Blogging the Zombies: Austerity (revised)

Update 21 November I’ve revised this as a result of thinking about the comments, though I haven’t yet had time to take all the comments on board. The main change has been to focus specifically on the idea of “expansionary austerity”. As Keynes said in 1937, public sector austerity is desirable if the economy as a whole is booming. And, later in the chapter, I’ll talk about whether austerity is sometimes the least bad response to problems of foreign debt. The claim that is implicit in the current policies of the ECB, the UK Tories and the US Republicans is not merely that austerity is necessary as a response to debt but that it makes sense as a response to a deep recession. This idea is commonly described as “expansionary austerity” End Update note

I’m working on a paperback edition of Zombie Economics and adding a new chapter on austerity. Like last time, I plan to blog it in sections and take advantage of comments and criticisms from readers. I’m opening up with the intro, but plan to serve up something more substantive soon.

 

“The boom, not the slump, is the right time for austerity at the Treasury.” – Keynes 1937
Keynes, John Maynard. 1937/1983. Collected Writings of John Maynard Keynes, vol
21. London: Palgrave Macmillan

Most of the zombie ideas discussed in the first edition of this book flourished in the late 20th century, and were killed, at least as defensible theories, by the evidence of the Global Financial Crisis. By the time I began writing in 2009 it was evident that these ideas, so recently declared dead and buried by virtually all observers, were clawing their way back to a zombie life. I hoped that economists and policymakers would have the good sense to lay them to rest once and for all.

In reality, the opposite has happened. The zombie ideas I criticized continue to walk the earth and do immense damage. Worse still, the long-buried corpse of an idea discredited ever since the Great Depression have re-emerged. The zombie economics of ‘expansionary austerity’ now threatens to turn what is already the worst slump to afflict North American and Europe since 1945 into a new, and global, Great Depression.
The advocates of expansionary austerity make two claims. The first is that our current problems are the result of governments living beyond their means. The claim is absurd on the face of things – there is no plausible link between government budget deficits and the speculative bubble and bust that produced the Global Financial Crisis – but it resonates with deeply imbued beliefs about the virtues of thrift and the need for sacrifice as a response to adversity.

The second, even less plausible, claim is that the way to secure a sustainable economic recovery is for governments to spend less[1] thereby making room for the private sector. The painfully evident fact that there is already plenty of room for private expansion, in the form of unemployed workers and idle factories, is simply ignored.

As Keynes observed during the depths of the Great Depression, austerity (that is, tight control over public expenditure, and measures to put government budgets into balance or surplus) makes sense when the economy is booming, and there is excess demand for resources of all kinds. Surpluses built up in good times can be used to repay debt or create ‘fiscal space’ for an expansionary stimulus in response to an unexpected contraction. But the use of austerity measures at a time when the economy is already depressed will only make matters worse. The contractionary effects of austerity will reduce government revenues and undermine attempts to balance the budget.

Just as zombies are grim and distorted versions of their living selves, so the ideology of expansionary austerity is a grim and menacing version of the ideology of market liberalism. In the triumphalist 1990s, Thomas Friedman’s metaphor du jour was the ‘Golden Straitjacket’. The idea was that, while governments now had no choice but to adhere to the dictates of market liberalism, their citizens would be richly rewarded when they did so. Now the claim is that we need to suffer the pains of austerity, but that the eventual reward will be nothing better than to return the economy to the more-or-less normal functioning that has delivered little or nothing to most of the population over the decades of market liberalism.

This zombie idea is at least as powerful as any of those I attacked in the first edition of this boo. As I write this, it has already defeated any hopes for a rapid recovery from the long slump that has followed the Global Financial Crisis. It is on the verge of destroying the common European currency and, quite possibly, the European Union itself. In the United States, Republican demands for austerity have repeatedly brought the political system to the brink of collapse. The shutdown of the government, and even default on US public debt, have been averted only at the last possible moment, and may yet occur.

Nor is the rest of the world immune. Even countries that avoided the worst impacts of the Global Financial Crisis would find it difficult to navigate through a new crisis, with a likely further contraction in global trade and disruption of capital flows. Yet this seems to be the inevitable outcome of the policies being pursued in the US and, even more, in Europe. Expansionary austerity is the deadliest of zombie ideas.

?
[1] Some advocates of expansionary austerity also advocate higher taxation as a route to budget balance. More commonly, the “austerians” favor a shift in the tax burden, away from corporations and the wealthy, and on to workers, the middle class, and (via hihger sales taxes) the poor.

“The boom, not the slump, is the right time for austerity at the Treasury.” – Keynes 1937
Keynes, John Maynard. 1937/1983. Collected Writings of John Maynard Keynes, vol
21. London: Palgrave Macmillan
Most of the zombie ideas discussed in the first edition of this book flourished in the late 20th century, and were killed, at least as defensible theories, by the evidence of the Global Financial Crisis. By the time I began writing in 2009 it was evident that these ideas, so recently declared dead and buried by virtually all observers, were clawing their way back to a zombie life. I hoped that economists and policymakers would have the good sense to lay them to rest once and for all.
In reality, the opposite has happened. The zombie ideas I criticized continue to walk the earth and do immense damage. Worse still, the long-buried corpse of an idea discredited ever since the Great Depression have re-emerged. The zombie economics of ‘expansionary austerity’ now threatens to turn what is already the worst slump to afflict North American and Europe since 1945 into a new, and global, Great Depression.
The advocates of expansionary austerity make two claims. The first is that our current problems are the result of governments living beyond their means. The claim is absurd on the face of things – there is no plausible link between government budget deficits and the speculative bubble and bust that produced the Global Financial Crisis – but it resonates with deeply imbued beliefs about the virtues of thrift and the need for sacrifice as a response to adversity.
The second, even less plausible, claim is that the way to secure a sustainable economic recovery is for governments to spend less[1] thereby making room for the private sector. The painfully evident fact that there is already plenty of room for private expansion, in the form of unemployed workers and idle factories, is simply ignored.
Just as zombies are grim and distorted versions of their living selves, so the ideology of expansionary austerity is a grim and menacing version of the ideology of market liberalism. In the triumphalist 1990s, Thomas Friedman’s metaphor du jour was the ‘Golden Straitjacket’. The idea was that, while governments now had no choice but to adhere to the dictates of market liberalism, their citizens would be richly rewarded when they did so. Now the claim is that we need to suffer the pains of austerity, but that the reward will be nothing better than to return the economy to the more-or-less normal functioning that has delivered little or nothing to 80 per cent of the population over the last decade.
This zombie idea is at least as powerful as any of those I attacked in the first edition of this boo. As I write this, it has already defeated any hopes for a rapid recovery from the long slump that has followed the Global Financial Crisis. It is on the verge of destroying the common European currency and, quite possibly, the European Union itself. In the United States, Republican demands for austerity have repeatedly brought the political system to the brink of collapse. The shutdown of the government, and even default on US public debt, have been averted only at the last possible moment, and may yet occur.
Nor is the rest of the world immune. Even countries that avoided the worst impacts of the Global Financial Crisis would find it difficult to navigate through a new crisis, with a likely further contraction in global trade and disruption of capital flows. Yet this seems to be the inevitable outcome of the policies being pursued in the US and, even more, in Europe. Expansionary austerity is the deadliest of zombie ideas.

?
[1] Some advocates of expansionary austerity also advocate higher taxation as a route to budget balance. More commonly, the “austerians” favor a shift in the tax burden, away from corporations and the wealthy, and on to workers, the middle class, and (via hihger sales taxes) the poor.

101 thoughts on “Blogging the Zombies: Austerity (revised)

  1. @sdfc

    What’s more, dozens of people predicted the GFC. I was reading many blogs right through that period and I remember warning people at work back in 2005 that many top economists and financial experts were predicting a housing crash and worse.

    Though most of those predicting it seemed to be as much taken by surprise as the ones talking things up. Ie they did not make money on it. Even some of the really well known ones who predicted it did not make money out of it.

    I guess it’s always about timing and faith in your words.

    pop

  2. pop@45 – Fine! But I don’t understand why you’re not able to acknowledge the possibilty of inflating debt out of existence.

    sdfc@46 – much as I love Steve’s work, he also predicted a recession in Aust in the second half of 2010. If you’re always banging on about how there’s just about to be an economic crisis, you’re bound to right some of the time – but let’s not forget the other times.

  3. POP

    The timing is pretty much impossible to predict but that doesn’t mean it is just dumb luck when the forecaster proves to eventually be correct. You need pretty deep pockets to bet against the market.

    Dan

    I think Keen’s problem is that he misunderstood the determination of the government and the RBA to keep a floor under house prices. With household debt to disposable income still over 150% I for one don’t think we are out of the woods by any stretch of the imagination.

  4. “To suggest that Steve Keen predicted the GFC by chance betrays a complete misunderstanding of the drivers behind the crisis and what Steve Keen has been saying all these years.”

    I hardly read Keen so I wasn’t making any particular claim about him. But hasn’t he been predicting a housing collapse here for a long time? Now maybe Keen made more specific predictions that are less likely to happen by chance (and Australian housing will collapse too), I’m sure you’ll find others with their own models who made specific prediction and disagree (e.g. the Austrians claim vindication too, etc). All I’m saying is it’s hard to tell.

    “You make the mistake of assuming economics boils down to neoclassical theory or the bastardised Keynesianism of the neoclassical synthesis.”

    How on Earth can you read such a level of detailed assumptions into my brief comment about the challenges of macroeconomics?

    “The concern over inflation is misplaced. A burst of higher inflation is exactly what those high debt economies need if they are to avoid years of stagnation.”

    I don’t claim to know much macro, nor do I trust anyone who claims to be very sure about macro, but what I have read suggests that’s right.

  5. @Rob

    “But economics is not some pure physics. Any theory which said the GFC could not occur is dead in the water, but we’re doing social science here, so the theories are more likely to say ‘X will be uncommon given A, B, C and D’. There’s a lot of wiggle room that allows you to say your ideas are not invalidated by one event.”

    The neo-classical model, underpinned by Walrasian general equilibrium theory, is in the same league as the great breakthroughs of theoretical physics. It is the only systematic and ‘Newtonian’ framework neo-classicists have to understand political-economic phenomena, even if most economics students only understand it in a half-baked kind of way (I am curtly dismissing the business of trying to explain a state of the world x by showing x is a function of the arbitrarily picked variables A, B and C because that’s entirely ad hoc and arbitrary).

    All you have, if you’re a neo-classicist, is Walrasian general equilibrium theory. According to this the GFC is impossible (and thus ‘dead in the water’ by Robert’s assessment): the system reaches the point at which supply equals demand and nothing moves. That’s just the mathematics of it. Neo-classicists must hold that the Great Depression was in fact the Great Vacation, since involuntary unemployment is impossible. The only possible explanation is that workers were asking too much for their labour.

    I will now launch a pre-emptive strike. You might accuse me of being too dogmatic here. In response a comparison with religion is in order. Even if some or all aspects of your religion seem silly, if you are truly religious you really have no choice but to be a fundamentalist. There is a tendency for some followers to cherry pick elements from their holy doctrines that seem sufficiently civilised while conveniently sweeping the ugly elements under the carpet. In this case they cease to be loyal followers by definition. In economics a similar sort of ‘buffet neo-classicism’ occurs. Free marketeers raucously proclaim their philosophy demands less taxes and regulation but refuse to accept the fact it also mandates zero profits, for example. Either you have the set menu or you don’t; you’re a neo-classicist or you’re not. You can’t have it both ways.

  6. Is all you do in life go around reposting the same boilerplate objections to what you imagine neoclassical economists believe Chad? I’m not about to have the same tedious semantic argument that we had 6 months ago, in which you define neoclassical economics to be some absurd caricature believed by no one and then proceed to demolish it.

    I haven’t made any arguments that could be regarded as neoclassical. My comments have all been general observations about the challenges of empirical macroeconomics and social science in general given small samples and our inability to do controlled experiments. This is not revolutionary stuff.

  7. Chad – as much of a critic of neoclassical economics as I am, you’ve characterised it very inaccurately indeed.

  8. Empirical macroeconomics and the activities of econometricians are fundamentally ad hoc. To know the variables A, B and C were the most important or relevant in explaining state of the world X requires a comparison of A, B and C to all the other variables in the world. You’ll die before that process is ever completed. I reject this dubious approach in favour of systematic general theories, of which Walrasian general equilibrium is one (that I greatly admire, by the way) and the most important for neo-classical economists.

    How have I mischaracterised neo-classicism in relation to crises?

  9. Chad’s caricature version is, pretty much, the research program of Real Business Cycle theory, and the crisis showed that although outright advocacy of RBC was only prominent for a few years in the 1980s, quite a few Chicago economists still believed it.

    The difficulty really is with the term “neoclassical”. Typically, this is used very loosely, sometimes referring to extreme absurdities like RBC and sometimes to apply to mainstream economics in general.

  10. Two important equations in economics:

    Gross Domestic Product = Federal Spending + Private Investment + Private Consumption + Net exports

    Federal Deficits – Net Imports = Net Private Savings

    Based on these equations, here is a simple question:

    How do federal tax increases and/or spending cuts (aka deficit reduction) reduce unemployment or grow the economy? If you can’t answer, then there clearly is something wrong with the whole debt-reduction movement.

    Those who do not understand Monetary Sovereignty (http://rodgermmitchell.wordpress.com/2010/08/13/monetarily-sovereign-the-key-to-understanding-economics/) do not understand economics.

    Rodger Malcolm Mitchell

  11. socrates :
    …. Fama is still defending his hypothesis, now saying it never guaranteed stability, and blaming government regulation for the failure:
    http://www.chicagobooth.edu/news/2011-10-28_fama.aspx
    To admit economic liberalism has failed would negate most of Fama’s career. He can’t do it.

    According to market worshipers like Fama the market is perfect, omniscient even, but the terminally stupid govt. can pull the wool over the market’s eyes so easily. Yes it is all the government’s fault. The big bad government wearing Grandma’s bonnet and Grandma’s clothes fooled little red riding hood market into investing not simply unwisely but downright ridiculously stupidly. Of course, truth is, the money invested wasn’t their’s, that is, wasn’t the money of those who invested it for the most part, and those that spruiked the whole process got incredibly rich from commissions, bonuses and other ill gotten gains. And after the whole thing went bung, they got to keep all those ill gotten gains. And no body in power wishes to hold them to account.

    Yes, of course. The market still as perfect as ever. Government to blame. And who can say what would have happened if the Aztecs hadn’t sacrificed all those people in years gone by? Where is the counterfactual?

  12. I was thinking that a chapter on how ‘zombie economists’ have ‘helped’ various economies, and how balefully wrong their pronouncements and predictions, and the results of their handiwork have been would be good. This might require some data-mining of newspapers etc. but I imagine that some great quotes should be available. (Pronouncements on the wonderful future of that Pacific Economic Miracle that never was, the one across the Tasman, might also be worth including.)

    One of the reasons for the abject pain in the former soviet empire I am sure was due to the army of self-appointed and IMF-World Bank anointed libertarian ‘experts’ who recommended extreme laissez-faire ‘shock therapy’ as the optimal transition to market economies. There ought to be some great quotes there. And I remember that the Economist magazine (or is that comic) which was quite gung-ho in support of the libertarian remedies was constantly predicting significant growth for Russia, in the ’90s, every year, yet every year Russia’s economy was shrinking, most years quite dramatically. Finally the Economist even stopped predicting Russia’s annual growth rate. A good one also, of course, would be the MPS Iceland 2005 Conference website where the MPS was taking credit for its wonderful ‘impact’ on Iceland, yet in 2006 their economy came close to disintegrating (nothing to do with the GFC) and, of course, blew up in a big way when it was stressed by the GFC. The MPS inspired radical transformation of Iceland doesn’t look so great in retrospect. Similarly there ought to be great zombie quote for Ireland and the UK. For both Ireland and the UK I am not so sure that even handed economic analysis would conclude that gaining temporary growth by turning themselves into tax havens for companies which by moving there demonstrate that they are not good corporate citizens was either a global or local net benefit.

    By the way, the Iceland MPS conference website has been removed. I imagine someone must have thought it embarrassing. Luckily, I know someone who copied that site before it disappeared.

  13. Some unintended humour from a pre-Murdoch Wall Street Journal – January 29, 2004
    Miracle on Iceland By HANNES H. GISSURARSON (Courtesy of the MPS Iceland website)

    “… As Oscar Wilde once quipped, the Icelanders had discovered America, but that they had had the good sense to lose it again.

    Over the past century, Icelanders have discovered not America but the free market. A hundred years ago this Sunday, when Iceland gained home rule from Denmark, the island was the poorest country in Western Europe. Now, after a radical and comprehensive course of liberalization that mirrors similar reforms in Thatcher’s Britain, New Zealand and Chile, Iceland has emerged as one of the world’s most prosperous countries.

    Much of the credit goes to Prime Minister David Oddsson. The leader of Iceland’s conservative party is now the longest serving leader in the Western world, having formed his first government in 1991. ….

    … Having stabilized the economy with monetary and fiscal restraint, the Oddsson government started privatizing. It began with small companies, later turning to large fish-processing plants, factories and financial companies. All the commercial banks are now in private hands. Altogether, the sales brought in $1 billion, not a bad haul for a country of 280,000. Only one large company remains, Icelandic Telephone, but it will soon be put on the sales block.”

    Just one success story after another! Yes, and New Zealand is “one of the world’s most prosperous countries” as is Chile. And Britain? Well, its Sterling old chap!

  14. @Rodger Malcolm Mitchell
    Good explanation Rodger and the discussion afterwards reveals the gamut: to ignore = Ignorance.
    People understand the sky is ‘blue’ but they do not understand or simply ignore monetary sovereignty: sacrificing the power to the markets????
    Can only happen where there is both ignoring and confusion. Like ‘turkeys voting for thanksgiving’ (recent comment at Mosler’s).

  15. @Rodger Malcolm Mitchell

    Good explanation.

    I guess the question then becomes, what can governments do while keeping a lid on inflation? (The answer may be: quite a lot, especially in recessions).

    I’d comment that, okay, great, we’ve decided that money is an abstraction – but there are simple resource constraints to face up to (which I think is what pop was trying to get at, although he kept tripping up on his conception of money). Although I think throughout most of the OECD it’s pretty obvious that the labour market (for instance) isn’t exactly stretched.

    But the doozy for me is: supposing policymakers start thinking about money like this, won’t interest rates just move to match the expectations of lenders of additional money being created, and won’t this lead to an inflationary spiral?

  16. @Rodger Malcolm Mitchell

    I think people are starting to get sick and tired of economists who present such simplistic formula that just reflect their own definitions of categories and with no units.

    Each of the categories: Federal Spending, Private Investment, Private Consumption, Net exports consist, in part, of real value, but in increasingly large part in debt.

    Silly equations as are too often peddled have no greater analytical power than writing:

    Height of building = length of shadow.

    This is true if the length of shadow is not inflated (by height of sun or slope of ground) but is false if the length of shadow is inflated.

  17. @Dan

    That ‘explanation’, by Rodger Malcolm, is pure bunkum. Zimbabwe is a simple recent example that the idea that governments can just print money and never go bankrupt is nonsense. As has happened time and again if a government doesn’t engage is some self restraint with seigniorage then trouble follows rapidly. The avatar reminds me of the picture American Gothic sans the pitchfork (and with the wife on the other side).

    I guess I don’t understand economics. (Something I’ve always suspected.)

  18. Look, I agree there’s something that doesn’t sit right but I’d love to actually specify what it is, rather than just dismiss it out of hand.

  19. Is it hyperinflation? Is it not possible for governments to run down their debt by increasing the money supply without triggering this?

  20. I don’t understand economics either. I thought I knew enough back in 1966 when I did economics at high school. It was easy then to conclude that it wasn’t worth bothering about economics; both socialism and free market capitalism would always fail because of ‘human nature’ and so human nature was the place to start to do anything about making the world a better place.

    So I’m intersted in those “deeply imbued beliefs about the virtues of thrift and the need for sacrifice as a response to adversity” that John talks about above.

    Apparently in Western societies the idea of thrift as a virtue was popularised by the newly emerging middle class who were mostly Protestants. Catholics were amazed and disgusted at the selfishness and they argued that this was God’s way of destroying protestants. Catholics thought the protestants would become so mean and frugal that they would destroy themselves.

    POP does your non Western society value thrift?

  21. @Dan

    Scott Fullwiler: What If the Government Just Prints Money?

    In sum, whether or not a deficit is accompanied by bond sales is irrelevant for understanding the potential inflationary effects of the deficit. Under normal Fed operating procedures in place until fall 2008, the operational function of bond sales was to support the interest rate target, not to “finance” a deficit. A government bond sale does not somehow reduce funds available for non-government agents to borrow as presumed in the loanable funds market approach, while the absence of a bond sale does not somehow mean there is a greater amount of liquid financial assets, income, or “funds available” for borrowing or spending than without the bond sale. Instead, a government deficit always adds to the non-government sector’s net financial wealth whether or not a bond sale occurs. Both the Treasury’s bond sales and the Fed’s operations affect only the relative quantities of securities, reserve balances, and currency held by the non-government sector; the total sum of these is set by the outstanding government debt. With or without bond sales, it is the non-government sector’s decision to spend or save that matters in regard to the potential inflationary impact of a given government deficit. [My emphasis] Indeed, to be more precise, a deficit accompanied by bond sales is actually the MORE potentially inflationary option, as the net financial assets created by the deficit will be increased still further when additional debt service is paid.

    Scary thought huh – politicians with an open cheque-book? All spending has the potential to cause inflation. Govt. sets the ‘price’ of money as monopoly supplier and should use taxation, monetary and fiscal policy, regulation and law to sustain aggregate demand and full employment; without cooking the economy or toasting the environment.

    @Chris Warren
    I guess you didn’t try the previous link Chris at #42 – but anyways – if you dearly love complexity and formulae:
    Scott Fullwiler: Interest Rates and Fiscal Sustainability
    Scott Fullwiler: Sustainable Fiscal Policy and Interest Rates under Flexible Exchange Rates

    @Freelander
    A ‘Gentleman’ or ‘Lady’ would not make personal comments about RMM or his wife. Am sure they are both very beautiful human beings, and passionate about engaging minds with their own. As for the Zimbabwe bit, that one is always the first objection, the second is Weimar – LOL …… Zimbabwe for hyperventilators

    [JohnQ – hope I am not breaking any ‘providing too many links policy here’ – am keeping in sight relevance to your post and the ensuing discussion !!]

  22. Right does not believe in “expansionary austerity”. They preach it only when Democrats control the White house, and do not preach it when it comes to military spending. They use it for two purposes. First to prevent Democratic president to reward their donors and voters and with it secures reelection. Second, to ruin social programs so they can privatize it easier and then give more tax cuts to their voters and donors – wealthy. Also if Democrats spend less there will be more for Repubs when they get back in power.

  23. @Dan

    The problem at one level, is the general trend of capitalism towards increasing macroeconomic instability (CPI, CAD, PSBR, Ue).

    The real problem at a deeper level, is the underlying cause of this instability (or structural source of macroeconomic contradiction).

    If the government was to ‘increase the money supply’ by employing workers to dig for gold to produce gold coins, then these money-fanatics may have an arguable case.

    Anything else is Zimbabwe and Weimar stupidity. But it may be the only option for our capitalists now.

    Tough.

  24. @Julie Thomas

    Yes Julie – and if it’s at all possible – far more than any “Westerners” I know other than maybe those of my mother’s generation who spent their childhood years in the Great Depression.

    My wife’s generation and her parents generation (and theirs) are so “stingy” that they will scowl at any expenditure that is not absolutely necessary – it’s a problem for me because I am trying to raise our two girls well – who need such frivolities as tutoring and braces – but their mum is very hard to convince and i often have to just ride rough shod over her opinion on such things. It’s not unusual for a family to earn less than 10K per year and prosper (with care).

    I can tell you from first hand experience, from having spent a fair amount of time in said countries, where thrift is highly valued and respected:

    Romania (everyone)
    France (older ones mainly)
    Italy (! – older ones only)
    Mexico (everyone i met)
    Thailand (everyone except the new middle class children)
    Korea (ditto)
    Japan (ditto)
    Israel (ditto plus the newcomers from eastern Europe)

    and believe it or not

    USA (older ones and ones from various locations)

    I also suspect it is the same for every other country in the world – if people have lived through very tough times they will be more careful with money than if they have been raised in plenty and without the influence of generations who have live tough times.

    If you look at some of our traditions – we used to eat tripe, we used to always turn all roast juices into gravy, throwing away food was always seen as bad. Some of our famous bush era stories are about financial hardship.

    I find it hard to believe that thrift is a middle class attribute – rather I suspect that it would be hard to gain middle class status without a foundation of thrift.

    but that’s me

    pop

  25. @Gaz

    🙂

    Yes.

    But what happens in a real village is that people freely provide rice to each other in times of need. I’ve never seen it when everyone is in need but i do know that the central government does a lot to cover such cases through carrying a large stock surplus – in fact the government “trades the basis” on rice and other products very astutely.

    pop

  26. @ Dan
    Yep, vampires show up only periodically, nightly, just as austerity idea show up only when Dems are in power.

  27. @Dan

    If there is spare capacity in an economy that capacity might be brought into production by government spending financed by expansionary monetary policy but once people cease to be scared (as they can become scared after something like the GFC) they will start to use their money as they do in ordinary times and prices will start to go up. In that case it would be expansionary monetary policy used to finance a fiscal stimulus. Depending on whether that approach works and how much inflation results the outcome could be good, or not so good.

    In ordinary times you cannot just expand the money supply willy-nilly without expecting to end up with hyperinflation. In ordinary times people use their money to buy things. In scary times they might hoard their money because having the money provides some sense of security in an uncertain world. With a lot of cash on hand you are better able to handle the unexpected. The expansionary monetary policy that has been used in the US and in the UK and some other places has been to buy financial assets. It has not been used to finance fiscal policy. Because those selling the financial assets haven’t spent (or lent) the money they received, little stimulus has been provided so far. Some are worried that if the liquidity that has been provided finally starts to get spent (or lent to others who spend) there could be significant inflation. That might be better than the current situation if the inflation doesn’t get out of hand. Fiscal policy would have been more effective and safer.

    However, expansionary monetary policy of the Quantitative Easing type can be used to prop up the financial system by buying financial assets. As far as the sovereign debt panic goes, buying some of those assets is probably best at the moment to quell the panic. Also, a bit of inflation reduces the relative size of the debt. Inflation is a legal way of giving debt holders a ‘haircut’. In the Eurozone the ECB should really have been engaging in Quantitative Easing to save their financial system. They shouldn’t have let things get as bad as they have. That said, the situation is very difficult and doing things exactly right would not be easy.

    However, what is clear is austerity is the last thing governments should be trying to do. And if there are cutbacks they should not be on the poor who tend to spend most of the income they get. If they are going to do cutbacks, better to cutback aid to, or increase taxes on the rich who spend less out of each additional dollar of income anyway. Also, that would be somewhat fairer because the poor were hardly the ones responsible for the GFC anyway, and never benefited from the ‘good’ times either.

    At the moment the Australian government is planning to ‘balance’ the budget which is silly. There is no need to and the contractionary fiscal policy that it represents is not what is wanted at the moment. The government was exceedingly brave after the GFC in implementing an excellent stimulus policy which saved Australia from a recession. They ought to show similar bravery again. And simply ignore the bleating of an idiot like
    Tony Abbott. And the occasional zombie who thinks austerity is a good idea.

  28. Freelander – I agree with everything that you’ve written, and emphasise that we’re not in ordinary times.

    As for the MMT stuff – I’m certainly not convinced by it, but I want to understand it (as least so I can feel like I’ve rejected it from a stable platform. Not unlike why I read Zombie Economics.

  29. @Dan

    Cameron is an idiot too. Though at least he is giving Merkel the right advice. Unfortunately Merkel is ignoring it. The UK three stooges in a row. Blair, Brown, and now Cameron.

  30. @Dan

    I find life too short to try to ‘understand’ some things. I try to save the effort for things that can be understood and that are worth understanding.

  31. @Dan

    Hyperinflation can not be avoided in a mass money printing scheme, if you didn’t look much at Zimbabwe, alternatively you can check what happened in Germany after World War I and the massive compensation Germans have to pay to the victors of WWI. It did use mass money printing, but the effects on the local economy is so bad that citizens literally carry a cart of money to the local bakery. Also mass money printing will significantly depreciate the exchange rate and it will force the creditor nations to charge 1000% if not million percent of interest rate to recover for that loss in the value of the loan.

  32. I’m guessing Prof Quiggin is in broad agreement with Paul Krugman on macro. Is this true or are there some points of difference?

  33. @Tom

    Except, of course, if they loan in their own currency (which they will). Then the debtor nation has their currency collapsing and is unable to make payments on even a modest interest rate on the loan in the other currency.

  34. @Tom

    Yes, I’m perfectly aware of hyperinflation in Weimar Germany and Zimbabwe, no one with any passing knowledge of 20th c. history or current world affairs is unaware of these examples.

    What I’m asking is whether this is an unavoidable outcome of treating money like this, ie. is the hyperinflationary process inherently runaway? No one has answered this yet, they’re just pointing to anecdotal (albeit important) cases.

  35. Hyperinflation usually happens because a government cannot get enough revenue through taxation and tries to get it by ‘printing’ money. Unfortunately the impact on an economy is likely to destroy whatever ability the government had to get revenue via taxation and finally because the currency is going down in value so fast people spend it really quickly and then turn to barter avoiding the worthless currency completely. The process is not necessarily runaway. Usually there are problems, even if only incompetence, that lead a government to trying this unwise approach to raising revenue. In Germany War ‘reparations’ and in Zimbabwe a failing economy and an incompetent corrupt government (I’m guessing).

  36. So that actually sounds pretty MMT to me; where taxation is recast as not a revenue-raising exercise but as something that creates or maintains the demand for fiat currency (ie. gives it value).

  37. Taxation is to raise revenue to spend. If the government did nothing it wouldn’t need any money to spend but people would still use the currency because the currency is useful and the currency is ‘legal tender’.

  38. POP I wasn’t saying that thrift is now a middle class value; I believe from my limited knowledge of history – that in medieval times no-one was thrifty. If you had wealth, you spent it on buying power and/or prestige. But when a middle class emerged as a significant group, they could see the benefits of having spare money and their idea was so useful and worked so well, that it took over. A simplistic analysis for sure.

    My point is that ‘culture’ has a great deal of influence on how much a society values ‘thrift’; defined as ‘restrained spending’. As you have noticed, it is usually only older people in western cultures that seem to still value this characteristic.

    The younger generation that I see, the ones who are not doing well in this society have no concept of saving, credit is all they know. What they call saving is paying off the credit card. All the marketing of stuff as a substitute for character, and the social engineering by the capitalist media – particularly the creation of the airhead celebrity cult – re-inforces the message to our kids that consuming is good and thrift and austerity are totally uncool.

    And then, they are blamed for not valuing thrift; but it is the capitalist system – in it’s current form – that has brought about the destruction of the values that are essential for succeeding. Am I ranting?

  39. “Taxation is to raise revenue to spend.”

    That’s certainly the conventional interpretation, but you’re showing a remarkable unwillingness to consider further possibilities, if only to dismiss them from an informed rather than ignorant position.

    Bear in mind, Keynes wrote positively about the Chartalists. And James Galbraith is one. I’m not myself, but I want to understand this thing.

    (Incidentally, under the present ‘interesting times’ circumstances, Chartalists and pos-Keynesians are saying the same thing.)

  40. Pr Q said:

    The second, even less plausible, claim is that the way to secure a sustainable economic recovery is for governments to spend less[1] thereby making room for the private sector. The painfully evident fact that there is already plenty of room for private expansion, in the form of unemployed workers and idle factories, is simply ignored….But the use of austerity measures at a time when the economy is already depressed will only make matters worse. The contractionary effects of austerity will reduce government revenues and undermine attempts to balance the budget.

    I would be the last economist to disagree with Keynes, Pr Quiggin or our dearly departed late Treasurer, Rt Hon Peter Costello, on the need for governments to follow counter-cyclical fiscal policy. Surplus in boom and deficit in bust, particularly, as in the case of EU and US, when monetary policy faces a liquidity trap due to a collapse in business and consumer confidence.

    My problem with Keynsian economics is that it may be necessary, but not sufficient, to restore growth. The early nineties Japanese bubble and bust resulted in a prolonged economic slump, despite continuing massive fiscal stimuli. Its possible that when private balance sheets (households and firms) receive a big enough hit from a collapsed financial system they may not recover for a generation, not matter how much fiscal compensation is applied. Just as a person may not recover from a big accident even if they receive the best intensive care.

    This is not merely a rehash of conservative pessimism. In his darkest moments Krugman has expressed dismay at the failure of Keynsian policy to revive Japan’s prolonged slump. TNR reviews Krugman’s reservations about the efficacy of orthodox Keynsianism in the light of Japenese resarch into the disappointing effects of two decades of deficit pump-priming:

    Writing in a special 2003 issue of the journal World Economy, Japanese scholars Toshihiro Ihori, Masume Kawade, and Toru Nakazato summarize the debate as follows:

    “One hypothesis is that the effects of fiscal policy were very large and hence recession would have deepened without fiscal expansion. Alternatively, it may be that fiscal policy did not have enough of an expansionary effect to push up macroeconomic activity, and hence unlimited public expenditures simply made the fiscal crisis worse.”

    Using quarterly economic data, which enabled them to track the effects of successive stimulus packages, they concluded that the second hypothesis is far more plausible than the first: “[I]ncreasing public investment in the 1990s crowded out private investment to some extent and did not increase private consumption much. … The overall policy implication is that the Keynesian fiscal policy in the 1990s was not effective.” The problem wasn’t that the stimulus packages weren’t big enough; it was that they were mistaken in principle, because they rested on the incorrect assumption that sustained deficit spending would stimulate aggregate demand.

    I would still support a strong Keynsian response to depression. But I am not confident that it would work without substantial command and control collectivism. Remember in the last great Keynsian crisis, during the thirties, it took rearnament and war to pull the industrialised economies out of the slump.

    In short, to recover from this depression the EU and US need to declare war on some great evil. My suggestion would be to declare war on death, but thats just me talking.

  41. @Chad Satterlee

    “I reject this dubious approach in favour of systematic general theories,”

    Reject a mixture of theoretical and empirical work in favour of pure theory from first principles? That way surely lies ruin.

    The weaker the empirical data the more we should emphasise theory, and the stronger the data the more we can be guided by empirics. But empirical work on macroeconomics doesn’t look futile to me. And theoretical macro untethered from observations suffers from its own problems. The world is too complex for humans to capture effectively in their minds. As a result there are many many models of how the world works from first principles, all capturing only a small aspect of it (at best). The Austrians for example would take the same theory-only approach and probably reach diametrically opposite conclusions to you. Without observation how do you propose to choose between them?

  42. ‘The weaker the empirical data (as opposed to the non-empirical data) the more we should rely on speculation.’ I suppose an alternative of recognising you don’t know is just out of the question! Certainly would be out of the question for an Austrian a Randian or some other assorted true believer. Nothing like faith-based ‘science’. But enough of that.

    More unintended humour from the pre-Murdoch Wall Street Journal – January 29, 2004
    Miracle on Iceland (continued) By HANNES H. GISSURARSON (Courtesy of the MPS Iceland website)
    [Yes, the article goes on. And it gets even better!]

    “… and, more importantly, allowed the free transfer of capital in and out of the country …

    … Last but not least, tax cuts propelled an economic boom. … ….Interestingly, revenue from the corporate tax in fact has gone up
    over the past decade — which proves that a smaller slice of a bigger pie is preferable to a big slice of a small one. …

    … Why did Iceland turn this way? The international trend toward economic liberalization played a role. Free-market economists like Friedrich von Hayek, Milton Friedman and James M. Buchanan all visited the country in the 1980s, influencing not only Mr. Oddsson but many of his generation. In the battle of ideas here, the right won. There was also a common recognition that the old methods did not work. …

    … But much remains to be done. The health and education systems are publicly operated, and so are the utilities, some broadcasting stations, and the hydro-electric power system. People close to Mr. Oddsson believe that two priorities are cutting the individual income tax and clarifying and strengthening private property rights, both to capital and natural resources. For example, many companies in Iceland, especially in agriculture, have no clearly defined owners, having initially been established as cooperatives. Also, while the pension funds were successfully restructured to ensure their financial health, the public has neither much say in their operations nor a choice about them.

    Yet some Icelandic intellectuals still believe the country’s future lies with membership in the European Union. Why? Iceland enjoys a bilateral defense deal with the U.S. and full access to the European market through the European Economic Area. What’s more, EU membership is no key to prosperity. As Mr. Oddsson notes, the richest countries in terms of GDP per capita are Luxembourg,Switzerland, the U.S., Norway and Iceland, in that order. Of these countries, only Luxembourg belongs to the EU. All are small, except the U.S., which is a federation of fifty smallish states.

    Small states tend to be more affluent than big ones when they maintain open and flexible economies. Smallness is not only a challenge; it is also an opportunity. Iceland has seized this opportunity and is becoming an attractive place for international corporations and capital.

    Mr. Gissurarson is professor of politics at the University of Iceland and a vice president of the Mont Pelerin Society.”

    What a clincher “is becoming an attractive place for international corporations and capital”? Well that was a success story. Good thing the MPS had a quarter century project of ‘fixing’ Iceland. Well and truly ‘fixed’, it was.

    So everyone can become rich by turning their country into a Cayman Islands and using such natural resources of being far away from everything with next to nothing substantive that anyone would want but otherwise having ‘flexible’ corporate friendly tax and other laws? (Iceland, a good base for pirates to operate from. Or Vikings.) But would parasitic activities that are carried out in tax havens be so successful if those countries that they were stealing from were not producing goods and services in the first place? Or if those countries took effective action against them? (Would being a robber be worthwhile if no one actually produced anything and everyone else was a robber as well? Or if there was adequate protection from robbers?)

  43. @Freelander

    “I suppose an alternative of recognising you don’t know is just out of the question!”

    Relying more on theory (relative to empirical work) doesn’t mean you are forming strong beliefs. And I certainly agree we should be very cautious about forming strong conclusions in macro.

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