Giles, good article.

On the subject of countercyclical fiscal policy, here are some speculative ideas I’ve had; I’d be interested to hear what you think.

Local councils, and central government agencies, should be responsible for maintaining a schedule of proposed “shovel ready” works (investments in infrastructure, housing renewal, even picking litter and planting shrubs) that can be accelerated upon the announcement of a recession. Perhaps some hypothecated fund should be put aside to pay for it. The point is that in future the govt. should ensure that it’s ready to press the button on job-creating worthwhile economic activity when a recession hits. I’d call this genuine counter-cyclical fiscal policy. It might require an independent fiscal authority to ensure the funds are there when needed.

This one is really just an idea … firms and landlords should be given tax breaks for putting aside income into a recession fund. It would work like this – when firms pay wages, they can put a percentage into a fund that, upon the occurrence of a recession, can be used to pay wages (effectively allowing firms to cut wages in a recession, because they can use the fund instead). This should preserve jobs and sustain worker incomes too. Landlords could do the same – when recession hits, rents are paid out of an accumulated funds, meaning that firms’ fixed costs (rents) can fall in a recession, again allowing them to keep operating without firing workers. This is can be thought of as countercyclical fiscal policy devolved onto the private sector.

There are a number of problems to be ironed out with the above. For example the funds may have to be portable, there’d need to a rule to govern what to do when funds are “full”, and lastly the question of what assets to invest in, such that prices don’t go south just when everybody is trying to liquidate those assets in a recession. Still, it’s a simple idea, just encourage firms to build up rainy day funds.

Could these be fresh policy ideas that could be embraced by the liberal left?

here is a fascinating article about a country that got it right: Chile. The interesting point is that while they were building up a rainy day fund during good times, the government was incredibly unpopular (only to be showered with praise once the recession hit and they could afford to start spending). This shows us that genuine countercyclical fiscal policy is hard for politicians to do because voters don’t like it – hence binding oneself with some rules, and selling the merits of the policy, (like above) may be a good move. I’d have thought now would be a good time for such a message.

Something inside my head keeps screaming “unintendend consequences”. And all sorts of worries. Like: should a firm in industry X keep money aside for the whole economy’s cycle, or for industry X’s cycle? Recessions not always sychronised.

Also: extra savings in the good times. But where do the savings go – if they lower the rate of interest, won’t they end up being invested? Will it then smooth the cycle?

Chile seem to have come as close as possible – it seems like it comes down to political courage, rather than clever rule design. I think that no matter how clever the fiscal rules that ARE designed, in a pinch the political calculus will swing behind breaking them – therefore time inconsistency. We had an early go at that, but came up with a pretty negative leaflet:

http://www.centreforum.org/publications/fiscal-rules.html

ta for the link

Giles,

yes, I share those worries about unintended consequences, and it’s not clear to me how the existence of such a fund would interact with the mechanisms that actually cause business cycles. As you ask, what are the consequences of a legislated increase in the savings rate, and would there be moral hazard style problems. No, I didn’t have in mind trying to cater for idiosyncratic industry cycles – too difficult, this is just to help with the big periodic bust, like that currently in progress.

still, a fund that would allow firms to cut wages and rent payments in a recession, without actually reducing wages nor rent received, and sustain employment when recessions hit, would be useful.

the idea of having “shovel ready” plans prepared in advance, seems unproblematic to me.

You are right that there hasn’t been a massive splurge of counter-cyclical investment since the onset of recession and may well be right that this is a shame. However, since deficits always rise in recession – because the economy shrinks and unemployment shrinks the tax take – the question is whether Government finances were in as robust health as they could have been after what Gordon never tired of telling us was a period of near unprecedented growth.

Luis Enrique is right that it is politically very difficult for a Government to run a surplus – remember the stick Gordon got for his war chest in the early years – but surely, after an exceptionally long period of low inflation and constant economic expansion, the Government might reasonably have been expected to be getting close to balancing the budget instead of wringing every last drop of credibility from the “Golden Rule”. All the more so since the Treasury must have been aware of the massive build up of household debt that occurred over the last ten years – a build up which may have every bit as much impact on the country’s ability to recover from recession as the public debt situation.

George V / Luis
What happened to the large amount of money that came in from North sea revenues and privatisation in the eighties
Also your point about Chile is a good one but that government has just lost the election

I could not help but notice the following sentence in the CPS paper:

Labour’s projected spending squeeze is much greater than that achieved from 1982-85

If Labour is reelected, will they really be able to squeeze that hard?

What will they be prepared to squeeze?

The Institute for Fiscal Studies (IFS) is the independent oracle source on the state of public finances in Britain.

For its longer term perspective on Public Spending, try: A survey of public spending in the UK
http://www.ifs.org.uk/publications/1791

A letter in today’s Sunday times, signed by an impressive list of high-profile economists, calls for a credible medium-term plan by the government to put Britain’s fiscal affairs on to a sustainable basis:
http://www.timesonline.co.uk/tol/comment/letters/article7026234.ece

Btw the list of signatories includes several names usually associated with support for the Labour Party, although not Lord Peston, father of the BBC business editor, Robert Peston.

Comapring government spending with GDP is problematic because the former has an impact on the latter.

Whats important and something that was missed (maybe deliberately) is that Brown is borrowing a dangerously high % of GDP ~12% this year, just to keep his vast client state ticking over. This is an IMF level of borowing, and comparable to Greece which is currently being given basket case status by most commentators.

I can see three or four collapses ahead because we’re all still borrowing like crazy and not doing anything productive. When Gov’t stops its financial stimulus the real state of our economy will be open for all to see.

“This is not to praise Gordon Brown as a fiscal genius – he has in fact made serious errors. But the right-wing criticisms are 180 degrees out.

Our deficits are not high because of Keynesian deficit spending – in fact, the problem (as CentreForum pointed out) is that he mismanaged the budgets in the good years, leaving too little room to boost the economy in the downturn. ”

Dunno about “right wing being 180 degrees out”.

I’m regarded as right wing (the burdens we classical liberals have to labour under) and this is exactly the criticism I’ve shouting from the blog tops for years.

If you’re going to be a Keynesian then you’ve got to do the fiscal contraction stuff in the boom times as well as the expansion stuff in the slumps.

Indeed, as a political criticism of crude Keynesianism, I regard the inability of governments (Chile notwithstanding: if only one government can actually do it out of 192 then we’re not really deascribing the real world, are we?) to do the fiscal contraction thing as invalidating the whole idea as a political possibility.

If you like, it’s James Buchanan proving JM Keynes wrong in the real world.

As an example of what I mean try reading back through the archive of Polly’s columns (I know, eyeballs bleeding time) from a few years ago. All those impassioned pleas for spending a little more here, a little more there (for the children!) because the coffers are bursting.

As best I can recall, informed commentators were remarking about the fiscal black holes (the structural deficits) in GB’s budgets at least as far back as c. 2000 but the story doesn’t end by claiming that GB should have closed the holes by hiking taxes or pruning spending to tighten the fiscal stance during “the good years”.

The Bank of England had and has the remit to set its interest rate to maintain a target inflation rate. With a tougher fiscal stance, the BoE’s interest rate would have been set lower to meet the inflation target – but that means, without other policy changes, mortgages whould have been even cheaper and easier and the house-price bubble would have likely inflated to even greater proportions.

This is why there was (and is) a need to reflect on proposals on whether: (a) the BoE should also have had a remit to curb identified (how identified?) asset-price bubbles; (b) the BoE should be empowered to impose higher capital requirements on the banks during credit booms to curb bank lending. The challenge is that the financial system is very open nowadays so if banks in Britain won’t lend some potential borrowers will be able to raise loans in other financial markets thereby creating an exchange risk against the Pound.

Lord Turner (chairman of the FSA) has raised these (controversial) issues but there has been little open public debate.

GB’s inner circle includes a group of highly educated economists (Ed Ball, Yvette Cooper, Ed Miliband) who have been conspicuously quiet about all this.

Tim

Fair enough. “Right” is lazy: I mean “obsessive anti KEynesians”, as in those who think it never works, ever, regardlesss of the position of the economy. John Cochrane perhaps? You are quite right about his boomtime policies: JMK would not have liked them.

No, I will NOT go through all Polly’s columns! That is a very unfair thing to ask someone to do on a sunday ….