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April 30, 2012


Luis Enrique

I was intrigued by a quote from Alan Kirman that I came across in a blog comments somewhere recently, that representative agent models should be replaced by agents that represent classes of worker and firm.

If you're right about why austerity worked in the 1970s I haven't come across a macro paper with a model that could capture that

(although as a rule whenever I complain about economists ignoring X, I soon discover somebody somewhere has come up with a DSGE model that incorporates X)

Luis Enrique

oh - although there's a class conflict story here (growth was achieved by hurting workers and helping capitalists) there's also potentially a story about workers' militancy acting against their own interests - it depends on just how much growth was created and how its gains were distributed, but maybe the interests of workers and capitalist were actually aligned. I don't know what happened to real wages for the median-and-below workers in the 1980s.


Mr Lillico writes in the Telegraph today that wages are in fact high.

And Allister Heath writes in CityAM that we are experiencing a collapse in corporate profits.

All in all, I've no idea what to think any more.

Brian Barder

It will be obvious that I'm not an economist, but I'm puzzled by a theory which asserts that investment leading to growth will be boosted by *reducing* the incomes of a large category of workers (those in the public sector), thus further reducing aggregate demand at a time when the low level of demand in the economy seems to be the main cause of lack of business confidence. Business is surely unlikely to increase investment or to hire more labour when lack of demand threatens the prospects for selling one's goods and services. Squeezing the spending power of those with the highest marginal propensity to spend (i.e. the poorest) appears to be suicidal folly -- steeply raising VAT, reducing welfare benefits, deliberately reducing the numbers employed in the public services and freezing or reducing the remainder's wages in real terms are all the diametrical opposite of what's needed. IOW, the problem stems from capital and top management taking a hugely disproportionate share of the national cake at the expense of labour. It's a funny time to be arguing that labour's share should be reduced even more! (It's not even necessary to rely on arguments about justice, fairness, compassion, reducing inequality, social responsibility and simple decency, although all these point clearly in the same direction.)


@ Hoover: may take on wages is here:
Corporate profits have fallen since the start of the recession, but I'm not sure you cal call it a collapse:


Fantastic post!

"One is that economics is not (just) about fancy [?!] models. It's about mechanisms. The question is: through what mechanisms can tighter fiscal policy raise growth? Mechanisms that are powerful in one time and place need not be powerful in other times and places - which is why economics has such a poor forecasting record."


Is there any data to support the idea that fiscal tightening can accompany growth when public sector debt is high and private low?

And that it is therefore unlikely to do so when private sector debt is high?


@ Andrew - Ta. There's bits of evidence that fiscal tightening might be good for growth when govt debt is high; many of the episodes cited by Alesina and Ardagna began from such positions.
There's less evidence about the importance of high private sector debt, simply because it is only in very recent times that such debt has been high.
@ Brian - you're right to be puzzled, as corporate investment is quite unstable. But businesses will be happy to invest if expected demand is low, as long as margins are high enough. The question - which is unanswerable ex ante - is: what is "high enough"?

Ralph Musgrave

The paragraph of Matt Mitchell’s with which Chris starts the above post is nonsense. It makes the conventional assumption that cutting the debt risks “killing the economy”.

The reality is that the speed of debt repayment and austerity / deflationary effects are almost entirely independent. We’ve actually made MASSIVE cuts in the debt with no “austerity” effects at all: by means of QE. Has nobody noticed? Of course QE involves leaving debt in the hands of the Bank of England. But those Gilts are essentially meaningless: they might as well be torn up, as I pointed out in a letter in the Financial Times a couple of weeks ago, and as someone else pointed out in an article in the FT a couple of days later.


@Ralph - yes, money printing is indeed possible and can be tolerated. So where are the limits?


@Chris - Thanks. Not withstanding the lack of data about private debt levels, do we think that it might be a factor in low aggregate demand?

If so, then what mechanism could fiscal stimulus ever operate successfully?


Have right wing policies raised growth? Where and over what time period?

Moving from expansionary to contractionary monetary and fiscal policy produced a huge rise in unemployment from 1979 - 83, then a very slow recovery until Lawson hit the accelerator towards the end of the 1980s, culminating in a mew recession.

When did the claimed transformation happen? I must have been sleeping.

Only taking credit for the recovery following the recession you caused to start with is a biased form of accounting. Harold wilson still seems to get the prize for growth. And full employment.

Ralph Musgrave

@Andrew, You ask where the limits are to QE. The answer is, as I intimated above, that there aren’t any limits as long as the stimulatory / inflationary effect of QE is counterbalanced by tax increases.

Exactly how much tax increase is needed per £100 of QE is a difficult question. But I go along with the widely held view that QE is a bit of a damp squid: it does not have a HUGE effect. Thus my wild guess is that £10 of tax increase would be needed per £100 of QE.

To illustrate, say £1,000 of your pension pot is in Gilts which you are induced to sell because government offers an attractive price for them. You make what you reckon is £100 profit. A reasonable reaction on your part might be to spend £50 and save £50. That’s £50 added to demand. So government would need to raise taxes by enough to counteract that increase in demand: perhaps a tax increase of £100 would do the trick – assuming that when taxes are raised, people cut spending by half the amount of the tax increase.

james higham

I suspect many right-leaning economists have in mind some idea that lower government spending reduces allocational inefficiencies and so boosts

Replace "right-leaning", which shows political bias, to "sound, rational" and the comment is absolutely correct.


@Ralph - I am confused why you want to counterbalance the supposed increase in demand that qe would produce. I thought the idea was to increase demand.

Ralph Musgrave

@Andrew, I was just making the point that the debt CAN BE reduced in a way that is neither stimulatory nor deflationary (contrary to the conventional wisdom that “consolidation” is inevitably deflationary).

If the objective is to the reduce the debt while increasing demand, then up the QE a bit and reduce the tax a bit. Or if inflation is looming and deflation is the order of the day, then do the opposite: up the tax a bit and reduce the QE a bit. I’ve expanded on this in a paper here:


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