Another case for plan B

Yesterday’s GDP figures have led to calls for a relaxation of Osborne’s fiscal tightening. For me, though, another less-remarked development provides another case for doing so.
I refer to the fact that the government’s real borrowing costs have recently fallen to a record low. The average yield on index-linked gilts with a maturity of over five years is below 0.4%. When borrowing is so cheap, doesn’t it make sense to do more of it?
The counter-argument to this is that such a move would raise interest rates. But even if rates were to rise by one or two percentage points, they’d still be lower than they were in the 90s, when no-one worried about government debt.
The counter-argument here is that rates would rise by more than this. I doubt it, for three reasons:
1. History shows that gilt yields are just not that volatile. Of course, history is not always a guide to the future. But there is something paradoxical about people who normally extol the virtues of free markets being concerned about massive volatility suddenly arising in a market where it has not done so previously.
2. The UK’s fiscal position is reasonably healthy. Our debt-GDP ratio is now 61.9%. With long-term real borrowing costs of 0.4% and trend growth of 2.1% (if you believe the OBR) this implies that we’ll stabilize the debt-GDP ratio even if we have a primary budget deficit of 1% of GDP*. Yes, our deficit is higher than this now. But on current plans,  we’ll have a surplus by 2014-15, implying a fall in the debt-GDP ratio by then. This, surely, gives us some wiggle room to loosen policy.
3. Low gilt yields are not simply - or even perhaps mainly - due to the markets giving a vote of confidence in Osborne’s fiscal plan. They also reflect pessimism about global growth, a global savings glut and a shortage (pdf) of safe assets in the world. These factors would keep yields low, even if fiscal policy were relaxed a little.
These thoughts tempt me to side with Ed Balls.
But not with any enthusiasm. I fear that our problem is not merely that the economy is in a temporary, short-lived “cyclical” slowdown of the sort that can be ameliorated by a modest fiscal easing. Instead, a combination of the investment dearth - which, remember, preceded the crisis - and the effect of the crisis in reducing trend growth has left us with (semi-)permanent slow growth. As Duncan says, Balls plan “isn’t enough to deal with the serious issues we face.”
* Even if we assume lower trend growth and higher borrowing costs, a tiny surplus would suffice to stabilize the debt-GDP ratio.

Comments

[anon]

I agree that the current slowdown in growth is clearly structural, if only because the BoE has been keeping a very accommodative policy stance (as measured e.g. by nominal GDP growth) and this has mostly translated to excess inflation, not real growth.

One possibility is that spending growth during the Gordon Brown administration has weakened the supply side of the economy; regardless, the best prescription at this point is structural adjustment, which may or may not involve fiscal cuts. The Bank of England will then be in the best position to manage the resulting AD/inflation radeoff.

[gastro george]

Only structural in the sense of the structural idiocy of consensus economists. Didn't Keynes call it "pushing on a piece of string"?

[Metatone]

Are there any other historical or geographical periods with a comparable glut of corporate savings/dearth of investment?

If so they might give us some clues about how to move forward.

At the moment it seems like a tautology - there's a dearth of investment opportunities reads a lot like a breakdown of the system.

When interest rates are close to zero, many opportunities should open up, but the reality seems to be that there's no virtue to taking risks. You won't be sacked for hanging on to a pile of cash and waiting for "things to pick up..."

As an aside there's some kind of "lump of investment time inverse" fallacy at work too - the calculation is that in a year's time the cash will earn a better return, so why invest now, except in things that will show a return in a year, but few real business opportunities show full returns in a year...

Which all looks pretty Keynesian when you get down to it...

[gastro george]

OT, and maybe an idea for another thread - have there been any estimates of the contribution of the Olympics build to the economy, and what effects we will see when it ends?

[Alex]

One possibility is not, etc etc. It rose from 39 to 44% of GDP in a series that has ranged from 34 to 48 since 1970. There was a similar scale of "spending growth" between 1989 and 1993 and we hear nothing of the disastrous supply side consequences this must have had. Who doesn't remember the productivity and growth disaster of the 90s?

[Dipper]

The answer does not lie in economics, so Economists prescriptions for getting us out of this are of little use.

There is something clearly wrong with Britain's economic make-up, and it needs correcting. Borrowing money to spend on state activities is half of how we got into this mess, so continuing is obviously wrong.

The other half of the explanation is successive government indifference to manufacturing. How many decades do we have to conduct this experiment of free markets for to understand that without government co-operation all our industry will disappear to those countries where governments care about their industries?

[Cahal]

anon,

The inflation is due to the VAT rise & oil/commodity price rises, not loose monetary policy. Monetary policy works by increasing private debt; fiscal works by increasing public debt. Private debt got us into the crisis; public debt is not in a crisis.

Dipper,

'Borrowing money to spend on state activities is half of how we got into this mess'

Borrowing money to spend on state activities had nothing to do with the crisis. As for the imaginary fiscal crisis, well, it's imaginary.

'so continuing is obviously wrong.'

The only way the economy public and private debt can simultaneous go down without a recession is if exports increase. This has stalled, so decreasing public borrowing will increase private debt, even though it is already well beyond the ability of the economy to pay. Continuing public borrowing is absolutely the right thing to do.

[BT]

Osbourne needs to embrace a new round of government borrowing to fund investment.

Just look at Japan's lost decade. Sustained government borrowing was necessary to keep the economy growing while the private sector deleveraged.

Same for Britain 2007-2017. Real economic growth will be close to zero over the coming decade. Only massive government investment can restore growth and employment.

[Andrew]

1. We will not have a surplus in 2014. And if we will, then how will the private sector have delevered? Speaking of which:

2. We will not have trend growth of 2.1%.

3. Our actual debt-to-GDP ratio is higher than 61%.

Despite all this, the principle of borrowing whilst borrowing is cheap is very appealing. If nothing else, it could be used to retire debt paying higher interest, couldn't it?

[Jim]

Where exactly is this 'fiscal tightening' then? The government figures show cash spending has been higher every month of this financial year against the previous year (which in itself was higher than the last year under Labour). Certainly various departments are having to make cuts, but the aggregate amount of money the State is injecting into the economy is rising, not falling.

[Keith]

If the problem of demand is a result of excess saving in the private sector you could reduce corporate saving by taxation and raise public investment without any more net state borrowing. That would be an even cheaper option.

[Ralph Musgrave]

What in God’s name is the point of government borrowing money when it can print money? Raving bonkers!

Keynes and Milton Friedman amongst others, pointed out that that governments can perfectly well do the above.

Of course printed money may well have a bigger stimulatory / inflationary effect than borrowed money, but what of it? The answer to that little problem is to use less of the stuff in the “print” scenario than in the borrow scenario.

[BT]

@ Ralph Musgrave

Government borrowing does create money, just like private borrowing. Credit is created in parallel with debt by the banking system. Credit is destroyed when debt is repayed.

"Printing money" refers specifically to cash/reserve balances at the central bank, which are created by the central bank. When the central bank buys bonds, it pays for them by increasing reserve balances at a bank which then increases deposits of the bondholder. When the bondholder withdraws cash from the bank, it decreases both deposits and reserves. Thus, QE effectively swaps bonds for cash.

The reason QE doesn't work is that bonds are basically a form of money themselves, so replacing them with cash doesn't increase the money stock in any meaningful way.

[Cahal]

Jim,

You need to look at budgets in real terms or as a % of GDP, not nominal. Cuts are definitely happening, and they are definitely big.

[Ralph Musgrave]

BT, Your first sentence claims that “Government borrowing does create money, just like private borrowing.” I agree that private borrowing (from a commercial bank) creates money: the bank just credits the borrower’s account with whatever is borrowed, and the borrower can spend the money created. But government borrowing is different.

The transactions when govt borrows seem to me to be thus. Govt borrows £X from private sector lenders, and gives the latter £X of bonds in return. Govt then spends the £X. Net result is that the private sector us up to the tune of £X worth of bonds (plus there is a stimulatory effect – thought the size of that depends on how strong the crowding out effect is).

To summarise, when government borrows the effect is an increase in bonds. And when a private sector entity borrows from a bank, there is a net increase in money.

Re your second para you are saying that the term “print money” is reserved for QE or what amounts to QE. I agree that the phrase “print money” is often used to describe QE, but I don’t think anyone can claim “trade mark” rights over a particular phrase. Anyone can use a particular phrase any way they want, as long as they make it clear what they are doing. Also Keynes used the phrase “print” in the sense in which I used it in my above comment in a letter to Roosevelt in the 1930s, for what that’s worth.

[Jim]

@Cahal: The spending figures for the last 12 months, adjusted for inflation, show an increase in spending, as detailed here:

http://www.spectator.co.uk/coffeehouse/7122543/what-you-need-to-know-ahead-of-tomorrows-growth-figures.thtml

I repeat, where is the fiscal tightening?

[Ralph Musgrave]

BT, My comment just above was not quite right. I said that when government borrows from the private sector, no money is created. That actually depends on which “sector of the private sector” govt borrows from. Where govt borrows from private sector banks (an idea Tim Congdon is keen on) money is created in exactly the same way as when I borrow from my bank.

In contrast, when govt borrows from private sector non- banks, no money is created. E.g. if govt offers bonds for sale, and I buy some, I just transfer money from my bank account to govt.

The reason for the difference stems from the fact that money is anything that is generally accepted in payment for goods and services. A cheque drawn on Lloyds or Barclays is “generally accepted”. In contrast, a cheque or bill of exchange drawn on me or my local pub, firm of solicitors, etc etc is not generally accepted: in fact such cheques or bills of exchange are near non existant.