...a blog by Richard Flowers

Wednesday, September 15, 2010

Day 3545: I Like To Ride My Economic Cycle


Featured on Liberal Democrat Voice

and, er

Featured on Liberal Democrat Voice


First, I keep meaning to say: economics is more ART than SCIENCE, like History with CALCULATORS.

Don't just take MY fluffy word. There ARE other opinions. They say ask TWO economists and you'll get THREE contradictory answers; or an economist is a man who can pick a fight in an empty room (especially if he's Mr Frown).

But, Ms Jane asks:
Can you explain what you mean by balancing the budget over an economic cycle? How do you know how long the cycle will last in order to do that?
That's a TRICKY ONE, but I'll have a go!

If you look at economic measures of how well the country is doing, GDP is the usual one, you will see a generally rising trend that we call GROWTH but with zigzag-y up and down waves: not QUITE your smooth S-shaped sine-wave, but still with noticeable peaks and troughs where the economy grows faster and then slower, or sometimes even shrinks (which is obviously a recession). If it's a really STEEP downward "zag" then that's what we call a crash!

One "economic cycle" is the time from the top of one peak to the top of the next peak, or from the bottom of one crash to the bottom of the next crash, usually something like every six or seven years.

Recent economic cycles have been marked by: the Oil Shock (1973); the Early Eighties Recession (1980/81); the Lawson "blip" (1987); the House-price Crash that finished in Black Wednesday (1992); the collapse (2000); and the Credit Crunch (2007/08/09).

(Funnily enough we seem to remember the crashes more than the peaks – just like people remember famous WARS rather than famous PEACES. Isn't it nice to be in the SIXTY-YEARS PEACE.)

But no one is really sure how long "a cycle" is or really when they start and stop or even necessarily whereabouts we ARE in the cycle.

Before you ask how can that be, I'll point out that there's a lot of TIME-LAG before we get these figures. We can get a rough estimate of the previous quarter's growth, but it's very CRUDE, and those figures get revised all the time. It's often a year or two before you get a reasonable GDP figure, and it can be up to six years before you're certain of your final tax take.

So although we can look back with the benefit of HINDSIGHT and know where we WERE, it's much harder to know where we ARE.

Mr Frown used this uncertainty to his advantage to keep moving the goalposts on his "golden rule" (that's the "don't borrow more than you pay back over the economic cycle" rule).

Essentially, if you care, he paid back a HUGE amount of money between 1997 and 1999 (paid for by raiding pensions, windfall taxing the utilities and flogging the 3G licences for a fortune) which is REALLY the last economic cycle (or last-but-one now, probably) and then kept insisting that "ooh no, that economic cycle hadn't ended yet" and so he could still count that big repayment against further borrowing. Which is basically CHEATING.

What the Golden Rule SHOULD mean is that if you are in a trough you can borrow more than you earn to tide you over, but if you are on a peak you should be paying back what you borrowed.

Our best guess is that at the moment we are on the upward curve starting to come out of a particularly deep and nasty trough.

In the Keynesian scheme of things, we should still be borrowing more than we earn this year but starting to narrow that gap with a view to, maybe in two to three years, balancing the budget and then running surpluses for the next part of the cycle… and I bet you can see the problem already.

The Coalition ISN'T planning on running budget surpluses in two to three years time; the deficit is SO HUGE that the Coalition's plans are to try to balance the budget in about five years… just in time for the next trough in the cycle!

(And if you think THAT'S bad, remember that even the non-insane/non-Bully Balls bits of Hard Labour were only planning on halving the deficit in that time and would almost certainly definitely have run into the next downturn before they could recover from the last one!)

HOWEVER that's all in the Keynesian scheme – that is if Mr Milton Keynes was driving the economy.

But Mr Milton Keynes is NOT driving the economy, and more importantly HAS NOT BEEN driving the economy for some time.

That "borrowing more than you earn" is called a CYCLICAL deficit and it's sort of okay, at least in Keynesian economics, so long as you really do pay it all back again.

Unfortunately Mr Frown DIDN'T pay it down again and that's why we're actually playing a DIFFERENT game which is called: "get rid of the STRUCTURAL DEFICIT before we even begin to worry about the CYCLICAL one".

A STRUCTURAL deficit is "what the deficit would be if you took the CYCLICAL deficit/surplus away". That is, if you could pretend that the GDP curve really WAS smooth, without the zigzags, then any difference between what you raise in tax and what you spend would be the real underlying or "STRUCTURAL" deficit.

Running a STRUCTURAL deficit means that there are ALWAYS things that you have to borrow in order to pay for. Even in the GOOD years, when your cyclical SURPLUS might hide your structural DEFICIT – i.e. it LOOKS as though you are repaying more than you borrow – it still means that you aren't repaying ENOUGH to pay back all that you borrowed in the last trough. It means that in the long term your debts inevitably go up and up and up. And that's impossible, so you go BANKRUPT.

Eventually, SOMEONE has to repay the debts you've run up.

That's why that sort of borrowing is NOT an "investment". That sort of borrowing is stealing from the future.

You're not robbing Peter to pay Paul; you're robbing Paul's KIDS to pay Paul. Maybe Paul is okay with that, but we're NOT.

(Oh, and to anyone who says: but France and Germany and Japan all have higher debt-to-GDP ratios than we do – where that debt-to-GDP ratios is how much they owe compared to how much they earn; like the way banks used to let you borrow up to three times your salary – I say to them: would you jump off a CLIFF because France and Germany and Japan have all jumped off A HIGHER CLIFF? Thought not.)

So… it all seems pretty obvious: eliminate any structural deficit and then use the Golden Rule as best you can to negotiate the peaks and troughs.

Only it's never going to be that simple. Of course not. Economists cannot agree which bit of the deficit is structural and which bit is cyclical. And even if they could, they cannot agree where in the cycle we ARE, so they STILL can't tell which bit is which.

So here is my RULE OF THUMB: if your growth this year is better than your growth last year, you should be SHRINKING your DEFICIT or GROWING your SURPLUS; if your growth this year is WORSE than your growth last year you should be SHRINKING your SURPLUS or GROWING your DEFICIT.

This, at least, is what we are doing.

Of course, as a fluffy elephant, I don't HAVE thumbs…

It was all a lot easier when we just did CLASSICAL economics which just said: "balance the budget or you go broke".

I guess we'll just have to WING IT and hope the next downturn doesn't come until after (a) the next General Election or (b) Master Gideon gets out of short trousers.

1 comment:

Jane said...

Thank-you. I will now turn your two posts on the economy into a cryptic code and write them in ballpoint pen on my sleeve so that I can cheat in the exam.