Thursday, 2 February 2012

Chris Giles on UK Austerity

According to Chris Giles in today’s Financial Times, “..the area in which Britain still leads the international debate is fiscal policy”. This might come as a surprise to many, such as Paul Krugman. I should emphasise that Chris does make one point which I totally agree with. Gordon Brown was quick to recognise the need for fiscal stimulus in 2008, and he applauds that. So, unlike some, the argument is not that fiscal stimulus is always and everywhere wrong. Instead it is that fiscal stimulus was appropriate in the downturn, but that once a recovery began, it was necessary to switch sharply from stimulus to austerity. This argument has of course been made for other countries, including the US, as well as the UK.
                Chris gives some arguments against austerity that he says range from ‘mad to bad’. The first, which he attributes to Labour politicians, is the suggestion that austerity is entirely responsible for the recent downturn in UK growth. Well, if anyone said this, they are obviously wrong (although not quite mad): there are other important deflationary forces, of course. But it is equally wrong to infer that austerity has little or nothing to do with the recent poor performance. I know of no evidence to suggest that is likely. Indeed it would be rather strange if stimulus had been effective in moderating the downturn, as Chris acknowledges it was, but that withdrawing that stimulus (and more) had no impact.
                The second argument against austerity which he describes as ‘bad’ is that low borrowing rates imply that we can “go on a spending spree”. Let’s forget about the ‘spending spree’ language. What I do take exception to is the suggestion that this is a bad argument. It could be wrong, but the idea that the market price might tell you something about demand and supply is hardly bad. What Chris and others seem to have in mind here is a rather unusual demand curve. Lenders want lots of UK debt under current austerity plans, but if these plans were moderated or delayed, or if a temporary stimulus package was laid on top of them, they would suddenly panic. It is possible that they might behave this way, but I think it is unlikely for various reasons.
                The source for this sudden panic idea is of course the Eurozone. However I think it is generally accepted now, among economists if not coalition politicians, that the Eurozone is different, because individual countries do not have their own central banks, and the ECB’s attitude is ambivalent. Certainly market panic does seem to be confined to the Eurozone. Indeed, with Quantitative Easing in place, the UK is in a particularly good position to respond to any market panic, as I argued here. We also have some evidence that, outside the Eurozone, the market does not panic at the first suggestion of stimulus. This does not seem to have happened in Denmark, as David Blanchflower noted, and it has not happened in the US. Also, as Olivier Blanchard of the IMF said recently, if we are concerned about market psychology we should be worried about growth as well as debt. 
It is far from clear why the current government’s rapid move to austerity is just sufficient to avoid market panic, but anything more moderate (like the previous government’s plans) would send them into a tizzy. The reduction in UK interest rates on debt that we have seen is part of a worldwide trend, and not an indication that the UK leads the world in finding the appropriate policy stance. Meanwhile, the UK recovery has stalled in a major way, and the scale of unutilised labour resources is large and growing. The view exemplified by Chris’s article that we should wait and see what happens, and hope that Quantitative Easing might yet do the trick, is much too complacent. It was wrong two years ago, and it is even more wrong today.

6 comments:

  1. Thanks for another very interesting post.

    There’s one thing that seems to be missing from the entire debate about stimulus vs. austerity, namely intergenerational equity.

    Commentators from both sides seem to take as given that if government spending can stimulate output and can do so without significantly increasing borrowing costs, then stimulus would be the way to go. Of course there's disagreement on whether that is possible and what a good stimulus looks like.

    But even if this effective stimulus could be achieved, it still implies a huge intergenerational transfer from taxpayers of the future to beneficiaries today. And as someone who has only recently left education and joined the labour force, I’m not sure I like the sound of that.

    I wouldn’t say this puts me in the camp of being anti-stimulus. But it is an important effect to take in to account, and at the moment few commentators seem to be doing so.

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  2. The stimulus does not necessarily imply a huge intergenerational transfer. True the debt will be repaid by future generations but it will also be owed to future generations - so the future generations more or less get an equal asset and liability. There is interest to pay of course and the asset/liability may not be shared equally amongst the future generations, but that's a question of fairness within generations and not betwen them.

    The best thing about the post for me is the idea that the interest rate is a market price. Everyone seems to miss that. It's as if there's a general idea that the debt markets are acting on a crack dealer principle: first loan really cheap just to get you hooked and then raise the price and before long we're out mugging small countries to make the interest payments.

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    1. Roy, that burden of debt argument got comprehensively shot down by Nick Rowe and others.

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    2. Certainly comprehensive! Not sure I'd say persuasive generally though. As Anonymous says below, it's not the debt but the drag of the financing that's important. Clearly wouldn't be an intertemporal problem if you were to pass on an undated debt with no coupon that never gets repaid. And, apart from the interest, that's close to what happens in practice because it never really gets repaid.

      The FASAB in the US raised the possibility of intergenerational accounting for national accounts a few years ago. I can't find the link just now but I've typed out a bit from a paper by Galbraith, Wrey and Mosely discussing the proposals:

      "Many of the FASAB’s proposed procedures appear to rely on the notion of intergenerational accounting. This exercise attempts to assess financial burdens through time, especially with a view to claiming that financial decisions taken in one generation can impose burdens on another. But this argument is specious. It refuses to count as real assets the infrastructure and other national assets that the current generation will leave for future generations.

      And it does not understand that federal government debt never needs to be retired, anymore than private sector net saving needs to be eliminated.

      In real terms, there obviously are no intergenerational
      transfers, except for the knowledge, physical assets, and larger environment that the present leaves to the future. The real goods produced in 2050 will be distributed to those alive in 2050, regardless of the public debt in existence at that time. Then, just as now, the deficits of the state will fund the nominal savings of the nongovernment sectors. In short, intergenerational accounting is a deeply flawed, experimental, and unsound concept. It should not be included in any government accounting."

      My impression is that a lot of the comment about passing on future debt burdens is more political than economic.

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  3. As the temporary budget deficits during a recession are supposed to be compensated by budget surpluses during the next boom we talk about timespans of years, not generations. Furthermore, as you rightly pointed out, the actual economic costs of public debt are not caused by debt itself but by the disincentive effects of taxation.

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  4. It is what is not done that is the real debt on future generations, the real capital that is not invested, the real factories and roads that are not built, the opportunities wasted. The financial debt is distributional. Some people, usually many, owe others, usually a few, money. The few, by imposing austerity, impose a poorer future on the whole of society, because things that should and could be built are not. They hope, by advantage of their position, and the fact that they are 'owed,' to be even richer in this poorer society, than they are now.

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