The G-20 held its annual Finance Ministers and Central Bank Governors Meeting in South Korea over the weekend. It was amazing to see just how comprehensive the impact of the deficit terrorists has been on the way in which the G-20 has shifted its views on the way to deal with the on-going economic crisis. The G20 communique released today clearly illustrates that the G-20 group have been won over by the terrorists and are now supporting austerity measures. This is another one of the amazing reversals in the public debate that are now becoming regular events. All of the reversals are making it harder for governments to do what we elect them to do – use their policy tools to advance public purpose. The increasing constraints that governments are voluntarily accepting to satisfy the demands of amorphous groups such as the “bond markets” impinge on the democratic rights of every citizen. We expect our governments will act in the best interests of the nation. Sadly they are no longer doing that because they have fallen prey of the deficit terrorists. We have a new term for this – democratic repression.
The Communique claims that the G20 Finance Ministers and Central Bank Governors said:
The G20’s strong policy response to the crisis has played a pivotal role in restoring growth and we stand ready to safeguard recovery and strengthen prospects for growth and jobs. We welcome the determined actions taken by the European Union, the European Central Bank and the IMF. We will pursue well coordinated economic policies. The recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, growth-friendly measures, to deliver fiscal sustainability … Those countries with serious fiscal challenges need to accelerate the pace of consolidation. We welcome the recent announcements by some countries to reduce their deficits in 2010 and strengthen their fiscal frameworks and institutions. Within their capacity, countries will expand domestic sources of growth, while maintaining macroeconomic stability. This will help ensure ongoing recovery …
In all this carefully worded speak what you read is that they are now supporting austerity measures – consider countries with “serious fiscal challenges” should cut faster and claim within this environment, countries will be able to expand domestic sources of growth. Exactly which macroeconomic model do they get that conclusion from?
So compared to their April statement when they were advocating no early withdrawals of the fiscal stimulus given how precarious private spending growth remains why the sudden change?
The only conclusion is that the deficit terrorists are gaining traction. Further, the Europeans seem intent on creating as much damage to their economies as they can all in the name of a strong Euro.
This sentiment is echoed by this article from The Economist – Governments were the solution to the economic crisis. Now they are the problem – published May 27, 2010. The article notes that “financial markets are more anxious today than at any time since the global recovery took hold almost a year ago” and that:
Gone is the exuberance that greeted the return to growth … Investors are on edge.
Remember the term investment is used here in the broad sense – of speculating in financial assets. In macroeconomics, the term investment is much more specific and refers to the spending to develop capital infrastructure – that is productive assets. Under this era of financialisation, there have been too many resources diverted into non-productive (wealth shuffling) speculating away from productive uses.
The Economist claims that there are two main reasons why the speculators have the “jitters”:
One is about the underlying health of the world economy. Fears are growing that the global recovery will falter as Europe’s debt crisis spreads, China’s property bubble bursts and America’s stimulus-fuelled rebound peters out. The other concerns government policy. From America’s overhaul of financial regulation to Germany’s restrictions on short-selling, politicians are changing the rules in unpredictable ways … And the scale of sovereign debts has left governments with less room to counter any new downturn; indeed, many of them are being forced into austerity … The danger is that these fears reinforce each other in a pernicious reversal of the dynamics of 2008-09. Then, co-ordinated government action on a grand scale stopped the global financial crisis from turning into a depression. Now, thanks to incompetence and impotence, governments may become the problem that will drag the world economy down.
First, the world economy is still in very poor shape and rather precariously balanced. So we should all be concerned about that especially as the crisis is nearly three years old. There has massive foregone income as a result of governments allowing the crisis to persist and in many cases, the unemployed and their families will never regain what they have lost.
Second, I agree that the other concern is government policy. I also agree is a lot of ad-hocery going on at present. What that tells me is that the economic policy process has been thoroughly perverted by the erroneous attacks of the deficit terrorists on the correct use of fiscal policy. There has been such a major campaign of misinformation that governments are spooked and yet realise that politically they have to be seen to be addressing these issues.
Instead of addressing them using the obvious policy instrument – fiscal policy – they are making policy at the margins and that is never an effective way to conduct counter-stabilisation policy.
Third, in financial terms, the scale of government debt is irrelevant when considering how much fiscal space a sovereign government has. For a currency-issuing government the minimum fiscal space is defined by the idle real resources that can be brought back into production with an increase in aggregate demand. It may be that the government has more scope than that if they want to alter the mix of public and private resource usage in the economy. But the bare minimum is to run deficits at such a level that all resources are fully employed.
With a major collapse in private spending and no particular desire to alter the public/private mix in resource usage, such stimulus efforts have to be calibrated to ensure they can taper as private spending recovers. As I have argued many times, the best place to start is to introduce a Job Guarantee. You may also like to read this blog – When is a job guarantee a Job Guarantee? – for further information.
A Job Guarantee operates as an automatic stabiliser and expands and contracts in a counter-cylical fashion.
Fourth, governments are becoming the problem because they are withdrawing their inadequate stimuluses too early. So they started out by failing to provide adequate fiscal intervention and now they are running scared and compounding problem. In all nations other than those within the EMU, there is no sovereign debt problem.
It is amazing that the media is now presenting the policy debate in terms of the government being the problem – in the sense that there is a reluctance to withdraw the fiscal stimulus quickly enough. It is almost beyond belief that the size and speed of an austerity package is being held out as the indicator of responsible government – the larger and quicker the better! And this is at a time when the world economy is on the brink of going backwards again.
The Economist and other mainstream (conservative) media outlets all supported the stimulus packages at the time because they could see the world collapsing back into a 1930s depression. Now they are leading the charge for austerity. But you will never find a coherent account about how boosting public spending is good at a time when private spending is flat or collapsing but bad when private spending remains flat three years later. The ideological statements drown out the lack of substance in their arguments.
Trying to cut our a major component of the growth cycle (net public spending) when the private sector is still a long way from: (a) recovering it zeal for spending; and (b) curtailed its massive debt exposure – is vandalism of the highest order.
Even in Australia, which escaped the recession technically, it was only net government spending which allowed us to do that. In the March 2010 quarter the stimulus effects were still the difference between positive and negative growth. If the government had had listened to the deficit terrorists last year and cut back when the terrorists were screaming blue murder then Australia would have been in recession almost all of last year and into this year. Please read my blog – Australia GDP growth flat-lining – for more discussion on this point.
Fifth, the EMU is another question altogether. In that mess, while they sort out whether they are going to disssolve or introduce a single fiscal authority, the ECB should be buying as much government debt as is required to stop the bond markets killing off the nations one by one – and when they have bought it – pressing the delete button on their holdings so that it disappears for ever. There would be no real cost in doing this – all gain. They won’t do that and so the problem will persist until defaults and exits become inevitable.
The Economist believes the major constraints are now fiscal:
For much of the rich world, however, the most important consequences of Europe’s mess will be fiscal. Governments must steer between imposing premature austerity (in a bid to avoid becoming Greece) and allowing their public finances to deteriorate for too long. In some countries with big deficits, the fear of a bond-market rout is forcing rapid action. Britain’s new government spelled out useful initial spending cuts this week. But the emergency budget promised for June 22nd will be trickier: it needs to show resolve on the deficit without sending the country back into recession.
First, only EMU governments can go the way of Greece. The analogy has no application at all when applied to sovereign governments. It is one of those on-going pieces of misinformation that has swamped the correct policy response to the crisis.
Second, there is no such thing as a “deterioration in the public finances”. Rising budget deficits often signal a deterioration in the real economy (falling output growth and rising unemployment) but the actual fiscal outcome has no dimension that we delineate as improving or deteriorating. It is what it is. Given it is endogenously determined by the state of private spending, the dynamics of the budget balance just provides information about the state of the economy.
Focusing on the budget outcome while ignoring the rest is very misguided.
Third, Britain never should have worried about a “bond-market rout” because they could have changed their rules to allow the Bank of England to cash government cheques. They have submitted to democratic repression and their growth will be pathetic for some quarters as a consequence.
The Economist claims that the US has more “fiscal room than any other big-deficit country”:
In America, paradoxically, the Greek crisis has, if anything, removed the pressure for deficit reduction, by reducing bond yields. America’s structural budget deficit will soon be bigger than that of any other OECD member, and the country badly needs a plan to deal with it. But for now, lower bond yields and a stronger dollar are the route through which American spending will rise to counter European austerity. Thanks to its population growth and the dollar’s role as a global currency, America has more fiscal room than any other big-deficit country. It has been right to use it.
As I noted above, the US has not more or no less fiscal capacity than any other sovereign currency-issuing nation. The size of its deficit is irrelevant for assessing whether it can continue to run deficits. The lower bond yields delivered in the markets can easily be engineered by appropriate central bank policy anyway. The stronger dollar is also undermining growth not assisting growth. And the population growth is also irrelevant when it comes to deciding whether the government can spend.
The US government can buy – at any time of its choosing – whatever is for sale in US dollars. There is never a financial constraint on it doing that. And given that up to 17 per cent of available labour in the US is idle – the US government could start exercising its fiscal room by offering as many of these workers are job that want them.
The point that you will rarely even read about in these debates is how public spending one minute saved us but the next minute it will ruin us when the private conditions are largely unchanged. The fact is that there is no credible theory to underpin this ideological claim.
In macroeconomic theory, output is a function of aggregate spending. We have witnessed a substantial drop in the private spending components of aggregate demand over the last few years which cause the collapse in growth.
Firms form expectations of future aggregate demand and produce accordingly. They are uncertain about the actual demand that will be realised as the output emerges from the production process. The first signal firms get that household consumption is falling is in the unintended build-up of inventories. That signals to firms that they were overly optimistic about the level of demand in that particular period.
Once this realisation becomes consolidated, that is, firms generally realise they have over-produced, output starts to fall. Firms layoff workers and the loss of income starts to multiply as those workers reduce their spending elsewhere.
At that point, the economy goes into recession unless the government expands public net spending to offset the private withdrawal. We saw in 2008 and 2009 as governments finally gave up on relying on monetary policy to solve the impending crisis and introduced relatively aggressive fiscal interventions that the collapse in real output growth was curtailed.
While there are asymmetries in this process – for example, private investment falls more quickly than it recovers due to irreversibilities in capital equipment which introduce caution into firm decision making – the fact remains that if you withdraw that net public spending before the private components of aggregate demand have recovered then you trigger off the inventory cycle again.
That is, firms will start laying off workers because there will be unsold output and these workers, in turn, stop spending and a malaise sets in.
There is no credible theory to support the opposite being the case – that is, a pro-cyclical fiscal withdrawal being a good thing when private spending is weak. It is almost certain that economies that introduce harsh pro-cyclical austerity campaigns will not only prolong their recessions but will cause massive damage to the living standards of their citizens.
Why would they do this? They are doing this because they are getting advised by economists who believe in their flawed models which tell them that price stability is the only real determinant of stable real growth.
Policy makers around the world have been led to believe the sovereign governments have fiscal constraints. That the debt that government issues is necessary. That certain financial ratios are not only meaningful in their own right but binding at levels well below the levels governments now find themselves in.
None of these beliefs has an application to a fiat currency issuing government. A sovereign government is never revenue constrained because it is the monopoly issuer of the currency.
Meanwhile, the situation in the EMU is getting worse by the week. The UK Guardian (June , 2010) carried the article – Germany joins EU austerity drive with €10bn cuts. They noted that the German government plans “include cuts to federal staff, lower social welfare benefits or tax rises, in the latest effort to get Europe’s massive debts under control”.
The Germans also reveal a perverted sense of economy. The Guardian quoted Angela Merkel who said that Germany:
… can only spend what we take in.
Taken to mean tax revenue and bond sales, this statement is correct. But only because of the currency system that these nations have voluntarily imposed on themselves as democratic repression.
The real situation is quite different. How does the statement that Germany is living beyond its means sit with all the wasted labour that is sitting idle? Are they living beyond their means?
The German Finance Minister Wolfgang Schäuble dropped another classic myth into the mix saying that the fiscal contraction would be “”stricter than necessary” to allow more room for manoeuvre at a later stage. This is in relation to the alleged strain on the German economy of the population ageing and its “generous social welfare system”.
The only actual problem will be whether there are enough real resources available at some later date to back the nominal value of the pensions that the German state is paying its retired citizens. If there are not enough real resources to go around then the problem is a political one – to determine where public spending will be targetted.
In Germany’s case, this problem becomes a financial issue because they have agreed to a nonsensical monetary system which cannot deliver optimal outcomes. It is a system that requires the anathema of sound fiscal policy – pro-cyclical austerity. Nothing in any textbook will provide any theoretical support for pro-cyclical fiscal policy implementation.
All these problems are non-problems for a sovereign nation. They are problems because of the self-imposed constraints the EMU member nations have introduced. None of these constraints bear any resemblance to a policy position that would advance the well-being of the individual nations.
And in Greece the nasty side of the EU-IMF packages are emerging as the government is promising “draconian economic reforms that included the privatisation of public companies”, some of which are highly profitable. So you now have a socialist government forcing the most neo-liberal (private property) changes on its country. That is one of the truly amazing indecencies that has come out of this crisis. The collapse of any meaningful progressive ideology. There is very little political choice now anywhere.
I note that the PIIGS have become GIPSIs in recent times. Well one thing GIPSIs seem good at is being on the move.
If I was in charge of one of these nations I would announce next weekend (when the banks are closed) that I was introducing a new currency, defining all Euro debt liabilities in the new currency and let the foreign exchange markets value that currency on the Monday morning.
I would withdraw any semblance of central bank independence (that is just another democratic insult) and I would expand the budget deficit immediately by introducing a Job Guarantee.
Then by Tuesday, I would start repairing the confidence of private spenders to get the economy rolling again.
And after a relatively short time I would notice that economic growth was gaining speed, private spending was returning, unemployment was low and … the budget deficit was falling.
Then I would send an open invitation to the citizens of Germany to abandon the teutonic ship and head south (or west).
If I was boss of the government in the UK, Japan or the US (to name any sovereign nation), then I would put the out of office sign up to the deficit terrorists and start doing what I was elected to do and protect the interests of my nation. I can only do that if I use the inherent fiscal capacity that the government in a fiat currency system has to first of all eliminate mass unemployment. There is not a day to be wasted.
That is enough for today!