Greece’s new Finance Minister on his ‘modest proposal’ for the Eurozone

Here is a nice video of Greece’s new Finance Minister Yanis Varoufakis being interviewed in Italy late last year before Syriza came to power. He talks about his ideas for resolving the Eurozone crises (plural) within the confines of  the current rules of the EU. These, he first set out in a paper entitled “A Modest Proposal for Resolving the Eurozone Crisis” (since updated). Notice how scathing he is of the President of the European Commission in particular. In his new role, he needs to be a little more diplomatic perhaps, but it will be interesting to see how he deals with the leaders of the Eurozone as they try to prevent Syriza from pursuing the policies it has a mandate to deliver.

Varoufakis was in Downing Street for a meeting with George Osborne today. It’s interesting to compare and contrast the two men. Varoufakis is a serious economist who has interesting ideas and talks in specifics, while Osborne speaks mainly in platitudes with no background knowledge of the economy whatsoever. Here’s the vid. The interviewer is Italian, but the interview is in English.

BBC’s Economics Editor struggles with economics of public debt

In a blog post about George Osborne’s Autumn Statement and what the future holds for the interest rate the UK government must pay on its debt, the BBC’s Economics Editor Robert Peston drew on conversations with his mates in the financial sector to concoct a story about the possible differences between Tory and Labour governments. Economists Paul Krugman and Simon Wren-Lewis objected to some of Peston’s post, causing Peston to write a response today. It’s not very impressive! This is the contentious passage from Peston’s original blog:

“Mr Market matters because he decides what price the government pays to borrow, and whether the government will continue to benefit from the current record low interest rates.

The Tory view is that those interest rates can only be locked in if the government continues in remorseless fashion to shrink the state and net debt.

What Labour would point out is that countries in a bit of a fiscal and economic mess and currently refusing to wear the hair shirt that the European Commission thinks necessary, such as Italy and France, are also borrowing remarkably cheaply.

And here is where Mr Market may be capricious, according to my pals in the bond market.

They say the UK’s creditors would probably be forgiving and tolerant of George Osborne borrowing more than he currently says he wishes to do, in that his record of reducing Whitehall spending by £35bn since taking office in 2010 has earned him his austerity proficiency badge.

But Ed Balls has never been chancellor, although he was the power behind Gordon Brown when he ran the Treasury and much of the country, both in the lean years from 1997 to 2000 and the big spending Labour years thereafter.

So Mr Balls has yet to prove, investors say, that he can shrink as well as grow the apparatus of the state.”

In his follow-up blog, he goes on to write:

“But does that mean a plan to reduce the deficit has been irrelevant to the borrowing costs paid by the HM Treasury? That seems implausible.

The government inherited a deficit (a gap between what it spends and what it raises in taxes) of 10% of national income or GDP. Wren-Lewis and Krugman would presumably agree that a 10% deficit is unsustainably high – and if it recurred for years would prompt fears for the UK’s solvency.

So getting the deficit down from 10% – or perhaps promising to get it down – must have had some bearing on the so-called risk premium for lending to the UK government, or the interest rate that the UK had to pay to borrow.”

So he’s selling the idea that the interest rates on government debt are determined by the bond vigilantes who look at how serious governments are at dealing with their deficits, weighing up the risk of default and setting rates accordingly. The trouble is, this is a total fairy story. Simon Wren-Lewis points out in his blog that interest rates on debt are based in part on expectations about future short term rates, and those expectations are for short term rates to stay low because the economy is still weak.

This is true, but there is an even more fundamental reason why Peston’s theory is a fairy story. The UK has its own currency, so the concept of solvency risk just does not exist. Don’t believe me? Here’s Alan Greenspan and head of the OBR Robert Chote making the same point, and this chart from Paul Krugman makes drives the point home well by comparing the rates paid by countries of the Eurozone with major economies outside the Eurozone.

Peston is not alone in believing this fairy story. The 2010 election was basically fought on this basis (although we don’t hear much about credit rating any more), but as economics editor he should be offering his viewers and readers some more reality-based analysis. Fair play to him for highlighting the disagreement over his first post, but he only succeeded in compounding his error by raising the issue of solvency. Let’s hope this conversation continues.

The Basics of Modern Monetary Theory

I haven’t done a post specifically about Modern Monetary Theory (MMT) for a while now, although that is the perspective from which I approach a lot of the issues I blog about. With that in mind, I thought I’d go back to basics and write a beginner’s guide to MMT as I see it. Any errors that follow will be mine alone. Please let me know if you spot one!

What is MMT? Modern Monetary Theory (MMT) is a branch of the heterodox Post Keynesian school of economics. At a basic level it is comprised of the following ideas:

1. Taxes drive money;
2. Taxes and borrowing don’t pay for government spending;
3. Countries like the UK cannot go bust;
4. Functional finance;
5. Sectoral balances;
6. Endogenous money;
7. Governments should pursue full employment;
8. Focus on real resources, not money.

So what do all these things means? In turn then:

1. Taxes drive money In theory, anyone can start their own currency. You or I could just print up some notes in our garage.  The trick though is getting it accepted. MMT posits that in order for governments to get its citizens to accept and use their currency, it is sufficient for them to impose a tax in that currency. Provided they are able to enforce the payment of the tax, people will be willing to work for payment in that currency in order to pay the tax. So the necessity to pay the tax in the government’s currency drives demand for that currency and ensures it has a value.

Further reading:

MMP Blog #8: Taxes Drive Money

Tax-driven Money: Additional Evidence from the History of Thought, Economic History, and Economic Policy

2. Taxes and borrowing don’t pay for government spending While governments do need to tax, MMT says that they do not do it to pay for their spending. Indeed, MMTers argue that government spending must come first. How can anyone pay a tax denominated in the government’s currency unless the government first spends it into the economy? So what are taxes for? We have already seen one function of tax in point 1. Taxes drive the nations currency. They also act to ‘make room’ for the governments spending, preventing that spending from generating inflation. Progressive taxes are also used for re distributive purposes to help a government meet it social aims, and taxes can also be effective to incentivise or disincentivise certain behaviours (e.g. smoking, drinking, polluting). But what about government borrowing? At the moment, if the amount of tax collected is less than the amount a government spends, it ‘borrows’ the rest by issuing government bonds. The amount it borrows is repaid with interest. MMT though, argues that similar to taxation, this borrowing is not undertaken to finance its spending, but to maintain its target interest rate. Under current arrangements, if a government didn’t match its spending to taxes plus borrowing, this would create excess reserves in the banking system, and this would drive overnight interest rates down to zero. Government borrowing also acts as a risk-free source of savings to the private sector, including pension funds.

Further reading:

Taxes for revenue are obsolete

Government bonds and interest rate maintenance

3. Countries like the UK cannot go bust In the run up to the 2010 UK General Election, it was said loudly and often that the UK was on the brink of bankruptcy, about the go the same way as Greece. We had run out of money. MMT says this is nonsense. Governments like the UK who issue their own currency cannot go bust, in the sense that they cannot run out of money. In this sense the UK differs from the Eurozone countries, who, since joining the Euro, no longer issue their own currencies. They are now currency users. This point is often missed when discussing government debts. The usual story is that when ‘the markets’ see government debts rising, they start to worry about how the debt will be repaid and so demand higher rates of interest before they will lend more. This happened in some of the Eurozone counties before the European Central Bank stepped in to stabilise the markets for these countries debt. Countries like the UK though have central banks that can always intervene if interest rates start to rise, so the risk of an interest rate spike here is low to non-existent. Interest rates on government debt are a policy choice for the currency-issuing government. To maintain the maximum flexibility over an economy, MMT recommends countries maintain their own free floating currency, and to only borrow in that currency.

Further reading:

There is no solvency issue for a sovereign government

Why do politician tell us Debt/Deficit myths which they must know to be untrue?

4. Functional Finance Functional finance is an approach to fiscal policy adopted by MMTers but first espoused by economist Abba Lerner. Functional finance has three rules:

1. The government shall maintain a reasonable level of demand at all times. If there is too little spending and, thus, excessive unemployment, the government shall reduce taxes or increase its own spending. If there is too much spending, the government shall prevent inflation by reducing its own expenditures or by increasing taxes.
2. By borrowing money when it wishes to raise the rate of interest and by lending money or repaying debt when it wishes to lower the rate of interest, the government shall maintain that rate of interest that induces the optimum amount of investment.
3. If either of the first two rules conflicts with principles of ‘sound finance’ or of balancing the budget, or of limiting the national debt, so much the worse for these principles. The government press shall print any money that may be needed to carry out rules 1 and 2.

Further reading:

Functional Finance

Functional finance and modern monetary theory

5. Sectoral balances Sectoral balances is an approach to viewing the financial makeup of the macro economy, popularised by economist Wynne Godley. It helps not to view things like the government deficit in isolation, but rather to see it in the context of what’s happening elsewhere in the economy. In the three sector version of Godley’s sectoral balances: Government balance = Private sector balance – Foreign sector balance If we apply this to the UK, we see a government deficit of 6%, a private sector balance (private sector sayings  – private sector investment) of 2% and a foreign balance (exports – imports) of -4%. MMTers argue that the natural state for the private sector is surplus, so for countries with trade deficits, a government deficit will also be the norm. If the government tries to reduce or eliminate its deficit, it will only succeed if the private sector is willing to reduce or eliminate its surplus.

Further reading:

What Happens When the Government Tightens its Belt?

UK Sectoral Balances and Private Debt Levels

6. Endogenous Money Endogenous money is the idea that rather than the central bank determining the amount of money in the economy – exogenously, the amount of money is instead determined by the supply and demand of loans. In shorthand, MMTers (and Post Keynesians in general) would say, “Loans create deposits”. That is to say that banks create money by extending loans to customers, while at the same time creating a corresponding deposit. This runs contrary to what is generally taught to students of economics – that savings are loaned out with banks acting purely as intermediaries, or at best leveraging an initial injection of government money by a predetermined ratio.

Further reading:

The Endogenous Money Approach

Money creation in the modern economy

7. Governments should pursue full employment In the post war period up until the early 70s, Western governments were committed to the principle of full employment, and largely achieved this, with the unemployment rate averaging around 3% in the UK throughout that period. The Conservatives famous “Labour Isn’t Working” campaign poster of 1979 was powerful because unemployment had reached previously unthinkable levels of 1 million. Today, the Government start high-fiving each other when unemployment falls below 2.5 million. MMTers argue that achieving full employment again is very much a realistic and achievable goal, but it means abandoning modern notions that “governments don’t create jobs”, and accepting that capitalism left to its own devices will never employ all those willing and able to work. A key tenet of MMT is that governments should act as the ’employer of last resort’, offering work to all those who are willing and able to work, but unable to find a job.

Further reading:

The Job Guarantee: A Government Plan for Full Employment

The job guarantee is a vehicle for progressive change

8. Focus on real resources, not money While politicians tell us there is no money left, millions are without sufficient work and resources lie idle. MMT argues that we should focus on these real things – people and resources – rather than money which is just a tool for putting those people and resources to work. Governments can and should spend money into the economy when the private sector cannot or will not to maximise the potential output of the economy.

Further reading:

Modern Monetary Theory: The Last Progressive Left Standing

Scottish Independence – A Modern Money Analyisis

Those are some of the basics of MMT then, not that I can capture it all in 1,500 words. For more reading, try some of the links on my blogroll.

Options for Britain in Europe

I’ve written a series of posts on the EU in recent weeks, where I’ve tried to show the confidence of the pro-Europe argument is not backed by good evidence. There are downsides to Britain’s membership of the EU, free movement of labour is not necessarily a good thing, and the EU is not very democratic. Many people struggle to see an alternative to EU membership, but there are actually a number of alternatives to the current status quo that Britain could adopt. In their book “Moored to the Continent“, Baimbridge et al, discuss some of the following options that could be considered:

1. Renegotiation of EU membership obligations. This is the Conservative Party’s stated position, although it is not currently known what they want to renegotiate. Baimbridge et al suggest possible areas could be the reconstitution of the Common Agricultural and Fisheries Policies, Britain’s contribution to the EU budget and it’s involvement in EU foreign and defence policy. There is some skepticism as to what could be achieved through renegotiation, as each nation would probably desire to change different aspects of the rules, but such is the importance of Britain’s market for EU exports, the could be some scope for renegotiation if the alternative was full withdrawal.

2. Creation of an Associated European Area (AEA). This arrangement would create a kind of two-tier Europe, with one group of countries continuing the path towards further integration, and a second group continuing to cooperate on areas like trade and the environment, while keeping control of other areas like economic policy, currency and social and labour market policies. This option could be facilitated by an amendment to the Amsterdam Treaty, and would allow those countries who wish to integrate further to do so, while  allowing others favourable terms while maintaining a looser association. Win win?

3. Membership of the single market through EFTA and the EEA. This option would mean the UK would formally leave the EU and rejoin the European Free Trade Association (EFTA), that it was a founding member of over 40 years ago. That would make the UK eligible to join the European Economic Area (EEA). This would give the UK some of the benefits of full EU membership (but also some of the downsides), while allowing it autonomy over areas like agriculture and fisheries, and allowing it to trade frrely with nations outside the EU. As an EEA member, they could also veto EU law if they think it goes against their national interest. This is a similar situation to that of Norway.

4. Bilateral free-trade agreement between the UK and EU. This one means full UK withdrawal followed by a negotiation of a bilateral trade deal. The UK would retain greater freedom than under option 3 and create a relationship similar to that between the EU and Switzerland. The UK is such an important market for other EU states, it is highly likely that such an agreement could be negotiated without the EU engaging in discriminatory practises – they would have more to lose.

There are advantages and disadvantages to all these options, but all involve the UK maintaining some kind of relationship with the EU, while regaining certain powers it has given away. I favour option 4, but can see some advantages of option 2. There is scope for cooperation on areas like environmental protection and scientific research that could cross national boundaries. Most people agree the EU will need to change, but while some feel this change should be closer integration, others are less enthused. We already have something of a two-tier Europe with those within the Eurozone and those without. Something more formal could be an option worthy of consideration.

“Squeezing the poor”

This post by @Ramanan_V prompted me to seek out Nicholas Kaldor’s “The Economic Consequences of Mrs Thatcher”. Kaldor was an eminent Cambridge economist and member of House of Lords at the time when Margaret Thatcher came to power in 1979, and this short book is a collection of speeches made during the first four years of Thatcher’s time as PM.

In ’79 when Thatcher rose to power, the UK economy was in trouble, with rampant inflation and low growth with rising unemployment. In the months preceding the ’79 election, Britain had experienced its “Winter of Discontent”. In his first budget in June 1979 Thatcher’s Chancellor, Geoffrey Howe increased VAT to 15%, reduced the top rate of income tax from 83% to 60% and announced reductions in public spending.

While there were many differences in both economic environment and policy between Thatcher’s early years and today, from Kaldor’s speeches, we can draw some interesting parallels between the justifications made for government budgetary decisions made then, and the justifications for austerity being made today. Here are a few examples from Thatcher’s first year in office.

On the incoming Conservative Government (13.6.79, p12):

“…up to now Conservative Governments in this country were predominantly pragmatist… This time it is different. This time we have a right-wing Government with a strong ideological commitment which is something new in this country…”

The new Thatcher broke with the post-war consensus and steered a different course, one which was continued through the Major, Blair and Brown years and a course which the present Government is now trying to accelerate before it’s too late.

On the tax changes in Howe’s ’79 Budget (19.6.79 p19):

“In this Budget the tax remission to a millionaire or to a man with £50,000 a year, is well over £6,000 a year – enough to allow him to get a second Rolls-Royce. Lord Boyd-Carter says that all this is small beer: a small price to pay for the enormous advantages which efficient entrepreneurship and risk-taking can bring us…

In 1979, the Tories cut the basic rate of tax slightly, while at the same time increasing VAT (on many items from 8% to 15%) and significantly cutting income tax for the highest earners. Sound familiar?

On ‘Squeezing the Poor’ (19.6.79 p21):

“The two main contentions of the Chancellor, that the economy must be ‘squeezed’ in order to get rid of inflation and that top people must be better off in order to induce them to work harder and become richer, in themselves imply that some people must be worse off. These people must be the poor people.

[The poor economic forecasts] will not reflect ‘a shortage in demand’ but a ‘growing series of failures on the supply side of the economy’.

Today we have tax cuts for the rich and bedroom taxes and real terms cuts to benefits and wages for everyone else, while poor growth is blamed on ‘the world economy’ and talk of the need for labour market reforms. The similarities to ’79 are unmistakable.

Here’s, Kaldor on ‘The Momentum of Decline’ (19.6.79 p23):

“These policies (in response to inflation in the 1920s) led to the unprecedented crisis of capitalism in the early 1930s, to Hitler and to the Second World War. We can only hope that on this occasion the outcome will not be so tragic. But the tone of the Chancellor’s speech was strongly reminiscent of what was said by Dr Bruning, by Herbert Hoover and by Philip Snowden in his Budget speech. There is one common theme in all those speeches: we must first suffer agony to be able to make a clean start.”

A bit dramatic perhaps, but the idea that austerity is something we must endure in order to renew our economy prevails.

Finally, here Kaldor on ‘An impotent government’ (7.11.79 p38):

“As far as output, employment and economic growth is concerned, the [Comprehensive Spending Review of its time] adopts a wholly fatalistic attitude. All it says is that ‘the prospects are poor… both in this country and the rest of the world’. This reminds me of a statement attributed to Neville Chamberlain during the Great Depression that the government is no more capable of regulating the general demand for labour than it is of regulating the weather. After a long circle, we now seem to have returned to the same point.”

This is very reminiscent of the current Government’s desire to blame all ills on the Eurozone and to stand idle while unemployment remains high, incomes stagnate and the housing crisis worsens.

The point of quoting the above then is to demonstrate that we’ve been here before (and not so long ago). The likely effects were predicted before the policies were implemented (as with Cameron and Osborne’s austerity). While in Thatcher’s time, the result was three million unemployed and the destruction of British industry, today, unemployment has not gone so high, but only because now we have zero-hour contracts, part time work and working tax credit-supported self-employment instead. The long-term impacts though could be equally as damaging.

Debt, Deficits and Interest Rates – Some More Charts

Following on from the last post on debt and deficits, this post will look at interest rates. This will be a somewhat superficial examination of the data as the reality of the link between debt, deficits and interest rates is a complex one, but I hope to show that the Government line on interest rates is at best simplistic, and at worst wildly misleading.

After the release of last week’s GDP figures, a succession of Ministers gave interviews where they mentioned the UK’s low interest rates as a positive outcome from austerity. The reasoning goes that if debt and deficits get too high, the markets will revolt and start demanding high interest rates on government debt. The Government’s argument is that since austerity began, the markets are now reassured that the Government is dealing with its debts (!!?) and so interest rates have remained low.

I think Jonathan Portes did a pretty good job of debunking this argument last year, but we are still hearing that this story that low interest rates indicate the success of austerity, so here are some charts that suggest something different. The data from all these charts comes from Trading Economics and is the latest available.

This first chart shows the debt-GDP ratios of a cross-section of countries (left hand axis) vs the interest rates they have to pay to borrow for 10 years (right hand axis). The Debt-GDP ratio remember, is the  total amount the government owes, expressed as a % of GDP. In this chart, apart from a couple of outliers, in particular Japan, the blue line does trend downwards, i.e the lower a country’s debt, the lower the interest rate it has to pay. Lets show this chart again though, but with the Eurozone countries excluded.This time, something weird has happened. Whereas before it seemed like highly indebted countries had to pay high rates on their debt, now the opposite seems to be true. The country with far and away the highest government debt is Japan, but Japan also has the cheapest borrowing costs. And Australia, with the lowest debts, pay the highest rate. What’s different? All the five countries in the second chart have their own currencies, while the first chart contained countries that do not. But maybe it’s the size of the deficit rather than the debt that makes the market get anxious?

This is a similar chart, but this time the bars show each country’s deficit as a % of GDP. The UK is in the middle. If you squint a bit, you might be able to discern a slight negative relationship between the deficit and bond yields, but it’s pretty weak. So there doesn’t seem to be a clear link between deficit size and the rate governments pay to borrow money. All that’s left then is some sort of vague notion that markets don’t look at the numbers but at the intentions and credibility of each government. Does this sound convincing to you? It doesn’t to me.

Let’s just look at the Debt-GDP chart once more, but only including the Eurozone countries.

This time, it does seem that higher debts lead to higher interest rates. Why would this be true for Eurozone countries, but not other wealthy nations? Well, by joining the Euro, these countries gave up their right to set short term interest rates, devalue their currencies or to print money. This means when a crisis hits, these countries are unable to pull the usual policy levers. The bailouts of certain Eurozone countries have seen rates fall (Greek rates were aroung 35% a year ago), but ultimately, there is a real default risk on these nations debts, so yields are priced accordingly.

Nations with their own currencies do not have this inherent risk of default because they can always make any payment due in their own currencies. Ultimately, they can print money if needs be. So what does determine long term interest rates in these countries (the UK included)? Lets look at one more chart.

Here we have the 5 country’s central bank base rates next to the rate they pay on 10 year bonds. They are quite closely correlated. That’s because as Portes points out in his post I link to above:

“…theory suggests that the low level of long-term interest rates in the UK reflects low expected future short-term rates.”

Short term rates are low today, and market actors expect them to be low tomorrow, so long term rates are low. Central banks can manage expectations by pre-announcing their intentions on rates, as Ben Bernanke has done in the US. The markets are also crying out for safe assets, so there is a rush into bonds and away from more risky investments.

So to conclude then, the take-away messages from this post are:

• The link between high deficits/high debts and high bond yields only applies to countries like those in the Eurozone which do not have full control over their own currencies.
• The Government’s belief that their economic policies have ensured interest rates stayed low is based on magical thinking. The idea does not stand up to scrutiny.
• The real reason long term rates are so low is partly because short term rates (set by supposedly independent central banks) are so low, as are expectations about future rates, and partly because the world economy is so depressed and so the markets are looking to invest in safe assets.

Countering myths about the reasons for austerity

The idea for this post came to me while watching Question Time last night and seeing the bizarre sight of Lib Dem Ed Davey and ‘celebrity’ MP Nadine Dorries teaming up to roll out the usual reasons why austerity was and is the only course of action available.

A lot of people on the left seem to concede that the economic crisis did mean that urgent action was required to reduce the deficit, and their policy proposals operate within those parameters. Alternative policies generally include raising taxes on the rich and cracking down on tax avoidance. Some even agree that we should get rid of universal benefits to save money. Every proposal seems to be of the form that “we will cut this or raise taxes on that to pay for this.”

This is a very unsuccessful strategy in my view because it implicitly accepts a lot of the myths that have grown up around how the economy works. These myths are repeated ad nauseum by politicians to the point now that they have almost become received wisdom. Unless the counter argument to austerity is altered to reflect the reality of the way the economy actually works, the deficit hawks will win every time.

I’m going to split this post into two parts. Here’s the first three (of six) common talking points you will have heard from those in favour of austerity and how you can counter them.

1) The UK could end up like Greece

On the face of it, this is a scary thought. Greece had a large deficit and the interest rates on its debts soared to the point where it became – to all intents and purposes – bankrupt. In reality though there is zero prospect of the UK ever becoming like Greece. If someone says there is, the appropriate response is to laugh in their face.

Greece joined a currency union with significantly wealthier nations which led to them using an overvalued (for them) currency over which they had no control leading to them having a massive competitive disadvantage. This led to ever increasing deficits and meant when the financial crisis struck, they were unable to pull any of the policy levers available to countries with their own currency like the UK. They couldn’t devalue, couldn’t change interest rates and most importantly couldn’t issue money. The lack of these tools means the ability of Greece to borrow on international markets very much depends upon the markets assessment of their ability to repay, and so bankruptcy becomes a very real risk.

The mere fact that the UK does issue its own currency, doesn’t borrow in others and its exchange rate floats means it could never end up like Greece.

2) The Coalition inherited the worst deficit in the Western world

Answer: No it didn’t. It inherited the largest deficit*. This is not the same thing at all. A deficit, whether large or small is neither a good or a bad thing. It could be either, but at the end of the day, all the deficit is, is an outcome, and all it tells you is that the non-government sector (the private sector here, plus the trade deficit) is running a surplus. The government’s deficit is the mirror image of the non-government surplus. A graphical representation of this can be found here. To a large extent the government has no control over its budget outcome. It depends upon the saving preferences of the private sector.

The appropriate response for the government to take when faced with excess private sector savings would be to either accommodate them by maintaining an expansionary fiscal stance, or to seek to confiscate some of the surplus through taxation (more difficult). Seeking to reduce the Government’s deficit while the private sector are still paying down debt, simply undermines those efforts and prolongs the slump unnecessarily. This is what we see now.

3) If we hadn’t implemented austerity, the markets would have panicked, interest rates would have gone up.

The underlying assumption here is that markets alone set bond rates based upon their view of the ‘credibility’ of the government’s fiscal stance. To a degree this is true for countries in the Eurozone for the reasons cited at point 1, but for a country like the UK, it’s just nonsense. For a start, countries that issue their own currencies like the UK present no involuntary default risk. Zero.

Secondly, even mainstream economic theory doesn’t say that markets set interest rates in the way politicians want us to believe. Jonathan Portes wrote a very good blog post on this topic in September here. Basically, long term interest rates are thought to be based on expectations about future short term rates. Short term rates are set by the Bank of England, and the Bank can make it clear what their thinking on future rates will be. The markets expect future rates to be low, so long term rates now are low. Nothing to do with the markets having ‘confidence’ in the government’s economic policies. Because markets don’t behave the way politicians suggest, there is no reason to believe alternative fiscal policies would place upward pressure on interest rates.

Part 2 will discuss these further common points we often hear related to austerity:

• Gordon Brown spent all the money and now there’s none left. Just ask Liam Byrne
• Cutting x will save £y
• What would you cut?

*EDIT: A reader has pointed out that the US actually had the largest deficit in 2010, and the UK only the 2nd largest (h/t Richard Evans via Twitter), but my point still stands. Many politicians continue to claim the UK’s deficit was the worst, including Ed Davey on Question Time this week . So another counter argument is that the US had a higher deficit in 2010, but took a different path. It’s deficit has now shrunk from around 11.4% of GDP in 2010, to about 7% last year. The US economy grew by 3.1% in Q3 of 2012. Although the US lost its AAA credit rating, the interest rate of US government debt has remained very low.

Must Reads for Opponents of Austerity

Economics can seem a bit impenetrable to the lay person. Partly, it seems to me, this is deliberate on the part of economists to complicate the field – baffle with bullshit you might say. Accessible texts are difficult to come across; ones worth reading even more so. Economics and economic policy are too important to leave to the economists and politicians though, particularly since the dominant paradigm in economics has failed us so badly.

Whilst Eurozone countries are faced with a choice of austerity or default/Euro exit, there is no sound economic rationale for austerity in the major nations outside the Eurozone. High debt and deficits do not create an inherent risk of default, nor do they need mean higher taxes in the future, or place a burden on our grandchildren. These basic truths are emphasised by a branch of economics known as Modern Monetary Theory (MMT). There are a lot of passionate opponents of austerity on the left of the political spectrum, but I feel they don’t yet have the weapons necessary to argue effectively the case for an alternative. I think an understanding of MMT can provide a sound basis for making that case.

Here I just want to draw attention to two great primers on MMT. Both written by Warren Mosler, they are easily understood by the average reader although the ideas presented will seem counter intuitive at first. The first is called “Soft Currency Economics”. It can be read on Mosler’s website here. Here is an extract:

“The purpose of this work is to clearly demonstrate, through pure force of logic, that much of the public debate on many of today’s economic issues is invalid, often going so far as to confuse costs with benefits. This is not an effort to change the financial system. It is an effort to provide insight into the fiat monetary system, a very effective system that is currently in place. The validity of the current thinking about the federal budget deficit and the federal debt will be challenged in a way that supersedes both the hawks and the doves. Once we realize that the deficit can present no financial risk, it will be evident that spending programs should be evaluated on their real economic benefits, and weighed against their real economic costs. Similarly, a meaningful analysis of tax changes evaluates their impact on the economy, not the impact on the deficit.”

The second primer is called “The Seven Deadly Innocent Frauds of Economic Policy”. This can also be read for free via Mosler’s website here. Here are the ideas Mosler calls “innocent frauds”:

“1. The government must raise funds through taxation or borrowing in order to spend. In other words, government spending is limited by its ability to tax or borrow.

2. With government deficits, we are leaving our debt burden to our children.

3. Government budget deficits take away savings

4. Social Security is broken.

5. The trade deficit is an unsustainable imbalance that takes away jobs and output.

6. We need savings to provide the funds for investment.

7. It’s a bad thing that higher deficits today mean higher taxes tomorrow.”

Mosler is an American, and writes for a US audience, but the arguments he presents are equally applicable to the UK (or Canada, Australia, Japan etc). Please read and let me know what you think.

Links

Soft Currency Economics

7 Deadly Innocent Frauds

Mosler’s Mandatory Readings