get anywhere near that for a long time.

    One more thing. As we think in a mindset of "Keynesian" demand management, it is easy to forget that demand does not create its own supply, except in the depths of a recession. Over the cycle, growth can only come from productivity boosting innovation (including of course better management techniques and freer trade), most of which only occurs through investment. Demand management cannot create growth, only mitigate fluctuations (or not, according to our point of view).

  23. Frances: perhaps I’m misunderstanding you, but your argument seems to be based on the premise that the level of net government debt does not matter and debt service costs don’t matter. I disagree with that, because of the consequences for eventual inflation.

    I think this dialogue has gone on long enough here, so I’ll stop now and give you the last word if you’d like it. Please email me if you’d like to continue the conversation. Thanks.

  24. PaulB and Frances Coppola

    Thank you both very much for your comments.

    Paul, I’m just looking at your contra-Dillow link – my own gut feeling is that it must be a circular argument, but I’ve not yet been able to pin this down.

    But what I feel strongest about is that the Martin Wolf/Chris Dillow argument has BEEN made, yet to my knowledge there has been no attempt by the advocates of austerity to repudiate it. The mainstream orthodoxy seems to be that the number one action must be for the government to reduce its deficit, and there are plenty of conventional reasons given for why this must be the case, yet nowhere does the mainstream explain why the Wolf/Dillow argument is wrong.

    As I say, my own feeling is that it IS wrong, but if I were in charge of policy, I’d want to make crystal clear that such a radical alternative was based either on flawed thinking or on an assumption I didn’t share. I’m afraid I get collywobbles about the thought of pushing forward with a concept about which there is a powerful counter-argument that I haven’t dealt with. If I were a clergyman at the time of Copernicus, I think I’d feel the same way.

  25. My understanding was the private sector surplus in the boom years was in the corporate not household sector?

    And the logic is that the govt can reduce borrowing at the same time the household sector does if the corporate sector goes on an investment binge (or pays out more in dividends)?

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