The letters economists write …

There is a long tradition of economists writing Open Letters to the media in support or in opposition to some government policy stance. The conservatives write them. The so-called progressives write them back. Usually around election times. Often the underlying economics supporting the arguments is difficult to differentiate given they both seek to comment on budgets and fiscal policy. In that context, the differences become matters of degree rather than substance. So the progressives usually take a deficit-dove position where they consider deficits are good sometimes but the budget needs to be balanced over some business cycle. In that sense, the progressives are not different to the more reasonable conservative economists. Neither position is correct and the continual repetition that deficits are only useful in times of recession demeans the public debate. The public ignorance about monetary matters and the role of deficits is continually being reinforced by these letters. Better to tell the truth I think – as long as you know what it is!

In the 1981 British election, 364 economists wrote an open letter which was published in The Times and was highly critical of the fiscal and monetary policies adopted by the Thatcher government. You may be interested in reading a reflection on that letter.

The introduction says:

There is a story (maybe apocryphal) that, not long after The Times published its letter from the 364 economists, Margaret Thatcher was asked in debate whether she could name two economists who agreed with her. Margaret Thatcher replied that she could, and named Alan Walters and Patrick Minford. On returning to Downing Street, a civil servant said to her, ‘It is a good job he did not ask you to name three.’ This anecdote illustrates how much opposition there was in 1981 to fiscal and monetary policies that would today be regarded as mainstream.

There are many more examples such as the 10 economists letter to the Queen of Britain from the British Academy in July last year after she has asked them the year before why no one had predicted the crisis and the reply came soon after from some progressives disputing the original explanation.

UK letter 2010

In the lead up to the 2010 British national election a group of 77 economists wrote a letter to The Times newspaper. There was also a background story about the letter.

At the time, I wrote about the letter in the blog – Taxpayers do not fund anything.

The letter to the UK Times said:

As expected, a key election issue concerns how much to cut government expenditure in 2010/11. The main opposition party now proposes to cut an extra £6 billion in 2010/11, on top of the measures already planned by the government. This cut is described as efficiency savings. But in macroeconomic terms it is just a cut by another name. It will lead directly to job losses and indirectly to further falls in spending through the standard multiplier process. At a time when recovery is delicate, it could even affect confidence to the degree that we are tipped back into recession – with much larger job consequences.

This is not the time for such a destabilising action. The recovery is still fragile. Firms and households are saving more to rebuild their balance sheets. This means that firms are investing less and households are spending less. Only when the recovery is well underway, will it be safe to have extra cuts in government expenditure.

The first step is to make sure that growth returns, and thus that tax receipts recover. Rash action now could imperil not only jobs but also the prospects for reducing the deficit.

While many of the 77 economists are mainstreamers who have helped to perpetuate the NAIRU myth (for example, Lord Layard) over the years and contributed to supply-side policy developments (for example, the OECD Jobs Study) which have damaged the life prospects of millions by prolonging unemployment, others among the 77 are leading Post Keynesians.

I noted that this was another demonstration of the enemy within.

As you read the text you will probably find yourself nodding in agreement. But the underlying tenor of the letter is orthodox. They are expounding a deficit dove line that old-style Keynesians follow. While they argue that tax revenues “funds spending” they are not loathe to see governments use deficits sometimes.

They worry about public debt issuance and totally fail to understand why it is issued. To tell them when deficits are sustainable they have nonsensical rules about stable public debt-GDP ratios. They think that these rules, if followed, will limit the size of the deficit – or so they think.

So “deficit doves” think deficits are fine as long as you wind them back over the cycle (and offset them with surpluses to average out to zero) and keep the public debt-GDP ratio in line with the ratio of the real interest rate to output growth. Torturous formulas are provided to students on all of this under the presumption that the government faces a financing constraint and as long as it is cautious things will be fine.

The point is that deficit-doves are essentially no different to the mainstream in perpetuating myths about the way the monetary system operates. The letter has all the deficit-dove hallmarks.

  • Now is not the time to cut but later will be.
  • Wait for recovery and then cut government spending.
  • Wait for tax revenue to rise then cut.
  • Cutting too early will increase the deficit which is a bad thing.

You will see all of those sentiments expressed in the letter. From the perspective of Modern Monetary Theory (MMT), none of the sentiments is of any applicability to a fiat currency-issuing government.

You might say that MMT would consider cutting too early to be a bad thing. That is certainly the case but the point is that it is the underlying sentiment that is misplaced and inapplicable. Cutting too early but having to cut later because you have to balance over the cycle is the erroneous sentiment that is rejected by MMT.

The overwhelming anxiety of the doves is that a government can live on the “wild side” (deficits) for a finite period only and then have to cut net spending and achieve surpluses during the other times. There is a constant level of anxiety underlying the positions offered by the doves.

They know that deficits help underpin demand and employment but are in fear of their inflationary consequences and also consider high public debt ratios to be dangerous and indicative of higher future tax rates. Doves think that governments are financially constrained.

MMT doesn’t offer an opinion about public deficits in this way. MMT considers them to be endogenously generated by non-government spending (and hence saving desires) and have to be whatever is necessary to underpin aggregate demand to achieve adequate employment growth. The goal is not a particular deficit position but other more important indicators of socio-economic well-being – for example, full employment.

Whether the budget deficit required to achieve full employment is 1 per cent of GDP or 10 per cent of GDP is immaterial to MMT. The differing scales just signal differences in non-government spending behaviour.

But a deficit-dove clearly sees a limit on the size of the deficit relative to the economy and current proportions are seen as needing attention. MMT also sees a limit on the deficit to GDP ratio – 100 per cent!

So while these 77 economists were trying to appear reasonable they missed the boat as badly as the more extreme mainstream economists.

Of-course, the Labour Party lost government and mindless fiscal austerity is now in full swing and will start impacting negatively on economic activity and employment growth later this year.

Across the Atlantic some more letter writing

On the other side of the Atlantic, on July 17, 2010, “sixteen notable economists” produced a Manifesto to save the economy. The document was characterised as being a “consensus statement … demanding urgent action on unemployment and the faltering recovery”.

The Manifesto read as follows:


Fourteen million unemployed represents a gigantic waste of human capital, an irrecoverable loss of wealth and spending power, and an affront to the ideals of America. Some 6.8 million have been out of work for 27 weeks or more. Members of Congress went home to celebrate July 4 having failed to extend unemployment benefits.

We recognize the necessity of a program to cut the mid- and long-term federal deficit but the imperative requirement now, and the surest course to balance the budget over time, is to restore a full measure of economic activity. As in the 1930s, the economy is suffering a sharp decline in aggregate demand and loss of business confidence. Long experience shows that monetary policy may not be enough, particularly in deep slumps, as Keynes noted.

The urgent need is for government to replace the lost purchasing power of the unemployed and their families and to employ other tax-cut and spending programs to boost demand. Making deficit reduction the first target, without addressing the chronic underlying deficiency of demand, is exactly the error of the 1930s. It will prolong the great recession, harm the social cohesion of the country, and continue inflicting unnecessary hardship on millions of Americans.

The day after, 24 more economists indicated their support for the Manifesto.

You will see that those who develop Modern Monetary Theory (MMT) would never sign up to this Manifesto. The offending statement is clearly – “We recognize the necessity of a program to cut the mid- and long-term federal deficit but the imperative requirement now, and the surest course to balance the budget over time, is to restore a full measure of economic activity”.

This is another example deficit-dove reasoning. There is no basis for the claim that it is prudent to balance the public budget as a matter of course. Usually this is expressed in terms of balancing the budget when averaged over a full business cycle (peak-to-peak).

But that just means that on average the private domestic balance will be exactly equal to the average external balance over the same cycle.

So if the country runs an external deficit (which is typical) then this policy rule would force the private domestic sector to run a deficit of the same magnitude over the cycle. In other words, the private domestic sector would be increasingly going into debt.

The problem is that while the deficit doves have most of the analysis correct when it comes to the expenditure system (aggregate demand) and its impact on output and employment, they seriously misrepresent the monetary side of the analysis, in particular, the sectoral flows and balances.

Some 4 days later, three Post Keynesian economists issued a public statement expressing their dissent from the Manifesto. Two of these dissenters (Skidelsky and Davidson) had signed the UK 77 economists letter, which is interesting to me for reasons I will explain.

In the Statement on Evans’s Stimulus Letter from Davidson, Galbraith, & Skidelsky we read:

We three were each asked to sign the letter … We support the central objective of the letter – a full employment policy now, based on sharply expanded public effort. Yet we each, separately, declined to sign it.

Our reservations centered on one sentence, namely, “We recognize the necessity of a program to cut the mid-and long-term federal deficit.. ” Since we do not agree with this statement, we could not sign the letter.

Why do we disagree with this statement? The answer is that apart from the effects of unemployment itself the United States does not in fact face a serious deficit problem over the next generation, and for this reason there is no “necessity [for] a program to cut the mid-and long-term deficit.”

On the contrary: If unemployment can be cured, the deficits we presently face will necessarily shrink. This is the universal experience of rapid economic growth: tax revenues rise, public welfare spending falls, and the budget moves toward balance. There is indeed no other experience in modern peacetime American history, most recently in the late 1990s when the budget went into surplus as full employment was reached.

We agree that health care costs are an important issue. But health care is a burden faced by both the public and private sectors, and cost control is a job for health policy, not budget policy. Cutting the public element in health care – Medicare, especially – in response to the health care cost problem is just a way of invidiously targeting the elderly who are covered by that program. We oppose this.

The long-term deficit scare story plays into the hands of those who will argue, very soon, for cuts in Social Security as though these were necessary for economic reasons. In fact, Social Security is a highly successful program which (along with Medicare) maintains our entire elderly population out of poverty and helps to stabilize the macroeconomy. It is a transfer program and indefinitely sustainable as it is.

We call on fellow economists to reconsider their casual willingness to concede to an unfounded hysteria over supposed long-term deficits, and to concentrate instead on solving the vast problems we presently face. It would be tragic if the Evans letter and similar efforts – whose basic purpose we strongly support – led to acquiescence in Social Security and Medicare cuts that impoverish America’s elderly just a few years from now.

I agreed with that statement although I think they could have added the point that fiscal rules are mindless denials of the role of the fiscal policy. But the point they made about the endogeneity of the budget balance was telling.

But I couldn’t discern much difference in the underlying sentiment about budgets in either the British letter or the US Manifesto, which makes the exception that Skidelsky and Davidson made difficult to understand. Both documents reflect a fundamental misconception of the monetary system. They are both old-style Keynesian deficit-dove statements.

And … to Australia

Australia is now in the grip of its own national election campaign. I have avoided writing anything explicit about it in my blog because the policy choice is limited and I totally disagree with the main thrust of all parties.

The Labor government stands for nothing (other than getting the budget back into surplus as quickly as possible and ignoring the fact that there are 12.5 per cent of willing workers without work). They also want to maintain the inhumane policy towards refugees that sees children imprisoned for years and driven into states of mental illness. They also abandoned any formal approach to climate change.

The conservatives are bereft of any credibility while The Greens think it is cute to advocate macroeconomic policy where the budget is balanced over the course of the business cycle.

The Greens are thus advocating macroeconomic positions which will make it impossible to implement their more enlightened social and environmental policies. I have spoken to the senior leadership of The Greens about this and they don’t even know what their macroeconomic policy actually means.

While I haven’t written anything I have been doing a lot of radio interviews about the issues that have come up in the campaign and the policies being presented by each party to deal with them.

But back to letters by economists. In recent days, I was approached to sign up to a letter of Australian economists which rightly sought to show that the fiscal stimulus that the government implemented was timely and very effective in keeping our economy out of recession.

So I am complete agreement with the motivation and most of the content. However, I have declined to sign the letter because once again it gives up the fight to the conservatives.

Here is the draft I received and I invite you to pick out the two paragraphs that I requested to be deleted before I would sign:

We the undersigned economists are convinced by the evidence that the coordinated policies of the Australian Labor Government have prevented the Australian economy from a deep recession and prevented a massive increase in unemployment. Unlike most OECD economies we have come out of the Global Financial Crisis and the subsequent world recession with only one quarter of negative GDP growth and a smaller increase in unemployment.

We note that during a recession automatic stabilizers (increase in total unemployment benefit payments and decreased tax revenues) lead to an increased government budget deficit. In almost all the OECD countries there has been a massive increase in unemployment and in budget deficits. In Australia both have been trivial by comparison.

The Government Fiscal Stimulus package that was introduced was carefully crafted and implemented in a clever sequence. The first stage, the payment of $900 to most households, helped to boost confidence in the retail industry.

The second stage of the stimulus package (the home insulation program, the Building Education Revolution, and the First Home Owners Grant) boosted the construction industry and created thousands of new jobs. Besides the employment effect, it also provided a much needed increase in the stock of public capital (better and greener homes, better schools) and prevented a sudden fall in house prices.

The last stage of the fiscal stimulus package (as it takes time to prepare plans etc.) was the infrastructure program that increased employment as well as increasing the stock of public capital and helping to overcome the significant short fall in Australian public infrastructure, and hence would increase future productivity, taxable capacity and the ability to repay public debt.

Just as a major corporation goes into debt to invest in its stock of capital, so does a government. Just as many householders have a debt to a bank or mortgage company, so does a government. A government has a budget deficit and a government debt, but it also has capital assets (roads, ports, better equipped schools, Broadband, etc.).

The performance of the Australian economy has been outstanding: the International Monetary Fund (IMF) and the Organisation for the Economic Cooperation and Development (OECD) have show-cased Australia as a model economy.

We hope that the economic achievements of the Australian Labor Government will be recognized by the population.

I wrote to one of the organisers and said (personal bits deleted):

I like your initiative and would like to be able to sign but I disagree with the inclusion of the section on household and private corporation debt and holding out the IMF and the OECD as arbiters of good fiscal behaviour … If those sections are edited out – for they are unnecessary anyway – I will certainly associate with the letter.

I clearly objected to the paragraphs:

Just as a major corporation goes into debt to invest in its stock of capital, so does a government. Just as many householders have a debt to a bank or mortgage company, so does a government. A government has a budget deficit and a government debt, but it also has capital assets (roads, ports, better equipped schools, Broadband, etc.).

The performance of the Australian economy has been outstanding: the International Monetary Fund (IMF) and the Organisation for the Economic Cooperation and Development (OECD) have show-cased Australia as a model economy.

This is classic deficit-dove rhetoric. It appeals to our reasoning and direct experience. As households we gain by being able to carry debt during our income earning period so that we buy a house. Businesses use debt to maintain working capital which allows production to flourish given the time gap between resource commitments and profit realisation upon sale.

But that sort of reasoning has nothing at all to do with a sovereign government such as Australia has (and the US and the UK and most other nations).

A sovereign government is never revenue constrained because it is the monopoly issuer of the currency. The household and corporation have to finance all their spending because they use the currency. The government issues the currency and thus can never been financially constrained unless it agrees to voluntarily put itself in a straitjacket.

So reinforcing the central neo-liberal myth – that the government budget is like the household budget – which is in all mainstream macroeconomics textbooks and gets rammed down the throat of all macroeconomics students is doing a disservice to the public debate.

I object to progressive economists being the vehicles for that disservice.

The other paragraph about the IMF and the OECD doesn’t merit further commentary.

I was told by way of reply that the wording was pragmatic and because the government has increased its stock of public debt the matter had to be dealt with in the letter.

Maybe so, given the conservatives are making a huge case that the government is incompetent because the debt ratio has risen. But I would never try to deal with the political issue by handing the keys of the car to the thief.

Instead, they could have written something like this:

In recent years, the Australian government has issued more debt to the public. This has given the public an risk-free, interest-earning asset which is giving better returns than the alternatives and allowing the financial markets to stabilise. The Australian government never faces as solvency risk and has always serviced all of its debt obligations.

Moreover, the Australian government does not have to issue the debt to fund its net spending increases because it issues the underlying currency. The public debt outstanding is only important because it provides an indication of the way in which public deficits have added to our private financial wealth holdings. In this risky international environment, the issuance of public bonds provides us with a secure financial vehicle to park our savings.

The letter will not be altered. And so this input from the progressive side of the debate serves to diminish the scope of the discussion rather than broaden it in such a way that the neo-liberal edifice begins to be seriously challenged.


That is enough blog economics for this week!

I am heading to Sydney tonight to watch a Tango dancing spectacular (Tango Inferno) – very exotic and musical (Youtube glimpse).

Tomorrow morning we will have a nice breakfast at Bill’s Cafe in Surry Hills. Family matters! Much better than thinking about economics.

Saturday Quiz

The Saturday Quiz will be back sometime tomorrow – even harder than last week!

That is enough for today!

This Post Has 8 Comments

  1. Bill,

    Is there a case for arguing that government investment in major capital expenditure and other large one-off costs (as opposed to e.g. ongoing support of employment) should be funded by debt rather than by issuing currency in order to spread the economic impact of a large spending package across years? I can imagine, perhaps wrongly, that if the government e.g. issued currency to build a major highway network, or something, then unless the funding was at least partially sought from private debt (bond sales etc) which reduced the amount of private capital accordingly, there could be an inflationary price shock as all that new money hit the economy. Am I barking up the wrong tree here?

  2. JamesH:

    Bill has often argued that the inflationary trade-off does not kick in until we reach full employment (and the spending is not chasing assets/labor that are already in demand). In other words, creating new money will be pretty much inflation free as long as people are out of work and want to work.

    This is because there is lots of empirical evidence that when faced with increased demand, businesses hire more people before they raise prices. They do this because they still have to compete on price, but market share is always desirable, and more output means more market share!

    So all that new money and increased demand will simply put people back to work. Recession over!

  3. People are always wrongly assume that only govt of a big country such as US Govt, Japan or UK could indulge in huge deficit spending, but US Govt Debt to GDP ratio is only at 60%.

    They overlooked something very important;

    Singapore’s public debt currently has reached 117.6% of its GDP (2009).
    Yeild for Singapore Govt Securities’ (govt bond)
    Maturity Yeild
    3 month 0.26%
    1 year 0.35%
    5 year 0.76%
    10 year 1.98%
    20 year 2.95%
    You could check for your self here
    Singapore’s unemployment rate is at < 3%.

    Spore over night interbank rate = 0.1%, it's 6 months interbank rate = 0.63% (very low, where's the crowding out??)

    Commercial Bank prime lending rate = 5.38% (quite low in comparison to other countries, where's the 'Crowding out'??)

    Spore's Inflation rate = 0.2%

  4. JamesH, it has been a frequent question in Saturday’s blog a while ago, i.e.e whether bond issuing is a better alternative inflation-wise than outright spending. The answer is – indifferent. And short explanation is whenever you have bonds financial sector will do its job for to convert your bonds into cash should you want it to. Even in today’s electron world where government sells bonds directly to households, the latter always have an option to redeem those bonds though at a fee. Which is fair enough since it is no way different from bank term deposits.

  5. “MMT also sees a limit on the deficit to GDP ratio – 100 per cent!”

    I sense tongue in cheek, but only in part.

    But why 100 per cent? Why not 101%?

    E.g. suppose its at 100 in a closed economy; why not 101 in a corresponding open one?

  6. “JamesH, it has been a frequent question in Saturday’s blog a while ago, i.e.e whether bond issuing is a better alternative inflation-wise than outright spending. The answer is – indifferent”

    well im not so sure,

    yes , a bond is only slightly more iliquid than cash, because its essentially a time deposit. but what about the leveraging potential of a bond.

    can a bond be used to obtain more credit, thus at a macro level, bond sales might contribute to credit expansion, rising assett prices, and the increase in debt service which are all potentially inflationary

    im not sure its a practical possibility, theoretical perhaps

    yes or no

    and as far as the election goes,

    what a bunch of weak kneed pussies our polies are(pardon the french), in there unseemly haste to dump on boat people.
    for god sake, its an endictment of our character to be afraid of a few boats here and there

    i thought as aussies, we had broad enough shoulders to handle a few boats. i mean we have gone to every far flung corner of the globe to get shot at, and a few boats scare us. unbelievable!

    as for the surplus, wonder who’s going to have to back down first, when they realise the credit markets may not be willing to satisfy the demand gap in the economy down the track.

    as always bill, a real parchment turner 😉

  7. Thanks all for the clear answers.

    What about the situation (which by some measures we were in in 2007/8) where some sections at least of the economy are near capacity and the government has to build new infrastructure to relieve bottlenecks (e.g. expanding port and freight transit facilities?) In that situation the government might be chasing assets that were in demand in the boom sector(s), eg construction equipment, skilled labour, etc. What’s the best way to do that while minimising inflation?

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