Monday 20 September 2010

Clegg offers Liberal obituary for Keynesian economics

Nick Clegg sought to persuade his party and the country that the government's deficit reduction strategy is the right one by saying that it was simply common sense as every household would know.

The problems are there. They are real. And we have to solve them. It’s the same as a family with earnings of £26,000 a year who are spending £32,000 a year. Even though they’re already £40,000 in debt. Imagine if that was you. You’d be crippled by the interest payments. You’d set yourself a budget. And you’d try to spend less. That is what this government is doing.

As Left Foot Forward points out, here Clegg has adopted Margaret Thatcher's famous argument: "Why don't you look at it as any housewife has to look at it?".

Danny Alexander had made the same point in his speech to conference yesterday.

For every £4 Labour spent, £1 had to be borrowed. Would you run your business or home like that? It simply wouldn’t be possible. You would have 3 choices. Take responsibility. Let the bank force you. Or wait for the bailiffs to come knocking. And so it is with countries.

Alexander's soundbite much aggravated a LibDem member who argued cogently at the Fabian/CentreForum fringe against the economic illiteracy of applying what he called "piggy-bank economics" to national accounts, particularly from the first Liberal Treasury Minister from the party of Keynes since the inter-war years.

Norman Lamb (who is PPS to Nick Clegg) in response told the fringe that he would not personally use the household analogy for national accounts, noting that there were of course important arguments for debt in cyclical reasons and the need for economic stimulus, though Lamb did defend the government's deficit reduction strategy as appropriate in the specific circumstances.

Vince Cable said yesterday that Keynes was his political hero.

Cable also offered, just under a year ago, a detailed critique of why Osbornomics would make Britain poorer and less equal, noting the perverse consequences of a deep ideological scepticism about deficit-financing in a slump.

The Conservatives have got much mileage out of their appropriation of John F Kennedy's quote about fixing the roof while the sun was shining. It was, however, never clear how this construction work could be carried out ... Now, the issue is whether the priority is to embark on large-scale, long- term, roof repairs or to rescue the inhabitants from a flood. The former, clearly, has to happen, but it is perverse to treat it as the most urgent task. The perversity undoubtedly has some deep ideological roots: a suspicion of the Keynesian legacy which is to champion the use of fiscal deficits to counter economic slump.

It would be wrong to characterise the underlying arguments as Keynes versus the Monetarists. Keynes and Friedman would both have supported the very aggressive and rigid monetary policy response led by the US Federal Reserve, learning from the mistakes of the 1930s and, more recently, Japan: very low interest rates; quantitative easing (an attempt to inflate money supply); and, in the UK, devaluation. In relation to fiscal policy, huge budget deficits are being run in the UK and US and even in countries said to be worried about deficit financing, like Germany. But here, the discretionary and deliberate deficit - that is, over and above the deficit caused by the crisis and recession - is very tiny: a stimulus of around 1% of GDP.

Cable gave a major IFS speech in 2008 locating his own intellectual development in the Keynesian tradition. (PDF).

Keynes noted in the General Theory that “practical men are usually the slaves of some defunct economist”. Keynes was, by this measure, a slave owner of some substance. Post-war economic policymakers from the 50s to the 70s – Macmillan and Heath; Wilson, Jenkins and Healey – all operated within a broadly Keynesian perspective: that an essential task of government was to manage aggregate demand so as to sustain growth in economic activity and maintain full employment.

It was a philosophy born out of a major economic crisis. Having been taught economics by Keynes’ Cambridge disciples – Kahn, Joan Robinson, Kaldor, Meade and others – I guess I also come from that tradition. It has sometimes felt as if we were dinosaurs, struggling to survive amongst the hot-blooded, furry, mammals of the monetarist era. But much of the Keynesian tradition of thought remains, not least the underlying neo-Keynesian model of the Bank of England in which aggregate demand is the main transmission mechanism feeding interest rate changes into the economy.

1 comment:

Daan said...

If having a large deficit is like "a family with earnings of £26,000 a year who are spending £32,000 a year. Even though they’re already £40,000 in debt."...

...does that mean that the coalition's deficit elimination strategy is like the family's providers quitting their job so they won't have to pay a bus fare on their commute commute?