It’s the Recovery, Stupid.

01/11/2013 2 Comments

Ok, I had a bit of fun in my last post but the (hopefully) obvious point I was making was really anything but fun.

The bloodletting analogy works very well and not only because that ancient practice lengthened the patient’s recovery but also because of the reason that it gained such popularity. And what was that reason? Well most of the time, patients undergoing a course of bloodletting got better. It had nothing to do with the bloodletting of course, it was due to the fact that when people are sick they usually get better. It’s easy to laugh at how dumb our previous generations were but when I look around today, I’m not sure we have learned any more than our ancestors about the difference between causation and correlation.

As I have mentioned several times over the last few years, the basic model of macroeconomics that is taught to first year students has performed very well during the financial crisis. It explained why our economy was weak and it explained why the economy, after an initial period of recovery in 2009, then went into a state of economic depression in 2010 from which it is only now, three years later, starting to recover. Basic macro did other useful things, like explain why a country whose debt was in a currency that they controlled (e.g. the UK) didn’t turn into Greece, (whose debt was in Euro, over which they had no control.)

You could summarise it by saying that the financial crisis gave a very strenuous test to the basic model of macroeconomics and that model came through with flying colours. That model, when applied to the circumstances in which our government came to power, (an economy suffering from a lack of demand, with interest rates at zero), said that cutting government spending would just make things worse. Output in the short term would be determined by demand and cutting government spending would further reduce demand. Cutting spending at such a time would cause the economy to remain unnecessarily weak for an unnecessarily long period.

Lo and behold that was what happened. The government had predicted, with their austerity measures in place, the UK would see significant growth in 2010, 2011 and 2012 but all we got, as the basic model predicted, was depression.

I think on that part of the argument we’re pretty clear – the basic model predicted bad things, the government predicted good things and we got bad things. There is though, apparently, some confusion regarding the fact that we are seeing the economy starting to recover, (and I do believe it is a recovery). The government is now saying this recovery advocates their policy of austerity in a depressed economy. That seems reasonable enough, doesn’t it?

Er, no. In making this argument, the government is intentionally misrepresenting the basic model and what it’s supporters said.

The basic model told us that output would be driven by demand in the short-run and supply in the long-run. In other words, assuming that the downturn didn’t cause the UK to lose its ability to make things, the economy would eventually adapt and growth would one day begin again.

The argument was never that growth would never return with government policy, it was simply, that when we have all of the knowledge and all of the tools to implement a recovery in the short-run, why should we wait for the long-run? The British economist John Maynard Keynes faced the same arguments in the 1930s when he proposed government spending to solve The Great Depression. He acknowledged that, irrespective of government policy, the economy would recover in the long-run but as he famously pointed out, in the long-run we’re all dead. If you have the knowledge and the tools to solve a depression now, you should probably do it. The alternative of waiting for the long-run would be pretty dumb.

But, remarkably that’s what we did and in doing so, created by far the longest recovery from a recession in our country’s history. This graph from NIESR, showing the current recession vs previous recessions, demonstrates just how dismal our ability to recover has been. No previous recoveries even come close to being as slow as our current one:

UK Recessions Compared (NIESR)

UK Recessions Compared (NIESR)

I wouldn’t care too much about saying, “I told you so”, if our politicians could just be honest about exactly how badly their austerity policy has performed. If they were now saying, “Our policies have directly caused the weakest recovery ever. Soz!”, I might leave things at saying, “Thanks for being honest and let’s not do anything this dumb next time around.”

Saying that a recovery now is advocation of their policy is entirely ridiculous though and there is a real danger, as the recovery continues, that people will accept that austerity in a demand-led recession causes a recovery and the same mistakes will be made next time.

Of course, the reality is that the government’s policy was never about engineering a recovery. The reality is that they used the recession as camouflage for the policy they wanted to implement anyway – shrinking the public sector and reducing taxes for the rich.

I often refer to the bad policies as “mistakes” but that is giving the government far too much credit because all along, they knew exactly what they were doing and why they were doing it. Economics is far from perfect but it will have proved an extremely useful discipline if only we learn the lessons of the past six years.

If an eventual and inevitable recovery in the long-run is taken to be a justification of what our politicians did then we might as well throw economics in the bin and just let our future selves be governed on nothing more than the political ideals of the right.

RedRearedRabbit

Advertisement

Filed under Economics, Politics Tagged with , , , , ,

Losing the Argument

12/06/2013 Leave a comment

I read Phillip Inman’s piece in The Guardian last weekend entitled, “9 reasons Keynesians aren’t winning the argument”. I always feel a little bit uncomfortable with how the term “Keynesian” is used, as it makes it sound like a bit of a cult rather than a mainstream view but anyway, for now lets go along with it.

So, as someone who falls into the category about which Inman is talking, let’s see how his arguments apply to me.

1. They think policymakers refuse to change course because they don’t understand

I disagree. Inman’s first reason implies that there are two possibilities – either policymakers don’t understand or they do understand and are doing something else anyway. My position is far simpler – whether policymakers “understand” or not is entirely irrelevant. Policymakers’ refusal to change course has nothing to do with the theory or evidence because they are not interested in the theory or the evidence. Policymakers don’t ever consider changing course because changing course is considered political suicide. Their “understanding” has no bearing on this argument.

2. They think that everyone agrees austerity is wrongheaded

I disagree. If that were the case then policymakers would probably have no option but to change course. The fact is that plenty of people still believe (in large part due to policymakers’ propaganda) that the UK’s economy works like that of an indebted household who must pay down their debt immediately in order to recover. Wrong as that is, I don’t think Keynesians believe that that isn’t a commonly held belief.

3. They think Brussels and the IMF have changed their tune

I disagree. Brussels has clearly not changed its tune and I haven’t said otherwise. Mario Draghi (President of the ECB) may not be as bad as Jean-Claude Trichet (his predecessor) but there is still plenty to criticise and I don’t recall too many people holding back. The IMF’s position has clearly moved though. Although they are not now throwing themselves unequivocally behind fiscal stimulus, they have nonetheless, amongst other things, admitted that fiscal multipliers are much higher than they initially thought, that George Osborne is “playing with fire” and most recently their admission that they had hugely underestimated the damage that austerity would do to the Greek economy. It is not in any way a total reversal of their position but to refuse to acknowledge a noted change is a bit silly.

4. They make out that a spending boost with borrowed money is risk-free

Inman doesn’t really explain what the mysterious risks are that I’m ignoring. Austerians say that the risk is that markets would lose confidence and interest rates would soar. I do strongly dispute that but that’s not a risk that Inman mentions. Inman’s risk seems to be that we might be the next Japan and that is pretty lazy journalism to be honest. I haven’t, (and I don’t think any Keynesian has), been singing the praises of Japanese economic policy over the past 20 years. A Keynesian view on Japan would be something like they should pursue higher expected inflation in conjunction with a significant and temporary fiscal stimulus. I don’t recall them doing that at any point in the last 20 years (although it looks like Abe might be starting to do that now.)

5. They think central banks can carry on printing money with no risk

Hold on a moment, why are the argument-losing Keynesians getting the blame for central banks printing money? That’s being done at the moment anyway. My take on QE has always been that the benefits have been and will always be hard to measure and that it’s almost certainly far less effective than fiscal stimulus. Of course a central bank can’t print money forever without consequence – I’ve never said that. I think all I ever said on it was that while we’re in a liquidity trap it wouldn’t be inflationary (and it hasn’t been.)

6. They think quantitative easing can be switched off and normality will return

Hold on again. In point 5 I’m ignoring the risks of carrying on printing money and now I’m ignoring the risks of not carrying on printing money? Ok, I’ll address it anyway.

It would be a bad idea if tomorrow The Bank of England decided to dump all of the debt they have accumulated back into the bond market. I don’t think any Keynesian has ever suggested they should do that though. When things are good again should we drip it back in slowly or should we just let it mature? To be honest I don’t think there is a massive problem either way but irrespective of that I don’t really understand why this is a reason I’m losing the argument – austerians have exactly the same decision to make.

7. They argue that no one should fear inflation

This is just not true. Higher inflation is bad for lots of people. If I’m a wealthy pensioner with lots of savings and inflation is higher than the interest rate I get, then that’s clearly a worry for me. In that situation I would “fear inflation”. What I’m saying is that while higher inflation has problems, it also has benefits and the benefits of higher inflation are often ignored. When interest rates are at the zero lower-bound and the economy remains depressed then what we need is a negative real interest rate and that means higher inflation. No one is saying that it’s going to be better for everyone but we should all be sensible here and understand that a 2% inflation target is not going to be the perfect rate in all economic circumstances.

8. They argue that stock market and house price rises are benign

Really? I seem to recall that I wrote a fairly damning post about the latter’s role in the economic crisis. “The London stock market recently neared its all time high”, warns Inman. Not when you take inflation into account it didn’t, and let’s be clear here – the potentially catastrophic effect of bubbles are well known and well appreciated by Keynesians. Paul Krugman spent five years before the crisis warning that the dotcom bubble had been replaced with a housing bubble.

9. They believe politicians can be trusted to spend stimulus funds in the best way

This really is a load of poo. When have I, or any other proponent of fiscal stimulus ever said, “the government should borrow money and I don’t care what they spend it on because they’ll know best”? I think a more familiar argument is, “the government should borrow money and spend it on those infrastructure projects that will increase employment, boost growth and need to be done anyway”. Rebuilding old schools, investing in renewable energy, replacing old bridges and roads that are falling to bits – that’s money that we need to spend soon anyway – all the Keynesians are saying is let’s spend it now when the economy is suffering from a lack of demand and borrowing is really cheap rather than after a recovery when unemployment is low and borrowing is more expensive.

Conclusion

Inman’s article really isn’t very good. It contains a couple of validish arguments that are badly represented but mostly it’s a list of things that really aren’t important in understanding why the argument is where it is. We can of course faff around, quibbling about what happens when quantitative easing is switched off but do you really think that this is the reason that public opinion has not unanimously fallen behind Keynesian policies? No.

As I mentioned earlier, our politicians have rejected reasoned arguments, economic theory, and the damning evidence that followed because to them, these things just weren’t relevant. Our politicians wanted low public spending and so they cut public spending. They then misrepresented the situation in order to make it look like their policies were good and with their charming little analogy about how we were just like an indebted household, they did a very effective job of perpetuating this fallacy within the masses. That is the important point and it’s one that Inman completely misses. The Keynesians have been trying to fight an economic battle but they are doing so against politicians who, with their weapons of spin, misdirection and misrepresentation, are simply too strong.

Inman doesn’t just misunderstand what the argument is he also misunderstands where the argument is. Keynesians are not losing this argument – Keynesians lost this argument a long time ago.

For three years we have pursued austerity. For three years we have failed to deliver economic growth. We have created the longest depression since the 1800s. We have created a society in which people unnecessarily lost their jobs and their houses. We have created a society in which people who want to work are forced to sit at home because there are no jobs for them to go to. We have created a society in which our school-leavers and university graduates go forth into a job market that has no use for them.

That is what Keynesians predicted that austerity would give us and this is what austerity has given us but winning the argument wasn’t about being able to stand around afterwards saying, “I told you so.” Winning the argument was about preventing this disaster from ever happening and we didn’t and therefore we lost.

To those of you who think I’m being overly defeatist, I ask this – take a good look at the state of our country today and then tell me that austerity hasn’t already won.

RedEaredRabbit

Filed under Economics, Politics Tagged with , ,

The Unteachable

25/02/2013 Leave a comment

As I wrote over the weekend, today was the day we’d find out what the markets thought of the UK’s credit rating downgrade. For the last three years George Osborne has been arguing that maintaining the UK’s AAA rating was crucial and used that as the primary reason why we should pursue austerity. Were we to lose our AAA credit rating we would be attacked by the bond vigilantes! No one would want to lend to the UK any more! Interest rates would soar ! We would be the next Greece!

Those people who understood a tiny bit about how sovereign debt works disagreed though. They said that interest rates were not low because of everyone loving the opinions of the credit rating agencies and instead offered another explanation. They said that long-term interest rates were low because the markets expected future short-term interest rates to be low. And they expected that because they expected the economy to remain weak. (Full explanation of that here.)

Throughout this debate, those people who whipped up fears of soaring interest rates in the event of a downgrade could get away with their scare-mongering because we still had a AAA credit rating. Today was the first day they couldn’t do that though so today we can put this argument to rest. If the government was right then today we should have seen a huge rise in government borrowing rates as the panicking markets attacked the UK.

So what did happen? Did the bond vigilantes attack? Did the rates at which the UK government could borrow go through the roof?

*Drum roll*

…..No.

They didn’t go through the roof. They didn’t go up at all. They actually went down a little. Five year rates went down from 0.86% to 0.83%, ten year rates went down from 2.11% to 2.08%.

So what does all of this mean? I’ll tell you and it is not good. It means that not only did the government’s economic strategy fail, it means it was based on a false pretence all along. Maintaining the AAA credit rating should never have been a priority. The priorities should always have been employment and growth.

You’d hope that with the cutting of the last thread by which the government’s economic policy was dangling, they would have come out today, apologised and agreed to listen to those people who had been telling them this all along. What did they say? Sadly they said what they always do when their economic policy explodes in their faces. That’s right – the news on the rating downgrade is even more evidence that they need to keep doing what they’re doing.

It makes me want to weep. Why not for a moment, reassess the policies that have continually got these things wrong and instead listen to the people who have continually got this stuff right? In the face of such evidence, would it really be that hard?

Sadly, it seems as though it would. A government getting things this wrong is bad enough on its own but their refusal to learn anything from it is simply staggering.

RedEaredRabbit

P.S. As of Wednesday, five year rates are down to 0.78% and 10 year rates down to 1.96%. Still no sign of those panicking markets, George.

Filed under Economics, Politics Tagged with , , ,

Depression and Optimism

28/01/2013 6 Comments

George W. Bush once famously said:

Fool me once, shame on you. Fool me… errr… twice…. errr.. umm…..

He was great, wasn’t he? I suppose the irony of that statement was that there are probably very few people in the world that you could fool more times than George W. Bush.

Just over a year ago I wrote a post called Economic Bloodletting in which I made a comparison between the government’s economic policy and the ancient medical practice of bloodletting, where doctors would try to cure an illness with a treatment that made the patient worse. Each time the patient had a a few glugs of blood removed their condition would deteriorate and in response the doctors would prescribe more bloodletting.

Fortunately our health service has moved on a lot since those days but what of the other side of that comparison? How has the government’s austerity policy served us over the twelve months since I wrote that? Do I have egg all over my face now? Have I been shown to be a scaremongering charlatan?

Let’s find out by updating the Depression Tacker!

Depression Tracker

Depression Tracker

For those of your unfamiliar with the Depression Tracker – I am comparing the current UK depression with the one from the Great Depression of the 1930s (until recently the benchmark for economic catastrophes). What’s worth noting is the position of the blue diamond on the graph. That’s when David Cameron came to power. You can see that at that time, the UK economy was doing much better than the equivalent period in the Great Depression, having never sunk as far and having been in recovery for the previous 12 months. After that point you can see that the recovery ground to a halt and in comparison, the economy during the Great Depression caught us up, passed us and kept on going. Five years after the economic collapse that started the Great Depression, the UK economy had not only recovered but was 4% larger than it was before the depression started. In comparison, our economy today is still 3.2% smaller than it was five years ago.

Now that’s a pretty stark difference and it’s not like I’m comparing things with a small economic hiccup – that green line is The Great Depression.

So what did the government do back in the 1930s to achieve the recovery? Yep – government spending. The government built a load of houses, employing a huge number of otherwise unemployed workers in order to do so. With the prospect of war on the horizon they increased military spending and built tanks and guns and planes and things. What they spent money on back then is not really important to the comparison, (I’m not suggesting we start a world war to end the depression). The important thing was the government spent money and when the government spends money in a depression they will get an extremely good return on it in terms of economic growth.

Since I wrote that post on Economic Bloodletting though, our current day government has done the opposite. They have continued to maintain their belief that decreasing spending during a depression will somehow magic up lots of growth. As you can see in the Depression Tracker above that has not happened and all they have actually achieved is the setting of a new benchmark to replace the Great Depression as the darkest point in our economic history.

Last week the ONS released its quarterly report showing that the economy is shrinking again. As I’ve said before, the results of one individual quarter is not the story here. The story is the longer term picture and when we look at that we can see that our economy has basically flatlined since the current government took office almost three years ago.

If the subject matter that I am discussing were something of a trivial nature then I would now be happily strutting around and saying, “I told you so!” but this subject is anything other than trivial. This failed experiment has meant a million people sitting at home waiting for work when there were no jobs for them. It has meant businesses going bust that could have otherwise continued and thrived. It has meant hundreds of thousands of students graduating into an economy that has no use for them. When you look at it like that you can understand why I would rather have been wrong.

Yet, I said in the title of this post there was optimism too and for the first time in years I do feel some. This is why:

One of these days, and probably sooner than you think, those people who stuck by the government when they said austerity would mean growth are going to run out of patience. Nick Clegg and Boris Johnson have both made comments in the last week to say that we need more government spending to get a recovery. They didn’t seem to want to expand too much on why they had been directly opposing it until last week but I have a theory on that – rats leaving a sinking ship.

Despite weak opposition, those who previously believed that austerity would create growth will not believe it for much longer and when this happens the government will have no choice but to do something sensible instead. Every quarter since the government came to power they have expressed solemn disappointment at the latest set of weak growth figures and sagely told us that more bloodletting is needed to cure the economy. The reason I’m optimistic is simply that I can’t see that there is any way people will continue to swallow it.

Fool me once? Fool me twice? Fool me thrice?

Seriously – even George W. Bush would have worked it out by now.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , ,

Good News

24/10/2012 2 Comments

Today David Cameron gave a strong hint that the GDP figures to be released tomorrow will be “good news”. As Jonathan Portes quickly pointed out, someone in the know even hinting at the figures before they are released is illegal. David surely knows this and it is a sign of the pressure he is under over the economy that he has blurted this out today.

When the GDP figures are bad the government says things along the lines of, “Things are worse than we thought, this is even more of a reason to pursue austerity!” And when they are good tomorrow they’ll say, “Austerity is working!” So whatever is going on they’ll say austerity is the right policy because they’re in too deep now to say anything else. But will these “good news” figures really mean a good economy?

GDP figures are always quoted relative to the previous quarter. The previous quarter was an absolute disaster so doing well in comparison to that is not necessarily good news. As I wrote three months ago:

We will almost certainly do better in Q3 – it is virtually impossible for us to repeat a quarter that bad. And when we get a recovery in Q3, the government will be saying it is advocation of their policy.

Q3 being better than Q2 isn’t that important. If the economy had been in free fall it would be important but the economy hasn’t been in free fall, it has been in depression and as I’ve mentioned on here before, the results in an individual quarter don’t tell us much at all. The important thing is not whether Q3 was better than Q2 – it is the longer-term trend, i.e. how much longer we have to wait until the economy returns to a healthy level?

Whatever the numbers are tomorrow it will certainly not represent an advocation of austerity – the expiry date on that fallacy is long passed and, in a depression longer than The Great Depression of the 1930s, it would be fairly ridiculous to claim it had worked.

The question we should be asking now is not, “When will the economy be bigger than it was in the second quarter of 2012?” A much better question would be, “When will the economy be bigger than it was at the start of 2008?”

And I promise you this much – that ain’t going to happen tomorrow.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , , ,

Lies, Damned Lies and Austerity

17/05/2012 3 Comments

Today David Cameron once again reiterated his intention to continue down the path of austerity in order to sort out the UK’s economy. David does this a lot and continually comes back to his belief that government spending caused the mess and that only a severe reduction in government spending can restore economic growth. As you probably know, in contrast to David, I am in favour of an economic stimulus.

When I write about that on here I often receive comments along the lines of David’s – that government spending caused the mess in the first place and more of it would just cause an even bigger mess. I have perhaps not addressed this directly in the past so, hold on to your hats, I will do so now.

First of all saying that the cause of the mess was purely the previous government’s spending is at best an extremely simplified view. There were many factors that combined to cause the financial crisis. People who say it was caused by government spending are conveniently forgetting what the banks were up to. That’s another story though and I do need to address the misconceptions about government spending. I am going to try to explain why I think spending is sometimes a good idea and sometimes a bad idea and why at the moment I think it is a very good idea indeed. So here goes…

Over time the economy swings between periods of growth and periods of contraction. Governments (despite often making claims to the contrary) have never been able to stop this happening and perhaps this shouldn’t be too much of a surprise. After all, a government has only simple tools at its disposal and economies are complicated things in which bad things have a habit of finding ways to happen.

Although we should accept that there will always be good and bad periods in the economy we should also appreciate that the government is certainly not powerless to help out. A government can use some of its simple tools to reduce the impact and duration of the bad times when they arrive and bring back the good times as soon as possible.

One of these tools is government spending and to see how this can help we need to first take a look at the private sector. Companies in the private sector have important short-term financial goals. They generally seek to make a profit every year and additionally have certain cash flow considerations (e.g. they need to be able to pay salaries, buy stock, pay rent etc). So if their revenue drops off, they may well look to reduce their spending in line with it. If their revenue increases, they may well look to increase their spending accordingly. For example, if a company is doing badly they may reduce their costs by making redundancies and if a company is doing well they may take on more staff. Simple enough. Let’s look at what happens in economic cycles.

In periods of strong economic growth, lots of companies do well and expand and take on staff. In periods of economic contraction, lots of companies do badly and lots of people lose their jobs.

This means that private sector spending closely follows how well the economy is doing as a whole – when the economy is doing well, private sector spending increases and when the economy is doing badly, private sector spending decreases. These spending swings in the private sector actually amplify the effect of the economic cycle. i.e. the redundancies they make during weak economic times weaken the economy further because unemployed people stop having money to spend and rely on benefits and in weak economic times they cannot easily find new employment.

One way the government (or actually the Bank of England since it is now independent) can influence this is through changes in interest rates. By lowering interest rates, it becomes cheaper for companies to borrow money and therefor encourages them to spend.

There is a problem with this approach though as you can only cut interest rates so far. Once they are down to almost zero (as they have been in the UK for over three years) then there is no way to stimulate the economy by cutting them further.

Another way the government can influence things is by spending money. When spending in the private sector dries up the government can step in and fill the gap. Governments of developed economies (who borrow in their own currency) can borrow very large sums over very long periods of time and don’t have to worry about the same short term profit or cash flow issues that companies face.

When the private sector is expanding, the government can reduce public spending and let the private sector fill the gap. When the private sector is contracting, the government can increase public spending and fill the gap. If the gap is not filled then we end up with unemployment and recession.

That’s what happens if the government does nothing but now imagine an even worse situation. In this situation the government spending tracks that of the private sector. i.e. when things are going well, the government increases spending and when things are going badly the government reduces public spending. Pushing up government spending when the private sector is trying to expand will help boost the economy a bit but it is an inefficient use of funds because the public and private sectors are in effect competing against one another. Essentially we create a strong supply of jobs for which there is weak demand. In contrast, reducing government spending when the private sector is contracting further amplifies the effect of the downturn. In this situation we are reducing the supply of jobs when there is strong demand. In the latter situation the government may cause a full-blown economic depression from which the economy may take many years to recover.

Actually, that sounds familiar.

Anyway. During the years preceding the economic crisis, the UK was experiencing some unspectacular growth. The Labour government at the time coupled this with some unspectacular increases in government spending when they should have, if they were sensible, made some unspectacular reductions in public spending.

So yes, I agree that they got things wrong. Their increase in spending was certainly fairly benign compared with the current government’s version of what happened but yes, they would have been better to reduce spending overall.

Since the crisis hit, however, the economy has contracted hugely and the private sector has shed hundreds of thousands of jobs. Now we have one of those spending gaps I mentioned and it’s a really big one. This is why government spending now would be a good idea – we’re not competing with the private sector, we are simply trying to increase the supply of jobs to help meet the huge demand for them. Let me be very clear – I am not saying that fiscal policy under the previous government was right but just because they got it wrong does not mean that we should be backing a plan now that is even wronger.

If it is this simple though, why is our government backing an austerity plan at all? Given the above argument, isn’t it the exact opposite of what they should be doing? Yes it is. Politicians are people with agendas though.

Let me give an example of an agenda. Suppose you were a politician who very much liked rich people. Your ideal UK might consist of low taxes on rich people but that’s expensive so you might try to fund those tax cuts by severely cutting public spending. Of course, since most people are not rich, you couldn’t just say that’s what you were doing because you need more than just rich people’s votes to stay in power. You might therefore invest significant time and effort trying to convince people that government spending during bad economic times was a terrible thing and the only way to restore economic growth was through reducing spending and cutting taxes on rich people.

The government has managed to get away with it quite well so far because the economy is complicated so it’s very hard for people to know whether they are telling the truth or have a hidden agenda. Additionally, the government is extremely effective at misleading the electorate. For most people the “reduce spending when things are bad” makes a lot of sense because they are able to relate it directly to their personal finances. If I have a big credit card bill and my household income drops I’d better cut back spending and pay off my credit card, right? Yes, that’s right for your household but there is a subtle and very important difference between household finance and the economy as a whole.

In your personal finances you are only concerned about your own personal incomings and outgoings. In the economy though, your spending is my income and visa versa. If we decide to kill off spending in the economy we by definition kill off income too. The government continually draws an analogy with personal debt and never takes the time to explain this distinction.

You might say that you accept the above arguments but it’s too late for us to borrow money because we already have so much debt no one will lend to us. You’d be wrong though – we have people queuing up to lend to the UK at the moment. A developed economy borrowing in their own currency (this importantly excludes the Eurozone) has a truly amazing capacity to borrow money cheaply. If you think we’re anywhere near the limit then have a look at Japan’s government debt in comparison:

And guess what? They can borrow even more cheaply than us!

Also worth pointing out on this graph is how little our debt actually increased during the years preceding the financial crisis. Yes, it should have been reducing but it wasn’t exactly the mad spending spree that everyone seems to think it was. Labour had, on the eve of the financial crisis, more or less the same amount of debt they inherited when they were elected in 1997.

In summary there are three important points in this post that David Cameron doesn’t want you to know because if you know them his argument falls to pieces:

  • Government spending during a period of economic growth and spending during a period of economic contraction are very different things. Just because the former is bad does not mean the latter is, especially when interest rates are at zero.
  • The personal spending analogy does not work when considering the economy as a whole because one person’s spending is another person’s income.
  • There is plenty of scope for the UK to borrow money

I know this post is quite a lot to digest but I have done my best to explain why I think the things that I do. Perhaps you’ve read through the post and think my reasoning is wrong and David Cameron’s is right. Perhaps you think austerity really is the way to restore economic growth. That’s fine, after all David and I each have a theory and at the end of the day that’s all they are – theories.

I suppose though, if I were being really picky, I might point out that the growing evidence strongly supports my one.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , ,

Depression

25/04/2012 4 Comments

Do you remember that time that Alistair Darling did that terribly apolitical thing of trying to tell the truth and said there was a recession coming that would be the worst since the Great Depression? And then Gordon Brown “unleashed the forces of hell” on him? I think in hindsight, there are a couple of interesting points to make about this event.

The first one, which is important to Christians, is that the forces of hell are clearly far weaker than we were taught at school. As we can see from this recent interview, Darling is alive and well, having suffered little more than a minor singeing of the eyebrows.

Secondly, we can say that Alistair was wrong. The Office for National Statistics published their quarterly Economic Review today and conveniently it contained some figures comparing the current economic cow-pat with that of the Great Depression. The below graph shows their results of comparing quarterly GDP against the pre-crisis peaks. The red line shows how GDP has changed since Q1 2008. The blue line shows how GDP changed for the equivalent period in the Great Depression (starting at Q1 1930).

(I have added a green dot to show when David Cameron came to power.)

Darling got it wrong because the current depression is actually worse than the Great Depression. By this stage in the Great Depression, the UK was going through a period of significant economic growth and had already passed the pre-crisis peak. The UK’s current GDP is still 4.3% lower than it was at the start of 2008.

The report said also, as you have probably heard today, that the UK economy has now contracted in two consecutive quarters and therefore, by the government’s definition, we are once more in recession.

If the government had achieved 0% growth as opposed to -0.2% in the first quarter they would have avoided recession and the media would be reporting it as such. The media, I feel, often puts so much weight on whether we are in or out of recession that we are essentially missing the big picture. Look at the red line on the graph above since David Cameron was elected and you see the real picture. We might be technically sometimes in growth and technically sometimes in recession but what we are actually in is a sustained period of economic stagnation.

Predictably, Cameron and Osborne have each made statements today saying that they will be strong in the face of the recession and stick with their current policy of reducing government spending. It makes me want to weep. Recession, stagnation, whatever you want to call it, this situation was caused by them. The government’s fiscal policy since they took office has been the exact opposite of what was needed to create growth in the economy and the effects are there for all to see.

When proposing a stimulus, I am often told that spending more would send us into a recession! Well, without spending more we’re now back in one but nevertheless I will explain my stimulus thoughts in a bit more detail.

Let’s take a look at say, renewable energy. By 2020 we are legally obliged to have 20% of our energy consumption coming from renewable energy. How’s that going to happen? Well it won’t happen without investing a lot of money building wind farms, tidal power stations and the like. This is money we need to spend anyway – we have agreed to be legally bound to the target. Why not bring the investment forward and spend the money now? The difference in government debt between spending the money now or in a couple of years is nigh on nothing and believe me, we won’t even get close to that target if we don’t get our arses in gear.

Or how about schools? I find it hard to believe that there are not thousands of state-funded schools not needing their ailing buildings, classrooms, gymnasiums fixing and rebuilding.

As you can see, I am not promoting the idea of spending money on things we don’t need – we need to do these things anyway so this money has to be spent sooner or later. All I am proposing is spending it now, at a time that we have economic stagnation and lots of people waiting for the jobs that such spending will create.

The government chose to implement a policy that opposed basic macroeconomic theory and that policy has had exactly the effect that basic economic theory predicts – depression. So how could they have got it so wrong? How could they not see that the fiscal policy they were pursuing was not just erroneous, it was completely irresponsible and entirely negligent?

One may as well ask, how could they not see that cutting tax on the rich at the expense of the poor was a terrible idea? Or, how could they not see that selling places at the Prime Minister’s dinner table in return for influence over government policy, was both morally and democratically abhorrent?

The answer is both surprisingly simple and hugely depressing. This government, (as with many other governments throughout history and throughout the world), did not come into power, assess the circumstances and devise the best possible policies to benefit the population and the country as a whole. They came into power with a particular idea of how they wanted the country to be. It involved private health care, lower taxes on the rich and yes, low government spending.

The fact that basic economics said that cutting spending would screw the economy was totally irrelevant. They probably knew it would. Their efforts have not gone into putting good policies into being but have instead gone into trying to make the country into their Etonian Utopia. They have cleverly coupled this with a massive campaign of bad marketing to mislead the electorate into thinking that all of these things are necessary. They know that economics is not a subject that is easily understood by the majority of the public and know they can use this to their advantage.

In forcing through the changes they wanted to make anyway, they have unnecessarily caused a depression on a scale not seen in recent history. As a direct result of these policies, people have lost their jobs and people have lost their houses.

If the 1930s was the Great Depression, then our current day situation will surely be looked on in history as the Even Greater Depression.

And the most depressing thing of all is that this was completely avoidable.

RedEaredRabbit

Filed under 10 Posts You Should Read, Economics, Politics Tagged with , , , , ,

The Austerity Fairy

25/01/2012 14 Comments

Today I’ve been playing with the greatest toy ever created. It’s not a Sony Playstation and it’s not a Pokemon. It’s a Rubik’s Cube.

The Problem

The Problem

One of the things that makes a Rubik’s Cube so great is that the problem you are trying to solve is very easy to understand. From the time you first picked one up, you understood exactly what you had to do – arrange it such that each face of the cube was the same colour.

The Solution

The very best people in the world have solved it in under 10 seconds, putting through around 5 moves per second.

I’ve just tried making 5 moves per second and I couldn’t even get close.

Let’s imagine taking someone who could move the cube this fast but didn’t know what they were aiming at, that is they know there is a single arrangement of the cube they are aiming for but don’t know what it is so they need to try every possible permutation. I done a sum and by my reckoning, assuming they were able to go at 5 moves per second and were able to keep track of every permutation they had tried so that they never hit the same one twice, it would take them around 274 billion years to get through them all and be sure to have hit the solution.

6 seconds vs 274 billion years – the importance of understanding the problem you are trying to solve.

So anyway, the economy is shrinking again – down 0.2% in the final quarter of 2011 😦

George Osborne was not worried though:

We have the right plan and we’re going to stick with it!

In fairness to him he was half-right. We are going to stick with it.

George thinks the problem is spending. He thinks that as long as we spend less, at some stage the Austerity Fairy will show up and magic the economy back to health.

He blamed firstly, the reckless spending of the Labour government. Let’s get this one out of the way quickly with the IMF data I’ve put on here before. Between 1997 when Labour came to power and 2007, the year before financial meltdown, the UK’s debt as a proportion of its GDP was the lowest in the G7. In every single year:

Government debt as a percentage of GDP (Source IMF)

Government debt as a percentage of GDP (Source IMF)

Yes, the UK is the orange line at the bottom.

Next he blamed Europe. Wait a moment – is that the same Europe who are also awaiting the arrival of the Austerity Fairy? How’s that working out for them? Oh.

Much as George would like it, it’s actually not all everyone else’s fault. The reason George has not solved the problem is because, like the poor bugger spending eternity on a Rubik’s Cube he doesn’t understand the problem he is trying to solve.

The problem isn’t that we currently have too much spending. The problem is a lack of growth and high unemployment. Let me explain further.

In normal economic times when employment is high, if the economy starts looking a little shaky the Bank of England can cut interest rates. Lower interest rates make people want to save less money and spend more. When people spend more the economy picks up. Even Robert Peston knows that.

We are not in normal economic times though. Interest rates have been at an all time low for almost three years and you know what? No one is spending. For the rising number of unemployed this is understandable but for the people who kept their jobs why would they be saving more and spending less with such low interest rates?

It’s fairly simple. In an economic depression, even those people with jobs are scared that they might not have jobs at some time in the not so distant future. What would happen if they were made unemployed? Probably they wouldn’t walk straight into another job so they save. Even with crappy interest rates they save.

We have reduced interest rates pretty much as far as they can go but have still not got people spending again and we have therefore become stuck in something that economists call a liquidity trap. We have nowhere to go with interest rates so as long as the economy is weak no one will spend and as long as no one will spend, the economy will be weak.

This is the problem. Understand that much and the solution is a bit easier to grasp – you plug the gap with government spending until employment goes back up to healthy levels and people are spending again. When people are spending again, then you reduce it.

Even if George were able to grasp the economic problem, it would lead immediately him to a political one. How would he possibly explain to the public that for the past 20 months he had pursued exactly the opposite strategy of the one he should have? It would be political suicide. He’s not going to do that.

Better to take David by the hand and skip off together down the road to nowhere in search of the Austerity Fairy.

RedEaredRabbit

Filed under Economics, Politics Tagged with , , , ,

Economic Bloodletting

19/01/2012 7 Comments

In older times bloodletting was a common medical practice. A doctor would treat a poorly patient by pumping out a few glugs of blood in the hope that it would cure them. The patient would then decline a bit and the doctor would say, “It’s more serious than we thought!” And he’d pump out some more blood. The patient would then get even worse and this bizarre cycle would continue, often until the patient died, at which point the doctor would say, “Well we did our best but they were clearly beyond saving.”

In 2010, the coalition government inherited a poorly economy. (Can you see where I am going with this?) They decided that what it needed was less spending. Less spending they claimed, would have the economy back on its feet in no time.

They predicted that with some much needed spending cuts, economic growth in 2011 would be 2.6%. Then a couple of months later with an even more sickly economy they predicted that with some more spending cuts, 2011 would enjoy economic growth of 2.3%.

November 2010 came though and the patient had deteriorated. 2011 economic growth was now predicted at 2.1% – despite economic bloodletting things were looking bleak. What this patient really needed was… bloodletting.

By March 2011 they had downgraded the annual growth from 2.1% to 1.7% but maintained that the patient’s only hope was spending cuts.

By November, the annual growth prediction was downgraded to 0.9%. We’ll soon see what the real figure was but it is clear that like the quacks of ancient times, the government is unwilling to recognise that there is any link between the treatment and the illness.

Some will disagree that this policy had anything to do with the worsening economy. What is indisputable however, is that the government’s policy of austerity has not led to the economic benefits that they predicted it would.

So let’s think about an alternative policy. Another option is that when the economy is weak we should pursue policies that encourage economic growth and employment. When unemployment rises, there are two immediate consequences. Tax revenues drop and government spending on benefits increases. Then public spending decreases because fewer people have money to spend, and those in employment save more because they are worried about rising unemployment. When public spending decreases, the economy weakens further, the whole thing becomes self-perpetuating and if unchecked we end up where we are today in an economic depression.

The government would say that you can’t spend your way out of recession. They say it all they time. It’s entirely incorrect though – government spending increases economic growth. So a better way of doing things might be to increase spending during a recession and then cut it back once the economy had recovered, employment had gone back up and tax revenues had gone back up. You could also supplement this with some taxes on the wealthy. So we have found a policy that is better than the government’s. Great! Let’s get ’em!

Oh, hold on. Where’s the opposition gone?

Oh dear.

The Labour party it seems, have decided not to take a stance against the spending cuts. Well, I think they have decided that. If I’m honest I’m not absolutely sure. For the past 18 months they have sort of said that they oppose them but have never really laid out a clear alternative. Now Ed Balls has decided that they would not commit to reversing spending cuts whilst maintaining that the government is cutting “too fast and too hard”.

Well I am confused. If they think we are cutting “too hard” but wouldn’t change the policy of cutting exactly this hard then what exactly are they proposing? Labour seems to have moved from a bit wishy-washy to some bizarre conflict of agreeing with government policies whilst saying they are bad.

If I were Ed Miliband, every time David Cameron said during PM’s Questions, “you can’t spend your way out of recession!” I would stand up and read bits out of a first year Macroeconomics text book to him.

And it doesn’t stop at economic policy. Opposition to the government’s proposed health care reforms have come more from doctors than they have from the Labour party despite the government’s argument being shown to be based on completely false statistics. We have a Secretary of State for Education who thinks we should fire more teachers for poor performance. If I were in opposition I think my criteria for firing secretaries of state would include trying to spend £60m on a boat for the Queen and £400,000 on personally inscribed bibles.

In my frustrated state, I am quickly running out of parties to vote for:

  • The Conservatives –  Implementing poor policies with no end in sight
  • The Labour Party – Unable to convey an alternative
  • The Lib Dems – Presumably I don’t need to explain
  • UKIP – Xenophobic
  • BNP – Racist
  • Green Party – In no way prepared for government but might have to look at them now

Ed Miliband’s time is running out to provide coherent opposition to what is going on. He was a good politician in government but for whatever reason he has been positively ineffective in opposition. A recent poll said that the UK public trusted the coalition more on economic policy than they did the Labour Party. I am in no way surprised by this. While I think the coalition policy is bad, it is at least coherent and clearly communicated. Rather than think of a better one, Labour seems to have given up and said, “That’s popular, let’s say that too!”

And say it they did. In a completely incoherent way.

The Conservatives might be poor when it comes to forming policies to gain economic growth, put people into jobs, or improve education and the NHS but never underestimate their brilliance when it comes to making a crap policy sound like common sense.

It is a fragile brilliance though and as their dumb marketing machine rolls forward we can see quite a few gaping holes at which to aim our wrath. I really do believe that a few carefully placed, well-argued policies could derail the whole thing but sadly I see no sign of them on the horizon.

And so, I am making one last, desperate, heartfelt plea:

Could the real opposition please stand up?

RedEaredRabbit

Filed under 10 Posts You Should Read, Economics, Politics Tagged with , , , , ,