http://www.telegraph.co.uk/finance/c...out-of-it.html
There are many uncertainties about the current situation but logic should not be one of them.
Yet I find that many people contemplating how we are going to escape from recession commit logical errors. I often hear: "We cannot hope to spend our way out of recession." Sorry, how else can we hope to escape from recession?
A recession is a situation in which output, spending and income are all below normal or below potential. If output and income are to go up then someone must spend more. There is simply no other way. As a matter of logic. The only sensible debate is about who should spend more, on what, and how they can be persuaded to do so.
If you think in terms of aggregates, there are four candidates to do the increased spending: consumers, companies, the government, and foreigners. And for the world as a whole, there are no foreigners. So if we say that governments cannot be allowed to borrow more, because they are too much in debt already or because they waste the money, then we are left with only two candidates.
If we also say that consumers cannot be expected to spend more because they need to repair their financial position, then we are down to only one: companies. If companies could be prodded into increasing their spending on investment that could be a good thing. But in current conditions the chances of getting companies to expand their spending are slim. They react to the state of demand, which at the moment looks dire.
So that's it, then. We are stuck with it. We had better learn to live with the recession. Or maybe even love it? After all, we brought it upon ourselves. It was thinking such as this which put the "Great" in the Great Depression.
We need to go back to the four candidates. Fortunately for us in the UK there is a real chance of getting some help by persuading foreigners to spend more on our output, or by us spending less on theirs (which comes to the same thing). We have been running a huge trade deficit for years and eradicating that would alone mean a boost to GDP of about 4pc.
I believe that this will eventually contribute the lion's share of the answer. For once our exports start picking up that will also be the spur to a surge in corporate investment. That is why the fall of the pound has been so important. It is part of the solution, not the problem. But the benefits of our increased competitiveness will take some time to come through. While the world economy is spiralling down I doubt that our exports can pick up. So the question is how to bridge the gap between now and then.
The answer to our troubles, we are often told, is a new frugality. Reduce government spending and borrowing. That is the way forward. Forward to where? The first mistake here is the confusion of two issues. Is government spending too high? In my view the answer is incontrovertibly "yes". There is a huge waste of resources pretty much across the board. Would we better off if this wasteful spending was eliminated and taxes cut commensurately? Yes. Would this help to end the recession? No. The recession is about a shortage of aggregate demand. Reducing government spending and giving the money to taxpayers to spend instead will do nothing directly to boost aggregate demand. In fact, it may well reduce it.
The second mistake is to think of the problem facing society as a whole as the same as the problem facing us as individuals. If we wish to improve our financial balance then we can either increase income or reduce spending. But for society as a whole, aggregate spending equals aggregate income. If we all as individuals seek to improve our position by spending less, our income will fall as result of someone else's reduced spending.
Which brings me to consumers and another logical tangle. Suppose we want increased consumer spending but do not approve of increased borrowing. The answer must be reduced saving. But I thought that we didn't want that either! The logic is inexorable. To get higher consumer spending than would otherwise have been the case then collectively consumers will have to save less or borrow more. In the current environment, trying to boost saving is the economics of the madhouse.
Nevertheless, I have much sympathy with all those savers, many of whom write to me complaining that their interests have not been taken care of, whereas excessive borrowers "who got us into this mess in the first place" are bailed out by lower interest rates. The Conservatives' proposal to end tax payments on savings income for basic rate taxpayers seems fair. It also makes perfect long-term sense. The new healthy economy which we must build after this crisis is over should involve higher personal saving.
But do not imagine that this will contribute to the growth of aggregate demand – which is our immediate problem. Encouraging more saving now will worsen the recession. That is the paradox of thrift which Keynes so clearly demonstrated in the 1930s and it applies today.
So I offer two morals and a suggested way forward. First, do not confuse the situation facing you as an individual with the position facing society as a whole. Second, do not confuse what needs to be done on grounds of equity or long-term economic health with what needs to be done to lift us from recession and prevent it becoming a depression. Some things which might contribute to the first objective would undermine the second.
There is a clear path ahead. In the short term, we must rely on an increased government contribution to demand through higher borrowing (although more by tax cuts, please) and increased consumer spending. The latter will require either more borrowing or less saving. Within a couple of years, though, these two sources of demand can be wound down as two others take over – a huge boost to growth from our net exports and a concomitant rise in corporate investment.
The winding down can take place through cuts in government borrowing, achieved through cuts to spending and higher tax receipts generated by economic growth, as well as higher interest rates, effectively undoing the stimulus packages of the last year. But it would be madness to be thinking about that now. Now is the time for doing everything possible to boost aggregate demand.
There are many uncertainties about the current situation but logic should not be one of them.
Yet I find that many people contemplating how we are going to escape from recession commit logical errors. I often hear: "We cannot hope to spend our way out of recession." Sorry, how else can we hope to escape from recession?
A recession is a situation in which output, spending and income are all below normal or below potential. If output and income are to go up then someone must spend more. There is simply no other way. As a matter of logic. The only sensible debate is about who should spend more, on what, and how they can be persuaded to do so.
If you think in terms of aggregates, there are four candidates to do the increased spending: consumers, companies, the government, and foreigners. And for the world as a whole, there are no foreigners. So if we say that governments cannot be allowed to borrow more, because they are too much in debt already or because they waste the money, then we are left with only two candidates.
If we also say that consumers cannot be expected to spend more because they need to repair their financial position, then we are down to only one: companies. If companies could be prodded into increasing their spending on investment that could be a good thing. But in current conditions the chances of getting companies to expand their spending are slim. They react to the state of demand, which at the moment looks dire.
So that's it, then. We are stuck with it. We had better learn to live with the recession. Or maybe even love it? After all, we brought it upon ourselves. It was thinking such as this which put the "Great" in the Great Depression.
We need to go back to the four candidates. Fortunately for us in the UK there is a real chance of getting some help by persuading foreigners to spend more on our output, or by us spending less on theirs (which comes to the same thing). We have been running a huge trade deficit for years and eradicating that would alone mean a boost to GDP of about 4pc.
I believe that this will eventually contribute the lion's share of the answer. For once our exports start picking up that will also be the spur to a surge in corporate investment. That is why the fall of the pound has been so important. It is part of the solution, not the problem. But the benefits of our increased competitiveness will take some time to come through. While the world economy is spiralling down I doubt that our exports can pick up. So the question is how to bridge the gap between now and then.
The answer to our troubles, we are often told, is a new frugality. Reduce government spending and borrowing. That is the way forward. Forward to where? The first mistake here is the confusion of two issues. Is government spending too high? In my view the answer is incontrovertibly "yes". There is a huge waste of resources pretty much across the board. Would we better off if this wasteful spending was eliminated and taxes cut commensurately? Yes. Would this help to end the recession? No. The recession is about a shortage of aggregate demand. Reducing government spending and giving the money to taxpayers to spend instead will do nothing directly to boost aggregate demand. In fact, it may well reduce it.
The second mistake is to think of the problem facing society as a whole as the same as the problem facing us as individuals. If we wish to improve our financial balance then we can either increase income or reduce spending. But for society as a whole, aggregate spending equals aggregate income. If we all as individuals seek to improve our position by spending less, our income will fall as result of someone else's reduced spending.
Which brings me to consumers and another logical tangle. Suppose we want increased consumer spending but do not approve of increased borrowing. The answer must be reduced saving. But I thought that we didn't want that either! The logic is inexorable. To get higher consumer spending than would otherwise have been the case then collectively consumers will have to save less or borrow more. In the current environment, trying to boost saving is the economics of the madhouse.
Nevertheless, I have much sympathy with all those savers, many of whom write to me complaining that their interests have not been taken care of, whereas excessive borrowers "who got us into this mess in the first place" are bailed out by lower interest rates. The Conservatives' proposal to end tax payments on savings income for basic rate taxpayers seems fair. It also makes perfect long-term sense. The new healthy economy which we must build after this crisis is over should involve higher personal saving.
But do not imagine that this will contribute to the growth of aggregate demand – which is our immediate problem. Encouraging more saving now will worsen the recession. That is the paradox of thrift which Keynes so clearly demonstrated in the 1930s and it applies today.
So I offer two morals and a suggested way forward. First, do not confuse the situation facing you as an individual with the position facing society as a whole. Second, do not confuse what needs to be done on grounds of equity or long-term economic health with what needs to be done to lift us from recession and prevent it becoming a depression. Some things which might contribute to the first objective would undermine the second.
There is a clear path ahead. In the short term, we must rely on an increased government contribution to demand through higher borrowing (although more by tax cuts, please) and increased consumer spending. The latter will require either more borrowing or less saving. Within a couple of years, though, these two sources of demand can be wound down as two others take over – a huge boost to growth from our net exports and a concomitant rise in corporate investment.
The winding down can take place through cuts in government borrowing, achieved through cuts to spending and higher tax receipts generated by economic growth, as well as higher interest rates, effectively undoing the stimulus packages of the last year. But it would be madness to be thinking about that now. Now is the time for doing everything possible to boost aggregate demand.
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