Tuesday, April 30, 2013

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.

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