Duncan’s Economic Blog

Cameron and the Dark Ages of Economics

Posted in Uncategorized by duncanseconomicblog on September 9, 2009

I’m starting to wonder… what on earth are the Tories talking about?

 Cameron now is pushing a strange line

“You need to start the process of bringing spending down now,” Mr Cameron said. He asserted that Treasury proposals to increase spending by £30bn in 2010-11 before tackling the deficit meant the election of “another Labour government could tip us back into recession”.

Is Cameron really pushing that line that increasing spending will cause a recession?

This is the same line as Niall Ferguson. As Paul notes:

Meanwhile, Ferguson writes and says what he thinks will please his readers and listeners, and what he knows will please most of his readers and listeners is the simplistic but dangerous certainties of fiscal conservatism.

How could Cameron be right?

The answer lies in crowding out. I.e.:

If increased borrowing leads to higher interest rates by creating a greater demand for money and loanable funds and hence a higher “price” (ceteris paribus), the private sector, which is sensitive to interest rates will likely reduce investment due to a lower rate of return. This is the investment that is crowded out. The weakening of fixed investment and other interest-sensitive expenditure counteracts to varying extents the expansionary effect of government deficits. More importantly, a fall in fixed investment by business can hurt long-term economic growth of the supply side, i.e., the growth of potential output.

But as wikipedia continues, things aren’t that clean cut:

However, this crowding-out effect is moderated by the fact that government spending expands the market for private-sector products through the multiplier and thus stimulates – or “crowds in” – fixed investment (via the “accelerator effect“). This accelerator effect is most important when business suffers from unused industrial capacity, i.e., during a serious recession or a depression.

That last sentence is important.  UK Capacity utilisation is currently at 72%. The lowest since the data was first collected in the early 1990s.

Note to the Tory Economic team: Remember to read more than just the first paragraph on wikipedia.

Paul Krugman has written of those contending that government borrowing will always lead to a fall in private investment:

The answer, I think, is that we’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.

And that’s what seems to have happened to macroeconomics in much of the economics profession. The knowledge that S=I doesn’t imply the Treasury view — the general understanding that macroeconomics is more than supply and demand plus the quantity equation — somehow got lost in much of the profession. I’m tempted to go on and say something about being overrun by barbarians in the grip of an obscurantist faith, but I guess I won’t. Oh wait, I guess I just did.

Cameron: a barbarian in the grip of an obscurantist faith…


9 Responses

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  1. Paul said, on September 9, 2009 at 10:10 am

    Good post as ever, Duncan. I’d be interested in your comments on the first comment on Robert Peston’s new post, about the need to focus on gilts.

    I also love the last paragraph: ‘Moody’s and the rest can keep their ratings, they didn’t help Lehman, they didn’t help Iceland and they can change in an instant. Ratings agencies remain the epitome of the problem, reactionary rather than genuinely incisive. We all know this.’ Interesting therefore to hear Phil Hammond on Newsnight last night using what he says are the warnings from S&P and Moody’s about the AAA rating as the key reason for immediate slashing of public spending.

    • duncanseconomicblog said, on September 9, 2009 at 10:22 am

      I’m not convinced about the gilt strike threat.

      Martin Wolf is good in today’s FT.

      Yes, yields will rise in the future. But to what? Say they hit 5%, we can still deal with that. If they rise to 7/8% then we have a problem – but I don’t see the catalyst for that yet.

      In Japan, despite 180% debt to GDP, yeilds have stayed below 2.5% for the better part of two decades.

      In the long run, we can’t run a 12% deficit every year. But now isn’t the time to be worrying about that. Spending cuts that kill off a recovery will lead to higher, not lower deficits and debt.

      (As a side point why do we always talk of spending cuts and not tax rises?).

  2. Paul said, on September 9, 2009 at 10:58 am

    Yes, I’d been wondering aloud why Japanese gilts remain so much lower. Andreas (Citizen) suggests it’s to do with high domestic savings. Either way, that does seem to suggest that the borrowing cost thing is as overrated as the whole international credit rating agency thing (about which Hammond was lying on TV last night – see my new post).

    Good point, your side point. Bears repeating a whole lot the whole time as it’s being drummed out of whatever common language there is on approach to post-recession.

    • duncanseconomicblog said, on September 9, 2009 at 11:10 am

      The savings rate matters (and what’s important is the whole economy savings rate, not just household savings – as John Ross keeps saying), but so does the attractiveness of other assets.

      Interesting read that I didn’t entirely agree with in Time this week.


      “There is a limit on how big the government’s borrowings can get before they start causing problems. But what’s the limit? In the early 1980s, many smart people would have told you that deficits topping 3% of GDP would bring economic pain, as government borrowing crowded out private investment and investors demanded higher interest rates on Treasuries to compensate for our country’s shakier finances. But during the Reagan presidency, deficits stayed above 4% of GDP for five straight years — and interest rates fell, and the economy boomed. ”

      Also worth a read (on the US):


  3. Mr. Mxyzptlk said, on September 9, 2009 at 8:21 pm

    wikipedia dunc? now come on reputable sources please

  4. Mr. Mxyzptlk said, on September 9, 2009 at 8:24 pm

    Cameron the barbarian………… has ring to it who could we cast to play the main role

  5. charliemarks said, on September 9, 2009 at 8:44 pm

    Since all parties are agreed that expansion of borrowing will not continue and that there will be a gradual (Labour) or sudden (Tory) reduction in deficit spending – how can Hammond – and other Tories – make such outrageous claims?

  6. […] Enough beating about the Bush. A practical example with David Cameron. The thing to grasp here is that whatever he’s apparently saying, or not […]

  7. […] and the usual cutting-edge Keynesians from across the Atlantic, bright economists on this side like Duncan are mystified by the Tory opposition’s pre-1930 approach to fiscal policy in a liquidity-trap […]

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