The madness of Osborne: ‘expansionary fiscal contraction’ explained


by Richard Murphy    
5:59 pm - June 29th 2011

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George Osborne believes in the absurd theory of expansionary fiscal contraction. It’s worth giving the notion a few minutes of thought since his belief is currently wrecking the lives of millions in this country and the prospects of millions more.

Expansionary fiscal contraction is what is called a ‘general equilibrium model’ based on the ideas of neoliberal economics. For the wonks there’s an explanation here. .

What this means in fairly lay terms is that the model assumes that we know the future.

This is of course something we can all recognise as being very obviously right: it’s glaringly obvious that we all know what is going to happen to us from now on, isn’t it? If you disagree, just note that means George Osborne disagrees with you, and vice versa.

The model also assumes that we all believe that if only the government spent less we’d all be better off. That’s clearly also universally true: isn’t everyone agreed we want less health care, education, pensions, protection when we’re sick, law and order, child protection, health and safety (so we can have many more industrial accidents), road safety, environmental protection and so on? We’re all agreed, aren’t we? Those are, after all, ‘bad things’, aren’t they?

George also agrees that if we now know that he has promised that he will spending less of our cash in future – then we all are absolutely confident he can deliver that objective without any disruption to our current well being and that we will all proceed to this land over-flowing with the riches of milk and honey without a hitch. All the benefits from lower taxes will flow into our pockets, wallets and offshore bank accounts (all full declared, of course) from whence we will be able to spend them.

And because George is sure we have that confidence, he’s also sure we will all go out now and spend more today to celebrate George’s largesse in cutting our taxes around 2014.

That, I promise you is how the theory of expansionary fiscal contraction works when all the crap and the formulas are cut away.

And that is the basis on which George Osborne thinks that his cuts will make the UK economy grow. He really does think we should all be dancing in the streets and borrowing money to spend now to celebrate the fact that he’s going to give us tax cuts with absolute certainty in the future even though he’s being coy enough to not say when.

It is this theory that suggests why he thinks that cutting public sector jobs will result in the creation of private sector jobs straight away because we will all be spending the anticipated savings now. And it is this theory that explains why his budget forecasts a considerable increase in private borrowing over the next few years – borrowing that he thinks we will all undertake in anticipation of his tax cuts that will follow which will allow us to repay the borrowing.

And let’s be blunt about this: it’s utterly crackpot. We don’t know the future. But on the basis of George’s crackpot belief in this crackpot idea the UK is being plunged into economic turmoil.

And the fact that the idea will not work is becoming increasingly apparent: 10,000 jobs have been lost on the High Street in the last week. And still George sticks to his guns because, to be candid, he believes in a world of make believe.

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About the author
Richard is an occasional contributor. He is a chartered accountant and founder of the Tax Justice Network. He blogs at Tax Research UK
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Reader comments


The paper you link to has the following wonderful line on page 7:

“By assumption, government spending has no direct utility value or value in production. This is obviously untrue in a literal sense.”

If you start off by assuming that government spending has exactly as much value as flushing tax revenues down the toilet it’s hardly a surprise you manage to prove that reducing government spending increases the value of the economy.

The authors are right to point that in the real world – well, people do actually place some utility value on schools, hospitals, policing and the like – but why they think their paper has any remaining value is unclear.

To summarise the paper, expansionary fiscal contraction only works if you’re a Tory in the first place.

2. Luis Enrique

you cannot say that neoliberal economics, models in which agents know what actions today mean for the future etc. are to blame for the idea of expansionary fiscal contraction, because plenty of (most) models with those features predict that fiscal contraction is …. wait for it … contractionary!

we may not know the future, but expectations about the future certainly do play a big role in explaining the economy …. a few moments thought will confirm this … and expansionary fiscal contraction is possible if the parlous state of public finances is so severe that the expecation of a coming public finance crisis tomorrow is depressing the level of economic activity today. Stated like that is should be obvious that this idea is both perfectly sensible and most importantly not applicable to the UK today. That vast majority of mainstream economists, whom Richard would certainly accuse of being “neoliberal” – for example the popular villain Larry Summers – agree that expansionary fiscal contraction only happens under certain conditions, and those conditions are not present at the moment.

here is a nice short paper by the Congressional Budget Office Can contractionary fiscal policy be expansionary?

3. Charles Wheeler

But Osborne et al don’t believe this. It’s simply an excuse to reach the nirvana of the small state by wiping out as much of the public sector as it can get away with because private=good public=bad. The last thing the Tories want now is a recovery which would undermine their deficit fetishism. How else to reduce the demand for healthcare and education from the poor and wipe out pensions and disability benefits?

has exactly as much value as flushing tax revenues down the toilet

You mean like building bridges and trains? Hmm…

Expansionary fiscal contraction is what is called a ‘general equilibrium model’.

Wait, wait, wait… wut?

6. gastro george

More importantly, trashing the economy now and getting a dead cat bounce in two years time fits in with the electoral cycle.

There are plenty of criticisms that could be leveled against Mr Osborne and the Chief Secretary to the Treasury and as usual Mr Murphy manages to miss all of them. If you accept that the government needed to consolidate their spending and Labour did believe that, then the only argument is about how you do it and timescale. Most of the theory says that you should cut spending and raise taxes on a 4-1 ratio. However, none of the theory says that you should raise taxes first and cut spending later. Therefore, the coalition are doing things back to front as the tax rises should come when the economy has recovered. Hence, we have an economy depressed and expectations has played the role of telling firms that they should hoard cash. As the likes of Adam Posen on the MPC has argued, the government should be cutting personal taxes at this time not raising them.

” The corporate liquidity ratio – sterling and foreign currency bank deposits of non-financial corporations divided by bank borrowing – recovered in April and May after a first-quarter dip. Excluding property companies, the ratio is at its highest level on record in data extending back to 1998 ”

Piles of cash. I wonder is the government giving off any signals that they should start spending it.

Expansionary fiscal contraction is except in limited circumstances mostly crap. However, so are fiscal expansionary policies with an inflation targeting central bank who will offset it. They could only possibly work if we were in a liquidity trap and the UK is not in a liquidity trap. With the benchmark 10-yr gilt yielding just over 3 per cent the government should be taking the opportunity for massive infrastructure investment. They are cutting capital expenditure which is a big mistake.

The private sector is creating jobs faster than the public sector is shedding them. With narrow money M1 rising by 9.7% annualised in the three months to May, following a contraction in late 2010 / early 2011. The sluggishness we currently are in is that contraction. The increase since early 2011 suggests that the economy will pick up in the second half of the year. Therefore, as long as the private sector continues to create jobs faster than the public sector shrinks the consolidation will have little macro effects. However, it will be suboptimal.

Expansionary fiscal contraction is what is called a ‘general equilibrium model’ based on the ideas of neoliberal economics.

It isn’t.

For the wonks there’s an explanation here. .

quote: This paper provides a theoretical exploration of the possibility of expansionary
?scal contraction in a dynamic general equilibrium model.

(my emphasis)

For a more cautious approach and conclusions, try this (much criticised) paper by Harvard economists Alberto Alesina and Silvia Ardagna: Large changes in fiscal policy: taxes versus spending.
http://www.economics.harvard.edu/faculty/alesina/files/Large%2Bchanges%2Bin%2Bfiscal%2Bpolicy_October_2009.pdf

Abstract: We examine the evidence on episodes of large stances in fiscal policy, both in cases of fiscal stimuli and in that of fiscal adjustments in OECD countries from 1970 to 2007. Fiscal stimuli based upon tax cuts are more likely to increase growth than those based upon spending increases. As for fiscal adjustments those based upon spending cuts and no tax increases are more likely to reduce deficits and debt over GDP ratios than those based upon tax increases. In addition, adjustments on the spending side rather than on the tax side are less likely to create recessions. We confirm these results with simple regression analysis.

The authors remind readers: In the UK the debt over GDP ratio at the end of WWII was over 200 percent but that country did not suffer a financial crisis due to its historically credible fiscal stance and the debt was gradually and relatively rapidly reduced. However, it would be probably too optimistic to expect another decade like the nineties ahead of us; that kind of sustained growth would certainly do a lot to reduce the debt/GDP ratio but the lower growth which we will most likely experience will do much less.

Try too this Alesina paper: Tales of Fiscal Adjustments
http://www.economics.harvard.edu/faculty/ardagna/files/Economic_Policy_1998_b.pdf

But see Krugman’s critical comments here:
http://krugman.blogs.nytimes.com/2010/10/05/the-imf-on-fiscal-austerity/

And these comments in The Economist invoking the IMF:
http://www.economist.com/blogs/democracyinamerica/2010/10/politics_and_economy

This blogged commentary considers the issue specifically from a UK perspective to remark that there is no evidence so far of any expansionary effects of Osborne’s policies:
http://www.econbrowser.com/archives/2011/01/uk_no_expansion.html

Actually, that sentence is even worse if you read it in context:

Expansionary fiscal contraction is what is called a ‘general equilibrium model’ based on the ideas of neoliberal economics….

What this means in fairly lay terms is that the model assumes that we know the future.

So the OP proposes the following:

1, There is this thing called “expansionary fiscal policy”;
2, Expansionary fiscal policy is what is called a “general equilibrium model”;
3, General equilibrium comes from “neoliberal” economics;
4, This means that the model assumes we know the future.

What can you say about such confusion…?

For once, bob’s links were vaguely relevant. See http://www.cobdencentre.org/2011/02/large-changes-in-fiscal-policy-taxes-versus-spending/

It might be a crap explanation of the underlying phemonenon, but the empirical evidence stacks in favour of budget cuts for long run growth.

13. Luis enrique

Vim #11

I know. That sentence makes about as much sense as: “global warming is what is known as a computer simulation ”

How does he get away with it?

How does he get away with it?

Same way as Johann Hari.

@Nick: “For once, bob’s links were vaguely relevant.”

Gee, thanks.

Of course, it is just possible that you could be too dim and ignorant to appreciate the relevance of the links I often post, which are usually intended to inform by providing access to official data sources and analyis. Predictably, some find such data sources and analysis an acute embarrassment when these conflict with dearly held and promoted illusions which have little or no foundations in fact.

What can you say about such confusion…?

What are you confused about? Perhaps its a reading comprehension issue rather than anything else?

I think Luis is suffering from the same problem. Just on another thread he asked of a comparison between private and public pensions though there’s an article on that just published this morning.

I swear we had a better class of trolls back in the day.

Whatever the credibility of the notions of “fiscal contraction expansions” and the offered theoretical rationales, this fundamental holds:

Aggregate demand for goods and services will fall as the result of public spending cuts unless the gap is made up by compensating increases in consumer spending, business investment and/or from net exports.

As I posted several times before with supporting ONS links, there is no evidence of this happening so far:
http://liberalconspiracy.org/2011/06/16/ed-balls-speech-will-osborne-the-ostrich-fly/

There are further concerns because so many of the large economies are currently engaged in fiscal contractions as this is likely to depress international economic growth and thereby reduce the scope for a compensating boost to demand through expansion of net exports.

Some of the academic papers espousing the expansionary effects of fiscal contractions make the point that the expansions observed tended to follow preceding depreciation of the country’s real exchange rates, which could be expected to boost net exports. Also, that it mattered whether growth of the international economy was currently buoyant.

18. Luis enrique

Sunny are you drunk?

We don’t know the future. But on the basis of George’s crackpot belief in this crackpot idea the UK is being plunged into economic turmoil.

“We don’t know the future,” Murphy sighed, shaking his head, “But we do know the future.”

20. gastro george

Anybody who believes in expansionary fiscal contraction – aka Ricardian equivalence – i.e. thinks that people are going to start spending now because today’s cuts mean that there will be tax cuts in the future – needs their sanity checking.

Osbornomics is packed with contradictions and fallacies.
Expansionary Fiscal Contraction is presumably chosen as a neat way of combining both.

Either Osborne sees himself as a master magician, who can deceive a bedazzled audience,
or he’s gambling on a willing media talking a good game for him, while the bulk of Labour MPs remain supine.

Of course, he could end up looking like a third-rate music hall illusionist
and being booed off the stage.

On consumer spending in 2011Q1, checkout this ONS publication: Consumer Trends:
http://www.statistics.gov.uk/downloads/theme_economy/CT2011Q1.pdf

“Household expenditure makes up about 60 per cent of GDP, and as a result has an important part to play in the path of economic growth. In Q1 2011 the volume of goods and services purchased by households (chained volume measure) fell by 0.6 per cent (seasonally adjusted). This follows a fall of 0.2 per cent in Q4 2010.”

23. Éoin Clarke

Great post Richard,

Let’s hope enough Neo-Liberal Ostriches pluck their heads out of the sand to read it and digest.

24. So Much For Subtlety

20. gastro george

Anybody who believes in expansionary fiscal contraction – aka Ricardian equivalence – i.e. thinks that people are going to start spending now because today’s cuts mean that there will be tax cuts in the future – needs their sanity checking.

I don’t see why. I mean I don’t buy what the government is doing, but if I really believed they meant what they said about tax cuts, I would spend more.

Housing is depressed at the moment. Not depressed enough in my opinion, but it is relatively low. Which means I could buy a bargain if I was so minded. And had the cash. But of course I don’t believe we have hit the bottom of the market yet. If I thought the government was serious about economic reforms and cutting spending, I would assume the economy would soon pick up. Even more so if I was insane enough to believe they were going to cut taxes. So I would buy now while houses are still cheap.

As would many other people.

As someone on the Right I wish people on my own “side” would admit that in the short term there needs to be a recession to purge the economy of malinvestments. It isn’t nice but at least it’s honest.

26. Under The Bridge

So there is more evidence favouring cuts to public services as a way of stabilising economies than there is for ignoring the deficit and carrying on as if everything was fine.

I find that most surprising. I would have sworn that the best way to cut debt was to spend more money employing people in unremunerative public service jobs.

@25: “As someone on the Right I wish people on my own ‘side’ would admit that in the short term there needs to be a recession to purge the economy of malinvestments.”

As Andrew Mellon, US President Hoover’s Treasury Secretary said shortly after the Great Stock Market Crash of 1929: “Liquidate labor, liquidate stocks, liquidate the farmer, liquidate real estate. It will purge the rottenness out of the system. People will work harder, lead a more moral life.”

By 1933, the height of the Depression, unemployment had risen from 3% to 25% of the nation’s workforce. Wages for those who still had jobs fell 42%. GDP was cut in half, from $103 to $55 billion. This was partly because of deflation, where prices fell 10% per year. By 1933, world trade plummeted 65% as measured in dollars and 25% in total number of units.

“David Cameron admits defeat over bankers’ bonuses – Downing Street has accepted that it cannot halt large bonuses for bankers and is instead negotiating to make employers disclose how many are given more than £1 million.”
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8251527/David-Cameron-admits-defeat-over-bankers-bonuses.html

“FTSE 100 board directors now receive final salary pensions worth on average £2.8 million, according to research by Incomes Data Services (IDS).

“The Executive Compensation Review found that, when converted into an annual pension, the £2.8 million pot could buy an employee a pension annuity worth more than £170,000 a year.”
http://www.employeebenefits.co.uk/item/13143/23/5/3

Chief executives of FTSE 100 companies saw their median earnings soar 32 per cent to £3.5m last year, prompting complaints that rewards are out of line with share prices and employees’ pay.

The median increase – the midpoint between the top and bottom earners – was more than treble the 9 per cent rise in the FTSE 100 index over the period, according to a survey by MM&K, the reward consultancy, and Manifest, the proxy voting agency.

The findings came as workers suffer the most prolonged squeeze in real wages since the 1920s.
http://www.ft.com/cms/s/0/11804c54-8a11-11e0-beff-00144feab49a.html#axzz1Qi4KCCYe

Aggregate demand for goods and services will fall as the result of public spending cuts unless the gap is made up by compensating increases in consumer spending, business investment and/or from net exports.

This is exactly right. And worst still, the Tories don’t explain how this shortfall will be made up.

the other day they were touting exports to China as a way to drive growth! Exports to China! Business investment keeps falling and household disposable incomes keep getting squeezed.

and yet this govt believes that expansionary fiscal contraction will somehow work. Beggars belief.

29. Maltese Cross

Small state governments are the most successful – See China/UAE and of course Malta.

30. So Much For Subtlety

28. Sunny Hundal

And worst still, the Tories don’t explain how this shortfall will be made up.

By rising consumption and business investment. At the moment Britain is approaching the point where no sane person thinks they will pay back their loans. We are looking at Greece-writ-small. That is, years of higher taxes, lesser services, and possibly defaults. In fact we have already started defaulting given inflation is a form of default.

The only sane response to this is to remain cashed-up and avoid both spending and investment. These are down as confidence remains low.

Telling people the government intends to spend more now and pass on more spending to our grandchildren via loans just means that investment and much consumer spending slows even more.

What they need to do is restore confidence that in the long run, government spending will be reduced. That taxes will be lower. That working is worthwhile. And that investments will be profitable. If people believe that they will stop saving up for a rainy day and start spending. Growth will resume. So the first step to long term fiscal health is to slash spending now. Yes, in the short term it will be painful. But in the real economy will benefit.

the other day they were touting exports to China as a way to drive growth! Exports to China! Business investment keeps falling and household disposable incomes keep getting squeezed.

What is wrong with the idea of exports to China? If business investment is falling the last thing you want to do is tell people that if they invest their money will be reduced to nothing by inflation, and if they do make any profits they will be taxed more heavily on them. That will just cause even more investment to dry up. In the same way if household income is dropping you don’t tell people they will have to pay more tax and so have even less to spend in the future. Because they will start saving up to pay off those taxes.

and yet this govt believes that expansionary fiscal contraction will somehow work. Beggars belief.

Everywhere it is tried, it works. The lower the government’s share of the economy, the faster the economic growth as a general rule.

31. gastro george

@24 So Much For Subtlety

So it would work if people believed in it, yet you don’t believe in it, and neither does anybody else judging by the figures for confidence and consumption.

@28 Sunny

“And worst still, the Tories don’t explain how this shortfall will be made up.”

But the OBR does, it thinks that households will go more into debt. Madness.

32. Luis Enrique

I’ll try and explain why it is the author that is confused, not Vimothy suffering from reading comprehension difficulties.

expansionary fiscal contraction is not a general equilibrium model. A GE model is one which tries to capture all feedback effects in a macro economy, i.e. how changes in one place affect other parts – like how government cuts cause unemployment that cause demand to fall that cause tax revenues to fall etc. That is a general equilibrium effect (with some frictions added to the model). So Sunny and others who quite rightly oppose cuts on the grounds it will damage growth are making general equilibrium arguments, even if they dont realise it. A GE model can be used to show that the goverment ought to borrow and spend, a GE model can be used to study very left wing economic policy, such as central planning. A GE model is a tool, not a policy prescription.

GE models are not “based on the ideas of neoliberal economics” they are based on the theories behind mainstream economics. If you want to identify “mainstream” with “neoliberal” then your whole argument falls apart because mainstream economics, based on GE models, suggests that fiscal contraction will hurt the economy, especially in the midst of a recession. If you look at the Congressional Research Office doc I linked to above, you will see they say the view of expansionary fiscal contraction “contrasts with that held by most economists and found in conventional models” – so when Eoin talks about neo-liberal Ostriches he must be using the term quite differently from Richard, because neo-liberals in the sense of those who use GE models, like Larry Summers, oppose fiscal contraction. Yet Eoin thinks he is agreeing with Richard. The section of the OP that Vimothy highlights is incoherent, and one suspects the author is using words he does not understand.

So, the author is confused, not the reader. Sunny I can only presume you fail to see this because you are in partisan attack dog mode.

33. Luis Enrique

Also, why scoff at exports? I don’t think exports are going to magically save the economy either (traded goods production is just too small a part of our economy) but here’s somebody quoted in the FT this month: ““Indeed, after a long wait, net exports started to contribute positively to quarter-on-quarter GDP growth in the first quarter. Today’s data mark a good start to the quarter and the likelihood that net exports will be the principle driving force behind overall GDP growth in the second quarter.” Not to be sniffed at.

43 Tyler

Clearly the only moron in the room is Richard Murphy.

No, you being here makes two.

12 Nick

the empirical evidence stacks in favour of budget cuts for long run growth.

Except it doesn’t.

Anyone with half a brain reviewing economic history since the 2nd world war can see that living standards rose most when government spending was highest.

Luis Enrique’s efforts under Richard Murphy articles are hilarious.

Such animated prejudice and fussy, unimportant critiques.

36. Luis Enrique

BenM

well, I agree that pointing out Richard is talking bollocks, where he talks about models and neoliberal economics, is unimportant next to the argument that expansionary fiscal contraction is a daft idea. But should blog commentators not point out where bloggers are talking rubbish?

Odd that you accuse me of prejudice under an OP displaying ignorant prejudice against models and “neoliberal” economics. After all, I merely point out that what Richard regards as neoliberal economics is actually in perfect agreement with him about fiscal contraction.

What are you confused about? Perhaps its a reading comprehension issue rather than anything else?

Erm…

No one who knows what the words general equilibrium mean would write a sentence like that. It has the effect of communicating to anyone who does that the author has no idea what he’s going on about. It’s simply a nonsensical statement. Now, there’s no harm in not understanding stuff. It’s just that if you drop it into conversation, or, say, online opinion pieces, to make yourself look smart, it may backfire. In general, I would go by the rule, if you don’t understand it, write about something else. There are literally hundreds of things I don’t understand, so naturally I’m well practiced at this.

“Anyone with half a brain reviewing economic history since the 2nd world war can see that living standards rose most when government spending was highest.”

Correlation =/ causation. Societies with increasing wealth can also afford a more bloated state.

“Expansionary fiscal contraction is what is called a ‘general equilibrium model’ based on the ideas of neoliberal economics.”

*Sigh*.

General equilibrium is based upon the ideas of neo-classical economics. Walras started it all off. Neo-classical !equal neo-liberal.

This particular paper is not based upon a general equilibrium model anyway. It’s based upon a dynamic model. The sort of thing the New Keynesians (who are not neo-liberals) base their work upon.

That’s two strikes against the Murphmeister right there. That the paper’s written in part by his hate figure, Mike Deveraux, probably doesn’t help the red mists descending.

“What this means in fairly lay terms is that the model assumes that we know the future.”

Snigger.

No, among the assumptions is that Ricardian equivalence holds (in parts of the model). This does not mean that “we know the future”. It means that consumers think they know the future. More specifically, that they actually trust what government tells them about future tax rates.

Now, Ricardian equivalence may or may not hold, but it certainly won’t hold if people think that govt is lying to them about future tax rates. However, it might, if people judge the promises about lower taxes in future to be believable.

“The model also assumes that we all believe that if only the government spent less we’d all be better off.”

No, it doesn’t. It doesn’t assume anything at all about how tax money is spent. Rather, it assumes that if government spent less money , and people believed that this was going to be true into the future, then people would believe that they will be paying less tax in future, have more money in their own pockets in future, and what are the implications of that?

The answer the paper gives, an answer which if you believe the previous paragraph is obvious, is that people will both consume more now and invest more now as they don’t have to save their money to pay those future higher taxes.

“And because George is sure we have that confidence, he’s also sure we will all go out now and spend more today to celebrate George’s largesse in cutting our taxes around 2014.”

The paper is exploring exactly this scenario. If the assumptions are correct (which they may or may not be) then what will happen if they are?

That’s what models do of course: explore the implications of the assumptions made in constructing the model.

“It is this theory that suggests why he thinks that cutting public sector jobs will result in the creation of private sector jobs straight away because we will all be spending the anticipated savings now.”

Ah, perhaps you should go back and read the paper again? There’s a distinction made between the short and the long term.

“While the model implies that the long run impact of fiscal spending cuts on the economy
are positive, and may be relatively large, the dynamic analysis suggests that these
gains are accrued only gradually, as real interest rates fall, and capital accumulation
takes place. Interestingly, the immediate impacts of fiscal spending cutbacks are quite
small, expect in the case where the cutbacks are perceived to be temporary.”

The *long term* effects are expansionary.

To think that the effects will be immediate would be to move to the New Classical or RBC models: which this paper simply does not do in the slightest. Nor does Osborne of course.

I’d suggest a) reading the paper you cite and b) at least skimming the Wikipedia articles on the theories you want to talk about.

If you want to identify “mainstream” with “neoliberal” then your whole argument falls apart because mainstream economics, based on GE models, suggests that fiscal contraction will hurt the economy, especially in the midst of a recession

What’s even more ironic is that it says all this on page 2 of the paper Murphy cites but seemingly didn’t read:

What are the macroeconomic e?ects of ?scal contractions? The conventional economics textbook view… is that government spending and de?cit reducing policies have negative e?ects on aggregate demand and output. De?cit reduction then has to be a balancing act between the achievement of ?nancial goals and the containment of the negative e?ects on the real economy.

(…)

The notion that a credible permanent ?scal contraction that reduces the long run tax burden could stimulate an increase in aggregate consumption is quite reasonable. But it seems unlikely that this e?ect could be so great as to increase aggregate national income. This would imply the presence of a negative government spending multiplier. Both textbook macroeconomic models, as well as neoclassical model of ?scal policy developed by Barro (1987), and others, predict that government spending multipliers are positive.

It seems to me that increases in household spending have less to do with real anticipation of future tax cuts than with the rapidly increasing cost of living. Unless incomes are seen to be increasing at least apace with household costs people will not be confident, so promises of jam tomorrow mean nothing.

That confidence must be further dented with the prospect of a race to the bottom for pensions and house prices that are out of reach for a generation of young workers.

For me the real issue of Osbornomics is that they are a smokescreen to justify massive social changes that nobody except a few radicals want or believe in.

42. gastro george

@39 Tim

Your post largely describes the gulf between theoretical economists and those with a more empirical approach.

A shorter version – Ricardian equivalence holds if the people think it holds.

I’m not sure what kind of intellectual integrity there is in basing your economics or the management of the country’s economy on statements like this – but I think the public are already making their judgement.

But maybe that’s the point – the economists can blame the public for the failure of the policy – because they didn’t believe in it.

“A shorter version – Ricardian equivalence holds if the people think it holds.”

No, that’s not what I said at all.

I said Ricardian equivalence might hold if people trust government but it certainly doesn’t if they don’t.

“I’m not sure what kind of intellectual integrity there is in basing your economics or the management of the country’s economy on statements like this”

As good a description of the Murph’s economics as you’ll see I think.

BTW, I’ve no problem at all with you or him or anyone else disagreeing with me. But it would help if our retired accountant from Wandsworth bothered to try and understand the economics he’s decided to use so that he can design an economic policy for the country.

@ 34 Ben M

Big words, little man.

Expansionary fiscal contraction;

GDP grows (and thus tax reciepts will also grow as a proportion).

NOMINAL government spending grows, albeit at a slower rate than inflation and/or GDP growth.

Thus, whilst GDP is indeed growing, GOVERNMENT spending is growing at a slower pace, which given inflation can lead to real terms cuts, as we are seeing in this case. In nominal terms the government are not making any net cuts at all.

What you of course have implicitly argued is that government spending drives all growth. In real life quite the opposite is often true – too much government spending, too much debt and too high taxes often stifle growth in the real economy.

You are also making a sugestion about the level of GDP growth. Whilst reducing government spending as a % of GDP you might well reduce short term GDP growth. The better long term debt dynamics should help longer term growth though. What you are really saying is that you aren’t happy with slightly sub-par growth (given 0.5% qoq) is roughly the long term trend) and that is a totally *subjective* view.

In purely objective terms, the economy can grow whilst real terms government spending contracts as a % of GDP.

So, expansionary fiscal contraction then, in terms so simply even you can understand.

45. gastro george

Tim – you miss the gist of what I was saying re Ricardian Equivalence.

There is no utility having an economic “law”, or basing your policies on it, if it is reliying on the whim of the public. Now you could argue that all economics is based on a reading of the whim of the public. But “trusting the government” (even if not believing in the Ricardian thesis) is not the sturdiest whim to rely on, as I’m sure you’d agree.

I’d far sooner base my policy on the reading “if people are seeing their income reduced, their jobs threatened and are being incessantly warned about the coming austerity, they are most likely to spend less”.

Which is why RE is tosh.

46. gastro george

@44 Tyler

“The better long term debt dynamics should help longer term growth though.”

“In purely objective terms, the economy can grow whilst real terms government spending contracts as a % of GDP. ”

You have to love the “should” and the “can”.

Back in the real world, companies are sitting on massive cash reserves, and unemployment is high. So why not invest and grow?

Because there is no demand … Companies will not produce stuff that nobody is going to buy. Have you seen the high streets recently?

Shorter Tyler and Worstall:

Expasionary Fiscal Contraction works because we believe it does!

“There is no utility having an economic “law”, or basing your policies on it, if it is reliying on the whim of the public.”

Most of economics isn’t about “laws”. There are a few, yes, the iron law of one price for example (which is what explains arbitrage).

But most of it is observation of what those odd things, human beings, do when facing particular sets of incentives.

Ricardian equivalence holds for most people some of the time, few people all of the time. We could even provide scenarios to illustrate this.

“Here’s a dollar, I want it back in one hour”. Just about everyone would simply keep the dollar and hand it back in an hour. Not everyone, but a goodly majority.

“Here’s a dollar, my seccessor wants it back from your kids in 100 years”. Fuck it, spend it.

In the first we’ve Ricardian Equivalence…..if we call the giving of the dollar a tax cut and the taking it back a rise in future taxes.

In the second it doesn’t hold.

There is no “law” of Ricardian Equivalence. There’s a behaviour which sometimes people do and sometimes they don’t. When designing our policies, policies that might be undone by this behaviour, then we’d like to keep in mind that point. That some people will always do it lessens the effectiveness of our policy. That most people will do it under certain versions of our policy means that we don’t want to craft our policy in a manner where most people will do it.

To give a real world example, back when Bush was trying to do expansionary policy. He said tax cuts: give everyone a $400 cheque. One of the criticisms (from the left note) was that people would just save it, or pay down a bit of debt.

However, if the same money were spent by government then the multiplier would be higher. More fiscal expansion for that $400.

Ricardian Equivalence holds more for tax cuts than it does for government spending…..that’s what they were saying. Now, whether they were right or not is another matter. But it is a real world example of when people have used that very argument to shape policy.

Ricardian equivalence is not a law, but a hypothesis.

Full Ricardian equivalence implies that a fiscal contraction would have no effect whatsoever on anything. GDP would not change. It does not imply that a fiscal contraction would be expansionary.

@ 47 BenM

Please prove where it isn’t working.

UK GDP IS growing (just not as fast as you’d like it to).

The deficit IS set to contract over time.

All you are really whining about is that GDP growth won’t be fast enough to prevent real terms spending cuts, which means you, your civil service bretheren and Labour’s client state are going to have less loot to play with.

Murphy’s (and Sunny’s and BenM’s) real problem is this;

As long as the economy is growing and the deficit is contracting, Osbourne is right.

It’s all well and good having a whinge about the UK not growing fast enough, but without actual proof to the contrary, rather than cirumstantial evidence, that really is the best you can do – whinge.

52. gastro george

At least we have that then. Tim and vimothy agree that GO’s economic policy is based on a hypothesis that only works in certain circumstances. Great. Sound idea.

@51 Tyler

“As long as the economy is growing and the deficit is contracting, Osbourne is right.”

As long as by “growing” you mean “growing at at least the historical average rate excluding inflation”, then that might be a success story. Looks to me like the economy is flat-lining at best, and the worst of the cuts are yet to come. I guess we shall see in the months ahead.

Bueller, Bueller, anyone, anyone…?

If you read my last comment, you would see that I actually disagree with Tim about the relevance of RE:

Ricardian equivalence implies that a fiscal contraction would have no effect whatsoever on anything… It does not imply that a fiscal contraction would be expansionary.

Capisce?

54. Luis enrique

If anybody is interested in what mainstream (neoliberal!) economics has to say on RE, check out these passages from the text book used in most graduate level macro courses:

http://economistsview.typepad.com/economistsview/2011/03/even-more-on-ricardian-equivalence.html

Spoiler: it is not supportive of RE

55. gastro george

@53 vimothy

My bad. I shouldn’t have used “agree”.

56. gastro george

@54 Luis

So we now have that RE is but a hypothesis, and even mainstream/neo-liberal (take your pick) economists don’t believe in it – so why is GO basing his policy on it?

57. Luis Enrique

gastro

well it could be that he genuinely believes it, and has just been listening to extremist crazy economists, but my guess is that it’s an ideological attack on the state, just like we all thought all along.

@ 52 Gastro George

“Looks to me like the economy is flat-lining at best”

you’ve fallen for the lefty trap again….you’ve made a *subjective* statement.

As long as GDP figures are positive there is real growth. It might not be as fast as you want it to be, but again that is a *subjective* measure.

Given the whole crisis and the global economy growth is likely to remain sluggish, but long term growth tends only to be jsut above 0.5% QoQ anyway…

As I say, the real complaint from the left is that growth is not fast enough to reduce the deficit without cutting real term spending (“cuts”)…which will adversley affect the Left’s typical voting demographic.

50 Tyler

The deficit IS set to contract over time

Oh the deficit will contract at some stage in the future. Just not now.

Osborne has £42bn to the deficit already. Thanks to pisspoor growth caused by Osborne’s recklessness.

*insert the word “added”!

61. gastro george

@58 Tyler

“As I say, the real complaint from the left is that growth is not fast enough to reduce the deficit without cutting real term spending (“cuts”)…which will adversley affect the Left’s typical voting demographic.”

I’m not quite sure what you’re arguing for here, as opposed to whining about the Left’s supposed whining. That we should accept the cuts, sluggish (at best) growth, higher unemployment, squeezed benefits, squeezed wages and pensions (for both public and private sectors), etc. And this will benefit who exactly?


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