The first two stem from Chris’ excellent recent post about the fiscal deficit. Not just because it links to me, but for the almost zen-like calm about deficits that it imparts. You can’t do anything about them with fiscal policy – they just reflect the mirror image of the private sector lending decisions, which are buffeted by far more than governments can control. From this post then comes the first graph:
In fact, you can see it as well in the US case, from Paul Krugman’s recent post on the Chinese WaterPistol:
The US private sector has gone from being a huge net borrower to being a net lender; meanwhile, government borrowing has surged, but not enough to offset the private plunge. As a nation, our dependence on foreign loans is way down; the surging deficit is, in effect, being domestically financed.
What is the tail, what is the dog? Policy Exchange sometimes imply that a government spending boom is what has is caused our problems. I have written too much about this to bore you with my responses. My view is that revenues collapsed; in cash terms, it is unambiguous that this is what separates the l0w-deficit plans from the high-deficit outcomes. So the collapsing private economy is the dog, and the public deficit the tail.
On the subject of dogs and tails, one of the articles Chris links to makes a funny point about interest rates. It says:
I don’t just mean that interest rates influence how much we save and invest. They also influence “animal spirits” – low interest rates can engender optimism about the future and hence contribute to investment booms.
I know that Chris knows this, but I’ll make the point anyway, because Scott Sumner taught me to: interest rates reflect supply AND demand for investment funds. So, of course, a government/central bank can influence the rate by promising to supply funds cheaply for yonks. Knowing this can cause finance officers everywhere to borrow funds with more confidence, knowing that they are safe from a future liquidity squeeze throwing them out of a job and onto some perp-walk into Congress.
But the level of rates also reflects how much people want to invest. This demand-side is the bit that worries me, and this last graph is an excellent illustration of the issue. It shows what people think the inter-bank borrowing rate will be in December 2010 (take the number off 100; a rising graph means falling rates). The trend is upwards – people think rates are going to stay weak, and they think this because they think the economy will be weak:
You may complain that rates are set by the Bank. This graph is just a reflection of what the market thinks the Bank will do. But in December 2010, the Bank will be looking forward two years, mashing together expectations of future growth, inflation and so on into one grand view about what it should do with rates. This graph is a view on a view, all of which amounts to the strength of the economy in the next few years.
So I agree with Chris – obviously – that we need loose money. But at the end of all this, low rates will be a sign of failure. Loose money, and persistent indications from the financial markets that they are falling over themselves to get and use some of the stuff, is what we need to see to know that 2011 will be OK.