Monday, 15 March 2010
Heed Keynes’ advice about tightening
John Maynard Keynes wrote during the Great Depression that only ‘fools and madmen’ will tell you ‘the path of escape is to be found in strict economy’. Several countries have now started ‘strict economy’, or fiscal tightening, after the biggest financial crisis since World War II.
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Heed Keynes’ advice about tightening
By DAVID BLANCHFLOWER
11 March 2010
John Maynard Keynes wrote during the Great Depression that only ‘fools and madmen’ will tell you ‘the path of escape is to be found in strict economy’. Several countries have now started ‘strict economy’, or fiscal tightening, after the biggest financial crisis since World War II.
The most obvious examples are Greece and Ireland. Portugal has released plans to cut its deficit to 2.8 per cent of gross domestic product in 2013 from 8.3 per cent this year by reducing spending on civil servants and public investment, and raising taxes on high incomes and stock market gains.
Any cuts in spending need to be dependent on evidence of growth in private industry. Growth is what will generate an increase in tax revenue. A sensible proposal would seem to be that the fiscal and monetary stimulus should continue at least until half of the loss in growth since the start of the recession has been re-established. Later is better than sooner.
In the UK, there has been much discussion among economists, most notably in a series of letters to national newspapers, about the demand for more dramatic cuts in public spending than the overly stringent ones already proposed by the Labour government. Local authorities already under these plans are proposing reductions of 10 per cent to 30 per cent, which might well mean the loss of half a million jobs. Most of these economists would leave austerity until later.
Former Federal Reserve chairman Paul Volcker, speaking in Germany on the weekend, argued that now isn’t the time to dispense with either fiscal or monetary efforts to spur demand.
However, George ‘Slasher’ Osborne, the opposition Conservative Party’s shadow chancellor of the exchequer, said in a recent speech that ‘there is no choice between going for growth today and dealing with our debts tomorrow’. Wrong. The UK has predominantly long-term debt that doesn’t roll over any time soon, putting it in a completely different situation than Greece.
Mr. Osborne was immediately contradicted by the International Monetary Fund, which rightly argued that ‘one of the key lessons from experiences of similar crises is that a premature withdrawal of policy stimulus can be very costly, particularly if the financial system is weak’.
In a televised interview this week, Alan Budd, an adviser for the Conservative Party, said that ‘if you go too quickly, then there is a risk that the recovery will be snuffed out and we will go back into a recession. I mean, what do the Americans say? ‘Remember 1937’.
That was the most famous double-dip recession in history.
All this talk of fiscal retrenchment is too much, too soon. Cutting public spending will increase unemployment, unless monetary policy can be loosened to compensate, and there seems little leeway to do that. And don’t imagine cutting public spending or freezing public-sector pay will be popular or easy.
About 250,000 UK civil servants went on strike this week over redundancy pay. Opinion polls have narrowed the Conservative Party’s lead before a general election, which must take place before June, on the news of the Opposition’s austerity plans.
The possibility of a minority government has investors concerned. Austerity budgets are the order of the day. And states in the US that have balanced-budget amendments are faced with identical difficulties. All have the problem that they can’t devalue their currency or loosen monetary policy in order to stimulate their economies.
In contrast, the UK has benefited because it has been able to devalue the pound by about 25 per cent, which has helped to stimulate exports and import substitution at home. As a member of the Bank of England’s monetary policy committee, I tried to talk the pound down, especially in the spring and summer of 2008, when my colleagues wouldn’t cut interest rates, even though the UK had entered recession in April 2008.
Since that time, governor Mervyn King has, appropriately in my view, been successfully talking the exchange rate down against most major currencies. But these options aren’t open to countries in the euro straitjacket or to US states.
At last, the European Commission has said it is prepared to propose the creation of a so-called European Monetary Fund to cope with future debt crises in the region. It’s about time.
Most nations in the Organisation for Economic Co-operation and Development (OECD), perhaps with the exception of Australia, have anaemic economic growth, driven mostly by government spending and stock building. In the United States, there are some signs that unemployment may have peaked and some industries other than temporary- help firms are starting to hire, though there is little sign that investment is picking up.
In the most recently published data, Ireland’s unemployment rate jumped to 13.8 per cent in January 2010 from 13.3 per cent a month earlier. The unemployment rate in Spain is 18.8 per cent, up from an average of 8.3 per cent for 2007, and an astonishing 40 per cent for those younger than 25.
I have every expectation that there will be a jobless recovery across the OECD. And there is little evidence to suggest the consumer will start spending again soon. The Conference Board’s latest Consumer Confidence Index fell to 46 in February compared to expectations among economists that the index would fall to 55 from 55.9.
The British Retail Consortium and KPMG retail-sales monitor in January 2010 was the worst reading in the 15-year history of the survey. The European Union- wide consumer-confidence index dropped again in February after improving a little in December and January.
A couple of months of positive data don’t make a trend.
Claims that cuts in spending should be done in the depths of a recession are driven by politics, not by economics. Electorates are likely to be unimpressed by governments deferring economic policy to financial markets, given that they got us into this mess in the first place.
Keynes warned that the classic policy error is to tighten too soon. Beware the fools and madmen who argue any different.
The writer, a former member of the Bank of England’s monetary policy committee, is professor of economics at Dartmouth College and the University of Stirling. The opinions expressed are his own
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