Duncan’s Economic Blog

The Government’s Growth Plan: Higher Unemployment

Posted in Uncategorized by duncanseconomicblog on January 5, 2011

We all know by now that the OBR has revised its unemployment forecasts higher. Others, such as the CIPD, think it is still too optimistic and unemployment could move even higher.

So there isn’t really any question on the facts – Tory policy will increase unemployment. The defence offered is quite straight forward – there is no alternative; we must pay down our debt.

Meanwhile the coalition is strangely quiet on its growth strategy, with last year’s long-trailed White Paper postponed. I say strangely quiet as their target is quite clear: an increase in net exports and investment. What they seem reluctant to talk about in public is how this goal will be achieved.

Could it be that unemployment is not just “a price worth paying” to regain fiscal credibility but actually a crucial component of their growth strategy?

The government like to talk about using UK diplomats to sell UK goods abroad; I call this the “Ferro Roche Growth Plan”. It’s a nice idea but one unlikely to work, especially as UK Trade & Investment is already rated as the best export promotion agency in the world and it has yet to achieve what Osborne & Co are aiming for.

Another way to boost net trade would be to devalue sterling further. But it’s also hard to see how that could be achieved in an environment in which nearly every country is trying to do the same.

So that really leaves what economists like to call “internal devaluation” as the only route to achieve the competitiveness needed to meet the Government’s aim of a large increase in net exports. In other words, reducing domestic costs.

In plain English this means cutting labour costs. In even plainer English this means cutting the wage bill.

And the best way to lower wages (relative to what they would have been) is to increase unemployment and so loosen up the labour market.

Maybe Osborne does have a growth strategy; he just doesn’t feel he can talk about.

42 Responses

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  1. Neil Wilson said, on January 5, 2011 at 11:22 am

    There is a straightforward option that nobody seems to be prepared to take. Stop issuing gilts.

    Let’s face it if you’re running a corporate surplus which would you rather do? Invest in the current British economy or take a 4% risk free return courtesy of government spending that would be more effective if directly spent elsewhere? You’re not going to mobilise the corporate surplus with such a subsidy on offer.

    They are a relic of the gold standard and completely unnecessary in our system. If you stop issuing them then people can either leave their money on reserve at 0.5% or do something else with it.

    Interest on gilts is effectively an import subsidy. Why do we want to do that?

    • Andreas Paterson said, on January 5, 2011 at 11:41 am

      I’m assuming that by “stop issuing gilts” you essentially mean printing money?

      • Chris Cook said, on January 5, 2011 at 1:32 pm

        Of course. That’s what a Central Bank is for.

        If private banks are too insolvent, or otherwise unwilling, to lend or spend money into circulation then the Treasury must do so, professionally managed by service providers with a stake in the outcome (formerly-known-as-banks) and accountably and transparently supervised by a monetary authority.

        Once new productive assets have been created they will be long term funded by eg pension investment and the public credit which financed them will be retired and recycled.

        The income received by the newly productive public and private sector employees responsible for the creation of this new generation of assets will be taxed, and that taxation will also retire and recycle public credit.

      • Neil Wilson said, on January 5, 2011 at 1:54 pm

        No I mean stop issuing gilts. The money has already been created. You can’t buy gilts with US dollars.

        In our system gilts act like savings certificates. It’s just like you moving money from your cheque account into your deposit account at the bank. You get a better rate of interest.

        • Andreas Paterson said, on January 5, 2011 at 2:06 pm

          I think I get your meaning, I think we’re just getting bogged down in technical terms here. So I assume what you mean is that since a government cheque can’t bounce theres no real need to issue debt to cover government spending.

          I do quite like this idea myself, it seems like the best way to once again get money circulating around the economy. I do think though, that politically it would be very difficult to do,

  2. liminalhack said, on January 5, 2011 at 12:13 pm

    Neil I quite agree. Gilts are an investment in /dev/null, and I personally believe we can lay many of our modern employment problems at their door.

    As I point out here on my little blog, risk free nominal bonds paying interest are themodern equivalent of a golden goose.

    http://liminalhack.wordpress.com/wp-admin/post.php?post=73&action=edit

    In a world withoput nominal bonds investors could either take the 0 yield of a bank deposit or they could invest in the real economy, which would have actual nominal risk or carrying costs or noth, all of which is supportive of employment.

    having said that, I don’t think this can be combined with regular chartalist style deficit spending straight into private bank accounts. The point about a chartalist mode of operation is that the government budget ought to be structurally balanced, with the option of deficit spending to fill a gap in demand but to be credible people would need to be convinced this is a policy option and not a structural deficit.

  3. Ian Davis said, on January 5, 2011 at 1:29 pm

    I think if they wanted to loosen up the employment market they would remove the minimum wage and allow wages to float down. I don’t see that happening so I’m not convinced by your suggestion that they’re looking for a looser employment market.

  4. F0ul said, on January 5, 2011 at 1:57 pm

    The question really is, what is the purpose of the economy? Is it to create jobs or wealth? We are currently in a situation where we have no wealth as we owe it all to someone else! However, we did buy jobs with the wealth we borrowed!

    I guess its either a case of trying to keep people in jobs while the government try and find a way to pay for them – or is a case of getting rid of the jobs of those who are not doing anything useful and paying back the debt a bit sooner.

    Personally, I think the Tories plan is the first one – hence the reason that the public sector is still employing 30%+ of the working population!

    BTW, an internal devaluation can also be called sky high inflation!

  5. Carl Packman said, on January 5, 2011 at 2:59 pm

    worrying; not unbelievable

  6. Luis Enrique said, on January 5, 2011 at 5:34 pm

    if so, would this resemble Germany’s recent policies … didn’t they take a decision about a decade ago to push down wages? I remember somebody somewhere posting a graph of German manufacturing wages over last decade versus UK. Everybody prefers to attribute Germany’s success to its ‘investment’ without explaining why that investment was forthcoming.

    I just don’t get this “stop issuing gilts” stuff. so government checks don’t bounce, so somewhere there is a government account being debited but no corresponding change in any asset positions – I am not using the right terms I am sure – but are you suggesting no longer balancing the books? Where does the money come from of the government is not borrowing it or the BoE printing it to buy gilts?

    • vimothy said, on January 5, 2011 at 6:31 pm

      Luis,

      Re: gilts. This is an MMT proposal. Essentially it boils down to the idea that, as currency issuer, the government does not need to borrow money in order to spend. Rather, it can choose to simply issue new currency. I’m afraid I don’t follow your accounting question exactly, but of course the books must still balance. The govt (as a whole) is still issuing liabilities in order to fund the acquisition of assets of whatever type, but the liquidity profile and average maturity of those liabilities is different under the MMT proposal. You can think of the “no gilts” policy as being akin to reducing the average maturity of govt debt and increasing its liquidity. In other words: nuclear QE.

      • Neil Wilson said, on January 5, 2011 at 7:39 pm

        The government is issuing cash to buy stuff and destroying cash by taxation. That’s how a fiat currency works.

        When saved currency is swapped for a gilt the currency liability on the govt balance sheet is destroyed and a gilt liability takes its place.

        That is it. No new financial assets are created. None are destroyed. Gilts are as liquid as deposits in a savings account, so no change there either.

        One liability costs 0.5%, the other about 4%. That cost difference is just government spending and needs to be assessed in the same way as any other government spending. All I see is an import subsidy.

        • vimothy said, on January 5, 2011 at 9:53 pm

          Neil, you seem to have confused yourself slightly. That’s actually not how a fiat currency system works. That’s your proposal for how it could work. In the current system, the DMO issues gilts on behalf of the government to finance spending. Money is neither destroyed nor created during this process.

          Gilts are certainly more liquid than some instruments—06 vintage subprime ABS CDO tranches, for instance—liquidity is a spectrum after all, but still, I have never found a newsagent who will accept 10 year govt bonds in exchange for a bottle of red and a pack of Marlborough Lights. What am I doing wrong? I guess life really is different out there in the big smoke, huh.

          One way to think about potential problems with the MMT approach is to imagine replacing the national debt with base money (i.e. reserves and currency). Base money can be thought of as zero coupon, zero maturity govt debt. This “debt” still needs to be held by the public as before. In other words, replacing outstanding and future gilts with M0 would require the govt to continuously roll the *entire stock* of govt debt!

          Since agents can’t dispose of this “debt” (i.e. base money) on aggregate, their attempts to (that is, their attempts to spend it) must raise the price level. (Your import subsidy is the price the market demands to hold the govt’s debt—why hold it for no return? No reason at all beyond the already existing demand for money, as far as I can tell). More than that, it’s just common sense that if the government stopped borrowing to fund net spending and started printing money, there would be some inflation.

          • Chris Cook said, on January 6, 2011 at 1:05 am

            “In the current system, the DMO issues gilts on behalf of the government to finance spending. Money is neither destroyed nor created during this process.”

            I don’t think that is necessarily true. Whenever a private bank credits the accounts of suppliers, staff, management, or shareholders in respect of dividends it creates credit and matching demand deposits aka money.

            Whenever a bank buys gilts from the DMO it is generally, as far as I am aware, creating credit and spending it in purchasing the gilts. But its not always banks buying gilts of course.

            Many people are under the misconception that banks create new money only when they create new interest-bearing loans and matching deposits, but that is not so.

            Base money is not a debt instrument IMHO, but rather more akin to a redeemable preference share – ie a credit instrument.

            You have the polarities reversed, I believe.

            The source of credit is not the bank, it is the borrower, and it is not the bank’s IOU which is being monetised, in fact, but the borrower’s. A private bank’s IOU is not a claim over value (value being ‘money’s worth’), but rather a claim over a claim over value. A double negative giving a false (deficit-based) positive.

            • vimothy said, on January 6, 2011 at 3:43 am

              Chris,

              Agree re bank spending and credit creation but of course the banks do not hold the national debt. Banks hold some govt debt for liquidity purposes but in most of the debt held domestically is held by pension funds. There’s a breakdown in this BBC article but you have to scroll down to second graph to get an idea of bank holdings pre QE:

              news.bbc.co.uk/2/hi/business/8530150.stm

              Blanking on the rest of your post. Care to explain it again for the hard of thinking? Where are you disagreeing with what I wrote? Agree with your final para as well, but don’t see how it relates.

              I did put “debt” in scare quotes, BTW, but let me try to rephrase my base money point slightly to make my own story clearer. A world in which the govt issues debt at 0% is equivalent to a world in which the govt finances spending by printing money (creating credit). In both cases govt issues liabilities that are just risk free claims on future govt liabilities at a 0% nominal interest rate.

              • Chris Cook said, on January 6, 2011 at 9:53 am

                “Agree re bank spending and credit creation but of course the banks do not hold the national debt. ”

                Maybe not, but the pension funds – who do not bank with the Bank of England – who do buy gilts will invariably be holding the money in some sort of interest – bearing bank account (e onlyven if short term, such as overnight) and new money will have to be created somewhere in the system by banks for the system to balance.

                When I refer to the ‘polarity’ of money, what I am getting to is the ‘Real Bills’ discussion.

                If I give you my IOU (a ‘Real Bill’ redeemable for money’s worth) in exchange for a widget, and you are able to have it accepted by Duncan in payment for something else of value, then the result is monetary system. ie a combination of barter and credit.

                In order for this to work more generally, there needs to be a Unit of account by reference to which you, me and Duncan transact – a ‘numeraire’ – and also a ‘framework of trust’.

                At the moment, this is provided by Banks who step in between me and you, and accept my IOU, and then give you theirs, for which they charge you ‘interest’. This is known as credit intermediation.

                What banks are actually charging for is the use of their balance sheet and implicit guarantee of MY credit. Anything above the cost of administration and cost of defaults is profit. Money itself has no ‘cost’ – it is a relationship, not the object imagined by many – but credit has a cost.

                The myth – which completely invalidates all schools of Economics except MMT/chartalism – is that it is the Bank’s IOU which is valuable, when it is precisely the opposite. ie a claim over value which it issues ex nihilo but backs with financial collateral (it’s capital).

                It is my IOU – the ‘Real Bill’ – which is valuable.

                The Swiss WIR is a barter system involving many thousands of Swiss SMEs, and they exchange literally billions of Swiss Francs’ worth of goods and services on credit terms not FOR Swiss Francs, but BY REFERENCE TO them through using a complementary currency. In this way WIR members have since 1934 accessed credit even where banks cannot or will not extend it. The framework of trust in respect of debit balances is provided by security over WIR members’s property, so that the WIR complementary currency is essentially land backed.

                Wherever there is a barter system involving credit the result is a monetary system.

                I have bene working with the Central Bank of Ecuador in respect of their FactoRepo system, whereby any VAT- registered business may have it’s VAT invoices (aka Real Bills) accepted and discounted (repo’d) by the Central Bank, thereby enabling the seller to access working capital.

                This has the benefit of reducing the Fed Dollars (Ecuador being dollarised) which are necessary in the system to a net, rather than gross figure.

                Such a ssystem could actually offer an interesting partial solution for the € as an EU-wide credit clearing union.

                As VISA demonstrates, no deposits are actually necessary in such a credit clearing system, which is what is needed for the circulation of goods and services and the creation of new productive assets. Where deposits are necessary is in relation to credit which is essentially based on the use value (particularly property rental value) which underpins secured credit.

                That is where I advocate the issue – within a suitable framework of trust – of Units redeemable in payment for such use value. That is not actually difficult, and could be commenced tomorrow.

                This presentation at the University of Strathclyde sets out my thinking in relation to the emerging networked economy,where banks transition from credit intermediation to service provisoon – which is in their interests as it minimises capital requirements

                http://www.slideshare.net/ChrisJCook/economic-systems-thinking230710

                • Chris Cook said, on January 6, 2011 at 10:07 am

                  “At the moment, this is provided by Banks who step in between me and you, and accept my IOU, and then give you theirs, for which they charge you ‘interest’. ”

                  Of course, they charge ME interest….in respect of my debit balance with them.

                • vimothy said, on January 6, 2011 at 5:00 pm

                  Chris,

                  You seem like a very smart chap, but I’m struggling to see how the idea that money is credit or a “relationship” is newsworthy. If borrow £5k from the bank I have £5k of credit—the bank has created £5k new money—and when I spend it I have a £5k debt. There is nothing to discuss here.

                  “Maybe not”—actually, just “not”. Banks do not hold the national debt. This is not a controversial innovation that I am introducing to the debate here. It simply is. They have small holdings of gilts for liquidity management purposes.

                  When a fund manager buys a gilt, he draws down his deposit balance and the govt’s account at the BoE is credited by the same amount. That is, money is neither destroyed nor created, but is merely redistributed away from the buyer of the gilt to the seller, i.e. from the pension fund to the govt. If the fund manager sold an asset in order to fund the purchase, someone else’s holdings of money are reduced. However many links you add to the chain the ultimate result is the same: ∆M<0.

                  “Pension funds… will invariably be holding the money in some sort of interest – bearing bank account… and new money will have to be created somewhere in the system by banks for the system to balance.”

                  I don’t see how that follows from the fact that money sits in the banking system. If the money ultimately used to pay for the gilt comes from the existing stock of money then no new money has been created, by definition. Think about UK QE. If what you’re saying is true, then the Bank’s QE programme is incoherent.

                  “This is known as credit intermediation.”

                  Thanks.

                  “The myth – which completely invalidates all schools of Economics except MMT/chartalism – is that it is the Bank’s IOU which is valuable”

                  Dude, you have been huffing gas—or crack, or something. Whatever it is, it’s clearly some high grade shizz. Why not pass it around? I feel like I could use a toke after reading that.

                  As an aside, what is it with chartalists? Why are you all so goddamn freakin’ arrogant?

                  Your detail on Swiss and Ecuadorean systems is interesting, but this all seems rather tangential to my argument, which was (if I can still remember) that if you monetise the national debt, unless the demand for money increases a great deal, inflation is the obvious result.

                  Oh and, in b4 "Zimbabwe"

                  • Chris Cook said, on January 6, 2011 at 6:55 pm

                    @ Vimothy

                    “When a fund manager buys a gilt, he draws down his deposit balance and the govt’s account at the BoE is credited by the same amount. That is, money is neither destroyed nor created, but is merely redistributed away from the buyer of the gilt to the seller”

                    The fund manager has a bank account. The bank is therefore in debt to him, and the balance may or may not be interest-bearing.

                    When he pays the BoE for his gilts, what happens as I understand it is that the Treasury’s account at the BoE is credited and a deposit is created, while the Fund manager’s account with his bank is debited.

                    In order not to shrink its balance sheet, the fund-manager’s bank will need a deposit from somewhere, and to avoid the system-wide balance sheet shrinking, that means that credit aka new money must be created somewhere in the system and cleared through the clearing system.

                    “I don’t see how that follows from the fact that money sits in the banking system. If the money ultimately used to pay for the gilt comes from the existing stock of money then no new money has been created, by definition. Think about UK QE. If what you’re saying is true, then the Bank’s QE programme is incoherent.”

                    The Treasury’s balance sheet, and everyone else’s, must balance.

                    If the Treasury issues and sells new gilts (a liability) they must be balanced by a corresponding asset of new sterling deposits at the BoE, and these deposits have to come from somewhere. These deposits arise out of the creation of credit by private banks in exactly the same way as when they credit the accounts of suppliers, staff, managers, shareholders and so on.

                    If any private bank – either for their own account or for a buyer maintaining an account – credits the BoE to buy gilts and this is not balanced with new deposits, then money bleeds out of the banking system.

                    Indeed, I think that to describe the BoE’s QE programme as entirely incoherent is correct. QE is necessary to replace credit bleeding out of both the shadow and conventional banking system through non-performing loans, and in that sense is anti-deflationary.

                    But I do not see how it is possible for QE to stimulate consumer price inflation because there is no mechanism for it to reach consumers, and it serves only to support the price of financial assets.

                    Finally, I am not a chartalist, or an MMT’er – although I think their core assunption in relation to money and credit reltes better to reality than other schools of Economics.

                    I’m just someone trying to get to the bottom of how the system works – not from an academic background, but from a background of 25 years’ practical experience of market regulation, development and operation – and if I come across as arrogant, I apologise. I’m probably defensive due to being an amateur ‘coarse’ economist.

                    • vimothy said, on January 8, 2011 at 3:41 pm

                      Chris,

                      Fair enough. No need for me to get annoyed either, so my apologies for that. After reading a lot of Chartalist blogs, I think I’ve been a bit overexposed to the casual, not necessarily well-informed, dismissal of everyone else with a view on the economy and/or economics and now it just brings me out in hives every time.

                      Mosler (IIRC) likes to say that “deficits fund saving”. When you say that, “if any private bank… credits the BoE to buy gilts and this is not balanced with new deposits… money bleeds out of the banking system”, you are of course correct, but you are missing out the other half of the story to which Mosler’s epithet alludes. The government borrows to spend, and so the net effect on sectoral balance sheets from bond financed spending is that the government’s liabilities have increased by gilts issued, and the non-govt’s assets have increased by gilts bought. There is no net change to deposits, since the money that bleeds out of the banking system is necessarily re-injected by govt spending. This insight forms part of the basis for the Chartalist critique of “crowding out” and their analysis of NFA.

                      A further point to consider is that banks do not make lending decisions as a collective, on the basis of their aggregate balance sheet, in order to stabilise it at some particular size (the banks’ collective balance sheet changes size every year). They make lending decisions as individual profit seekers according to the availability of risk capital, cost of funds and demand from credit-worthy borrowers.

                      Regarding the Bank’s QE programme, which you dismiss as incoherent—your criticisms fall wide of the mark slightly. Perhaps you are thinking of a QE programme run by a different central bank? No one at the Bank expected QE to rise CPI inflation through some magical quantity theory process. The explicit goal of their asset purchases was to reduce the cost of non-bank corporate funding and prevent a large contraction in the money supply.

                      That said, I agree that the demand for financial assets is not the same as demand for taxi rides and haircuts (and that this is an important insight). But the Bank does not and did not expect QE to cause consumer price inflation. There is a lot of literature on its website discussing the rational and strategy for its unconventional monetary policy programmes. Why not give it a read? You might be pleasantly surprised by how much some of these guys understand!😉

          • Neil Wilson said, on January 6, 2011 at 8:07 am

            The return on reserves at the BoE is the Bank Rate – 0.5% not zero. The issuing of gilts at a higher interest rate defeats the efforts of the MPC.

            The corner shop won’t accept your deposit account book from the bank either. You have to ‘sell’ your deposit account at the bank before you can buy anything with it.

            So why is a deposit at the Bank of England bad and gilts good? Both swap currency for something else (BoE deposit or gilt) – one pays a lower interest than the other that’s all.

            I really don’t get where this ‘extra money = inflation’ mantra comes from. It has no logic to it.

            Firstly with the entire UK economy, five million out of work and the rest of the world’s production at our disposal you are actually suggesting that there would be no quantity adjustment, no extra supply made available in return for extra spending. And that some of that spending wouldn’t become investment in new capital.

            If the baker gets demand for more bread he will bake more loaves. That is common sense. If Next gets extra demand for clothes they will sell more clothes. That is common sense. An investment that doesn’t stack up when you can get a 4% risk free return may just stack up when the risk free return drops to 0.5%. That is common sense.

            Hiking prices in response to demand is not common sense. It just racks of your current customers.

            Secondly the government creates money all the time. And even if you don’t believe that it does create new currency then the logic just follows along the chain until you get to the gilts – which are then created out of thin air, just as bank loans are. We’re getting extra financial assets into the system now via deficit spending and we’re not seeing any demand pull inflation.

            Thirdly removing gilts and simply leaving currency on deposit at the Bank of England reduces the amount in interest paid. Since that is just government spending the effect is actually deflationary. We would need to move that spending elsewhere to maintain parity.

            The price rises we are seeing at the moment are due to the currency going down. They are one off price adjustments, not inflation.

            If you dropped gilts you would likely see a temporary drop in the currency as the rent seekers take their ball home. Which is where we came in: ‘Another way to boost net trade would be to devalue sterling further’.

            • Luis Enrique said, on January 6, 2011 at 8:56 am

              “I really don’t get where this ‘extra money = inflation’ mantra comes from. It has no logic to it.”

              ah, I think I can help you there. It comes from thinking about how increasing the money supply would effect prices combined with studying historical episodes where rampant money printing has created rampant inflation.

              • Chris Cook said, on January 6, 2011 at 10:02 am

                Wrong.

                Consumer inflation is everywhere and always a fiscal phenomenon: asset price inflation is a monetary phenomenon.

                Rampant money printing merely facilitates fiscal incontinence.

                eg the Zimbabwe episode was facilitated by money printing, not caused by it. It was the collapse of Zimbabwe’s productive economy through badly executed land reforms and corruption which destroyed the basis of their monetary system, and which is ‘money’s worth’ of production backing the tax base.

                • Luis Enrique said, on January 6, 2011 at 10:48 am

                  what? nobody every supposed that rampant money printing happened for any other reason that ‘fiscal incontinence’ – this is semantic bullshit.

                  Fine, have it your way, fiscal incontinence ‘facilitated’ by rampant money printing causes inflation. rampant money printing causes inflation

                  • vimothy said, on January 6, 2011 at 3:31 pm

                    “Semantic bullshit”–indeed.

                    • Chris Cook said, on January 6, 2011 at 5:01 pm

                      @ Luis, Timothy

                      If only it were merely semantic.

                      ‘Money printing’, whether public or private, inflates the financial economy – the ‘FIRE’ (Finance, Insurance and Real Estate) sector – which is now the preserve of the 10% of the population which owns substantially all unencumbered assets, and to which the other 90% is now more or less indebted.

                      It does NOT inflate the increasingly precarious ‘real’ consumer economy of the 90% who have little or no wealth other than mortgaged property – which may or may not be worth more than the debt secured against it . For this majority, there is little or no prospect of their purchasing power increasing to cause inflation, since they have low income, poor creditworthiness, or both

                      The whole point of monetarist Economics is that money printing causes consumer price inflation. That’s complete ‘bullshit’ to use your phrase because the assumptions underpinning Keynesian and Monetarist economics (other than MMT) as to the nature of credit and money are complete bollocks – to use another.

                      What is happening now at the zero bound of dollar interest rates is that it is risk averse ‘inflation hedger’ investors who are – through exchange traded funds and otherwise – buying or borrowing commodities and inflating commodity prices to the benefit of producers.

                      Contrary to popular myth, and regulators at least should know better, speculators motivated by greed and transaction profit are not responsible for the high price levels across commodities, but only for short term volatility.

                      The reason I mention this is that UK domestic monetary policy will have no effect whatever in addressing such commodity – and particularly energy – price increases caused by financial purchases by investors, rather than consumer purchases for actual use.

              • liminalhack said, on January 6, 2011 at 11:18 am

                Neil is right to some extent. Money invested in government bonds is not spending money, it is saving money. Therefore if it is converted to base money there is no reason to think it won’t continue to just sit there as savings. Those gilts are someones pension.

                It will of course get spent when its time to draw down that pension but then so would the gilts be spent.

                Assuming the saver requires a yield then presumably the money would be spent on yielding assets such as equities or possibly real estate. But there is no obvious reason to assume that changing the supply of gilts into a supply of base money would have much effect on CPI for example by virtue of its increased stock.

                When it might have an effect (and is doing) is when there is a significant difference in yield between one economy and another, in which case money will leak out of one into the other.

                Once again though, the stock of government debt versus base money is not the primary cause here, its the difference in yields.

                Also with regard to buying a sandwich or fish and chips or whatever with a gilt, it can’t be done. But then neither can you with a bank deposit. Both a gilt and a bank deposit must be changed to base money to make a high street purchase so in this sense they are equivalent. Its just that with bank deposits the electronic POS technology hides this clearing process.

              • Neil Wilson said, on January 6, 2011 at 11:46 am

                Except that such correctly constructed econometric studies show that a demand impetus causes the economy to quantity adjust, not price adjust, up to the point where it starts to run out of real resources.

                There are five million in the UK out of work at the moment. That’s a lot of real resources with zero bid.

                • vimothy said, on January 6, 2011 at 4:42 pm

                  “Except that such correctly constructed econometric studies show that a demand impetus causes the economy to quantity adjust, not price adjust, up to the point where it starts to run out of real resources.”

                  Orilly?

                  Please link to some of these studies.

            • vimothy said, on January 6, 2011 at 9:00 pm

              I think it will be easier to follow if I just respond to you point-by-point, Neil. Here goes…

              “The return on reserves at the BoE is the Bank Rate – 0.5% not zero. The issuing of gilts at a higher interest rate defeats the efforts of the MPC.”

              Don’t understand what your point is here (I never wrote that the Bank’s target rate was 0%), but the DMO issues gilts at the market rate not the BoE’s target rate.

              “The corner shop won’t accept your deposit account book from the bank either. You have to ‘sell’ your deposit account at the bank before you can buy anything with it.”

              My corner shop accepts bank money as readily as currency. In fact, I just paid for my lunch with my debit card. Assuming that we bank at different institutions, our banks will settle with reserves via the payment system (CHAPS or Fedwire or whatever) but that’s neither here nor there. You can’t spend a bond; you have to sell it or borrow against it. “Bank money”, on the other hand, is effectively money, and trades for it at par. This is something with which MMTers agree.

              I mean, are you claiming that all assets are money? Of course not. So what are you claiming? A gilt is not money, even though it is a lot more “money-like” (i.e. liquid) than many securities.

              “So why is a deposit at the Bank of England bad and gilts good? Both swap currency for something else (BoE deposit or gilt) – one pays a lower interest than the other that’s all.”

              One is money and one is a claim on future money. What is the difference between money of zero maturity and money which is not? No difference at all, except that one is of zero maturity and the other isn’t.

              “I really don’t get where this ‘extra money = inflation’ mantra comes from. It has no logic to it.”

              Are you sure? Because it’s actually pretty straightforward.

              “Firstly with the entire UK economy, five million out of work and the rest of the world’s production at our disposal you are actually suggesting that there would be no quantity adjustment, no extra supply made available in return for extra spending.”

              No, I’m not suggesting that at all.

              “If the baker gets demand for more bread he will bake more loaves. That is common sense.”

              The problem is you need a theory, not common sense.

              “If Next gets extra demand for clothes they will sell more clothes. That is common sense. An investment that doesn’t stack up when you can get a 4% risk free return may just stack up when the risk free return drops to 0.5%. That is common sense.”

              It’s conditional on other factors, is what it is, Neil. What if the cost of increasing production at current rates is greater than the additional revenue it generates?

              “Secondly the government creates money all the time.”

              The Bank of England creates (and destroys) new money all the time. Govt deficit spending creates net financial assets for the non-govt sector all the time. The two are not identical and distinguishing between them is totally consistent with MMT.

              “And even if you don’t believe that it does create new currency then the logic just follows along the chain until you get to the gilts – which are then created out of thin air, just as bank loans are. We’re getting extra financial assets into the system now via deficit spending and we’re not seeing any demand pull inflation.”

              See above.

              “Thirdly removing gilts and simply leaving currency on deposit at the Bank of England reduces the amount in interest paid. Since that is just government spending the effect is actually deflationary.”

              If you could hold *everything else* constant and just halt current interest payments on the national debt, then I agree that the effect could be deflationary or disinflationary. If you’re talking about the gross effect of the MMT no bonds proposal, and not holding everything else constant, then that is certainly far from given.

              Also, where does the phrase “removing gilts and simply leaving currency on deposit at the Bank of England” come from? That is not the MMT no bonds proposal. If you continuously inject net new money into the economy via money financed govt spending, that money does not sit in deposit accounts at the BoE. (BTW, normally when we say “currency” we mean notes and coin, which are held by the public and by banks as vault cash. Banks can convert currency one-for-one for reserve balances at the BoE, or vice versa. So a reserve account at the Bank is like a transactions account for banks. The public do not get accounts at the central bank).

              “The price rises we are seeing at the moment are due to the currency going down. They are one off price adjustments, not inflation.”

              Right. And what about the inflation we’re seeing now—where does that come from?

              “If you dropped gilts you would likely see a temporary drop in the currency as the rent seekers take their ball home.”

              If you dropped gilts you would be massively increasing the amount of money in the economy. What happens then depends on the behaviour of private actors and the structure of the economy.

    • Neil Wilson said, on January 5, 2011 at 6:58 pm

      In accounting everything has to sum to zero. That includes the entire Sterling zone.

      For the non-government sector to run a surplus (net savings in Sterling) the government sector has to run a deficit (net spending in Sterling).

      All the money the UK government spends appears out of nowhere. All of it. They are the currency issuer – they must spend the currency before anybody else gets to use it. In our system it is best to think of the government Spending and then Taxing with the difference being Savings. Taxation simply deletes money from the system entirely.

      Savings are merely a stock of government spending that hasn’t been taxed away entirely yet.

      This is a good starting point even though it is US focused.

      http://pragcap.com/resources/understanding-modern-monetary-system

      Be warned. It will make your head hurt until you get it.

    • duncanseconomicblog said, on January 5, 2011 at 7:46 pm

      Luis,

      The Germany point is spot on. 1990s and early 2000s were all about a slow grind of driving down wages.

      The OBR seems to think we can achieve the same effect quicker and less painfully.

      • Neil Wilson said, on January 5, 2011 at 7:54 pm

        Driving down wages rapidly?

        Surely they can’t be driven down any further without significantly affecting the demand side.

  7. […] The Government’s Growth Plan: Higher Unemployment « Duncan’s Economic Blog […]

  8. charlesbarry said, on January 7, 2011 at 11:24 pm

    I’m with you up until you write:

    And the best way to lower wages (relative to what they would have been) is to increase unemployment and so loosen up the labour market.

    Strong disagree. Firstly, consider the reverse: the best way to raise wages is to lower unemployment. That sounds rather tentative. The causal mechanism in both instances is obviously more complex even to the layman.

    Secondly, statistically the data goes against you. While it is true to say that the two are negatively correlated, so a decrease in real wages coincides with an increase in unemployment. But the correlation coefficient for real wages and LFS unemployment between 1971-2007 is -0.07661, so the relationship is trivial in other words.

    As a side note the data available to me shows that from 1971 to 1981, increases in real wages coincided with increases in unemployment. From 1981 to 2007 the opposite effect occured.

    It might well be that George Osbourne’s master plan is to increase unemployment, however the rationale for doing so is non-existent.

  9. duncanseconomicblog said, on January 8, 2011 at 9:49 am

    Charles,

    Whilst the statistical evidence, in the uk, might not support the theory, this is the standard analysis behind internal devaluation.

    Duncan

  10. The Two, The Five « Max Dunbar said, on January 8, 2011 at 4:13 pm

    […] decades of craft and experience in British industry wasting their talents on workfare courses. See, unemployment is part of the plan. The easy way to get rid of the deficit is to cut domestic costs. Which means cutting labour costs. […]

  11. richie said, on May 26, 2011 at 12:33 pm

    Evaluate the performance of uk governments since 1971 in terms of their ability to achieve low inflation and low unemployment. Which decade showed the best management of the economy and which showed the worst!!!

    any answers to this please


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