Autumn Statement was a confession of abject failure

The half-way mark came last week for the suffering, seemingly, ever stoical British. Why they are ever stoical in the face of an exploitative, class society where the rich always find ways to push the losses of their caprice and incompetence onto the poor is a cultural story I have never understood (despite living in Britain for a time in the 1980s). But the Autumn Statement (December 5, 2012) from the failed Chancellor marks the half-way point in the British government’s tenure on office. At this stage, the assessment is that it has unambiguously failed in its mandate and its now transparent attack on the poor is the only thing that is obvious. All that can be said is that the half-way mark is gone and the national election draws nearer every day. The pity is that the display by British Labour, in their response to the Autumn Statement, was worse than pathetic. They better hurry up with alternative policy development, which doesn’t include proposing deficit cuts that are more “humane” than the current Government’s approach.

The Chancellor’s – Autumn Statement 2012 – was a dismal admission of policy failure and ideological stubbornness despite what the words spoken by the Chancellor literally meant.

With all the vital indicators heading south and the financial measures upon which the Chancellor holds out as being crucial turning against him it was outrageous for him to claim that:

… British economy is healing.

It is getting sicker by the day and had a temporary visit from the good fairy (in the form of the Olympics) that is by definition a once-off impact which will dissipate before the winter is done.

The fact that the results (“debt starts to fall”) of the austerity horizon is being extended to 2016-17 (“delayed by one year”) is an admission of failure.

The fact that the Office of Budget Responsibility has seriously under-estimated the damage the fiscal position is causing does not justify the Chancellor saying:

I want to thank Robert Chote, his fellow Members of the Budget Responsibility Committee Steve Nickell and Graham Parker, and all their staff at the OBR for their rigorous approach.

One of the advantages of the creation of the OBR is that not only do we get independent forecasts, we also get an independent explanation of why the forecasts are as they are.

If, for instance, lower growth was the result of the Government’s fiscal policy, they would say so.

But they do not.

They say the economy has “performed less strongly” than they had expected.

Which is about as bad as it gets.

The OBR’s forecasts have been abysmal – plain wrong by a margin.

After the Autumn Statement 2012 was delivered by the British Chancellor, the BBC Newsnight’s Jeremy Paxton interviewed the Chairman of the UK Office for Budget Responsibility (Robert Chote) on December 6, 2012. In the interview – Chote: Economic forecasts ‘difficult’ to make – you learn quite a lot about how career economists are prepared to be compromised to their political masters and when pushed know full well that the political spin does not reflect the underlying reality.

The interview began with Paxman asking “What is the point of the OBR?”, which was in the context of the massive errors in forecasts that the agency published over the last two years and which the government used to justify its harsh austerity program.

Chote replied that OBR had to make “Difficult judgements” – but “You got them wrong” – we “Changed our mind” – but “What use are you?” – “To provide best professional judgements” – “How has it helped George Osborne to have dud forecasts” – “It has helped to know where the forecasts come from” – “But their wrong” – “Every economic forecast turns out to be wrong” – “So when George Osborne cites your figures we should conclude they are wrong?” – “Absolutely”.

Chote was then asked: “Would you give this country a AAA rating?” – “That is not our job … the key difference is that we have our own currency. The notion of the insolvency is broader” – “You mean the government could just print more money” – “Yes, the government has been doing that” – “Would it matter if Britain lost its AAA rating?” – “Other countries have lost their ratings and it hasn’t made an enormous difference”.

In other words, the credit rating agencies are largely irrelevant, which is counter the entire political narrative coming from the British government.

The interview finished with this Q and A:

Q: So as a highly trained economist you have no views on this topic?

A: I have very interesting views and you will have to wait for my memoirs

No principle. Pure political functionary.

Why were the forecasts so wrong and they are now forecasting an extended recession? According to the Chancellor the OBR:

… forecast growth this year of -0.1%, but in their view “the weaker than expected growth can be more than accounted for by over-optimism regarding net trade”.

The mantra that the UK economy could fill the gap in spending left by the fiscal austerity with a boom in net exports was always wrong. It has been a centrepiece of IMF austerity programs. Don’t worry – you can export your way out of the doldrums.

Wrong – if austerity is generalised, which it now is. Spending equals income – first rule of macroeconomics. Exports require imports. Imports require spending. You cannot get spending by cutting spending and undermining private income growth.

Forecasting a strong growth in net exports in the face of almost universal austerity – exchange rate depreciation or not – was a demonstration of the incompetence of the OBR (and all the rest of them the pundits and sycophants (the two are interchangeable in this context) who bought and/or perpetuated this line).

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

The Chancellor was also wrong to suggest the IMF was currently supporting the Government’s position. The Chancellor said that “the IMF” agrees that the problems besetting the UK economy are “largely driven by problems abroad”.

In July 2012, the IMF published its latest – Article IV assessment of the British economy. These papers relate to “Article IV of the IMF’s Articles of Agreement”, which requires that the “IMF holds bilateral discussions with members, usually every year” and report on the outcomes of the meetings.

In that Report, the IMF conclude that:

Recovery has stalled. Post-crisis repair and rebalancing of the UK economy is likely to be more prolonged than initially envisaged. Confidence is weak and uncertainty is high. Looking ahead, the economy is expected to grow modestly, but with current policy settings the pace will be insufficient to absorb significant slack in the economy, raising the risk of a permanent loss of productive capacity.

It emphasises (in bold) that “Demand support is needed” – “More expansionary demand policies would close the output gap faster” and “planned pace of structural fiscal tightening will need to slow” and:

The UK has the fiscal space to make such adjustments.

Now reject the IMF’s concept of “fiscal space” – see discussion below about surpluses and fiscal capacity. But what we can conclude is that the IMF doesn’t support the claims made by the Chancellor in his Autumn Statement, such as:

… some say we should abandon our deficit plan, and try to borrow more.

They think by borrowing more, they can borrow less.

That would risk higher interest rates, more debt interest payments and a complete loss of Britain’s fiscal credibility.

We are not taking that road to ruin.

Clearly, the IMF rejects that logic.

The IMF also implicated the British financial system and said that the British government needed to do more work in addressing “to big too fail issues” via legislative reform, “intensify supervision and broaden its authority over financial holding companies” etc.

Now whether one agrees with the proposed financial reforms is not the point. The point is that these are domestic issues within the control of the Government. They are not largely “problems abroad”.

I could obviously spend a lot of time analysing the Autumn Statement line items. The most alarming aspect was the decision to cut indexation for welfare recipients, which according to the Liberal Democrats coalition partners, started out as an absolute three year freeze. Whatever the truth, forcing real income cuts onto the most disadvantaged citizens in Britain is a vicious act not to mention economically irrational.

It isn’t “fair” in the sense of sharing the burdens of the austerity especially when the reductions in the corporation tax will help the high income groups and foreign owners.

It also is not very sensible from an economic perspective because it takes more spending out of the economy than the meagre cuts because the marginal propensity to spend of that group is as close to one as you will get.

The welfare cuts disclose – or adds transparency – the real agenda that is being pursued – which is a wholesale attack on the British system of welfare.

Another interesting point that the IMF Article IV made was that:

Budget neutral reallocations should be undertaken to make room to increase government spending on items with higher multipliers (e.g., public investment).

It is interesting because it introduces the concept of the level of fiscal support for demand and the different impacts that the composition of public spending can have.

First, it is true that a government can maintain the same level of stimulus or contraction by altering the composition of its spending. For example, a nation might already be at full employment but the government might conclude there is too much income inequity.

It doesn’t want to just give the low income workers cash bonuses or tax breaks because that would push nominal demand growth beyond the real capacity of the economy to absorb it by increasing production.

In that context, the government might also impose higher tax rates on other income cohorts to redistribute the aggregate spending capacity in the economy towards low income groups.

So its overall budget position – the degree of stimulus – remains unchanged – by the distributive effects of the overall government spending is changed by altering the composition of government spending and taxes.

It is also true that fiscal policy multipliers are all equal. There is really no such thing as “the” multiplier. Before I go into that it is fair to say that the IMF is generally confused about multipliers.

In the IMF Working Paper WP12/150 (June 2012) – What Determines Government Spending Multipliers? – there is an elaborate technical discussion about how multipliers are low.

But despite the 46-pages of analysis and modelling the clue to the use of this paper is to be found on Page 4:

As the number of observations in our sample is limited and fiscal shocks may be measured with error, confidence intervals are, in general, quite wide, and point estimates must be taken with a grain of salt.

Which means in English – the econometric results presented as authority are useless.

That is no surprise given the theoretical model that the paper explores, which is full of neo-liberal myths.

For example they conclude that:

A second finding with direct policy implications concerns the marked increase in fiscal multipliers during times of financial crisis. On the one hand, this may be taken as evidence in support of fiscal stimulus during times of acute financial stress. On the other hand, our empirical results also show that many countries have historically cut back government spending during financial crises, presumably out of concern over debt sustainability. In this sense, a large conditional multiplier provides a stark warning about the costs of financial turmoil and an argument in favor of building up fiscal buffers in normal times so as to avoid fiscal retrenchment when it is most painful.

The concept of building up fiscal buffers has no application when a currency-issuing government is in focus. What does it mean? The IMF would tell us that budget surpluses provide those buffers and enhance the capacity of the nation to run deficits at a later date if necessary.

The reality is that for such a government a surplus today provides no more or less financial capacity tomorrow to run a deficit. A truly sovereign (currency-issuing) government can run whatever budget outcome is required (in financial terms) irrespective of its past budget outcome. A currency-issuing government cannot meaningfully save in its own currency. It can always buy whatever is for sale in its own currency at any point in time.

In fact, all we can say, is that it is likely that running a surplus today will increase the probability that it will have to run larger deficits “tomorrow” because the surpluses will have drained aggregate demand growth. But even that statement is highly conditional on what the other sectors – private domestic and external – are deciding with respect to income and spending decisions.

This point resonates with the earlier discussion I had about “fiscal space”.

On the topic of multipliers, one economist who explored the literature (see reference below) concluded that:

One clear message emerges from (this) vast literature: estimates of multipliers are all over the map, providing empirical support for virtually any policy conclusion. The diversity of findings, often based on the same U.S. time series data, highlights the difficulties in obtaining reliable estimates of fiscal effects and points to the need for systematic analysis that confronts fiscal policy’s complexities.

[Full Reference: Leeper, E. M. (2010) ‘Monetary Science, Fiscal Alchemy’, NBER Working Papers 16510, National Bureau of Economic Research]

For further discussion about multipliers, please read my blog – Spending multipliers.

Remember the revelations (on Page 43) in latest IMF World Economic Outlook update (October 12, 2012) – Coping with High Debt and Sluggish Growth:

More work on how fiscal multipliers depend on time and economic conditions is warranted.

This was part of the WEO Update, where the IMF spell out how inaccurate their estimates (biased towards zero) of the fiscal multipliers have been. I covered this revelation in this blog – So who is going to answer for their culpability?

But the IMF are now not only admitting that they (like all these “agencies”) have grossly underestimated current output gaps but they also have admitted in that WEO update that they severely underestimated of the size of the fiscal multiplier.

The first error leads to imposing policies that are excessively contractionary.

The second error leads the government to underestimate the damage that the fiscal contraction causes. Both lead to disastrous outcomes accompanying fiscal austerity and explain why the world is in such a mess.

On Page 41 of the IMF WEO Update we encounter “Box 1.1. Are We Underestimating Short-term Fiscal Multipliers?” There is a lot of technical talk contained in the box, which is meant to give the impression that this is science we are dealing with and the IMF modellers are on top of their game.

But this is what the IMF are now saying:

The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2, depending on the forecast source and the specifics of the estimation approach. Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.

Which is contradicting most of their earlier research that governments around the world used, in part, to craft and justify their austerity packages.

In English, the IMF admission means that if the government cuts spending by $1 billion that once all the adjustments are exhausted the official estimates would suggest that real GDP falls by $500 million (based on a multiplier of 0.5).

However if the multiplier was 1.7, real GDP would fall by $1.7 billion – more than 3 times the official estimate.

In other words, the estimates of the damage caused by the IMFs constant hectoring for governments to impose fiscal austerity, have been grossly understated.

The reverse holds for an expansion.

In terms of changing the composition of net spending (spending and tax policy) = there is widespread agreement that tax cuts are less expansionary than spending increases – for a given initial fiscal change. The tax multiplier, is a macroeconomic rather than a microeconomic concept, and builds on the fact that households pay some tax out of gross income and the tax rate specifies that proportion. In reality, there are a myriad of tax rates but the total effect can be summarised by a single (weighted-average!) tax rate.

Households consume out of disposable income. Assume the overall propensity to consume is 0.80 – which means that overall consumers will spend 80 cents for every extra dollar of disposable income received.

So, if the tax rate rises, then disposable income falls. If nothing else changes, then this fall in disposable income will lead to a reduction in consumption (equal to the propensity to consume times the fall in disposable income). The resulting fall in GDP is defined as the tax multiplier.

Similarly, when tax rates falls and increase disposable income, the reverse occurs. Not that some of the tax change impacts on saving – that is, not all of it goes into spending changes.

In contrast, when the government spends a $, the full $ goes into the expenditure stream.

There are also discussions about the multipliers associated with different components or types of government spending. For example, a cash transfer to a low-income earner will have a higher impact than the same transfer to a higher income earner because less will be loss in saving in the first case. That is the marginal propensity to consume varies across different income cohorts.

Further, it is argued (as the IMF is doing in the quote above), that the multiplier impact of public spending on infrastructure is higher than spending on consumption (for example, personal transfers) because it “crowds in” more private spending.

As an example, if the government builds a major piece of public infrastructure – a new road, bridge, port etc – then it would expect complementary private spending to occur because firms will have an incentive to invest in their own profit-seeking capacity to exploit the new public capital.

There is merit in exploring the composition of a stimulus package to gain the most expansion for a given nominal outlay. The focus should mostly be on gaining the best employment outcome per net spending dollar but the two – output and employment – are, of-course intrinsically linked.

However, it is highly unlikely that a fiscally neutral change in policy will make much different. The fact is that the overall fiscal stance in the United Kingdom is becoming highly contractionary at at time when non-government spending is also draining demand.

That is, fiscal policy is pro-cyclical.

Given the private domestic sector is deleveraging overall and the external sector is failing to drive growth, the fiscal stance has to be counter-cyclical rather than pro-cyclical.

So it might be of merit to reconsider the composition of the Government’s fiscal position – and I would urge they provide a vastly improved outlook for low income workers, introduce large-scale employment creation (preferably a Job Guarantee) and invest heavily in environmentally sustainable renewable energy infrastructure.

But that will not be sufficient. They have to move the fiscal stance into a highly expansionary position and trying to rely on exploiting differential multipliers will not be sufficient.

Conclusion

The Autumn Statement 2012 was a declaration of failure and exposed the underlying intent of the British government – to undermine income support to the most disadvantaged citizens and increase the state withdrawal from the economy.

There is no economic justification that they can find to suggest the British economy is “healing”.

All that can be said is that the half-way mark is gone and the national election draws nearer every day. The pity is that the display by British Labour in their response to the Autumn Statement was worse than pathetic. They better hurry up with alternative policy development, which doesn’t include proposing deficit cuts that are more “humane” than the current Government’s approach.

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.