George Osborne’s Misconceptions About Countercyclical Fiscal Policy

Britain's Chancellor of the Exchequer George Osborne attends the Lord Mayor's Dinner For The Bankers And Merchants Of The City of London

George Osborne just came out in favour of counter-cyclical policy — saving more in the boom, and spending more during a “rainy day”. This is consistent with John Maynard Keynes’ notion that “the time for austerity at the Treasury is the boom, not the slump”.

The thing is, George Osborne seems to believe that right now we are moving toward a boom and need to adopt the policies of the boom:

Chancellor George Osborne has said he wants the government to be running a surplus in the next Parliament and can get there without raising taxes.

He told the Conservative conference the public finances should be in the black when the economy was strong as insurance against a “rainy day”.

His comments were taken as suggesting more years of spending restraint.

Business welcomed the goal but Labour said Mr Osborne had missed targets before and could not be trusted.

The BBC News Channel’s chief political correspondent Norman Smith said Mr Osborne’s underlying message was that austerity would continue after the next election despite the return to growth.

If 7.8% unemployment and a smaller real economy than 5 years ago doesn’t constitute a rainy day, I’d like to know what does. To me, and to many economists this kind of thing doesn’t just constitute a rainy day, it constitutes a full blown great depression. Eventually, sooner or later, someday the economy will return to growth and full employment. With the right luck — technology breakthroughs and other exogenous shocks etc — that could be two or five years from now. The experience of Japan, however, who have endured a 20 year depression suggests that it could be much later rather than sooner.

The safer alternative is to use fiscal policy — as Osborne himself implies — during the rainy day to directly bring back full employment sooner, rather than later by engaging in infrastructure projects and the like. Even if a government hasn’t saved money during the boom, interest rates are so low during the slump that it is cheap to do so, even in the context of soaring national debt levels as is the case in Japan today.

Getting the economy to a point where the government can run a budget surplus, of course, is still a noble ambition. But Osborne has shown no awareness whatever of the steps that need to be taken to get to that position. Infrastructure and housing investment and a jobs program would be a start. So too would liberalising planning laws and lending to and deregulating business startups so that more houses can get built and more businesses can get started. For now, Osborne is preaching responsibility while doing something deeply irresponsible — prolonging a depression with unnecessary demand-sucking job-killing austerity. The boom, not the slump, is the time for austerity at the Treasury and this (for the love of God) is not the boom.

21 thoughts on “George Osborne’s Misconceptions About Countercyclical Fiscal Policy

  1. “If 7.8% unemployment and a smaller real economy than 5 years ago doesn’t constitute a rainy day, I’d like to know what does. To me, and to many economists this kind of thing doesn’t just constitute a rainy day, it constitutes a full blown great depression.”

    John, one might expect that the economy should contract somewhat after a 100 year cycle of central bank insanity, no?

    • Britain has had a central bank for much longer than 100 years. And no, whatever the credit conditions were in the past it’s naive to think that a contracting economy with high unemployment is a reasonable outcome.

      • You don’t want a contracting economy [necessarily], just one where you have sound money and real economic growth.

        The purpose of the fever is the kill the pathogens. Sometimes the patient is so sick that the fever kills the patient, but one way or another, the system comes back to equilibrium.

        You must return to reasonable debt levels and a financial sector that supports the real economy. We can’t get there without some serious de-leveraging, and that implies contraction.

        And I know the BoE has been around since 1694, but it hasn’t been overly relevant for a while.

  2. Again, I ask: why fiscal policy (i.e. govt spending) instead of a direct helicopter drop to households?

    Some will quibble, “Oh, the effects are ultimately equivalent to fiscal policy.” But terminology isn’t important. Whether you call it relaxing the Minskian “survival constraint” or “restoring monetary equilibrium” doesn’t matter. It will allow for total nominal spending to increase and compensate for the unexpected slowdown in inflation we have seen post-crisis (and which has increased the real value of household debt). But it would also allow growth in nominal spending to be driven by individual decisions, rather than govt mandate, and it entails less risk (I believe) w.r.t. blowing up asset bubbles in the stock and housing markets.

    What are the flaws?

    • A good question. I’d be happier with either or a mixture of both than the current policy mix. Obviously the advantage of fiscal policy is that it directly creates jobs, while a helicopter drop is still pushing on a string as a form of monetary policy to some degree and relying on confidence. And helicopter drops may prove excessively inflationary if the quantity is gotten wrong. But again, I will support either or both so long as they are tied to deregulatory policy that free the hands of small businesses to form and grow.

      • Re: inflation–that’s a possible danger (although of course, *some* inflation is what most Market Monetarists believe is needed), which is why I think it best to start small, observe effects, and re-evaluate. Unfortunately, every time I ask Scott Sumner, he doesn’t seem willing to give an inch on endorsing helicopter drops, strangely citing Japan as evidence that it doesn’t work (why he conflates govt spending with helidrops is beyond my understanding).

        “deregulatory policy that free the hands of small businesses”

        What is the status of equity/debt crowdfunding in Britain? The “JOBS” Act was supposed to loosen restrictions, but it’s very slow going.

        • Scott Sumner thinks helicopter drops don’t work? And he cites JAPAN as evidence of that?

          OK then I cite Japan and the USA and Britain as evidence that the Rube Goldberg QE mechanism doesn’t work and I think I have a hell of lot more empirics going for me than Sumner does.

        • Here’s a representative post.

          In Sumner’s defense, I believe he is saying that helidrops won’t work if the central bank maintains its inflation fighting credibility (essentially sabotaging its own efforts, as the BOJ had been prior to Abe). Why this constitutes an argument against the potential for helidrops to raise NGDP (or bypass/supplement the credit-transmission channel) still baffles me, however.

          As for QE: I think there’s mixed evidence about whether it’s “worked.” Certainly, the US and Japan both have enjoyed more growth than tight-money Europe. Also, some Keynesians predicted a slowdown in growth in the US due to the payroll tax holiday ending. That hasn’t happened, and monetary offset seems like the main countervailing factor (it’s still premature to draw any strong conclusions).

          I think a combined effort–helidrops + QE–could eliminate much of the pushing on a string factor. Thanks to QE, banks are flush with reserves, but consumers aren’t spending and businesses consequently aren’t investing. Direct drops would either be spent or deposited (speeding deleveraging). Once the nominal spending ball is rolling, bank lending will grow.

        • Direct drops would either be spent or deposited (speeding deleveraging).

          deposited –> used to pay down debt (with some portion being saved)

        • John S
          “In Sumner’s defense, I believe he is saying that helidrops won’t work if the central bank maintains its inflation fighting credibility”

          But like any monetary policy mechanism the degree of expansion is relative to the inflation target. If inflation is too then you do “heli drops” at a pace and frequency that will arrive at the target without exceeding it.

      • “while a helicopter drop is still pushing on a string as a form of monetary policy to some degree and relying on confidence”

        A helicopter drop will increase confidence for several reasons:

        The money received by the public will increase debt repayments, reducing defaults and increasing profitability of banks and their balance sheets. Money received by public will increase spending which will increase demand and also improve balance sheets of people making them more accesible to credit.

    • From the looks of the article it seems closer to Monetary policy than fiscal. It’s implying the central bank pursues quantative easing but instead of injecting it into banks it’s giving it to the general public.

      It’s a nice idea because a large portion of GDP is consumer spending but a helicopter drop would only produce temporary results. People need regular money coming in so that we create a decent wealth effect, once people either feel they are better off or feel they will become better off there will be more spending from consumers.

      • Thank you for the compliment, but I still stand by the statement.

        Suppose an friend of yours came up to you and said, “Ralph, I just can’t understand why I am having these financial problems. I make a nice income [$100,000./year], but I am still in trouble.

        Then your friend goes on to tell you the particulars. All on credit, he bought a $750,000. home, a $75,000. Porsche, goes on two or three expensive vacations per year, has amassed credit card bills in excess of $50,000., etc., etc.

        What are you going to tell you friend, Ralph? How is your friend going to solve his problems?

        The global financial crisis is the same…TOO MUCH DEBT. The solution, get rid of the debt…any which way you can.

  3. Hmm, I can paraphrase your argument, “Let’s spend, spend, spend!”

    Never mind the fact that’s been the mantra since post WW2 – pesky Gold Standard got in the way before 1970 so that was binned. Paper money allows for unlimited QE, unlimited tinkering by government. The answer to every problem faced is to spend yet more money – Minsky moment now requires either the illusion to be revealed (i.e. debt write off, 1 oz platinum coins = $1T) or a break on further spending because the sums simply don’t add up with any interest rate greater than 0.1% rapidly moving to asymptotic zero to support asymptotic infinite debt.

  4. If I may include a reference to the US: the two countries’ specific problems and government mismanagement differ widely, but “preaching responsibility while doing something deeply irresponsible” is common to both governments and many others. President Obama is juggling so many falsehoods that he has to double-up: “A government shutdown would throw a monkey wrench into our continuing recovery”. And, BTW, I see that there have been a total of 17 previous shutdowns without any lasting effects.

    Here in the US, Republican politics are bad, Democratic are WORSE; bi-partisan is NOT non-partisan; and it’s government VS. the people.

  5. I hate to drag out the poor old dead horse [once again], but until people stop trying to get something for nothing [printing money…creating and transferring debt…de-frauding…taxing…levying…outright stealing…and all the rest], not one thing is going to change.

    And the number one reason why nothing changes is that Elite cut the investing class in on the party but sharing the booty with them. 99.999…% of investing is simply legal theft and this is why nobody [with any power] says anything, nobody does anything, and why it will continue until it can continue no longer…

    Human greed simply knows no bounds.

  6. I haven’t been following the UK econ situation very closely, but according to Scott Sumner’s latest post, Britain has already been running large deficits (3rd largest in the world in 2011 and 5th largest in 2013; 8.8% and 7.6% of GDP, respectively).

    Any thoughts? How much, in your view, should deficit spending increase?

  7. Pingback: Infrastructure spending is NOT A GOOD WAY of curing recessions. | The Jefferson Tree

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