« Origins of the Tory implosion | Main | The cost-cutting error »

October 17, 2022


James Charles

" . . . how the left should think about fiscal policy."?
“ . . . whereby the coefficient for ∆g is expected to be close to –1. In other words, given the amount of credit creation produced by the banking system and the central bank, an autonomous increase in government expenditure g must result in an equal reduction in private demand. If the government issues bonds to fund fiscal expenditure, private sector investors (such as life insurance companies) that purchase the bonds must withdraw purchasing power elsewhere from the economy. The same applies (more visibly) to tax-financed government spending. With unchanged credit creation, every yen in additional government spending reduces private sector activity by one yen. . . .
“Equation (22) indicates that the change in government expenditure ∆g is countered by a change in private sector expenditure of equal size and opposite sign, as long as credit creation remains unaltered. In this framework, just as proposed in classical economics and by the early quantity theory literature, fiscal policy cannot affect nominal GDP growth, if it is not linked to the monetary side of the economy: an increase in credit creation is necessary (and sufficient) for nominal growth.
Notice that this conclusion is not dependent on the classical assumption of full employment. Instead of the employment constraint that was deployed by classical or monetarist economists, we observe that the economy can be held back by a lack of credit creation (see above). Fiscal policy can crowd out private demand even when there is less than full employment. Furthermore, our finding is in line with Fisher’s and Friedman’s argument that such crowding out does not occur via higher interest rates (which do not appear in our model). It is quantity crowding out due to a lack of money used for transactions (credit creation). Thus record fiscal stimulation in the Japan of the 1990s failed to trigger a significant or lasting recovery, while interest rates continued to decline. ”


The fundamental cause has been liquidity being drawn back ias US quantitative easing is reigned back. This is creating turbulence in the global capital markets. In such conditions interest rates and the dollar rise, particularly as it is a safe haven currency, the world's reserve currency.

Even before this budget, a number of prominent City analysts were saying that the uK was showing characteristics normally seen in emerging markets -an extraordinary, but telling, remark. Emerging markets lack hard currencies,and have to be cautious about trade deficits so that they can afford the dollars needed to purchase vital, domestically unsubstitutable, imports. A risk premium is added to bonds denominated in their currency. Such countries have to be cautious about running large unfunded government deficits. The link between external deficits and budget deficits is not an obvious one, and it applies more in some countries than others.

When the US was flooding global markets with liquidity it hid a lot of problems in weaker countries. Now those problems are out in the open (Deutsche Bank identified low productivity and an historically high trade deficit as problems). The Kwarteng budget was a bad budget at the worst of times. While not the underlying cause of the crisis, it was the spark.


"unfunded deficits"- I mean unfunded tax cuts or spending.

Emerging markets also face limits to monetising their debts, and economies like the UK do as well.

Inflation is a factor, but it is not the critical one at the moment for the UK. By far the critical factor is the US' decision to start reversing its QE.

It is the balance of payments constraint that a few people had forgotten. Very important when we are talking about a small open economy dependent on foreign capital markets to finance that deficit.

It is important we do not use America-centric theories to talk about the UK. They are two very different economies. BOP deficits don't matter for places like the US as they do for Britain. Again, we don't have the USD's exorbitant privilege.

Dr Zoltan Jorovic

Economics is the art of making wrong forecasts based on impossible assumptions using inaccurate data and disguising it in excess mathematical detail. Unsurprisingly no Economists agree, and no formula for consistently running an economy successfully has ever been developed. It has provided a good living for many, and ample opportunity for argument. All heat, and little light.

shoreline view

Wouldn't a wealth tax control asset price inflation? The very rich run around, buying up properties purely as wealth stores, inflating the housing market, creating asset bubbles in general, destabilizing the stock market. Tax them more and they'll be less careless and less likely to disrupt regular peoples' finances.

The comments to this entry are closed.

blogs I like

Blog powered by Typepad