Ideology and economics

Barack Obama says:

Government has to start living within its means, just like families do. We have to cut the spending we can’t afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs.

For ideological reasons, one might believe that limiting or reducing government is better. However, it does not follow that doing so is a painless exercise.

If one does want to see government expenditure reduced for ideological reasons, the question is when and how to do so. Clearly, doing so in an abrupt way after a credit bubble is going to be the wrong way. I believe both President Obama in the US and Prime Minister Cameron in the UK understand this. They are trying to make cuts (or reduce the pace of growth) in a way that doesn’t lead to the outcomes we saw in Ireland, Latvia, or Greece. It remains to be seen whether they will be successful.

Still, we have to be clear what is happening here: Post credit bubble fiscal austerity leads to depression. We are making cuts that suck money out of the economy – and there is no confidence fairy that causes businesses or households to compensate for that adjustment as President Obama points to. Rather, the desire to save in the private sector is due to the need for deleveraging in the household sector and Corporates spending like it’s the 50s due to business uncertainty in the business sector.

Basic accounting tells us that when the private sector wants to net save, a reduction in government expenditure leads to a concomitant reduction in private sector expenditure as well and a loss of jobs – just the opposite of what the confidence fairy in voodoo economics would say. And that means, in the short run, focusing on deficit reduction increases deficits unless the cuts are very, very large.

Everyone knows the debt ceiling debates are not about deficits anyway. It’s about limiting government for ideological reasons. Why the Republicans don’t just say so is beyond me. I reckon it is because they fear people will be more resistant to supporting their agenda if they knew the real reasons behind it. Look at how seniors in New York have rejected Paul Ryan’s Medicare plans for example. So the Republicans have chosen deficit reduction for ‘bureaucratic reasons’.

Ostensibly the rationale for limiting government is because the debts and the waste are just too great. Real resources are being diverted away from more efficient and more socially desirable uses in the private sector. We do know, however, that cuts dealing with discretionary spending, and not with Medicare or Military spending, are chicken feed. Moreover, the US federal government budget would be balanced at full employment and a slight trade surplus. Social Security and Medicare are longer-term issues.

To me that says full employment is the shorter-term issue, entitlements and military spending are the longer-term issues. Realistically, you could cut future deficits by cutting future military spending, raising future Social Security age limits, and build in means testing to Medicare and Social Security without affecting the current economic situation. This is a political loser, though.

As far as the short- to medium-term go, remember that households are currency users while government creates the currency. That means government doesn’t face the same liquidity constraints that households do. The household analogy for government, while effective for people who don’t understand this, is flawed. Looking at Greece’s brush with default and sky-high interest rates shows us this. Greece with its 160% debt-to-GDP is a currency user in EMU, while Japan with its 200% debt-to-GDP is a currency creator like the US.

The expectations theory of interest rates tells us that long-term bond yields largely reflect consensus estimates of future short-term rates plus a liquidity premium. The bond vigilante wolves are simply not coming to blow our house down. Long rates reflect inflation and interest rate expectations. Full stop. The Fed could well target long-term rates with ‘rate easing’ if it so chooses, something that would be more effective than ‘quantitative easing’.

On the other hand, If you abdicate currency solvency as governments in Euroland have done, then, yes, the wolves will blow your house down.

In the quote at the outset, President Obama has simply chosen to use voodoo economics to justify something that will weaken the economy. Not only is it foolhardy to do so because it plays into his opponents’ hands, it is simply bad economics.

I may write up how to put this in terms that has the economics right – i.e. that satisfies key planks of Austrian small-government ideology but also gets the accounting tautologies right. Maybe then people will understand the issues.

  1. Dave Holden says

    “I may write up how to put this in terms that has the economics right – i.e. that satisfies key planks of Austrian small-government ideology but also gets the accounting tautologies right. Maybe then people will understand the issues.”

    I would be interested in this.

    On Obama – again he reminds me very much of Blair. What comes out of his mouth being more an indication of his short term political interests rather than what he believes.

  2. David Lazarus says

    “If one does want to see government expenditure reduced for ideological reasons, the question is when and how to do so. Clearly, doing so in an abrupt way after a credit bubble is going to be the wrong way. I believe both President Obama in the US and Prime Minister Cameron in the UK understand this.”

    Wrong. The cuts are primarily ideological in the UK. They deliberately left the NHS and overseas aid out of the cuts, yet the NHS is struggling with the change in regime and medical inflation. The cuts elsewhere have been deep and in areas that the coalition do not ideologically support have been deeper. For example cuts in regeneration grants for areas of high unemployment have been slashed. They favour letting the market find the equilibrium in these areas. While some cuts could have been made easily they did not specifically target those immediately.

    1. Edward Harrison says

      “Clearly, doing so in an abrupt way after a credit bubble is going to be the wrong way. I believe both President Obama in the US and Prime Minister Cameron in the UK understand this.”

      Both Obama and Cameron know that a recession is bad for electoral politics – and do not want to cut so much as to cause a double dip. This is what those two sentences mean. The sentences have nothing to do with WHY the cuts are being made/contemplated.

      1. David Lazarus says

        Well Cameron has a lot more breathing room electorally. He does not have to go to the polls for nearly 4 more years. So the cuts are now so that they can have an election giveaway in four years time. Obama has very little room with elections every two years. Plus with the Tea Party stopping any real debate, my long term prognosis for the US is bad. Not as bad as Greece, but definitely another Japan.

        Recessions are natural features in an economy but not allowing them to deflate bubbles lead us to this crisis. I find it frankly incredible that people actually thought property prices could never go down. That was true in the UK as well. If central banks had raised interest rates to stop the property bubble there would be a lot more banks around as it would have shown that property can fall and would have tempered speculation.

        I have been following William White from the BIS comments about regulation and think that the Fed’s policy of cleaning up the financial messes after ignores that they have no idea of how big these crisis can get. I prefer to lean on them much earlier with strict rules based regulation with no scope for human error in actually following them. Such a policy will lead to smaller recessions as the bubbles cannot get so big.

        1. Edward Harrison says

          Read Fred Sheehan’s account of what Fed officals and economists are saying today versus what they said in the 1950s. It is 100% clear that policy is more (asset price) inflationary.

          Easy money sends false signals to allocators of capital and always ends in tears.

          1. David Lazarus says

            As a Keynesian I do believe in sound money but actual wealth creation rather than the bubble wealth which while easier to achieve can have repercussions like credit binges and asset bubbles. Though I would have wanted savings targets as well. One thing that is exacerbating this crisis is the paradox of thrift as everyone rebuilds their savings. If they had adequate savings at the time of the crisis they would not need to save heavily and would have lower debts as well. Prevention would have been better but governments want the easy way out with credit fuelled bubbles rather than having to resort to proper fiscal management.

          2. Philip Pilkington says

            Isn’t that a bit like saying that policy during the Great Depression was more inflationary than in the 1950s?

            Apples and oranges.

            The 1950s — which came right on the back of massive government spending/(forced) private savings during the war years — were a time when underlying inflationary pressures were strong. Today they’re not — nor were they during the Great Depression.

            I agree with the sentiment regarding QE inflating asset prices — which is well dodgy — but I see little reason in comparing today’s macroeconomic policy with the 1950s. The 1930s, maybe. The 1870s-80s, maybe. But the 1950s? Surely not.

  3. Dave Holden says

    But isn’t the problem with “Keynesianism” that the business cycle rarely coincides with the electoral cycle so we never get the countercylical “saving” for the countercyclical spending?

    Not a solution to the current crisis but I’m more and more attracted to the “Positive Money” approach

    1. Benedict@Large says

      Dave Holden: “But isn’t the problem with Keynesianism that the business cycle rarely coincides with the electoral cycle so we never get the countercyclical saving for the countercyclical spending?”

      The problem with Keynesianism is that Keynes lied in his General Theory. He is later on record as saying that no, the part of the cycle where the stimulus got paid back was not true, and that the reason he didn’t include this was that he didn’t trust the people with that knowledge. Why? He didn’t say, but he was correct.

      What happens is that rents act to siphon off the money supply (yeah, Marx) until it can no longer support full utilization of capacity, and the “stimulus” then acts to replenish the “missing” money. Viewed in this fashion, of course, paying back any stimulus would simply push the economy back into recession.

      This also answers the criticism as to why the stimulus effect wears off. Instead of the quite ridiculous “rational expectations” theory (which has NEVER been able to explain its transmission mechanism), the siphoning simply continues until the money supply has once again dropped too low to support full economic activity.

      Now, is there an inflation problem cooked in here somewhere? Yes (from MMT), but unlike most suggest, it is supply side and NOT demand side inflation. What happens is that (Marx again) it becomes harder and harder as capitalism “matures” for the capitalist to maintain a sufficient ROI, and so the capitalist turns to increasingly non-capitalist measures to achieve it. Specifically as relates to inflation, the capitalist tries to establish monopolies where there is no price competition, something that is well evident in the recent right side obsession with privatizing public (monopolistic) infrastructure.

      So is there anything we can do to allow us to replenish the diminishing money supply without building up this tendency towards supply side inflation? Sure. TAX THE RICH.

  4. joebhed says

    Ed says that we are making cuts that take money out of the real economy. Stay there and ponder the debt-based money system of fractional-reserve banking.
    Then ponder, if you will, a new money system that is not based on debt – we can introduce real money into the economy without increasing debt.
    What is money?
    Why is ALL money created as a debt?
    Why is all money a debt?
    Why do we create money as a debt, repayable with interest that is never created?
    Not ever.
    We need to have growth in the economy to pay that interest
    And more debt.
    The fractional-reserve banking system does not work in reverse.
    And thus, in order to balance the budget, we need to take real money out of the real economy.
    You’re getting close, Ed.
    It’s the money system that’s broken.
    We need a new money system.

  5. Philip Pilkington says

    “It’s about limiting government for ideological reasons. Why the Republicans don’t just say so is beyond me.”

    Because if they cast the debate in ‘moral’ terms they wouldn’t get consensus from dumbass Democrats.

    Democrats love to think they’re more ‘rational’ than Republicans. They think that deficit reduction is ‘rational’ (note that this proves that most Democrats are just as irrational as Republicans, insofar as they follow quasi-moralistic soundbites rather than reasoned argument — they’re just more snooty about the way they present themselves). So, the Republicans realise that they need to fight the Democrats on their own pseudo-rational turf. And the Democrats swallow it — hook, line and sinker. Idiots.

    On another note, I don’t see any way that modern economies would function without increased government intervention. Ideology aside, I think this is where history is pushing us — toward Japan.

    No matter what they do, most Western governments are going to have to run sustained deficits for years to deal with the private wealth wipeout from the crash. Even when/if they can push the private sector back into debt to ‘reign in government’ this will just causes more crises and a reversion to high deficits. Either this never-ending cycle will continue or sustained deficits will be recognised as the norm (I obviously favour the latter, ‘stable’ approach).

    The alternative ‘high export model’ (i.e. China et all) are clearly going down the VERY Big Government path too. And just wait until they start bumping up domestic consumption. Those societies are going to become far more centralised; mark my words.

    Government intervention in the economy is what it is. History has been moving this way since the turn of the 20th century. At the same time the private sector has moved toward oligopoly (corporations etc.). I don’t think these are coincidences. I think they’re necessities built into the running of a mass society — especially a mass consumer society.

    Recently I started reading up on Janos Kornai’s work on planned Soviet economies. It’s very illuminating. He was fiercely critical of command economies (and rightly so), but to me the work reads into an overarching need for mass societies to have somewhat conglomerated institutions. It reminds me in many ways of Max Weber or Joseph Schumpeter. I really think that these are the realities of a mass society. You can either take that or leave it, as far as I can see.

    1. Valissa says

      Although on the surface it appears that ideological reasons predominate, the ongoing concentration of power needed to organize mass society is the important trend to understand. Since Philip has made those points well already, I will simply add that I am currently reading about this in “The Parable of the Tribes: The Problem of Power in Social Evolution (2nd ed.)” by Andrew Bard Schmookler. Highly recommended.

  6. Philip Pilkington says

    Another note on this.

    I think people too often misunderstand just how people feel that government ‘intrudes’ upon them. When working as a journalist I was always struck that people’s real problems with government and ‘The Man’ generally rarely had to do with too much government spending. Here’s an example — one among many.

    The head of the small businesses group in my local town told me about the group’s main concerns as they took a pounding amidst the Irish recession. I expected her to start whining about wages — which, from the point-of-view of aggregate demand is a self-defeating argument for small business owners to make. But not so.

    Her main concern was that the local government had increased the rates on parking meters around the town. This was encouraging people to shop elsewhere. I reflected on this and she was no doubt right. I often avoided the area due to the high parking fees.

    Now, the local government had done this in order to bump up revenues amidst the depression (tax receipts had obviously fallen, amongst other things). So, this was a problem not with TOO MUCH government spending, but TOO LITTLE.

    Add to this her other concern. The local Tesco — a large shopping chain (like Wal-Mart) — had bought lots of land in the town and had used it to build car parks. These car parks offered free parking… on condition that you shopped at Tesco. She told me that many of her regular customers (she is a florist) would always have supported her over Tesco, but now the parking fees were driving them away.

    Time and time again, these are the REAL problems that I find small business owners to face vis-a-vis government. And time and time again, it comes back to governments trying to run surpluses (or reduce deficits). Top level analysts — yourself included Ed — think that the macro overlaps with the micro. As per usual, it doesn’t.

    Will people ever realise this? I don’t think they will — I really don’t. The local politician listen with a tin-ear to the complaints and associates them with ‘too much government’. When he gets to the national level he equates ‘too much government’ with deficits and tries to reign in spending. What a strange cycle, indeed!

    1. David Lazarus says

      Yes, the same has happened in the UK. New Labour boxed themselves in with a pledge not to raise main income taxes. So to raise money, they created lots of small little taxes which hit you everywhere. They were called “stealth taxes”. So they might cap spending but local governments would raise all the local taxes they could to fill the gaps. Unfortunately these would include parking fees etc, just as Philip described, and they hit small businesses disproportionately more. Small businesses are the job creators and should have as level a playing field as anyone.

      Most people that I have asked think that being honest and increasing headline rates of taxes but at the same time abolishing and rolling all the other taxes up into income taxes is the fairest of all. The issue is that many usage taxes are under priced and so are like a giveaway for the rich. The recent arguments about an EU airline carbon tax are typical. The same for abolishing loopholes in the US. The Republicans are against any form of taxation. If so go and live in your Utopia, it is called Somalia.

      1. Philip Pilkington says

        But I think the key point here is that stealth taxes — we have lots in Ireland — are geared toward ensuring that the national/federal government run as low a budget deficit as possible. (In Ireland, our stealth taxation system is so effective that we ran budget surpluses for years — all under the tyranny of a grotesque nanny-state!).

        The national/federal government try to curb spending to ‘get government off our backs’ and this causes local government to… well… get on our backs.

        This problem is so misconstrued by small government types that I often wonder how they function at all, so much cognitive dissonance they must acquire in their daily lives. But then I realise, most ‘small government’ types work in the corporate sector — or at least, operate a business directly tied to the corporate sector — and never encounter actual small business owners.

        The social historian Christopher Lasch called this phenomenon the ‘revolt of the elites’. How fitting. But their revolt just squeezes the taxpayer ever harder and harder.

        1. David Lazarus says

          Yes central government have unrealistic expectations. When they cut the central taxes they must realise that local taxes will have to go up to make up for their changes. That has happened here nationally. Many local councils have increased their charges to make up for the losses and this harms small businesses most of all.

  7. Chad Kiernan says

    Admittingly I am an Austrian. I have a difficult time understanding how decreasing 43% of global military spending down to sat 35% would make the US Somalia. I do not see how that would drastically effect our national security either. We have 900 military bases in 135 countries. China comes in 2nd at 7% of global military spending. Currently US spends more than all CPU tires combined. I would appreciate your thoughts on specifically military spending in US. Looking forward to it.

    1. David Lazarus says

      My comment about Somalia was a GOP utopia of no taxation. You would then have the super rich paying for private armies as there would be no government revenue to cover the cost of any military spending.

      As for the US cutting its military spending. I have no problems with cuts to the military, but having seen what a mess the UK coalition have done with their cuts I feel sorry for the US with its bigger overspend on the military. I would exclude its black research projects as they have good long term prospects for the economy. I would target procurement. The fact that it costs $20 billion a year just to air condition the tents in Afghanistan and Iraq shows where easy cost savings can be made. In fact they could cut the spending down closer to 25% of worlds GDP, that would bring it into line with other countries. Though it would not have to be that deep. I would have thought anywhere between 30% and 35% would be adequate for now. Military spending has a low stimulus effect of around 0.4 so even if the savings went solely into inefficient tax cuts they would still be better overall.

  8. Chad Kiernan says

    Specifically, David and Phillip, I would appreciate your comments when you have a moment.

Comments are closed.

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