Why post war surpluses don’t cause recessions.

Advocates of Modern Monetary Theory (MMT) frequently claim that surpluses are followed by recessions. And no doubt Keynsians claim likewise  - and there isn’t much difference between Keynsainism and MMT. 

However, there is a big exception to that rule: it can be argued that there are instances of  surpluses following wars but with no recession occurring as a result.

For example the Napoleonic wars were followed in Britain by the biggest economic expanssion  the human race had ever seen: the industrial revolution – or should I say the continuation of the industrial revolution. 

World War I was followed by the “roaring twenties”. And the 1950s and 60s in Britain were two decades of very low unemployment compared to today.

I’m not suggesting that there is a boom in every year immediately after a major war. But it’s certainly possible to point to instances of a surplus in one or two years being followed by an absence of a recession one or two years later.

So does that weaken the claim that surpluses cause recessions? Well no – because there is something unique about wars: it’s that governments tend to run up large debts during wars and then pay them off afterwards.

In other words during a war, the private sector acquires large dollops of “net financial assets” to use MMT parlance, but it cannot spend those assets during the war because private consumption is artificially constrained during wars. It is constrained by the borrowing itself, and possibly by extra tax and possibly by rationing (as occurred in Britain in WWII).

But after the war, those government bonds mature, so the private sector’s cash flow position is transformed. And as regards bonds which have not yet matured, they can always be used as collateral to obtain a bank loan.

In that situation, government can of course allow private consumer spending to go thru the roof. But governments normally want to retain a significant chunck of GDP for their own uses: to spend on education, the military, law enforcement and so on. So with a view to damping down private spending and leaving room for government spending, governments have to keep taxes high relative to government spending. That is, government has to run a surplus. But that surplus is not necessarily going to totally outweigh the above “improved cash flow” phenomenon.

Of course governments’ grasp of economics was far too unsophisticated to implement the latter policy DELIBERATELY after the Napoleonic wars and WWI. Plus I doubt they were sophisticated enough to do it deliberately after WWII.

But if you are looking for the reason why a surplus does not necessarily cause a recession just after a major war, then the reason is set out above – er  - I think.

Euro periphery competitiveness can be improved by adjusting taxes.

The current austerity in the periphery is aimed at cutting periphery costs, that is, effectively devaluing the currencies of the periphery – or “internal devaluation” as it is sometimes called.

And devaluation raises the costs of imports for the country that devalues, while reducing the price of exports for foreigners buying stuff from the country.

But those effects can attained by adjusting taxes in the relevant country. In 2010, I suggested doing it by cutting payroll taxes and increasing personal taxation.

Gita Gopinath suggests an alternative, namely to cut payroll taxes (as above) but instead of raising person taxes, to raise VAT. See also here.

The above tax adjusting policy might very easily not be a full solution to the problem (as I think Gita concedes). That is, adjusting taxes might not bring as big an effective devaluation as is required. But the measure would certainly help.

Moreover, adjusting taxes is a trick that can be played only once every decade or two. That is, those adjustments distort the tax system away from what was previously considered to be an optimum assortment of taxes. And that distortion must presumably be unwound, which of course constitutes a REVALUATION. And the latter has to be countered with austerity.

Still, the above sort of tax adjustments are a way of spreading  austerity over a larger number of years: i.e. avoiding extreme austerity in relatively few years.

How to cut the cost of housing by 25%.

The price of the average house in Britain (around £160,000) is artificially inflated to the tune of about £45,000 because of artificial constraints on the amount of land made available to house builders. That’s according to this Policy Exchange study. I actually did my own back of the envelope calculations BEFORE coming across the Policy Exchange study, and got much the same answer: around £45,000.

So . . cut the amount of bureaucracy involved in getting planning permission to build houses and the reduction in the cost of housing would make an owner occupied house unaffordable for many more first time buyers. Plus there is a saving in the form of fewer bureaucrats for taxpayers to pay for.

But that would be too simple. Instead, the British government has thought of a more expensive way of making housing more affordable for first time buyers: it’s to subsidise them.

So while one lot of bureaucrats are busy making it difficult to build houses, there is another lot of make it easier.

And if you object to more countryside being covered with concrete and housing estates, then answer this: which political party have you been voting for for the last ten or fifteen years? On of the main three parties: Conservative, Labour or Lib Dem? Then you’ve voted for a party which advocates or turns a blind eye to mass immigration, the main cause of the rise in demand for housing. You’re getting what you voted for.

The IMF is still mesmerised by “consolidation”.

This recent IMF publication repeats over and over the idea that countries need to “consolidate”, i.e. reduce their deficits and national debts. They say for example:

“the top priority for the U.S. is to . . . .  agree on a credible medium-term fiscal roadmap to bring down debt.” (p.1).

“Japan needs to balance upfront stimulus with more ambitious plans to bring down debt…”. (p.1)

“Medium-term fiscal consolidation remains key.” (p.6).

Here (for the umptheenth time) is why aiming for any specific amount of consolidation is nonsense.

National debt is an asset for the private sector, i.e. for those who actually hold such debt. Moreover, that debt is not greatly different to money (monetary base to be exact). That is, both national debt and monetary base are a kind of liability of the government / central bank machine.

If the private sector is in saving mode, rather than in “irrational exuberance” mode, it will try to accumulate national debt or monetary base. And if the public sector or “government / central bank machine” does not supply the savings that the private sector wants, then demand declines and unemployment rises, and for the well known “paradox of thrift” reason pointed out by Keynes.

It is therefor nonsense to “consolidate” as long as the private sector is in savings mode.

Moreover, it is near impossible to predict what the private sector will be doing in one, two or three years time: the private sector may have a fit of irrational exuberance in two years time, or it may not.

Ergo any “consolidation” needs to REACT TO whatever the private sector is doing. Put that another way, it is nonsensical to make any sort of long term plan as regards deficit reduction or “consolidation”.

As for trying to work out how much consolidation to do in ten or twenty years time – something you will see attempted over and over in Peterson Institute publications - that is just moronic.

And that’s it. It’s desperately simple.

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Hat tip to Mike Norman’s blog for alerting me to the above IMF publication.

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The hyperinflationary effects of QE :-)

The impotence of QE.

Congratulations to Azizonomics for publishing this chart showing the non-effect of QE over the last four years on endogenous money (commercial bank created money).

Of course the collapse of endo money might have been worse had it not been for QE (a favourite argument used by the Bank of England). But I prefer the explanation given by Steve Keen and advocates of Modern Monetary Theory, namely that the endo tail wags the exo dog. In other words, commercial banks lend money into existence when they see viable lending opportunities. As to what the central bank is doing with its exo money, well commercial banks just couldn’t care less.

Or put another way, as Simon Jenkins keeps pointing out, the best solution for a recession is to hand money to the consumer or raise public spending (depending on your political preferences). Having done that, commercial banks will then expand their lending (or not) as they see fit.

And if anyone wants to argue that businesses are currently having difficulty getting bank loans, my answer is that that is hardly surprising: banks were lending like there’s no tomorrow prior to the crunch and have now realised their mistake. I.e far from bank lending now being LESS THAN optimum, it is arguably NEARER the optimum.

Banking in the UK has expanded by a whapping TEN FOLD relative to GDP over the last 30 years. Was economic growth severely constrained 30 years ago because an inadequately sized banking industry? I think not. In fact economic growth then was much better than over the last 5 years. How on earth did we manage 30 years ago despite an grossly inadequate banking industry. I’m baffled.