The Economic Policy Delusion

There is a huge problem at the centre of economic debate in this country, perfectly encapsulated in two different events this week.

First, Andrew Marr grilled Rebecca Long-Bailey over the nitty gritty details of Labour’s spending proposals, pushing hard on the exact details and timescales of various figures. Then, David Davis, the supposed “Brexit Secretary,” told the Exiting the European Union Committee that he hadn’t done an economic analysis on a default to WTO rules but assumed everything would work out because, I don’t know, magic or the power of prayer.

These events highlight two different but related fallacies that remain stubbornly undisputed at the heart of economic policy debate. The first is that left wing politicians are always nice but feckless and must be held to account, while right wing politicians are nasty but hard headed realists even if their figures are non-existent. The second fallacy is that government accounts can be treated the same way as a household budget and that “fiscal credibility” is required for any policy proposal.

Let’s take the second point first. Across the economics profession the notion that “governments are like households” is roundly and emphatically denied. There is a gradient among economists as to how much freer the government is to run budget deficits, but there is no credible economist who will claim that a sovereign government like the UK is as income restrained as a country like Greece, let alone a household.

The most conservative dispute is the simple Keynesian doctrine of countercyclical spending. Put simply, when the private sector is undergoing a contraction, the government sector should step in to shore up spending, prevent recessions turning into depressions, and speed up recoveries.

The IMF has admitted that its advice that governments should carry out what it terms “fiscal consolidation” and what we know as austerity was, in actual fact, dead wrong and counterproductive. In other words, that rather than looking to shrink the deficit and cut spending in 2010, governments should have been looking to keep running or even expanding their fiscal deficits. Journalists “holding politicians to account” before the election by asking “how will you pay for these policies?” were guilty of perpetuating the myth that a balanced budget rather than a large sustained deficit was the answer to the UK’s economic malaise, just as much as the politicians who beat that false narrative like a rented mule. As the IMF points out, they are “paid for” down the line with economic growth, just as government debts always have been.

As we can see from our own economy, the empirical data matches the IMF’s assessment that austerity was a mistake. Not only did it slow down the recovery, it also failed to reduce the deficit. This is obvious when you remember that government spending has macroeconomic implications across the broader economy in a way that individual households do not. As cuts slowed down the recovery, they also reduced incomes and profits and therefore the government’s tax base, creating a spiral that cut growth and raised the deficit — 0 for 2 on the government’s proposed goals.

Beyond simple Keynesianism, many economists also point out that we need to be aware of the positioning of governments within what’s termed the “sectoral balances” framework. This points out that the sum of money in the economy always nets to zero. If government is fiscally “tightening” it is literally taking money out of the economy. Growth can therefore only come from the private sector running down its savings or taking on more debt. Steve Keen of Kingston University London points out that debt-financed economies are guaranteed to enter a period of contraction through a process Irving Fisher called “Debt Deflation.” In that view, the government should not simply stand ready to spend countercyclically in case of recessions, but should in fact take steps to keep private sector debt under control by running near permanent deficits except in exceptional circumstances. Randall Wray of University of Kansas City Missouri points out that this appears to hold empirically too — in the USA fiscal surpluses have always been followed by depressions, with the exception of the Clinton surplus which was merely followed by a recession and global financial crisis.

Other economists insist that the errors run even deeper, to a fundamental misunderstanding of what it even is that we’re talking about. Stephanie Kelton, former economist for the US Senate Budget Committee, says that we get it wrong because we don’t understand the difference between money and real resources.

Kelton frequently quotes Alan Greenspan in testimony to Congress: “There is nothing to prevent the government from creating as much money as it wants. The question is, how do you set up a system which ensures that the real assets are created which [that money is] employed to purchase?”

Whenever you talk about “money creation” people clutch their pearls and scream “Inflation! Zimbabwe!” This inhibits them from discussing the situation rationally. Private banks and governments already create and destroy money on a daily basis. The idea that there will be naught but ruin if the money supply increases is undermined by the fact that the money supply has, in fact, increased.

It is trivially true to say that the British government can, at any time, lay its hands on as much sterling as it wants. It is similarly trivially true to say that it cannot, at any time, lay its hands on more labour, concrete, steel or international trade negotiation services than exist in the real economy. It is these real resources which create the constraints on government spending. However, economists like Kelton would argue, government is the 800lb gorilla in the economy. It can and should be pursuing policies which seek to improve productivity, bring idle capacity online, raise wages, reduce rent/wage ratios, and enable the household sector to deleverage down to a safer level of debt.

Abba Lerner’s “Functional Finance” proposals “completely reject the traditional doctrines of ‘sound finance’ and the principle of trying to balance the budget over a solar year or any other arbitrary period.” Instead Lerner proposed that the government should ignore any arbitrary measures on the deficit entirely, and government activity “shall be undertaken with an eye only to the results of these actions.” Taxes, bond issuing, money printing, government spending — all these, in Lerner’s view, are permissible provided that they achieve the twin ends of “full employment and price stability,” regardless of measures such as the size of government debt or the fiscal deficit.

Such proposals do not advocate spending wildly and infinitely, as the inflation kneejerkers always believe, but simply that we need to stop asking “can we afford it?” and instead ask “what will the results be?” A government which adds £100Bn to the debt to buy gold will achieve nothing except an increase in the price of gold. Cutting taxes on the top 0.1% will achieve some marginal stimulus, but will mostly drive up the demand for investment instruments and increase the risk of a systemic collapse like 2007. Government spending which puts real wages people’s pockets will have a positive economic impact, provided that it does not do so in a way which is excessively inflationary. These effects are true irrespective of the government’s fiscal position vis a vis deficits and surpluses.

One way of looking at the difference between money and real resources is to see the currency issuing government as the scorekeeper in a game. The government can no more “run out of money” than the referee in a football match can “run out of goals.” Likewise, just as a 0–0 draw doesn’t leave the ref with a goal surplus, the government will not “save” money in a meaningful sense by not spending. Sovereign governments neither “have” nor “do not have” money in any meaningful sense. In this formulation, governments setting themselves arbitrary limits are like referees deciding that football matches have a four goal limit, with any goals scored beyond that figure requiring some complex formulation of borrowing against future matches. Lerner notes that, just as a referee should issue the correct number of goals for the game that has been played, so the government should simply concern itself with making sure that the right amount of money is “in play” in the economy to achieve its ends.

The point of all this is to point out that, whatever level of radicalism you are comfortable with, “balancing the budget” and the journalistic conflation of holding government to account with this notion of “fiscal credibility” are concepts which are, at best, often deployed incorrectly and at the wrong times, and at worst are complete red herrings that should not be deployed at all.


This leads us back to why these flawed lines of critique are so resilient in the economic policy space, and links back to the first fallacy. It’s notable that the Tories enjoy a reputation for “fiscal credibility” even if that supposedly credible fiscal policy is both theoretically and empirically garbage, and that left wing policies are always viewed with deep suspicion.

“Governments = households” is an example of something which is “simple, intuitive, and wrong.” It fits into a standard narrative that we easily understand. The trouble with macroeconomics is that it’s counter-intuitive. In 2013 David Cameron mocked Labour by saying “they think borrowing more money would mean borrowing less.” His argument did not rest on any economics, simply on the appeal to intuition. Again, though, let me refer you back to the IMF and to economists like Paul Krugman who point out that it would have been precisely and entirely true, and that in fact the Tory policy ended up meaning that by borrowing less money we’ve ended up borrowing more. Intuition often leads us down the wrong path.

“The left is nice but irresponsible, the right are responsible bastards” is another standard narrative that tempts us into error. The idea that everything must somehow be “paid for” extends beyond the financial sphere into the moral. “No pain no gain,” as the saying goes. If we have a robust welfare state and a strong healthcare system something must be amiss somewhere. Contrariwise, Theresa May’s arbitrary viciousness at the Home Office stands as ipso facto proof that she’s “tough.” A “hard choice” that leaves someone locked up in a Nigerian prison for being gay is itself a demonstration of credibility because May is willing to sacrifice people for the “greater good,” or at least the good of people who we consider more important than LGBT refugees. The viciousness of Tory austerity stands alone as proof that it’s necessary. The more brutal the cuts, the more that proves they were needed.

Again though, it does not hold. There are, indeed, win-win scenarios. Some of the right wing’s most deeply held beliefs, such as the power of markets and the theory of comparative advantage, explicitly rest on the idea that there are transactions which produce net benefits. Co-operation can often produce large net gains that are unattainable to individuals working in isolation. The entire history of civilisation is based on groups of people coming together, in tribes, cities and larger political groups to share resources and labour in ways which benefit the whole.

Philosophers from John Donne to Martin Luther King have covered the inverse, the idea that pain does not necessarily lead to gain. “No man is an island… Each man’s death diminishes me, for I am involved in mankind.” “Justice denied anywhere diminishes justice everywhere.” The zero sum calculus that reducing inequality must be somehow fiddling the figures is incompatible with a robust view of history. Protecting people from the capricious violence of the natural world enables them to more fully realise their potential which benefits us all socially and morally, and in large part economically too.

The “cruel policies are inherently credible” narrative is all the more pernicious because it is often unspoken and thus unchallenged. Even the left lacks confidence, constantly allowing itself to be baited into the fiscal credibility trap which implicitly concedes this frame.

The left must rediscover its confidence in this, arguing firmly against the idea that “fiscal credibility” can be narrowly defined as raising taxes to match spending, and that policies which benefit marginalised and disadvantaged people are wasteful luxuries that we have to discard to get through economic downturns. Good students answer the paper, but great students question it. The left can’t ever win by conceding the fallacious premises of the right, it must be prepared to tell Andrew Marr that he’s full of shit.

The “hard questions” media also has a responsibility here, though, to not be completely full of shit in the first place. It’s no excuse for us to merely go along with the frames that the sitting government wants us to accept, or to claim that we can’t do anything about our own inherent biases. Nor is “everyone else is doing it” a good excuse. The press’s duty to hold power to account must be underpinned with the capacity to challenge ourselves and make sure that we’re not simply stenographers for fallacious thinking that fits within easy narratives.

It is difficult to push against the grain. Anyone with a grain of self awareness will look at a consensus that doesn’t make sense and think “am I wrong? Am I a crank?” There are lessons from the last crash here, though. “Nobody” — quote unquote — saw the housing crisis coming. Allegedly. Actually quite a lot of people saw it coming. Herd mentality and groupthink pushed them to the side. “Are you saying that the entire US banking system is dead wrong and you’re the only right one?” The thing is, the entire banking system didn’t actually believe that its web of derivatives was financially sound. It didn’t need to be. What it believed, and what turned out to be true, was that when it turned out to be unsound they could walk into a room with the Treasury Secretary, point a gun at their own heads and say “bail us out or the economy gets it.”

Simon Wren-Lewis calls the media inability to push against the grain of received wisdom on deficits and “fiscal credibility” mediamacro — a set of shared delusions that persist within the bubble of the media despite attempts by economists to get rid of them. It is well documented enough that journalists who take even a passing interest in the economy should have no excuse for continuing their self-delusions on this score. Journalists ostensibly on the left have even less excuse, as we should always be looking for ways to challenge the austerity fetishists in government, not simply conceding their economic arguments and accepting the narrative that the left wing’s promises of social justice sound nice but “don’t work in practice.” What doesn’t work in practice is the right wing garbage economics of cutting your way out of recessions, the same thing that we have inexplicably been calling “credibility” for ten years.

The Tories are not “credible” or “competent.” Not on Brexit, not on the economy. The arguments are there to support this position. It is only our inability to let go of cherished easy narratives which stop us from seeing it.

Show your support

Clapping shows how much you appreciated McDuff’s story.