I read an article in the Financial Times earlier this week (September 23, 2023) -…
Today I was reflecting on a book I read a few weeks ago which has been picked up by progressives and the mainstream alike as a visionary construction of the latest crisis and its remedies. It is so comprehensively wrong that I am amazed celebrated. It reinforces another theme that the mainstream conservatives are increasingly rehearsing in the media and in policy debates – governments have exhausted their options and have to take fiscal austerity measures as the only way to bring their public debt ratios under control. The point is clear – there is very little concrete argument about how the proponents of austerity see growth returning. There is a lot on cutting peoples’ living standards via prolonged unemployment, the retrenchment of pension and health entitlements etc; transferring public assets via privatisations – but not a lot on how austerity promotes growth. Further, the idea that sovereign governments have exhausted their fiscal space is just a total fallacy. They may have exhausted their political space but that is quite a different matter requiring a different solution.
In today’s UK Guardian there was an article – A worldwide financial crisis couldn’t happen again. Could it? – that exemplifies the growing sense I have that policy makers are steering the world economy back into recession.
The article compares the viewpoints of the optimists who “see economies shaking off recession and corporate results improving” with the perspectives of the pessimists who “see a growing debt crisis and a new slump that the world would be powerless to halt”.
The direction of fiscal and monetary policy at present in many countries would suggest that the pessimists will be closer to the mark but for the wrong reasons. Indeed, the very arguments they present as informed economic commentary are the very reasons their predictions are likely to be fulfilled.
So it is case of not understanding the problem and its solution; implementing the opposite policy stance; and making things worse as a result.
The article says that:
The bears are not so sure there are solutions, at least not any obvious ones. They argue that all the rescue remedies enacted in the first phase of this crisis – guarantees and recapitalisation for the banking system, public-sector assumptions of private-sector liabilities – cannot be repeated. In Crisis 2010, there is no obvious candidate to shoulder the burdens that governments took on in 2008 and 2009.
This is the central hypothesis that is around now. You hear it expressed in all sorts of different ways – the government has run out of money; the government has no bullets left in the locker; the government has exhausted etc.
So just as fiscal policy was compromised in the mid-1970s when the OPEC oil price hikes led to rising costs and policy-makers were unable to comprehend that you do not solve a nagative supply shock with a negative demand shock, once again, the debate is being pursued on false premises. A sovereign government quite simply cannot run out of money.
There might be voluntary institutional arrangements in place that force the government to jump through certain hurdles before it can spend but if push-comes-to-shove a sovereign government will always find a way to spend if it needs to.
A sovereign government can purchase anything that is available for sale in any period in the currency of issue.
The book I was reading a few weeks ago (The Origin of Financial Crises) was written by one George Cooper. The Guardian chooses to hold him out as an authority and claims he “argues that Keynesian stimulus – where policymakers seek to stimulate demand to help growth and jobs – was enacted at the wrong time and is now closed off”. They quote Cooper as follows:
We have cocked up the macroeconomic situation big-time … If this is the next leg down – and personally I think it is – the problem we have got is that both safety nets are down. You can’t fiscally stimulate and you can’t cut rates any more. In the near term, we should expect more quantitative easing as a step to the inevitable end game of outright monetisation or printing money.”
My reaction to this statement: almost unbelievable. I have no problems with the conclusion that the fiscal interventions were not managed as well as they might. For a start they were too late and too frugal (which I know is not what Cooper is thinking about). I would have introduced a Job Guarantee immediately to provide an unconditional buffer stock of jobs in every city and region to avoid the rapid rise in unemployment.
I would have spent much more on public works programs particularly with investment aimed at education, health, and (most importantly) renewable energy.
I would have put zero funds into the banking system – instead I would have nationalised any failing banks and recapitalised them under that basis. Please read the following blogs – Operational design arising from modern monetary theory and Asset bubbles and the conduct of banks for further discussion on this issue.
But to conclude that you cannot “fiscally stimulate … any more” is plain nonsense. Sovereign governments have to fiscally stimulate more at present to avoid a return to recession.
The general point that should never be lost is that irrespective of the past fiscal position, a sovereign government can spend what it likes in the current period. There are no financial constraints imposed on a government now who has been running deficits in the past. And … most significantly, past surpluses do not enhance the capacity of the government to spend now.
The only path-dependence worth acknowledging is that a nation that has been deficits in the past, particularly if they have been discretionary, will be more likely to have a growing economy on its hands than a nation that has been running surpluses. Not always but typically.
Further, quantitative easing is not what mainstream economists call outright monetisation. QE merely swaps long-term bonds (or other assets) for bank reserves in the false belief that banks need prior reserves to lend. “Monetisation” is when the central bank buys Treasury bonds and then credits banks accounts to ratify treasury spending.
Please read my blogs – Quantitative easing 101 – for more discussion on this point.
Cooper then went on to claim that we are all in a “Japanese-style scenario where the state buys its own government debt, the private sector deleverages, risk on the taxpayer’s balance-sheet rises and growth is hampered. When authorities print money to create inflation, there is little good news for households”. Specifically:
In aggregate, this all has to be paid for by society as a whole. It’s either going to be paid for by high tax rates or going to be paid for by inflation running ahead of wage growth … What this debt crisis is telling us is growth over the last couple of decades has been artificially elevated by excess debt and we now have to start paying that excess debt back by having a couple of decades of subdued growth.
Hmm, I love it when they talk about a Japanese-style scenario and then get obsessed with inflation. Japan has been struggling with deflation for nearly 2 decades and has the largest public debt ratio around.
There is no inflation threat at present that I can see. Unless demand grows faster than the real capacity of the economy there will be no generalised inflation. The size of the public debt ratio is irrelevant in making this risk assessment.
Further, we have to be careful what we call the debt crisis. The private debt build-up, which in part, brought the financial system unstuck is the problem because non-government entities are financially constrained. The only way they can pay down the debt (as a sector) is to resume saving. That means aggregate demand growth falters and unless the spending is replaced by the government sector, recession is the result. That is what got us into this mess.
But the public debt build-up for sovereign nations (that is, excluding currency board nations; EMU economies etc) is not a problem at all and does not reflect the fact that the public contribution to growth has “been elevated for the last couple of decades”.
The increasing public debt ratios just reflect the collapse of private spending and the voluntary and unnecessary institutional arrangements that governments have in place whereby they issue debt $-for-$ to match (but not finance) their net public spending.
Nothing more than that.
In the May 27, 2010 article from The Economist Magazine – A sticky gas-pedal – this mythology is further elaborated on.
We read that “America contemplates yet more fiscal stimulus and leaves the pain for later”. The obvious question is what pain are they talking about?
The only pain that matters relates to the lost income opportunities, the unemployment, the lost housing occupancy, the rising health strains brought on by recession, and all the other pathologies that are well researched in the literature.
This idea that by if you don’t cut back now there will be more pain in the future is the ultimate neo-liberal con job.
The Economist says that:
America’s long-term fiscal challenge is huge, by some measures bigger than that of the euro zone. By 2015, for instance, the IMF reckons America will have a structural deficit (ie, the deficit that would prevail at full employment) of more than 6% of GDP compared to 4% for the euro area.
As you will note in the next section, the IMF has not track record in predicting anything with any accuracy. But moreover what is so special about a 6 per cent structural deficit (per cent of GDP) anyway? Assuming that estimate was accurate that just tells me about the growth in non-government spending. Concentrating on the size of a financial ratio, when applied to a sovereign government is completely missing the point of how the deficits arose in the first place.
Lessons of Argentina
The lessons of Argentina in 2000 have not been learned. Argentina was roped into a currency board with the US in the 1990s which guaranteed peso-convertibility into US dollars. What this effectively meant was that US monetary policy dominated Argentina – it could not set its own interest rates. This was fine for a short-period while the US economy was growing but by 1996, as the US Federal Reserve tightened monetary policy and risk premia on Argentinean debt rose the appreciating currency started to choke trade.
They had relied on an export-led growth strategy (the “IMF model”). As expected, real growth collapsed and unemployment rose dramatically. The automatic stabilisers pushed the budget deficit and public debt ratio up. So we had a strong US economy trying to choke inflation via contractionary monetary policy pushing that policy onto a weakening Argentine economy via the currency board.
The neo-liberals got to work and demanded labour market deregulation, privatisations and fiscal austerity measures to be introduced. The attention was focused, as it is now, on the meaningless public finance ratios. They became the goal of policy rather than being seen as symptoms of deteriorations in the more appropriate policy targets (for example, growth, unemployment etc).
Conservative academics, as now, produced an array of papers with dazzling (to most) mathematical narratives about how the government could restore growth by dramatically cutting the public deficits. They all argued that unless you take action now to reduce the public debt ratio (heavily denominated in foreign currency because of the currency board) then there would be lower growth in the future. Same arguments as now. Mindless repetition of results drawn from economic models that have no application or meaning in a real monetary system.
The IMF bullied the Argentine government into introducing a harsh debt reduction plan via fiscal contraction. In their Second Review Under the Stand-By Arrangement and Request for Augmentation released in January 2001. They claimed that there would some modest growth damage in the first year but solid growth would return in 2001 and 2002 (see graph below).
The government was also pushed into introducing a raft of neo-liberal policies such as privatisation, deregulation etc all packaged and promoted as “structural reform”, which is code for reducing the size of the public sector and putting more resources into the hands of private enterprise. The austerity program attacked pension and health care systems – dramatically cutting back the generosity of entitlements, coverage etc.
As a result of the hectoring by international agencies and conservative forces within Argentina, the government introduced a harsh fiscal austerity program in late 2000 under the guise of the “Fiscal Pact of November 2000”. The IMF projections were all favourable – debt reduction, growth, reduction in unemployment etc. The Pact was reinforced with more fiscal lunacy in July 2001 in the form of the Zero Deficit Law. The IMF agreed to provide short-term finance given the private bond markets had push risk premia through the roof.
This graph is taken from the IMF paper on Argentina referred to above and data available from the Argentine Statistical Office. It shows actual real GDP growth from 1998 to 2002 (blue bars) – so what occurred; and the IMF actual and projected real GDP growth in late 2000 (so the observations for 2000 on a projections). The projections were captured in the IMF policy recommendations which pressured the Argentinean government into implementing a harsh fiscal contraction.
So while the IMF were lauding their macroeconomic credential and blackmailing Argentina into taking more loans from them in return for harsh fiscal austerity, the actual economy was behaving nothing like their model projections. In 2001, the IMF predicted that the economy would grow by 3 per cent whereas, in fact, it shrunk by -4.4 per cent. Things became much worse in 2002 – while the IMF was telling everybody that real GDP growth was going to be 4.5 per cent, by the time the austerity policy impacts had played out the real economy had shrunk a further 10.9 per cent. So by 2002, there was a 16 percentage point gap in the forecast and reality – that is huge.
The IMF should have been disbarred from having anything further to do with any economy after that fiasco – which was just one in many devastations there policy advice caused aroudn the world. And they are still playing the same cards.
The reality that followed is well documented. This faulty policy strategy saw demand collapse further and unemployment skyrocket. The harsh decline in conditions ultimately led to a social and economic crisis that could not be resolved while it maintained the currency board. In December 2001, the people rioted.
At this point, the government realised it had to adopt a domestically-oriented growth strategy. As soon as Argentina abandoned the currency board, it met the first conditions for gaining policy independence: its exchange rate was no longer tied to the dollar’s performance; its fiscal policy was no longer held hostage to the quantity of dollars the government could accumulate; and its domestic interest rate came under control of its central bank.
One of the first policy initiatives taken by newly elected President Kirchner was a massive job creation program that guaranteed employment for poor heads of households. Within four months, the Plan Jefes y Jefas de Hogar (Head of Households Plan) had created jobs for 2 million participants which was around 13 per cent of the labour force. This not only helped to quell social unrest by providing income to Argentina’s poorest families, but it also put the economy on the road to recovery.
Conservative estimates of the multiplier effect of the increased spending by Jefes workers are that it added a boost of more than 2.5 per cent of GDP. In addition, the program provided needed services and new public infrastructure that encouraged additional private sector spending. Without the flexibility provided by a sovereign, floating, currency, the government would not have been able to promise such a job guarantee.
The data is instructive. The resumption of growth has been strong and persistent (8.8 per cent in 2003, 9.0 per cent in 2004, 9.2 per cent in 2005, 8.5 per cent in 2006 and 8.7 per cent in 2007). Real wages have also risen modestly over the same period.
Please read my blog – Why pander to the financial markets? – for more discussion on this point.
The following graphs are taken from the excellent datasets available from the US Office of Management and Budget and show the federal deficit, outlays and receipts as a percentage of GDP from 1930 to 2010. History is not even being repeated at present. The fiscal expansion was nothing like that which occurred during the prosecution of the Second World War.
The reason the US economy grew again after the War is because they did not try to invoke harsh austerity packages to attack the financial ratios. They managed the transition from war-time policy to peace-time policy via an acceptance of the (by then) Keynesian consensus that growth was dependent on demand and that the public deficit could underpin spending.
Growth reduced the public deficit as taxation receipts rose and spending could be wound down in an orderly manner relative to the growing size of the economy. Growth also saw the public debt ratio drop significantly It also reduced the public debt ratio drop significantly during the 1940s and into the 1950. There were no oppressive intergenerational burdens to be paid. The early baby boomers in the US and elsewhere enjoyed the growing prosperity of the peacetime 1950s. It was a time of optimism not austerity.
The following graph shows the US public debt ratio from 1940 to 2010. The same story applies.
Some argue that the economies around the world will not be able to sustain the strength of economic growth that emerged after the Second World War. Question: Why not? Answer: No reason – it is just a matter of sustaining aggregate demand within the capacity of the real economy to absorb it. The austerity approach will guarantee that economies will fail to achieve this growth.
Gas now and whenever you need it to avoid paying anytime
On May 28, 2010, the UK Guardian carried a story from Leeds academic Malcolm Sawyer. I have had some interesting academic exchanges with Malcolm over the years – for example, the debate between himself and Randy Wray and me in the Journal of Economic Issues in 2005.
But in this article – David Cameron’s back-to-front economics – the essential point is well made. Sawyer said:
A large budget deficit is a sign that the economy is working well below capacity and that there is insufficient demand in the economy … There is now a clear danger that each country across Europe is attempting to reduce its budget deficit by cutting expenditure. This will have relatively little effect on the actual budget deficit but will both increase unemployment in the country concerned and reduce its demand for the exports of other countries. As their employment and income then decline, their budget deficits will actually get worse because of reduced tax revenue: the worst of both worlds.
So the “gas now, pay later” crowd assume that somehow – out of the austerity – as incomes are cut, pensions reduced, charges increased and unemployment rises – that there will be “a substantial revival of private spending whether on consumption, on investment or from exports, well in excess of anything foreseen at present”
I agree with Sawyer that there is virtually no likelihood of that happening.
The lessons from history are clear. Cutting the gas now will not only increase the burden now but the costs of the lost income and related effects endure for years into the future.
The people in all countries where austerity is being imposed should simply engage in mass revolts in the streets at this stage and overthrow their governments.
That is enough for today!