The architects of the Euro hung by their own petard

With acknowledgements to the Economist: front cover 26 November, 2011

Dear readers…posted this last night, but  failed to add links…so have updated this morning….And now at 12.54 on 28 Nov, following revelations from Bloomberg, am adding in a reference to the extent that Morgan Stanley was bailed out in 2008.

A petard, I am reliably informed by the Web,

“was a bell-shaped metal grenade typically filled with five or six pounds of gunpowder and set off by a fuse. Unfortunately, the devices were unreliable and often went off unexpectedly. Hence the expression, where hoist meant to be lifted up, an understated description of the result of being blown up by your own bomb.”

Correct or not, this is a helpful analogy for the crisis of the Euro. The grenade that is the Euro has a fizzing fuse that threatens to explode imminently, causing visible panic in markets, in parliaments and treasuries across the world. Mainstream economists are either dodging the bullets and like the cowards they are, pretending that ‘it’s nothing to do with me guv’.  Or else they’re panicking in ways that are crass and unhelpful, banging their heads against the brick wall that is the Bundesbank and ECB, and demanding that someone, somewhere defuses the bomb.

The Economist has a dramatic leader this week (“Is this really the end?”) warning of grave threats and offering Chancellor Merkel and other EU leaders ways of avoiding a comet-like crash. Like many others, leader writers on the Economist, somewhat belatedly, want the ECB to act as a central bank, and to  provide liquidity to sovereign members of the Eurozone.

Continue reading… ›

Clinton spots it: the austere emperor has no clothes.

The austerity brigade is rattled. Daniel Knowles at the Daily Telegraph is so worried, he has had to rise to the defence of the Treasury and OBR – and then resorts to proposing Greece’s economic strategy for the UK. Why? Because orthodox economic ideology has been challenged by none other than Daniel’s ‘hero’ President Bill Clinton. Bill gets it. On the deficit that is.

Thanks to Left Foot Forward and Mehdi Hasan we have all read Clinton’s  speech:

“(the) UK’s finding this out now. They adopted this big austerity budget. And there’s a good chance that economic activity will go down so much that tax revenues will be reduced even more than spending is cut and their deficit will increase.”

Daniel Knowles contests his hero by drawing attention to the OBR’s use of the multiplier, on the following grounds:

“The Office of Budget Responsibility..using a Keynesian model, estimates that the fiscal multiplier is about .35”……that means that…overall the deficit is will be smaller than it would have been without cuts….. (Note: Knowles Update:  “I actually made a mistake with that statistic – 0.35 is the estimate for the multiplier for VAT. Estimates of the fiscal multiplier overall, including those of the OBR, IMF and others, are closer to 0.”)

Before I respond, let me say what a relief it is to hear orthodox economists and right-wing bloggers talking about the multiplier. For the past twenty years multipliers have been buried in macroeconomic models, and not discussed as matters of substantive consequence. But they most certainly merit being drawn into the light of day, given unemployment in the UK stands at around 2.5 million and the widespread fear and paralysis now prevailing. To do so, let us examine the consequences of the government investing £1 billion in building wind farms.

Keynes and Hubert Henderson devised the original idea of the multiplier. They understood that the primary expenditures on any public works project would lead to secondary expenditures as the newly employed spent their wages on other goods and services produced by the private sector. Richard Kahn then looked to quantify the scale of these repercussions. He concluded that the effects on national income of investment expenditures would be around twice the original outlay, and equally the impact on employment would be of a similar order. Repeated assessments supported Kahn’s view: the multiplier was around two.<!–more–>

There were then improvements to the public finances. Increased national income and employment meant increased taxation revenues and reduced benefit expenditures. Keynes was always very confident, and asserted that the effects of the spending would more than cover the costs. The exact impact, however, depends on the precise value of the multiplier, the average tax rate and the size of benefits.

The ‘Economic Consequences of Mr Osborne’ written by Professor Victoria Chick, myself and PRIME colleagues, vindicates Keynes and Kahn. We show that spending did reduce the public debt (and as Clinton claims, cuts increase the public debt), so their assessment of the multiplier must have been roughly right.

Today the multiplier may well be different (around 1 1/2 perhaps), but tax rates and benefit expenditures will be higher, so it seems likely that a similar assessment should hold today. The building of the wind farm would return at the very least, £1 billion to the Treasury.

We are now told that the Office for Budget Responsibility has adopted a model of the economy with a ‘multiplier’ of 0.35 on VAT, and 0.0 on government [investment?] spending overall.

These figures imply that the investment of £1billion in a windfarm would lead to no change in overall GDP.  Given the expenditure on the windfarm has to score in national income, – the only way this conclusion can come about is through a simultaneous cut of £1billion in other government expenditures.

So, the OBR implies, the consequences of government investment in a windfarm are as follows:

a)      The workers who get new jobs, stash their wages/salaries under the bed, and do not spend these.

b)     If they do happen to spend, then all their expenditure goes on imports – they spend nothing in British-owned businesses.

c)    The rest of the economy takes such fright at government expenditure policies that the private sector cuts back on expenditure on consumption and investment.

There may be some who believe that this is a realistic outcome from an investment of £1 billion, but they can only live in ivory towers. Most people understand the basic principle that when the private sector is not spending the government must step in and that this government investment will in turn revive private fortunes. When people are employed and earn money, they use it to buy or pay for the basics: accommodation, food, clothing and travel. When they are unemployed, and without income, they do without these.

So all Daniel Knowles reveals is that the OBR model is most definitely not Keynesian.

In fact it is an insult to his and Richard Kahn’s work to describe it as such. It is the very reverse of what Keynes and Richard Khan argued, (for more see appendix 1 of ‘The Cuts Won’t Work‘)


But Knowles inadvertently has done a public service. He has revealed how the OBR has managed to arrange the books so that austerity does not damage the economy. The multiplier has been used in a thoroughly un-Keynesian way so that the OBR can draw conclusions that are the opposite of Keynes’s own. It explains how the OBR can present huge cuts in public investment as making no difference to overall prosperity. Moreover, given it involves the negative processes outlined above, he has revealed how unlikely this is to hold in practice.

Some may see debate about the multiplier as being about a mere technicality – opaque economic jargon.  It is not. It is fundamental to the possibility of economic recovery.

Those who argue for government investment – as we do – have backed up our arguments by showing that spending on public works leads to both economic recovery – but also improved public finances.

Those opposed to government investment – argue instead that government investment makes no difference either to recovery, or to the public finances.

Which is why we have to thank Daniel Knowles for shining a light on the OBR’s tactics.

How Ed Balls was trapped.....

Have just been told that my post on the Left Foot Forward on Ed Balls’s speech  crashed the site “under weight of people wanting to read it”…so here it is for those of you that may have missed it….

David Cameron was delighted when the formidable Ed Balls walked straight into his framing of the debate on the deficit – and was promptly trapped.

That framing goes as follows. We (the government) have spent beyond our means. And the way to pay for it, is by cutting (public sector) jobs, and raising taxation – like VAT.

Ed Balls’s speech concedes (as Labour has done since Alastair Darling’s time at the Treasury) the deficit-reduction-emphasis agenda set by his opponents. And by so doing – implicitly concedes the need to cut public sector jobs.

But I am being unfair.  Balls began his speech by mentioning Labour’s “emphasis on jobs and growth” But the speech immediately morphed into Labour’s concession to the Coalition: that what is needed is “a steady and balanced approach to halve the deficit in four years”. The implication being that cuts must be matched by ‘jobs and growth’.

But the highlight of the speech – the sound-byte that his spin doctors no doubt intended the media to emphasize-  is a call for a cut in VAT “to boost consumer confidence and jump-start the economy.”

Cameron flashed back his retort: “slashing taxes” he argued, would only make the UK’s fiscal deficit worse.

And so Balls is trapped.

Continue reading… ›

Bankers must be made to serve the economy.....

21 February, 2010

Once again apologies for a longish absence. This is down in part, to smashing (literally) building works, to a little grandchild-minding, and to other writing commitments. But have been itching to comment on a) Greece and the EU b) Iceland (it seems the UK is easing up on the pressure); c) the progress of the global recession; and d) China-US relations… posts on a, b, c and d are on their way….promise.

In the meantime this is the text of a letter I signed and helped draft, published in today’s Observer, and yesterday (20 Feb 2010) in the Times. It is a response to the letter written to the Sunday Times last week by 20 conservative economists, including Ken Rogoff of Harvard, Lord Megnad Desai, previously a Labour peer, and Bridget Rosewell, who was Mayor Ken Livingstone’s economic adviser.

Our letter has a number of distinguished economists as signatories, as well as my pals in the Green New Deal group – all of whom I am proud to be associated with.    See below.


We urge the UK government not to heed the siren song of the 20 economists who, having failed to predict the crisis, now seek to advise on its resolution. The world economy is in the deepest recession since the Great Depression. In the UK, output has collapsed by £70bn on an annual basis. Under such conditions, common sense tells us that the government must compensate for the collapse in private investment and address the high level of unemployment.

The only way to restore the public finances to health is to restore the economy to health.

Continue reading… ›

Osborne's puppet-masters: Société Générale.

15th January, 2009.

Patient readers this blog is triggered by Jeff Randall’s column in the Daily Telegraph today.

In it he inadvertently discloses the identity of the puppet-masters dictating the Tory political agenda around public spending cuts.

In a somewhat histrionic column in which he describes the public deficit as a ‘disaster’ ( he should mind his language: Haiti’s earthquake is a disaster) Randall quotes a piece of ‘research’ by the French bank, Société Générale.  The paper is titled “Popular Delusions” and its authors explain some simple facts about government spending cuts to Telegraph readers:

Continue reading… ›

The pre-budget report: bullies in the playground

9th December, 2009

It has been an extraordinary day this day, and something to witness: this frenzy of pre-election fisticuffs.

Extraordinary because Conservatives, like mindless bullies, are fighting a phoney war against the victims of this crisis.

The fact is the Tories are spineless scaredy cats, too timid to take on the perpetrators, who have successfully bribed them with various inducements, including the playground’s shiniest marbles.

As a result they have turned away from the perpetrators, and   are picking on nurses, policemen, teachers, civil servants, Alzheimer-carers, school cooks, hospital cleaners and psychiatrists – to categorise but a few.

All these victims of the financial crisis now stand accused – by the Tories and their friends –  of pillaging Treasury coffers of £250 billion  – the rise in government debt since this crisis started in 2007.

Continue reading… ›

Green New Deal - 'The Cuts won't work' report is published.

7th December, 2009

This is the press release from the new economics foundation:

“Two days ahead of the pre-budget report, and as the UN climate change talks open in Copenhagen – the second report from the authors of the original Green New Deal argues that the British Chancellor is likely to miss a historic opportunity to tackle public debt, create thousands of new green jobs and kick-start the transformation to a low-carbon economy.

The cuts won’t work, the Green New Deal Group’s second report shows how, contrary to the policy of all the major political parties, cutting public spending now will tip the nation into a deeper recession by increasing unemployment, reducing the tax received and limiting government funding available to kick-start the Green New Deal.

Instead a bold new programme of ‘green quantitative easing,’ rather than simply propping up failing banks, could help reduce the public debt and kick-start the transformation of the UK’s energy supply while creating thousands of new green-collar jobs.

Continue reading… ›

Debts and deficits: stocks and flows

6th December, 2009.

Most economists (who should know better) confuse the government’s budget deficit with total government debt.

The distinction really is important.

Mixing them up is a little like confusing stocks and flows.  Or confusing your outstanding mortgage – say £200,000 – with your monthly debt repayments. They are quite different things, and if you were to lose your job, the flows (paid with your salary) come to a halt, and then it’s the stock – the £200,000 – that really matters.

Furthermore it is quite possible to increase your mortgage – and lower your monthly payments.  Many did this in the boom years of mortgage re-financing. Or even to decrease your mortgage and increase your monthly payments.

So, just as the movements in regular mortgage payments tell us little about the outstanding stock of debt, so government deficits tell us little about the stock of debt invested and the stock of debt outstanding.

Continue reading… ›

Cuts could increase the deficit

6th December, 2009

The Observer asked a small group of people to comment in advance of next Wednesday’s Pre-Budget Report. This from yours truly:

“Public debt will rise higher if government slashes spending, and recovery will elude us. Unemployment has high costs, but productive government spending, unlike private spending, pays for itself by creating jobs that generate tax revenues and cut welfare benefits.

Will the bond markets revolt and raise interest rates? No, because the markets apply common sense, as they did when Britain exited the exchange rate mechanism. Despite a rise in government debt from 40% to about 70% of GDP, and the extension of the Bank of England’s balance sheet by £200bn, bond markets have been positive – only too grateful for a safe haven in turbulent times. Confidence in sterling will only return when the economy recovers, and only then. Without public investment compensating for the collapse in private investment, there is little hope of recovery or confidence.”

Governments must spend away the debt

25th November, 2009

Dear patient readers of this blog…please find below my latest Huff Post post.

Some may wonder why I cheered when White House Chief of Staff Rahm Emanuel announced that the president plans to cut the deficit, because he “does not want to keep on adding to the debt.”

It’s no secret that conservative economists believe that the way to cut the deficit is to cut government spending. In other words, government must manage the federal budget in the same way that you manage your household budget.

But in truth, the president must do the opposite.

To strengthen the levees against the rising tide of debt and the “hurricane of unemployment,” the president must both spend down the debt with a bigger fiscal stimulus, and also get a grip on monetary policy — regulating lending and keeping interest rates low for all of us, not just the banks.

Third, the administration must manage government debt effectively and not leave it to the self-serving and private financial markets.

I am surprised at how often I have to explain why the fiscal stimulus is so important. But because fiscal conservatives just don’t get it, they must be reminded of the well documented evidence again and again.

Government spending, unlike private spending, will pay down the debt by generating income, including tax revenues, and by reducing welfare payments. For unlike private households, governments generate revenues when they spend or invest, particularly on projects at home.

When a household spends its savings on say, a new wind turbine, solar panels for the roof, or insulation, money drains away from the household bank account. The engineers, builders and laborers that construct the turbine don’t pay money back into the householder’s bank account — regrettably.

By contrast, when the federal government invests in jobs that can’t be exported to China, the engineers, builders and laborers employed pay taxes back into the government’s account. They then spend the balance of their incomes in shops and businesses, and these pay taxes too. Indeed the spending might stimulate a small business to invest and hire, adding even more taxpayers paying back into the government’s account.

It’s called the multiplier effect because guess what? It multiplies government revenues. The evidence shows that the increase in revenues outweighs the spending and thus helps cut government debt.

However, it’s not enough to spend away government debt. More must be done, (and this is where Paul Krugman and I part company).

If the president is really determined to not “keep on adding to the debt,” then he must tackle monetary as well as fiscal policy. As John Maynard Keynes repeatedly emphasized, monetary policy must always precede and underpin fiscal policy. They go together like a horse and carriage — you can’t have one without the other.

It is not enough to use public funds to bail out the economy, while at the same time allowing the private banking sector to arbitrarily raise interest rates for government, commercial and household borrowing.

It’s particularly not fair — indeed it’s downright immoral — that the private banking sector is reaping such rich pickings from low rates set by the Federal Reserve; from the struggling body that is the US economy, and from government borrowing.

For proof of the bankers’ rich pickings, study the chart below from the International Monetary Fund. It shows (in pink) the low rates of interest paid by banks to the Fed and other central banks, in contrast to the rates of interest (in green) that the banks then charge to companies, households and individuals.

Note how the rates for those of us active in the real economy are always higher than they are for bankers borrowing direct from the Fed and/or central banks.

Then note how much they diverge after 2008. Bank borrowing costs fall to nothing, while private borrowing costs soar. No wonder bank profits are ballooning.
(The chart is from the IMF’s October 2009 Global Financial Stability Report. The composite real private borrowing rate [RPBR] is a GDP-weighted average of the U.S., Japan, euro area, and U.K. RPBRs.)

The Treasury must get a grip on high rates of interest — rates bankrupting businesses and homeowners, causing foreclosures and unemployment to rise — all “adding to the government debt” by increasing welfare spending.

The administration (through the Treasury, the Fed and the banking system) must adopt policies to force down rates across the spectrum, for government and the private sector; for the commercial and household sector as well as banks; all loans, short-term and long-term, safe and risky.

To stop “adding to the debt” it is vital to keep interest rates very low — while ensuring that lending is ‘tight’ — i.e. well regulated. Today, in the midst of the crisis, money is tight, and it is expensive.

Above all the Treasury must get a grip on its own debt management — and not leave that to the private, self-interested finance markets.

Because after all, bankers have one great way of making capital gains: by “adding to the debt.”