Monday, November 02, 2015

Defining Austerity

The term "austerity" has an awful lot of people confused, so I thought I'd do a quick post on the subject explaining it from an economic point of view. The first point to get out of the way is that the kind austerity being discussed by and large is _fiscal_ austerity, relating directly to policy decisions by the government on spending and taxation. It's not the only thing we can deem as "austerity", but it's generally what people have meant in discussing it over the last 6-7 years. What follows simplifies the details a little, but makes a pretty good rough guide.

First we need to come up with the concept of aggregate demand (Written as the letter Z). We specify

Z = C + I + G

That is total demand in the economy is equal to demand for private consumption (C), plus investment demand (I), plus government demand (G). We then add total output (or GDP, written as Y) to the mix. Because total demand equals total output we can move on to getting an equation that crops up a lot in economics (the goods market equation in IS-LM):

Y = C + I + G

Finally, we add in taxes, we place taxes next to consumption to denote that they act to reduce consumption:

Y = (C-T) + I + G

Now that we have our equation, we need to start to talk about fiscal policy by looking at the two variables in this equation that are within the gift of the government: government demand (G) and taxes (T). Any government policy that acts to raise Y in this equation, tax cut or spending rise, is fiscal expansion, anything that acts to reduce Y is a fiscal contraction (aka what we can call austerity).

That, in a nutshell is how economist/econoblogger community defines "austerity", although there is a couple of final complications. The first in that GDP (Y) is a moving target that is usually growing at a slow trend rate. In that sense we do need to look at how the two government controlled components (G and T) behave relative to overall growth of output, G growing more slowly than overall output can be considered austerity in this sense (indeed, in order to make this happen you would probably need to make cuts). The second which relates to the moving target nature of GDP is that determining with any precision whether a policy is expansionary or contractionary can be difficult as you can't be sure what GDP growth holds, we can for example guess that the coalition's raising of the tax threshold was expansionary as it was way beyond any regular inflation/wage related expansion but it would be hard to define what the precise figure for said expansion was.

Monday, September 14, 2015

The UK and the Liquidity Trap

I had an interesting exchange of tweets with Nick Shaxson and the hated Sam Bowman of the ASI (or is that Sam Bowman of the hated ASI) on the subject of companies hoarding cash. Sam suggested that companies hoarding cash was not a problem, I suggested that it would be in a liquidity trap to which he asked if the UK is or was in a liquidity trap (or if such a thing really exists). I think it is the case that we are essentially in a form of liquidity trap, so what follows is the way I intuit the basic IS-LM model with regards to the UK economy. I'd also add that Krugman

So first off, the basic IS-LM model is based around a static closed economy with a goods market and a money market. In the money market we find an equilibrium between the demand for bonds that give a return at an interest rate (i) and cash. The goods market is governed by good old Output(Y) = (C - T) + I + G with the level of investment being determined by the interest rate hence giving us the downward sloping IS curve. A liquidity trap occurs when we get a situation a bit like the one below with the yellow lines, in the money market demand for money is so low at the given level of output that consumers are indifferent between holding cash and bonds. I've also put a more normal scenario where we are above the ZLB in green.

Translating the model into the real world can be a bit tricky, but I think it's reasonable to look at the rate on government debt as a good guide to where interest rates are at. In terms of money supply, I think here we can interpret moves by the bank to loosen policy (lower interest rates, QE) as shifting the money supply curve right. Finally, in terms of growth, I don't think we should necessarily assume that growth shifts the IS curve right, instead I'd interpret this as a sign of how "hot" the economy is. We can see growth despite the kind of zero lower bound equilibrium of the yellow and blue lines, shifts in "output" in this diagram manifest through fluctuations in the overall rate of growth. A low equilibrium output is seen in the form of slow growth, excessive austerity could shift the IS curve left to the point of causing a recession.

The liquidity trap I describe here is one of output being depressed through keeping aggregate demand low through austerity. The main place I see it here is in the money market equilibrium, the low interest rates on what we might classify as bonds are a sign of depressed output and a loss of economic potential, I think we are seeing the results in the form of below trend output (see this from Simon Wren-Lewis). In terms of other things that might justify us being in a liquidity trap, I think we can also look at the two textbook insights:

  • In a liquidity trap fiscal policy is very effective
  • In a liquidity trap monetary policy is very ineffective

Both those insights seem like a fair assessment of our current situation.

Monday, August 17, 2015

A Look at Corbynomics

There's lots of discussion of what Jeremy Corbyn's economic plans are, so I thought I'd put some of the major elements under the microscope. I should add the disclaimer that because as it's clear to people who follow me on twitter, Corbyn is my favoured candidate. I will try though to keep my views as analytical as possible (although I do abandon impartiality in the last section).

Deficit Reduction

If my reading of his policy on deficit reduction is actually pretty conventional, the view I've cobbled together is that while he believes we need to reduce the deficit and ultimately stabilise debt/GDP but he believes we should be far slower and more careful in reducing the deficit, not setting an arbitrary time frame. This seems to appreciate something that few politicians realise and that is that we have far less control over the economy that we actually do, a suitable metaphor might be attempting to reach a destination by sail, sailing close to the wind looks like a more direct route but might ultimately end up counter-productive as you may end up being blown off course.

The reason that this is a sensible approach is that borrowing is currently very cheap and we appear to be at the zero lower bound in terms of interest rates, textbook macroeconomics tells us that fiscal policy is very effective in this kind of situation which is a pretty good case against austerity and for borrowing to invest (something that Jeremy also proposes).

Tax Raising

I'm not so keen on this section. Richard Murphy is quite confident of the figures he's put forward here although my hunch is that they are optimistic, I'm not sure if the figures are as large as is said and even if they are I'm not sure how easy it would be to get out hands on this money. That said, there are still some good proposals, country by country reporting in particular would be very useful.

He also talks about the £93 billion in corporate reliefs and subsidies, this is also something I'm not so sure about. I'm sure there are some of these that could be cut, but an awful lot of them seem to be things we should be encouraging (investment and R&D allowances for example) and there are some that could cause serious problems for the way some businesses operate.

All in all I think the tax raising possibilities mentioned in the document are very optimistic.

The Helicopter

The proposal that's got most people talking is his QE for the People idea, which appears to be getting the Bank of England to print new money which is then spent on infrastructure. The policy looks a little like what's called "helicopter money", an idea originally proposed by Milton Friedman and has been discussed more recently by people like AdairTurner, Mark Blyth, Eric Lonergan and Simon Wren-Lewis and Willem Buiter. The main difference is that they have all treated it as a monetary policy instrument, an additional weapon to be put to use to get inflation back on target when the interest rate isn't cutting it.

As a monetary policy instrument the simplest way would be for a universal simple lump sum payment to all adult citizens, this could both provide a rapid boost to demand and the nature of the universal nature of the transfer would mean the Bank of England remains independent. The problem with using helicopter money on infrastructure is that it's really quite difficult to time infrastructure projects in such a way that they can raise aggregate demand. It can take years of preparatory work before you start building a new road for example, this essentially means that it would be little use as a way of rapidly raising raising the quantity of money and aggregate demand in order to combat inflation. The political nature of this new spending and money creation would in effect create a second, politically controlled monetary authority which would undermine the role of the Bank of England as the UK's monetary authority (Tony Yates is good on this).

My overall opinion on the helicopter money idea is that it's a good idea when done in the right way, but that infrastructure QE is not a good idea and that any National Investment Bank would be better financed through conventional government borrowing. That said, one of the main criticisms I've heard is that it would be inflationary doesn't really stand up. A large enough amount this kind of QE could be inflationary, but if inflation was to start to tick up you could simply turn money taps off. An alternative and perhaps better way of looking at QE for the people is to view it as a way of selling expansionary fiscal policy to a debt averse public, this to me seems to be what People's QE is really all about.

A Final Note

You might have noticed that I am quite harsh on Corbyn in what I say, so the obvious question arises: Why am I voting for him? Firstly, while I think Corbyn's policies are flawed, I do not think they are policies that can be dismissed out of hand, they are ideas that deserve to be taken seriously. Corbyn's political opponents have not attempted to developed a serious critique of his ideas, given that trust on the economy is important for winning an election you would hope they would be able to do this.

The second point is that again while I don't like everything Corbyn is offering, his policies seem on balance the best on offer. As I've said, there's much to like about his fiscal stance and there are variations on Peoples QE that could work effectively. He's probably promising more than he can deliver, but it is at least a vision of a better future.

Monday, July 20, 2015

Labour and the Structural Deficit

On a recent leadership hustings hosted by Andrew Neil, the charge was made that the UK under Labour was running the largest structural deficit in Europe apart from Greece. The candidates answers unfortunately missed a very important point.

The large structural deficit in question only appeared as a result of taking into account data from after the crash. Before the crash, it was assumed that the UK economy was running at close to but slightly below capacity. With the arrival of the crash and the resulting deficit, that view was revised to assume that in fact the UK economy must have been running significantly above capacity.

The point here is that the structural deficit was the result of the way that estimates were constructed based on post crash data, not on estimates that were available before the crash. This is, I think something that should be emphasised by leadership contenders.

There are those who will say that we should nevertheless run a surplus on a just in case basis. To those people I would point out that running a surplus unnecessarily could have a serious cost in lost output and also that the UK national debt was low in 2007 and that despite the crash the UK never had any problem financing it's debts, the UK governments finances were in a good secure position before the crash.

As a final note I'll point out that, inflation, the traditional sign of an overheating economy was not present in 2007. The state of the UK economy in 2007 is something that has not been examined closely enough and does warrant further study.

Thursday, June 18, 2015

An Unconvincing Argument from Liz Kendall..

Something I've been hearing from Liz Kendall and her supporters has been an argument along these lines:
 "..there is nothing progressive about spending more on debt interest repayments than spending on the future of educating our children." 
 I suspect it's an argument we'll hear repeated quite a lot because it has all the hallmarks a good bit of propaganda, it's short ,catchy, repeatable and has a kind of intuitiveness about it. The problem with it is that it doesn't have much merit as an effective policy.

 Even if we disregard arguments about the zero lower bound, multipliers and the economic dividends from investment in things like infrastructure (and I don't think we should) there's still the plain simple maths of it all. According to the 2015 budget, total managed expenditure is £743bn, debt interest is £46bn (or £34bn if you count the APF), paying off every penny of debt interest would only allow us to increase spending by 6.5%.

 More to the point, reducing debt by any serious amount would take a considerable amount of time. If we start from a debt of 90.6% of GDP, assume a 1% surplus and nominal GDP growth of 4%, it would for example take 13 years to half the outstanding national debt (as a % of GDP, another aside would be that running a 1% deficit would still see debt reduced by 29%). It would take a long time to see even small dividends from reducing the national debt.

 It may be a good sound bite, but it's just not in any way sensible policy.

Update 22/6/15: Jonathan Portes posted a link on twitter to a more academic take on this subject at Vox EU.

Thursday, August 29, 2013

Mysterious Economic Numbers

I've read an intriguing little piece the paper that tells City Boys what they want to hear (that's City AM folks) by Paul Ormerod in which he is supposed to be demolishing the anti austerity arguments. I'm a little puzzled by some of the claims he's making, this one in particular:

But the two other components of GDP – investment by companies and current expenditure by the public sector – offer a marked contrast between the US and the UK. Despite the widespread belief that austerity policies are being rigorously pursued in the UK, current public spending grew by 3.3 per cent in real terms between 2009 and 2012. In the US, meanwhile, it fell by 4.1 per cent.

This is quite a claim real terms spending has increased in the UK and decreased in the US, I've seen people make the mistake of confusing deficit reduction with fiscal contraction before but this is obviously not what's happening here. My own understanding of the situation was that public spending in the UK and the US had followed roughly similar spending paths. In the US a federal spending increase was offset by a decrease at the state and local level but the net result was essentially a degree of austerity in both countries. Those don't seem to fit the numbers quoted in the article.
Looking at the numbers just makes things more confusing. For the UK, I've looked at the PESA 2013 release from the ONS, that gives the following figures for total managed expenditure:


I don't know what periods Ormerod uses for his numbers but going from 2008-09 to 2011-12 would give a 9.5% increase in nominal terms but once we add CPI inflation (I make it arround 11.8%) into the mix this drops down into negative territory (I make it around 2.1%). For the US I've taken a look at a couple of sets of data, the seasonally adjusted quarterly figures and the annual figures for total government expenditure from the St Louis Fed:





I've chosen the use the annual figures for 2009-2012 but I thought for this one I get nominal spending growth of 4% once we set this against US CPI inflation (around 7%) I get a drop of around 2.9%. By my calculations both the US and the UK have endured austerity, with slightly more in the US I don't really see how this tallies up with the figures Ormerod quotes.
So what I'm left with is a bit of a mystery, where did Ormerod's figures come from, perhaps I've chosen the wrong periods or used a different measure of inflation, but it's hard to see how to make this Austerity in US spending in the UK narrative add up.

Thursday, May 09, 2013

23 Shades of Free Market Capitlism

Tim Worstall is writing a very amusing set of pieces for the ASI called "23 Things We're Telling You About Capitalism", I think it's intended as a kind of rebuttal to Ha-Joon Chang's 23 Things They Don't Tell You About Capitalism. Reading it is really quite amusing, simply for the number of omissions and giant stretches it requires to make Tim's worldview work.
"...But don't forget, Chang is writing a book about how capitalism and the free market just aren't all they're cracked up to be: if so, then how did we end up with the better technologies, better institutions, better firms and infrastructure  Could it, possibly, have anything to do with the fact that we've been largely capitalist and free market for a couple of centuries?" 
 The word "largely" in this particular point is doing one hell of a lot of work here, the USA for example has had a long history of imposing protectionist tariffs  in addition all western countries have spent a large number of decades developing their welfare states. The problem becomes even more acute when you get to some of the more recent developing countries.
 "..This isn't confined to any one group or set of countries either. Just since WWII, Hong Kong, Japan, Taiwan, S. Korea have all joined the nations that enjoy that distinction. China is catching up fast. Those countries that haven't haven't: like, for example, the bureaucratic and planned Licence Raj in India which still impoverishes Ram..." 
Let's we start with suggestion that democratic India is somehow not as capitalist or free market as a nation who's ruling body is called "The Communist Party of China"? Also, perhaps we can look at one of Chang's previous works for some fine examples of free market capitalist innovations South Korea.

For example, by the ASI's definition, the following government policies are now "free market" and "capitalist":

  • Government seizing control of the nations bank's and using them as a tool to control industrial development. 
  •  Government instructing one firm that it is only allowed to produce diesel engines for marine vessels while instructing another to work exclusively on diesel engines for motor cars.
The problem all through Worstall's piece is that the definition of free market capitalism that he defines as a good thing is so broad almost as to encompass a gigantic variety of policies. All this would obviously be fine, except that reading the work of both Worstall and the Adam Smith institute they would seem to subscribe to a rather narrower definition of free market capitalism in their own work. S

Still, for now I'm quite happy in advocating policies that will further extend the welfare state and increase the size of the state sector in the happy knowledge that I'm being a good free market capitalist.