Tag Archives: multiplier

Treasury responds to Vox’s austerity challenge

osborne britaindeserves

Last month, Vox Political wrote to the Chancellor of the Exchequer, a Mr Osborne, politely asking him whether he had any other documentary justifications for his disastrous programme of austerity after the previous principal pillar of his faith – a paper by Harvard economists Reinhart and Rogoff – had been disproved by a student at a rival university.

Today we received a response! A lengthy, well-considered one at that.

What a shame that we found a way to trash it before we reached the end of page one.

But we’re getting ahead of ourselves. Let’s all read the letter together, shall we? It begins:

“Thank you for your letter dated 22 April about the recent publication by Herndon, Ash and Pollin, a critique to the paper ‘Growth in the time of Debt’ by Reinhart and Rogoff.

“You asked for the Treasury’s views on the recent criticism of the paper by Carmen Reinhart and Kenneth Rogoff which concluded that public debt above 90% of GDP could prove a significant drag on economic growth.

“As you will be aware, the Coalition Government inherited the largest deficit in post-war history due to unsustainable increases in Government spending by the previous Government and the effects of the financial crisis [We don’t know that at all. The largest deficit in post-war history is something to which this writer cannot respond – I only know that the national debt at the end of WWII was 250 per cent of GDP, or very nearly four times as much as it is now. Spending by the Labour administration was less than that of the Conservatives until the financial crisis took place, so the writer is effectively admitting that Conservative spending between 1979 and 1997 was even more unsustainable. As for the financial crisis, the Tories would have done the same as Labour at the time, as is borne out by the history books]. In order to address these problems the Coalition Government set a clear and credible consolidation plan to reduce the risks of a costly loss of market confidence in the UK, to restore confidence and underpin sustainable growth.

“As noted by the OECD in their Economy Survey of the United Kingdom February 2013, ‘global developments have shown that the consequences of loosing [sic] market confidence can be [a] sudden and severe and sharp rise in the interest rates [that] would [be] particularly damaging to an economy with the United Kingdom’s level of indebtedness.’ A 1 percentage point increase in government bond yields would add around £8.1 billion to annual debt interest payments by 2017-18.

“Fiscal consolidation also reduces the risk of adverse feedback between weak public finances and a strained financial sector. This feedback can be very damaging, as evidenced by recent events in the euro area. Globally, the UK has one of the largest financial systems relative to the size of its economy, meaning that any loss of investor confidence in the UK’s fiscal position would not only affect the UK, but also the global economy. As the IMF has stated in their United Kingdom – 2011 Article IV Consultation Concluding Statement of the Mission, ‘the UK financial system thus serves as a global public good’. It is the IMF’s view that the UK’s economic and financial sector policies have a systemic impact on the global economy.

“The Government’s approach is supported by a large body of academic and professional literature which finds that there are strong theoretical and empirical grounds for a relationship between high levels of debt and slow growth, including:

“1. Work by staff of the Bank for International Settlements:

“* ‘The Real Effects of Debt’ by Cecchetti et al, 2011 (published as a Bank of International Settlements working paper in September 2011), found that government debt above 85% had a negative impact on growth.

“2. Research by staff of the International Monetary Fund:

“* ‘Public Debt and Growth’, an IMF 2010 working paper prepared by Kumar and Woo, found that an increase in debt ratio of 10& resulted in an annual decrease of 0.2% in per capita GDP growth, with a stronger effect at higher levels of debt. The paper found some evidence of nonlinearity with higher levels of initial debt having a proportionately larger negative effect on subsequent growth. Analysis of the components of growth suggested that the adverse effect largely reflects a slowdown in labour productivity growth mainly due to reduced investment and slower growth of capigal stock.

“* ‘How costly are debt crises’, an IMF 2011 working paper prepared by Furceri and Zdzienicka, finds that debt crises produce significant and long-lasting output losses. This study also provides support to the idea of a threshold for the debt-to-GDP ratio above which output growth starts to decline.

“* The IMF 2013 WEO box 1.2 ‘Public Debt Overhang and Private Sector Performance’, cites studies that have found a threshold beyond which public debt harms growth. It also lists several reasons why a debt overhang can affect economic activity.

“3. Work by staff of the Organisation for Economic Co-operation and Development:

“* ‘Public Debt, Economic Growth and Nonlinear effects, Myth or Reality?’ Egert, OECD 2012, finds ‘some evidence in favour of a negative nonlinear relationship between debt and growth using a variety of econometric models.

“4. Work by staff of the European Commission:

“* Report on Public Finances in EMU 2012 supports the statement that public debt can trigger economic growth: ‘higher debt levels and interest rates might weigh on economic growth, especially when debt exceeds a certain threshold level as a number of papers suggest.’

“There are also theoretical reasons, highlighted in Boskin, 2012 and OECD, 2012 for believing that higher levels of public debt will damage medium-term growth prospect:

“* First, tax hikes needed to service a higher public debt may crowd out private investment by reducing disposable income and saving.

“* Second, if the higher debt servicing costs associated with increased debt levels are financed by increasing tax revenue, they also imply a deadweight loss on the economy as a result of distortionary effect of raising tax revenues.

“* Third, there is broad agreement that large deficit and debt levels are associated with a higher level of long-term Government bond yields which may crowd out productive public investment and reduce private investment through an increase in the cost of capital. Reduced investment in research and development will have long-lasting negative impacts on growth.

“The approach is also supported by international organisations. The OECD, for example, noted in its November 2012 Economic Outlook that ‘With the budget deficit (excluding temporary factors) at over 8% of GDP and gross government debt at over 80% of GDP, fiscal consolidation is necessary to restore the sustainability of public finances and will strengthen medium-term growth prospects. The fiscal stance remains appropriate, and is supported by the strong institutional framework.’

“Olli Rehn, Vice President of the European Commission, on the speech of the Spring Forecast in May 2013 noted: ‘It is important that the UK follows through with consistent consolidation of public finances with a view to achieve (sic) a more sustainable fiscal position.’

“At the end of this letter you can find the papers referred to above online.”

I shan’t embarrass the letter’s author by naming that person.

The online papers are:

Cecchetti, Bank of International Settlements, 2011. ‘The Real Effects of Debt’ http://www.bis.org/publ/work352.htm

Kumar and Woo. ‘Public Debt and Growth’, IMF 2010 http://www.imf.org/external/pubs/ft/wp/2010/wp10174.pdf

Furceri and Zdzienicka. ‘How Costly are debt crises’, IMF 2011 http://www.imf.org/external/pubs/ft/wp/2011/wp11280.pdf

IMF April 2013 World Economic Outlook (WEO) http://www.imf.org/external/pubs/ft/weo/2013/01/

Egert, OECD 2012. ‘Public Debt, Economic Growth and Nonlinear effects, Myth or Reality?’ http://www.oecd-ilibrary.org/economics/public-debt-economic-growth-and-nonlinear-effects_5k918xk8d4zn-en

Boskin, M. Stanford Institute for Economic Policy Research, 2012. A Note On the Effects of the Higher National Debt On Economic Growth http://siepr.stanford.edu/publicationsprofile/2491

OECD Economic Outlook, November 2012. http://www.keepeek.com/Digital-Asset-Management/oecd/economics/oecd-economic-outlook-volume-2012-issue-2_eco_outlook-v2012-2-en

European Council, 2012 UK Country Specific Recommendation (CSR). http://ec.europa.eu/economy_finance/economic_governance/sgp/pdf/20_scps/2012/04_council/uk_2012-07-10_council_recommendation_en.pdf

… all of which can be picked apart with one observation and a couple of attached questions:

Mr Osborne demanded in 2010, that cuts to welfare benefits alone should total £18bn per year by 2014-15 (meaning a total of £90bn over the five years of Coalition government). Other government departments have had to take huge hits as well.

So why is the total drop in the deficit this year just £300 million? And why is the national debt now more than 88 per cent of total GDP – well inside the danger zone that Mr Osborne has been trying to avoid?

Could it be that, once put into practice, the theories outlined above aren’t actually worth a farthing?

Expect much more on this subject as we really get our teeth into the material the Treasury has kindly provided.

GDP figures due – will Gideon have anything to show for his austerity idiocy?

Triple-dip breakfast: Will we all be dining on the sour cereal of recession again, when GDP figures are published on Thursday morning?

Triple-dip breakfast: Will we all be dining on the sour cereal of recession again, when GDP figures are published on Thursday morning?

Thursday will be another ‘crunch’ day for our part-time Chancellor of the Exchequer – he’s having quite a lot of those lately, isn’t he?

Only last week, the academic justification for his austerity policy was disproven by an American student (oh, the shame!), and then his former allies at the International Monetary Fund distanced themselves from him (oh, the betrayal!) saying he should calm down a bit.

That’s the best advice this columnist has ever heard the IMF provide; if not for his own health, then for the nation’s.

Thursday, though, is a really big day. On Thursday, GDP figures for the first quarter of 2013 will be published.

It is a sign of how low expectations have fallen, that all the economic commentators are saying the best we can expect is to have kept out of a triple-dip recession – with falls in output due to the weather, among other things, making that unprecedented outcome more likely.

There is a problem with all of these predictions, which should be obvious to those of us living in the real world: Short-termism.

It’s all about how the UK managed in the last quarter, how it will manage in the next; what the situation is today. What about six months from now? What about next year? What about 2015, when we’re all expecting an election and the chance to banish this nightmare? What about 2017-18, when 0sborne still reckons he’ll have eliminated the budget deficit (fat chance)?

The fact is that the only options open to a Chancellor in the current climate are unpalatable to the Boy.

He could boost investment in infrastructure, in a bid to make this country a better place to open – and carry out – business. The trouble is, this tends to be a long-term project and he no longer has the time. His chances would have been better if he had started this in 2010, but his government cancelled as many such projects as they could back then, claiming it was more important to cut public spending in order to balance the books.

That was a vain hope. Without new investment, the country has lost revenue.

But if that is unpalatable, the other alternative is likely to make him choke on his pate de foie gras (or whatever it is these posh boys ingest): Increase the spending power of the poor.

It is known that the ‘trickle-down effect’ is a myth – giving all of a country’s money to the very rich, in the belief that they will spend it, boosting the economy and the income of the poor, is nonsense. What they actually do is bank it – in offshore tax havens, most likely. That is what 0sborne has been doing; it is another reason the economy has bombed.

It is also a rock-solid fact that poor people do spend their money – or as much as they can get their hands on. When you are constantly struggling to make ends meet, it’s very hard to keep cash in the bank – you have to spend it on food, clothes, rent, heat, light, water… the list is endless, because it constantly repeats.

When you don’t have much cash, as Edmund Blackadder once said, you feel like a pelican. Everywhere you turn, there’s a large bill in front of you.

That money does work for society. It reinvigorates the economy as it filters through different hands. And it brings with it the extra joy of fiscal multipliers – every pound that gets put into the economy is worth more after it has been through.

The trouble is, Gideon shut off that money supply. He raised VAT, making it harder for working-class people and those on benefits to buy certain economy-boosting products, and then he and Iain Duncan Smith spent the last few years on their project to depress wages.

(For clarity, it goes like this: The DWP makes the benefit system so difficult to navigate that people in receipt have to do their utmost to get off-benefit as soon as possible. This means they are constantly looking for jobs, which in turn makes it possible for employers to refuse pay rises for their workforce, with the classic line that “there are plenty of other people who’d be happy to have your job, you know!” You didn’t really think the benefit cap was about making work pay, did you?)

Say what you like about Labour, but they’ve got the right idea when it comes to the money supply. Ed Balls wants to cut VAT; he wants to bring back the 10 per cent tax rate for the lowest-paid; he wants to bring in a National Insurance holiday for companies that agree to take on new employees.

These are measures that will help.

What is Gideon going to do?

Place your bets on Osborne’s next excuse for economic failure

This is not a good time to run a retail business - the effect of the Coalition's benefit cuts will trickle up and bite our rich retailers and industrialists hard.

This is not a good time to run a retail business – the effect of the Coalition’s benefit cuts will trickle up and bite our rich retailers and industrialists hard.

According to the BBC website, business activity was hit hard by last month’s exceptionally cold weather, with the number of people visiting shops down by more than five per cent.

For one person, this will have been an extremely pleasant piece of news, because for once he won’t have to explain himself.

That person is, of course, Gideon George Osborne.

For one month, he hasn’t been in the unenviable position of having to root around in the political undergrowth for a reason the economy has tanked – that isn’t related to his own hopelessly inadequate economic policies.

For one month only!

He will not have an excuse when the figures come in for April, worse than for March, as sane economic forecasters should expect.

Instinct says he will tell us the funeral of Margaret Thatcher will have something to do with it. He used the wedding of the Duke and Duchess of Cambridge as a shield – what goes for ‘matches’ must surely apply also to ‘dispatches’.

The real reason will be the effect of the huge benefit cuts, that will take £19 billion out of the economy over the next year, if commentators are to be believed.

That’s just in money terms. Add in a conservative estimate of the fiscal multiplier (the effect on the economy) and we’re staring into the black pit of a £30.4 billion loss. That would be £500 for every person in the UK, if we were all affected.

But the richest among us won’t be. It is on the poorest and least able to defend themselves that this hammer blow has fallen. The government has been giving money back to the richest, as we all know.

In fact, this show of support for his cosseted buddies might protect them from the storm that’s coming, and may therefore prove to be a shrewd move – but we must all remember that Osborne is not an intelligent man and good fortune coming to anyone as a result of his policies is pure chance.

Because the rich will be affected by the benefit cuts. Poor people have no choice but to spend the money they receive. They have to buy things they need and pay the bills, so it goes on food, heat, light, water, the rent, repairs and other necessaries. With less money available to them, they will not be spending as much in the shops, and will be more careful about how much gas, electricity and water they use, as well.

Who owns and runs the shops? Who owns the shares in the utility companies (now that the bulk of shares have been bought up from the middle-class speculators who bought them in the 1980s)?

The rich.

After a few months of this, we’ll see what happens to their profit margins. My guess is that a £100,000 tax rebate won’t help very much.

The propaganda machine keeps spewing out nonsense, of course. Only last weekend we heard Francis Maude telling Jonathan Dimbleby and the Any Questions audience in Exeter: “The Coalition government, which is two parties which have come together from a different place, in the national interest, to do something quite big and difficult, which is to address the biggest budget deficit any country in the west had.”

It wasn’t the largest budget deficit of any western country – either by size or percentage of GDP. That was a flat-out lie and I wish Jimbles would pull him up on it.

The deficit in the United States is greater than ours in percentage terms; in money terms, it dwarfs the UK.

Across the whole world, Japan has the biggest deficit.

Strangely, you don’t hear the Japanese making a big fuss about it.

Does anyone remember those pesky banks? (Fixing the economy part three)

I was listening to Gideon George Osborne’s Autumn Statement the other day – and my word, don’t I wish I hadn’t! In between lapses of concentration due to boredom and bursts of sudden fury, depending which idiot pronouncement he was drooling, I had the odd lucid thought, one of which was this:

The financial crisis was caused by bankers. Did anyone ever identify who they were?

It’s a good question and one that I don’t believe has ever been answered. A cursory search reveals no list of British names on the Internet but I don’t think we can blame it all on Fred Goodwin, can we? (Fred ‘the Shred’ was, you’ll recall, stripped of his knighthood due to his role in the banking crisis, as chief executive of the Royal Bank of Scotland)

If nobody else has been named, we can conclude that none of them have been made to account for their actions or pay recompense to those of us who have had to suffer hardships – some extreme – indeed, some fatal – as a result of the foolhardy way they gambled with money that was not theirs and nearly brought the global financial edifice crashing to destruction.

It’s nearly five years since the crash. We can reasonably expect that these people are still in position, still taking home huge bonuses every year (debate among yourself whether they have earned these amounts or not). They have not been held accountable. It seems increasingly unlikely that they ever will.

But their organisations have absorbed huge amounts of public money, paid during the great bailouts of 2008 onwards by the UK Treasury in order to keep them going. It seems to me that these fatcats should be on starvation rations until that debt is paid off but I don’t see that happening. This leads me to my next question:

When are we going to get our money back?

The answer comes to mind immediately: If events continue along the current pattern – never.

That’s not good enough. In fact, it’s downright disastrous for the British economy because we all know by now – and the Autumn Statement confirmed it – that the welfare squeeze and other measures that Gideon has levelled at those of us on low or medium incomes, for the hideous crime of having nothing to do with the banking crisis that led to the recession, isn’t going to make anything better. In fact it can only make matters worse.

Consider fiscal multipliers. Every pound invested by a government in its economy generates more money as it goes through the system. The classic example is investment in construction, which yields more than £2 for every £1 spent. But if you subtract money – for example, by a fiscal squeeze – it follows that the economy suffers a greater loss than just the money that was taken away. I believe writers other than myself have suggested that the planned extra £10 billion welfare squeeze will remove £16 billion from the economy.

Meanwhile the banks, that caused the crisis, are off the hook and free as birds.

I have already stated my belief that the economy needs government investment in order to grow. If that investment took place, people would start making money again and they would logically put it into the banks. At this point, I suggest it would be reasonable to start encouraging the banks to start paying off their debt to us; there could be no argument that repayment would harm their viability as they would be benefiting from new money.

They could start paying a financial transactions tax (FTT) at a rate of 0.1%, applicable to all transactions through the CHAPS (Clearing House Automated Payments System) which is used to make same-day, irrevocable payments. If spent on deficit reduction alone it was envisaged in 2010 that this would halve the deficit by 2013/14. The introduction of the tax at that time would also have fended off overtures of a rise in regressive taxes such as VAT to 20 per cent, which left the most vulnerable in society picking up the bill for the mistakes of the very well-off. It differs from the ‘Robin Hood’ Tax Campaign for a 0.05 per cent tax on banking transactions, as the latter targets a broader range of banking activities. Most of the major EU countries supported such a tax, and on July 18, 2010, the then-head of the IMF, Dominique Strauss Kahn, announced he would back it.

I would also continue levying the Bankers’ Bonus Tax introduced by Alistair Darling in 2009, which raised £2 billion, and extend it to other institutions such as hedge funds and private equity houses, which benefited from the bailout through government-backed guarantees and quantitative easing.

If banks continued to pay excessive bonuses then the tax yield would remain high, accruing a large amount for the Treasury, and a permanent bonus tax could lead to bonus payments being reduced as a way to avoid tax; discouraging the payment of bonuses.

This windfall tax has been replicated in France, where the government warned banks that if they did not obey the strict guidelines on pay they would be excluded from competing for exclusive government contracts.

How about a remuneration cap? This would be a short-term ceiling on total remuneration, given as both cash and share options. This would tackle flagrant high pay, shoring up balance sheets and providing a level playing-field across the banking sector.

The link between excessive pay and the economic crisis is widely acknowledged. Remuneration caps could therefore give greater economic stability to the banking system.

I would also create a High Pay Commission – an open, balanced and thorough examination into pay and income at the top in order to find long term and tested solutions into how better to reduce excessive risk and excessive rewards.

Obviously I would separate banks that engage in ‘retail’ activities from those that engage in ‘investment banking’. I would close that casino because the players use other people’s money. Also, ‘casino’ bankers would be less likely to make riskier choices as they would not have protection from the taxpayer. They would also be regulated, to ensure their actions do not put the economy at risk. I understand this is taking place but I can’t fathom why the government is dragging its feet.

Banks should be encouraged to profit by serving their customers well and collectively providing liquidity and capital to the economy.

These banking regulations would be best enforced multilaterally, by other countries as well as the UK, but this should not stop the UK government taking action on its own.

The disproportionate influence of the financial sector over the UK economy leaves it particularly vulnerable to future crises and we should not allow ourselves to be at the mercy of international consensus.

We know that some automatic opposition to these policies will include fear-mongering that talented individuals will leave Britain in droves and growth will be hit. Evidence indicates this is unlikely but if they want to go, I say, let them. There are plenty more talented people just itching for a chance to take their place.

Others will claim that some tinkering with the system, such as banks planning how they wind-up and toughening up existing rules on capital adequacy and liquidity, will solve all our problems. They won’t. There are some fundamental problems that need to be solved if we are to avoid repeats of this crisis.

Better people than myself have said we must reverse the trend of the past 30 years, where private financial risk has been publicly shared and the gains increasingly privatised.

That’s the truth of it. If we can’t punish the transgressors, we can at least claw back the money they have taken.