{"id":11495,"date":"2010-09-10T17:21:49","date_gmt":"2010-09-10T07:21:49","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=11495"},"modified":"2010-09-10T17:21:49","modified_gmt":"2010-09-10T07:21:49","slug":"the-authority-to-justify-fiscal-austerity-is-lapsing","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=11495","title":{"rendered":"The authority to justify fiscal austerity is lapsing"},"content":{"rendered":"

\t\t\t\tYesterday, 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.
\n
\nMore cuts coming in the UK<\/strong><\/p>\n

The UK Guardian reported yesterday (September 9, 2010) that – George Osborne to cut \u00a34bn more from benefits<\/a> – which signalled that the British government is seeking further budget cuts to unemployment income support payments.<\/p>\n

The Guardian said:<\/p>\n

\nThe 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 \u00a34bn, 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.”\n<\/p><\/blockquote>\n

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.<\/p>\n

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) – \u00a34 billion is \u00a34 billions pounds of orders and sales that will now not be there.<\/p>\n

It is likely to be a \u00a3-for-\u00a3 cut because the unemployment (lifestyle or not) probably have a marginal propensity to consume of 1 (meaning they spend every extra \u00a3 they get).<\/p>\n

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.<\/p>\n

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.<\/p>\n

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).<\/p>\n

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.<\/p>\n

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.<\/p>\n

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”.<\/p>\n

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<\/a>. In that sense, I would not provide income support to anyone who refused a JG position within close proximity to their residence.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

If you recall at the time the new British government was taking office the OECD thought it was appropriate to praise their austerity plans.<\/p>\n

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

\nOECD Secretary-General Angel Gurr\u00eda 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.”\n<\/p><\/blockquote>\n

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.<\/p>\n

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

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<\/a>, albeit a conditional one.<\/p>\n

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.<\/p>\n

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.<\/p>\n

For example, on May 31, 2010, the OECD released a paper entitled – The Political Economy of Fiscal Consolidation<\/a>.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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

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<\/strong>.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

Please read the following blogs – The dreaded NAIRU is still about!<\/a> – Structural deficits – the great con job!<\/a> – Structural deficits and automatic stabilisers<\/a> – Another economics department to close<\/a> – for more information on this point.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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).<\/p>\n

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.<\/p>\n

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.<\/p>\n

Remember a government deficit is always equal $-for-$ to the non-government surplus (and vice-versa).<\/p>\n

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.<\/p>\n

The May 2010 forecasts<\/strong><\/p>\n

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.<\/p>\n

You can download the spreadsheet they released on May 25, 2010 to accompany the OECD Economic Outlook No 87<\/a> publication. This is their major outlook statement.<\/p>\n

These forecasts apparently provided support for their claims that the world was ready for fiscal austerity.<\/p>\n

The September 2010 forecasts<\/strong><\/p>\n

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?<\/p>\n

An interim assessment<\/a> 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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

The point I am making is that forecasts should always be additional information that might be helpful in framing discussions.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

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.<\/p>\n

Now the OECD has issued new forecasts which are looking fairly bleak.<\/p>\n

You can read the Handout for journalists <\/a> that the OECD released yesterday to accompany the presentation of their Interim Assessment.<\/p>\n

You will see charts with headings such as:<\/p>\n