The British Prime Minister gave a New Year’s speech in Nottingham on Monday (January 12, 2015), where he railed about the “dangers of debts and deficits” as part of the buildup to this year’s national election in Britain. There does not appear to be an official transcript available yet so I am relying on Notes that the Government released to the press containing extracts (Source). However, it is clear that the framing used by the British Prime Minister was seeking to personalise (bring down to the household level) public fiscal aggregates and invoke fear among the ignorant. The classic approach. There was no economic credibility to the Prime Minister’s claims. But that doesn’t mean that it wasn’t a politically effective speech. So woeful was the response by the Opposition that it suggested Cameron’s speech was very effective. That is the state of things. Lies, myths and exaggeration wins elections.
The British Prime Minster said that overhanging the election was “The spectre of more debt” if the Opposition was elected.
He said that:
With the Conservatives, you get the opposite. A strong and competent team, a proven record, and a long-term economic plan that is turning our country around …
And then went on to claim that economic chaos would follow under Labour because debt would be higher, there would be “more spending … and higher taxes” and “higher interest rates too – punishing homeowners, hurting businesses, losing jobs.”
He claimed that “reducing the national debt is essential” but for moral as well as economic reasons:
It is about the values of this country, whether we as a nation are going to pass on a mountain of debt to the next generations that they could never hope to re-pay. To every mother, father, grandparent, uncle, aunt – I would ask this question. When you look at the children you love, do you want to land them with a legacy of huge debts?
Hmm, we have travelled this path before. The statements have no economic foundation – but are framed cleverly to appeal to the ignorance of the population and the well crafted fears about what a Labour government would do.
Of course, the Labour government is as neo-liberal as the Conservatives but that is a minor detail in the political struggle.
As this article – David Cameron and the national debt monster in three charts – in the populist UK Telegraph (January 12, 2015) notes:
It’s a sign of successful that attack has been that the respectable macroeconomic debate about whether deficit spending in an era of low growth and low interest rates is or is not a bad thing is almost wholly absent from British politics: for politicians and most voters, deficits are bad, debt is bad. End of story.
There is no economic foundation to Cameron’s claims.
There is no debt burden borne by the future generations. That is a total myth.
The only reasonable conclusion when you understand how the monetary system functions is that burdens can only be considered in terms of real resources. In that context, the level of public debt that is carried through time has no bearing on what each generation is able to consume (or produce).
The next generation will be able to consume the outputs of their labour in the same way that the current generation is potentially able.
Clearly, governments bent on fiscal austerity deliberately deny successive generations the ability to consume and produce but that is not an intrinsic function of the level of public debt outstanding.
It is rather a wrongful policy direction driven by an irrational fear (and ignorance) of what the public debt means.
The mainstream belief is based on the erroneous conflation of a household and government budget. So when a household/firm borrows now to increase current consumption (or build productive capacity) there is a clear understanding that future income will have to be sacrificed to repay the loan with interest.
This result follows because spending by the non-government body (household and/or firm) is financially constrained.
A household must finance its spending either by earning income, running down saving, borrowing and/or selling previously accumulated assets. There is no other way. Borrowing has to be repaid via access to the other sources of spending capacity but by implication such repayments reduce the future capacity to spend.
This is translated (erroneously) into the public sphere with the claim that governments have to pay the debt back in the future by increasing taxes.
The consumption benefits of the higher spending now are enjoyed by us and our children pay for our joy by facing higher tax burdens. That is the nub of the mainstream argument.
But do our children forego real consumption in this way? Answer: no!
If our children produce $x billion in real GDP in 2020 all of that flow of real goods and services (and income) will be available for consumption should they choose to do that. They probably will save some of it (especially if the government runs a deficit of sufficient magnitude to fill the spending gap left by the desire to save by the non-government sector).
But the important point is that real GDP is not a reverse-time traveller. There is no government agency collecting real output to “pay back past debts”.
Moreover, running fiscal deficits which support aggregate demand at levels where everybody who wants a job can get one maximises employment and output each year and provides each demographic with the best opportunities to expand their real consumption possibilities.
Fiscal austerity – in the misguided hope that the public debt ratio will fall – undermines growth over time and the resulting unemployment erodes the capacity of our children to consume in the future. Potential output (expanded by investment) and productivity growth are cyclical in the sense that if an economy is in recession or stagnating investment falters and future growth potential is reduced. Similarly, productivity growth lags when aggregate levels of activity falter.
So the best way to increase the opportunity set for our children is to keep (environmentally-sustainable) economic growth strong and fiscal austerity will typically work against that reality.
The public debt ratio has no bearing on any of this. The only possible burden on our children relates to my term “environmentally-sustainable” which includes consuming through time within the limits of real resource availability.
If the current generation undermines the world’s environment and exhausts finite resources then unless technology changes dramatically (for example, to use different energy sources for transport, etc) then our children will not enjoy the same lifestyle that we enjoy (using enjoy liberally!). But that conclusion relates to competing uses of real resources.
The public debt ratio has nothing much to do with that possibility.
Public policy should be aiming to promote material prosperity across time that allows the available real resources to be shared across generations and prorated according to a sense of public purpose. Using the “price system” only prorates according to “dollar votes” and intertemporal considerations are subjugated.
Once you understand that there are no real consumption burdens to be borne by our children as a result of the public debt ratios, you then can trace the origin of this myth to the false government/household analogy.
A sovereign government is never revenue constrained because it is the monopoly issuer of the currency. A household is always financially constrained because it is the user of the currency.
This distinction means that the implications of a government budget is not even remotely like that of a household. When the government spends it credits bank accounts. The funds come from nowhere! When it taxes it debits bank accounts. The funds go nowhere!
These blogs tell you that government debt is just an interest-bearing manifestation of non-government saving and the funds “borrowed” by the government are just come from what it has spent anyway.
Governments pay back debt (upon maturity) and service the interest payments just like it spends more generally.
It moves funds from an account at the central bank to the commercial banking system. There is no “financing” constraint involved.
There are clearly distributional issues involved in issuing and servicing public debt. The poor typically do not have savings which are can be used to purchase the debt and hence do not enjoy the income flows arising from servicing the debt. While these issues are important and should be considered they have no bearing on the legitimacy of the “debt burden” argument.
That argument is plain wrong.
There is a case to be made that the government should stop issuing any debt when it net spends. Such an action is unnecessary in a fiat monetary system and the benefits of the debt issuance do flow to the top-end-of-town more often than not.
The other side of the equity argument however is that we should consider who benefits from the net public spending. Both considerations are important aspects of public policy. But the debate is never about the burdens of paying back the debt. There are no burdens.
Please see these blogs – Lower deficits now, undermine our grandchildren’s future – When 50 per cent youth unemployment is (apparently) protecting the grand kids – for further discussion.
Mainstream economists also claim that government spending crowds out private spending by pushing up interest rates. The story goes that governments have to borrow to fund their spending and that that borrowing is drawn from a finite pool of savings at any point in time.
As the pool diminishes, the cost of drawing on those savings rises – that is, the interest rate rises.
As a consequence, components of private spending that are sensitive to interest rate rises fall.
The alternative view, which reflects the way the system actually operates, is that a spending increase stimulates aggregate demand, which in turn, boosts output and incomes. The rising incomes generate higher savings.
Further, the capacity of households and firms to borrow from commercial banks is not constrained by the current reserves held by those banks.
In that sense, government borrowing does not limit the capacity of private sector borrowers to access funds at the current interest rates.
Moreover, the funds that the government borrows came from past government spending anyway.
The conceptual issues aside, the British Prime Minister’s speech also seemed to defy reality. It goes to show that if you say something enough times for long enough the facts become irrelevant and one can even defy one’s own logic (however flawed) and still advance one’s self interest.
At his Nottingham Speech, he addressed the audience in front of a backdrop which featured text about leadership and economic plans with the slogan “A Britain Living Within Its means” being prominent. Here is a snapshot of the background.
And closer up:
Despite the beautiful blue tones on display, I thought his framing was, in itself, fraudulent, although few would pick that up.
First, even within his own twisted neo-liberal logic, the British government has (thankfully) failed to meet is fiscal targets.
After they were elected in May 2010, the Conservatives delivered their – Autumn Statement 2010 on November 29, 2010, which outlined the fiscal strategy of the Government.
The Chancellor stated that:
… the most important point is this – the lesson of what is happening all around us in Europe is that unless we deal decisively with this record budget deficit then many thousands more jobs will be at risk – in both the private and the public sector … let me summarise the forecast for the public finances – which shows that Britain is decisively dealing with its debts.
They forecast that the public debt to GDP ratio would fall to 69 per cent in 2013-14 and then to 67 per cent by 2015-16.
They also said they would “eliminate the structural current budget deficit one year early, in 2014-15”.
Well, they didn’t do any of that and their ‘failure’ is one of the reasons the economy resumed growth with declining unemployment.
Had the Government actually succeeded in their ridiculous ambitions the recession would have continue unabated.
In the – Economic and fiscal outlook – December 2014 – the Office of Budget Responsibility estimated in the 2014 Autumn Statement (delivered in December 2014) that the public net debt to GDP ratio in 2013-14 will be around 79 per cent (December forecast) and will rise to 80.4 per cent in the current fiscal year (2014-15).
Then the OBR estimate that the public debt ratio will:
… rise as a share of GDP this year and next, peaking at 81.1 per cent of GDP in 2015-16, before then falling at an increasingly rapid rate to 72.8 per cent of GDP in 2019-20.
So ‘living within their means’? Not according to their own logic. But I am sure some of the unemployed that managed to get jobs are not going to complain about the ‘failure’.
Please read my blog – UK economy grows and so does its budget deficit and British economic growth shows that on-going deficits work– for more discussion on this point.
The increased borrowing ratio is because the fiscal deficit has not be cut as sharply as predicted. Since 2010-11, spending has risen by some £32 billion, while total central government revenue has risen by £61 billion meaning the fiscal deficit has fallen by only £29 billion. The increased tax revenue is mostly being driven by the growth that the continuing large deficits have been supporting.
And relative to the forecasts that the Government made at the outset, they have been (using their own terminology and framing) ‘binging on taxpayers funds’ and ‘mortgaging their grandchildrens’ futures’!!
The data shows that in the – Budget Forecast – June 2010 , the Government predicted that by 2014-15, the fiscal deficit would be £17 billion (2.3 per cent of GDP) and the PSNB (allowing for depreciation of capital items) would be £37 billion (3.5 per cent of GDP).
The December 2014 Economic and Fiscal Outlook tells us that the likely 2014-15 fiscal deficit will be of the order of £63.6 billion (3.5 per cent of GDP) and the PSNB would be £91.3 billion (5 per cent of GDP).
Again, ‘living within their means’? Not according to their own logic.
As an aside, Chart 4.10 in the Economic and Fiscal Outlook demonstrates how ridiculous it is trying to pin down fiscal targets when the final outcomes are dependent on the spending and saving decisions of the non-government sector.
The so-called ‘PSNB fan chart’ (PSNB = Public Sector Net Borrowing or fiscal deficit plus any new debt) shows the dergree of confidence that the British Treasury has concerning their deficit forecasts shown in the graph as the thick black line surrounded by the blue shading. The thick black line up to 2013-14 (approximately) is the actual (known) PSNB and then the forecast period goes out to the 2019-20 financial year.
The blue shading “represent 20 per cent probability bands, based on the pattern of past official forecast errors”.
To understand how to interpret the chart, imagine that the economic situation (and all other forecasts) were to hold at the start of the forecast period for 100 separate occasions.
Then the forecasted PSNB would lie in the darkest band on 20 out of the 100 occasions. And as we move out to lighter shaded areas we would make similar statements for the implied PSNB number.
Overall, the OBR is telling us that by 2019-20, the fiscal balance (approximately) will lie somewhere between a surplus of just over 4 per cent of GDP or a deficit of around 3.8 per cent of GDP in 2019-20 80 times out of 100.
In other words, the accuracy of the projections is so low at the end of the forecast period to be meaningless, given that the two possible fiscal outcomes are so different in their implied impact on the economy and their implications for what non-government balances would be to support such outcomes.
The Government then proposes the following nonsensical fiscal cut back over the next five years. Obviously, some genius in the Treasury (or OBR) has been told that they have to get a surplus by 2018-19 and then drew the spending cut line to meet that objective.
If that net public spending contraction was to happen given the state of the external sector and the already heavily indebted private domestic sector, then pigs would be flying or the economy would be pushed back into deep recession.
The problem is that if they really try to cut spending by that much and that quickly then the recession will come before the pigs take-off.
Of course, the other side of the picture is what the non-government sector is up to. As I noted in my analysis of the Conservative’s first fiscal statement in June 2010,
As I noted then, there was a lot of reference to debt.
Under the heading “A strong and stable economy” (Page 7) you read:
… Over the pre-crisis decade, developments in the UK economy were driven by unsustainable levels of private sector debt and rising public sector debt. Indeed, it has been estimated that the UK became the most indebted country in the world … Households took on rising levels of mortgage debt to buy increasingly expensive housing, while by 2008 the debt of nonfinancial companies reached 110 per cent of GDP. Within the financial sector, the accumulation of debt was even greater. By 2007, the UK financial system had become the most highly leveraged of any major economy … This model of growth proved to be unsustainable …
This discussion is in the context of a vulnerable and unbalanced economy relying too much on private sector indebtedness for growth and being very sensitive to housing price movements.
I completely agreed that a growth strategy that relies on the private sector increasingly funding its consumption spending via credit is unsustainable. Eventually, the precariousness of the private balance sheets becomes the problem and households (and firms) then seek to reduce debt levels and that impacts negatively on aggregate demand (spending) which, in turn, stifles economic growth.
The GFC showed how stark those type of adjustments can be.
But that quote was the only reference to household debt (or private debt) in the 2011 UK fiscal documents.
There was a massive amount of hectoring about the evils of public debt and the need to reduce it liberally appearing throughout the documentation.
The stated aim was to stimulate growth while bringing down debt levels in the economy (private and public). An appreciation of macroeconomics told us at the time that the only way those goals could be achieved would be if the external sector provided the demand stimulus to the economy capable of (more than) offsetting the net saving desires of the private domestic sector and the fiscal drag coming from the public austerity program.
At the time, there were very optimistic forecasts provided in Annex C (Table C.1) for Household consumption and net exports over the period 2011 to 2015. The net export forecasts have clearly not been achieved.
But, even if the net exports had have come in at forecast, the real GDP growth forecast provided at the time would have requred the very strong forecasted recovery in household consumption at a time when unemployment was still very high and growth in Real household disposable income was forecast to be negative in 2011 and then sluggish in the following years of the forecast horizon out to 2015.
At the time, I did some digging to try to resolve this apparent contradiction. I discovered this document (published April 21, 2011) – Household debt in the Economic and fiscal outlook – which solved the puzzle but was deeply hidden in the fiscal documentation and barely referred to in any of the higher profile documents.
That document revealed the March 2011 household debt forecast that the OBR used as input for the “household debt projection in the Economic and fiscal outlook” (that is, the Fiscal Estimates):
Our March forecast shows household debt rising from £1.6 trillion in 2011 to £2.1 trillion in 2015, or from 160 per cent of disposable income to 175 per cent. Essentially, this reflects our expectation that household consumption and investment will rise more quickly than household disposable income over this period. We forecast that income growth will be constrained by a relatively weak wage response to higher-than-expected inflation. But we expect households to seek to protect their standard of living, relative to their earlier expectations, so that growth in household spending is not as weak as growth in household income. This requires households to borrow throughout the forecast period.
The following Table is taken from the OBRs Table 1 showed the forecasts for household assets and liabilities as a percentage of disposable income. The OBR says that “net worth is forecast to decline as a percentage of income as the household debt ratio is expected to rise and the household assets ratio is expected to fall”.
In other words, all the fuss about private and public debt levels and “dealing with our debts” in 2010 and 2011 was a smokescreen.
Its own growth strategy was always contingent on the private sector taking on a rising debt burden over the forecast period and becoming relatively poorer?
What the British government’s strategy amounted to was a deliberate plan to reduce public debt at the expense of more private debt.
Prudent fiscal management requires that exactly the opposite is the case when the economy is floundering – given current conventions about matching fiscal deficits with public debt issuance.
So which part of Britain is actually “living within its means”?
In July 2014, the Bank of England warned that the high household debt to income ratios in Britain remained a major risk to sustained recovery and financial stability
In a speech – guiding the economy towards a sustainable and safe recovery – the Deputy Governor noted that:
The rapid expansion of debt and accumulation of risks in the financial sector ended, as we all know, in a damaging and painful crash – for the financial sector and for the economy as a whole. There is a substantial body of international evidence that recessions are deeper and more painful when they follow a sharp run-up of debt and a banking bust. The UK recession in 2008-9 was a case in point …
At around 135% UK household indebtedness is high … But starting from this elevated level, the risk … is that with limited housing supply, the demand for housing in the UK continues to push prices up; that lenders are ever more willing to finance high loan-to-income mortgages as house prices rise, and that as a result household indebtedness climbs sharply, making the economy and financial system more vulnerable. This risk is greater at a time of exceptionally low interest rates which may well mask the likely true cost of a mortgage over time.
The latest data from the British Office of National Assessments (ONS) – United Kingdom Economic Accounts Time Series Dataset Q3 2014 – shows that while household debt to income ratios have fallen as a result of the crisis, they
In the – Economic and Fiscal Outlook – December 2014 – the OBR publish one interesting graph (Chart 3.31), which shows the Household gross debt to income ratio fromm 2003 to 2020. I reproduce the graph below.
The OBR say that the ratio “has been revised up significantly since our March forecast” – by some £174 billion by 2019. They also acknowledge that there will be “a weaker forecast for wage growth” over the same period.
It is clear that British households are not forecast to be ‘living with their means’ anytime soon.
It is clear what ground the British election will be fought on in the coming months. Economic myths, data denials and lots of well-crafted myths about money, debt and deficits.
The real problem is that the British Opposition will go along with it and claim it will conduct austerity better and more fairly and all the rest of the nonsense. It might be time to close down any analysis of Britain for a while.
Further, please don’t take this “living within the means” stuff seriously when applied to the financial ratios of currency-issuing governments. When there is mass unemployment and underemployment then an economy has plenty of ‘means’ to bring back into productive use. Means mean real resources.
There is no sense that a currency-issuing government is ‘living within its means’ as measured by any fiscal outcome. The only sense that can be made of such a concept is to examine the state of productive resource utilisation. That, of course, was not what David Cameron was seeking to focus on.
Tomorrow, the first Australian labour market data for the year (actually for December 2014). We will see about that. I am not sure when the blog will come out as I have a long flight tomorrow which will take me to Sri Lanka! I hope to get it the labour market analysis done before I depart.
That is enough for today!
(c) Copyright 2015 William Mitchell. All Rights Reserved.