Yesterday, the - Flash Germany PMI - was released, which shows that "German business activity"…
The Olympics have come and gone. No doubt the event gave some macroeconomic respite to the British economy because major events bring immediate spending and spending drives output and national income. But the fourth-quarter 2012 real GDP data showed that the British economy had contracted by -0.3 per cent. Household final consumption expenditure slowed throughout 2012 as private investment growth contracted over the second-half of 2012. Further, despite the hope that the fiscal austerity would be painless as a result of a boost in net exports, especially given the depreciation in the British currency, the data showed the the current account deficit increased as a result of a fall in exports over 2012. It was in this context that the British government brought down the – 2013 Budget – which provides no path out of this malaise. At a time when the correct economic strategy would have included a political admission that the previous 3 budgets were detrimental interventions for the British economy and a commitment to some discretionary stimulus, the British government chose to adopt a neutral position in the coming financial year, which when taken in perspective just maintains the contractionary bias of fiscal policy. The mismanagement of the British economy thus continues.
The Budget followed the typical pattern that we have seen in the past in a number of countries riddled with neo-liberal ideology. As the separation between reality and narrative widens, the dogma turns to meaningless catch-cries – such as we saw in the – Budget speech of the Chancellor.
For example, he told the British public that:
“It is a Budget for our Aspiration Nation”.
“unless we fire up the aspirations of the British people, light the fires of ambition within our nation …”
“So this Budget makes a new offer to the aspiration nation”.
“For in the end, aspiration is about living in a country where people can get jobs and fulfil their dreams”.
and claims such as that in the face of dreadful economic data that has been, in no small way, caused by the policies introduced in the Chancellor’s last three budgets.
The substance has gone. The reality is clear. And so it is time to ramp up the abstract – the denial of the reality.
It is the same sort of denial as we heard earlier in the year when European Commission president José Manuel Barroso declared that “the euro crisis is a thing of the past”.
The reality is a disastrous record of forecasting failure by the Government. Rising poverty rates. Falling real wages. Persistently high unemployment. And … a contracting economy.
I agree with the assessment of the New Statement analysis (March 20, 2013) – The real message of Osborne’s Budget: as you were, only poorer.
The article writes that:
So what we heard today was above all a statement of political positioning by the Chancellor. He has no intention of conceding that his own policies are in any way responsible for the parlous state of the national finances (deficit reduction stalled; debt rising) so he is obliged to pretend that the broad outline of the strategy is the right one and that only extraneous and transient factors are to blame for disappointing economic performance.
You should note that from the perspective of Modern Monetary Theory (MMT) terminology such as “parlous state of the national finances” has no meaning. The budget outcome just reflects what is happening in the real economy.
It is the parlous state of the real economy that matters and which the British government should be held accountable for, given that it can hardly blame the past Administration after 3 years of office.
But the blame all sorts of extraneous factors is the tactic the British government has adopted and the Opposition seems incapable of breaking down that myth. That is mostly because the macroeconomic narrative of the latter is only different from the former by degrees. They are both captured by neo-liberalism and cannot see beyond that blindness.
The Budget continues to offer the same rhetoric – the Ricardian dream – that something mystical will happen which will convince the private sector to reverse its current caution – notwithstanding the persistently high unemployment and falling economic growth.
The Government wants the British people to believe that the vast body of evidence from behavioural science that confidence comes with good news and caution and pessimism accompanies (and reinforces) bad news is wrong.
Nothing new was produced to provide a reversal of the current negative trend in the British economy. There was nothing to accelerate that trend. But that isn’t the point.
The following graph shows the successive real GDP growth forecasts starting with the 2010 British Budget through to the current Budget. As you scan through the sequence you should realise that the previous year’s bar is the actual outcome (that is, is not a forecast).
The pattern is very clear – a sequence of gross errors of optimism. The more distant forecasts become progressively downgraded as the actual data reveals that the Government’s fiscal strategy is not consistent with the underlying behaviour in the economy.
You should note that I am not against forecasting (I do it) and realise that forecast errors will always be present given the nature of the exercise – making up estimates in the face of endemic uncertainty.
The problem is that the forecasts that come out of organisations such as the IMF and the British government that are driven by macroeconomic modelling, which is more a product of blind ideological belief in the virtues of the market model than any concordance with reality, are systematically biased. That is, the errors tend to be non-random. They are over-optimistic when government is withdrawing its net spending – so as to understate the impacts of austerity.
Year after year they understate the slowdown in economic activity. The lagged response to the actual data in the following year is also biased towards optimism.
However, they will never admit they got it wrong because they were using the wrong model. They blame ructions in Europe and other extraneous circumstances. Sure enough, the failed macroeconomic policies in the Eurozone have undermined world trade conditions. But the same can be said of the British government behaviour.
Please read my blog – Fiscal austerity – the newest fallacy of composition – for more discussion on this point.
Whatever, the external position facing a nation, and whatever the intentions of the private domestic sector, the government remains in the central position to manipulate aggregate demand growth to ensure that these forecast errors are not systematically biased. The systematic bias, in this case, occurs because of the fiscal austerity.
We can make whatever assumption we like about the “faith” of the Office of Budget Responsibility and the British Treasury. That is, do they lie or do they just produce the outcomes of totally inappropriate models. I suspect the truth includes both of these descriptors.
In terms of the forecasts, the – Budget Report – produced a Table 1.1 Contributions to real GDP growth from 2010Q1 to 2012Q3 (Page 11), which I reproduce here:
What is apparent is that when the Government took office in May 2010 and handed down its first Budget in June 2010 it categorically failed to understand the macroeconomic circumstances that it had inherited. Not just the data but the behavioural context which drives the data.
It clearly thought that the private sector would have a greater thirst for more private debt and would drive overall aggregate spending growth. In part this was part of the Ricardian rhetoric that the Prime Minister and his Chancellor pushed out ad nauseum as they tried to justify the imposition of fiscal austerity.
The notion of Ricardian Equivalence – these days captured by the claim of “fiscal expansion contraction” – claims that that private spending is weak because the private sector is scared of the future tax implications of the rising budget deficits.
So if the government spends and borrows, consumers and firms will allegedly anticipate higher future taxes and spend less now, which has the effect of offsetting the stimulus.
The modern “founder” of the idea, Robert Barro claimed that if the individual perceives that the government has spent $500 this year but proposes to tax him/her next year at such a rate that the debt will be cleared then the person will still be poorer over their lifetime and will probably cut back consumption now to save the money to pay the higher taxes.
So the government spending has no real effect on output and employment irrespective of whether it is “tax-financed” or “debt-financed”. That is the Barro version of Ricardian Equivalence.
Please read my blog – Pushing the fantasy barrow – for more discussion on this point.
Every time this notion is advanced to predict real world events, the Ricardian Equivalence models have got it exactly wrong. There has never been any predictive capacity in the models.
Once again this was an example of a mathematical model built on un-real assumptions generating conclusions that were appealing to the dominant anti-deficit ideology but which fundamentally failed to deliver predictions that corresponded even remotely with what actually happened.
Barro’s RE theorem has been shown to be a dismal failure regularly and should not be used as an authority to guide any policy design.
Please read my blog – Deficits should be cut in a recession. Not! – for more discussion on this point.
The overwhelming evidence shows that firms will not invest while consumption is weak and households will not spend because they scared of becoming unemployed and are trying to reduce their bloated debt levels.
While the politicians on both sides of the English Channel promoted Ricardian notions – either explicitly or implicitly – the recent data is once again showing that the concept of a “fiscal contraction expansion” is deeply flawed.
The 2010 forecasts reflect the belief of the British government in Ricardian effects. The real world outcomes which are compared with the forecasts in this Table once again provide the refutation of that belief. The Table spans 2 years, which would have been enough time for the reversal of private sector intentions. The evidence is consistent with years of research in psychology – pessimism builds on itself and high unemployment and flat spending growth undermines confidence among private households and firms.
The other myth promoted by the current British government was that net exports would boom and lead the economy out of its malaise. That has now been revealed to have been a serious error of judgement.
The flip side of all that is that they also failed to understand that attempts to reduce its net fiscal position would be thwarted by the fact that anticipated GDP growth was much less than has actually occurred. The automatic stabilisers work against attempts to reduce budget deficits at a time when the other sectors are not in a position or do not want to provide the offsetting spending boost.
To dig into what is happening at the sectoral level, the following graph shows the sectoral balances for the UK from 1980 to 2012 (the 2012 observation is an estimate and the budget deficit will be slightly larger than depicted here).
The brief statement of these balances is:
(S – I) = (G – T) + (X – M)
The three balances have to sum to zero as a matter of national accounting. The sectoral balances derived are:
- The private domestic balance (S – I) – positive if in surplus (overall private spending is less than income), negative if in deficit (overall private spending more than income).
- The Budget Deficit (G – T) – negative if in surplus, positive if in deficit.
- The Current Account balance (X – M) – positive if in surplus, negative if in deficit.
The private domestic and the current account balance sum to be equal to the non-government balance. The basic result that the government balance equals exactly $-for-$ (absolutely or as a per cent of GDP) the non-government balance (the sum of the private domestic and external balances).
The familiar pattern is evident. There is a reciprocal relationship between the budget deficit and the private sector balance. When the British government ran surpluses in the late 1980s and then later in the period 1997-2001, the private domestic sector moved sharply into deficit.
More recently, the larger deficits driven both by discretionary stimulus measures in 2008 and 2009 and the automatic stabilisers associated with the downturn in the cycle, allowed the private sector to achieve higher savings overall.
The highly indebted private sector is now being squeezed again by the attempted fiscal reduction. in the 2012 British Budget, the implicit strategy was that growth would come from an increase in private sector debt driving consumption and investment spending (refer back to the Table 1.1 above) and net exports.
The upshot of the failure of the policy to address the economic reality the Government faces is that the British people are becoming poorer (on average).
The following graph shows real GDP per capita in Britain from 2000 to 2012 (using IMF World Economic Outlook data). It is obvious that, on average, the British population has become poorer under this government, quite apart from the impact of the Global Financial Crisis, which saw a plunge in real living standards in 2008 and 2009.
With the support of the expanding fiscal deficit, the British economy started to recover in 2010. Then in May 2010, the current Government took office and as the deficit effects dissipated through 2011, the underlying impact of the current fiscal stance started to be defined – and that impact is negative.
The macroeconomic spending system is like a river flowing. For the river to maintain its level the inputs into that river system have to remain constant. The British river is being drained by net exports. The overall private sector flow is also negative now as it retreats from its previous credit-driven spending binge.
The river level is falling. There is only one other net source of spending to offset the failure of non-government spending to drive growth – government deficit spending.
At present the deficit is not falling as fast as the Government desired and that is helping to moderate the decline in real GDP growth.
But this Budget should have been about admitting the policy mistakes – exemplified by the sequence of biased forecast errors over the last 3 Budgets – and committing the Government to ensuring the river level rises rather than continuing to allow it to fall.
I thought the UK Guardian conclusion (March 20, 2013) was apposite:
Above all, Osborne’s budget relied on closing one’s eyes to the wider picture of an anaemic, ailing economy. Cheaper beer is nice, but makes little dent when wages are falling in real terms, by 9% since 2009 on one estimate. Nor does cheaper petrol much help public sector workers now facing a below-inflation pay freeze for a further year
A long flight south awaits me … so
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.