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The IMF finally admits that government austerity depressed our economy


8:51 am - October 10th 2012

by Owen Tudor    


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The IMF’s world growth forecasts issued Monday night were, bizarrely, not front page news in most papers yesterday morning, despite the UK’s growth estimate being cut by more than any other OECD economy bar Italy.

Slashing the growth rates of most industrialised and emerging economies (apart from the USA, where the growth prediction went up, on the assumption that a deal is reached on the budget) is only part of the news though.

Far more revealing is the IMF’s explanation of why the IMF’s growth estimates have been persistently over-optimistic – covered in the report in a two-page box on page 41 co-authored by IMF Chief Economist Olivier Blanchard.

An admission – what follows is really over-simplified, for clarity and brevity – apologies.

The IMF now accepts that for every £1 cut from government spending, the reduction of economic activity as a whole is potentially as much as £1.70 – far higher than the £1:£1 ratio the IMF’s original predictions were based on, and of course in completely the opposite direction that British Government policy is based on: that cuts in Government spending will be more than replaced by increased private sector expenditure (based on the so-called ‘crowding-out hypothesis’.)

So, the IMF is now said to be alarmed that the relentless austerity measures of most of the developed world could lead to weaker and weaker growth even in the emerging economies like Brazil and China. But, bizarrely, this hasn’t stopped the IMF from continuing to support the cuts that Governments like Britain’s are imposing. As former European trade union economist Andrew Watt puts it: “the patient is dying, increase the dosage!”

The argument that changes in Government spending have a greater impact on the economy than 1 is of course central to Keynesianism, and while Keynes is most famous for arguing that increased Government spending creates a ‘multiplier’ of greater than 1 (hence his counter-intuitive allegory involving the state paying workers to bury cash, and letting the private sector dig it up again), cuts in Government expenditure also have a multiplier effect greater than 1. As the IMF now appear to have realised.

Instead of continuing austerity, we urgently need measures to restore growth, because that is the only sustainable (let alone morally acceptable) way to cut deficits.

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About the author
Owen Tudor is an occasional contributor to LC. He is head of the TUC’s European Union and International Relations Department and blogs more regularly at the Touchstone blog.
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Reader comments


What you totally fail to mention though is that:

1. The IMF is playing catch-up when on the latest growth downgrades. The OECD’s forward looking forecasts are now higher.

2. The IMF also understands that government debt acts as a massive fiscal drag – a large negative multiplier. So while spending debt financed money might make sense when you have small or no budget deficit and low national debt, it is a very different story when you have an exteme deficit and relatively large national debt.

You also seem to have failed to read/understand the part of the IMF analysis that lays bare the grotesque overheating of the Brown years, or to take on board the implications of that for potential real growth now.

two years ago this site published a story saying the IMF fears government cuts will damage growth

how many times can the IMF “finally admit” something? What stops people who write about the IMF actually paying attention to what the IMF says?

fyi, the IMF’s chief economist Oliver Blanchard is generally regarded as left-leaning, and for years has produced research that says austerity will depress an economy. here he is in 2009 advocating fiscal stimulus to restore confidence and demand.

also fyi, it seems the multiplier the IMF used to generate its forecasts was more like 0.5, not 1 as suggested in the OP. Note that research economists (headed by Blanchard) might be quite separate from the people who actually produce country forecasts, it depends on how the IMF is organised.

Every time IMF downgrades UK GDP it says UK should reconsider.

Here’s a timeline of IMF reaction:

http://www.edmundconway.com/2012/10/imfs-unwavering-confidence-in-plan-a/

Plan A is stiffing the UK economy. There is no doubt about that.

Problem is that we have such an inept government bent on this economic destruction and the IMF has to cosy up to its agenda.

5. Man on Clapham Omnibus

@1

For the economically unwashed perhaps you could explain your comments further.

I am not sure the IMF are a particularly independent source of wisdom so the notion that Brown and overheating are to blame may be right or it may be wrong.

I am aware that the IMF were reputed to be responsible for the Asian crash of 1999 through their insistence that the Asian economies rapidly reduce social spending.

I would have thought it was axiomatic that without spending
you will get declining performance in the economy.

6. gastro george

@1 “The IMF also understands that government debt acts as a massive fiscal drag – a large negative multiplier.”

@2 “… the IMF analysis that lays bare the grotesque overheating of the Brown years …”

Because the IMF has such a good analytical and forecasting record …

@ 4 MoCO

Depends on where that money for spending is coming from.

If you are simply financing spending by issuing new debt, then after debt/GDP passes a certain level (about 90%, Rogoff and Reinhardt) it tends to act as a massive fiscal drag on growth.

What Owen Tudor has done here his ignore the effect of debt when mentioning his multiplier effect. Fine, the mulitplier of the new cash alone might be in the order of 1.1-1.7, but what happens when you take the cost of debt financing into account? Especially when you start taking into acocunt that the cost of that debt starts to displace other spending – leading to a negative multiplier.

Eventually you can get into a debt trap where yoou keep having to issue new debte and run a deficit just to keep primary spending (i.e. govt spending on items excluding debt servicing) OR cut your deficit and pay down debt by reducing primary budgets – which any Keynesian would argue has a negative multiplier on GDP.

8. Man on Clapham Omnibus

@6

OK I get that but firstly we haven’t hit 90% and secondly the debt is still rising.
If public expenditure is further cut, isn’t that going to lower GDP further?

9. Chaise Guevara

@ 5 gastro george

“Because the IMF has such a good analytical and forecasting record …”

…and is not in any way, shape or form ideologically obsessed with promoting laissez-faire politics…

I’d like to say thank to Owen for the link to the paper and the page number of the box. For it’s absolutely fscinating and not quite what Owen says it is.

“The argument that changes in Government spending have a greater impact on the economy than 1 is of course central to Keynesianism, and while Keynes is most famous for arguing that increased Government spending creates a ‘multiplier’ of greater than 1 (hence his counter-intuitive allegory involving the state paying workers to bury cash, and letting the private sector dig it up again), cuts in Government expenditure also have a multiplier effect greater than 1. As the IMF now appear to have realised.”

No, that really isn’t what they’re saying. Read the last few paras of the box again. What they are saying is not that they were wrong before and right now. They are saying that the value of the multiplier has changed in the last three or four years.

It really did used to be 0.5. For the last three decades in fact. Which is something of a problem for those who have been spouting Keynesianism for the past three decades really. Because at 0.5 it doesn’t work.

Anyone who is willing to stand up and agree that they were wrong, but that the world has now changed to make them right I’ll listen to on this point.

There’s also another more technical point about their findings. They’ve not tested for the effects of either monetary policy or exchange rates. And what we’re being told is the average effect across a number of economies. Many of which, in the eurozone, do not control their own money supply nor do they have flexible exchange rates.

And yes, there is very good theoretical reason to believe that the effects will be different in the two cases. Even Keynes, in fact especially Keyenes, would agree with that.

A country in which yout can do QE to stop the money supply falling is going to respond differently to one in which the ECB is allowing said money supply to plummet.

@ 7 MoCO

Two points here:

1. Depends how you calculate debt/GDP. If you include off balance sheet liabilities, specifically things like public sector pensions and things like PFI, which ultimately the government are on the hook for, the debt/GDP number looks more like 200%.

For example, Eurostate and the CIA (yes, they do collate such data) includes some of those liabilites (but tend to exclude pensions liabilities, which are around 120% of GDP) and have UK debt/GDP at 86%. The UK ONS exclude everything except actual issued debt and the number is 66%.

2. “If public expenditure is further cut, isn’t that going to lower GDP further?”

Maybe. Some public spending doesn’t have that high a multiplier, and the negative multiplier on new debt might be larger. They also might have different time frames. You might get a very short term boost simply from spending, but at the cost of lower long term growth as debt servicing displaces other spending. This is essentially what Gordon Brown did with the UK economy – front load growth – which boosted growth a bit over 10 years but at a huge long term cost. There are also lots of examples where spedning has been cut and growth increased, as the spending cut had lower multipliers than the cost of financing that spending through debt or taxation.

You also run the risk that the debt/GDP number becomes so big you cross a point of no return, where growth of debt can never realsitically be outpaced by GDP growth. This death spiral then gets compounded by the bond markets losing faith in a country’s ability to repay it’s debt, pushing interest rates higher, pushing debt servicing costs higher and so on….Italy and Spain are great examples of this process at work.

If I’m understanding this correctly, then, it’s official: the double-dip recession *was* made in Downing Street. The government’s planned fiscal consolidation of c. 2% of GDP per year has suppressed growth by somewhere between 1.8% and 3.4% (depending on whether the actual multiplier is closer to 0.9 or 1.7), pushing it below zero.

So after two years of ‘deficit reduction’, the economy is probably around 5% smaller than it would have been if no spending cuts or tax rises had been implemented. That’s what – £75bn or so?

So assuming a tax burden of 40%, if no ‘deficit reduction’ programme had been pursued, tax receipts would now be around £30bn a year higher than they are and the deficit would therefore have fallen by £30bn from c. £155bn to c. £125bn. Instead of which it now looks to be heading back above £130bn.

‘Expansionary fiscal contraction’ indeed.

It’ll be fascinating to see whether the OBR start using a multiplier in line with the IMF’s new thinking in preparing future forecasts. What would Osborne do if the OBR started taking the line that cuts are worse than useless in terms of deficit reduction? It would certainly make for some interesting Budget speeches.

“tax receipts would now be around £30bn a year higher than they are and the deficit would therefore have fallen by £30bn from c. £155bn to c. £125bn”

…plus whatever spending reductions might be associated with £75bn of growth – reductions in working-age benefit payments, for instance.

14. gastro george

@10 “”Italy and Spain are great examples of this process at work.”

Tyler, as always, ignores monetary sovereignty – you can never compare the UK to the eurozone.

“This death spiral then gets compounded by the bond markets losing faith in a country’s ability to repay it’s debt, pushing interest rates higher, pushing debt servicing costs higher and so on….”

As if we are not in a death spiral now. Japan rather shows that this argument is incorrect.

15. Man on Clapham Omnibus

@13 George

Can you expand on this? The Japanese experience and why this is relevant

There is usually no forecast that gets better coverage than the IMF. However, as I have been pointing out for the last couple of years on here that the IMF has a lamentably bad forecasting record. They produce world class analysis after the event telling you what happened and why it happened. One could call it world class analysis of why their forecast turned out to be wrong.

I think this IMF UK forecast for next year is too bearish, not because I think the Coalition economic policies are optimal but because there are growing signs that monetary policy is gaining traction. There are lots of headwinds that are risks to derail everything but I am pretty sure this IMF forecast will prove to be as wrong as all the rest.

17. Luis Enrique

Tim Worstall

some people you might call Keynesians might have been arguing for the past three decades that government spending ought to be higher on account of the >1 multiplier, but for most people “Keynesianism” means that when a recession hits and there is a large output gap, private sector agents all try to save simultaneously and demand collapses, the government needs to step up and spend (or the corollary, that if the government slashes spending to try to reduce the deficit, it will achieve a lot of pain and very little gain) and this variety of Keynesian – not a group I’d previously put you amongst – have received some vindication from the IMF.

now, why is it that you can get irate about government failures that at worst shave a bit off the welfare of us citizens, but don’t appear to be concerned about a government failure – pursuing austerity in current circumstances – which is knocking blocks off welfare in the form of higher than necessary unemployment and income cuts for the worst-off?

18. gastro george

@14 MoCO

Japan has a debt of approx 200% of GDP and interest rates of approx 0.

Tyler will tell you that Japan is an exception. He, along with many others, has a touching faith in orthodox “rules” that apply … except where they don’t.

@ GO

You make the statement that the government’s fiscal consolidation has reduced GDP…but actually please look at the actual spending numbers. The fiscal consolidaion has been a reduction in real terms growth in spending. As yet there haven’t been at real terms cuts in spending.

Which makes it very hard to pin the same cut in GDP on this efefct at least.

Regardless, had the government not reduced the rate of spending growth, which entails running a deficit 2% higher, we can work back that the UK would be taking on roughly 30bn extra debt a year (1600bn GDP assumed).

So even if ALL your extra spending translated into extra growth, and the UK grew at a healthy pre-crash rate, itself a big assumption given global economic headwinds, the tax raised from the extra growth would only barely cover the extra debt raised, let alone the servicing costs.

You have jsut done a GOrdon Brown and moved growth from the future to the present by fuelling it with debt. And we all know how that turned out.

@ Gastro

Japan has a slightly different story. Though it has very high debt, it also has a fully funded pension system. If the UK had the same thing, UK debt/GDP would be much the same as Japan’s. These savings, especially if domestically held, tend to allow a country more leeway in terms of bond yields.

It also has less private sector debt than the UK. It also has trillions of US dollars held as reserves.

That all said, there are a lot of worries that even at super low Japanese interest rates their debt is becoming overwhelming when compared to revenues raised through tax. Debt servicing costs even at under 1% rates make up the bulk of all income tax reciepts. The day of reconing there isn’t miles away.

It’s not like all this debt, even at super low interest rates, has helped Japan’s economy into high growth either now has it? They’ve suffered 20+ years of low growth now, and issuing more debt just isn’t helping.

20. Luis Enrique

This death spiral then gets compounded by the bond markets losing faith in a country’s ability to repay it’s debt …

if the multiplier is sufficiently high then cutting public sector spending could even reduce the country’s ability to repay debt. If you want Spain to be able to pay its debts, wrecking its economy is not helpful.

21. gastro george

@18 Tyler

“Debt servicing costs even at under 1% rates make up the bulk of all income tax reciepts. The day of reconing there isn’t miles away.”

Do you not see the contradiction here? You previously stated that it was the bond markets that set the rate to penalise countries for “bad finances”. If the day of reckoning is not far away, then why haven’t the markets increased the Japanese interest rate?

@ Gastro

Japan isn’t an exception – especially if you compare like with like. Add in unfunded liabilities to the UK national debt and that is over 200% too.

And even with ultra low rates looming on the horizon is a massive problem.

http://seekingalpha.com/article/513951-the-japanese-debt-crisis-part-2-when-does-japan-cross-the-event-horizon

http://www.forbes.com/sites/stephenharner/2011/11/18/coming-to-grips-with-japans-government-debt/

Please read the above – especially the forbes piece which is very much to the point. You can find hundreds of such pieces with a quick google search. Roubini economics has a few recent pieces out but are *very* technical.

23. Luis Enrique

One could call it world class analysis of why their forecast turned out to be wrong.

yes, that’s precisely what Blanchard is doing here.

“Do you not see the contradiction here? You previously stated that it was the bond markets that set the rate to penalise countries for “bad finances”. If the day of reckoning is not far away, then why haven’t the markets increased the Japanese interest rate?”

One thing that recent events might have impressed on you. That when the markets do turn they turn very quickly indeed. As the experiences of Spain, Italy, Portugal and so on have shown. One month they’re trundling along with 3% long term bond rates and three months later they’re at 6% and rising and that debt is now unsupportable.

Not, note, because they have to pay higher rates on the debt they’ve issued. But because they’ve got to pay higher rates on the debt they’re rolling over. At which point the average maturity of the debt becomes important. An area where (and give the Treasury and BoE under Brown their due, they did this well) the UK is an outlier with a much longer average maturity than other countries.

25. gastro george

@22 Tim

Just to repeat. Anybody who compares the UK and the Eurozone do not know what they are talking about.

@ 24 Gastro

Please enlighten us as to why the UK and the Eurozone are so different, in the terms of debt mechanics at least…….

I also see you haven’t bothered to respeond to my comments regarding Japan.

Just to repeat. Anybody who compares the UK and the Eurozone do not know what they are talking about.

Yes, but that’s exactly what Blanchard and Owen Tudor are doing. They’re taking an average fiscal multiplier, which is worked out using many of the eurozone nations, and using it to predict what is the fiscal multiplier for the UK.

I agree it doesn’t work…..but that is what they’re both doing.

28. Luis Enrique

IMF is aware that multipliers vary with exchange rate regimes etc.

Instead, fiscal multipliers are likely to depend on a number of factors which vary both across countries and time. Traditional Mundell-Fleming analysis posits that the effectiveness of fiscal stabilization hinges on financial development, capital mobility, trade openness, and the exchange rate regime. In addition, the response of private demand to a fiscal intervention
may also depend on the state of public finances. For instance, fiscal expansions at high levels of debt could play out differently if they increase the likelihood of a sharp future retrenchment. Another potential determinant is the health of the financial system, notably the extent to which the private sector has access to credit, given that binding liquidity constraints generally reinforce the impact of fiscal stimulus. In a similar vein, recent quantitative analysis predicts exceptionally large government spending multipliers during deep recessions when monetary policy is constrained by the zero lower
bound on policy rates.

http://www.imf.org/external/pubs/ft/wp/2012/wp12150.pdf

29. Luis Enrique

Tim

haven’t looked in detail, but Blanchard is not estimating the multiplier, he is estimating the relationship between planned fiscal consolidation and forecast error. So I don’t think he’s making the mistake you attribute, or at least you cannot conclude that.

You want to say UK and EU would have different multipliers, but that should be incorporated into forecasts; he’s showing the larger the planned consolidation, the larger the error. This information can be used to correct whatever multiplier was used in the generation of the UK forecast, so the analysis can be used to say something about the UK despite being based on a heterogenous group of countries.

As it happens, GBR is bang on the regression line, in Fig 1.1.1 in Box 1.1, which also suggests the analysis fits the UK pretty well.

Try Martin Wolf in Wednesday’s FT on: Lessons from history on public debt
http://www.ft.com/cms/s/0/e26e46ae-1138-11e2-8d5f-00144feabdc0.html#axzz28u8jnn8k

31. gastro george

@24 Tyler

The Eurozone countries aren’t sovereign in their currency – so they are forced to be debt financed. The UK is not. That’s the reason why the bond markets are important for the Eurozone. There is a real risk of default. The UK and Japan have no such risk, although there is a devaluation risk.

Which is why I didn’t respond to much of what you said about Japan – for example, I don’t believe that the bond markets care if their pensions are fully funded or not.

You didn’t respond to the question about your contradiction.

32. Luis Enrique

yep, on further reading, I think Tim @ 26 you are quite wrong. Blanchard is not taking an average fiscal multiplier, which is worked out using many of the eurozone nations, and using it to predict what is the fiscal multiplier for the UK.

For a dissection of the IMF WEO relating to Britain, try Chris Giles in the FT on: IMF forecast leaves Chancellor in a fix
http://www.ft.com/cms/s/0/7c825870-121a-11e2-bbfd-00144feabdc0.html#axzz28uSqR9zP

@ Tyler

“You make the statement that the government’s fiscal consolidation has reduced GDP”

Did I? Poor phrasing maybe. By “planned fiscal consolidation of c. 2% of GDP per year” I just meant the attempt to shave c. 2% a year off the deficit by refraining from spending a figure equivalent to 2% of GDP in year 1, a further 2% in year 2, etc. I understand that that doesn’t amount to a real-terms cut in overall spending.

“had the government not reduced the rate of spending growth, which entails running a deficit 2% higher, we can work back that the UK would be taking on roughly 30bn extra debt a year (1600bn GDP assumed)”

‘Extra’ compared to what? If my admittedly rough-and-ready calculations are right, the amount of debt we’re taking on this year is about the same as it would have been if we hadn’t reduced our rate of spending growth. £30bn a year is indeed about what it would have cost us to maintain that rate; but it’s also about what it’s now costing us to plug the hole in tax revenues created by having zero growth over two years rather than the 5% or so we would have had, assuming a multiplier in the middle of that 0.9 – 1.7 range, had we chosen to maintain that rate.

I can hardly contain my patience awaiting the new editions of economics textbooks with the scrounging theory of unemployment, which seems to have bypassed the economists at the IMF.

The curious will perhap puzzle as to why scrounging seems to have afflicted so many countries at about the same time. Growth has slowed even in the economies of China and India .

Good piece and funny how the IMF’s findings have been largely ignored by those gathering at the Tory conference this week!
We have analysed the figures in the following piece:
http://www.allthatsleft.co.uk/2012/10/david-cameron-deficit-fetishism-and-the-uk-economy/

37. Luis Enrique

There used to be a comment from me #3, pointing out the IMF has long warned cuts hurt the economy, and citing a two year old post from this very site to make the point.

What has happened to that comment?

Don’t tell me LC has started deleting critical comments like that

38. Northern Worker

Excuse my ignorance, but if the Greek government hadn’t cut back on spending (austerity) and just kept on spending, thereby presumably increasing its budget deficit and debt, who would have lent them the money? Even if they could borrow the money, isn’t their interest rate prohibitive?

Luis: “There used to be a comment from me #3, pointing out the IMF has long warned cuts hurt the economy, and citing a two year old post from this very site to make the point.”

The obvious insight for any writing in the Keynesian tradition is to question as to what will happen if net exports, business investment and spending by heavily indebted consumers fail to rise sufficiently to make up for the cuts in public spending.

We have no government answers for that, just a lot of spin about tough decisions, scroungers, cutting the fiscal deficit and how wonderful the Olympics were.

40. gastro george

@36 Northern Worker

What you say WRT Greece is correct – because Greece is in the same position as a depressed and uncompetitive region of the UK or the US. Without transfers from the richer parts of the country, the local economy is unsustainable.

If you try internal devaluation, which is what the Eurozone is imposing on the Greek people (and is it any surprise that the Tories are suggesting the creation of regional pay and benefit rates in the UK), then you just create more poverty and a weaker local economy. Until the Eurozone resolves this conflict, the crisis will continue.

And Greece is not the UK.

Gastro: “(and is it any surprise that the Tories are suggesting the creation of regional pay and benefit rates in the UK)

Centrally negotiated pay agreements in the monolithic NHS mean that hospitals and other healthcare supply units can’t respond to local labour market conditions.

LSE researchers predicted that the ensuing difficulty of recruiting and retaining nursing staff in regions with relatively strong labour markets would have worse medical outcomes on average than regions with weaker labour markets where it is easier to recruit and retain nurses. And that is just what they found:

“Hospitals in the north gain from a more stable pool of nurses. Southern ones have to lean on temporary agency nurses, who can be paid more but tend to be less experienced, less familiar with the hospital and less productive. Do southern patients suffer as a result?

“The economists look at the proportion of patients aged 55 or more, admitted to hospital after a heart attack, who die within 30 days. They find a strong link between this ratio and local private-sector wages. The higher the private wage, making it harder to get good nurses in the NHS, the higher the death rate: to be precise, if the private wage is 10% higher in one area than another, the death rate is 4-5% higher.”
http://www.economist.com/world/britain/displaystory.cfm?story_id=E1_TDVGGRSS

@ 30 Gastro

You don’t seem to understand. I have jsut provided you with several articles regarding Japan, which talk about how their debt is heading towards unsustainable levels.

Whilst you are correct that the UK and Japan can print currency whereas the Eurozone countries can’t, if it came to money-printing to pay off debt as a bondholder currency devaluation and inflation, plus the higher yields would cause you just as much pain in real terms – a technical default – as would a true default. The damamge to an economy of such a situation would be just as bad if not worse.

Ultimately, both ways around governments alleviate some or all of their debt burden and bondholders lose much or all of their cash. Both ways the country will be forced to issue any new debt (if it even can) and much higher yields to compensate for the threat of default or devaluation/inflation.

@ 33 GO

What I was trying to say is this:

We are arguing over the effect of cutting or *not* cutting the deficit by about 2% a year, the latter case the money being spent on “growth”.

In your case, you suggest that the extra growth (and it’s a big assumption there will be extra growth) will add about 30bn of tax reciepts to government coffers. You might be right.

However, by running the extra 2% budget deficit you have run up another 30bn of debt, plus the associated servicing costs.

That money has to be repaid, by less spending or higher taxes. Both of which reduce growth – something as a Keynesian you have to agree with. What you have done is move spending forward to generate growth now, at the cost of lower growth and possibly higher costs later.

You also argue there is some kind of multiplier on this deficit spending. You haven’t considered the negative multiplier on the debt needed to finance it though. Net the two out and it’s certainly not obvious about how great the *total* positive effect on the economy is – if there is one at all.

Indeed, I would argue that the net effect is negative. Countries all over the world are running massive deficits, and have been doing so since the crisis. Your analysis is that this should provide a boost to these economies. yet we are not seeing good growth in any of these high deficit developed economies. If anything, the countries with the lowest budget deficits are growing fastest in the developed world. I assume then, yoou would also argue for ever more spending till you do see growth?

43. gastro george

@42 Tyler

Those articles are just more elaborate re-iterations of your usual debt hysteria.

You still haven’t answered my point about your contradiction. If Japan is on the brink of disaster, and the bond markets are all-seeing and all-powerful, then why are Japanese rates zero?

@41 Bob B

It should come as no surprise to you that the Tory policy would lead to lower wages in the regions, not higher wages in London – which wouldn’t exactly address the problem.

But I get your point – I would have thought that there are better solutions – like building more affordable housing.

44. Luis Enrique

oh, I see my comment #3 has reappeared. I presume it was a tech glitch and nothing to do with eds.

@ Tyler

“and it’s a big assumption there will be extra growth”

No bigger than the contrary assumption, that spending restraint would not (significantly) suppress growth. The IMF are now saying that we have been wrong in making that assumption, and that in fact growth might be suppressed by as much as £1.70 for every £1 of spending restraint. I’m just trying to think through the implications of that.

“However, by running the extra 2% budget deficit you have run up another 30bn of debt, plus the associated servicing costs.”

But we’re running up another 30bn of debt *anyway*, just to plug the hole in tax receipts created by 75bn of ‘lost’ growth. And that hole, and the borrowing needed to fill it, will continue to grow year on year for as long as growth stays below trend.

And isn’t it highly plausible that discretionary deficit spending on capital investment projects, job creation programmes etc. has a higher multiplier than the sort of deficit spending the Government are now being forced into as tax revenues stay stubbornly low and unemployment/underemployment stubbornly high?

“You also argue there is some kind of multiplier on this deficit spending. You haven’t considered the negative multiplier on the debt needed to finance it though. Net the two out and it’s certainly not obvious about how great the *total* positive effect on the economy is – if there is one at all.”

Indeed. Conversely, it is not obvious that the negative effects of spending cuts and tax rises in terms of suppressing growth are not cancelling out (or worse) their intended effect in terms of cutting the deficit.

46. Luis Enrique

Tyler

talking about running a bigger deficit is confusing the policy (decisions concerning government spending) with the outcome (the deficit). If the multiplier is large, cutting spending will not reduce the deficit, and increasing spending will not increase the deficit. The OP tells us the IMF now thinks the multiplier is substantially larger than it had previously thought.

@ 43 Gastro

Ah, the Richard Murphy defense. If I don’t agree with the evidence supporting the viewpoint, I’ll simply ignore it and label it hysteria.

Tell you what, I’ll take Nouriel Roubini’s (amongst dozens of others) researched view over your totally unresearched one, and agree that Japan is heading towards a debt fuelled calamity.

As to why Japan has very low rates:

Firstly, they have very low inflation, if not outright deflation. This means even if nominal yields are low, their *real* yields are often higher than comparable countries.

For comaprison (data from mkt prices);

Japan 10y Bond yield = 0.75%
Japan CPI = -0.4%
Japan real yield = 1.15%

UK 10y Gilt yield = 1.75%
UK RPI = 2.5%
UK real yield = -0.75%

US 10y Treasury yield = 1.70%
US CPI = 1.7%
US real yield = 0%

I hope this shows you that Japan DOES NOT have particularly low real interest rates, which are what ultimately matter.

Secondly, Japan benefits massively in so far as most JGBs are held locally. Principly by Japanese pension funds and the government pension providers. This captive market delays the day of reckoning by a margin. However, with Japan’s aging demographics, rather than new capital being put into these funds, they are now seeing net outflows to pay for people’s retirement.

Of course, if yoou had bothered to read any of the articles or research regarding this topic, you’d know this already. So my guess is you’ve simply not bothered to read any of it and made a blind statement”, essentially that because the UK can print it’s own money we should spend spend spend, not worry about the debt or deficit and totally ignore any consequences of it getting out of control.

Is your name really George, or is it Ed?

@ GO

Do you see what you’ve done here? You are double counting. You’ve taken the 2% reduction in the deficit AND the reduction in growth and have added them together.

I’m saying you can have a 2% smaller deficit but lower growth OR 2% larger deficit and higher growth, but in terms of the numbers they come out roughly equal.

As for discretionary spending on investment, it is possible that some of it has a +ve multiplier. Some of it has seen to have -ve ones in many countries and many projects. It’s not a given. And again, how it is financed *really* matters. You can’t take the one without the other.

@ Tyler

“Countries all over the world are running massive deficits, and have been doing so since the crisis. Your analysis is that this should provide a boost to these economies. yet we are not seeing good growth in any of these high deficit developed economies. If anything, the countries with the lowest budget deficits are growing fastest in the developed world.”

Huh? My analysis – well, the IMF’s analysis – is that we should be seeing lower growth in countries where there is greater spending restraint. Spending restraint is likely to be greater in countries that are running large deficits, because such countries have been trying to reduce those deficits by restraining spending. So in fact I would expect to see higher growth in countries which have lower deficits and which have therefore been less inclined to restrain spending. (I’d also expect to see higher growth in countries which have higher deficits but which have been cautious about restraining spending – which was, after all, the pattern in the UK for most of 2009 and 2010.)

“I assume then, yoou would also argue for ever more spending till you do see growth?”

I guess so. Basically we seem to face a choice between digging ourselves a tunnel in the hope that we eventually see a light at the end, and digging ourselves a hole in the hope that we eventually float up and out of it by magic.

49. gastro george

@47 Tyler

You can froth all you like …

So the core of the argument now is that the all-supreme bond markets have taken their judgement on Japan, so their rates are now a real 1%. Wow … quaking in their boots I’m sure. But hardly a judgement of imminent catastrophe.

I’m trying to remember what your view of QE is. Isn’t that “printing money” in your terms?

50. Northern Worker

gastro george @ 40

So it’s austerity in the form of ‘internal valuation’ that is killing the weak countries in the eurozone. Basically, then, the only alternative – apart from leaving the euro and devaluing – is for the Germans to hand over money to Greece, Portugal, etc ad infinitum to keep these countries and the eurozone afloat. I can’t see the Germans doing this on a permanent basis even if they could afford it.

The people I do business with in Germany are incandescent with rage that any money is being handed to the Greeks. They really don’t see why the Greeks can retire earlier than Germans (not sure they can now), and they are sick to death of the massively corrupt Greek government and its pampered (and equally corrupt, according to them) public sector workers. Okay, it’s only a survey of a couple of dozen people, but they really are ranty about the situation. They are, unsurprisingly, very unimpressed with nazi connotations. And to a man (and woman – especially the women), they can’t see how Greece can dig itself out of its hole because they don’t really make anything.

I can see their point. The last time I was in Greece for a holiday, apart from tourism it was hard to see what Greece produces. Their saviour, by all accounts, would seem to be the possibility of mineral and oil wealth, but who’s up for investing in developing these saviours?

Right now in the so-called advanced economy of Europe, people are living on the streets and starving. That’s the problem and not whether the well-paid people at the IMF (who apparently don’t pay tax) got some multiplier or other wrong. The Greek people are being used in some sort of grand experiment by the colleagues in Brussels to save their ‘project’ and the elite of the IMF, and others who don’t need to worry about whether they and their children will eat today.

If it makes me furious, imagine what all the homeless, starving, unemployed Greeks think. There will be trouble. You can’t treat literally millions of people like this and not expect them to rise up and start burning down buildings and killing people!

51. gastro george

@50 Northern Worker

Your kind of half right. Yes, one solution is euro-exit and devaluation. Then their economies are allowed to adjust.

The alternative is not “Germans to hand over money”, as it is commonly put. Instead, let German wages rise and for them to invest in the cheaper southern countries.

The Germans may be incandescent, but it’s not particularly well-founded. Regarding work conditions, etc., Germans work shorter hours than Greeks and have a larger public sector than Greece. German industry has benefited tremendously from the suppression of the value of the Euro internationally. And their higher levels of investment has led to a growing competitivity gap with the rest of the Eurozone. With no devaluation option, the other countries are stuffed in the short or long term unless some re-balancing is allowed. This is the same as all of the old fixed-exchange-rate crises writ large.

Of course German workers are equally incandescent because they haven’t seen any benefit from the German export machine – wages having been suppressed in recent years.

@ 48 GO

A while ago on another topic on this site I showed via simple example that it is *really* hard to simply grow your way out of debt, even with super low interest rates, when you have large deficits. Unless you assume unrealistic growth assumptions, the extra debt and debt servicing costs tend to smother all the extra tax reciepts from growth.

It also leaves a country with absolutely no wiggle room. If it goes wrong and all that extra spending doesn’t improve growth, then you have an either problem. Japan, as mentioned many times above, is a great example, who have been deficit spending like crazy for decades and have nothing to show for it.

Going into the crisis, the countries with the lowest debt/deficit metrics have faired the best, and had the best growth. Your point is more on the countries (PIGS) whose debt metrics are so impaired that in all possibility they are beyond the point of no return. If they cut spending their growth goes down, making it harder to repay debt. If they don’t they run out of cash because no-one in their right minds will lend to them. Same end result.

What a lot of people seem to forget when saying “just borrow more”is that you need someone to lend it to you. Scare away those investors and however much you may want to, you simply *can’t* borrow.

@ 49 Gastro

What are you? Ill-informed and proud of it? I’ve posted a couple of links for yoou to read and suggested several more sources, and you just ignore it. Dreams are *inside* you head, reality *outside*, sunshine.

Had you bothered to read those articles, you would have found that the general gist of the research they’ve done is that Japan, without major, painful reform is going to fall over the edge of a major fiscal cliff within the next 20 years. Some predict it happening a lot sooner.

Nor have I ever labelled QE money printing. Indeed, I have many a time been at pains to point out that it isn’t anything of the sort. let me explain, again.

DMO issues bonds to market. BoE buys bonds from market, and issues “new” cash to market though a ledger entry. Simple enough so far, right?

Now, when those bonds on the BoE balance sheet mature, the BoE has one of two options. Either unwind the QE ledger entry, reducing the money supply, or it can go and purchase more bonds with the cash.

The former is effectively hiking interest rates. The latter is essentially debt issuance – forward starting debt to be more exact. Becuse this new cash is reversible and sterilised it is NOT “money printing” in the weimar republic/zimbabwe sense.

53. gastro george

@52 Tyler

My question re QE was genuine, I couldn’t remember what you’d said previously, it wasn’t an attempt at obfuscation. So let’s leave that there.

Back to the point. The problem with debt hysteria is that if it’s not hysteria about today, it’s hysteria about tomorrow. But, do I detect some backtracking? Earlier Japan was imminently about to fall off a “fiscal cliff”. Now it’s “within the next 20 years”. As most mainstream economists seem to find it hard to predict the figures for the next quarter, forgive me for having a wry chuckle.

Let’s get back to the judgement of the markets. You were talking earlier about how Japan was different as most Japanese bonds were held locally. So you would still be expecting the wiser foreign bond holders to be dumping Japanese bonds in the face of the imminent tragedy. Yet foreign ownership of Japanese debt is at record high.

@ 53 Gastro

In economic and finance terms, 20 years is fairly imminent, and a lot of commentators are expecting it to happen a lot sooner. Roubini’s mob in the next 5-10 years. Which is the fixed income markets version of next week. Certainly if you are looking at problems evolving over that time frame, governments have to start doing things soon, given how long reform and fiscal consolidation can take. It’s not like the UK is trying to cut it’s budget deficit tomorrow is it? It’s happening over 5-6 *years*.

I should have added that it’s a good thing for foreign investors when most bonds are held locally, as it makes them less volatile to offshore investor and currency movements. Onshore pension types can’t really go anywhere else without taking loads more risk, specifically currency.

Offshore guys are holding more JGBS, but are also holding more Gilts, Bunds and USTs, given those countries high credit ratings. Part of it has also been the unwind of the great hedge fund carry trade. They used to borrow money in Japan then convert to USD to fund their leveraged positions, when US rates were much higher (pre 08). Now US rates are a lot lower, they can fund just as cheaply there, so are unwinding the carry trade. With the appreciation of the Yen, it means they’ve made massive profits on that trade alone, and are now holding lots of Yen. Thanks to dumb US tax laws it’s hard to repatriate, so most of it ends up sitting in Yen banks accounts, so they tend to go buy safe Japanese assets with the money to get some return – like JGBs – not least because the real return they get on those JGBS is actually higher than they can get on a lot of other AAA bonds, as I showed earlier. Like I said, for a AAA country Japan is paying HIGHER rates than most.

55. gastro george

@54 Tyler

You’re starting to squeeze the end of the toothpaste.

So now Japanese bonds are now (supposedly temporarily) popular because of a paltry 1% “real” rate? Is that all you can offer?

So let’s look at the facts. The only countries that the bond markets are bidding up are those that are not monetarily sovereign or have fixed exchange rates. Yet you’re running around like a demented priest clutching a cross against the perils of debt maybe some 20 years in the future. As Fraser said, “we’re all doomed”.

@ Gastro

No, people are buying Japanese bonds because the sovereign is still rated AAA, they still have a +ve real rate and there are a lot of people with a lot of cash stuck there. BOJ QE certainly hasn’t hurt either.

People are on the whole buying sovereigns with good debt and deficit dynamics and are relatively high grade in credit terms. People are selling everything else.

“The people I do business with in Germany are incandescent with rage that any money is being handed to the Greeks.”

For survival, monetary unions depend on fiscal unions.

This means regions and national economies with chronic trade surpluses channeling funds to regions and national economies with chronic trade deficits. That is what happens in monetary unions like the US and the UK. Without that mechanism, there will be a continuing deflationary pressure in deficit regions and countries which will transmit to other parts of the monetary union.

The trouble is that politicians in Eurozone countries lept into a commitment to monetary union without understanding the essential policy implications. They really need to read the standard texts, like De Grauwe: The economics of monetary union (OUP, 9th ed. 2012).

As Delors said in an interview in December 2010: Euro doomed from start

The euro project was flawed from the start and the current generation of European leaders has failed to address its fundamental problems, Jacques Delors, the architect of the single currency, declares today.
http://www.telegraph.co.uk/finance/financialcrisis/8932647/Euro-doomed-from-start-says-Jacques-Delors.html

58. gastro george

@56 Tyler

Actually Japan are AA- at S&P, which tells you more about S&P than Japan.

Japan have not been triple A since 2001, and they were downgraded again just a few months ago. Most of their big banks are rated just a notch above the banks in Spain and Italy. The dynamics in Japan are just a mystery and plenty of people have lost lots of money betting on a fiscal crisis that never turned up. The high household savings rate that was thought to have helped depress yields has been in decline for twenty years as the population aged and now has all but gone and the nominal yields are still on the floor. Would funding pressure increase and yields rise if the goods and services surplus declined? Who knows, but everyone who has bet on it have had their head handed to them on a plate for the past twenty years.

The real story of Japan over the last two decades is the relatively little understood demographic dynamics of aging societies and powerful home country investment bias.

60. gastro george

Some bedtime reading for you, Tyler.

A fiscal collapse is imminent – when? – sometime!

@ Gastro

Ah yes, a hard left economist of the RIchard Murphy school of money printing. You can always find someone on the internet with an opposing view. Forgive me if I don’t take him at his word.

I can also easily tear massive holes in that article.

“Further, there is no necessary relationship between the “money supply” and inflation.”

That’s a corker just to start.

Then we can look at his scatter plot of growth vs debt/gdp. He tells us “which suggests that when growth is strong the national net debt ratio declines and vice versa.”

Except it tells us nothing of the sort, correlation not being causation and all that, and growth would affect the budget balance/deficit and NOT immediately affect the overall debt stock, which is what he is suggesting. If anything, the scatter plot shows us that growth is likely to be higher when debt is lower, not the other way around.

Helpfully, Mitchell also answers the question for us in the chart above the scatter plot. This shows annual growth vs debt/gdp. The two are negatively correlated….which suggests as your debt/GDP ratio increases your annual growth rate declines. Which is exactly the same conclusion Rogoff and Reinhardt came to in their seminal work on this subject.

Again, it looks like you haven’t bothered to read any of the many other papers out there.

http://media.rgemonitor.com/papers/0/Economic_Forecasting

Let’s go with Roubini, not least because they address most of the points you and Bill Mitchell make. I’ll leave you to actually read it this time.

On another note, you dont seem to understand that bond crisis happen almost overnight. It wasn’t long ago that Greek bonds were trading a few basis points over Germany. Now they can’t access the bond markets.

You also seem to blame the Euro for all of the PIGS ills. Whilst it’s true that were they not in the Euro they would be able to devalue their currency and essentially inflate their way out of trouble, that is *still* an implicit (partial) default, as bondholders would take massive losses via real yields and fx, that isn’t what *caused* them to have high interest rates in the first place. After all, there are plenty of countries still in the Euro and not experiencing super high interest rates.

The CAUSE of the problem was too much debt, which the country could never repay, so investors simply stopped lending. The Eurozone blocks a particular solution (external devaluation) but it wasn’t in itself the root cause.

62. gastro george

@Tyler
Heh, heh. Ah yes, a hard right economist of the Austrian school of “hard money” …

I have a plane to catch, so no time right now, but …

[… yawn … more Euro comparison …]

“The CAUSE of the problem was too much debt, which the country could never repay, so investors simply stopped lending.”

Of course the problem in the Euro is to much debt – but that’s down to trade imbalances (see arguments above, from Bob B @57 as well).

Outside of the Euro (and other fixed exchange rate mechanisms), you still don’t get the primary idea – which is that bond issuance does not finance sovereign governments.

@ Gastro

Bill Mitchell is very much hard left. He makes Richard Murphy look like a neoliberal – just check his “about” page.

As for bond issuance financing a sovereign….just look at the chart on the roubini paper which shows how much Japan is financing itself through debt issuance…..

OOther than taxation and debt issuance thouh, enlighten me, how does a sovereign fund itself?

64. gastro george

God, what part of monetary sovereign don’t you understand.

And before you start hyperventiliating about printing money/inflation again, we’re talking about principles here. There is no requirement for bond issuance, and I’m not talking about printing money willy-nilly.

The point is that for bond issuance, for example, the causality is the reverse of the orthodox view. Bonds do not finance governments (unless you’re in the Eurozone), but a government may want to issue bonds as a way of absorbing liquidity (to prevent inflation) and as a source of safe investment. But a sovereign government is not required to issue bonds.

But then I don’t expect a hard-money debt-obsessive to accept that.

@ Gastro

Ummmm….so if governments don’t have to issue bonds, how do they end up running deficits?

I assume what you are saying is that governments can simply print money, but that has been tried many times and does inevitably lead to inflation, if not hyperinflation. Why? Because governments are usually pretty useless when it comes to fiscal control – promising everyone a pony to win votes. Without a system of control on that practice the fiat money system falls over as people lose trust in it.

Debt is part of that control mechanism.

I suppose technically you are correct, in so far as a sovereign *could* just print money, but using historical evidence of countries whoo have done just that they don’t last long and the fallout is severe.

Iran is trying this very same game at the moment. The current official iran rial/usd spot price is 12335:1. If you are so confident in your assertion i assume you would be happy to trade at that level, right? Because Iran doesn’t need to issue debt – it can be perfectly self financing.

66. gastro george

“I suppose technically you are correct, in so far as a sovereign *could* just print money, but using historical evidence of countries whoo have done just that they don’t last long and the fallout is severe.”

It’s also true that a country *could* print *too much money* which, of course, leads to inflation. But if you look at the historical records, deficits are staggeringly normal (>90% of years in major economic countries in modern times). Because it’s a simple accounting fact that, if people wish to save money, then either the country has to print/spend more, or earn it through their foreign trade balance. And trade balances are a zero sum game.

In fact, what countries need is *just the right* deficit to balance those factors.

It’s also a notable fact that government surpluses, in the absence of a positive trace balance, *always* lead to a recession. Because of the consequent loss of aggregate demand.

Does that remind you of anything?

@ Gastro

You are wrong on both points.

Thanks to fractional reserve banking and the credit it creates, governments catagorically DON’T have to print or spend more.

M4 money supply figures should give you a clue about that. In the UK M4 is falling whilst the government is flooding the market with cash. There have also been times when the opposite is true.

“It’s also a notable fact that government surpluses, in the absence of a positive trace balance, *always* lead to a recession. Because of the consequent loss of aggregate demand.”

This is complete nonsense. Just for example, the UK was running a surplus between 98 and 01 and that didn’t cause a recession.

“Does that remind you of anything?”

Yes, you being too lazy to check your facts again, leading to you being wrong, again.


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