Sunday, 25 January 2015

Quantitative impotence

For all of my 50 year career as a teacher of economics I have  taught that a central bank can control the quantity of money in its economy by a process called Open Market Operations.  If the central bank  wants to increase he quantity of money in the economy it buys (government) bonds on the Open Market: if it  wants to contract the quantity of money it sells bonds.  In order t  help students remember which way round the process works I used to point out that LESS is more or less  SELL backwards, so to make the money supply LESS the Bank SELLS bonds.

For some reason totally beyond me this well established process is now called Quantitative Easing (QE) and many commentators seem to think it is something new.

Keynes acknowledged the importance of "monetary policy," to give it another of its names: after all, the great work is called "The General Theory of  Employment, Interest and Money " (my emphasis). But he was sceptical about the effectiveness of expanding the money supply to stimulate demand in a recession. He famously compared it to "Pushing on a piece of string."  For further and better particulars see

The reasons for the ineffectiveness of monetary expansion are that:

a)  households are not inclined to borrow (unless desperate) when, in a situation of unemployment or job insecurity, they are not confident of being able to pay back, and
b)  businesses are not inclined to borrow for investment if they see no or little demand for the products they would like to sell.

This was the experience in the Great Depression of the 1930s, when a loose monetary policy coupled with very low interest rates were ineffective in stimulating demand and thus reducing the level of unemployment.

Hence Keynes argued that the most effective method of influencing the level of economic activity was through fiscal policy: taking demand out of the economy through higher taxes and lower government spending to curb a boom, and injecting demand through lower taxes and higher government spending to stimulate demand in a slump.

A third problem with monetary policy is that the government has no control over what, if anything, is going to happen to the extra money.  My memory is now vague, but I seem to recall that when Edward Heath's Conservative government relied on monetary expansion way back in the 1970s the result was not a recovery of the whole economy but a boom in the price of commercial property. The recent bouts of QE in both the US and the UK have been used to shore up the reserves of the banks, and a cause  booms in asset and house prices.  Investment in the productive parts of the economy has been minimal, for reasons a) and b) above.

Consequently I doubt  that the QE programme now initiated by the ECB will do much to revive the European economy.

It is extremely frustrating to have to spell out, metaphorically in words of one syllable, reasoning that has been so commonplace that way back in the 90s even 18 year old pre-university students were asked in an examination to comment on the assertion that "relying on monetary policy alone to revive an economy  is like "playing golf with one club."  For further and better particulars of the source of that simile click here.

Expansionary fiscal policies are  what are needed to revive the economies of the Euro-zone.  What such central economic authority as the Zone has should be calling in finance ministers to discuss  the varying degrees on which borrowing rules can be relaxed  to facilitate public investment  and allow the more depressed economies to recover.

What is most frustrating is that we in the UK, not being in the Eurozone, have no need to ask anyone's permission. We could "just do it" if one of our political parties had the guts to put the option forward.

Step forward the Liberal Democrats, heirs of the  party of Keynes.

Friday, 23 January 2015

Greece: a solution

Keynes recognised that, when an economy goes into recession, leading to  falling government revenues through a falling tax take, but a rise in expenditure through increased welfare payments, then the obvious solution, to try to balance the government's books by raising taxes and cutting expenditure and so imposing austerity, is the wrong one.

The counter-intuitive solution, to re-stimulate the economy by cutting taxes and increasing government expenditure, is the correct solutions.  In shorthand:  "Look after the economy and the deficit will take care of itself."

The experience of the 1930s (and in the US in the 2010s!) proves Keynes correct on both counts.  Astonishingly, in the EU and the UK, politicians have ignored the lessons of history, reverted to pre-Keynesian orthodoxy and caused misery for millions, most tragically in Greece.

Whatever the result of the Greek elections this weekend,  the situation presents  a marvellous opportunity for a controlled experiment which will (once again) prove Keynes right.  In outline, this experiment would:

  • "Ring-fence" the Greek government's current debt mountain, and give them moratorium on interest payments for, say, five years:
  • Facilitate further borrowing by the Greek government at market rates of interest to finance infrastructure investment, employment creation and generous welfare payments .
If Keynes is right, this will enable the Greek economy to recover, the tax take to increase and welfare  expenditure eventually to  fall.

I claim no expertise on the Greek economy but, from hearsay, understand that their citizens, and not just the very  rich ones,  have developed tax evasion and avoidance to a fine art, and that their civil servants have organised a prolonged feather-bedded retirement beyond the wildest dreams of  most of the rest of Europe..  The five year breathing space would give the government the chance to sort out these and any other deep-seated problems.

If the experiment succeeds, then not only will tens of thousands of young Greek lives be rescued from  resentful dejection and disillusionment, but the EU will have the advantage of a vibrant and healthy economy, able to work in equal partnership with the rest of us, and able to pay off the debts of its somewhat feckless past.  

Given that Greece forms only some 2% of the economy of the EU, the experiment is worth the unlikely risk of failure.

Wednesday, 21 January 2015

Pensioners add to UK deficit and national debt.

When I hurried to buy my tranche of the Pensioner Bonds for the Over 65s, generously issued by our Chancellor George Osborne last Thursday at the currently attractive 4% rate of interest, I was wryly aware that in doing so I was actually helping to add to the government deficit and the National Debt, both of which the Tories scream it is their number one priority to reduce.  What I hadn't thought through was the idiocy of the government's doing it in such an expensive way.  The hypocrisy of this is detailed in two blogs, by  Richard Murphy of the Tax Justice Network, and
 by Chris Dillow, which my friend John Cole has kindly brought to my attention.

First, let's be quite clear that the National Debt, the accumulation of government deficits over the years, is largely held internally and is not therefore a  "burden" on the economy as a whole.  These Pensioner Bonds provide a useful illustration.  By buying them we pensioners are lending to the government and so adding to the National Debt.  Since I already have  some National Savings Certificates I already own part of the National Debt.  If my application for the Pensioner Bonds is successful I shall own a bit more of it.

I shall receive interest on this money I have lent to the government.  I also pay taxes.  Some of those taxes will be used to pay me the interest.  What goes round comes round.  In the jargon it's known as the "Circular Flow of Income" and in economics lessons we draw pretty pictures to illustrate it.

National Savings, of which the Pensioner Bonds are part, constitute a fairly small part of the National Debt.  The bulk of government borrowing is done by the sale of bills and bonds ("gilts") to institutions such as private pension funds, insurance companies, banks and other financial institutions.  As Chris Dillow  points out, the current rate of interest necessary to attract buyers for gilts is a mere 0.6%.

So Osborne has set aside £10bn to be borrowed from we pensioners at 4%, (or 2.8% if we buy the 1 year bonds) when he could have borrowed it from the markets at 0.6%.  Dillow calculates that, if the whole of the £10bn  is taken up  then the government will be paying out £300m per year more in interest to pensioners than it would have had to pay if it had borrowed from the usual sources.

Financial sense this is not.

Both bloggers further point out the effects on the distribution of wealth  of the fact that  only the over 65s may buy these Bonds and benefit from  such a generous (by present standards) rate of interest. But everybody in the country pays tax - those who don't earn enough to pay income tax  pay VAT, duty on petrol, alcohol and cigarettes if they consume them, and sundry other taxes. So this is a transfer of wealth from everybody, including the young, to the elderly.  Some might call that a bribe.

Lest the Labour supporters get too self righteous about this wickedness, it is worth remembering that Gordon Brown gave us an even more obvious bribe when he doubled our Winter Fuel Allowance in 2000, with an election due in 2001.

Mature democratic politics this is not.

Monday, 19 January 2015

UK election 3: Tories' six key themes.

Last week David Cameron set out the six key themes on which the Tories will fight the general election .  They are:
  1. Tackling the deficit.
  2. Creating jobs.
  3. Lowering taxes.
  4. Improving education.
  5. Tackling the housing shortage. 
  6. Helping the retired.
Perhaps it is a bit unfair to comment on these priorities before they publicly flesh out the policies they are going to follow. Nevertheless here are a few comments in anticipation.

The deficit: is not a priority.  This is not only my view but was expressed on the Radio 4 "Today" programme last week by a leading economist  (I didn't catch his name but he was not one of the "usual suspects.")  His view was that cutting the public deficit was not particularly urgent, and that a time when interest rates are at an historic low is not a bad time to be owing money.

The Tories will cut the deficit by further reducing public expenditure and abjuring tax increases.  This will reduce state expenditure to the proportion that existed in the 1930s.  This is not the same as reducing state expenditure back  to the level of the 1930s, as a left-wing shorthand  likes to claim: it will be 30% or so of a much larger national income.  But the responsibilities of the sate have increased since the 1930s.  We have a National Health Service with a plethora of wonder treatments which didn't exist in the 1930s, but  some of them are expensive.  And we have a far bigger proportion of  people, including  me, living to a ripe old age, which means not only more expenditure on health care but  but also on pensions.  And we now have universal secondary education, higher education provision for half the population rather than the five per cent back then, and lots more. So we need a bigger proportion of the national income to pay for these welcome advances.

 The really urgent problem is, of course, the balance of (external)payments, because that is money owed to other economics, not largely money circulating within our own.  But the balance of payments, which dominated economic discussion in the 50s and 60s, and helped to defeat the Wilson government, now hardly gets a mention

Creating jobs: the jobs created so far have very largely been the wrong sort of jobs: part-time, zero hour contracts, unwelcome self-employment - and in the wrong places (London and the South East rather than the rest of the country).*  Tory policies have not yet succeeded in achieving the promised "rebalancing" of the economy, away from dodgy London based finance to skilled, well-paid work in the rest of the rest of the UK.

Lowering taxes:  agreed, lower taxes are part of the Keynesian formula for stimulating economic recovery.  The most sensible tax to lower would be VAT as that is the one which would give most stimulus to demand (as Alastair Darling's cut to 15% in 2008 indeed did).  Tax cuts to the richest will have least effect, and there's not much evidence that such cuts stimulate entrepreneurial innovation.

Improving education:  although the present structure of our education system is profoundly wrong, practitioners are desperate for a rest from disruptive re-organisations.  Therefore the best thing to do is leave education  alone for at least five years, and give the practitioners the chance to make the flawed system work as best they can.  More academies, so called "free" schools, faith schools, schools for profit, league tables, centralisation  and other items in the Tory lexicon will continue to do more harm than good.  The one change that would do good rather than further harm is to abolish OFSTED, compensating its ex-staff with guaranteed posts in their nearest inner-city comprehensive

Tackling the housing shortage:this will not be achieved by allowing private builders to build posh houses wherever they wish.  I can't see the Tories offering the practical solution of allowing local authorities to borrow in order to finance the building of mixed housing with a large proportion of affordable homes, as far as possible on brownfield sites.

Helping the retired: a higher state pension, an end to the bedroom tax and better care facilities for those of us who need them would be welcome.  I'd be happy to help finance these by giving  the winter fuel alliance and free TV licence only to those not on the list of income tax payers,  but I suspect these perks will be retained in order  to buy our votes.

A good election campaign would see constructive discussion on measures to deal with these areas.  Instead so far all we've had is a cry of "chicken" from Labour because  the Tory list doesn't include the NHS or Europe.

PS  added 21/01/14

To the "wrong sort of jobs" list should be added the 1.2 million agency workers"  Their "ghost" conditions, without any guaranteed hours, income, holiday entitlement or security to be expected from employment in a developed county are described in an article by Aditya Chakrabortty in yesterday's Guardian.  In the same issue an article by Polly Toymbee discusses the proposal to privatise the staff at the National Gallery and the consequent likely deterioration in the service provided and the conditions of those who provide it.

Thursday, 15 January 2015

UK Election 2: Leaders' Debates

David Cameron's anxiety that the case for the Green Party be thoroughly aired in the coming election is very touching.  Maybe we're back to the days of "hug a huskie."  Or maybe the cynics are right and he's merely looking for any old excuse not to be confronted by the UKIP leader, Nigel Farage, whose presentational charisma somewhat exceeds even his own smooth performances.  If the debates do not take place because Cameron takes his bat home if the game is not to be played according to his liking, that will remove some of the fun from with election campaign.  But it will also remove some of the potential harm.

The debates in the 2010 election attract viewers in their millions and thus, it is claimed, increased interest in politics. This interest was indeed reflected in  a slight increase in turnout, to a not all that respectable 65.1% compared with a miserable 61.4% in 2005 and a disgraceful 59% in 2001.  But I can't help feeling that the leaders' debates generate voyeurism in the manor of X-factor and the Big Brother House rather than a genuine interest in the policies presented.

True it is important to be able to judge the personality of someone who wants to be our prime minister and his or her performance in a debate is one way of doing this.  But we must remember that our most successful post-war prime minister, Clement Attlee, would probably have fared very badly under the TV lights had they existed at the time.  And the personalities of the other leading politicians contending to be in to be in the government are important, and the policies they advocate even more  important..

If the 2010 pattern is followed then the three leaders' debates will be supplemented by one debate featuring  the rival  chancellors of the exchequer (and please, Mr Clegg, put Vince Cable up for this rather than Danny Alexander, for reasons that are pretty obvious to those of us who have seen and heard both perform). I would take this further and :

  • add additional debates by the relevant party spokespersons on  Home Affairs, Foreign Affairs including Defence,  Social Security and Health,  and Transport and Housing.
  • cut the leaders' debates to two, one at the beginning of the series and one at the end.
The excitement of such a series might sag a little in the middle  but it would  give us a much better  idea of the qualities of the rival teams and the policies they hope to implement - less of a "circus" and more of the likely quality of our lives in the future.

Saturday, 10 January 2015

UK Election 1: A sensible start from the Liberal Democrats

Battle has now been joined in earnest for our general election in May, and it looks as though we're in for a very boring four months.  So far the Conservatives have boomed  that Labour is not to be trusted on the economy (which is perfectly true, but not in the way they mean) and Labour shrieks  that the Tories are not to be trusted on the National Health Service (NHS) which is perfectly true by any definition - after all the Tories specifically promised in 2010 that the NHS was "safe in their hands" and that there would be "no top down reorganisation."

Whether the much publicised difficulties of the past week (a private firm pulling out of its contract to run a hospital, several hospitals unable to meet their four hour "waiting times" targets  in their accident and emergency departments) are the result of the inappropriate and ill-timed top down re-organisation  or the funding freeze when the demands on the service are increasing, or both, or something else, is for experts to argue.  Whatever the reason(s) the fact remains that the NHS is not meeting our expectations, and the evidence is that "privatisation" is making it less rather than more effective.

Predictably Labour claims that the NHS is in "crisis."  This is nonsense, typical of the hyperbolic campaigning style which puts people off politics.  The truth is that the NHS is a highly efficient and cost-effective means of caring for the nation's health, but it is getting a bit frayed at the edges, partly because our  expectations are increasing, and partly because  people like me are living longer (a jolly good thing in my view)  but tend to have an increasing number of "health issues" which we'd like dealt with.

Amid the furore Nick Clegg has come up with a balanced and reasonable proposal.  In summary he suggests that we should increase the current funding of the NHS by £8bn in three stages by 2020-21 by:

  • continuing each year the additional £2bn announced in the recent autumn statement for 2015-16;
  • adding a further £1bn per year financed by (i) capping pension tax relief for the wealthiest (long overdue in my view), (ii)  raising dividend tax to the level of income tax and, (iii) scrapping the "shares for rights " scheme intruded by the Tories, which apparently costs £100m a year);
  • from 2017-18, increasing health spending in line with growth in the economy.
I admit to being not at all t sure how that adds up £8bn, but I find the  proposal welcome for two reasons:

1.  it not only admits that extra money is necessary, but also explains how it is to be raised, and
2.  it acknowledges that funding for at least this part of the state is to increase along with the growth of the economy.  This is in stark contrast to Tory proposals to continue cutting back the size of the state.

So well done, Nick, and continue to put forward balanced and costed proposals.  The signs are that much of the media has now written us off as an irrelevance, but I am confident that if we avoid the shrillness of the others and are sensible with what we offer we shall gain a hearing.  We may even reap an electoral reward.

Saturday, 27 December 2014

Orwell's "Newspeak" has arrived, and few of us notice.

My first appointment as a teacher was in the late 50s, to a school in Northolt, outer London.  There discipline was maintained  by the award to any pupil who offended against the school's ethos of a "black mark."  Recipients of these were made to stand up in one of the daily  assemblies and were were given a public lambasting by our somewhat ferocious Scottish headmaster. I don't recall any corresponding "white mark" for achievements of which the school approved, but maybe there was one.

However, when in the early 70 I took over my post as deputy headmaster of Port Moresby High School, then in the Australian sphere of influence  a more liberal regime operated. Although misdeeds were noted by a "demerit," good works received  a "credit."  I worked on this system by urging the "demeriters" in private to adopt more virtuous paths, but praising the "top credit winners" publicly in the weekly assembly.  I like to think that this was instrumental in improving the "tone" of the school.

In his very readable book "How to Speak Money"* novelist and critic John Lanchester, who claims not to be an economist, attempts to unravel the language of economics for the general reader. To facilitate this he has invented the word "reversification:" a way in which economists in general, but monetarists is particular, turn the meaning of a word into its opposite in order to make the concept it describes more acceptable.

To me the most striking example is the use of reversification to make the concept of debt respectable.  Debt used to be a "black mark" or "demerit":  a condition entered into by only the most feckless of people.  In extreme cases, they were put into prisons.  A common form of debt in my youth was called "hire purchase" and my parents were very proud of the fact that, to furnish their home, they never descended  to this disreputable device.  "Every stick was paid for."

So to make debt respectable we have changed its name to "credit"  What was laudable at Port Moresby High School is now the superficially  respectable condition which, in what turned out to be its  unsustainable private form, brought  the western economic system to a halt  in the mid 2000s.  And if, in Britain, the system is recovering, it is largely the consequence of the accumulation of yet more private debt based on yet another housing boom, the very conditions which brought the system down in the first place.

John Lanchester's book* is a excellent read, even for those who think they know quite a lot  about economics.

* How to Speak Money, pub Faber and Faber, 2014