Niall Ferguson | Ukraine, Zelensky, Putin & China

 

Explaining Biden's Economic Plan

 

1 A new economic era: is inflation coming back for good?

 Chris Giles in The FT 

The December meeting of the Federal Reserve’s most important economic committee was routine. Policymakers agreed that the economy could cope with rising levels of spending “without any strong general upward pressure on prices”. 

Although prices of a few raw materials were rising sharply, “finished goods have not been subject to pervasive upward cost pressures”. 

Generalised inflation, the committee concluded, was not a serious concern. 

This meeting of the Federal Open Market Committee was held on December 15 1964, just two weeks before the start of a 17-year period the Fed now dubs The Great Inflation. Inflation: 

Turning points in price trends tend to occur just at the moment when the authorities and expert opinion dismiss the risks. The current consensus is that price rises in commodities and goods markets have clear pandemic-related explanations and that the risks of a resurgence in global inflation remains remote. 

Three decades after the authorities in advanced economies managed to suppress the beast, they remain confident they are in control. The mantra of the moment is summed up by Andrew Bailey, Bank of England governor, who likes to say he is watching inflation “extremely carefully” but not worrying. 

This view is still the mainstream but it is losing supporters. One notable recent defector is Roger Bootle, author of the book The Death of Inflation, who spotted the coming decline in price rises in the mid 1990s. He is now worried. “Financial markets are going to have to get used to the return of troublesome issues that had, until recently, seemed long dead,” Bootle wrote in May. 

Central bankers have not had to deal with an inflation problem during their careers. Having averaged around 10 per cent a year in the 1970s and 1980s, global inflation rates fell to an average close to 5 per cent in the 1990s in the rich world countries of the OECD, 3 per cent in the 2000s and 2 per cent in the 2010s. The question today is whether their view is complacent. Is the world entering another inflationary era? 

While many households think the definition of price stability would be an absence of inflation, economists and policymakers favour a gentle annual increase in prices of around 2 per cent. This reduces the risk that an economic crisis could spark a deflationary spiral with spending, prices and wages all falling, raising the real burden of debts and further hitting spending. Holger Schmieding, chief economist of Berenberg Bank, explains that a little inflation also greases the wheels of the economy, allowing declining sectors to fall behind gracefully. 

“Higher inflation eases economic adjustments as it creates more scope for changes in relative wages without a need for an outright fall in wages in sectors under pressure,” he says. 

In most advanced economies — the US, the eurozone and Japan — central banks have fallen short of meeting their targets of inflation of around 2 per cent despite having slashed interest rates to zero and having created trillions of dollars, euros and yen, which has been pumped it into their economies by purchasing government debt. A modest rise in inflation therefore would be welcomed by central banks, which have generally been delegated the task of achieving price stability. 

And until this year, the main economic concern regarding prices was the risk that countries were turning Japanese and might soon emulate the nation’s 30-year struggle with mild deflation. Such was the difficulty of keeping inflation high enough that some economists even began to question the doctrine of Ben Bernanke, former Fed chair, who argued in 2002 that “under a paper-money system, a determined government can always generate higher spending and hence positive inflation”. 

But this view of the world has turned on its head in 2021. A new whatever-it-takes borrowing and spending programme by the Biden administration, enforced savings during the coronavirus crisis giving households additional firepower, bottlenecks in the supply of goods and a reversal of longstanding downward pressures on global wages and prices have rekindled fears of excessive inflation. 

No one is talking about hyperinflation of the sort seen in Weimar Germany in 1923 or Latin America in the 1980s or even the 10 per cent global rate of the 1970s, but a creeping rise to persistent levels of generalised price increases not seen in a generation. When the April rate of US inflation jumped to 4.2 per cent, financial markets swooned. 

The new concern about a return to inflation is not just the result of immediate economic forces but also reflects longer-term, underlying changes in the structure of the global economy. The aggressive economic stimulus is being adopted at the very moment when the global economy is feeling the impact of ageing populations and the maturing of China’s 40-year transition. 

Moreover, history also tells us that neither politicians, economists nor policymakers can guarantee the world will maintain low and stable inflation. As the Fed’s experience from the 1960s demonstrates, turning points in inflation arrive with little warning. Unlike in the US, where there was no fear of inflation after the second world war, concern about inflation was “always rumbling on” following devaluations of sterling and higher import prices in the UK during the full employment years of the 1950s and 1960s, according to Nick Crafts, professor of economic history at Sussex university. 

But it only really took off in the 1970s after the first Opec oil shock and a switch in government policy from austerity to “a massively excessive stimulus, pushing the economy beyond any reasonable estimate of the sustainable level of unemployment”, Crafts adds. 

Research from Luca Benati, professor at Bern university, suggests that the world’s faith in central bankers being able to tame any similar episodes is probably overblown. The UK’s inflationary pressure in the 1970s was so strong, he found, that when he ran history again in multiple simulations assuming an independent central bank is in charge of controlling prices, inflationary forces would have been more powerful than any likely action by a Bank of England with an independent Monetary Policy Committee. In the 1970s, it would have had only a “limited impact” on quelling price rises which reached an annual rate of 26.9 per cent in 1975. 

According to Karen Ward, chief European market strategist at JPMorgan Asset Management, this means the Bernanke doctrine still stands and should not be forgotten. “We’ve always assumed that the structural supply side enhancements such as technology and globalisation are so great that we could never overwhelm them with demand, but it still must be the case that you can overwhelm supply with demand and ultimately generate inflation,” she says. 

It is exactly this fear which is raising inflation rate expectations in the US and Europe at the moment. Alongside a recovery of energy prices to pre-Covid levels, there has been a shortage of microchips, wood products, many metals and even cheese. These have been the proximate causes of higher inflation, but financial markets worry that the ultimate cause has been the pandemic-related fiscal and monetary stimulus which has led to a much faster economic recovery in advanced economies than was thought possible at the end of 2020. 

With economic policy pressing harder on the accelerator than at any time in recent history, spending could exceed the capacity of economies to provide goods and services, especially if the coronavirus crisis and government support have left people less willing to work, creating labour shortages and significant pressure on companies to raise wages. 

Such is the potential imbalance between rampant demand and more constrained supply, especially in the US, some supporters of centre-left policy ideas say that warning lights are flashing. Larry Summers, Treasury secretary in the Clinton administration, thinks policy has become far too lax, repeatedly criticising the “dangerous complacency” over inflation of today’s policymakers in recent weeks. 

While the White House has hit back, saying “a strong economy depends on a solid foundation of public investment, and that investments in workers, families and communities can pay off for decades to come”, even Janet Yellen, current Treasury secretary, has acknowledged the possible need for interest rates to rise “to make sure that our economy doesn’t overheat”. 

The policy shift has come at a point when economists generally accept that some of the big global forces holding prices down are much weaker than they were. In the 1990s and 2000s, globalisation led to a huge transfer of the production of goods from high wage economies to China and eastern Europe, accelerating a decline in the power of workers in advanced economies to force their employers to pay them more, keeping prices low. 

But these forces are at a turning point, according to Charles Goodhart, former chief economist of the Bank of England, and an author of the book The Great Demographic Reversal. The long boom in the size of its workforce has ended and its population is on the verge of falling for the first time in decades. Goodhart says that fewer new workers becoming integrated into the global labour force at a time of shrinking workforces in advanced economies as populations age will raise the pressures on companies to push up wages, increasing underlying inflationary pressures. 

The change in demographic pressures have already been around for a decade and are intensifying, Goodhart says. He had been wary of putting a date on the coming inflation, saying that the world is likely so see rising inflationary pressure within five years and “we are fairly sure it would have happened by 2030”. 

That was before Covid struck. Now, he says the underlying pressures, alongside more stimulative policies and Covid-related restrictions in supply, have brought forward the moment. “We tend to think that because of supply constraints in particular, it’s going to be more inflationary in 2021 than central bankers originally thought and it will last longer in 2022 and 2023 because there will be a confluence of the build-up of large monetary balances . . . combined with large continued fiscal expansion.” 

Turning to specific examples of prices he expected to see rise, Goodhart notes how the added demand for holidays in the UK would push up the prices of holiday rentals, hotels and even ice cream this summer. “You’d have to be a saint not to raise your prices,” he says. 

Demographic pressures are not something that can be reversed quickly, nor he argues can the forces of globalisation, which have gone into retreat having become politically unpopular in many advanced economies. Again, this is most acute in the US where economists such as Adam Posen, president of the Peterson Institute for International Economics, urges Americans to “embrace economic change rather than nostalgia” in domestic production, especially in manufacturing, as a means to improving living standards and promoting non-inflationary growth. 

So far, however, although financial market expectations of inflation have risen sharply in 2021, mainstream policymakers are remaining calm. 

There is increasing chatter in the Fed that at some point the current members of the interest-rate setting committee need to think about scaling back the pace of money creation and purchases of government bonds. But the view is that inflation is recovering to more normal levels and the US central bank has pledged to keep policy ultra accommodative until it achieves a more inclusive recovery. 

This is the right approach, says Laurence Boone, chief economist of the OECD in Paris, a view which chimes with similar attitudes in central banks around the world. “It’s too early to ring the alarm bells about inflation,” she says. “That doesn’t mean one doesn’t have to watch what’s happening and we’re seeing frictions with the reopening of demand and supply after the crisis . . . but the right policy is to ease tensions on the supply side more than central bank action [to quell inflationary pressures].” 

In most economies, there remains significant slack in the labour market, she adds, and the big demographic pressures could be eased significantly with later retirement, while other parts of Asia and Africa would be delighted to integrate into the global economy as China did. 

Boone’s view still represents the consensus opinion among economists and there is considerable confidence in central banks that any rise in inflation this year will be temporary and easily tamed without having to tighten policy significantly. 

But, for the first time in many decades, there is the possibility that a significant turning point has arrived, that price rises will be more than a flash in the pan and something more difficult to control.

The 3 big unknowns that have forced Nirmala Sitharaman to be prudent with economic package

The future of Covid-19 in India and its impact on the economy and govt revenues is unknown, so it’s better not to exhaust all options by May writes Ila Patnaik in The Print

Finance Minister Nirmala Sitharaman has indicated that she cannot use up all her options in the first two months of the fiscal year, as there are many unknowns. Her strategy may be unpopular, but it is prudent.

There are three big unknowns — the spread of Covid-19 after the lockdown is lifted, the impact of its spread on the economy, and the impact of the slowdown in the economy on government revenues.

-Also watch

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The spread of Covid-19 was contained during the lockdown, but the crisis is not over. A cure has not been found. A vaccine, despite all best efforts, will take a while to be developed and become accessible to all. Until then, as the country is opened up, strategies for containing the virus are still being put in place.


So far, even though the number of cases and deaths have risen, they are not as high as predicted without the lockdown. Now that offices, shops, buses and flights will resume, the virus will spread again. Testing of all employees in high-risk professions, isolation of citizens above 55-60 and those with co-morbidities, and social distancing norms are critical to how we contain the number of cases and deaths. The sooner these are enforced, the better we may do.

Impact on economy

The impact on the economy is difficult to quantify. This is the first time such a global lockdown has occurred since economists have been making models to forecast growth. Most models are built utilising past behaviour of the economy, but the present situation is completely unprecedented. Many economists who were forecasting a positive rate of growth when the lockdown was first announced are now forecasting a contraction. Forecasts are still being revised downwards.

There will be a loss in GDP simply due to not producing in the nearly two months. For a back-of-the-envelope calculation, look at the IIP: Industrial production contracted by 16 per cent in March this year.

The lockdown was announced on 24 March, which suggests that factories were shut for 20 per cent of the days in that month. The whole of April saw almost a complete lockdown. We expect to see a serious contraction — maybe 70 to 80 per cent, if the March figures are anything to go by. Similarly, in the month of May, production was shut for most of the month.

Seven worries for production

In addition, there are seven reasons why production will take time to bounce back fully.

First, supply chains have been broken. Even if one part is not available, has not been produced or imported, it may delay the resumption of full operations in manufacturing. As densely populated urban areas have been in red zones, they have been shut at least the third phase of the lockdown. This has disrupted many supply chains.

Second, all labourers may not come back to work. Even for the spaces where there were no restrictions, there are many anecdotes of people not coming to work after the second phase of the lockdown got over. This was partly due to fear and partly due to difficulties of travel, domestic responsibilities, or old parents at home. About 30 per cent households in India live with elders, or where at least one member of the family is above 65. These people have repeatedly been warned to keep their elders isolated. In small homes, this is difficult.

In addition there is the migrant crisis. After being unable to be with their families, many workers are heading home. It may be some time before they come back, and even then, all of them may not come back.

Third, credit will be a constraint. The government has eased liquidity and banks can give credit to their customers. However, there is an entire ecosystem of small firms who depend, not on the banking system, but on informal sources of credit. These are sometimes their suppliers or their buyers who give them working capital for purchase of raw materials or payment of wages. There are an estimated 64 million small firms in India.

The MSME package announced by FM Sitharaman is expected to give relief to 4.5 million of these. For the nearly 60 million others, adequate credit may not be available to restart production.

Fourth, travel could remain restricted, could become more expensive, and until the fear of Covid-19 remains, the impact on many sectors — like aviation, hospitality, tourism etc. — may last for a few quarters.

Fifth, consumption will take time to pick up. Incomes have been disrupted. There is uncertainty about future incomes. Until now, people were not able to step out to buy, and so, sales were stalled. But now expenditure may get postponed even after people are able to step out to buy.

Sixth, exports contracted by 60.3 per cent in April. Orders will be down until the rest of the world economy picks up. Exports depend on global demand and world trade. This is expected to be severely hit this year.

Seventh, investment was already in trouble before the Covid-19 crisis. It was going to be an uphill task to revive it. The increase in uncertainty and the difficulties of credit, labour and restrictions are going to make the investment climate worse. This could also pull down growth.

Impact on government revenue

Finally, the third big unknown is the impact the economic slowdown will have on government revenue. As I have argued before, tax revenue will decline and that leaves the government with limited fiscal space.

So far, in the economic package, the government has permitted people to delay tax payments. If the economy does not pick up, the government may need to cut tax rates, including GST, to put money in people’s hands. This may impact tax revenues further.

With the large number of unknowns, the Finance Minister’s economic package tries to push liquidity, encourage reforms and increase agricultural incomes. No doubt, more can always be done, but it is prudent not to use up all her ammunition in the first two months of such an uncertain year.

On India's Economic Stimulus - Is it a false promise?

The austerity delusion. Why does Britain still believe it?

The case for cuts was a lie.

Paul Krugman in The Guardian

In May 2010, as Britain headed into its last general election, elites all across the western world were gripped by austerity fever, a strange malady that combined extravagant fear with blithe optimism. Every country running significant budget deficits – as nearly all were in the aftermath of the financial crisis – was deemed at imminent risk of becoming another Greece unless it immediately began cutting spending and raising taxes. Concerns that imposing such austerity in already depressed economies would deepen their depression and delay recovery were airily dismissed; fiscal probity, we were assured, would inspire business-boosting confidence, and all would be well.

People holding these beliefs came to be widely known in economic circles as“austerians” – a term coined by the economist Rob Parenteau – and for a while the austerian ideology swept all before it.

But that was five years ago, and the fever has long since broken. Greece is now seen as it should have been seen from the beginning – as a unique case, with few lessons for the rest of us. It is impossible for countries such as the US and the UK, which borrow in their own currencies, to experience Greek-style crises, because they cannot run out of money – they can always print more. Even within the eurozone, borrowing costs plunged once the European Central Bank began to do its job and protect its clients against self-fulfilling panics by standing ready to buy government bonds if necessary. As I write this, Italy and Spain have no trouble raising cash – they can borrow at the lowest rates in their history, indeed considerably below those in Britain – and even Portugal’s interest rates are within a whisker of those paid by HM Treasury.

On the other side of the ledger, the benefits of improved confidence failed to make their promised appearance. Since the global turn to austerity in 2010, every country that introduced significant austerity has seen its economy suffer, with the depth of the suffering closely related to the harshness of the austerity. In late 2012, the IMF’s chief economist, Olivier Blanchard, went so far as to issue what amounted to a mea culpa: although his organisation never bought into the notion that austerity would actually boost economic growth, the IMF now believes that it massively understated the damage that spending cuts inflict on a weak economy.

Meanwhile, all of the economic research that allegedly supported the austerity push has been discredited. Widely touted statistical results were, it turned out, based on highly dubious assumptions and procedures – plus a few outright mistakes – and evaporated under closer scrutiny.

It is rare, in the history of economic thought, for debates to get resolved this decisively. The austerian ideology that dominated elite discourse five years ago has collapsed, to the point where hardly anyone still believes it. Hardly anyone, that is, except the coalition that still rules Britain – and most of the British media.

I don’t know how many Britons realise the extent to which their economic debate has diverged from the rest of the western world – the extent to which the UK seems stuck on obsessions that have been mainly laughed out of the discourse elsewhere. George Osborne and David Cameron boast that their policies saved Britain from a Greek-style crisis of soaring interest rates, apparently oblivious to the fact that interest rates are at historic lows all across the western world. The press seizes on Ed Miliband’s failure to mention the budget deficit in a speech as a huge gaffe, a supposed revelation of irresponsibility; meanwhile, Hillary Clinton is talking, seriously, not about budget deficits but about the “fun deficit” facing America’s children.

Is there some good reason why deficit obsession should still rule in Britain, even as it fades away everywhere else? No. This country is not different. The economics of austerity are the same – and the intellectual case as bankrupt – in Britain as everywhere else.

Stimulus and its enemies


hen economic crisis struck the advanced economies in 2008, almost every government – even Germany – introduced some kind of stimulus programme, increasing spending and/or cutting taxes. There was no mystery why: it was all about zero.

Normally, monetary authorities – the Federal Reserve, the Bank of England – can respond to a temporary economic downturn by cutting interest rates; this encourages private spending, especially on housing, and sets the stage for recovery. But there’s a limit to how much they can do in that direction. Until recently, the conventional wisdom was that you couldn’t cut interest rates below zero. We now know that this wasn’t quite right, since many European bonds now pay slightly negative interest. Still, there can’t be much room for sub-zero rates. And if cutting rates all the way to zero isn’t enough to cure what ails the economy, the usual remedy for recession falls short.

So it was in 2008-2009. By late 2008 it was already clear in every major economy that conventional monetary policy, which involves pushing down the interest rate on short-term government debt, was going to be insufficient to fight the financial downdraft. Now what? The textbook answer was and is fiscal expansion: increase government spending both to create jobs directly and to put money in consumers’ pockets; cut taxes to put more money in those pockets.

But won’t this lead to budget deficits? Yes, and that’s actually a good thing. An economy that is depressed even with zero interest rates is, in effect, an economy in which the public is trying to save more than businesses are willing to invest. In such an economy the government does everyone a service by running deficits and giving frustrated savers a chance to put their money to work. Nor does this borrowing compete with private investment. An economy where interest rates cannot go any lower is an economy awash in desired saving with no place to go, and deficit spending that expands the economy is, if anything, likely to lead to higher private investment than would otherwise materialise.

It’s true that you can’t run big budget deficits for ever (although you can do it for a long time), because at some point interest payments start to swallow too large a share of the budget. But it’s foolish and destructive to worry about deficits when borrowing is very cheap and the funds you borrow would otherwise go to waste.

At some point you do want to reverse stimulus. But you don’t want to do it too soon – specifically, you don’t want to remove fiscal support as long as pedal-to-the-metal monetary policy is still insufficient. Instead, you want to wait until there can be a sort of handoff, in which the central bank offsets the effects of declining spending and rising taxes by keeping rates low. As John Maynard Keynes wrote in 1937: “The boom, not the slump, is the right time for austerity at the Treasury.”

All of this is standard macroeconomics. I often encounter people on both the left and the right who imagine that austerity policies were what the textbook said you should do – that those of us who protested against the turn to austerity were staking out some kind of heterodox, radical position. But the truth is that mainstream, textbook economics not only justified the initial round of post-crisis stimulus, but said that this stimulus should continue until economies had recovered.

What we got instead, however, was a hard right turn in elite opinion, away from concerns about unemployment and toward a focus on slashing deficits, mainly with spending cuts. Why?


Conservatives like to use the alleged dangers of debt and deficits as clubs with which to beat the welfare state and justify cuts in benefits

Part of the answer is that politicians were catering to a public that doesn’t understand the rationale for deficit spending, that tends to think of the government budget via analogies with family finances. When John Boehner, the Republican leader, opposed US stimulus plans on the grounds that “American families are tightening their belt, but they don’t see government tightening its belt,” economists cringed at the stupidity. But within a few months the very same line was showing up in Barack Obama’s speeches, because his speechwriters found that it resonated with audiences. Similarly, the Labour party felt it necessary to dedicate the very first page of its 2015 general election manifesto to a “Budget Responsibility Lock”, promising to “cut the deficit every year”.

Let us not, however, be too harsh on the public. Many elite opinion-makers, including people who imagine themselves sophisticated on matters economic, demonstrated at best a higher level of incomprehension, not getting at all the logic of deficit spending in the face of excess desired saving. For example, in the spring of 2009 the Harvard historian and economic commentator Niall Ferguson, talking about the United States, was quite sure what would happen: “There is going to be, I predict, in the weeks and months ahead, a very painful tug-of-war between our monetary policy and our fiscal policy as the markets realise just what a vast quantity of bonds are going to have to be absorbed by the financial system this year. That will tend to drive the price of the bonds down, and drive up interest rates.” The weeks and months turned into years – six years, at this point – and interest rates remain at historic lows.

Beyond these economic misconceptions, there were political reasons why many influential players opposed fiscal stimulus even in the face of a deeply depressed economy. Conservatives like to use the alleged dangers of debt and deficits as clubs with which to beat the welfare state and justify cuts in benefits; suggestions that higher spending might actually be beneficial are definitely not welcome. Meanwhile, centrist politicians and pundits often try to demonstrate how serious and statesmanlike they are by calling for hard choices and sacrifice (by other people). Even Barack Obama’s first inaugural address, given in the face of a plunging economy, largely consisted of hard-choices boilerplate. As a result, centrists were almost as uncomfortable with the notion of fiscal stimulus as the hard right.

In a way, the remarkable thing about economic policy in 2008-2009 was the fact that the case for fiscal stimulus made any headway at all against the forces of incomprehension and vested interests demanding harsher and harsher austerity. The best explanation of this temporary and limited success I’ve seen comes from the political scientist Henry Farrell, writing with the economist John Quiggin.Farrell and Quiggin note that Keynesian economists were intellectually prepared for the possibility of crisis, in a way that free-market fundamentalists weren’t, and that they were also relatively media-savvy. So they got their take on the appropriate policy response out much more quickly than the other side, creating “the appearance of a new apparent consensus among expert economists” in favour of fiscal stimulus.

If this is right, there was inevitably going to be a growing backlash – a turn against stimulus and toward austerity – once the shock of the crisis wore off. Indeed, there were signs of such a backlash by the early fall of 2009. But the real turning point came at the end of that year, when Greece hit the wall. As a result, the year of Britain’s last general election was also the year of austerity.

Chapter twoThe austerity moment



rom the beginning, there were plenty of people strongly inclined to oppose fiscal stimulus and demand austerity. But they had a problem: their dire warnings about the consequences of deficit spending kept not coming true. Some of them were quite open about their frustration with the refusal of markets to deliver the disasters they expected and wanted. Alan Greenspan, the former chairman of the Federal Reserve, in 2010: “Inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued. This is regrettable, because it is fostering a sense of complacency that can have dire consequences.”

But he had an answer: “Growing analogies to Greece set the stage for a serious response.” Greece was the disaster austerians were looking for. In September 2009 Greece’s long-term borrowing costs were only 1.3 percentage points higher than Germany’s; by September 2010 that gap had increased sevenfold. Suddenly, austerians had a concrete demonstration of the dangers they had been warning about. A hard turn away from Keynesian policies could now be justified as an urgent defensive measure, lest your country abruptly turn into another Greece.

Still, what about the depressed state of western economies? The post-crisis recession bottomed out in the middle of 2009, and in most countries a recovery was under way, but output and employment were still far below normal. Wouldn’t a turn to austerity threaten the still-fragile upturn?

Not according to many policymakers, who engaged in one of history’s most remarkable displays of collective wishful thinking. Standard macroeconomics said that cutting spending in a depressed economy, with no room to offset these cuts by reducing interest rates that were already near zero, would indeed deepen the slump. But policymakers at the European Commission, the European Central Bank, and in the British government that took power in May 2010 eagerly seized on economic research that claimed to show the opposite.

The doctrine of “expansionary austerity” is largely associated with work byAlberto Alesina, an economist at Harvard. Alesina used statistical techniques that supposedly identified all large fiscal policy changes in advanced countries between 1970 and 2007, and claimed to find evidence that spending cuts, in particular, were often “associated with economic expansions rather than recessions”. The reason, he and those who seized on his work suggested, was that spending cuts create confidence, and that the positive effects of this increase in confidence trump the direct negative effects of reduced spending.


Greece was the disaster austerians were looking for

This may sound too good to be true – and it was. But policymakers knew what they wanted to hear, so it was, as Business Week put it, “Alesina’s hour”. The doctrine of expansionary austerity quickly became orthodoxy in much of Europe. “The idea that austerity measures could trigger stagnation is incorrect,” declared Jean-Claude Trichet, then the president of the European Central Bank, because “confidence-inspiring policies will foster and not hamper economic recovery”.

Besides, everybody knew that terrible things would happen if debt went above 90% of GDP.

Growth in a Time of Debt, the now-infamous 2010 paper by Carmen Reinhart and Kenneth Rogoff of Harvard University that claimed that 90% debt is a critical threshold, arguably played much less of a direct role in the turn to austerity than Alesina’s work. After all, austerians didn’t need Reinhart and Rogoff to provide dire scenarios about what could happen if deficits weren’t reined in – they had the Greek crisis for that. At most, the Reinhart and Rogoff paper provided a backup bogeyman, an answer to those who kept pointing out that nothing like the Greek story seemed to be happening to countries that borrowed in their own currencies: even if interest rates were low, austerians could point to Reinhart and Rogoff and declare that high debt is very, very bad.

What Reinhart and Rogoff did bring to the austerity camp was academic cachet. Their 2009 book This Time is Different, which brought a vast array of historical data to bear on the subject of economic crises, was widely celebrated by both policymakers and economists – myself included – for its prescient warnings that we were at risk of a major crisis and that recovery from that crisis was likely to be slow. So they brought a lot of prestige to the austerity push when they were perceived as weighing in on that side of the policy debate. (They now claim that they did no such thing, but they did nothing to correct that impression at the time.)

When the coalition government came to power, then, all the pieces were in place for policymakers who were already inclined to push for austerity. Fiscal retrenchment could be presented as urgently needed to avert a Greek-style strike by bond buyers. “Greece stands as a warning of what happens to countries that lose their credibility, or whose governments pretend that difficult decisions can somehow be avoided,” declared David Cameron soon after taking office. It could also be presented as urgently needed to stop debt, already almost 80% of GDP, from crossing the 90% red line. In a 2010 speech laying out his plan to eliminate the deficit, Osborne cited Reinhart and Rogoff by name, while declaring that “soaring government debt ... is very likely to trigger the next crisis.” Concerns about delaying recovery could be waved away with an appeal to positive effects on confidence. Economists who objected to any or all of these lines of argument were simply ignored.

But that was, as I said, five years ago.

Chapter threeDecline and fall of the austerity cult



o understand what happened to austerianism, it helps to start with two charts.

The first chart shows interest rates on the bonds of a selection of advanced countries as of mid-April 2015. What you can see right away is that Greece remains unique, more than five years after it was heralded as an object lesson for all nations. Everyone else is paying very low interest rates by historical standards. This includes the United States, where the co-chairs of a debt commission created by President Obama confidently warned that crisis loomed within two years unless their recommendations were adopted; that was four years ago. It includes Spain and Italy, which faced a financial panic in 2011-2012, but saw that panic subside – despite debt that continued to rise – once the European Central Bank began doing its job as lender of last resort. It includes France, which many commentators singled out as the next domino to fall, yet can now borrow long-term for less than 0.5%. And it includes Japan, which has debt more than twice its gross domestic product yet pays even less.

The Greek exception

10-year interest rates as of 14 April 2015

Chart 1Source: Bloomberg

Back in 2010 some economists argued that fears of a Greek-style funding crisis were vastly overblown – I referred to the myth of the “invisible bond vigilantes”. Well, those bond vigilantes have stayed invisible. For countries such as the UK, the US, and Japan that borrow in their own currencies, it’s hard to even see how the predicted crises could happen. Such countries cannot, after all, run out of money, and if worries about solvency weakened their currencies, this would actually help their economies in a time of weak growth and low inflation.

Chart 2 takes a bit more explaining. A couple of years after the great turn towards austerity, a number of economists realised that the austerians were performing what amounted to a great natural experiment. Historically, large cuts in government spending have usually occurred either in overheated economies suffering from inflation or in the aftermath of wars, as nations demobilise. Neither kind of episode offers much guidance on what to expect from the kind of spending cuts – imposed on already depressed economies – that the austerians were advocating. But after 2009, in a generalised economic depression, some countries chose (or were forced) to impose severe austerity, while others did not. So what happened?

Austerity and growth 2009-13

More austere countries have a lower rate of GDP growth

Chart 2Source: IMF

In Chart 2, each dot represents the experience of an advanced economy from 2009 to 2013, the last year of major spending cuts. The horizontal axis shows a widely used measure of austerity – the average annual change in the cyclically adjusted primary surplus, an estimate of what the difference between taxes and non-interest spending would be if the economy were at full employment. As you move further right on the graph, in other words, austerity becomes more severe. You can quibble with the details of this measure, but the basic result – harsh austerity in Ireland, Spain, and Portugal, incredibly harsh austerity in Greece – is surely right.

Meanwhile, the vertical axis shows the annual rate of economic growth over the same period. The negative correlation is, of course, strong and obvious – and not at all what the austerians had asserted would happen.

Again, some economists argued from the beginning that all the talk of expansionary austerity was foolish – back in 2010 I dubbed it belief in the “confidence fairy”, a term that seems to have stuck. But why did the alleged statistical evidence – from Alesina, among others – that spending cuts were often good for growth prove so misleading?



The answer, it turned out, was that it wasn’t very good statistical work. A review by the IMF found that the methods Alesina used in an attempt to identify examples of sharp austerity produced many misidentifications. For example, in 2000 Finland’s budget deficit dropped sharply thanks to a stock market boom, which caused a surge in government revenue – but Alesina mistakenly identified this as a major austerity programme. When the IMF laboriously put together a new database of austerity measures derived from actual changes in spending and tax rates, it found that austerity has a consistently negative effect on growth.

Yet even the IMF’s analysis fell short – as the institution itself eventually acknowledged. I’ve already explained why: most historical episodes of austerity took place under conditions very different from those confronting western economies in 2010. For example, when Canada began a major fiscal retrenchment in the mid-1990s, interest rates were high, so the Bank of Canada could offset fiscal austerity with sharp rate cuts – not a useful model of the likely results of austerity in economies where interest rates were already very low. In 2010 and 2011, IMF projections of the effects of austerity programmes assumed that those effects would be similar to the historical average. But a 2013 paper co-authored by the organisation’s chief economist concluded that under post-crisis conditions the true effect had turned out to be nearly three times as large as expected.

So much, then, for invisible bond vigilantes and faith in the confidence fairy. What about the backup bogeyman, the Reinhart-Rogoff claim that there was a red line for debt at 90% of GDP?

Well, in early 2013 researchers at the University of Massachusetts examined the data behind the Reinhart-Rogoff work. They found that the results were partly driven by a spreadsheet error. More important, the results weren’t at all robust: using standard statistical procedures rather than the rather odd approach Reinhart and Rogoff used, or adding a few more years of data, caused the 90% cliff to vanish. What was left was a modest negative correlation between debt and growth, and there was good reason to believe that in general slow growth causes high debt, not the other way around.

By about two years ago, then, the entire edifice of austerian economics had crumbled. Events had utterly failed to play out as the austerians predicted, while the academic research that allegedly supported the doctrine had withered under scrutiny. Hardly anyone has admitted being wrong – hardly anyone ever does, on any subject – but quite a few prominent austerians now deny having said what they did, in fact, say. The doctrine that ruled the world in 2010 has more or less vanished from the scene.

Except in Britain.

Chapter fourA distinctly British delusion



n the US, you no longer hear much from the deficit scolds who loomed so large in the national debate circa 2011. Some commentators and media organisations still try to make budget red ink an issue, but there’s a pleading, even whining, tone to their exhortations. The day of the austerians has come and gone.

Yet Britain zigged just as the rest of us were zagging. By 2013, austerian doctrine was in ignominious retreat in most of the world – yet at that very moment much of the UK press was declaring that doctrine vindicated. “Osborne wins the battle on austerity,” the Financial Times announced in September 2013, and the sentiment was widely echoed. What was going on? You might think that British debate took a different turn because the British experience was out of line with developments elsewhere – in particular, that Britain’s return to economic growth in 2013 was somehow at odds with the predictions of standard economics. But you would be wrong.

Austerity in the UK

Cyclically adjusted primary balance, percent of GDP

Chart 3Source: IMF, OECD, and OBR

The key point to understand about fiscal policy under Cameron and Osborne is that British austerity, while very real and quite severe, was mostly imposed during the coalition’s first two years in power. Chart 3 shows estimates of our old friend the cyclically adjusted primary balance since 2009. I’ve included three sources – the IMF, the OECD, and Britain’s own Office of Budget Responsibility – just in case someone wants to argue that any one of these sources is biased. In fact, every one tells the same story: big spending cuts and a large tax rise between 2009 and 2011, not much change thereafter.

Given the fact that the coalition essentially stopped imposing new austerity measures after its first two years, there’s nothing at all surprising about seeing a revival of economic growth in 2013.

Look back at Chart 2, and specifically at what happened to countries that did little if any fiscal tightening. For the most part, their economies grew at between 2 and 4%. Well, Britain did almost no fiscal tightening in 2014, and grew 2.9%. In other words, it performed pretty much exactly as you should have expected. And the growth of recent years does nothing to change the fact that Britain paid a high price for the austerity of 2010-2012.

British economists have no doubt about the economic damage wrought by austerity. The Centre for Macroeconomics in London regularly surveys a panel of leading UK economists on a variety of questions. When it asked whether the coalition’s policies had promoted growth and employment, those disagreeing outnumbered those agreeing four to one. This isn’t quite the level of unanimity on fiscal policy one finds in the US, where a similar survey of economists found only 2% disagreed with the proposition that the Obama stimulus led to higher output and employment than would have prevailed otherwise, but it’s still an overwhelming consensus.

By this point, some readers will nonetheless be shaking their heads and declaring, “But the economy is booming, and you said that couldn’t happen under austerity.” But Keynesian logic says that a one-time tightening of fiscal policy will produce a one-time hit to the economy, not a permanent reduction in the growth rate. A return to growth after austerity has been put on hold is not at all surprising. As I pointed out recently: “If this counts as a policy success, why not try repeatedly hitting yourself in the face for a few minutes? After all, it will feel great when you stop.”

In that case, however, what’s with sophisticated media outlets such as the FT seeming to endorse this crude fallacy? Well, if you actually read that 2013 leader and many similar pieces, you discover that they are very carefully worded. The FT never said outright that the economic case for austerity had been vindicated. It only declared that Osborne had won the political battle, because the general public doesn’t understand all this business about front-loaded policies, or for that matter the difference between levels and growth rates. One might have expected the press to seek to remedy such confusions, rather than amplify them. But apparently not.

Which brings me, finally, to the role of interests in distorting economic debate.



As Oxford’s Simon Wren-Lewis noted, on the very same day that the Centre for Macroeconomics revealed that the great majority of British economists disagree with the proposition that austerity is good for growth, the Telegraph published on its front page a letter from 100 business leaders declaring the opposite. Why does big business love austerity and hate Keynesian economics? After all, you might expect corporate leaders to want policies that produce strong sales and hence strong profits.

I’ve already suggested one answer: scare talk about debt and deficits is often used as a cover for a very different agenda, namely an attempt to reduce the overall size of government and especially spending on social insurance. This has been transparently obvious in the United States, where many supposed deficit-reduction plans just happen to include sharp cuts in tax rates on corporations and the wealthy even as they take away healthcare and nutritional aid for the poor. But it’s also a fairly obvious motivation in the UK, if not so crudely expressed. The “primary purpose” of austerity, the Telegraph admitted in 2013, “is to shrink the size of government spending” – or, as Cameron put it in a speech later that year, to make the state “leaner ... not just now, but permanently”.

Beyond that lies a point made most strongly in the US by Mike Konczal of the Roosevelt Institute: business interests dislike Keynesian economics because it threatens their political bargaining power. Business leaders love the idea that the health of the economy depends on confidence, which in turn – or so they argue – requires making them happy. In the US there were, until the recent takeoff in job growth, many speeches and opinion pieces arguing that President Obama’s anti-business rhetoric – which only existed in the right’s imagination, but never mind – was holding back recovery. The message was clear: don’t criticise big business, or the economy will suffer.
If the political opposition won’t challenge the coalition’s bad economics, who will?

But this kind of argument loses its force if one acknowledges that job creation can be achieved through deliberate policy, that deficit spending, not buttering up business leaders, is the way to revive a depressed economy. So business interests are strongly inclined to reject standard macroeconomics and insist that boosting confidence – which is to say, keeping them happy – is the only way to go.

Still, all these motivations are the same in the United States as they are in Britain. Why are the US’s austerians on the run, while Britain’s still rule the debate?

It has been astonishing, from a US perspective, to witness the limpness of Labour’s response to the austerity push. Britain’s opposition has been amazingly willing to accept claims that budget deficits are the biggest economic issue facing the nation, and has made hardly any effort to challenge the extremely dubious proposition that fiscal policy under Blair and Brown was deeply irresponsible – or even the nonsensical proposition that this supposed fiscal irresponsibility caused the crisis of 2008-2009.

Why this weakness? In part it may reflect the fact that the crisis occurred on Labour’s watch; American liberals should count themselves fortunate that Lehman Brothers didn’t fall a year later, with Democrats holding the White House. More broadly, the whole European centre-left seems stuck in a kind of reflexive cringe, unable to stand up for its own ideas. In this respect Britain seems much closer to Europe than it is to America.

The closest parallel I can give from my side of the Atlantic is the erstwhile weakness of Democrats on foreign policy – their apparent inability back in 2003 or so to take a stand against obviously terrible ideas like the invasion of Iraq. If the political opposition won’t challenge the coalition’s bad economics, who will?

You might be tempted to say that this is all water under the bridge, given that the coalition, whatever it may claim, effectively called a halt to fiscal tightening midway through its term. But this story isn’t over. Cameron is campaigning largely on a spurious claim to have “rescued” the British economy – and promising, if he stays in power, to continue making substantial cuts in the years ahead. Labour, sad to say, are echoing that position. So both major parties are in effect promising a new round of austerity that might well hold back a recovery that has, so far, come nowhere near to making up the ground lost during the recession and the initial phase of austerity.


For whatever the politics, the economics of austerity are no different in Britain from what they are in the rest of the advanced world. Harsh austerity in depressed economies isn’t necessary, and does major damage when it is imposed. That was true of Britain five years ago – and it’s still true today.

Why Karl Marx was right

Lee Sustar explains why mainstream economists are referring to Karl Marx in discussions of the world economy--and why they won't talk about the whole Marx.

September 13, 2011

ECONOMIST NOURIEL Roubini, whose predictions of the financial crash of 2008 earned him the nickname "Dr. Doom," has referred his patients to a specialist in capitalist crisis: Dr. Karl Marx.

In an interview with the Wall Street Journal, Roubini said:

Karl Marx had it right. At some point, capitalism can destroy itself. You cannot keep on shifting income from labor to capital without having an excess capacity and a lack of aggregate demand. That's what has happened. We thought that markets worked. They're not working. The individual can be rational. The firm, to survive and thrive, can push labor costs more and more down, but labor costs are someone else's income and consumption. That's why it's a self-destructive process.

For several hours on August 12, the Journal website ran the video of the interview as a top story, under the headline, "Roubini: Marx was Right."

Considering that the first edition of Marx's three-volume masterwork Capital appeared in 1867, Roubini's revelation isn't exactly news to socialist opponents of capitalism. But given the intractable nature of the current crisis--a deep global recession, a weak recovery in the traditional core of the system in the U.S. and Europe, and now the possibility of a lurch into a second recession--mainstream, or bourgeois, economics has been exposed as ideologically driven and incapable of offering solutions.

Stimulus spending, championed by liberal followers of the economist John Maynard Keynes, was in full swing two years ago. It staved off total economic collapse after the financial crash, but failed to produce a sustained boom and led to big government budget deficits.

That opened the door to the free-market champions of the so-called Austrian economic school of Friedrich von Hayek, who argued that slashing spending was key to an economic revival--only to see such measures choke off growth in Europe and, more recently, the U.S.

But in August, stock markets gyrated worldwide amid a worsening European debt crisis, a near-stall in U.S. economic growth and a slowdown even in China, home of the world's most dynamic big economy. Suddenly, the ideological crisis that accompanied the 2008 crash was palpable once more as the world system appeared on the brink of a new recession.

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ROUBINI, A professor at New York University, made his name--and quite a bit of money--by telling the unvarnished truth to Big Capital before the Wall Street meltdown hit. He's done so once again, this time referring to Marx for an explanation.

In his interview with the Journal, Roubini argued that the U.S. economy is flagging because business is hoarding cash--more than $2 trillion by one estimate--rather than investing it in factories, new equipment and hiring workers. As he put it:

If you're not hiring workers, there's not enough labor income, enough consumer confidence, enough consumption, not enough final demand. In the last two or three years, we've actually had a worsening, because we've had a massive redistribution of income from labor to capital, from wages to profits.

That shift has taken place not during the crisis, but during the recovery, as economist David Rosenberg pointed out earlier this year when he noted that the "labor share of national income has fallen to its lower level in modern history," 57.5 percent in the first quarter of 2011, compared to 59.8 percent when the recovery began. While that might seem like a small change, given the $14.66 trillion size of the U.S. economy, it's huge.

In alluding to this trend, Roubini is apparently referring to Marx's observation about a central contradiction of capitalism. "The consuming power of the workers is limited partly by the laws of wages, partly by the fact that they are used only as long as they can be profitably employed by the capitalist class," Marx wrote in Capital Volume 3. "The ultimate reason for all real crises always remains the poverty and restricted consumption of the masses."

It's wrong to assume, Marx contended, that capitalists limit their investments during a crisis because "the absolute consuming power of society" has reached its limit. On the contrary, the unemployed want jobs and workers desire a higher standard of living as the slump wears on.

But during crises, capitalism can't deliver, even when business has plenty of capital to invest. That's because capitalists won't put their money into building factories and offices and hiring workers--as Roubini pointed out--unless they have a reasonable chance of making a profit. Otherwise, they sit on their money.

"The capital already invested is then, indeed, idle in large quantities," Marx explained. "Factories are closed, raw materials accumulate, finished products flood the market as commodities. Nothing is more erroneous, therefore, than to blame a scarcity of productive capital for such a condition."

The result, Marx wrote, was both a "superabundance of productive capital" and "paralyzed consumption"--a fairly accurate description of recent trends in the U.S. economy.

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THE BIGGER questions are these: Why do such capitalist crises come about at all? And why are some downturns in the economy mild recessions, while others generate protracted crises, like the Great Depression of the 1930s or the "depression-with-a-small-d" that's gripped the world economy since late 2007?

Marx wasn't the first to observe what today's mainstream economists call the "business cycle"--the economic slumps that take place every few years. His contribution was to delve into the reasons for that pattern. He concluded that the internal contradictions of capitalism doomed the system to periodic, highly destructive crises.

The root of these crises is in the unplanned and competitive nature of capitalist production. For the capitalist, what matters isn't meeting social needs, but obtaining the maximum profit. If obtaining profit is possible from producing a life-saving medical device like a heart pacemaker, that's fine. But if more money can be made by producing junk food or nuclear weapons, greater investment flows into those industries instead.

Meanwhile, competition puts capitalists under constant pressure. They have to make sure that workers produce goods in as little time as possible--at what Marx called the "socially necessary labor time" required to produce a particular commodity. Otherwise, more efficient capitalists will drive them out of business. Thus capitalists are constantly compelled to invest in labor-saving machinery to cut production costs.

That is the secret of capitalist profitability. For example, new technologies may allow workers to produce enough to cover the costs of their wages in, say, just three hours instead of the four needed previously. The result is an increase in labor time spent working just for the capitalist--increasing what Marx called "surplus value," which is the source of profits.

But a portion of surplus value must also be reinvested in the production process. Refusing to do so is not an option for capitalists--who live by the rule of eat or be eaten. To the capitalist, Marx wrote in Capital Volume 1, the motto is:

Accumulate, accumulate! That is Moses and the prophets!...save, save, i.e., reconvert the greatest possible portion of surplus-value, or surplus-product into capital! Accumulation for accumulation's sake, production for production's sake: by this formula classical economy [the original bourgeois economics] expressed the historical mission of the bourgeoisie, and did not for a single instant deceive itself over the birth-throes of wealth.

The drive to accumulate is blind and chaotic. As Roubini recognized, "markets aren't working" because what is rational for an individual person or corporation--the maximization of profit by pushing down labor costs--can be irrational for the system as a whole.

During the upswing of the business cycle, the problems are largely hidden. As long as profits are high and credit is available, companies can borrow to invest in new production and hire new workers. Pundits proclaim that recessions are a thing of the past.

But even as production expands, profits are squeezed as new entrants flood the market. Companies go bust, which hits their banks hard. The banks, in turn, raise interest rates or simply refuse to lend, which triggers further bankruptcies. Factory closings and mass layoffs ensure--and, in the modern era, job cuts hit the public sector as tax revenues decline.

In the section of Capital Volume 3 quoted above, Marx described how the crisis can seem to erupt out of nowhere. Thanks to the extension of credit, he wrote:

[E]very individual industrial manufacturer and merchant gets around the necessity of keeping a large reserve fund and being dependent upon his actual returns. On the other hand, the whole process becomes so complicated, partly by simply manipulating bills of exchange [i.e., checks and promises of future payment], partly by commodity transactions for the sole purpose of manufacturing bills of exchange, that the semblance of a very solvent business with a smooth flow of returns can easily persist even long after returns actually come in only at the expense partly of swindled money-lenders and partly of swindled producers. Thus business always appears almost excessively sound right on the eve of a crash.

Marx's description of how credit could delay, but then exacerbate, a crash applies to the financial debacle of 2008, which involved no small amount of the kind of manipulation and swindling Marx saw in his day. Set aside the toxic alphabet soup of today's financial assets--CDS, CDO and MBS--and Marx's analysis of the role of bankers sounds familiar: "the entire vast extension of the credit system, and all credit in general, is exploited by them as their private capital."

The development of credit, in turn, helps expand capitalist production beyond the capacity of the market to absorb new commodities: "[B]anking and credit...become the most potent means of driving capitalist production beyond its own limits, and one of the most effective vehicles of crises and swindle."

But Marx also stressed that the credit crunch is actually a symptom of problems in the underlying productive economy. He wrote in Capital Volume 2, "[W]hat appears as a crisis on the money-market is in reality an expression of abnormal conditions in the very process of production and reproduction."

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THERE ARE longstanding debates among Marxist economic theorists about just how capitalist crises play out in general and their manifestation in different historical periods.

Marx identified a long-term tendency in the rate of profit to fall--the result of the constant pressure to invest in technology to replace workers, who are the source of surplus value. But capitalists have been able to counteract the falling rate of profit in various ways--for example, by destroying unprofitable capital through highly disruptive means, ranging from bankruptcies to wars like the Second World War, which ultimately was the most important reason the system finally overcame the Great Depression and was launched into a postwar boom.

In the 1970s, severe slumps returned to the world system as a revived Europe and Japan, along with several newly industrialized countries, emerged as more effective competitors to the U.S. But the restructuring of uncompetitive industries, free-market policies and corporate globalization opened the way to a new boom in the 1990s, when the U.S. declared that its "miracle economy" was the model for the world.

Ultimately, however, the economic expansion of the 1990s set the stage for a new crisis--one that Marx would have recognized. In the Communist Manifesto, written in 1847, years before he undertook a systematic study of the system, Marx and co-author Frederick Engels noted that capitalism's drive to expand led to crises of overproduction--of too many goods to be sold at a profit:

In these crises, there breaks out an epidemic that, in all earlier epochs, would have seemed an absurdity--the epidemic of overproduction. Society suddenly finds itself put back into a state of momentary barbarism; it appears as if a famine, a universal war of devastation, had cut off the supply of every means of subsistence; industry and commerce seem to be destroyed; and why? Because there is too much civilization, too much means of subsistence, too much industry, too much commerce...

And how does the bourgeoisie get over these crises? On the one hand by enforced destruction of a mass of productive forces; on the other, by the conquest of new markets, and by the more thorough exploitation of the old ones. That is to say, by paving the way for more extensive and more destructive crises, and by diminishing the means whereby crises are prevented.

That passage still has the ring of truth. It was capitalist overproduction on a world scale in the 1990s that set the stage for the 1997 East Asian financial crisis and the recession of 2001. But by dropping interest rates to rock bottom, the Federal Reserve was able to postpone the real day of reckoning for the U.S. for nearly a decade. Cheap credit and the housing bubble kept American consumers spending and the number of Asian factories growing, even if the number of manufacturing jobs in the U.S. continued to decline during the 2002-2007 expansion.

As we now know, banks were happy to make the loans for mortgages and then pass them along to Wall Street, which bundled them into securities that later turned toxic. When even a limited number of sub-prime loans started to go bad, a credit squeeze quickly destroyed investment banks Bear Stearns and Lehman Brothers. Nouriel Roubini, who had been warning about all this for years, was suddenly a business celebrity--and even Karl Marx made the financial press.

The bad debts of that era of casino capitalism continue to weigh down the world economy. Yesterday's toxic assets held by private banks have morphed into today's government budget deficits, thanks to the no-questions-asked, multitrillion-dollar bailouts in the U.S. and Europe.

And the global crisis of overproduction is still unresolved. In the U.S., the capacity utilization rate for total industry was 77.5 percent in July, some 2.2 percentage points above the rate a year earlier, but 2.9 percentage points below the average for the period between 1972 and 2010. That's unmistakable evidence of a depressed economy--and it's what Roubini was talking about when he cited "excess capacity" and mentioned Marx.

With mainstream economists fresh out of ideas about how to overcome the crisis, perhaps it shouldn't be surprising that Marx made news even in Rupert Murdoch's Wall Street Journal. But don't hold your breath waiting for a follow-up Journal headline: "Capitalism Isn't Working: Socialism is the Alternative." That part is up to us.

9 reasons Keynesians aren't winning the argument – and what to do about it

If the 'obvious' failure of austerity is to make way for Keynesian policies, its advocates must confront their critics head on

• 
• • Phillip Inman
  • guardian.co.uk, Friday 7 June 2013 12.20 BST

British economist John Maynard Keynes, at the UN International Monetary Conference, circa 1946. Photograph: Hulton Archive

Keynes is out of favour. In his place are the austerians who mistakenly liken the finances of nation states to domestic budgets. Unfortunately the Keynesians have fallen into the trap of thinking that the case they make is incontrovertible. It would hardly matter, except that their failure to address legitimate concerns – not those of rightwing commentators or the super-rich, but of voters on middle and low incomes – has blunted their sound argument for a stimulus package and allowed austerians to make most of the running. The "obvious" failure of austerity, recent improved figures for the economy notwithstanding, has done little to derail its continued application by the UK, Brussels and to a lesser extent, the US Congress.

Why? Here are nine assumptions that trip the Keynesians up.

1. They think policymakers refuse to change course because they don't understand

Liberal academics believe in the power of argument. If only the other person were intelligent enough to understand, they would realise that Keynesian economics is the only way to view the world. Paul Krugman, the Princeton economist who heads the list of left-leaning thinkers challenging austerity, believes officials in Brussels have opted for austerity simply because they misunderstood its negative effect on growth. Yet officials and politicians in Brussels are well aware of Keynesian theory and the history of the 1930s. The German finance minister, Wolfgang Schäuble, is many things, but being a bit thick is not one of them.

2. They think that everyone agrees austerity is wrong headed

Dean Baker is a left-leaning US economist and regular contributor to the Guardian. He said in a recent article: "We allowed policy to be waylaid by a misplaced obsession with deficits. Now that everyone in the debate recognises this mistake, it is time to focus on getting the country working again." Everyone agrees? In fact, most polls show voters approve of austerity. They want governments to cut annual budget overspends. The governor of the Bank of England believes in austerity. Three eminent mainstream British economists told MPs on the all-party Treasury select committee last month that the government had struck the right balance between cuts and spending. Austerity is bang on the mark, they said.

3. They think Brussels and the IMF have changed their tune

The EU commission boss, José Manuel Barroso, made comments in April that were leapt on by everyone on the left. He said austerity had reached its limits. Liberals said to themselves: finally he understands. But he only meant that in some countries voters were unwilling to accept more salary and welfare spending cuts, not that he agreed with them. He still thinks austerity is the right medicine. Later, a Brussels official told the Reuters news agency that Barroso had "miscommunicated" and there was no alternative to austerity, even if the word was avoided.

4. They make out that a spending boost with borrowed money is risk-free

The risks need to be explained. It is quite possible for governments to spend and find that growth remains elusive. A two-decade long spree by the Japanese has taken borrowing to more than 240% of GDP without boosting growth. To some extent it depends what the money is spent on. For instance, a high-speed rail link built by foreign companies (HS2, anyone?) will create less benefit than an immediate maintenance budget boost for existing lines.

5. They think central banks can carry on printing money with no risk

Quantitative easing involves central banks using their own money to buy government bonds (effectively lending the government money). They mostly buy the bonds from banks, which then use the cash to lend to other institutions and possibly, at some point along the chain, to small businesses. No risk? Not really. First, the banks can hoard the money to satisfy regulators who believe they are unsafe. Second, they can lend it, but factor in huge profit margins and pay themselves massive bonuses as a reward. And the money can be used to invest in property, for an easy profit, bypassing manufacturers.

6. They think quantitative easing can be switched off and normality will return

Just three central banks – the Bank of England, the Fed and the Bank of Japan – have created more than £3tn of debt and the figure is rising all the time. The Federal Reserve is creating around £50bn a month and the Japanese have joined in. Can all this money be sold back to the private markets without spooking investors, most of which have bought bonds or shares on the basis of never-ending central bank support? Probably the bonds will never be sold, but held until they mature, or they could be slowly drip-fed back into the international money markets, but the risks should be discussed.

7. They argue that no one should fear inflation

UK inflation fell to 2.4% in April, but remains well above wage rises, which trail at 0.8%. That's a big cut in living standards. Any politician who says inflation at 5% is not a worry will be blown away on election night. But that is what plenty of Keynesian economists, including Krugman, advocate. They have sound reasons for being relaxed about inflation. Most countries are worried about falling prices. And a stimulus package that raises demand is worth the risk of a short-term rise in inflation, even in the UK. Yet fearful middle-class savers and workers suffering pay freezes have legitimate fears.

8. They argue that stock market and house price rises are benign

Krugman is chief propagandist for the "spend now, deal with structural problems later" brigade, which means he simply won't address the issue. The London stock market recently neared its all time high despite a backdrop of static growth across Europe. UK house prices in property hotspots are above their 2007 peak. Is there a danger that some economies, the UK included, are simply repeating the mistakes of the early 2000s and encouraging debt-fuelled spending on unproductive assets like property to make a quick buck? Nouriel Roubini, known as Dr Doom for his pessimistic outlook for western economies long before the 2007 crash, oscillates between the Krugman view and warning of asset bubbles that could become the next economic atomic bombs. There needs to be a closer inspection of asset bubbles.

9. They believe politicians can be trusted to spend stimulus funds in the best way

Liberal economists assume voters trust politicians to spend funds sensibly. Multibillion pound investments in rail, nuclear energy and housing are needed but only a minority of voters trust the public sector to make a good job of it. For the time being, there needs to be an acknowledgment that civil servants and politicians of all political colours failed to spot the crash and are therefore not as smart as people once thought.

Conclusion

Keynesian economics is a valid response to the UK's protracted economic depression. There are always risks, but there were always risks with austerity and it has pushed up borrowing by as much if not more than a Keynesian stimulus would have done. Far from re-establishing confidence and generating growth, the UK has grown by 1.1% in three years. And it has a worsening trade balance and higher debt levels. Unemployment failed to rise by as much as expected, but it could be even lower by now. Economic green shoots are appearing, but can vanish with an early frost, which is possible with banks still strapped for cash and reluctant to lend.

It's important, then, that Keynesians win the argument. But if they want to do so, they've got to face their critics head on, and deal with legitimate concerns about the approach.