Sunday, July 1, 2012

Tim Worstall’s hopeless criticism of Krugman and Layard.

I’m much heartened by the response so far to the Krugman / Layard manifesto. That is, I’m heartened by the low quality of the criticism aimed at it.

First, there is a hopeless article by Tim Worstall in the Telegraph. Worstall is normally clued up on economics (and witty and sarcastic, which I like). But he went right of the rails in the Telegraph article.

He makes a very common mistake, namely claiming that deficits during recessions have to be matched by surpluses at other times. He argues further that since it is difficult to cut public spending or increase taxes (with a view to implementing surpluses), Keynsianism is fatally flawed.

Deficits never have matched surpluses!!!

As to the idea that deficits need to be matched by surpluses at other times, the first whapping great flaw in this idea is that deficits over the last century or so JUST HAVEN’T matched surpluses. I.e. it’s been a case of more or less constant deficits. For some figures, see here or here. It’s a sea of red ink!

And there is a simple and perfectly acceptable reason for this more or less constant deficit, which stems from the fact that we aim (I think rightly) for inflation of around 2%.

First, assume national debt (ND) and monetary base (MB) are to remain constant relative to GDP (which over the very long term is the actuality). For example UK national debt relative to GDP in 1900 was much the same as a century later: a bit under 50% of GDP.

Assume also that inflation is running at the target 2% rate. That means ND and MB will decline at 2% p.a. in real terms unless they are constantly topped up. And that topping up can only come from a deficit.

Moreover, there is economic growth in real terms to consider. If that’s running at say 2%, and assuming again that ND and MB are to remain constant relative to GDP, than requires even more “topping up”. Now that’s a fair amount of “topping up induced deficit” in total.

That explains why deficits during the last half century or so just haven’t matched surpluses at other times. It’s been a case of more or less constant deficits.

Bread and circuses.

As Worstall’s final point, namely that the plebs are always demanding more bread and circuses, i.e. more free goodies supplied by the state, while objecting to the increased taxes inevitably required to pay for the goodies, well that’s ALWAYS a problem. But the fact that the average citizen or voter lives to some extent in Alice in Wonderland is not a valid criticism of Keynes.

Moreover, Keynsian style deficits DO NOT NECESSARILY require increased public spending. A Keynsian deficit can perfectly well consist of reducing taxes rather than increasing public spending: a further nail in the Worstall coffin.

Josef Joffe

Another silly attack on Krugman and Layard appeared in a letter in the Financial Times from the editor of Die Zeit. (I thought Germans had brains!!).

Joffe employs about three hundred words to tell us he doesn’t understand where the money for the KL manifesto will come from. Well I’ve got news for Joffe.

The entire world now operates a fiat money system!!!! That’s a system under which banks, both central and private, can create money out of thin air.

Of course, as the massed ranks of economic illiterates never tire of reminding us, that ability to create money out of thin air has inflationary risks. But the historical reality is that for 95% of the time, responsible countries manage to keep inflation under reasonable control.

Keynsianism does have an inflationary bias. Keynsians are well aware of that. I’m not sure exactly what the alternative to Keynsianism is, but let’s call it a “gold standard / Austrian / do nothing” policy. And the problem with the latter is that it has a DEFLATIONARY bias: i.e. it gives us 1930s style decade long mass unemployment and human misery.

I prefer Keynsianism warts and all.


No comments:

Post a Comment