The authority to justify fiscal austerity is lapsing

Yesterday, two public statements were made which caught my roving eye. First, the British Government claimed they were going to cut harder than planned to weed out the unemployed who took income support payments to support their “lifestyles”. That was the approach the previous conservative government took in Australia between 1996 and 2007 and so we have experience with it. It failed dismally to achieve anything remotely positive. Second, the OECD released their Interim Assessments to update the May Economic Outlook publication. It showed that the GDP growth forecasts for 2010 and beyond were being revised sharply downwards. The OECD now claims there are many negative indicators and that governments should not push ahead with their austerity plans if the world economy is really slowing. The British government has used the earlier May EO forecasts (which were overly optimistic) as authority to justify their proposed cutbacks. Well now that authority is gone. However, their proposal to further cut back public spending would seem to be in denial of what is now obvious to even the right-wing hacks at the OECD. It is time for George to admit his austerity push is purely ideological in motivation.

More cuts coming in the UK

The UK Guardian reported yesterday (September 9, 2010) that – George Osborne to cut £4bn more from benefits – which signalled that the British government is seeking further budget cuts to unemployment income support payments.

The Guardian said:

The chancellor George Osborne today dramatically turned up the heat in the spending review by revealing he would slash the benefit budget for the unemployed by a further £4bn, and saying he would go after those who regarded welfare benefits as “a lifestyle choice” … Osborne said: “People who think it is a lifestyle to sit on out-of-work benefits – that lifestyle choice is going to come to an end. The money will not be there for that lifestyle choice.”

Apparently it riled the “leftwing Lib Democrats” who claim to be “left wing” but to get hold of power take their orders from the more extreme right-wing conservatives. The only reasonable conclusion is that they are not left wing at all and are hypocrites to boot. But I digress.

The “money will not be there” was the bit I read first. This spending is income to those without a job and as such it supports aggregate demand. While the retrenchment of these payments will reduce demand by less than would be the case if a worker lost their job (given how low the payments) – £4 billion is £4 billions pounds of orders and sales that will now not be there.

It is likely to be a £-for-£ cut because the unemployment (lifestyle or not) probably have a marginal propensity to consume of 1 (meaning they spend every extra £ they get).

In the past I have mentioned that I consider these austerity programs to be more a “finishing off” process than any sensible response to the current economic circumstances. The conservatives are intent on completing the neo-liberal attack on the welfare state and want to contract the government sector as much as they can.

This retrenchment program started in the early 1990s in various OECD economies with some degree of urgency and resulted in anti-labour legislation, so-called welfare-to-work rules, pernicious activity tests for the unemployed, the abandonment of full employment as a policy objective, and a host of other spurious assertions about the role government policy played in perpetuating unemployment and sluggish economic growth.

The agenda has been successful in purging many of the meagre supports that governments provide the most disadvantaged citizens in their nations but has failed spectacularly to end the business cycle and eliminate unemployment. It has really only made life even more difficult for the poor and the increased inequality that is has spawned was one of the pre-conditions for the current crisis (because it forced the household sector, in part, to rely on credit for growth in consumption spending).

It is clear that the conservatives are now using the “faux budget crisis” to try to finish the job off – to purge as much of the welfare state as it can.

Statements like ‘lifestyle choice’ are dead give-aways. In Australia, the conservatives who ruled from 1996-2007 used terms for the unemployed like “cruisers”, “job snobs” and of-course “dole bludgers” to vilify the most disadvantaged people in our societies and to turn the middle class against them. They garnered political support for their mean-spirited attacks on the victims of their failed policies (macro strategies that failed to create enough jobs) by inventing this evil nomenclature.

Seems that Osborne is following the same route. It has nothing at all to do with reducing unemployment. The reality is that the best work activity test for an unemployed person one could construct is to offer them a job. If they refuse a reasonable job offer at a socially-acceptable minimum wage payment then you have some case for saying they “don’t want to work”.

Whether the discovery of such an attitude warrants eliminating them from income support is another matter. I personally think that if a person can work then they should as part of their responsibility to the community especially if the government is committed to providing socially-acceptable minimum wage jobs under a Job Guarantee. In that sense, I would not provide income support to anyone who refused a JG position within close proximity to their residence.

But other colleagues within the Modern Monetary Theory (MMT) camp have different views and consider that the dole and the JG can run together. While I don’t agree with them the discussion is a nuance to the overall debate. The fact is that the national government could afford to run an income support system and the JG without any issue. Whether it does has to be decided on other grounds. It is those grounds that there are different MMT views.

Anyway, the austerity packages which the British government is starting to introduce and will start impacting in the coming European winter (including the cutting of heating subsidies to the poor) will restrict economic growth and damage private confidence even further.

The signs are emerging throughout the advanced economies that the fiscal-stimulus led recoveries that we have been seeing over the last six months are now waning as the stimulus spending is withdrawn.

In nations that adopt formal austerity programs (so-called fiscal consolidation strategies) the slow down will be worse and it is likely they will be plunged back into recession. Witness Ireland! They were first in early 2009 to embrace this nonsense (instead of just defaulting and exiting the Euro). Some 18 months after they started hacking into public demand things are getting worse not better.

There is no rocket science operating here. Aggregate spending supports business sales. Cut spending and you cut sales. Cut sales you cut growth. Cut growth you cut employment. Cut employment you cut tax revenue. Cut tax revenue and the automatic stabilisers push the budget deficit up. Simple causal relations which are denied by the deficit terrorists.

Some of them deny these relationships because they do not know better. Others deny them as a political strategy to pursue anti-welfare, anti-government intervention strategies. The first group need education. The second deserve imprisonment for crimes against humanity.

If you recall at the time the new British government was taking office the OECD thought it was appropriate to praise their austerity plans.

For example, on June 26, 2010 the OECD issed a statement – Economy: U.K. budget “courageous”, provides support for recovery which said:

OECD Secretary-General Angel Gurría hailed the budgetary measures announced today by U.K. Chancellor of the Exchequer George Osborne as a courageous move that will underpin fiscal consolidation … “It provides the necessary degree of fiscal consolidation over the coming years to restore public finances to a sustainable path, while still supporting the recovery. The plan for a gradual reduction in the deficit over the next five years is concrete and far-reaching. It is appropriate that the bulk of the adjustments come from public expenditure restraint, and that the tax measures focus mostly on consumption.”

At the time I laughed when I read this and considered it to be another ultra ideological statement coming from the now firmly right-wing organisation.

Around that time, the OECD started pushing the fiscal austerity line fairly hard. In this blog – The OECDs perverted view of fiscal policy – I reviewed a paper they put out about the need for fiscal consolidation.

I saw the increasing austerity rhetoric coming from the OECD as a vehicle to re-assert their intellectual authority on the policy debate again after being unable to provide any meaningful insights into the cause of the global crisis or its immediate remedies. The OECD and the IMF were relatively quiet in the early days of the crisis and the IMF even issued an apology, albeit a conditional one.

It is clear that the policies the OECD and the IMF have promoted over the last decades have not helped those in poorer nations solve poverty and have also maintained persistently high levels of labour underutilisation across most advanced economies. It is also clear that the economic policies these agencies have been promoting for years were instrumental in creating the conditions that ultimately led to the collapse in 2007.

But as the crisis dissipated as a result of the fiscal support that governments introduced, the IMF and the OECD started to emerge, unashamed, and touting even more destructive policy frameworks. These frameworks tried to argue that fiscal rules were now needed to wind back fiscal support.

For example, on May 31, 2010, the OECD released a paper entitled – The Political Economy of Fiscal Consolidation.

It was a 43-page documents running to some 12,000 words or more. Not once is the string “unemployment” found in the text yet it is about fiscal policy. That one observation is enough to tell you that the OECD has a strange construction of the notion of political economy.

As you will read the paper, you see that the focus is entirely on financial ratios – deficit to GDP and public debt to GDP ratios – both of which are largely meaningless in economies with sovereign governments.

The paper presents a juxtaposition between lax governments (who create deficit biases) and the institutions that discipline this laxity. The good guys are the
central banks and bond markets, while the government is inherently bad and likely to be wasteful and ineffective.

The paper completely misunderstood the way the monetary system operates and the role that the sovereign government plays in it. The paper is obsessed with the fallacious notion that the general public services government debt via taxation. The reality is that in a modern monetary economy such as the US, Australia, Japan etc, tax revenue funds nothing.

The government taxes to create a demand for the currency and to fine-tune aggregate demand to avoid inflation. It may also tax to capture rents (as in the current mining tax dispute in Australia) or re-allocated resources away from “bads” (for example, alcohol, tobacco). A sovereign government, which issues its own currency never taxes to raise revenue even though it might say it is doing that.

By trying to confine fiscal policy settings to given “fiscal rules” as a demonstration of fiscal responsibility the OECD jettisons the idea that governments should use fiscal policy to advance public purpose – which in this context means that it should ensure that aggregate demand is robust enough to maintain high levels of employment and low (frictional) levels of unemployment.

We know that the automatic stabilisers operate in a counter-cyclical fashion. So they dampen aggregate demand in an upturn (tax revenue rises and welfare payments fall) and boost aggregate demand when economic growth falters (tax revenue deteriorates and welfare payments rise). So in a major downturn, the automatic stabilisers will always be pushing the budget balance towards deficit, into deficit, or into a larger deficit.

The actual budget balance can be decomposed into the cyclical component (the automatic stabilisers) and the discretionary component which is now called the “structural deficit”. I have discussed how that decomposition is engineered in several blogs and noted that the mainstream approach is to overestimate the structural component.

Please read the following blogs – The dreaded NAIRU is still about!Structural deficits – the great con job!Structural deficits and automatic stabilisersAnother economics department to close – for more information on this point.

The essential point is that there is no pre-conceived “good” structural balance. It all depends. On what? Answer: on the state of private spending.

In this context, one of the most important elements of public purpose that the state has to maximise is employment. It is not the only thing the government should be pursuing but employment is a basic connection that people have with the economy and it is usually the difference between living in poverty or not.

Once the private sector has made its spending (and saving decisions) based on its expectations of the future, the government has to render those private decisions consistent with the objective of full employment. Given the non-government sector will typically desire to net save (accumulate financial assets in the currency of issue) over the course of a business cycle this means that there will be, on average, a spending gap over the course of the same cycle that can only be filled by the national government. There is no escaping that.

The national government then has a choice – maintain full employment by ensuring there is no spending gap which means that the necessary structural deficit is defined by this political goal. It will be whatever is required to close the spending gap.

However, it is also possible that the political goals may be to maintain some slack in the economy (persistent unemployment and underemployment) which means that the government structural deficit will be somewhat smaller and perhaps even, for a time, a budget surplus will be possible.

But the second option would introduce fiscal drag (deflationary forces) into the economy which will ultimately cause firms to reduce production and income and drive the budget outcome towards increasing deficits.

Ultimately, the spending gap is closed by the automatic stabilisers because falling national income ensures that that the leakages (saving, taxation and imports) equal the injections (investment, government spending and exports) so that the sectoral balances hold (being accounting constructs). But at that point, the economy will support lower employment levels and rising unemployment.

The budget will also be in deficit – but in this situation, the deficits will be what I call “bad” deficits. Deficits driven by a declining economy and rising unemployment.

So fiscal sustainability requires that the government fills the spending gap with “good” deficits at levels of economic activity consistent with full employment – which I define as 2 per cent unemployment and zero underemployment.

Fiscal sustainability cannot be defined independently of full employment. Once the link between full employment and the conduct of fiscal policy is abandoned, we are effectively admitting that we do not want government to take responsibility of full employment (and the equity advantages that accompany that end).

So it will not always be the case that the dynamics of the automatic stabilisers will leave a structural deficit sufficient to finance the saving desire of the non-government sector at an output level consistent with full utilisation of resources.

What this means that it is perfectly reasonable for there to be on-going structural deficits reinforcing the cycle and “financing” the desire of the non-government sector to save.

Remember a government deficit is always equal $-for-$ to the non-government surplus (and vice-versa).

This is the context in which one should understand the austerity debate. One thing is certain is that the OECD is clearly unqualified to offer advice to governments about fiscal policy.

The May 2010 forecasts

At the time, governments were being bullied into introducing fiscal austerity, the OECD put out some growth forecasts which they used to justify their claim that austerity was growth-enhancing.

You can download the spreadsheet they released on May 25, 2010 to accompany the OECD Economic Outlook No 87 publication. This is their major outlook statement.

These forecasts apparently provided support for their claims that the world was ready for fiscal austerity.

The September 2010 forecasts

At 11 am yesterday (September 9, 2010) in Paris, the OECD showed us why they are a dangerous organisation. In their What is the economic outlook for OECD countries?

An interim assessment the OCED recanted quite markedly on forecasts they provided to the policy debate in May 2010, which were used by governments, including the new British government to justify their austerity obsessions.

Now lets be clear. I am a time-series econometrician which means I understand the concept of forecast errors and the need to qualify one’s forward-looking projections. Uncertainty stops us knowing what the future holds and while econometric models can be helpful there is always error. So my criticisms are not that the OECD (or bank economists) or anyone else makes forecasts that are later shown to be inaccurate.

Typically, we provide further information to the readers by publishing standard errors which give some indication of the degree of imprecision in the forecasts. The OECD rarely does that however.

The point I am making is that forecasts should always be additional information that might be helpful in framing discussions.

However, the OECD and other bodies use their forecasts as authoritative statements backing their policy frameworks which are constructed – in advance – as a reflection of their theoretical models. The models are all deeply flawed and do not accurately depict, conceptually, the way the monetary system operates. They are mainstream macroeconomics fairy tales about a mythical economy.

From those models, the OECD justified the call for fiscal austerity which was in itself indefensible. They then backed up their ideological demands with “forecasts” which showed how rosy things would be into 2011.

The reason the economies were starting to grow was the result of the fiscal stimulus. At the time the positive forecasts were made, private demand was subdued if not falling. Nothing much has changed except now the fiscal support is starting to be withdrawn.

The OECD and other mainstream (neo-liberal) organisations and think tanks then tried to run the line that by withdrawing the main engine of growth, economies would further prosper. The forecasts were central to that erroneous claim.

Over the last few months, there has been at first a faint clucking sound in the background which has been steadily getting louder and more dominant. It is the sound of the chickens coming home to roost on these morons.

Now the OECD has issued new forecasts which are looking fairly bleak.

You can read the Handout for journalists that the OECD released yesterday to accompany the presentation of their Interim Assessment.

You will see charts with headings such as:

  • The pace of recovery could be slower than anticipated
  • Business confidence has weakened
  • Investment is particularly low
  • The bounce-back in industrial production is moderating
  • The recovery in world trade is losing momentum
  • The housing market has lost momentum
  • Bank lending continues to be weak
  • Underlying inflation remains low
  • Inflation expectations are trending downwards in some countries
  • Central bank balance sheets remain enlarged

The picture is becoming clear. Their May forecasts were poor and too optimistic (surprise about that). The empirical basis for their fiscal austerity support has vanished.

The Interim Assessment says:

Recent high-frequency indicators point to a slowdown in the pace of recovery of the world economy that is somewhat more pronounced than previously anticipated … Private consumption growth may be constrained by additional adjustments by households to the balance-sheet losses suffered during the recession … uncertainty about unemployment could put a damper on the expansion of private consumption …

The following graph is taken from their summary and shows the revised GDP growth forecasts for the third- and fourth-quarters in 2010. The May forecasts are the little stars above the bars – so you can see the disparity and the downward revisions. If you click the chart you will see a much larger and more detailed version of it that comes from the chart pack.

As a result of these new “insights” they are now saying that if things get worse, governments “with more fiscal space could also delay plans for fiscal consolidation”.

You can see they cannot really let go of their nonsensical notions of fiscal space but realise that the hard data is not looking good and that they would be hard-pressed denying the obvious – growth is declining as fiscal policy support is being withdrawn.

The OECD Directors should be the targets of class actions against them by the unemployed!

Back to the UK

In this context, I was pleased to read Larry Elliot’s column in the UK Guardian yesterday (September 9, 2010) – This is George Osborne’s chance to back away from austerity – which was written after the OECD released their revised September forecasts.

I agree with Elliot’s assessment:

The OECD’s volte-face over the dangers of spending cuts gives the chancellor plenty of cover to rethink his approach. If he doesn’t, he will be making a catastrophic blunder …

He argues that the legitimacy of the British austerity cuts has vanished and would appear to give the British Chancellor of the Exchequer a political free kick – just as the OECD were used in May 2010 to justify austerity – now they could be used as an authority to withdraw the austerity program.

Elliot calls the OECD’s latest forecasts and outlook a “crash re-think”. He characterises the OECD Statement about “recent high-frequency indicators” that I quoted above in this way:

If you are wondering what that tortured prose actually means, it can be expressed quite succinctly as “Careful: that looks like an iceberg ahead.”


He also argues that the data so far for the UK is far from encouraging. Despite “the 20% drop in sterling over the past three years, the trade gap in the three months to July was the worst on record”. Remember the Tories were relying on an export-led recovery to compensate for the public spending cuts. There won’t be such a recovery because growth is slowing everywhere.

Please read my blog – Fiscal austerity – the newest fallacy of composition – for more discussion on this point.

Elliot concludes in this way:

To sum up, then: the world economy is clearly slowing; both the OECD and the International Monetary Fund are now warning against over-aggressive tightening of policy; Britain’s economy is both unbalanced and weakening; and in less than six weeks’ time the government is planning to announce the biggest programme of spending cuts since the 1930s. Osborne has now been given a perfect excuse for moderating his plans. If he carries on regardless, he risks making the biggest economic blunder since John Major took Britain into the Exchange Rate Mechanism.

I agree!


There is no possible justification at present for any nation withdrawing the fiscal stimulus packages they introduced to stop their nations falling into another depression.

The rising and now persistently high unemployment is evidence that the fiscal support has not been sufficient. The fiscal support helped avoid a catastrophe but needed to be significantly larger to insulate the economies from the collapse and now persistent sluggishness in private spending.

The political point that Elliot is making is that the OECD and the IMF are now pushing out revised statements that undermine their earlier forecasts that growth was getting stronger and fiscal austerity would not hurt.

That “authority” which was false at the time is gone. There is now a political way out for these governments. If they don’t take it they will further trash their economies.

A note on monetary policy effectiveness

In their latest statement discussed above the OECD said that:

… if the slowdown in the recovery becomes entrenched, and the risk of downturn increases, additional monetary stimulus in the form of quantitative easing and keeping interest rates close to zero for a longer period may be necessary. Countries with more fiscal space could also delay plans for fiscal consolidation.

So the obsession with the effectiveness of monetary policy remains at the highest policy levels.

In this context you might like to read this New York Times article (September 8, 2010) – Falling Rates Aid Debtors, but Hamper Savers – which explains why monetary policy outcomes are uncertain because of different distributional impacts across the economy.

The article says:

Households and corporations alike are refinancing their loans in droves to take advantage of interest rates that seem impossibly cheap. But those same low rates come with a flip side, driving down the income of retirees and others who live off their savings … It is a side effect of a government policy meant to push down interest rates to a point that businesses and consumers are compelled to borrow and spend again, and yet it is hurting anyone with a savings account.

I will leave it to anyone who is interested to read the whole article – I haven’t time today to give an in-depth analysis but the point is one that MMT makes often in defence of the primacy of fiscal policy.

Monetary policy changes are too uncertain to be a reliable source of aggregate demand support (or discipline). Central bankers do not know accurately how interest rate changes impact on the different affected cohorts.

They not only do not know the net effects, but they are also unclear on how long these impacts take to work through the economy. All we know is that the lags fairly long.

Fiscal policy is direct and can be closely targeted to where you will get the best aggregate demand impact. It is also virtually immediate. For example, announce a Job Guarantee today and start paying the wages tomorrow and you will see aggregate spending rising (among the most disadvantaged) during the same week – virtually $-for-$ for the wage.

Monetary policy can never replicate this degree of precision and should be discarded as a counter-stabilising tool.

Meanwhile, back home … The Greens continue to demonstrate their neo-liberal leanings

Last year I wrote this blog – Neo-liberals invade The Greens! – which focused on the macroeconomic policy platform that the Australian Greens maintained.

I provided an excerpt from the The Greens Economics Policy platform (current as at November 2008). That section of their policy remains that way today and was part of their election manifesto. Here are two key macroeconomic policy statements:

8. government finances must be sustainable over the long run; budget deficits and surpluses must balance each other over the business cycle.

9. long term government borrowing is the preferred mechanism for funding long term infrastructure investments.

So they first of all advocate a policy that in the context of our national economy will see the private domestic sector running deficits overall (and continually increasing their indebtedness) commensurate with the external deficits (we always run) over the business cycle. That is the outcome of a government that could actually balance the national budget over the business cycle. It is a mindless fiscal rule to impose on a government because it ignores the fact aht the private sector are likely to desire to save overall.

Further, they perpetuate the myth that the federal government has to borrow to spend. A sovereign government such as Australia’s government is never revenue constrained because it is the monopoly issuer of the currency. Issuing debt is an act of corporate welfare and is totally unnecessary from a fiscal policy angle. Why do The Greens support providing guaranteed annuities to the top-end-of-town yet also support policies which maintain persistently high unemployment (which is the outcome implied by the policy 8 statement)?

It doesn’t really matter whether the policy statements represent political posturing or their flawed attempt to understand how the modern monetary economy works. The fact is that they are totally inapplicable depictions of the way a modern monetary economy such as Australia works.

They are also dangerously naive statements because they erode the capacity of the Government to achieve much of what The Greens aspire to.

There was some vigorous debate from Green supporters who essentially tried to deny the claim that the party’s macroeconomic stance was neo-liberal. I catalogued my responses to those claims and counter-claims in the following blogs – A response to (green) critics … Part 1A response to (green) critics – Part 2.

Anyway, our so-called most progressive party is still at it.

Yesterday (September 9, 2010), The Greens Federal Leader Bob Brown was talking to the ABC current affairs program – AM – about the likelihood of them pushing through legislation in cahoots with the conservatives now the Greens have more power in both houses of Parliament under the new arrangements. The discussion was about the monetary (budget) implications of any Green legislative action. Such things as the introduction of mandatory maternal leave were broached.

Brown offered these comments to various related questions (read the full transcript for the entire context):

BOB BROWN: … So what I am looking at here are bills that don’t involve a cost on the public purse but do give a good outcome in terms of governance, for example, a better democracy …

BOB BROWN: Yes that’s true but again the Greens will not be upsetting the bottom line of the budget in this legislation, but…

INTERVIEWER: So it’s more at the fringes rather than…

BOB BROWN: Not a cost on the public purse and that’s what we’ll be concentrating on in terms of getting good outcomes from this situation for the Australian people.

Conclusion: Bob Brown is a neo-liberal macroeconomics conservative. More damaging though is that this sort of ignorance about the way the budget works and its role in a modern monetary economy to further public purpose would undermine the prospects of introducing the good aspects of The Greens platform.

Their complicit consent to the erroneous neo-liberal myths about sovereign government budgets makes them part of the problem and so it is a pity more “left leaning” voters who used to support the Labor Party are now voting for The Greens and giving them the balance of power in the upper house and a more important role in the House of Representatives.

The left or progressives should form their own party and build their policy platform from the basis of a sound understanding of how the monetary system works and the opportunities it provides the national government to advance public purpose.

Saturday Quiz

The Saturday Quiz will be back sometime tomorrow. Too many people are starting to boast how they get 5/5 each week. So something has to be done about that – my brain is ticking over and I will stop that trend 🙂

That is enough for today!

This Post Has 26 Comments

  1. I don’t think fiscal austerity is driven purely by neo-liberal ideology with a misguided notion of the monetary system. We must also understand the financial beneficiaries (or perceived beneficiaries) of the policy.

    Take for instance the Tea Party in the USA. Recently announcements of ~$300 million funding for select Tea Party candidates. Is anyone putting up this kind of cash for a mere ideology? I seriously doubt it.

    For example: Holders of cash in the nations currency benefit, bond holders benefit. There are many people prepared to flush the economy down the drain to further their own personal wealth. It has to be said, this does not bode well. These wealth hoarders are not putting their capital to productive use at present. In good time they will acquire distressed productive assets. Only then will credit growth kick in to raise the value of the assets.

    Understand the motives and figure out the important players before beating up the ideology. The ideology has developed and evolved to support the financial positioning of the major players.

  2. Not only is the current UK government targetting welfare payments, they are also pushing crazy ideas about the ‘funding of university places’.

    I would have thought this was the easiest sell for state funding ever – even in ‘tax funding terms’. Graduates earn more. Taxes are percentage based. More tax paid. Ergo even in neo-classic terms you get your money back (of course the state always does anyway, but let’s leave that to one side for now).

    Yet now they want to increase the tax percentage even more on graduate workers to ‘fund’ universities. And nobody, but nobody seems to be making the counter argument. What is going on?

  3. In regards to the New York Times article — Falling Rates Aid Debtors, but Hamper Savers — I see your point that monetary policy has some uncertain distributional outcomes, but you must admit that the argument that low interest rates “hurt savers” is a fallacy. Low interest rates reduce the incentive to save, but only out of a given income. Because they tend to increase demand for investment, low interest rates increase savings overall. Furthermore, the supposed savers who are forced to accept low interest rates on Treasuries are most likely the same people who are enjoying massively out-sized capital gains from their existing stock of bonds in the first place.

    I am surprised at how often this “low rates is punishing savers” mantra gets repeated — the rebuttal to this comes straight out of the General Theory which was published only about 75 years ago. I hope you would agree that, unless loose monetary policy somehow reduces demand for investment, it cannot reduce the level of savings in the economy as a whole.

  4. My problem with this is that I worry that prior structural deficits have created the build up of wealth that is creating the distortions resulting in the current need for stimulus spending. The bountiful funding available for the Tea party is a perfect example of the process in action. If capital gains tax, inheritance tax and income tax for those on >1.5x the median wage was used to fund a flat £4000/year hand out to everyone, then even a surplus budget could surely get the economy going whilst at the same time reducing the distorting glut of private wealth. To me the best way to get real work for the least employable is to give them (and everyone else) a flat money hand out irrespective of whether they can get employment on top. Currently in the UK if someone gets some work they can be little better off then they would be when unemployed. What I’m saying would probably hold up more for the US than the UK though as the UK is so financial services dependent that it is more like wall street as a country on its own rather than the USA as a whole.

  5. stone,

    Taxes don’t fund anything. Taxation is just friction to stop state spending causing inflation.

    If the state gives somebody £4000 then a number of transactions are induced and the state takes a percentage every time. Taxation ensures that there are a finite number of transactions the £4K will induce before it disappears from the economy. The size of the taxation determines whether that is a smaller or larger number of transactions.

    Because the UK is a fiat issuing nation sovereign in the currency, we don’t have to prior fund the £4K.

    Much better that the £4K is linked to a job – that way we don’t just get the spending demand, we get some real value for the money (and those working get some self-respect). It also sorts out the hard pressed from the work shy – which would keep the Daily Mail mob happy.

  6. Neil Wilson:I agree taxes don’t fund anything. I’m just saying that the pressing need at the moment is for taxes to reduce the pool of wealth. I think the pool of wealth is a tremendous distorting influence that is stopping the private sector from functioning and corrupting the state sector. I disagree about job creation schemes being better than just handing money out. To my mind, if the public sector wants work done it is vital for employment to be seen as a cost not an aim in itself. Otherwise there is awful waste surely.

  7. The Greens need to add a few points to their economic program:

    “8. government finances must be sustainable over the long run; budget deficits and surpluses must balance each other over the business cycle.”

    8a. There must be no increase in net financial assets over a business cycle, regardless of the productivity of the economy.

    8b. Households must increase their indebtedness over the long run, while government does nothing.

    This is kind of fun, we should do this for all of the political parties’ economic policy statements.

  8. Neil Wilson –

    Taxes do fund things. They don’t usually prior fund things, but they’re much more than just a friction.

    There are three different kinds of inflation: demand pull, cost push and currency slide. Currency slide inflation is potentially the most serious because unlike the others, it can (under certain circumstances) develop into hyperinflation. Friction will only stop demand pull inflation.

    Creating money reduces its value, which can lead to currency slide inflation. But funding things with taxes reduces or eliminates the amount of money that governments have to create.

  9. Neil Wilson:You make it sound as though the £4000 doesn’t need to be got rid of because it just mills around harmlessly. Think about the series of transactions from that £4000. A loaf of bread is bought, a supermarket makes a profit, share buy backs increase the stockprice, a trading program captures that for an investment bank, they fund political parties, employ retired prime-ministers etc etc but above all they accumulate financial power.

  10. pebird, The Greens in the UK used to be overtly in favor of a zero economic growth model as in your “8a. There must be no increase in net financial assets over a business cycle, regardless of the productivity of the economy.” Its perfectly possible to have increasing affluence due to increasing efficiencies whilst at the same time having asset price deflation due to a government surplus surely?

  11. Neil Wilson: I realize my saying “accumulate financial power” is very vague. What I mean is (at the most innocuous level) their ability to entirely capture that profit made by the supermarket even though most of the supermarket shares are actually owned by pension funds etc. At the other end of the spectrum it is the potential power to corner markets and hold the world to ransom. Basically to put property law under such stress that the rule of law collapses. Also the countries affected are not necessarily those doing the deficit spending.

  12. Bill –

    So they first of all advocate a policy that in the context of our national economy will see the private domestic sector running deficits overall (and continually increasing their indebtedness) commensurate with the external deficits (we always run) over the business cycle. That is the outcome of a government that could actually balance the national budget over the business cycle. It is a mindless fiscal rule to impose on a government because it ignores the fact aht the private sector are likely to desire to save overall.

    You’re confusing what’s typical, what always happens and what rarely happens!

    External deficits over the business cycle are typical, but there’s no reason why they have to occur – indeed if the mining boom continues, they probably won’t.

    But the private sector do always run continually increasing deficits – that’s the main driver of the economic cycle. If they fail to do so, we are likely to go into recession.

    The private sector are unlikely to desire to save overall, except in a downturn or a depression. So the Greens are advocating a sensible policy.

  13. Bernanke’s been broadcasting that it is our elected officials responsibility to engineer employment incentives. That is tacit confirmation that Bernanke knows that buying Treasuries doesn’t create new jobs. We should have been arguing all along about: why did Congress gave the FED an employment mandate in the first place?

    Fiscal spending can be used to target specific investment decisions (your “degree of precision”). But Congress has not demonstrated that it knows how to legislate new spending. We no longer get the bang for the buck at the Federal level.

  14. A great blog, thanks Bill.


    Bill is not confusing (except Saturday quizzes- more semantic traps than the King James Bible) anything.

    How does mining, 6% of GDP, produce a current account surplus? That wouldn’t be a boom, it would be a miracle.

    It is not sensible policy for any government, sovereign in its own currency, to force its domestic private sector into debt and/or poverty at any stage of the business cycle.

    It is especially suicidal, in a planetary (not political party) sense, if economic delusions stand in the way of government running whatever deficit it takes to convert shabby 19th century forms of energy production (oops there goes mining) to green sustainable, renewable forms. Well run deficits could get us to full employment too.

    That, Aidan, is a sensible policy. Greens parroting the two major parties’ line in economic mythology is tragic.

    All the Best,


  15. I had a thought last night. The fiscal austerity movement is just a manifestation of the concerns of the baby boomer generation.

    What is keeping baby boomers awake at night? They are entirely consumed with thoughts of a wealthy and healthy retirement. Preservation of wealth, passing their wealth to the next generation. These are the primary political motivators of the day.

    Gen X and Y are only interested in the next shiny hand phone. BB’s are the politically active force. Financiers have their hand perfectly on the pulse, their fiscal strategy is aligned perfectly with BB aspirations.

    This is an unstoppable juggernaut, BB political power backed by a powerful financial lobby. It will only die with the BB’s. Any political attempts to change policy have to resonate with BB’s aspirations to stand half a chance. All attempts that interfere with the financiers profit strategy will be fiercely fought in the press.

  16. AQ –

    Bill is not confusing (except Saturday quizzes- more semantic traps than the King James Bible) anything.
    How does mining, 6% of GDP, produce a current account surplus? That wouldn’t be a boom, it would be a miracle.

    I didn’t say it would produce a current account surplus.
    It is likely to produce a trade surplus, because the vast majority of the stuff we mine is exported.

    It is not sensible policy for any government, sovereign in its own currency, to force its domestic private sector into debt and/or poverty at any stage of the business cycle.
    I agree, but that’s irrelevant. The private sector don’t need forcing – it’s what they do naturally!

    In a depression the private sector may desire to net save, but in normal time the opposite is true. And in a boom the private sector desires to increase its debt so much that governments typically raise interest rates to force them not to increase their deficits so much.

    It is especially suicidal, in a planetary (not political party) sense, if economic delusions stand in the way of government running whatever deficit it takes to convert shabby 19th century forms of energy production (oops there goes mining) to green sustainable, renewable forms.
    True, but that’s more the result of value judgements. We can afford to move to sustainable energy production, but ultimately governments don’t think it’s worth doing so to a great extent yet.

    And no, there doesn’t go mining. The thermal coal industry may be devastated, but there’s still metallurgical coal, iron ore, bauxite, gold, copper, uranium, lead, zinc, silver and many other minerals…

    Well run deficits could get us to full employment too.
    Deficits alone are not sufficient to achieve full employment. Nor should deficits be needed to get us to full employment in the boom times.

    That, Aidan, is a sensible policy. Greens parroting the two major parties’ line in economic mythology is tragic.
    Until there’s a credible alternative, they don’t have much choice. What’s tragic is that Bill’s reliance on the incorrect assumption that the private sector desires to net save is helping prevent MMT being seen as that alternative.

    Even so, the objective to balance the budget over the economic cycle is quite reasonable, and completely different from the major parties’ objective of rushing back to surplus as quickly as possible.

  17. “In a depression the private sector may desire to net save, but in normal time the opposite is true”

    As far as I can discern, this situation is a recent one – around 15 years old. Before that, households at least typically saved betweeen 10% – 15% of their income. They did not merely save in response to recession and dissave the rest of the time.

    At least that’s how I seem to recall it. Do you have any graphs showing that the private sector has always accrued net savings during recessionary episodes only and that savings have typically fallen very low or gone negative soon after and not risen again until the next downturn?

  18. Lefty, isn’t the situation of US and UK people not saving like they used to a symptom of the widening gulf between asset prices and wages/ non-speculative earnings from assets?

  19. Lefty –

    Considering how many people take out large mortgages, I view your figure with some skepticism. But even if you’re right, it’s largely irrelevant because the trend is dominated by businesses rather than individuals.

    Sorry, I don’t have any graphs.

  20. stone: I think that during an asset price deflation, you have a restructuring economy, so those with lowered incomes will be faced with balance sheet crises – which is more devastating for households than firms. That may be efficient for entities with potentially infinite lives (firms), but for individuals it is barbaric, in my humble opinion.

    Any increase in affluence is relative only – on a net basis the economy is poorer surely.

  21. Pebird, is your meaning about households and small businesses that debts become awful to pay off? Surely that only is the case if wage deflation matches asset price deflation? Surely if you have a £200K house and a £200K morgage and the house value drops to £40K but your wages remain the same then you are not in financial hardship? I thought that that was what happened with Japanese households and that they did not suffer. I’m probably missing something crucial but I’m can’t see it.
    What I meant by an increase in affluence was whether people are more able to get health care, education, food, spend time with kids, not work until they are 75years old unless they want to etc. Or measures such as child mortality rate and life expectancy.

  22. Pebird, I’m trying to think out what asset price deflation (without wage and consumer price deflation) entails to sense how it could be barbaric. House prices would fall but existing morgages could be met, farmland prices would fall but rents payed by farmers would be the same, the stock market would drop but profits would be maintained so P/E ratios would be say 8:1 rather than 16:1 or whatever. I’m pig ignorant about such matters but surely what matters to corporate bond holders is what the stock market value of a company is at the time it goes bust ie what the “stay the course” capital value is and it means nothing to have a lot of “now you see it now you dont” market capitalisation. I’m really struggling to spot any barbarism in there. The benefits would be that investment would then be on the basis of potential genuine earnings from the real economy and so would allocate resources to those companies that could best use them to provide real goods and services. Capital would be scarce and so would be fully occupied with the real economy rather than with managing and harvesting a swirling glut of excess money. That would free up highly numerate hard working people currently occupied by financialization.

  23. Aidan – go to the link below (Reserve bank chart pack).

    Click on no.2 PDF (Output, expenditure, activity, and financial conditions indicators for the Australian economy). Page 3 shows household assets and saving from around 1990. You will see that households dissaving is only a phenomenon of this decade just gone. Note as well the enormous run up in household debt beginning around 15 years ago.

    For a longer term veiw, this treasury document shows private sector net saving back as far as 1960 (hopefully the link works).

    It is a 30 page long document which I have not been inclined to read thoroughly yet so you may see things I have not. However, it is clear that although the ratio trends up and down over the decades, historically, the private sector – as Bill says – desires to net save. I’m a little under 40 and I clearly remember my grandparents extolling the virtues of saving and lecturing us kids quite often about it.

    As an aside, when the document says……….

    “In summary the significant decline in the ABS net household saving ratio since
    the mid-1970s appears to reflect measurement and classification limitations
    rather than a significant change in saving behaviour”

    ………..and they appear to argue that household saving should be veiwed in the context of rising asset values ie household debt has gone stratospheric but don’t worry because the value of the houses they are sitting on has gone stratospheric as well, you have to wonder what they think of that now (I believe the paper was written pre – Global Financial Crisis) that the value of those assets has been severely impacted but the debt commitments remain.

  24. “Lefty, isn’t the situation of US and UK people not saving like they used to a symptom of the widening gulf between asset prices and wages/ non-speculative earnings from assets?”


    I have no formal economic training but that appears to be a large part to me.

    As I said above, I wonder what they think now that in many places the value of the assets have been severely impacted (Australia appears to be an exception thus far) but the debt commitments remain.

    I seem to recall that before the GFC, the RBA made statements to the effect of “don’t worry about ballooning household debt, households can manage heavy debt burdens better than they once could”.

    Recently, Guy Dobelle – assistant RBA govenor – made a speech titled “On risk and uncertainty” in which that veiw appears to have changed quite markedly. Bill has no doubt read it and I’m sure he appreciates it when high-profile RBA figures begin a speech by qouting musicians (Jim Morrison in this case).

    Anyway, the final paragraph says….

    “Given these difficulties, it is important to try to make the system as robust as possible to the inherent irreducible uncertainty. One key element of this is restraining leverage, which can limit the number of illnesses that turn into fatalities. ”

    So restraining leverage is now good apparently. As they say, hindsight is always 20/20.

  25. stone: “My problem with this is that I worry that prior structural deficits have created the build up of wealth that is creating the distortions resulting in the current need for stimulus spending.”

    Could you explain your view a little more? Usually when people talk about a structural deficit they mean deficits caused by ongoing deficit spending on social programs. Such spending does not build up wealth. What do you mean by structural deficits that have built up wealth? Thanks. 🙂

  26. Min, as I understood it, the MMT idea is that deficit spending by the government is what creates money in the private sector (vertical money creation). The money may initially go to social programs but subsequently ends up accumulating as savings/investments/assets. To my mind the problem is when the ratio between wages/consumer prices and savings/investments/assets gets out of whack leading to financialization of the economy and state.

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