We have been here before …

The daily rhetoric being used to promote fiscal austerity maybe couched in the urgency of the day but we have heard it all before. In this blog I just reflect on history a little to remind the reader that previous attempts to carve public net spending, based on the “expectations” belief government was not going to tax everybody out of existence, failed to deliver. The expected spontaneous upsurge in private activity has never happened in the way the mainstream macroeconomic supply-siders predicted. Further, the chief proponents usually let it out in some way that the chief motivation for their vehement pursuit of budget cuts was to advance their ideological agendas. Of-course, the arguments used to justify the cuts were never presented as political or class-based. The public is easily duped. They have been in the past and they are being conned again now. My role is to keep providing the material and the arguments for the demand-side activists to take into the public debate.

The American Prospect Magazine article – “Strategic Deficit” Redux (published January 27, 2010) concluded:

But apparently Democrats still haven’t learned even in the midst of an economic crisis that prioritizing federal deficit reduction is a game for suckers. Somewhere David Stockman is having yet another laugh.

So for non-Americans and Americans who cannot remember:

President Ronald Reagan’s budget director David Stockman coined the phrase “strategic deficit” to describe the usefulness of creating long-term budgetary shortfalls to undercut political support for governmental spending … Moreover, strategic deficits can enable opponents of public investments to sound compassionate — “We can’t steal from our children to pay for our short-term desires.”

The logic that Stockman adopted and which was all the rage in the early 1980s was the so-called “supply-side” economics (famously represented by the Laffer curve). In a famous interview published in the Atlantic Monthly (December 1981) – The Education of David Stockman – we learn a lot about the conservative hypocrisy of this era:

The supply-side approach … assumed first of all, that dramatic action by the new President, especially the commitment to a three-year reduction of the income tax, coupled with tight monetary control, would signal investors that a new era was dawning, that the growth of government would be displaced by the robust growth of the private sector. If economic behavior in a climate of high inflation is primarily based on expectations about the future value of money, then swift and dramatic action by the President could reverse the gloomy assumptions in the disordered financial markets. As inflation abated, interest rates dropped, and productive employment grew, those marketplace developments would, in turn, help Stockman balance the federal budget.

Stockman admitted in that interview that “”The whole thing is premised on faith … On a belief about how the world works.” He also predicted that “The inflation premium melts away like the morning mist … It could be cut in half in a very short period of time if the policy is credible. That sets off adjustments and changes in perception that cascade through the economy. You have a bull market in ’81, after April, of historic proportions.”

Students of economic history will already recall that none of this happened. The “faith” was misplaced.

In the Atlantic Monthly interview, several salutary admissions were made by Stockman. He admitted that his plan to dramatically cut the federal budget:

… boils down to a political question, not of budget policy or economic policy, but whether we can change the habits of the political system.

He also exposed the agenda of the Reagan tax cuts:

But, I mean, Kemp-Roth was always a Trojan horse to bring down the top rate.” … he was conceding what the liberal Keynesian critics had argued from the outset – the supply-side theory was not a new economic theory at all but only new language and argument to conceal a hoary old Republican doctrine: give the tax cuts to the top brackets, the wealthiest individuals and largest enterprises, and let the good effects “trickle down” through the economy to reach everyone else. Yes, Stockman conceded, when one stripped away the new rhetoric emphasizing across-the-board cuts, the supply-side theory was really new clothes for the unpopular doctrine of the old Republican orthodoxy. “It’s kind of hard to sell ‘trickle down,'” he explained, “so the supply-side formula was the only way to get a tax policy that was really ‘trickle down.’ Supply-side is ‘trickle-down’ theory.”

However, things didn’t turn out the way the ideological pronouncements predicted. History also didn’t obey his ideological presuppositions:

In August, when enactment of the Reagan program was supposed to create a boom, instead, the financial markets sagged. Interest rates went still higher, squeezing the various sectors of the American economy. Real-estate sales were dead, and the housing industry was at a historic low point. The same was true for auto sales. Farmers complained about the exorbitant interest demanded for annual crop loans. Hundreds of savings-and-loan associations were at the edge of insolvency. The treasury secretary, perhaps also losing his original faith in the supply-side formulation, suggested that it was time for the Federal Reserve Board to loosen up on its tight monetary policy.

The US economy went into recession and the budget deficit rose. Stockman resigned from his role at the OMB less than 5 years into Reagan’s presidency. In that time, the gross federal debt level had nearly doubled. Unemployment had risen sharply, growth was slow in returning and all the predictions of the supply-siders were exposed for what they were misplaced faith statements.

As an aside, Stockman left government and went to Wall Street and got involved with the Blackstone Group. This is the company that made Peter G. Peterson rich. The latter is one of the principal deficit terrorists in the US, using his considerable fortune to fill the minds of Americans with propaganda (ably supported by News Limited – Fox).

Stockman admitted that the supply-side view of “expectations” was flawed:

Stockman … was beginning to leave the … (supply-side) … church. The theory of “expectations” wasn’t working. He could see that … Stockman began to disparage the grand theory as a kind of convenient illusion – new rhetoric to cover old Republican doctrine.

In the end, the initial premise that he used to justify the austerity cuts also collapsed:

Now, as the final balance was being struck, he was forced to concede in private that the claim of equity in shrinking the government was significantly compromised if not obliterated.

Fast forward to 2001, and the new President (Bush) inherited a recession made worse by the fiscal drag arising from the Clinton administration that budget surpluses were good policy. Bush enacted large tax cuts mostly of benefit to the very high income earners and eliminated the Clinton budget surpluses within 7 months of taking office. The automatic stabilisers were significant in this regard.

In this New York Times article (August 25, 2001) – President Asserts Shrunken Surplus May Curb Congress – Bush said:

… there was a benefit to the government’s fast-dwindling surplus, declaring that it will create “a fiscal straitjacket for Congress.” He said that was “incredibly positive news” because it would halt the growth of the federal government.

The reality is that it didn’t and now Obama’s lackeys are trying to use the Bush deficit build up to gain political capital as they try to cut net public spending, despite the US economy being mired in stagnant growth after a lengthy and debilitating recession.

But despite not being able to contain the budget outcome, Bush was described in this article – The Inside Scoop – (published January 28, 2003) and written by the conservative journalist Fred Barnes as a “strategic deficit” supporter:

An old notion from the Reagan presidency has come alive again in the Bush White House: the strategic deficit. It was associated with Reagan’s budget director, David Stockman, and posits that a budget deficit is a good thing to have because it holds down spending schemes. In other words, spenders can be told, “Nope, can’t pay for that. We’ve got the deficit, you know.” The most important fan of a strategic deficit in Bushland: Bush.

Now fast track to July 2010 and all the same arguments are being rehearsed in the public debate.

There was an interesting article in the UK Guardian (July 11, 2010) – Deficit cuts: We’re all in this together. But some are more in it than others – by William Keegan.

Keegan says that:

… from the insouciant way they are going about the cuts, and the savagery of their approach to the public sector, the coalition is in danger of reviving an old-fashioned class war. I say “in danger”, but perhaps this is what some of them want … I have known policymakers who have had to take counter-inflationary measures which they knew would result in higher unemployment. But seldom have I witnessed a government announcing, with apparent relish, that it intends to reduce public sector employment by 600,000 at a time when unemployment is already high, and the threat in western economies continues to be deflation rather than inflation.

I have already discussed in this blog – The BIS is part of the problem – that the UK austerity measures will cost about 1.3 million jobs over 5 years.

Keegan notes that even the OECD “which, to my mind, is too keen on premature deficit-cutting, expressed concern last week that Osborne’s budget ends funding for two important government job-creation schemes.”

The point is that austerity cuts always impact on the most disadvantaged. Reprise Stockman’s “discovery” that the supply-side attacks on spending worsened equity and failed to achieve the planned fiscal goals anyway.

The neo-liberals have been attacking the equity basis of economies throughout the world for the last 30 years or so. As I have shown in several blogs – for example, The origins of the economic crisis – these years have seen massive redistributions of real output towards capital away from labour. The way this was engineered was to outlaw key labour protections and allow real wages growth to lag dramatically behind labour productivity growth.

Keegan notes that this change was essential for the financialisation of the global economy to occur and we saw from the 1980s onwards a huge increase in speculative capital flows. The pre-conditions of the current crisis were being sown. The question is posed: “If profits and output rise persistently faster than wages, who will buy the output?”

In this regard, Keegan quotes on informed commentator who said:

… real wages were not growing fast enough to underpin final demand without excessive borrowing by wage earners.

In other words, “the growth of inequality contributed to the borrowing spree and the crisis” and when the:

… crunch came and the private sector cut back, government deficits were the natural counterpart of the private sector’s “de-leveraging”. They still are.

You would think that was obvious and given how history has discredited the “strategic deficit” and supply-side agenda by history.

Now to 2010. In an New York Times article (July 5, 2010) – A Little Economic Realism – by conservative David Brooks (who is actually held out as being a small-L liberal) the full supply-side agenda is once again being argued.

He argues that “demand side theorists” (like me by the way) have no practical experience and who use theoretical models to show that stimulus spending will increase employment. But:

Are you really willing to risk national insolvency on the basis of a model?

So the argument shifts from a distrust of econometric modelling (which has some foundation) to the totally spurious and emotional argument that budget deficits compromise national solvency. There is never a risk of insolvency for the US government in terms of being able to honour all its public debt obligation denominated in US dollars (which is all of it). Any notion to the contrary is a “trojan horse” along the lines of Stockman’s admissions above.

Brooks also says that:

… the Demand Siders write as if everybody who disagrees with them is immoral or a moron. But, in fact, many prize-festooned economists do not support another stimulus. Most European leaders and central bankers think it’s time to begin reducing debt, not increasing it – as do many economists at the international economic institutions. Are you sure your theorists are right and theirs are wrong?

I am definitely sure. All the noted parties were also proponents of the policy regimes that created the crisis. They also have other agendas.

This is a theme taken up in the UK Guardian article (July 9, 2010) – The European right is capitalising on a crisis – by Mark Weisbrot.

He says:

One thing should be made clear about the situation in the eurozone economies that is not clear at all if we rely on most of the news reports. This is not a situation where countries face a “dilemma” because they have overspent and piled up too much public debt. They do not face “tough choices” that will force them to cut spending and raise taxes while the economy is weak or in recession, in order to “satisfy financial markets”.

What is really going on is that powerful interests within these countries – including Spain, Greece, Ireland and Portugal – are taking advantage of the situation to make the changes that they want. Perhaps even more importantly, the European authorities – including the European commission, the European central bank and the IMF – who are holding the purse strings of any bailout funds, are even more committed than the national governments to rightwing policy changes. And they are further removed from any accountability to any electorate.

Ironically, the people who want to take advantage of the “crisis” in Spain are actually increasing the risk of more serious debt problems, since the debt burden will rise if the economy lapses into recession or years of stagnation because of their fiscal tightening measures. But they are willing to take these risks in order to accomplish their political objectives.

I have argued that theme previously. Please read my blogs – The poet and the economist and The assault on workers’ rights continues – for more discussion on this point.

The neo-liberal attack on welfare and unions and the public sector over the last three decades (variously) was damaging but not emphatic. Public sectors survived and welfare states resisted widespread retrenchment. Now we have the situation that a major economic crisis brought about by the near-collapse of the financial system is being used to finish the agenda off.

If you think about it for any more than a nano second you will wonder why we are all being duped.

You have a period of vigorous promotion of the self-regulating capacities of the “market” and intense lobbying of governments to relax long-standing rules that protected the financial system from excess and meltdown. The lobbying was universally successful and the regulations tumbled.

Then the excesses started appearing and a few economists (including the Modern Monetary Theory (MMT) camp) started to ring the warning bells (like, back in the late-1990s!). But the lobbying continued and the bell-tollers were vilified in various ways by the arrogance of the mainstream economists.

They even coined terms to describe how the business cycle was dead – please read The Great Moderation myth – for further information.

The strutting arrogance of my profession – all these notables that Brooks think should be listened to – was something to behold as the underlying conditions for the crisis were being created by their policies.

Then it crashed and the hands of those who had been the most vociferous opponents of government fiscal initiatives were quickly held out to receive their bailouts. Many of the large banks that are once again highly profitable would have gone under had not the governments provided the fiscal support.

A much deeper crisis that the one the world is already enduring was prevented by fiscal intervention – the type hated by the neo-liberals. Once the financial interests and their support clubs (Peter Peterson Foundation etc) realised they were safe they unleashed a massive and on-going campaign of deficit terrorism.

Virtually nothing has been done to reform the banking sector. We are still essentially operating with the regulative environment that brought us unstuck. There is a massive resistance in all nations to any changes which would stop the free-wheeling bankers from getting as much of the real output as they can.

Returning to Brooks, he claims that:

The Demand Siders don’t have a good explanation for the past two years. There is no way to know for sure how well the last stimulus worked because we don’t know what would have happened without it. But it is certainly true that the fiscal spigots have been wide open. The U.S. and most other countries have run up huge, historic deficits. And while this has helped save public-sector jobs, we certainly haven’t seen much private-sector job growth. It could be that government spending is a weak lever to counter economic cycles. Maybe monetary policy is the only strong tool we have.

Maybe Brooks should read my blog – Fiscal policy worked – evidence – and several I wrote before that as the evidence was starting to mount that the stimulus packages were working.

I am the first to admit that most of the fiscal interventions were poorly considered both in magnitude and targetting. First, the reality is that given the collapse in private spending the fiscal input had to be much larger. The fact that we have “huge, historic deficits” is just a reflection of the size of the private collapse and the disruption to world trade.

China which provided the largest fiscal stimulus showed the way.

Second, the spending should have been evaluated using a better jobs for dollar criterion. Governments everywhere would have been able to spend less for more jobs by announcing an unconditional Job Guarantee. That would have targetted the stimulus directly at jobs and put purchasing power into the hands of the most disadvantaged workers.

Third, MMT has an excellent explanation for the past two years and the thirty that preceded them. The mainstream macroeconomic theory has not explanation for any of this period. Please start with the following blogs – Deficit spending 101 – Part 1Deficit spending 101 – Part 2Deficit spending 101 – Part 3. Then proceed to the others within the Debriefing 101 category of my blog.

But then we get to the Brook’s agenda:

The theorists have high I.Q.’s but don’t seem to know much psychology. Lord Keynes, though a lesser mathematician, wrote that the state of confidence “is a matter to which practical men pay the closest and most anxious attention.” These days, debt-fueled government spending doesn’t increase confidence. It destroys it … Consumers are recovering from a debt-fueled bubble and have a moral aversion to more debt.

You can’t read models, but you do talk to entrepreneurs in Racine and Yakima. Higher deficits will make them more insecure and more risk-averse, not less. They’re afraid of a fiscal crisis. They’re afraid of future tax increases. They don’t believe government-stimulated growth is real and lasting. Maybe they are wrong to feel this way, but they do. And they are the ones who invest and hire, not the theorists.

So this is just a restatement of the supply-side, trickle-down whatever driven by a fundamentalist belief that private agents are “Ricardian” and will start saving now to pay for the higher taxes in the future because of the deficits.

There is no historical correlation between tax rates and deficit dynamics. Taxes rise when deficits fall but that is because economic growth drives both through the automatic stabilisers.

What Keynes said was that when private agents become mired in pessimism and the economy gets stuck with high unemployment, there has to be an exogenous aggregate demand intervention from government to get the economy moving again.

The supply-side agenda erroneously assumed that firms would invest even if there was no demand for the product and that consumers, who were deeply pessimistic would immediately start consuming again. Neither proposition has ever had any empirical support.

The fact is that firms are more concerned with their order books than they are about statements from economists about the fiscal disaster. No firm will invest and start producing if their sales books are flat.

Further, consumers facing unemployment or already enduring unemployment will not suddenly start spending in a blissful demonstration that they understand the mainstream macroeconomic models. As their job prospects worsen they always increase their saving (if they can).

Both demonstrations of pessimism ensure that aggregate demand fails to promote growth. The mindless belief in Say’s Law (supply creates its own demand) has never described any economy that humans inhabit.

We have heard all of Brook’s “expectations” arguments before. They were wrong then as they are wrong now.


It is always salutary to go back in history. You will find the same arguments that are being used by the mainstream economists now in past debates. You will also find they were discredited then by empirical developments.

There is nothing new in mainstream macroeconomic thinking. It was always an ideological position dressed up to look “scientific”. It never had any credibility then and it doesn’t now.

That is enough for today!

This Post Has 22 Comments

  1. Chilling stuff. One wonders at what point these zombie theories will finally die – if ever.

  2. I remember hearing a quote from a christian poet (I don’t remember the name):

    “History repeats itself – it has to, nobody listens.”

    I am expecting the new coallition government in the UK to continue its attacks on benefit payments. I think they already know that their plans could be thwarted by the automatic stabilisers, so their approach will simply be to reduce benefit payments to compensate. Then when homelessness and suicide statistics go up, they will simply stop collecting these statistics claiming that it is necessary to “save money”. I feel I know what they are going to do before they do.

    The previous government had a “Job Guarantee” scheme implemented from January 2010. I don’t know what Bill would think of it, and I have found very little information about it, so it’s hard to compare with Bill’s proposals. Either way the coallition are replacing it with a “Work Program”, but I have found no details sofar, but it may well be “working for your benefits”.

    Given this I wonder if you (Bill) know about the previous scheme in the UK (now coming to an end next year), and if you might consider a comparison of this with, both your own, and the new coallition version when it is anounced.

    Kind Regards

  3. “The previous government had a “Job Guarantee” scheme implemented from January 2010″

    No it didn’t. The ‘Flexible New Deal’ was a pathetic attempt to look like a job guarantee without any money behind it (in fact it had less money than the ‘New Deal’ that came before). The Labour project had degenerated into smoke, mirrors and reannouncing initiatives at that point. A sad end to a government that was bequeathed everything and did nothing with it.

    “As with all good soap operas, someone is killed off early. Sadly in the New Deal saga it’s the turn of the Wage Subsidies.

    DWP have decided to withdraw the New Deal wage subsidy early and it is now going to be withdrawn from 1 January 2010 (plan was April). They say that this is due to the complexity of concurrently running ND employment and the 6-month offer. We can’t really see why this is complex – on New Deal = ND subsidy; not on New Deal = recruitment subsidy.

    The £1000 recruitment subsidy was introduced in April. The overall amount is less than the New Deal subsidy by a fair bit and is only paid in full if the employee is still in work 26 weeks after they start eg £500 up front, £500 retention. Worse deal for employers, better deal for the treasury.”

  4. Neil,
    Thanks for that. I suspected that Labour’s “JG” was just smoke and mirrors as you say. Do you know if there is any kind of campaign in the UK for a proper JG scheme? It would be something we would need to push onto both government and opposition. JG and JSA are seen simply as ‘social policy’ by most voters, and few are aware that they are also ‘economic policy’, as they are important automatic stabilisers, and in the case of JG, potentially alot more besides.

    Similar to my point above, I believe that this government (and to some extent the last one too) are happy to undermine the automatic stabilisers during a downturn as they reach for their gold-standard comfort blankets.

    Kind Regards

  5. Perhaps, when the zombie theories that deficit spending can fix this crisis die out as well. As MMT implicitly assumes, there is no reason to run a deficit to produce zero unemployment. Eliminating unemployment need not be accomplished through increased debt, since Washington can issue whatever quantity of money is needed to reduce unemployment to zero.

  6. And, if this result in too much money in circulation, Washington can impose a sufficient tax on the very wealthiest incomes to soak up the excess currency.

  7. Excellent post, Bill. The irony is that one of the chief architects of supply-side “trickle-down” is Arthur Laffer, of the Laffer Curve fame. Warren Mosler, who worked for Laffer at around that time, reports that Laffer is actually a soft-currency economist that understands full well how the modern (post-1971) monetary system operates and can be used to influence economies through government fiscal policy. Now, he is back at it again, trundling out the old supply side “trickle-down” boilerplate that benefits his class, but this time more extreme – cut out all taxes, including the capital gains and inheritance, and prune back (social welfare) spending. Same old, same old.

    Deficits and the national debt, coupled with the false household-government finance analogy and a lot of other empirically baseless claims, are used, as Bill says, to increase profits by widening the gap between employee compensation and productivity gains. Capitalists view this increased profit as resulting largely or solely through investment in technological innovation, so, corporate boards reason, why share it with employees other than top management, cronies, and key minions? Recently the reasoning runs that the corporate elite is to be rewarded even more than shareholders, on the ground that they produced the increase through excellent management and bold risk-taking where opportunity presented itself to those able to see it early and act on it before others.

    The mainstream economic debate is disingenuous to the degree that the people orchestrating it using sophistry that they know is false or misleading. But many people, and I suspect that David Brooks is one of them, naively accept what is “orthodox” for their class and political affiliation – economic neoliberalism, political conservatism – as a matter of quasi-religious belief. There is not a whole lot of real difference between Establishment Republicans and Establishment Democrats in this regard. The rhetorical differences are cosmetic. Their agreement on policy that favors the elite is touted as constructive “bipartisanship.”

    Where effective demand that results in increased spending is supposed to come from? The stock answer is spending by firms (investment) rather than the public (consumption). The argument is that interest rates are typically very low in economic troughs, so firms, which know that cycles inevitably reverse, will naturally increase investment at bottoms in order to take advantage of cyclically low rates.

    The problem is that the real economy has shown some signs of bottoming, and there are some signs of real recovery (financial recovery, not so much, in spite of the “profits” that banks are reporting). But investment is still lagging when it is supposed to be leading. This perplexes those looking at the numbers. Globally, high worth individuals are sitting on 10 trillion in liquid assets, and 31% of them reside in the US. Similarly, corporate coffers are flush with cash. Something is not working. The liquidity available for investment is high, but velocity remains low. “What are they waiting for? Can’t they see that the time is ripe to invest? What’s wrong here? It’s not supposed to work like this.”

    It seems pretty clear that without an increase in consumer effective demand that increases velocity confidence in recovery will remain low. Given the private sector fiscal drag (increasing propensity to save and necessity to delever as debt service becomes more burdensome), households are not spending and not demanding loans. In fact, the endogenous money supply is shrinking rather than growing, even are the monetary base swells, perplexing the monetarists, many of whom are screaming “inflationary pressure” when there is not to be seen, even any masts protruding over the horizon.

    Instead, deflation is threatening, which is encouraging more hoarding of liquidity, resulting in persistence of the paradox of thrift and a liquidity trap, as expectations of falling prices are strengthened. Those with effective demand that are interested in buying are setting targets of opportunity well below current market prices and waiting for sellers to capitulate more. This is a self-augmenting cycle. Jawboning about fiscal austerity due to the prospect of national insolvency (and conveniently not mentioning private sector insolvency, especially of the financial system) in such an environment reinforces the propensity to save and springs the liquidity trap even tighter.

    The problems is not national insolvency, an oxymoron in a fiat system. It is private sector insolvency, beginning with the To Big To Fail banking institutions, which need to be put into resolution and reorganized, effective reform instituted, and wrong-doers held accountable. Think back to the S&L crisis, when a thousand scammers were successfully prosecuted.

    Tune it to this station tomorrow to learn what happens in the next episode. Will Superman be able to save Gotham from this diabolic trap engineered by his arch-nemesis (fill in the blank with your favorite evil genius)?

  8. Neil,
    I had a thought! Since Labour implemented their “Job Guarantee”, it makes it difficult to campaign for a proper Job Guarantee – effectively the JG ‘brand’ has been ‘jammed’ by Labour. So I think we should come up with a new name (in the UK) to avoid confusion – ‘Full Employment Guarantee’ or something. By using the Full Employment bit, it would become hard for a elected government to riggle out of it.

    Kind Regards

  9. ‘Full Employment Guarantee’

    I like it. Hard to oppose other than by whipping up fear of inflation. Who can be against full employment when labor is suffering? And then the attempt to stoke inflation fears opens up the fiscal debate to inclusion of the MMT paradigm based on full employment AND price stability. Sounds like a good strategy.

  10. @ Tom,
    Couldnt agree more with your macro view.

    You know in the US also over the last 25-30 yrs, as the policy rates were on their descending sawtooth pattern from 20% to now 0%, by this time in the cycle those who were not yet thrown out of their jobs could have gone in and re-financed their household debt and probably saved over 2% APR on all they had out (against their homes and cars). This phenomenon helped increase the monthly cash flow of households and perhaps acted to jump start AD in the broad economy by this time. Now that we are at 0% that seems like it is not available (only works to 0%).

    Seems “this time it is different” and we need a bottom up tax cut to increase current household monthly incomes. The trickle down (only) is not working this time as it seems to have (by luck!) over the last 25-30 years due to the concomitant interest rate backdrop imo.

  11. Mark Weisbrot also wrote in the article about Spain’s problems:

    The story that Spain got into a mess because of government overspending is not supported by the data. Spain reduced its gross debt-to-GDP ratio sharply as the economy grew from 2000-2007, from 59 to 36% of GDP, and was running budget surpluses in the three years prior to the 2008 crash. The crash was triggered by the collapse of a large housing bubble in Spain, as well as the bursting of a big stock market bubble: the value of stocks plunged from 125% of GDP in November 2007 to 54% of GDP a year later. The collapse of each of these bubbles had a huge impact in reducing private spending. The world recession added more external shocks to the Spanish economy.

    So Spain was running balanced budgets and lately did have surpluses, at the same time they did have a huge foreign deficit, 2007 and 2008 I believe it was in the range of 10% of GDP. At the same time there was an increasing debt build up in the private sector materializing in a housing bubble and a stock market bubble.

    Spain’s debt is quite manageable, since they started with a net debt of just 45.8% of GDP in 2009, and interest payments of just 1.8% of GDP. (Most news reports use the country’s gross debt, but net debt is a better measure.

    Spain is running a large central government budget deficit of about 9% of GDP this year, and this cannot go on indefinitely.

    One would have thought that in such a overview of a countries economy sector balances would have been something to also look at for an explanation of what’s happen.

  12. Hard to oppose other than by whipping up fear of inflation. Who can be against full employment when labor is suffering?

  13. To illustrate Tom Hickey’s point about “people orchestrating it using sophistry that they know is false or misleading.” – Pete Peterson was one of Nixon’s advisers back in 1971 who advised Nixon to put the USA on fiat currency. His deficit terrorism isn’t raving – it’s conscious lying.

  14. The great marxist experiment of the 20th century featured full employment–one of the reasons it failed.

    Let’s keep it simple–21st century capitalism makes the money pile up in the front of our boat where the rich people sit:forward motion slows,waves begin to wash over the bow (the rich have bad weather gear) and when the propeller begins to rise out of the water—then either the gov’ment adds more money to the working end of the boat or the rich are persuaded to send some back.

  15. Bill,

    A very minor point to pick up on, but

    You quote Brooks as stating “……..You can’t read models,………..” – In my personal view, I would immediately and forever discount anything written or spoken by this gentlemen. Everyone else should form their own opinion, many will probably disagree with me.

    Actually, you can read models. Although not a modeller myself, I’ve been intimately concerned with computer based models and they can be read and understood within the limited working area for which they were designed. All models should have a document, a logbook, call it what you will, that defines the models purpose, its limitations, its valid area of working and ALL the assumptions that are built-in – where they are built in and what they affect.

    To state that you “You can’t read models,” seems to me to show a level of ignorance and belittle the work of many who strive to produce computer models that provide insight and added value. The real problem is that there is always the temptation to use a model and its output outside its design parameters. This can be, and sometimes is, fatal. It allows people to make statements like the above and feel justified. In fact it just debases a valid tool. The output will almost always need interpreting and explanation with qualifying / limiting conditions and remarks. These should always be kept together to inform anyone looking at a model’s output everthing of relevance. But in these days of oversimplification, the attention span of a goldfish [sorry goldfish], the output is distilled to no more than 5 bullet points on a powerpoint presentation and all the qualification statements disappear forever.

    Sorry rant over!

  16. A couple of things:

    1. I’m not a supply-side advocate (I’m mostly with you guys), but I think their Say’s Law argument was addressed toward new product innovation …. not just producing more of the same thing and expecting demand to follow. For example, the demand for the I-Phone is now very large …. before Apple took the risk to invent, produce, and market this product, the demand for I-Phones was zero. I think this is the sort of thing the supply-side true believers had in mind when they proclaimed that supply would produce its own demand. Build it and they will come. So they were right in some sense. How much this is relevant to achieving full employment and a robust economy is another question.

    2. My memory of that time (which may be faulty) was that Stockman was never really on-board with supply-side economics and was never really trusted by the supply-side faithful. So while his critique was and is interesting, I’m not sure it proves that the supply-side agenda was really just a nefarious plot to reintroduce trickle-down. It may have boiled down to that in practice …. but in my opinion the principal supply-side advocates of the time, including Reagan himself, and Jack Kemp, Jude Wanniski, Laffer, etc really did believe their own dogma (dogs**t?).

    I may be wrong on these points …. memory is a funny thing. I also recognize that there was and is a “starve the beast” element on the right that is only too happy to use the “true believers” to front their own agenda of demolition.


  17. Ken, of course, the supply siders have a point. Investment and innovation are integral. Markets are made up of supply and demand, which function like scissor blades working in tandem. The blades of a scissors cut by putting paper on the anvil (flat edge of the scissors) and bring down the knife (sharp edge) against the side of the anvil. The flat edge won’t cut anything but the knife edge cannot do it job without the anvil to work against. Markets are like this. Investment and innovation are the knife edge of supply and income and effective demand are the anvil. Unless income (or credit drawing on future income) leads to effective demand, investment in expanding supply will go for naught because there will be no one able to purchase, even if they want to.

    No one on the demand side is claiming that investment in supply is unimportant. Rather they are claiming that supply without effective demand sits as inventory (bottleneck) or gets marked down below the cost of production to force sales (liquidation). In the trough of a cycle, effective demand is lacking, and either it increases to meet real output capacity or contraction sets in until it increases again. But with incomes declining curing contraction, how is the effective demand supposed to increase by providing more supply? Therefore, relying on increasing investment, e.g., through tax cuts for the wealthy, is a non sequitur. Actually, the wealthy and large corporations are awash with cash right now and aren’t investing for the above reason.

    This is also the case with the emerging world. Investment only goes there for resources extraction until the population has enough income to create the level effective demand necessary for a developing consumer economy. The question of development is not so much about investment, the way it is usually pictured, but about creating effective demand sufficient to develop a consumer base. That has not been the objective of foreign investors, who are generally chiefly interested in extraction.

  18. Following up, the obvious retort is that investment in the economic sense means primary investment (firm spending) and this generates workers’ income, which increases demand. This is true in principle but in fact, investment typically doesn’t step in a troughs to increase demand either enough or quickly enough, so unemployment rises. Automatic stabilizers kick in to address this, but if the crisis is significant, this may not be enough and unemployment may get out of hand – like now.

    The answer of Keynes (according to his biographer, Robert Skidelsky, investment lags due to lack of confidence resulting from uncertainty about conditions. According to micro theory, if wages and prices were perfectly flexible and responded to changing conditions as they happened, there would be no market failure and no problem of unemployment. But that is not what happens in a modern economy, where markets are imperfect. Uncertainty results, and the market mechanism is unable to correct the problems.

    JL: In the U.S., Keynes’s cause is being championed by Paul Krugman, most notably in a recent New York Times Magazine article that I’m sure you’ve seen. Do you have any thoughts on his argument regarding the neoclassical school’s ignorance of Keynes? Are there significant ways in which your thesis differs from his?

    RS: Paul is not convinced that uncertainty lies at the heart of Keynes’s explanation why economies are not self-correcting following a disturbance. Indeed, he believes (I think) that Keynes never did provide a satisfactory explanation of this. He and other economists like [Nobel laureate Joseph] Stiglitz are “sticky price Keynesians.” Output adjusts to a shock because wages and prices are if not rigid, insufficiently flexible. This lack of flexibility is explained by information problems of one kind or another — either the information is too costly to acquire, or some economic agents have more information than others. Paul admits, though, that this type of theorising, which takes place within a rational expectations framework, doesn’t get to the heart of the problem of sticky prices. I believe that Keynes put it much more directly: wages and prices don’t adjust when the economy has started to slide because no one knows what the correct wages and prices are. Economic theory needs to start from the assumption of uncertainty, not of perfect information.

  19. Ken,

    Well there was no demand for Zunes before they came out and now … no demand for Zunes. I call it the “Say What? Law” supply creates no demand argument.

  20. Maybe no demand for Zune, but a large portion of the things which do make up current demand are things which didn’t even exist 30 years ago. Computers, smart phones, etc. That’s what I mean by saying Say’s law is true in some sense. However, I agree with all of you that the “supply-side” ideology was and is lacking as a diagnosis or prescription for the macro economy.

    However, I also believe that the principal advocates of that ideology were not evil …. they were just wrong. I don’t think they invented it all as a way to sneak something else in …. they really believed it … and in many cases still do.

    BTW, I find it amusing how we separate ourselves into “supply” and “demand” advocates in accordance with our politics. Only in economics. I like to picture engineering students in thermodynamics class dividing themselves up into “pressure” and “temperature” factions and having heated (ha ha) debates about it. Silly silly. Personally I’d like to find out things that are true, and I don’t care if they come from Keynes or Hayek … or Adam Smith or Karl Marx. I feel like I’m still a long way from sorting it all out.


  21. joe berg: “The great marxist experiment of the 20th century featured full employment-one of the reasons it failed.”

    Really? While the great marxist experiment was failing, the U. S. was experiencing mostly full employment, too. That suggests that full employment was irrelevant to the failure of Soviet-style communism.

  22. Thanks to Jo Berg for keeping it simple, thanks to Bill for the order book thing as I find it easyer to understand actual micro examples of the macro (macro to me could read “no accountability taken for big wonderful bright ideas”).
    If your serious about stimulating demand pull down all the cheaply built 50 year old post war homes (whole suburbs of them) and insentivize the building of new cheaply built homes that people will fill with new goods. This creates jobs, directly and indirectly, and demand at the same time. It seems to me this was the engine for growth all along. I cant see any country that has an excess of everything (incl housing) will ever stimulate more consumpion infanitum. The consumer is full up with stuff and may pause to reflect on whether the goods are worth the pain of repayment. This is hard for bankers to belive! The consumer is suposed to never stop consuming more and more every year without pause.

    The consumpion cycle may have peaked and the evidence may be the lack of growth.
    Not impirical for sure but the best I can do from here.
    Anyone who can explain macro systems in a micro way will eventually convice/convert the government changers that realy matter, the less well educated and journalists. Trying to impress/covert accademics and policy makers may be the wrong target group: something to think about. I know this is a macro site (I have been told before!) so ignore the post if you like.

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