The Fiscal Crisis - Borrow Long - If You Can!
This is a related post to my recent blog on the scale of government borrowing and debt. The Debt Management Office is responsible for finding buyers for the new debt issued by the UK government and they have their hands full this year with the challenge of selling over £220bn worth of new securities. Edmund Conway has a fascinating blog piece here about the term structure of this debt and what is means for the cost of making the interest payments. This week the UK government issued new bonds that will not be due for repayment until 2060 when most of us will be long gone! A fifty year bond is perhaps the longest bond (gilt) to have been issued for many years. And it turns out that the average date to maturity for UK public sector debt is significantly higher than for most advanced economies.
“The UK’s debt market is peculiar. In the US, average length of the existing Treasury bonds was, at recent count, 4.7 years and falling. Because this is such a short maturity, it means the debt has to be rolled over far more often, and at every point the government runs the risk of setting in stone any changes in interest rates. In France, the average maturity is 7.1 years, in Italy 6.9 years, in Germany 6.35 and in Japan 5.7 years. In Britain, the weighted average maturity of government bonds is a whopping 14.2 years. Admittedly, as the IMF points out this is slightly lower in the wake of the crisis, but it is still significantly longer than any other major economy.”
Keynes v Friedman
A cross posting from my blogging colleague Jon Mace
Today’s extract in The Telegraph from Edmund Conway’s new book looks at Milton Friedman and Monetarism. Economics students need to have a sound awareness of the Monetarism versus Keynesian debate. Friedman and Keynes came from opposing ends of economic ideology. They doctrines have dominated economic thinking and policy over the last 50 years. In short Keynes placed greater emphasis on unemployment than inflation and gave warning that the state of the economy could be improved by some government interference. Friedman argued otherwise.
Conway provides a good analysis of the difference between these two economic giants:
“Inflation is always and everywhere a monetary phenomenon,” Friedman said. In short, by pumping extra money into the system (as the Keynesians were prone to doing) governments would drive up inflation, risking major economic pain. Friedman believed that if central banks were charged with maintaining control of prices, most other aspects of the economy – unemployment, economic growth, productivity – would take care of themselves.
While Keynes had asserted that it was difficult to persuade workers to accept lower wages, classical monetarist theory argued otherwise: that lower incomes for workers and lower prices for firms were acceptable in the face of rising inflation. The growth rate of an economy, argued Friedman, could be determined by controlling the amount of money being printed by central banks. Print more cash and people would spend more, and vice versa. It also marked an important political departure: whereas Keynes argued politicians should attempt to control the economy through fiscal policy, Friedman advocated giving independent central banks control over the economy using interest rates
The piece then goes on to examine the successes and failures of the two doctrines over the last fifty years. I always think it important for students to have an awareness of the changing economic conditions and favored policies over the decades, it only helps them to ingrain a deeper understanding of the theory.
He finishes the extract with an excellent quote from Martin Wolf:
Just as Keynes’s ideas were tested to destruction in the 1950s, 1960s and 1970s, Milton Friedman’s ideas might suffer a similar fate in the 1980s, 1990s and 2000s. All gods fail, if one believes too much.
The article in full can be found here.
Keynes and the Multiplier Effect
I am cross-posting Jon’s excellent blog on Keynes and the multiplier over at his excellent IB Blog that flags up some handy recent articles on this important macro policy concept:
The Telegraph continues with it series of extracts from Edmund Conway’s new book and today it focuses on the twentieth centuries greatest economist John Maynard Keynes.
In its simplest form Keynesianism argues that governments should be proactive during economic downturns rather than relying upon the power of the markets and interest rate cuts. Proactive in the sense that the government should borrow money and start spending. The doctrine lost favour in the 1970s as monetarist theory gained popularity. As you will be well aware Keynes has returned in earnest over the past 18 months as governments across the globe have pumped billions into the spluttering economies in the hope of restarting them. Although early days there are tentative signs that Keynes may have be right once again.
Key to his argument of the effectiveness of pumping money into an economy is that of the multpier. Conway provides an excellent overview of the multiplier in his piece today:
Say the US government orders a $10bn (£6bn) aircraft carrier. You might assume the effect of this would be merely to pump $10bn into the US economy. Under the multiplier argument, the actual effect would be bigger. The shipbuilder takes on more employees and generates more profits; its workers spend more on consumer goods. Depending on the average consumer’s “propensity to consume”, this could raise total economic output by far more than the amount of public money actually injected.
If the $10bn increase caused total United States economic output to rise by $5bn, the multiplier would be 0.5; if it rose by $15bn, the multiplier would be 1.5.
The article also provides some good points that students could use when being critical of fiscal policy (these were particuarly prevalent when monetarists were arguing against Keynesianism in the 1970s):
One of their main arguments was that governments cannot “fine-tune” an economy by regularly adjusting fiscal and monetary policy to keep employment high. There is simply too long a time lag between recognising the need for such a policy (tax cuts, say) and the policy taking effect. Even if policy-makers speedily identify the problem, it takes time for laws to be drafted and passed, and more time still for the tax cuts actually to drip through the wider economy.
There are a couple of recently published books on Keynes that you may want to get your teeth into:
Keynes: Return of the Master by R Skidelsky
Keynes: The Twenthieth Century Most Influential Economist by P Clarke
Explaining comparative advantage
In an extract from his new book 50 Economic Ideas, Edmund Conway considers the importance of comparative advantage built on the work of David Ricardo.
“Ricardo’s theory of comparative advantage is typically used as the backbone of arguments in favour of free trade – in other words abolishing tariffs and quotas on goods imported from foreign countries. It is claimed that, by trading freely with other countries – even those that, on paper, are more efficient at producing goods and services – one can become more prosperous than by closing one’s borders”
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