The real choices
Daniel Korski 5:46pm
Have you ever watched two people argue for a while, trying to make up your mind who you thought was right, only to realise both were arguing around the real issues? That is how I feel, having listened to the Government and Opposition on how to deal with the current crisis. Gordon Brown has made the case for an expansionary fiscal policy – pushing money into the economy -– and paying for it later through taxes. David Cameron, on the other hand, has argued for a more long-term approach, demanding that no stimulus come back to haunt taxpayers.
But both have, in a sense, become Keynesians, believing that some kind of stimulus is required to jump-start the economy or, at the very least, preventing it from tanking further. So I have recently been racking my decidedly non-economic brain with the choices presented by the Government and the Opposition. To push for stimulus, damn the long-term consequences and the risk that borrowing might make it harder for the Bank of England to cut interest rates; or to think long-term, with the risk that any fiscal stimulus -– by the nature of it being costed –- will not have any effect. A or B. Brown or Cameron. Government or Opposition.
So far it has not been looking good for the Conservatives. Though I am a fiscal conservative and inherently believe that people more than governments know best how to spend (most kind of) money, Labour does seem to have the rest of the world behind their plans. I hate to say it, but Tom McNulty did score a point against the otherwise excellent Alan Duncan when he told Newsnight watchers that the Tories were alone in the world with their economic policy proposals.
Thinking this through, though, I realised that the choice before us is probably false. Because getting the economy out of its current mess is not necessarily a choice between a reckless stimulus and a balanced stimulus. Instead, the government faces three choices.
The first it to try to get the economy moving again by a clever mix of fiscal stimulus, pumping money into the system (by lowering the interest rates) and giving some people a bit more walking-around cash through tax cuts to boost private consumption. This is probably going to fail as a stimulus will probably not be sufficiently large to have any real impact on the coming recession and would, anyway, not counter-balance the fact that much of today’s economy is build on bad debts and false assumptions. Past experiences of government stimulus have also not had to contend with the problems in the financial sector. In so far that the economic crisis has its roots there, any stimulus will struggle to make a difference.
The second option is to allow for the recession to take hold, which would force bad businesses to close and sustainable ones to survive. This can now been know as the “Maples Model” after the Tory MP who said: “The recession has to take its course... bad debts have to be written off, bad investments have to be written off and people and businesses need to repair their balance sheets.” No government or opposition could say they were pursuing this model --- even if that is what they expect to happen if they follow the first option -- and John Maples has duly apologised for causing offence to the “victims of the recession.”
This leads us to the third option – courting a gradual, long-term but manageable rate of inflation. Inflation is sometimes referred to as the cruelest tax, but a little inflation is not a bad thing, actually, and even periods that have seen elevated inflation levels produced, on balance, more winners than losers.
In the current situation, inflation might be they best thing to pursue because the biggest problem is all the bad debt floating around, which is making banks cautious of lending. Under inflationary conditions, debtors gain because the debt becomes smaller relative to earnings growth. (The debt is a fixed amount, whereas nominal earnings grow.) Inflation makes it easier for the government to pay off or roll over existing debt at a "real" cost is less than the historical cost. This can facilitate higher rates of economic growth (by virtue of higher levels of nominal spending, and thus stimulus), with reduces real burdens on the Treasury.
Inflation, of course, has a price. Losers during periods of inflation are those who hold non-interest-bearing currency (cash) and creditors whose interest on the loans they charge proves to be less than the current inflation rate. (They lose the difference between the rate of inflation and the rate charged for the loan.) In addition, this model assumes a slow and manageable level of inflation – but who can guarantee that?
Like the “Maples Model”, the “Inflation Model” is politically unpalatable and that is why both government and opposition are busy arguing about the details of the first option, the “Stimulus Model” even though they know that getting out of the current crisis will probably involve a bit from each of the models.
Previous
Anthony
November 22nd, 2008 6:24pm Report this commentMr Korski,
I think we have all worked out that there all the possible solutions will produce lots of casualties. Sad to say, but the only solutution that really matters is which one can politicians sell to the voters.
They will be deaf to any reason any politician is stupid enough to put before them in the next two years.
It's like walking into a party where everyone else is drunk and your sober.
Reason hardly comes into it.
God help us all.
AmandaP
November 22nd, 2008 6:30pm Report this commentWhat? This article seems divorced from reality.
The Tory front bench is doing anything BUT backing a fiscal stimulus. There are some tories in favour (clarke in the times today) but the front bench is definitley opposed.
Clearly any stimulus package has to be "funded" over time. The Government will not propose a stimulus which isnt paid back eventually because of the impact that would have on sterling.
But the tories have consistently opposed a fiscal stimulus or indeed any increase in borrowing to pay for such a stimulus.
Cameron this week said he was in favour of monetary measures but not fiscal ones.
Osborne and Cameron have both repeatedly said that they believe borrowing will rise through the automatic stabilisers but SHOULD NOT rise further to pay for spending or tax cuts.
There is no sense in which the tory front bench is in favour of a fiscal stimulus, which necessitates borrowing to which they are opposed.
If they are about to change their position (i dont know if that's what you are suggesting?) then they are going to become a laughing stock.
Old Hack
November 22nd, 2008 7:01pm Report this commentThere is third way. If the stimulus package is injected too soon it will not have much effect on the trajectory of the downturn, or how severe it will be at it's worst.
However a well packaged stimulus package introduced later have the effect in kickstarting recovery and restoring confidence. It may also be self financing if tax receipts start to improve.
So even if Brown is right about the need for stimulus he may still be wrong, disastrously so, about the timing which is as much about politics as anything else.
Daniel Korski
November 22nd, 2008 8:26pm Report this commentDear AmandaP,
Thanks for this. I'm happy to admit struggling to understand the choices before us. But as far as I know, David Cameron has called on the government to cut employment taxes paid by businesses by 2.6 billion pounds -- in order to stimulate the economy. How is that not a form of fiscal stimulus? How is that not an attempt at increasing aggregate demand and therefore the level of economic activity through a fiscal instrument, namely a tax cut?
Daniel
pilsdon
November 22nd, 2008 8:36pm Report this commentNone of it matters economicetrics shows that with a 3% fall in Gdp you would need a 5% stimulus.In honour of george leaving we are entering a w shaped recession. Quite frankly when letting down bubbles fast or slow the result is the same its just how long you take to get there.Good luck everyone batten down whatever is your hatch
Tanuki
November 22nd, 2008 9:04pm Report this commentThe idea of a "fiscal stimulus" based on yet more government borrowing is suicidal: it's a short-term attempt to borrow your way out of debt. Just as you can't pay off your Barclaycard/VISA debts with your American Express card, you can't try to prolong a credit-fueled spending-binge by borrowing against future taxation.
We need a government - and personal - spending-retrenchment.
Sure' it's gonna hurt those fools who've spent the last decade over-extending themselves on their credit-cards, mortgages and "home equity-release plans" - but in reality I don't see any alternative that will be long-term sustainable.
Herbert Thornton
November 22nd, 2008 9:29pm Report this commentAn interesting analysis, but when I read it I ask myself - how would a Hjalmar Schacht attack the problem? He would certainly insist on close regulation of the economy including special attention to the regulation of foreign trade, but he would definitely not countenance inflation. Indeed it was Schacht's opposition to inflation that caused Hitler to relieve him of his positions and that eventually led to his being put in a concentration camp.
AmandaP
November 22nd, 2008 9:37pm Report this commentDaniel Korski - in answer to your question, he proposes to do this through savings in employment benefits.
It is therefore a very good idea, but NOT a fiscal stimulus.
mckenzie
November 22nd, 2008 10:14pm Report this commentWe are all doomed, doomed I say, doomed!!!!!
Rhoda Klapp
November 23rd, 2008 11:10am Report this commentOk, here's a challenge to Coffeee Housers who read this far into a Korski post. Of all the people who are pushing one or another stimulus package, how many of you are planning personally or in business to increase your spending based on a little encouragement from Gordon and Alistair? And how many, like myself (and all my other noms de net) are pulling their horns in, planning to reduce debt and to have a quiet Christmas, because what is good for the nation (?) is not actually a good idea for an individual? Hands up?
RODEST
November 23rd, 2008 1:36pm Report this commentDaniel,
I think tagt the governments approach is wrong and dangerous for the long term recovery of the economy and business confidence.
Gordon Brown wants banks to lend at 2007 levels which implies that he wants the public to spend at the same level, does it not?
In my opinion this is the policy of the greedy credit card operators who raise credit levels on the more an individual spends regardless of the ability to repay any debts.
This indicates to me that Brown does not comprehend the seriousness of the current crisis for ordinary families. The stimulus that Brown/Darling are about to introduce will have a limited effect and will hurt those who he claims he is helping.
£120 of tax benifit to the low paid is akin to feeding them crubms from the bread board; 2.5% off VAT only becomes noticeable when spending a thousand pound or more at one tiime and invisible on daily items (as you point out).
I think the harsh reality will be runaway inflation and interest rate in 6 to 12 months whoever is in government.
Another factor that is likely to come into play next year when Obama takes his seat is lack of finance/credit from America.
Susan Hill
November 23rd, 2008 2:06pm Report this commentHands up. Quiet Christmas. Saving more, spending far less. Feels good. Not what Brown wants though.
Tom M
November 23rd, 2008 7:48pm Report this commentWhenever economists talk about moral hazard the response is always "we can't afford to worry about future risks when we face such a serious crisis today".
So lets be absolutely clear about what moral hazard is.
Moral hazard is government policies that reduce the cost of borrowing, reduce the benefits of saving and, over a sustained period of time, try to teach large sections of the population that it doesn't pay to save.
Then - when the stupidity of trying to build an economy through ever increasing debt levels has finally dawned on even the dumbest central banker and neo-keynesian - moral hazard is proposing any kind of desperate, brain-dead action to reward the feckless and further punish the prudent.
For 10 years people who have spent less than they earnt (savers) have seen their living standards eclipsed by those who chose to fund their current lifestyle by drawing forward their future earnings (borrowers).
Now that the bill for those borrowings is finally due, what does the government and its co-conspirators like Mr Korski recommend?
Punish the savers to rescue the bankrupt. Raise taxes to fund bailouts. Inflate the money supply to destroy the value of debt (and savings). Slash interest rates to enable credit addicts to keep feeding their habits.
John Maples is the only person I've heard talking with any kind of moral integrity about the current "crisis", and he's also the only one who's been hounded by the media into issuing an apology.
There are times when despair just isn't a big enough word.
Back to top