What with his new column in the New Statesman and his articles for other outlets, David Blanchflower – a former member of the MPC – really does seem to enjoy laying into the Tories. Problem is, much of what he says fails to convince – so much so, in fact, that I thought I’d bash out a quick fisk of his Guardian article from last Friday. Here’s the full article with my comments in bold:
We are in the midst of the worst recession most people alive have ever experienced, or will probably ever experience. It is already worse than the 1980s and it isn’t over yet. The only comparison is to the 1930s (my parents, now in their 80s, can remember how bad it was). The monetary and fiscal authorities have so far managed to prevent a recession turning into a depression – but it still could, especially if David Cameron and George Osborne have their way.
Some people seem to think it is all over and have called an end to the recession. Far from it, normality is a long way off. It will take a very long time for output, employment and unemployment to return to pre-recession levels. As Mervyn King said at a press conference recently: “It’s about levels, stupid.”
The evidence is that financial crises are especially harmful and have especially long-lasting effects. Hence any recovery is likely to be slow and anaemic at best.
The solution to this is fixing the banks as Norway/Sweden/Finland did when faced with similar problems in the early 1990s. Leaving a broken banking system to push ever higher interest charges onto it’s customers is the recreate the mistakes of the Great Depression and Japan in the 1990s.
The simple lesson when you are deep in recession is that a serious policy error is to reverse stimulus too early, which then sends the economy crashing into a depression. This is what happened in the United States in the 30s. Monetary and fiscal policy were tightened before recovery was firmly established, which drove the country back into a deep recession at the end of 1937.
I believe this is why George Osborne is constantly going on about the importance of sustaining easy monetary policy, while David Cameron emphasises the importance of inflation stability – with stable inflation being the best way to keep mortgage rates low. The experience of many European and smaller Anglo-Saxon countries over the past quarter-century is that, ultimately, excess government debt drives up interest rates, regardless of where the unemployment rate is.
What caused the Great Depression was the failure to hold interest rates low and, in particular, allowing the banks to try to pay for their losses by constantly increasing margins to their customers. It wasn’t that government didn’t spend enough money.
And this week into the current economic crisis stepped the Tories with their ill thought-out plans for (a lack of) recovery. Cut public spending here, freeze public sector wages there, reduce the benefits of the poor, raise the pension age, and so on. It was hard to see any group that stood to benefit from their proposals.
Aside from every mortgage holder and taxpayer in the country perhaps? These “ill thought-out plans” being very similar to those which proved highly successful in Canada, Sweden and Australia in the 1990s, and which are strongly recommended to the UK right now by the IMF and European Commission.
Lesson one in a deep recession is you don’t cut public spending until you are into the boom phase. Keynes taught us that. The consequence of cutting too soon is to drive the economy into a depression. That means rapidly rising unemployment, social disorder, rising poverty, falling living standards and even soup kitchens. The Tory economic proposals have the potential to push the British economy into a death spiral of decline that would be almost impossible to reverse for a generation.
The debate at such times is not about big government versus small government. It isn’t about moving this service from public to private sector because the private sector can do it better. The debate here is about maintaining levels of aggregate demand. In a deep recession the choice is: the government does it or nobody does it; it is public spending v no spending. You don’t worry about paying off debt when you are at war: you have other priorities. Win the war first.
Actually, very low mortgage rates allow people to pay debt and maintain spending. The list of countries who’ve got out of recessions while cutting public debt and spending in the last 30yrs is very long.
To cap it all, the leader of the opposition, in his speech to the Tory conference, amazingly discussed what he called option one – the possibility that the UK should default on its debt. Mr Cameron, you shouldn’t even be raising such possibilities. It’s exactly what markets want to hear from a potential leader – you have actually even considered defaulting on our debt? Unbelievable. Better to have said nothing honestly.
Let’s get this straight: the guy making a pitch for being Prime Minster of the UK shows that he realises borrowing money to the point where you have no means of repaying it risks a default, and Blanchflower thinks that’s a bad thing? I think it’s a good sign David Cameron may be thinking hard about the repercussions of continuing on this debt-ridden path.
There was one bit of his speech I thought sounded like quite a good plan, which he dismissed. That was what he called his option two: “We could encourage inflation, which would wipe out the value of the debt, making it easier to pay off.” Sounds like a good idea to me, and probably to you.
Moderate inflation would help all the people in negative equity; rising asset prices would certainly help, and are one of the stated purposes of quantitative easing. A few years of inflation, around 5% or so, would be a really good idea. Keep interest rates low for the foreseeable future, keep the stimulus going.
Mortgage holders can pretty quickly work out that much higher inflation equals higher mortgage rates. Say inflation does go to 5 percent – that would mean mortgage rates around 8 or 9 percent, given our previous experience with that level of inflation. Will anyone finding the money to pay a mortgage each month feel better off, or spend more, if they have to stump up twice the amount each month?
Debt has service costs as well as principle repayment – the higher inflation, the higher the interest rate, the higher the cost of the mortgage.
In addition, most people in financial markets would view the deliberate targetting of much higher inflation to reduce the effective value of debt as a “default”. Something as unsubtle as a 3 percent rise in the CPI target rate would rather make that point clear to international markets. Argentina tried this approach recently, and most folk tend not to view this as a success. There are very good reasons why countries have very consistently seen low inflation as a good thing.
One possibility is to keep the Bank of England’s inflation CPI (consumer price) target at 2% until there is any possibility of hitting it and then simply raise the target. Or perhaps replace the CPI with an index that includes house prices, which would have the same effect of allowing monetary policy to remain loose. We don’t need the central bank to reverse policy too soon either. We need to create some inflation for a while.
Cameron concluded his speech arguing for his third option – “for me the only option”. He went on: “We must pay down this deficit. The longer we leave it, the worse it will be for all of us.” Actually, wrong: the longer we leave it, in a recession, the better it will be for all of us. I personally would vote for option two and certainly would never even consider discussing option one.
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