In assessing the role of the multilateral international institutions such as the IMF, the World Bank, and the OECD, one has to have an idea of what their purpose is. The IMF was created to provide funding support to nations under the Bretton Woods system of fixed exchange rates when their trading accounts endangered their capacity to sustain the agreed parities. After the system collapsed in August 1971 (effectively), the IMF had no further purpose. It reinvented itself as a neo-liberal attack dog on government intervention, and, as such, has no progressive (productive) role to play and should be scrapped. Similarly, the World Bank. The OECD was created (as the Organisation for European Economic Co-operation (OEEC)) to manage the Marshall Plan funds that Canada and the US provided to reconstruct Europe at the end of World War II. It has similarly outlived its productive purpose and is now a major source of disinformation. Even in the realm of fiction, there are much better fiction writers than exist within the bowels of the OECD in Paris. Its latest entreaty, specifically – Using the fiscal levers to escape the low-growth trap – from the exemplifies the way in which the OECD chooses to perpetuate myths about government policy options, even when its message might appear reasonable to progressive eyes and ears. That is the problem really, by buying into the neo-liberal scam that mainstream economists have been running for the last 3 or 4 decades, progressive politicians and their apparatchiks have no room to move and will applaud the OECD’s current message, not realising how destructive that complicity becomes. That has been the problem all along and Trump, Brexit and the rising extremism in Europe is the outcome. Reap what you sow!
I have written about fiscal space before and two blogs may provide some background:
The latest OECD intervention into the debate about fiscal policy is indeed largely an exercise in fiction … and poor fiction at that.
The premise in Chapter 2 of the latest Economic Outlook is that:
Almost a decade after the outbreak of the financial crisis, the global economy remains in a low-growth trap with weak investment, trade, productivity and wage growth and rising inequality in some countries. Monetary policy is overburdened, leading to growing financial risks and distortions. Alongside structural reforms, a stronger fiscal policy response is needed to boost near-term growth and strengthen long-term prospects for inclusive growth.
The problem has been a weak fiscal response all along, driven by the sort of neo-liberal Groupthink that the likes of the OECD perpetuated early on in the financial crisis.
We should remember back to 2009, when the OECD issued its Economic Outlook, 2009, Issue 1. In that document, they presented what they called their “medium-term scenario to 2017”.
They recognised that the financial crisis had created “large output gaps” and they assumed that by 2017 (p.227):
… output gaps are closed as a result of sustained above-trend-growth (despite significant fiscal consolidation); and most countries do not experience deflation despite continued negative output gaps over this period …
They actively advocated “that fiscal stimulus packages in operation during 2010” be “removed from 2011 onwards”. They believed that “further improvement in fiscal balances comes about as automatic stabilisers react to output gaps being closed”.
They claimed (p.232) that:
… fiscal consolidation is inevitable for many conutries, as is already recognised by many OECD governments which have announced plans for moving back towards more sustainable fiscal positions.
The OECD said, in this regard (p.233):
The scale of action needs to be ambitious …
They also said that governments had to make even further cuts to ensure that the “effects on public budgets from population ageing and continued upward pressures on health spending are … offset …”
They urged governments to engage in this “ambitious … fiscal consolidation” using “lower government primary expenditures … rather than higher taxes”.
Here they argued that it was desirable that (p.235):
… virtually all countries would be running a surplus on primary balance (the fiscal balance excluding net interest receipts) by 2017.
They went on to claim that so-called “structural reform” (cutting wages and job protection, reducing consumer protection rules etc) “may help to boost living standards and so facilitate fiscal consolidation” (p.238)
Neo-liberal Groupthink at its worst.
The OECD was one of the organisations (along with the IMF and others) that tried to claim that the path to recovery was through a so-called ‘fiscal contraction expansion’.
This myth is predicated on the idea that non-government spending entities (households, firms) cut their spending when fiscal deficits rise because they try to save up money in order to pay for expected future tax increases that the government will impose to pay back the deficits.
According to this fantasy world, if the government cuts its net spending and withdraws demand from the economy (reducing sales, employment, etc), then these forward-looking non-government agents will reassess that future tax obligations will be lower and so they don’t have to save as much.
Result – they go on a spending binge which exceeds the withdrawal of government spending (so as to close the output gap).
Even the unemployed who are made jobless through the fiscal cutbacks jump on board and spend up big. Even firms that have their sales levels cut by the elimination of government contracts have no fears – they start borrowing up big to increase investment in productive capacity.
If you believe any of that then send me an E-mail and I will arrange the sale of the Sydney Opera House in your favour – cheap even!
The facts since 2009 speak for themselves. Even the OECD recognises (without saying) that these futuristic applications of neo-liberal Groupthink were ridiculous.
Their opening premise now is that after a decade “the global economy remains in a low-growth trap with weak investment, trade, productivity and wage growth and rising inequality in some countries.”
They also realise that fiscal policy is effective in altering the economic cycle – up and down – and advocate fiscal expansion in some cases.
They are silent on how that stacks up with their 2009 vision that output gaps would close despite ambitious fiscal consolidation – aka ‘austerity’.
It doesn’t pay for an organisation such as the OECD to reflect to much on what they said yesterday. Rather, they gloss over their mistakes and fail to recognise that the litany of mistakes they make are the result of the flawed economic framework they deploy.
That would amount to a concession that their whole charter was flawed. Senior executives and the bevvy of economists locked in the high-pay jobs (the ‘golden cage’ is how insiders refer to it) would then struggle to justify their jobs.
So now the OECD presents a new take on the situation, which really continues the underlying myths.
To motivate their premise – that fiscal policy now needs to be expansionary in most cases – the OECD goes through and exercise:
… to assess the extent of countries’ fiscal space and the temporary deficit increase they can afford to run.
The caution they invoke is because “public debt has reached high levels in most OECD countries”.
If we were being generous we would suggest the difference between OECD-2009 and OECD-now is that, in the current environment, “very low sovereign interest rates provide more fiscal space.”
That is their fundamental claim. That governments have more room to move because they are paying low interest rates on debt.
Even alleged progressives, like Joseph Stiglitz, Paul Krugman and others are making the same noises.
Now is the time they say to borrow up and spend on public infrastructure because funding is cheap.
It is inane really.
They use various measures of ‘fiscal space’ all that deny the basic capacities of a currency-issuing government – which is never revenue constrained, if it chooses, because it is the monopoly issuer of the currency.
One measure they deploy exploits “the gap between actual debt and estimated levels at which market access would be compromised”.
In other words, at some point a government (in their conception) will run out of money because it will not be able to borrow any further funds from the bond markets.
They say that this gap has risen because:
1. There are “lower interest rates”.
2. Fiscal austerity has reduced some of the “long-term ageing-related spending pressures”.
3. “Structural reforms that aim at containing the cost of healthcare and pension spending, including by reforming entitlements, can create additional space.”
So cutting pension entitlements and making it harder for people to gain access to health care reduce government spending projections which allow them to spend more in the future.
This would allow the governments (in question) to increase spending by around “1/2 percentage point of GDP” for around “three to four years” and still contain debt ratios.
The projected output gains are positive but small.
The OECD also provides a so-called ‘background paper’ (Economics Department Working Paper No 1352) – A Re-Assessment of Fiscal Spce in OECD Countries – which it cites as an authority.
It provides no authoritative basis for anything they actually say.
The authors (as far as one can assess) have previously worked in the institutions such as the World Bank, European Central Bank, and appear to be among this professional class that do not have doctorates but make a lucrative career working in these multilateral organisations – supporting the consensus Groupthink that these institutions ferment.
The background paper, upon which the Chapter 2 discussion is based asks the question:
To what extent can public deficits increase without putting fiscal sustainability at risk, given the specific current macroeconomic situation of protracted low growth and low interest rates, combined with relatively high government debt levels? The answer depends on many factors, such as the state of the economy, the fiscal track record and projections of population ageing and their effect on government spending.
In fact, none of these factors are relevant (in the way the OECD claims) in assessing whether a currency-issuing government, and the OECD makes no distinction, for example, between such a government and a Member State of the Eurozone, can bring real resources into productive use via its net spending capacity.
A basic rule of thumb in deciding whether an author(s) understand the workings of the monetary system is whether they conflate currency-issuing states with non-currency issuing states. If they do, then you know their knowledge is awry.
Please read my blog – Who is in charge? – for more discussion on this point.
Its basic conclusion is that:
1. “there is fiscal space in most of the large advanced economies”.
2. “fiscal space may have risen in most OECD countries since 2014, mainly driven by the decrease in interest rates”.
3. “Reforms to health and pension programmes would help to create additional fiscal space.”
Any measures of ‘fiscal space’ based on “market access” assume that a currency-issuing government is passive and compliant to the demands placed on it by the bond markets.
So they will only ever spend if they can borrow from private bond markets, who ultimately, in this vision, can close down government activity whenever they wish.
Perhaps the OECD might explain the massive bond buying capacity revealed in recent years by governments through their central banks – which might simply be characterised as the left pocket placing funds in the right pocket.
The bond markets are the ones who are the beggars. Witness the increasing number of governments issuing long-term debt at low to negative interest rates.
Who is in charge then?
Another approach the OECD uses to assessing ‘fiscal space’ is based on Dynamic stochastic general equilibrium (DSGE) models, which are now the dominant modelling structures used by mainstream macroeconomists. They are tangential to meaning.
Even mainstreamers like Willem Buiter described DSGE modelling as “The unfortunate uselessness of most ‘state of the art’ academic monetary economics”.
He noted that:
Most mainstream macroeconomic theoretical innovations since the 1970s (the New Classical rational expectations revolution … and the New Keynesian theorizing … have turned out to be self-referential, inward-looking distractions at best. Research tended to be motivated by the internal logic, intellectual sunk capital and esthetic puzzles of established research programmes rather than by a powerful desire to understand how the economy works – let alone how the economy works during times of stress and financial instability. So the economics profession was caught unprepared when the crisis struck … the Dynamic Stochastic General Equilibrium approach which for a while was the staple of central banks’ internal modelling … excludes everything relevant to the pursuit of financial stability.
This conclusion was made with some style in evidence that famous (pre-DSGE) economist Robert Solow gave to the US Congress Committee on Science, Space and Technology – in its sub-committee hearings on Investigations and Oversight Hearing – Science of Economics on Jul 20, 2010. The evidence is available HERE.
Here is an excerpt relevant to the topic:
Under pressure from skeptics and from the need to deal with actual data, DSGE modellers have worked hard to allow for various market frictions and imperfections like rigid prices and wages, asymmetries of information, time lags, and so on. This is all to the good. But the basic story always treats the whole economy as if it were like a person, trying consciously and rationally to do the best it can on behalf of the representative agent, given its circumstances. This can not be an adequate description of a national economy, which is pretty conspicuously not pursuing a consistent goal. A thoughtful person, faced with the thought that economic policy was being pursued on this basis, might reasonably wonder what planet he or she is on.
An obvious example is that the DSGE story has no real room for unemployment of the kind we see most of the time, and especially now: unemployment that is pure waste. There are competent workers, willing to work at the prevailing wage or even a bit less, but the potential job is stymied by a market failure. The economy is unable to organize a win-win situation that is apparently there for the taking. This sort of outcome is incompatible with the notion that the economy is in rational pursuit of an intelligible goal. The only way that DSGE and related models can cope with unemployment is to make it somehow voluntary, a choice of current leisure or a desire to retain some kind of flexibility for the future or something like that. But this is exactly the sort of explanation that does not pass the smell test.
Solow also said that the DSGE fraternity “has nothing useful to say about anti-recession policy because it has built into its essentially implausible assumptions the “conclusion” that there is nothing for macroeconomic policy to do”.
None of the DSGE models (or papers) anticipated the financial crisis despite the portents of it being obvious for at least a decade or more.
In my 2008 book (with Joan Muysken) – Full Employment abandoned – we considered the standard DSGE approach in detail. I summarised a bit of that discussion in this blog – Mainstream macroeconomic fads – just a waste of time.
So not a very hopeful basis for assessing ‘fiscal space’ when the concept is vitally conditioned (as I will explain soon) on the level of unemployment in an economy.
They also use another method of measuring ‘fiscal space’ which assumes that deficit has to, ultimately, be closed through tax increases. History tells us that that is not a very good depiction of the way governments operate.
The OECD background paper is essentially the core of Chapter 2 in the Economic Outlook.
Whichever method is used to estimate ‘fiscal space’ they underlying presumption is that there are ‘debt limits’ on governments, which implicitly assumes that governments have to borrow in the first place.
They assume that governments have to raise taxes to “service debt”, which agains belies the reality that currency-issuing governments have no financial constraints if they choose not to impose them voluntarily.
No manner of fancy diagrams that the OECD presents about “debt spiral”, “fiscal fatigue”, “Laffer curve”, “maximum primary surplus” and the rest of the nonsense, can deny the basic capacity of a currency-issuing government.
The OECD chief economist wrote this blog (November 24, 2016) – Time to deploy the fiscal levers actively and wisely – to summarise the Chapter 2 material.
The message is obvious. Short, small fiscal stimulus will boost output by a small amount without compromising market access to funds.
This, from an organisation, that sucks in massive funding, maintains palatial offices in Paris, cuts down huge numbers of trees producing their reports, and swans around the world lecturing all and sundry about their work.
And, the message is patently false anyway.
As I explain in this blog (among others) – The ‘fiscal space’ charade – IMF becomes Moody’s advertising agency (which also provides several background links to previous blogs):
- A sovereign government is not revenue-constrained which means that fiscal space cannot be defined in financial terms.
- The capacity of the sovereign government to mobilise resources depends only on the real resources available to the nation.
- A currency-issuing government can always meet the liabilities it issues in its own currency.
- Nations that have ceded their sovereignty by entering currency zones (such as the Eurozone); by dollarising their currencies; by running currency boards; and similar arrangements clearly are not sovereign and face the same constraints that a country suffered during the gold standard era.
In relation to the Eurozone governments who do not issue their own currency and thus can only get it from taxation or borrowing, we know clearly that if the ECB had played a constructive, rather than its destructive role over the last 8 or so years, there would not have been a bond market crisis.
We know from experience that as soon as the ECB started buying bonds on the secondary markets (May 2010) the yields dropped rapidly and the bond markets were effectively dealt out of the game.
Had the ECB funded fiscal stimulus the Eurozone would have come out of the crisis relatively quickly and the nations would have been able to deploy all the fiscal space available in the form of idle productive capacity and idle labour.
The surrendering of the currency-issuing capacity by Euro nations combined with the recalcitrance of the ECB has caused the crisis. It has nothing to do with what the bond markets did after the crisis emerged.
Those sovereign-issuing nations with no or negligible debt denominated in foreign currency have no default risk on their public debt associated with factors such as size of deficit, outstanding debt stocks etc.
Their government’s can always meet their liabilities and would only default as an insane act of politics.
There are no financial risks associated with their debt.
Where nations have outstanding debt that is denominated in foreign currency, these nations can always meet their domestic obligations (including servicing debt denominated in their own currency which is held by foreigners) but in some weird situations might find it hard to service their foreign-denominated debt. There is a smidgen of risk in these cases.
All the ‘fancy’ econometric modelling that the IMF and the OECD uses to come up with some debt limit or fiscal space measure ignores the basic realities.
Even if the governments issue debt, the central bank of a sovereign nation can set whatever yield on public debt that it considers desirable. These nations might pretend they at the behest of the private bond markets but when push comes to shove, the central bank always dominates.
Please read my blog – Who is in charge? – for more discussion on this point.
So the idea that a government has to stop net spending or needs harsh austerity if the private bond markets start pushing up yields to ridiculous levels is ridiculous.
Even the ECB in the Eurozone has demonstrated it can control yields whenever it wants by buying up government bonds in secondary markets.
Moreover, a sovereign, currency-issuing nation does not even have to issue debt to maintain deficit spending levels at whatever level they desire. It can instruct the central bank to credit bank accounts at will. Given the propensity of such governments to impose voluntary restrictions on themselves, such a move might require a legislative change.
But the fact is that when the crisis hit these governments have no trouble getting cash.
And then we have the case of Japan. The OECD modelling leads them to conclude that:
… most large advanced economies have fiscal space, Japan being a notable exception. The “market access” approach also suggests that Japan lacks fiscal space.
Such a conclusion was also made about Japan more than two decades ago. This has been a repeated claim.
Since that time, Japan has continued to run large deficits and issue bonds and very low yields. It reached the IMF debt limit from their models years ago.
So how do they explain that?
Essentially, Modern Monetary Theory (MMT) constructs the concept of fiscal sustainability in terms of available real resources, including idle labour.
If there are idle real resources then within current considerations of the public-private mix, a sovereign government can always bring those resources back into productive use with a fiscal expansion. Always! The bond markets are irrelevant.
If there is mass unemployment, then the fiscal deficit is too low.
The government can always employ all idle labour should it choose to. That is the only relevant concept of ‘fiscal space’.
That is enough for today!
(c) Copyright 2016 William Mitchell. All Rights Reserved.