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July 05, 2017

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Business Blog

I agree with this thinking to a degree - it becomes a snow-balling effect. Not only does it increase tax revenues, but also the increased economic spending from these additional workers will go back into the economy. However, a better way would be to increase capital expenditure too. On the other side of this coin is efficiency, businesses have to be efficient to make a profit and to survive...councils, government departments etc, needed to become more streamlined and efficient to reduce the burden on society too.

Blissex

«It’s inflation, and not the lack of a magic money tree, which has traditionally been the obstacle to higher public spending. Which brings me to why I agree with Richard. This danger isn’t especially great.»

As usual proper Economists focus on wage inflation and entirely disregard the foreign trade situation, very politely indeed, because talking about it is so rude.
Just like it is uncouth to mention what M Pettis calls "The volatility machine", that is the structure as well as the amount of public and private debt matter.

«If I am wrong, though, there’s a simple solution: higher interest rates.»

But interest rates are already quite high, except to favoured constituencies like financial speculators in the City and property speculators among the middle classes in the south-east and London.

«A mix of these plus looser fiscal policy would have some advantages.»

A mix of less loose credit ("interest rates" is not quite the same thing) less targeted at speculators and looser fiscal policy would be an improvement.

«They’d take us away from the zero bound»

There is no zero bound except for financial speculators in the city. The ZLB argument today is a clever bit of propaganda.

«and so give the Bank of England more room to loosen policy in the next downturn.»

The number one worry of the BoE seems rather how to keep pushing up property prices to postpone a collapse of the banking sector right now, I doubt that they worry very much on such a subtle academic topic as how “to loosen policy in the next downturn”.

«And they’d tend to dampen down house prices and financial speculation.»

That is fueled not so much by low interest rates, even if property and financial speculations are the only uses for which credit is at zero or low interest rates.
Given how profitable property and financial speculation is, higher interest rates would not dampen it; they are fueled by the availability of credit, and that availability is a coonsequence of the political goal to boost “house prices and financial speculation” rather than dampen them.

JK Galbraith in the essential "The Great Crash 1929" wrote:

“In the stock market the speculative buyer also gets the earnings of the securities he purchased. However, in the days of the this history the earnings were almost invariably less than the interest that was paid on the loan. Often they were much less. Yields on securities regularly ranged from nothing to one or two per cent. Interest on the loans that carried them was often eight, ten or more per cent. The speculator was willing to pay to divest himself of all the usufructs of security ownership except the chance for capital gain.“

Ralph Musgrave

“..higher interest rates. A mix of these plus looser fiscal policy would have some advantages” says Chris. Not a brilliant argument because it can easily be reversed: “lower interest rates (maybe negative rates) plus tighter fiscal policy would have some advantages” – which I’m sure it would.

So the big question is: what’s the OPTIMUM rate of interest. Well economists long ago worked out the optimum price for anything, including the price of borrowed money: it’s the FREE MARKET PRICE, absent any compelling reasons for thinking social costs or benefits are so large that we need to overrule market forces - as is the case with for example kid’s education, which is available for free, or alcohol, which is only available at way above the free market price.

Unfortunately, that conclusion leads to a problem as follows. The rate of interest is heavily influenced by the amount of government borrowing, and how much interest government pays for that. So what’s the optimum amount of government borrowing, and what rate of interest should it pay? Milton Friedman and Warren Mosler claimed the answer is “zero”: i.e. they argued that governments should offer no interest at all on their liabilities.

That question is too complicated to answer here, but I think Friedman and Mosler were right, or least nearly so: i.e. there is no excuse for government paying more than one or two percent. Certainly government should not pay anything above the rate of inflation.

Next, in advocating public sector pay rises, Chris needs to prove that public sector employees are paid less that private sector employess for given skills etc. Far as I know they aren’t.

Blissex, your claim that interst rates are high is odd. Far as I know they’re lower then they’ve been for a good 30 years.

Neil Wilson

" This means that for every £100 the government borrows, it will have to pay back only £72. "

It won't ever pay anything back. The entire stock is merely rolled over - because it is just a form of savings. In terms of linkers: from UK private pension savings funds - thereby destroying the notion that such funds are in anyway private.

The feedback loop between pension funds and linkers is unsustainable. If it continues, the government will have to take them over. Taxing pension funds by issuing overpriced linkers is a really stupid thing to do.

There is no need for government to pay any interest at all to any private operation. The money can be saved as cash, or in targeted National Savings products if there is a welfare issue that requires government intervention.

c

If additional borrowing/printing leads to (enough) inflation then there's not a magic money tree - or, more accurately, there's a nominal money tree but it's neither magic nor real. So rather than saying there definitely is a magic money tree, better say there is one now.

(I realise this is what the article actually says - my quibbles just with the analogy)

c

Question.

You say pay rises won't be offset by productivity gains. But... if increased public spending will increase (real) growth, and we're pretty much at full employment.... then surely productivity must increase?

Or have I got this all wrong?

Matt Young

UK government debt, 1.5T. UK government interest payments are 46 B or 30B depending on whether you include seigniorage.

Let us divide:

30/1.5T is 1.9%
46/1.5T is 2.5%

Roughly.

Wait, the UK can borrow at the one year rate! Yes, but the UK still uses a unified budget and the total rate remains about the ten year rate.

Real growth is a little less than 2%. But we are in luck, consumer prices are up, rising at 2.6% a year. But I doubt you will ever get to infrastructure spending, all those entitlees will want a hike in checks to cover the inflation rate.

Dipper

They could pay for increased public pay levels through taxation, for which I think they are clearly doing the ground work.

Surely none of this would matter if our productivity had increased over the last ten years on trend instead of stagnating? Isn't that the real problem?

Matt Usselmann

"This means that for every £100 the government borrows, it will have to pay back only £72. "


Not quite. That £72 gets multiplied by the change in the price index between now and 2037. Whatever that is at the time.

I suspect it will turn out to be around 2% a year, based on the current coupon gilts with a maturity of 20 years. In which case £100 borrowed now will need to be repaid by 2037. About £140 in total by then.

Kallan Greybe

I always found the assertion that an increase in public spending necessarily means an increase in inflation weird, for a couple of reasons.

First off, it involves the assertion that an increase in demand necessarily causes an increase in prices. Why? There are plenty of reasons why an increase in demand could just lead to an in production. For various reasons a business could be reluctant to increase prices, at which point increasing supply becomes a way to take advantage of the increasing demand without, for example, alienating existing customers by increasing the price. The only reason that might not be on the table would be if there was no way to increase production because of one or another bottleneck, but the UK's low productivity implies that there probably is no bottleneck, not least because we were perfectly capable of supporting far higher levels of production just before the crisis.

The second reason is historic. The most recent case of government spending driven inflation was the hyper-inflation in Zimbabwe around the same time as the great recession hit. One of the really surprising things about Zimbabwe's hyper-inflation though was that it largely only hit rural areas: rich urban Zimbabweans (read *white*) entirely avoided inflation by getting paid in dollars. I'm no expert on the literature here, just someone who happened to be in the right place at the right time to spot the trend, but that seems really telling to me; Zimbabwe's hyper-inflation looks suspiciously like class warfare from the right angle.

Phil

The Bank of England certainly has not printed money to pay for extra borrowing. They've printed money to buy up existing Treasuries held by banks. It's a liquidity operation.

c

Could someone tell us definitvely whether Matt Usselman or Chris is right - £140 or £72?

Blissex

«£140 or £72?»

It is the the same amount, whether expressed before or after inflation.

Blissex

«They've printed money to buy up existing Treasuries held by banks. It's a liquidity operation.»

Ah the usual excuse, just like for insolvency some years ago, now for financing government debt: it is about liquidity.

But precisely because government bonds are liquid it does not matter whether central banks buy them on the primary or secondary markets, the effect is the same: they have printed money to pay for extra borrowing. Yields have fallen, where they would not have fallen that way if the extra borrowing had not been financed by the central banks.

What's worrying is that despite claims that "the markets" have an insatiable appetite for "safe" paper, central banks have felt the need to help absorbing that "safe" paper in such colossal amounts.

Interesting graphs and arguments in this talk by R Koo (even if his insights fall short of being fully illuminating, I guess for political reasons):

https://www.youtube.com/watch?v=8YTyJzmiHGk

The amusing detail is that he has asked the FOMC whether they have any idea on how to get rid safely of that overhang of "liquidity", and they told him "no":

https://www.youtube.com/watch?v=W2L4k3rMG-g

Luis Enrique

"Another is that governments can print money to pay for extra borrowing. The Bank of England has done £435bn of this."

are you sure that's right? It printed £435bn to purchase already outstanding bonds from their owners. is that really the same thing - in terms of macroeconomic impact - as "extra borrowing"?

Extra implies a change relative to a counterfactual - is UK national debt £435bn higher than it would have been in the absence of QE? I'd have said not.

c

So in 2037 you'd pay £140 but that'd only be worth £72 today?

Luis Enrique

though I agree with your conclusion.

What would happen if the BoE raised interest rates a the same time as direct money financing an increase in public expenditure?

cityunslicker

um, that magic money tree is a fiction - always was, always will be.

The minute you espouse this rubbish in the real world, the bond markets will turn on the country. Then, instead of -1.6% interest, the interest rate will soar. The cost will be enormous and the country stuck with it for years.

Whilst it remains on paper, it looks real. However, in the real world it won't work out that way. Like most socialist and communist ideals, it wont survive contact with reality.

Postkey

". Like most socialist and communist ideals, it wont survive contact with reality."

So was Milton Friedman a 'socialist' or a'communist'?

Postkey

"First off, it involves the assertion that an increase in demand necessarily causes an increase in prices. Why?"

Because of the assumption of diminishing marginal productivity of labour.

An increase in the 'price level' not necessarily 'inflation'.

Blissex

«um, that magic money tree is a fiction - always was, always will be. The minute you espouse this rubbish in the real world, the bond markets will turn on the country.»

Well, curiously enough, the UK and USA government have shaken vigorously the "magic money tree" and handed over for free stupendous (trillions) amounts to their best "friends of friends" in the finance sector, to recapitalize them and refill their bonus pools, and the bond markets have celebrated this. In part because 30-40% of the "bond markets" are central banks.

While wage inflation has not happened, inflation has happened, with fantastic rates of increase in asset prices, because that gigantic handout has been tied by regulatory means to buying financial assets like government bonds and mortgages and shares. As a member of the Fed said:

http://globaleconomicanalysis.blogspot.co.uk/2016/01/former-dallas-fed-governor-richard.html
“What the Fed did, and I was part of that group, we frontloaded a tremendous market rally starting in march of 2009. [ ... ] Once again, we frontloaded, at the federal reserve, an enormous rally in order to accomplish a wealth effect.”

The fruits of the magic money tree have not been directed at investment in productive activities so wage inflation has been largely negative.

The impression I get is that the policy of repression of wages is deliberate to minimize imports of oil, as deliberate as the policy of pumping up asset prices to maximize the incomes of property owners and financial business executives.

R Koo has some very interesting graphs on the "magic money tree" topic, and an interesting presentation, even if somewhat slanted as to asset price impact, here:

https://www.youtube.com/watch?v=8YTyJzmiHGk

Richard McKean

I think there is another problem with ending the cap - it doesn't end the de facto cap on private workers income. Private sector workers do not have secure income, secure pensions, and pay for the benefits of public sector workers. This seems unfair. Ending the cap would only be fair if private sectors workers also get an increase in earnings.

Oakchair

@cityunslicker
We're talking about the UK. It's a currency issuing government with a central bank that sets interest rates. Your statement is like warning a farmer that the price of his peaches are going to skyrocket.
It is physically impossible for the UK to run out of pounds the risk of not getting paid back is zero. Japan is cowering in fear over the bond markets ROTFL. Try again this time go with education over feeling.

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