Duncan’s Economic Blog

Cameron & Crowding Out

Posted in Uncategorized by duncanseconomicblog on November 23, 2009

In his speech today David Cameron made a rather bold claim.

The idea that the deficit brings the risk of higher interest rates for businesses and families isn’t a theoretical possibility – it is actually happening already.

One of the things that is limiting the supply of affordable credit is that banks need to build up their deposit bases and become less reliant on unstable wholesale funding.

But amazingly the most attractive – and therefore competitive – one year savings product on the market at the moment is actually being provided by the Government, through National Savings and Investments.

So the Government’s need to finance its borrowing is already affecting the supply of credit to families and businesses – and its cost.

In other words, government action is already beginning to crowd out the private sector.

Essentially Cameron is advancing the ‘loanable’ funds’ theory – that there are a certain amount of savings out there and that the government is taking up too much of them through borrowing. The private sector is crowded out. This was the prevailing economic wisdom of the 1930s.

The premise of Cameron’s argument can be challenged with reference to the Bank of England’s latest Survey of Lending:

Overall, demand for new bank lending was expected by the major UK lenders to remain subdued during the remainder of the year. The outlook for 2010 would depend on the prospects for working capital and mergers and acquisitions activity in particular. On the supply side, the major UK lenders noted signs of increasing competition among those lenders currently active in the market. Some business contacts of the Bank’s regional Agents — particularly from larger firms outside of the property sectors — also reported that credit availability had eased.

The Bank believes this is much a problem of demand for finance as it is of supply. Not something covered by Cameron.

But, leaving aside empirical evidence (as Conservative economic policy making is want to do), the speech highlights the theoretical approach of Tory economic policy. The ‘loanable funds’ theory is an 1930s throw back and  only holds if an economy is operating at full capacity – a situation far from what we have presently. As Paul Krugman has written:

So what does government borrowing do? It gives some of those excess savings a place to go — and in the process expands overall demand, and hence GDP. It does NOT crowd out private spending, at least not until the excess supply of savings has been sopped up, which is the same thing as saying not until the economy has escaped from the liquidity trap.

Now, there are real problems with large-scale government borrowing — mainly, the effect on the government debt burden. I don’t want to minimize those problems; some countries, such as Ireland, are being forced into fiscal contraction even in the face of severe recession. But the fact remains that our current problem is, in effect, a problem of excess worldwide savings, looking for someplace to go.

Cameron, like his Shadow Chancellor, is advocating what I’ve dubbed ‘neo-classical nonsense’. As I said then:

This is more than an academic economic theory debate. George Osborne is pushing a neo-classical (almost classical!) line that the government spending less and people saving more, will lead to high investment and higher growth. That’s been tried before in the real world – in the 1930s. The result was depression.

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12 Responses

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  1. tim f said, on November 23, 2009 at 5:38 pm

    Are you sure it’s even that elaborate?

    It seems more likely Cameron is slightly worried about Labour’s line that Tory plans would lead Britain into a double-dip recession. His way of dealing with that is by turning the line back on Labour, and hoping mere contradiction is enough to muddy the waters. There doesn’t have to be any actual economic theory behind it, as most voters won’t understand anyway.

    • duncanseconomicblog said, on November 23, 2009 at 6:37 pm

      Fair point Tim – I may be being too kind.

  2. [...] Cameron & Crowding Out Duncan's Economic Blog on Cameron's CBI speech. David Cameron claimed today that higher public borrowing was damaging the economy. Duncan responds to one of his key arguments in his usual well-informed fashion. [...]

  3. thelocalgovernmentofficer said, on November 23, 2009 at 7:08 pm

    NSI have withdrawn that account, actually, about a week after introducing it. I was wondering why and am now pondering if perhaps someone got wind of his plan to use it in the speech and orders came down. Certainly I don’t think the Government “needs” to pay 3.95% on 1-year borrowings at the moment…

  4. [...] it clear when enough is enough. I think we are getting close but not there yet.  Duncan thinks Cameron is obviously wrong. But the IMF’s Global Stability Report had similar logic about demand and supply of credit.  [...]

  5. Chris Cook said, on November 23, 2009 at 10:12 pm

    The loanable funds theory ignores the reality of credit creation by credit intermediaries.

    Money created as interest-bearing debt/credit is instantaneously the subject of a matching deposit somewhere in the system as an accounting identity.

    The ‘loanable fund’ theory is consistent with the belief of 99.999% of the population that banks take in deposits and lend them out again. If that were the case then there could not BE any new money other than (interest-free) cash created ex nihilo by Central Banks or (possibly) Treasuries.

    The belief is also consistent (and equally misconceived) with the ‘savings glut’ canard. US etc credit=money created as debt and used for consumption came first – Chinese deposits/savings and purchases of T Bills followed – and was a consequence, not a cause.

    So I have to disagree with you, Duncan, ‘loanable funds’ is IMHO a fallacy in all cases.

  6. dannyboy said, on November 23, 2009 at 11:21 pm

    Chris, perhaps duncan is alluding to a situation in which the central bank agressively sticks to an inflation target in a situation close to full employment. In this case, significant new bank credit creation would be inflationary as the economy could not absorb it all at least not initially.

    In such a situation the only source of non inflationary new investment funds would be a reduction of consumption.

    Of course the historical situations in which we have attained anything approaching full employment are exceedingly rare.

    The impulse of society generally when faced with growth opportunities in a tight employment environment is to maintain consumption more or less as is and just generate the new funds on top, hence inflationary growth.

    • cjenscook said, on November 24, 2009 at 11:47 am

      I think that virtually all of the fundamental assumptions of economics are wrong.

      I think that the profit motive is the ’cause’ of what Gunnar Tomasson calls ‘Final Demand Inflation’ and that this is engrained within the economy through a combination of:

      (a) double entry book-keeping – and accounting identities; and

      (b) entities operating “For Profit”, of which the Plc is the apotheosis.

      Credit (=money in a deficit-based economy ) follows and accommodates transactions at prices inflated by profit. The fact that profit causes inflation is a from of financial pornography which is ignored and unrecorded

      Bank credit creation – plus the profit motive and the ‘inflationary expectation’ that asset prices only ever go up – certainly leads to asset price inflation. But I do not buy the idea that credit creation leads to retail price inflation, which I see as a largely fiscal phenomenon.

      I do not believe that individuals build inflationary expectations into their wage claims, although it suits the dominant narrative to say so. There is never a good time for a wage rise. If growth is positive, wage rises will stifle it; if stable, then wage rises will prevent growth; and in a recession, wage rises will make things worse, of course.

      Joe Blow does not think “inflation will be 10% therefore I claim a 12% wage hike” – he thinks “I’ve just lost 10% of my purchasing power, therefore I claim 12%”. And the reason Joe has had to borrow is that he has not HAD wage hikes and is short of purchasing power, because all of the productivity gains in the last 30 years have gone to Capital not him.

      Conventional economics is entirely bollocks – and ideological bollocks at that – aimed at justifying the unjustifiable.

      End of rant.

  7. duncanseconomicblog said, on November 24, 2009 at 8:20 am

    Chris (and Dannyboy),

    Today’s post – which I’m nearly finished will demonstrate that I don’t buy the loanable funds theory.

  8. Bill le Breton said, on November 24, 2009 at 11:26 am

    The creation of money is what we need. If it is done as a result of financing Government Expenditure (as the PSBR) so much the better as it creates demand, increases capital (physical, social and intellectual), more directly engages the accelerator effect and probably has a higher multiplier effect than alternative forms of expenditure.

  9. [...] No, I am not accusing the chancellor of drafting his budgets to Mott the Hoople (although a bit of All the Way from Memphis would perk up discussions of fiscal policy). And yes, I know that he was only born in 1971. But there’s a two-word phrase that both Osborne and Cameron use which sums up their economic philosophy – and which is straight-up 70s revivalism. Those two words are: crowding out. [...]


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