Last week, we posted on the Fed’s “Operation Twist”, its latest attempts at stimulating the US economy through manipulation of borrowing rates. There was much to be said about this, both in terms of its limited effect and the ways in which it was going about its business. Moves by Central Banks, even if limited in their overall impact, still have the potential to redistribute wealth. We noted that in so far as the Fed’s approach has been to moderately inflate away debt, this also means inflating away wage increases achieved over this period.
This discussion about inflation and the Fed’s interventions in the crisis is worth extending further. One important point is that for all of its creativity in manipulating interest rates, the Fed’s overall approach has involved a conservative assessment of its own mandate. A graphic produced by The Economist a couple of weeks ago provides a useful illustration of this.
Formally speaking the Fed is meant to pursue the twin goals of low inflation and low unemployment. In the policy wonkery literature on central banking, this makes the Fed a less “hawkish” institution than, say, the European Central Bank, whose own mandate only extends to price stability and not to growth as such. A feature of the current crisis in Europe has been that the ECB has had to venture well beyond its mandate, playing a role in managing the crisis that has little to do with inflation in the Eurozone. The Federal Reserve, in contrast, has appeared more concerned about prices than about jobs. In this crisis, the low unemployment goal of the Fed has been breached dramatically, with unemployment over 3% points above what economists consider to be the US’s “natural” (i.e. non-inflationary) level of unemployment (around 6%) for the last two years. Had the Fed overshot to the same degree on its inflation goals, Bernanke would have been subject to the most scathing of criticism. There is evidently a bias, both in the Fed and outside, towards keeping a lid on prices, even at the cost of rising unemployment.
In the discussion about the Fed’s quantitative easing program, it is worth keeping this in mind. It points to the broader issue of the Fed’s mandate and its particular interpretation of that mandate. It also points the fact that today, for all the manipulation of interest rates downwards, we are perhaps beginning to reach the limits of what low interest rates can achieve (see here and here for discussion of what monetary policy options are available under liquidity trap conditions). Can the Fed really stimulate the US economy in the way that it would like through reducing borrowing costs? One reason why the Fed may be reluctant to modify its existing inflation targets in favour of a higher rate or to switch to the monitoring of nominal GDP instead (see rational for this here) is that it may not think it will help in bringing unemployment down. We may have reached the limits of what interest rate policies can achieve but the Fed doesn’t seem to have anything else up its sleeve.
In France, the word rigueur is associated with political failure: it brought down the government of Raymond Barre in the late 1970s, marked the abrupt end to François Mitterrand’s experiment with “socialism in one country” in 1983-4 and coincided with the downfall of Alain Juppè’s government in 1997. Unsurprisingly then, current president Nicolas Sarkozy and his finance minister, François Baroin, are refusing to employ the term rigueur to describe their own recently announced austerity plan. Looking at the details of the plan, there is little doubt that rigueur is what lies ahead. Strikingly, though, France’s plans are relatively restrained compared to some others undertaken by national governments across Europe. Le Monde recently detailed these different austerity plans, reproduced below.
Europe’s Austerity Plans
||Size of cuts
||12 bn Euros (2011-2012)
||Exceptional 3% tax on highest earners; tax hikes on alcohol and cigarettes
||28 bn Euros of cuts (2011-2015); 50 bn Euros raised through privatisations
||Cuts in salaries of public workers; rise in retirement age; freeze on pensions; rise in VAT; lengthening working week of civil servants
||45.5 bn Euros (2012-2013)
||Freeze on hiring and salaries in public sector
||Approx. 20 bn Euros
||80 bn Euros (2010-2014)
||Tax rises, privatizations
||65 bn Euros (2011-2013)
||5% cut in public sector salaries; pension freeze
||15 bn Euros (2011-2014)
||Reduction in welfare spending and cut in minimum wage; cut in public sector employment
||95 bn Euros (2010-2015)
||End of fiscal opt-outs and modification of regime of family benefits; freezing of public sector salaries
Source: Le Monde (27/08/11)
Compared with a few months ago, governments and economists seem to have realized that if austerity is applied universally across Europe then it will lead to a collapse in growth. Medium-term fiscal rectitude combined with short-term stimulus is the message from the IMF, but not heeded by many European governments.
Those critical of austerity have tended to focus on its equity effects. Do the plans hit the rich more than the poor? This we saw was the line of attack of France’s Front de Gauche, led by Mélenchon. The theme of fairness also drives those out in the streets protesting against cuts. At issue for protestors is not the need to balance budgets so much as a desire to shift responsibility from ordinary taxpayers to risk-loving bankers. It is less a question of ‘should we pay’ so much as ‘who should pay’.
The size and nature of the plans listed above tell us two things. The first is that the approach taken by governments has been to freeze wages and cut social security. Exceptional taxes on high incomes have been levied in some cases but they are, as is made clear to everyone, only exceptions. The second is that those voices critical of the cuts have little by way of their own growth model to propose. Export-led growth demands a buyer of last resort to soak up exports. Austerity plans demand a laggard of last resort able to show by virtue of his own profligacy how well other governments are doing. These are all zero-sum options. Hiding behind the collective and consensual appearance of the Eurozone is competition between national capitals, referrred to by many as the “asymmetry” of the Eurozone. Whether or not this competition will be transformed into conflict will depend on whether the Eurozone is able to return to growth.
In a recent article, Robert Barro, professor of economics at Harvard, takes up the problem of the US debt deal and its long term consequences. He chides the Obama administration for using an “unrealistically high” spending multiplier when predicting the effects of its expenditures on the national economy. The concept of the multiplier, developed by economists Kahn and Keynes, claims that government spending will add something more to the economy than just debt. The sum, if you like, is more than the value of its parts: individual “pump priming” government projects will together push the private sector to start investing again, with the multiplier a measure of how much more production can result from a given amount of government stimulus. In practice, 800 billion US dollars have been channeled into the economy via the Fed’s quantitative easing policy, with more in the pipeline, and yet the US economy remains in the doldrums. As Barro points out, this spending is now having a contractionary effect on the economy as it takes the form of an unwieldy debt burden.
A standard critique of Keynesian pump priming is that its long-term impact is nil and all it does is burden individuals with higher taxes as governments seek to pay off their debt. Another is that spending by the state has the effect of “crowding out” private sector investment. This presumes that there is a dynamic private sector out there, being stifled by government intervention – one of the main arguments made for rolling back the British state in the early years of Thatcherism in the 1980s.
Whether or not there is a dynamic private sector in the US being held back by the Fed’s quantitative easing will be a matter for future posts. For the moment, it is worth considering Barro’s proposal for dealing with the US debt burden. His arguments illustrate well the way in which the effects of pump priming can be regressive in the long run, hitting those very people neo-Keynesians think they are helping. Barro recommends that reducing the US debt burden should start with setting US corporate tax and estate rates at zero. He also argues for the phasing out of tax expenditure ideas, like tax preferences for home-mortgage interest and employee fringe benefits. He also recommends the lowering of the structure of marginal income tax rates, stressing that rates on higher incomes are already high enough. His final recommendation is perhaps the most important: a flat-rate value added tax. A rate of 10%, he writes, would raise about 5% of GDP.
Barro’s proposals are highly regressive. It would represent an added tax burden for lower earners relative to higher earners. The rightwing critique of government spending is that it only leads to higher taxes. But the bit they don’t mention is that those taxes, when they come around, will hit lower earners hardest. It may seem crazy to be talking about cutting spending during a recession but increasing spending is no solution either. As well as failing to stimulate an anemic private sector, it risks leaving lower earners with the burden of paying off the debt. Austerity budgets may be no solution, but neither is pump-priming.
Tuesday I mentioned the difficulties of re-regulation given the strength of the financial class. In fact, the problem is considerably wider than just a matter of being able to get the right regulations in place. It is also a matter of what we think a recovery is, who benefits from the recovery, and who does not. The mainstream conception of what counts as recovery is determined by financial markets – rising stocks supposedly float all boats. Resistance to this way of thinking is beginning to seep into mainstream discussions, with liberals like Krugman noting that the recovery is largely for the people at the top. A recent graph, found at naked capitalism, points out that, at the bottom, things are slow to improve.
The jobless recovery, of course, has been part of the news, but few have bothered to connect this joblessness to the financial character of the bubble, not to mention the ‘recovery’ itself. Doug Henwood is one of the few to point out the connection between the two as general feature of financial bubbles.
The implication of Henwood’s analysis, and the steady stream of facts supporting it, is not just that somehow financial interests have managed to seize control of the state and economy and use it to their benefit – though they have managed to do a good deal of that. It is that the general model of growth and job creation, starting in the 1970s, is defunct. Cheap credit, debt-financed consumption, readily available mortgages, rising debt-income levels, alongside stagnant wages, rising inequality, and asset bubbles were at least some of the key features of this model. It was, significantly, not just a model of growth and job creation in the narrow economic sense, but a kind of tacit social compact. Post-war living standards would be maintained, not through high wages, public provision, and regulation of the economy, but through the instruments of the market – which effectively meant credit. This was sometimes called a ‘neoliberal’ model, though notably the concept neoliberalism rarely includes mention of the financialization of the economy. Whatever the name, it is that model of capitalism in general that would have to be replaced before any real recovery takes place – at least a recovery in which everyone recovers.