Tag Archives: Fiscal Stimulus

UK 2017-2025? Post anaemic recovery, post Brexit, lousy post

So, at last, George Osborne has just cancelled his appointment with eliminating our deficit, ie having a budget surplus, by 2020. I’m not sure if that means he has come to believe in textbook macroeconomics, is appreciating the limitations of neoconservatism, or is just dealing with the reality of the impossibility of the task given what is likely to happen to the UK economy post-Brexit.

Some people are saying that if the UK economy really tanks as a result of Brexit there will be a need for more austerity. God help us. It’s more the case that there will be a need for really massive stimulus. But here is what George Magnus thinks will happen, somewhat mangled by me: a UK ‘demand shock’ recession will be fully evident by end 2016 and through 2017, with rising unemployment and more spending cuts but rising fiscal deficit from the ‘fiscal stabilisers’ of social services support and as the government also tries to stimulate somehow with infrastructure projects, along with the possible removal of OAPs ‘triple lock’ on their pensions, maybe even removal of the alleged ‘ring fence’ for NHS. All this will probably erupt into the open in the (new?) Chancellor’s Autumn Statement later this year.

But, more significantly, there will be a substantial ‘supply-side shock’ through 2020-25 as business investment, particularly from foreign companies (the likes of Toyota, Nissan, Siemens, etc) is diverted elsewhere, while investment spending from UK companies is reduced, along with housing starts etc. If there is lower immigration (or, indeed, movement of immigrants to their home countries or elsewhere) this would further weaken the supply-side of the UK economy. Any ‘total factor’ productivity benefits from supply chain integration with other EU countries will evaporate, making even some UK-made goods more expensive at home and reducing any benefits of a shrunken pound to our exports. The average Brit will be noticeably poorer than now.

And, by the way, any ‘money printing’ where there is a supply-side recession could well cause significant inflation, unlike with the demand-side recession we have recently encountered.  Whether any government is equipped to recognise when one type of recession melds into another type of recession is a moot point.

George Magnus is more dispassionate than I am, because he does not mention social unrest, which will likely become significant. Among other things there will likely be a further rise in active racism.

Another equally  dispassionate blog on the Triple Crisis site, while pointing out very real negative economic effects of Brexit, indicated that they will not necessarily be quite as bad as some have suggested. However, it is less sanguine about the inevitable accompanying rightward shift of Conservatives in power in the UK (more pro-austerity, more pro privatisation of NHS) and of the negative knock-on effects on the EU itself and on the euro.


What happened between 2010 and 2016. All about Austerity…

I came across something on Yves Smith’s excellent #NakedCapitalism blog, which I thought I’d share with my future self.

Before linking it, here’s my own version of the story so far…

I’ve kept banging on about the follies of #austerity ( aka ‘fiscal consolidation’) as introduced by the UK’s Chancellor George Osborne, much aided and abetted by the hapless Nick Clegg in the coalition government which came to power in 2010.

But it is important to be clear that fiscal consolidation is very appropriate under certain circumstances – namely, when an economy is judged to be growing strongly, and, for any reason you like, it is judged desirable to rein in public debt. After all, why burden your future self or future generations with debt which is unnecessary because you can easily afford to reduce it without harming your growth or harming your public services? All governments borrow by issuing debt in the form of government bonds and the UK government has nearly always been in debt. Think of it as a mortgage. No problem, as long as you can afford the interest payments. Even with a strongly growing economy a government may legitimately wish to borrow in order to raise large sums, beyond the scope of taxation, for state investment purposes – on infrastructure, hospitals, universities, schools, weapons, scientific research, and so on (war also comes to mind). But if it needs to borrow to pay for ongoing salaries, unemployment benefits, social services, road maintenance, etc., (etc.) – then clearly something is wrong. In that case it may mean taxation is just too low: as a growing economy may mainly be putting the proceeds of its growth into the pockets of a very few, with little ‘trickling down’ to the many. In which case the government’s coffers would be receiving too little tax to pay for current expenditure, because inequality is too high.

The current UK austerity policy was introduced by the Clegg-Cameron coalition shortly after the massive increase in debt incurred by the UK government of Gordon Brown: an increase which was necessitated by the bailout of the poorly-regulated financial sector (for which blame Bill Clinton and blame Blair-Brown) after the financial sector, especially the banks, brought much of the world economy to its knees. The same events occurred in the USA, where it all started, and in many other major economies.

Financial sector bailouts, the monetary policy of reducing central bank interest rates and fiscal stimulus by governments – ie extra government spending – were initially applied and sort-of saved the day. But the initial very appropriate fiscal stimulus was quickly followed by panicky fiscal retrenchment even as the previous policy was starting to work. The immediate result of the 2010 newly elected Conservative fiscal retrenchment was to immediately turn shaky recovery back into recession. In the UK George Osborne lifted his foot off the fiscal brake a little when it became obvious to the Treasury in 2011 that his austerity policy was damaging the economy, which had started to grow again in 2009-10. All the while Mr Osborne was claiming that there was no alternative to Plan A, and that he was still pursuing it. But he wasn’t. Much to the chagrin of some of the ‘Tory Press’.

However, by then the damage caused by Osborne’s ceasing all UK government investment, and his other austerity measures, had already been done; followed by knock-on (‘hysteresis’) effects on private investment as well as further state investment. Of course, the UK economy did eventually start to recover yet again – they always do…eventually. But this UK recovery, despite significant employment growth, has since been pretty anaemic and fragile in terms of GDP, with appallingly low productivity and an unsustainable ‘trade deficit’. not to be confused with the fiscal deficit, which was hardly shrinking at all, despite the cuts. Similar government behaviour elsewhere in the world produced similar results, though Britain’s productivity remains the worst among developed nations.

Of course, in the middle of all this, the euro area had its own special problems to add to the mix, largely due to irresponsible bank lending, most especially by German banks, to irresponsible  private borrowers – mainly property developers in other countries, especially Ireland and Spain. Greece was a special bad case with Greek government profligacy which was pretty obvious when it joined the euro and which should have stopped its joining, except nobody had the courage to call out the Greek govenment over its bogus data.

Basically, what was forgotten by the UK government and others, as they focused their attention on the higher than normal Debt/GDP ratio (obviously more important than the actual debt itself), was that while, if this ratio is considered too high to be sustainable, there are, on the surface, two ways to bring it down:

  1. to directly cut debt by cutting the government deficit (difference between tax take and expenditure), through severely curtailing government spending, or…
  2. a longer term strategy of raising GDP by means of additional government spending on capital investment and encouraging business to invest… (and there is always ‘helicopter money’ to consider, as well – giving money directly to consumers to spend)

… in most countries, especially the UK, the focus was wholly on response (1) from which the private sector bit of (2) was supposed to occur via… er…’confidence’.

The reason for choosing opton (1) was the alleged sheer urgency of ‘bringing down the debt’. This was supposed to mean the private sector would regain its confidence to spend and business, thereby, would invest more. It was hoped by the more full-blooded neocons that this would also have the benefit of shrinking the state, which, for many, was their main ideological and selfish motivation (lower taxes, y’see).

Of course it failed and continues failing, even in its anaemic form.

This is because businesspeople are not stupid and did not actually have confidence that the policy was going to work, whatever they may have been saying to the press. And so, instead, they pocketed their profits and tax cuts by proceeding to increase senior management salaries/bonuses while massaging up their share prices via buying their own shares, thus ‘justifying’ increased bonuses… etc., (etc.). British productivity, in particular, suffered from a lack of investment and cheap labour, some imported.

Neither were ‘the markets’ confident. Thus they went about increasing their purchase of government bonds in the secondary market, driving up bond prices and thereby decreasing bond yields, since the interest paid is monetarily fixed on the initial government issue price. This was, amazingly, widely reported by an ignorant press and others as ‘success’ in raising the confidence of the markets and, by inference, business generally. After all, if a country’s bond prices are high (interest rates therefore low) doesn’t that mean the country is a safe bet?

Bollocks it did.

In this case it meant that while ‘the markets’ understood that a country in charge of its own currency would have some difficulty actually going bankrupt, because if push comes to shove it can legally pay its debts in its devalued currency, government bonds were being bought instead of shares or investing in productivity-enhancing schemes because, in reality – as opposed to what was put in company reports – they had too little confidence in their sales and profitability being steadily sustained in the future. There was nowhere else really to invest with any confidence, squire.

In the euro zone, countries can easily go bankrupt, because they do not have their own currency and so debt must be repaid in euros. They are in a situation a bit like the old discredited ‘gold standard’.  This was why Britain could never ever have become ‘Greece’ despite the ignorant warnings from people who should have known better, or did know better but were just being mendacious.

Throughout, there was also the ‘monetary policy’ employed by central banks, namely reducing interst rates drastically and quantitative easing  – otherwise known as ‘unconventional’ monetary policy – employed to overcome the ‘zero lower bound’, when you cannot stimulate an economy via lower interest rates any more because they they have already been reduced to zero or near zero. That had relatively poor stimulative success – unless, maybe it worked to keep us out of recession once we had managed to get out of it. In fact, we mainly got out of it through consumer spending and increases in consumer debt, or at least consumer ‘dissaving’.

So, in the UK, here we still are, with an anaemic recovery (yes, yes, better than some, but still anaemic) which can easily be knocked off course by any old external shock – and any old self-inflicted internal shock like the Brexit vote and its rumbling longer term repercussions.

Quite early on in all this, the IMF had changed its mind about the desirability of fiscal consolidation as a way of reducing debt (murmurings and research from them in 2010 and later, as I posted in previous blogs). But the OECD seems only very recently to have come to its senses and started to call for governmental fiscal expansion policies. It says the need is urgent, urgent, I tell you! It has to be remembered that these august instutions are often run by politicians and bankers who have a major say in the official pronouncements, which may actually conflict what their economists are actually saying, until eventually the economic realities and the narrative of their economists successfuly break through.

Meanwhile, Germany is still stuck in its traumatic Weimar fear of inflation – forgetting Bruning deflation – and employs a version of macroeconomics allegedly invented by Schwaebian Housewives: debt=bad…always… and never ever print money. Their behaviour is also dictated by a belief that every country in the euro zone should be like them and export more than it imports: a logical impossibility… (except to German finance ministers, apparently).

Finally, here is the link I promised originally.

But now we are starting a new story. Post the Brexit referendum. Next blog.

 


Secular Stagnation … I Think

I’m not totally sure what secular stagnation means – other than growth is low and difficult to jump-start, and that is the new normal.

But I do know that large companies are not investing significantly, preferring to sit on cash-piles and pay their most senior executives enormous salaries and bonuses instead. This is because large corporations are oligopolies – pretty close to monopolies. So they have near complete control of their pricing and profit levels, which are hardly reined in at all by either the competition nor by adequate regulation. If a competitor does break rank, that competitor may well be bought out. So the large corporations are in an excellent position to milk their customers, their existing products and their productive methods for all they can. They have little or no incentive to invest in better products or services or better means of producing them. Why do that when they can give their senior executives bigger salaries and bigger bonuses instead. And it’s not even as if shareholders get a raise in dividends either, because fund managers who hold most of the shares have no real incentive to perform better – and, if they do protest at meagre dividends , they can safely be ignored: after all share prices can be kept high by the simple method of buying more of their own shares to distribute to employees, especially the most senior ones. The ‘light touch’ low regulation situation was initiated by Mrs Thatcher in the UK and Ronald Reagan in the USA. And then continued by Messrs Blair/Brown and Mr Clinton.

Free enterprise is easily corrupted into monopolies/oligopolies without adequate regulation. This kind of corporate behaviour illustrates the difference between short-term greed and long-term self-interest, because if the corporations were to be investing economies would grow more and everyone would live happier, healthier and longer lives, assuming reasonable wealth distribution, natch. (But the inequitable wealth distribution we currently have also started in the 1980s and is a linked phenomenon). Better growth and better wealth distribution would benefit the corporate execs’ descendants. But I suppose said execs are holding to the view that in the long term we are all dead, and in the short term ‘mine’s bigger than yours’ competition among the top 0.1% must be a very difficult mental habit to shake.

It is largely because of all this that productivity is so low – most especially in the UK, where it is now in a particularly abysmal state even compared with other major (G7) economies where it is none too healthy. And, of course, low productivity leads to low growth, which further inhibits investment because of lack of confidence. A viscious circle, indeed.  Employment of cheap labour from a cowed and nervous workforce has been kept up for a while, as cheaper than new plant, etc. But it now looks as if even that may be slipping, too.

Attempts to boost economies via central bank quantitative easing have not been particularly successful, as we are constantly reminded (it was well known to be a gamble from the beginning – likened to ‘pushing on a string’).

So now central banks are toying with the idea of negative interest rates – and some, including the ECB, are actually implementing it. This is also likely to prove ineffectual in its aim to boost investment and consumer spending. So some (wishful thinkers) are predicting ‘helicopter money’ as a last resort (just distributing cash to consumers to spend).

In an economy your spending is my income and my spending is your income. That’s why an economy is not like a household or a firm. So ‘Schwabian Housewife’ economics (we-must-all-live-within-our-means-and-debt-is-inherently-bad) is such total rot. It is based on a fallacy of composition (the whole is exactly like its parts: national economy=firm=household=individual), and takes no account of the ‘paradox of thrift‘ where if everyone saves and no-one spends, we are all impoverished.

The simple answer in a case like this is through what is called fiscal expansion by governments. Governments need to spend, even if it means borrowing to do so. But because of Schwabian Housewife economics this has become politically unfeasible. Most Western governments don’t even want to spend on infrastructure investment, let alone welfare, health, the military, research into carbon dioxide capture and storage, etc (etc). In the UK if the hapless Mr Osborne were to be seen contemplating anything more than a short tactical about-turn from austerity, as he did in 2011 and is now doing after his latest budget fiasco … well he couldn’t because the press would not let him. Plus, of course, the theology of shrinking the state in order to ‘unshackle’ so-called free enterprise remains a convincing-sounding argument to many like Mr Osborne, despite the fact that we have seen what unshackling free enterprise has led to so far. Obviously free enterprise has not been unshackled enough…? Ayn Rand stuff, anybody? That’s an argument like proper communism has never really been tried? Both obviously bullshit.

Of course what would really lead to fiscal expansion would be a good war. But that really would not be the kind of rescue from North Korea or Mr Putin that I would be hoping for.

 

 

 


Austerity: The UK Government’s Current Motives Are Not The Original Ones

It looks as if the UK government’s austerity drive to reduce the deficit in haste no longer has the objective of improving the economy. It has other objectives.

It looks this way because the excuses for austerity not apparently actually improving the economy are transparently weak. They boil down to ‘our main export markets are in a terrible state, the global economy is in a pretty poor state, other countries are in the same boat, so we are doing the best we can under highly adverse circumstances; but don’t worry – we are getting there, slowly – just look at our improving employment situation‘.

This is transparently weak because, for a start, it ignores the fact that our major companies are simply not investing. These companies do not need to borrow (or borrow much) to invest as they are generally sitting on large cash-piles. So while it is true that our SMEs may be experiencing difficulty raising funds – because the banks are still in a ‘delicate’ position – if our major companies were to be investing we would be seeing some real growth. But they are not, despite the once-alleged confidence building effects of the austerity policy. This is because they are fearful there won’t be enough demand to justify their investment in new products, new plant, new machinery. They see a lack of demand stretching into the future. This demand shortfall arises because consumers do not have the wherewithal or confidence to go out and spend. For some years now, their wages and salaries have not kept pace with consumer prices and they are nervous about their jobs. One major reason why their wages remain ‘stickily’ low.

But what about our ‘improving’ employment situation? Well, it’s true that private employment has grown and even outpaced the engineered decline in public sector employment. But at pretty low wage levels. And anyway, there is a marked decline in productivity associated with these employment improvements. More private jobs is not translating into more production and growth. Cheap labour is being hoarded by firms and hired, too, as a cheaper or less risky alternative to capital investment. And in the service sector much labour is being expended fruitlessly chasing more business which refuses to materialise because this is a negative-demand-led recession.

David Cameron, George Osborne and Nick Clegg are none of them stupid. Neither (now, at least) are they ignorant. They know all this stuff. So what is their stated excuse for not abandoning their policy of short term fiscal consolidation – though, of course, it is now not quite so short term because the end-of-this-parliament targets are definitely going to be missed, and the government has admitted it? When, instead, they could be borrowing – at what are actually negative real interest rates – in order to boost demand through increased capital investment in productivity-enhancing infrastructure, building works, school repairs, more housing, etc? All things which are really needed, and which would, much of it from the get-go, have significant economy-boosting effects. The stated excuse is that to be seen to be changing the austerity policy and embarking on a borrowing ‘binge’ when the national debt is ‘so large’ in relation to GDP would cause the bond markets to freak out. The markets would suddenly cease purchasing UK government bonds. And this would result in a rapid rise in market interest rates on the bonds significantly increasing the price of government borrowing in the future. Also, they claim, the UK would lose its AAA status because the government would have lost credibility in its perceived ability to reduce the deficit and ultimately the national debt. Um… well the credit rating agencies are going to do that anyway, and soon. Because, clearly, the government is failing in its endeavours to fix the economy, while the deficit remains stubbornly high, with debt still increasing in relation to GDP. GDP is still bumping along the bottom, if not actually decreasing, further exacerbating the debt-to-GDP ratio. Obviously the best way of actually reducing this ratio would be to increase GDP, the denominator in the equation. We really, really need growth.

There is also, of course, a major unstated reason for not changing policy: that no senior politician can be seen to admit they were wrong, as this would have a seriously deleterious effect on their personal credibility and future career path. Tough one that… Moral dilemma, eh?

So therefore the purpose of continued austerity is now no longer to fix the economy, but (i) to try to hold off a sudden rise in UK government bond interest rates (a sudden drop in demand for bonds) and (ii) to shore up policymakers’ personal credibility until ‘something turns up‘. This is just finger-in-the-dyke stuff. It can’t help but fail. Even more disturbing is that, actually, there is also a third reason (iii) that some Very Serious People, possibly including Mr Osborne – but if not, certainly people he rubs along with at dinner parties, perceive government debt as immoral. They do, too. They may give reasons for this, relating to future generations – reasons which don’t generally hold water. This is really ideological, emotional, not susceptible to argument. Oh, and a related fourth reason (iv) The belief that the state must be shrunk so that the well-off can keep as much of their income as possible and not be burdened by more than the minimal amount of taxation: purely ideological, this one, to put it politely.

So – there we have it: four motivations for continued sharp fiscal retrenchment – none of which actually relate to the reason we were given for front-loaded fiscal retrenchment at the outset: that this austerity would cause the private sector to invest and grow. This was the myth of ‘expansionary austerity’. A myth, by the way, cleanly, neatly and tightly debunked in an essay/paper from the USA’s Center for Economic Policy Research (CEPR) published some 7 months ago. Here (PDF).

Way back in 2010 Olivier Blanchard of the IMF clearly said ‘Commandment II: You shall not front-load your fiscal adjustment, unless financing needs require it’. That was in June 2010.

All this is not to say that the national debt is too low, or just right. The national debt is, by general agreement, even among KrudeKrugmaniteKeynesians, too high in relation to GDP. A credible plan for its reduction – and therefore reduction of the deficits which feed it – is definitely needed. But we do not have such a plan at the moment. Plan A has, indeed, been discredited. To be at all credible, a rational plan needs to be stated now, to be implemented when GDP does significantly turn up in what looks like being a sustained manner. Austerity in a time of growth may be a virtue. In a time of depression/recession it is definitely a self-defeating ‘sin’. As the IMF pointed out way back then.

Addendum

1. How does our debt to GDP ratio actually look? Is it as bad as it is claimed? Well, it is not brilliantly good. But putting it into a historical perspective shows that it is not actually all that terrible, either. Here are some charts. So we need to do something to bring it down. But all that now-now-now panic was totally unnecessary. (EDIT: And long after this was originally written, a paper by Reinhart and Rogoff widely used to justify debt panic, has been thoroughly debunked for (i) sloppy use of Excel, (ii) deliberate exclusion of data that didn’t fit the thesis and, (iii) perhaps the greatest sin, assuming causality and ignoring the possibility of reverse-causality: high government debt results in slow growth, when it could equally be that slow growth causes high government debt).
2. Did the last government cause the sharp increase in national debt? Well, it did happen on their watch. But that was because of the extreme financial crisis caused by the meltdown of the banks, requiring an expensive bank rescue operation, and causing a sharp drop in tax receipts.
3. Could we have been in a stronger position when all this actually started? Probably. But Spain and Ireland were paragons of fiscal rectitude, and still got sunk by their banks (and the euro and the ECB – but that is another story). The UK was not particularly fiscally profligate before this all happened. The fiscal deficit of the UK was actually less than 3% of GDP at the time. Not so bad, as it happens. Similar to the USA and France. But, of course, if the banks had been better regulated… Well, that’s another story. And the blame for that can certainly be laid at the door of Gordon Brown. However, the Conservative party at the time was all for very light-touch regulation too.

EDIT
There is one potential flaw in the argument that the government should switch course, and borrow for investment in beneficial infrastructure, etc, etc… But nah… That’s for others to elucidate… If they have some evidence, that is…

…Oh well, all right then. The potential flaw is that – although I do not believe it would happen, it is, theoretically possible that some muddled thinking on the part of some people in ‘the markets’, combined with herding, might result in either refusal to buy new UK government debt, or, if not immediate, a sudden rise in their yields (free market interest rates) as those who had bought the new debt (mainly banks) found that they could not sell it on at prices above or equal to what they had bought it for. In other words, if the UK government were to abandon current austerity policies and borrow for worthwhile capital-type investment to boost GDP (fiscal stimulus, yay!) interest rates on UK debt might possibly go stratospheric.

As I said, I don’t believe this would happen. But, if it did… what would happen then? The answer, from history, seems to be here. Nice charts and explanation from that KrudeKeynesianKrugman (KKK). So, not Greece, nor Spain, nor Ireland today. But but France in the 1920s. When an awful ‘bond vigilante’ strike actually happened. So France, which had started with an enormous post WW1 debt problem, recovered strongly. what a surprise! The effect of the sharp rise in French bond yields caused a sharp decline in the value of the franc (surprise? No). Resulting in increased exports (surprise? No). Some inflation eroding the value of the debt (but definitely no Weimar, note). And on to a full economic recovery. France boomed in the 1920s – until the Great Depression. But that is a whole other story.

Meanwhile here is a blogpost and chart chart snitched from Not The Treasury View (aka Jonathan Portes and NIESR) which says it all about the current recession, compared with previous ones.


Getting My head Round Deficits and Debt and What Happens Next

I’ve sort of got my head around this stuff. But I need to write it down to be sure.

Firstly – ‘Debt’  is money a country borrows on ‘the markets’ by issuing bonds, of a particular value/price, paying a particular rate of interest (eg 3%) and which may be redeemed for the purchase price after, say, 10 years.

People buy these bonds at the issuing (nominal) price and may then either hold them or trade them. This is where it gets interesting – because when they are traded on the open market, the price, here, may go up or down according to supply and demand. Thus, depending on the risk perceived by the markets, the price increases or decreases on this open market. But since the interest paid is static (eg 3%) in respect of the original issue price, if their market price goes down (too little demand, because too much perceived risk) then the interest they actually pay on the actual price they are traded at will be higher than their nominal interest. The real interest paid is inversely related to the price at which they are traded. It is this real interest which gets quoted and is seen in the press. The more risk there is perceived to be that the Sovereign (the issuing country) will not be able to redeem the bonds from whomever now owns them, at their original face value at the end of those bonds’ fixed period, the higher is this quoted interest rate (ie the lower the price at which they can be traded on the open market). Phew!

Now, obviously, if there is a perceived significant risk that a country will ‘default’ on its obligations to redeem the bonds at their face value (or maybe even keep up the interest payments!) the harder it will be for the country to issue more bonds – because ‘the market’ will be demanding that new market interest rate has to be paid by the issuing country on its new bonds – to a point that it will no longer be able to afford to service its Debt and pay its internal and external bills. If the price of its bonds collapses on the open market (interest rates quoted skyrocket) this is a sure sign that the market (that is – the traders – mainly banks) believes the country is on the brink of national bankruptcy. Even if there is no foundation to such a belief, the belief itself would make it very difficult or impossible for the country to issue any more bonds – thus it would become a self-fulfilling prophesy.

So the ‘confidence of the markets’ is very important for a country.

However, it is important to note that low yields on government bonds (as currently for US and UK Treasuries) do not necessarily mean that the market is confident in the way the country is being run economically – only that there may be nowhere else for the market to put its money – eg shares being considered a dead loss, as at present! (Evidence: August 5, 2011 S&P Downgrade the U.S, but the 10-Yr US Treasury Yields 2.5%…)

‘The Deficit’ is not the national debt. The deficit is the difference between national income and national expenditure – approximately. Sometimes a country is in surplus with this respect, and sometimes it is in deficit. Often a rich country will run a deficit for years and years – adding to the size of the national debt as it issues more bonds. But as long as the markets believe the country will not default, they’ll keep buying the bonds and the quoted interest on them remains relatively low. How can this happen? Never mind. It just usually does for advanced economies. Perhaps the subject of another blog piece – talking about say, the USA, Japan and the UK and maybe the role of Sovereign Wealth Funds…

So – what is going on at the moment in the UK and the USA?  Here is my take:

  1. The whole developed world is going into austerity mode at the same time, particularly all the European countries – so no European country which is in trouble is going to be able export their way to GDP growth and hence out of trouble (eg the way Sweden did in the mid-90s via domestic austerity);
  2. In the meantime austerity is contractionary – and the private sector is not going to pick up the slack because it is also in austerity mode: profitable businesses are actually sitting on their cashpiles rather than investing because they do not have any confidence that their markets will buy their goods/services in sufficient quantities to make it worthwhile to invest; consumers are trying hard not to spend too much, and to reduce their own debts;
  3. It’s not a good idea for economies to run large deficits over a long period of time and thus increase their debt: so in the long run (even the medium run) deficits need to be reduced or eliminated;
  4. If a country with large deficits wants to be able to keep borrowing money on the markets at advantageous rates, it needs to keep the markets confident: thus it needs a credible plan to reduce its deficits in the medium term.  Nobody out there apart from the ‘Pain Caucus’ – (we have overborrowed and binged and sinned, therefore we must suffer pain, painItellyou, nownownow) – really needs a short-term plan to reduce the deficit. But is may fit in neatly with an ideological-cum-religious desire to ‘shrink the state’ and ‘let me keep more of my own money’ – eg, as with UK conservative party and US Republican party type people and Libertarians;
  5. Economies can have any level of national debt they like – as long as they can afford – via their tax receipts – to pay the interest on their debt – just as you or I can take out any mortgage we like – as long as the bank will lend it to us and we know that through our income we can afford to pay the interest, and ideally some of the principal;
  6. Currently, for the USA for Japan and for the UK  – the market is willing to buy our debt for very low interest rates – in other words, pay a  high price for our bonds (especially now that the stock market has tanked!)
  7. The ratio of debt or of deficit over GDP depends on the absolute size of the deficit or debt and also the absolute size of the GDP
  8. If you want to reduce this ratio you can do it in two ways – (a) cut the deficit or (b) raise the GDP
  9. There are various ways to cut the deficit – however, it should never be done ‘nownownow’, but over the medium term, if you do not want to harm your economy/reduce your GDP; (contractionary policies are, well… contractionary… doh!)
  10. Reducing taxes for the rich (typically, unfortunately, these are the so-called ‘Very Serious People’ that government ministers mix with) produces hardly any dividends for the economy – because they hoard their excess money or spend it (often abroad) on yachts, planes, property and jewellery. It’s a myth that it encourages them to invest productively or work harder (that’s checkable by the way: lots of research);
  11. Reducing taxes for the not-so-rich – most especially the relatively poor – does stimulate the economy because they spend the extra money on goods and services;
  12. So one way of stimulating the economy is to reduce taxes on the relatively poor – and this may possible produce more income for the govt than it loses. But reducing taxation across the board for rich and poor is only deficit-increasing – because it is the rich who benefit the most (which is why the GOP in the USA is so hypocritical about its desire to reduce the deficit);
  13. Because of the low price of borrowing for, say, the UK and even the USA (despite the most recent shenanigans in the USA) – now is a good time for those countries to borrow more – provided only that they can put their borrowing to GDP-enhancing use;
  14. The most important thing is to kick-start the economy and get growth; ideally via capital projects, etc, that will pay dividends longer term;
  15. This implies that  fiscal stimulus via government spending and *judicious* tax reduction would be A Very Good Thing;
  16. There is an economic theory that government spending squeezes out private investment – but this is incorrect when interest rates set by central banks are near zero;
  17. Monetary policy (interest rate-setting by the central bank) cannot help because we are up against this ‘zero bound’ – unless possibly via quantitative easing (about which the jury is out – it may just be pushing on a string);
  18. We have high unemployment, set to grow further: this reduces Government income and also increases Government spending to keep the unemployed unproductively alive and living a sort-of life;
  19. So wage-increase demands will certainly remain weak – unless and until the unemployment becomes ‘structural’ (square pegs and round holes) which all the research shows it is not, currently – here or in the USA; (but long-term unemployment does tend to become structural eventually as skills are lost);
  20. Worldwide, most inflation, currently, is imported, via commodity price (etc)  increases, not domestic – and is anyway going down (‘core’ inflation definitely is going down);
  21. So – as thing stand – the governments of the UK and the USA can ‘print’ as much money as they like and it will not be inflationary; those who believe it will be inflationary do not understand the difference between domestic inflation and imported inflation;
  22. A household cannot print its own money – but a sovereign country can do so; although eorozone members are not sovereign in this sense: they have no control of their own money supply, which is controlled by the European Central Bank;
  23. Obama’s fiscal stimulus was too little, and has now run out.  Some economists were predicting it was too little right at the beginning; others are saying this shows that fiscal stimulus cannot work – but that is bullshit;
  24. Apart from bailing out the banks – the UK, since the Conservatives came to power, has not even tried fiscal stimulus;
  25. The last great depression was ended by the fiscal stimulus of a big war and its aftermath; I don’t see that happening this time, thank goodness – so this ‘lesser depression’ could last a very long time, because current policies are likely not to reduce the deficits;
  26. And now – because of the latest shenanigans in the USA Congress and the governance of the eurozone – things can only get worse… We may be heading straight into another Great Depression.

Er… that’s all I can think of for now.
EDIT
But when things get better in an economy, that can also send bond yields up!!
This is because their traded price goes down because investors are confident enough not to need to park their money in bonds (at low yields) but prefer to use it for investment and/or buying shares, for higher expected yields. So they sell the bonds.
Thus rising bond yields do not automatically mean loss of confidence in a country’s ability to service its debt: you need to know what else is going on in its economy.