Sunday, 23 September 2012

Hot air from Jonathan Portes and John Van Reenen on consolidation.

To consolidate or not to consolidate, that is the question – the question that troubles those who don’t understand consolidation.

This Financial Times article by the above two advocates a middle of the road policy as between two extremes: fast consolidation which spells severe austerity right now and the other extreme, slow consolidation which allegedly means a very high national debt.

All “sensible” middle of the road people will applaud the above sensible, middle of the road policy: mainly because they’ve no grasp of the subject, and if you want to sound sensible and reasonable, and have no idea what you’re talking about, then you can’t go wrong with a “mid-way between two extremes” policy. If you’re a politician, that’s bound to win votes.

Two phrases in the article illustrate the authors’ non-grasp of the subject.

First, they say “The modelling confirms that doing nothing was not an option; our “no fiscal consolidation” scenario leads to unsustainable debt ratios. So some pain was inevitable.” The “modelling” refers to the NIESR’S super duper computer model (paid for by you, the taxpayer): not to mention the £2m or so of taxpayer’s money that the NIESR spends on staff salaries, etc.

Their other revealing sentence is their last, which reads, “This analysis shows that the economic pain resulting from fiscal consolidation, while unavoidable, could have been substantially reduced by a sensible application of basic macroeconomic principles.”

Funding the debt with monetary base.

The first mistake comes in the first sentence where the authors claim that slow consolidation leads to elevated levels of national debt. As Keynes, Milton Friedman and no doubt dozens of other economists pointed out, a deficit can be funded EITHER BY increased debt OR BY an increased monetary base. No doubt the super duper advanced technology NIESR computer model reached the conclusion that deficits lead to increased debt because that was the (false) assumption fed into it.

In fact the deficits of the last year or two ACTUALLY HAVE BEEN funded by an increased monetary base in that most of the increased debt has been QEd. Of course that process leaves billions worth of so called debt in the hands of the central bank. But that debt might just as well be torn up: it’s meaningless. It’s a debt owed by the Treasury to the central bank. I.e. it’s a debt owed by one arm of the state to another.

Pain is not inevitable.

Next, let’s assume that a deficit (contrary to what Keynes and Milton Friedman told us) can only be funded by increased debt. And let’s take the idea that “some pain was inevitable” because “no fiscal consolidation leads to an unsustainable debt ratio”.

The idea that Britain or America’s debt is “unsustainable” even if it gets substantially larger is an odd claim given that the REAL RATE OF INTEREST (i.e. the inflation adjusted rate) is around ZERO! I’m happy to borrow a billion any time at a zero real rate of interest.

Of course it’s possible the interest rate suddenly rises, but that would have no effect on the interest paid on debt with some time to go before maturity. In contrast, there is debt reaching maturity and due for roll-over, and there might seem to be a problem there.

The apparent problem is this. If the debt is rolled over, the country has to pay a substantial amount of interest. But if it’s not rolled over, and we just print money and pay off debt holders, the effect is stimulatory - even inflationary.

Hang on . . . . did I say “stimulatory”? Shock, horror. Isn’t stimulus exactly what’s needed in a recession?

Of course the stimulus might be TOO MUCH. But that’s not a problem: the relevant government just needs to raise taxes (or cut public spending) by whatever is needed to counteract the excess stimulus.

At this point, the massed ranks of economic illiterates will chirp up and claim that increased taxes or public spending cuts equals the “pain” to which Portes and Van Reenen referred. My answer is “not true” (though I’d prefer to use stronger language.

The purpose of those taxes / spending cuts would simply be to rein in demand to a level that can be accommodated. Put another way, the purpose is to prevent excess inflation. In short (and ironically) those taxes far from making anyone WORSE OFF would actually make them BETTER OFF in that excess inflation involves significant costs or damage.

Or put it yet another way, to print money and increase public spending when an economy is at capacity won’t result in any increased public spending in REAL TERMS. It just leads to inflation.


Government should AT ALL TIMES keep the deficit at the maximum level that is consistent with acceptable inflation. As to the actual size deficit or debt: ignore them.

In fact the basic point in the above paragraphs comes to the same thing as a short phrase enunciated by Keynes: “look after unemployment and the budget will look after itself”. But then as already pointed out, Portes and Van Reenen don’t seem to have a full grasp of Keynes’s ideas. .


  1. 'The purpose of those taxes / spending cuts would simply be to rein in demand to a level that can be accommodated.'

    That might be their purpose, but surely not their only effect. There seems to be a risk here from large fluctuations and uncertainty over prices, tax rates and government expenditure plans.

    1. The only alternative is to pay an elevated rate of interest on national debt, as I intimated in the paragraphs just prior to the passage you quoted. And paying that interest would have to be funded by increased tax (or public spending cuts). So I don’t see that it makes much difference (as far as tax or public spending goes) which option a country goes for. Re prices, which I’ll interpret as meaning “inflation”, if aggregate demand is the same in the above two scenarios, there shouldn’t be much effect on inflation.

      BTW: hope you got my comments on that draft.

  2. Why don't you ask/persuade/challenge them to run the NIESR model with a "debt monetisation" scenario ?


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