. . . though that will not stop the Telegraph following it, slavishly.

I’m afraid I’ve only skimmed Policy Exchange’s latest attempt to convince us that government spending really doesn’t have any useful economic effects. The theory section on page 25-27 seems to imply that:

  • insufficient demand is never a problem unless financial markets are broken
  • Ricardian equivalence is a proven fact that stops public spending working, ever, in normal conditions
  • very little needs to be said of the zero bound constraint on monetary policy.

Given all these, and the evident bias, it is difficult to expect much from the voluminous history-description that follows, in terms of the endless macroeconomic debate about the efficacy of fiscal stimulus.   Since they start with bad theory, there is likely to be some bad history. Moreover, the point about macroeconomic analysis, surely, is that it is fairly context-specific.  Asking what happens on average is pointless if there is a crucial difference to this situation. The rule “Don’t throw buckets of water over people’s heads” is a pretty good one, on average.  But not “if their hair is on fire”.  Ditto “cutting back on public spending boosts growth on average” and “but not if we are threatened with deflation and the banking channel is f***ed”.

So in how many of the situations they examined were the interest rates needed minus 6%? Oh, none?  Thought so.

This is really 101, and over the Atlantic, where the debate is really raging, pretty standard stuff. So I am not tempted to use a couple of hours reading it.  To snark at just one bit of the theory section:

households will understand that if the government borrows extra today, it will have to raise taxes tomorrow to pay off that borrowing. In anticipation of those extra taxes tomorrow, households will save extra today

NO. (a) Households do not anticipate like this. If so, why did they spend so much when Brown was borrowing too much earlier? They would be magic-balancing-creatures, forever calibrating their consumption for long run fiscal equilibrium (b) when the economy is far below capacity, government spending can provide INCOMES that enable people to spend and save.  As has been endlessly pointed out, since the beginning of time.  Imagine an economy where 30% are unemployed.  The government comes along and promises to do some spending – build some homes, say.  Do the people with their incomes from this get all worried and not spend it, because of the taxes that might arise in 10 years’ time? No.

And this is a terrible explanation for why Keynesians think as they do:

it is precisely the denial that Ricardian equivalence applies in such cases that motivates the belief in Keynesian stimulus can work

No.  A belief is not motivated by a denial.  Keynesian stimulus is motivated by a combination of commonsense and inspiration about how economies operate in deflationary, sub-capacity situations.  This sentence is the logical equivalent of “my belief in gravity is motivated by a denial of the existence of levitating elves”.

It is deeply tedious to keep bringing this up, so once more I refer to the far more vicious blogs of American geniuses similarly frustrated.  In his musings on an intellectual train wreck, Brad De Long writes:

There is nothing illogical or inconsistent about the economy being in a state in which aggregate planned expenditure is greater or less than income. Today’s Chicago school would know this, had it not forgotten all of monetary economics from David Hume on.

Policy Exchange seem keen to join the Chicago School. What I can’t understand is the determination to have the SAME economic policy regardless of circumstances.  Facts. Change.  In 1-2 years’ time, I too will clamour for fiscal restraint.  LIke Martin Wolf, I want a plan, but just not to have it implemented until it is safe.  Now let’s move on*.

If there is a redeeming feature to this dip into pre-Keynesianism, it is that they seem to have done some work on the political problems of spending cuts.  But in many ways, what is far more interesting than “Policy Exchange don’t like fiscal stimulus” is “Mervyn King won’t ALLOW fiscal stimulus” – which is what he effectively said yesterday.  Who is in charge of fiscal policy?  The Bank.  We need an Independence of the Government bill soon.

Other news: Vince has fleshed out the National Infrastructure Bank idea.

I thought Charles Dumas’ letter to the FT was excellent:

the idea that the UK (and presumably the US) should have run fiscal surpluses in 2004-07, “saving up for the next crisis”, neglects the fact that a balanced overall policy to promote full employment and low inflation would have then entailed lower interest rates (and probably exchange rates) than we had. An even more extravagant housing boom would have resulted, with greater upward distortions in house prices and consumer debt than the “fools’ paradise” (Dr Weale’s words) that actually occurred.

The FT has a useful breakdown and scoring of the Government’s many small financial interventions.

Finally, for light relief, Don Paskini STILL thinks that asking people questions about how to fix the financial crisis is in any way relevant. The Don still thinks that democracy fixes problems.  Quite apart from some of the ideas being really bad (CAP interest rates = Welcome Loan Sharks), and others really tired (“Educate in Financial literacy” is up there with “Spend more efficiently” and “no more wars”), and everything optimistic-statist (yes, a ‘charter for responsible lending’ should fix the mess), you have to ask: why are we asking citizens, as if this is all a political matter?  Why does putting “citizens” in front of something make it suddenly wise and efficient?

I want the centre-left to do well.  This sort of platitudinous talk-to-ourselves is going to go precisely nowhere – but make the participants feel important for a few minutes.

*(not moving on) If you want further, confusing but brilliant reasoning for how investment now can determine saving later, this blog of Andy Harless is wonderful. It proceeds with this assumption: all income is instantly saved.  You then have a decision how much to dissave – the residual is saving.  The dissaving is what gives someone else an income to save.


6 thoughts on “Not sure what Policy Exchange are adding here . . .

  1. Hi Giles,

    I know that democracy can be very frustrating for bright technocrats, but ‘the centre left should learn that democracy doesn’t fix problems, and the little people have nothing useful to say about the financial crisis’ is, with respect, one of the worst pieces of political analysis that I have read in a very long time.

    Happy to debate the details of the policies (is the problem of loan sharks really so much worse in France or any of the other countries where they cap interest rates?), but the underlying principle has to be to engage and involve ordinary people in figuring out what to do next.

    A few years ago, some people made exactly the same criticisms about the demand for a Living Wage – today it is supported by radical leftists such as Boris Johnson, Barclays Bank and Pricewaterhouse Coopers. Whatever the merits, the ideas put forward last night were the exact opposite of ‘platitudinous talking-to-ourselves’ – every main political party, the Olympics Legacy Agency, city law firms and banks and the Corporation of London all sent representatives to pledge to work with London Citizens. That’s a lot more influence than, say, a think tank producing a pamphlet.

    If you don’t treat economic policies as a political matter, don’t try to involve and engage people and win support for your ideas, then no matter how good your ideas, they will be irrelevant.

  2. Apologies for any flippancy or scepticism. but writing this from the launch of philipp blond’s think tank, i am not overly convinced by rightleaning people paying lipservice to radical ideas.

    i quite agree that this is a problem of political economy, not just technocracy. but i severely doubt how cou nting heads or hearing what gets the loudest cheer will have a any reliable relationship with fixing systemic crisis..

    democracy works when people need to decide how to share resources. it is highly relevant for the fiscl crisis.. but for new capital rules?

  3. Giles, Don,

    With respect to you both, we citizens give pretty bad answers and (more often) non-answers to all sorts of technical questions when they are asked out of the blue (or out of the red). However, we tend to give pretty interesting answers once we are assembled, briefed and have discussed the question. Insofar as this is a question of political economy, a Citizens’ Assembly for the subject might give the normal political process a much better starting point than we now have.


    You may be over-rating Charles Dumas letter to the FT, and the virtues of Gordon Brown’s mistake in over stating the UK’s potential growth trend which lead him to square his Budgetary Golden Rules with sizeable deficits in the good times. The main savings flow was from the trade surplus countries. I surmise (without doing the arithmetic) that an increase in UK and US government savings would have meant that a greater proportion of the surpluses would have found a home in Western private sector assets. The surplus countries would therefore have bourne more of the costs of the crash, so probably leaving less of the losses on the Western banks’ balance sheets.

    The arithmetic that I have not done is feeding the scenario through a stock-flow conditioned model of the world economy.

  4. Perhaps I am unfair about a citizen’s assembly. If they are given the full consequences of all the decisions they have to make – unbiased, of course, not just “do you want to bash bankers or murder puppies” – then it may be useful. I would love to see what they would do with £100 to spend on £150 of public services, without the option of taxing someone who is not in the room.

    David. This is the puzzle that Greenspan could not solve – low real rates despite high short rates. But why do you think that we would have borne less of the losses? If we had had more savings, why would they not have gone off to CDOs etc in even greater quantities?

    I think all these counterfactuals are fairly academic. Politically, it would have been very hard to save or stand in the way of the housing boom.

    1. Giles,

      My point about losses was that we bear the eventual cost of government debt issued to the foreigner. If there had been less of our governemnt debt, the foreigner would have bought more CDOs, etc. He would then bear the losses on them instead of our picking up the losses in the course of propping up our banks. But the counter factuals are only of interest for exploring theory.

      Nobody really knows about the uses of Citizen’s Assemblies; but the experience so far has been more promising than I expected.

  5. Ah, now I understand

    Although the foreigners may have only wanted government debt instruments, so they may have bid up government debt prices instead? Interest rates would still have fallen in this country, don’t you think?

    I will continue to read the Don’s stuff on Citizen’s assemblies with interest. On solving the political expenses crisis, I support the idea strongly. If they could agree not to use MP’s as proxy councillors, I think we may get somewhere.

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