European Tribune - Community, Politics & Progress.

We're all Keynesians now

by Migeru
Sat May 29th, 2010 at 03:23:01 AM EST

In the Financial Times, Martin Wolf begs to Spare Britain the policy hair shirt:

The UK should tighten fiscal and monetary policy now, in the depths of a slump. That, in essence, is what the Organisation for Economic Co-operation and Development calls for in its latest Economic Outlook. I wonder what John Maynard Keynes would have written in response. It would have been savage, I imagine.
...
Above all, the private sector is forecast by the OECD to run a surplus - an excess of income over spending - of 10 per cent of GDP this year. On a consolidated basis, the UK's private surplus funds nearly 90 per cent of the fiscal deficit. Thus, fiscal tightening would only work if it coincided with a robust private recovery. Otherwise, it would drive the economy into deeper recession. Yes, that is a Keynesian argument. But this is a Keynesian situation.

Apologetically, but we're all Keynesians once again. Except the people in charge.

A I asked yesterday, which part of the following argument doesn't translate to just about every country now in the throes of fiscal austerity?

Let us translate this proposal into ordinary language: "If you are unwilling to starve yourself when desperately ill, nobody will believe you would adopt a sensible diet when well." But might it not make sense to get better first?
Here are some facts, to keep the hysteria in check: the UK economy is operating at least 10 per cent below its pre-crisis trend; the OECD estimates the "output gap" - or excess capacity - at slightly over half of this lost output; the UK government is able to borrow at a real interest rate of below 1 per cent, as shown by yields on index-linked gilts; the yield on conventional 10-year gilts is 3.6 per cent; the ratio of gross debt to gross domestic product was 68 per cent at the end of last year, against 73 per cent in Germany and 77 per cent in France and an average of 87 per cent since 1855; the average maturity of UK debt is 13 years, according to the International Monetary Fund's Fiscal Monitor; and, yes, core inflation has risen to 3.2 per cent, but that is hardly a surprise, given the large - and essential - sterling depreciation.
Above all, the private sector is forecast by the OECD to run a surplus - an excess of income over spending - of 10 per cent of GDP this year. On a consolidated basis, the UK's private surplus funds nearly 90 per cent of the fiscal deficit. Thus, fiscal tightening would only work if it coincided with a robust private recovery. Otherwise, it would drive the economy into deeper recession. Yes, that is a Keynesian argument. But this is a Keynesian situation.

Mutatis mutandis, I'm sure it applies to all of them, but we should be able to figure it out from the just-published OECD Economic Outlook.

When you have a large output gap and an equally large private sector positive balance which matches the size of the public deficit, reducing the deficit is going to widen your output gap even more. Why this should be controversial is beyond me, but the policy makers keep arguing that the real risk is inflation (see the picture of the ECB's Inflation Monster-in-the-closet), and that the markets are spooked by the large deficits. Well, guess what? They're also spooked by the reduced grow prospects that fiscal tightening will cause. And if you don't believe this, ask Spain - a day after passing a first round of fiscal austerity measures on the argument that it must be done to avoid a run on Spanish government debt, a rating agency downgraded Spain on "growth worries".

Fitch downgraded Spain's credit rating to AA-plus, and said it expects the country's adjustment to a lower debt level will materially reduce its rate of economic growth over the medium-term.

The financial markets are like thermodynamics - you can't win, you can only break even, and you can only break even at absolute zero.

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We're all Keynesians now | 11 comments (11 topical, 0 editorial, 0 hidden)

Spain: the face of Pyrrhic victory (4.00 / 6)

Spain - a day after passing a first round of fiscal austerity measures on the argument that it must be done to avoid a run on Spanish government debt

(pic attached to this AFP story in Spanish)

On the front bench (in Spain, the "blue bench"), from left to right: PM Zapatero, Deputy PM María Teresa Fernández de la Vega, Economics minister Elena Salgado and Minister for Territorial Organization Manuel Cháves.

The newspaper El Mundo had on its front page a longer photo showing only the front bench, but with seven or eight ministers, all "really happy".

On the second row, one can see the PSOE also has clueless blondes.

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan

by Migeru (migeru at eurotrib dot com) on Sat May 29th, 2010 at 04:28:43 AM EST

Re: Spain: the face of Pyrrhic victory (4.00 / 4)

See also my diaries:

Spain Crisis Report (May 22nd, 2010)
Stick the fork in Zapatero: he's done (May 27th, 2010)

and kcurie's:

What should Spain do? (April 28th, 2010)
What a GREAT capitalism refoundation (May 15th, 2010)

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan

by Migeru (migeru at eurotrib dot com) on Sat May 29th, 2010 at 05:21:22 AM EST
[ Parent ]

Re: We're all Keynesians now (none / 1)

On the upside, it's nice to see sanity on the FT editorial page.

What do Spain's interest payments look like as a chunk of the budget?

Be nice to America. Or we'll bring democracy to your country.

by Drew J Jones (myfriends@thisispancakes.com) on Sat May 29th, 2010 at 08:16:00 AM EST

Re: We're all Keynesians now (4.00 / 5)

I read the article. It was linked from Krugman.. and I even register in the FT.

Good actions need rewards...
He really hits it... We have now Krugman, Pearlstein, Wolf , Stiglitz, De Long,....

all the economists I know that know economics think the same thing.
The masters of the universe think otherwise....

This is a power grab.. this is not about reducing deficits but about reducing wage purchasing power in front of financial rents.. adn if they destroy the economy .. so be it.. they can do it again after all..

Unless they are wrong.. and recession is again around the corner... then , those same financial assets would be even more useless that goods and services. The first voices about nationalizing credit will be heard... and more importantly, tehre is no way China will privatize credit, their days in power are numbered.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Sat May 29th, 2010 at 08:57:05 AM EST

Re: We're all Keynesians now (4.00 / 4)

The masters of the universe think otherwise....

About now The Masters Of The Universe are trying to figure out how they can keep their winnings. Some of them will make out in a default situation via CDSs, but all face counterparty risks. In the increasingly likely event of a collapse, there comes the question of WHERE they can keep their winnings and how much of those winnings will still mean anything.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer at eurotrib.com) on Sat May 29th, 2010 at 01:17:32 PM EST
[ Parent ]

Re: We're all Keynesians now (4.00 / 3)

Precisely.

It is amazing how they do not understand that a feudal system is just not possible.. high unequality is possible if you accept not to become mega-uber rich (Brazil and mexican uber rich are not that rich).. but a full feudal system collapses. A system with very low equality can even collapse (Minsky logic or Lehman logic) but a feudal system has no equilbrium point with high technology and a service economy. I think DeLong clearly showed that this is the case... but never mind... they would never read DeLong.. he is an historian or historicist or whatever.. who cares, he is certainly someone not to be trusted..even if once upon a time he was a rational republican.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Mon May 31st, 2010 at 04:08:48 PM EST
[ Parent ]

Re: We're all Keynesians now (none / 0)

You know, I'm going to raise a

on these claims and ask for a diary....

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan

by Migeru (migeru at eurotrib dot com) on Sun Jun 6th, 2010 at 11:05:17 AM EST
[ Parent ]

Re: We're all Keynesians now (none / 0)

..private sector is forecast by the OECD to run a surplus - an excess of income over spending - of 10 per cent of GDP this year.

Obviously by "private sector surplus," he means profits, not economic surplus (=the amount of wealth created).

On a consolidated basis, the UK's private surplus funds nearly 90 per cent of the fiscal deficit.

..and profits are savings and all savings come from profits. Not from labour. The solution: Increase profits, so that public sector can take more debt and fix the economy.
Sorry, but it does not work that way.

by kjr63 on Sat May 29th, 2010 at 09:37:25 AM EST

Re: We're all Keynesians now (4.00 / 4)

The private sector tries to decrease its leverage. Income is used to pay down debt and not reinvested. I don't think looking at the situation in terms of profits is useful.

Wait this is important. Someone is wrong on the Internet.

by generic on Sat May 29th, 2010 at 11:08:13 AM EST
[ Parent ]

Re: We're all Keynesians now (none / 1)

Are we all Keynesians now, or are we all crass Keynesians now?

- Jake

"Terraforming your own planet to make it uninhabitable hardly counts as epic win." - ThatBritGuy

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat May 29th, 2010 at 12:13:38 PM EST

Re: We're all Keynesians now (4.00 / 3)

By following the recommendations of the IMF and other "austerity" mongers, when deflation really sets in affected governments will have the opportunity to tell the financial markets:

"We did as you asked and it produced this situation. Now we are even less able to pay. Take a 50% haircut or take nothing. Your choice."

Another response would be to form state banks along the lines of the Bank of North Dakota and use it in a similar manner. This does not require the country to have its own currency.

But most important is that someone in the government push back on the ridiculous, self defeating demands that the feckless financial sector has been making and point out that it is largely their behavior that has enabled and created the problem and that having the existing financial sector collapse and disappear would lead to a much quicker revival of the economy than will trying to make them whole when they have filled the market with counterfeit money.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer at eurotrib.com) on Sat May 29th, 2010 at 01:27:57 PM EST

We're all Keynesians now | 11 comments (11 topical, 0 editorial, 0 hidden)

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