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Posts Tagged: Keynes

Stimulus

Tuesday 21st May 2013

There’s an argument made that the reason the UK’s economy is struggling is because the government is cutting spending. This line of logic originates with the work of John Maynard Keynes, who theorised that economic output is influenced by the total amount of spending in the economy, called aggregate demand. He argued that aggregate demand drops in recessions, and that when this happens the government should provide fiscal stimulus to make up the shortfall.

A key signal of aggregate demand is the unemployment level: higher unemployment, lower aggregate demand. In other words: in a recession lots of people lose their jobs, and so there is less spending in the economy, therefore the government should spend more money to make up the difference.

It’s an interesting idea and it might even be true. However, it is argued that this is the situation that Britain is in now, and so more fiscal stimulus is needed to help the recovery. But that doesn’t really stack up.

The signal for aggregate demand is unemployment, and one of the curious things in Britain throughout the downturn is that unemployment hasn’t actually risen that much, compared to the change in economic output. In fact, the drop in labour productivity during the downturn has had a lot of economists somewhat puzzled.

So if unemployment hasn’t risen, there can’t be a problem with aggregate demand. Fiscal stimulus solves aggregate demand. So why do we want more fiscal stimulus?

In fact, you could possibly argue the opposite. Yes, there have been real cuts in government spending, but actually they haven’t been that significant. The British government is still spending a historically high amount, and still has one of the largest deficits in the world. So the government has been providing fiscal stimulus, and that’s why unemployment didn’t rise as much. It might be true, I have no idea. It’s an interesting idea though, and if it is true it surely vindicates a lot of the Keynesian viewpoint.

So why is no-one making this argument?

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On Keynes and Cuts

Tuesday 22nd June 2010

Keynes’ central insight was that the economy is cyclical. That when observed over a long period of time, there are economy-wide fluctuations; that there are times when the economy is generally doing well and we’re all getting richer (expansion), and times when the economy doesn’t do so well and we get poorer (recession).

I suppose there is an argument against this; that the problems which occur aren’t generally structural issues to do with the economy, but rather specific issues to do with the way the economy is run. For instance the credit crunch which precipitated the current downturn was caused by the default of loans on assets which were overvalued (i.e. people not paying their mortgages), and you may say that this isn’t something which will always happen. That there doesn’t need to be a cycle, if only things were run better.

This is almost academic though; looking back through history, clearly there are cycles for whatever reason (there have been recessions in the 70s, 80s and 90s as well as the more recent one). Keynes said that the government should act in a manner which is counter-cyclic. That a period of recession is marked by a shortage of demand, and that the government should spend lots of money during that period in order to pick up some of the slack and help the economy at large. That, in essence, during a recession the government should run a deficit and spend more money than it takes in.

That was the rationale that was used to inform the response of the government to the downturn in 2007-8, but it’s not a complete analysis. Because Keynes said that the government should pursue counter-cyclic policy. By definition, running up a deficit in recessionary times is only half of the story; the other half is that the government should run up a surplus in the boom years, that it should save money. The previous government didn’t pursue this policy, instead they borrowed and spent more and more money. They then added to this with deficit spending in the downturn, which means that we now have a staggering level of public debt and we need to pay it off. The question that today’s budget is trying to answer is: how?

By the way, the costs of bailing out the banks aren’t entirely part of this problem. Because when the government did that, they mostly did it in exchange for shares in the business. As far as I remember, we should actually make a profit from this when the government sells those shares on in a few years, because the banks will be worth more then than they were when the government bought the shares.

Some people have offered the defence that the previous government “didn’t know there would be a recession”. I reckon that is an incredibly poor argument, because even without the recession it was really poor policy to run up such a large amount of public debt. In addition, I simply don’t buy the idea that the recession was unforeseeable. I was working in a retail bank during 2007, and even I had thoughts along the lines of “they’re giving money to people who can’t afford it… is that really wise?”. The causes of the crash were not rocket science, and I know that I’m writing with the benefit of hindsight, but I contest that the Chancellor of the Exchequer really should have shown a bit more foresight. Proclaiming “the end of boom and bust” is nice rhetoric, but seems somewhat blind to the economic reality (pun not intended :-P).

I’ve also heard the argument that people look at public debt in the same way as household debt but that really the two aren’t comparable. People seemingly use this to justify a deficit, to argue that it’s acceptable for the government to borrow large sums of money. This is disingenuous, because whilst there are differences, the fundamental principles are the same. When someone borrows money, they are giving up some money in the future in order to have some now. This isn’t a bad thing as it allows us to be more productive, but we have to be aware that this is what we are doing. And if we take on too much debt, then the cost of that debt can become crippling (I believe that the current figure is £80,000 per day in interest). Increasing debt reduces our future spending power, and if the costs of paying back loans is greater than we can afford, then we have a problem (see the issues presently facing Greece for an example). We need to make moves now to reduce our debt, to reduce the likelihood of that happening.

This budget is painful, but it needs to be. The grim reality is that we simply can’t afford for anything else, so the task was to cut the deficit in a manner which is least damaging. It’s very easy for the opposition and their supporters to snipe, to point out that the budget is tough, and to blame the big mean Tories for screwing the poor and the Liberal Democrats for “selling out” in exchange for cabinet positions, but that version of reality ignores who helped get us into this position to start with.

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