I think it fair to say that whatever we once thought we knew about economics, we no longer know. Saying so, I am not talking that much about economics theory, which few have ever comprehended, and whose relationship with reality has been so remote for so long that this might be a blessing. I am instead talking about the economic heuristics that govern what most people think about the way that the economy works.
Saying this I am, of course, talking in part about the impact that modern monetary theory (MMT) has had on economics, but that is by no means all that I am referring to. For these purposes heuristics are those economic ‘rules of thumb' that dictate our reactions to any economic news and very largely dictate the politics of economic decision making intended to placate the expectations of those willing to support a politician seeking power. These are things like:
- The books must balance
- There is only taxpayers money
- Government debt must be repaid
- We're leaving a burden of debt to be repaid by future generations
- Tax pays for government spending
- Taxpayers' money
- There is no magic money tree
- Inflation is bad
- Savings are good
- Unless we save we can't invest
- We invest in the stock market
- If government spending goes up so must taxes
- Unless we keep debt under control our exchange rate will collapse
- We must keep the markets happy
- Businesses must maximise profits
- We can't afford an ageing population
- We must save for our old age
There are more, of course. And they are routinely rolled out to support the maintenance of a failing economic system even though it is clear that they no longer hold true simply by observing the fact that they do not offer solutions.
What I want to stress is that even very good thinkers are constrained by such maxims. Martin Sandbu, who writes for the FT, is a good thinker, and yet he wrote this in an article very recently:
[The cost of the coronavirus crisis] is going to force a simple choice on just about every government. They can tolerate the high debt burdens indefinitely, rather than try to bring them back down to moderate levels. Alternatively, they can permanently increase the state's tax take to balance the books and start whittling down the debt. Either way, combining “responsible” policies on both debt and tax burdens is no longer an option.
And even this choice – whether to be “fiscally responsible” with debt or with taxes – is only available in a best-case scenario. We may have to jettison both and learn to live with permanently higher public debt and permanently higher taxes. This will be true if economies never recover to their pre-pandemic growth trend, which seems almost certain if another wave of infections forces a new round of nationwide lockdowns. The resulting permanent shortfall in government revenues would mean taxes having to be raised not to reduce debt ratios, but simply to prevent them from growing ever bigger.
Implicit in what Sandbu says is a remarkably limited range of comprehension when it comes to macroeconomics. He is suggesting that the available choices are:
- Tax increases, or
- Debt reduction.
Or, in some (and, maybe, many) cases:
- Tax increases, and
- High debt.
But he's quite simply wrong. First that's because he assumes increasing debt is a burden. According to current heuristics that's true. But that's because our heuristics also assume:
- High debt is associated with high inflation;
- That's because high debt is associated with excessive government spending;
- Excessive government spending is thought to push up prices because it creates labour shortages;
- Inflation is associated with interest rate rises;
- Interest rate rises increase the cost of debt servicing;
- Therefore more debt is a burden.
But the heuristics underpinning this logic are no longer true.
- Government debt can now be funded by QE at no cost;
- QE has created a situation where both short and long term interest rates are at record lows, and seemingly likely to stay there because QE as a policy instrument permits that;
- Inflation has virtually disappeared in most major economies, at least with regard to consumer prices, and whatever the level of debt;
- We now face massive labour surpluses, or unemployment;
- Even when we had higher relative employment rates we could not create wage inflation;
- High government spending is now considered necessary, and not excessive;
- The cost of debt servicing, even on higher debt volumes, is falling.
In this case the heuristic driven paranoia about high debt makes no sense. High debt is not creating high cost; it is not squeezing out other spending; it is not draining resources from the economy as much of the debt is being funded by QE; and anyway, debt self is being reappraised. That is for two reasons.
First, what has traditionally been called debt is now simply seen to be saving. And the government acting as the place of deposit of last resort is seen as being no bad thing.
So, second, what was once called government debt is not seen as the threat it was. In fact, it's appreciated that it's not really debt at all, but simply people's savings, and since the government can set the rate on those savings it can guarantee to retIn them.
In other words, the heuristics that shackle even better thinkers simply make no sense.
So what should Sandbu have thought? That's a much more interesting question.
First, his range of options was much bigger than he noted. The tax/so-called debt trade off is a false dichotomy when we know the government can now fund its activities to whatever extent it wants through money creation, whether by direct borrowing from its central bank or indirect borrowing via QE.
Second, we now also know that tax and so-called borrowing are simply ways of withdrawing funds from the economy to balance money supplies, fiscal stimulus and inflation, which gives them a very different purpose.
So, third, we can see that the tax and borrow (in the sense of current heuristic thinking) choices that Sandbu discusses are themselves both inaccurate mechanisms for describing the government financing cycle, and too limited as approximations to reality even if, as approximations, they were ever useful.
In that case the question he should really have asked was something quite different. His error was to begin with a question on finance, as if funding were the most important issue in macroeconomics. Of course, it is not. What he should instead have started with was the real question which now has to be addressed, which is what is the scale of government intervention in the economy that is required to meet the needs of society at this moment? Instead of obsessing about the funding this is, surely, the right question to ask?
There is, of course, only one available answer to this question. It is that the scale of government intervention in the economy has to increase. Some of that is because of what are called the automatic multipliers. Benefit payments will, for example, increase. So too will the costs of the NHS rise, even without Covid-19 being taken into account. But very clearly the government will need to do more than that: the cost of recovery, as well as rebuilding the economy on a new sustainable basis, will largely fall to it. The private sector has not got the confidence, or the capital, to take on that task. What is more, after likely massive rates of insolvency in that sector, and borrowing having already been pushed to its limits in many cases to cover losses, that sectors capacity - not least to take on further borrowing - will be greatly reduced.
So if Sandbu had an assumption to make it was that the government must spend more by necessity.
But there was another assumption he should also have made. That is that without government intervention there is going to be a liquidity crisis in the economy. Banks are not going to be lending with any enthusiasm. And companies are not going to be taking on new debt. This conventional source of new cash creation is not, in that case, available to the economy. And given that consumer credit creation is also likely to reduce with fewer people in employment that too will restrict cash creation opportunity. So, not only will the government have to intervene more actively in the real economy to drive recovery, it will also fall to the government to create the cash the economy needs to function as bank created funds reduce, at least relatively.
This just emphasises how wrong Sandbu's limited choice of heuristic options is. Neither scenario he considers addresses the need for government cash injection into the economy. Instead, he concentrates on methods of cash reduction, simply because he never considered this issued as a part of the funding question. He ignored that government ‘borrowing' reduces cash availability and that tax literally destroys government created money by taking it our of circulation. His available choices do then only include scenarios that can make the economy worse.
What should he have considered? The obvious answer is that he should have addressed the question as to what options there were for the government to increase money supply. That could be in three ways. One is tax cuts. An other is by QE, but it is cumbersome and indirect. The third is by direct government injection of funds as a result of the government spending funds created for it by the Bank of England. Any combination is possible. And both tax cuts and QE directly oppose the positions Sandbu takes of increasing tax or debt, the latter because QE reduces real net government debt.
The conventional heuristics fail us then. And they fail economic commentary too by appearing to reduce the choices available to us when every option needs to be available now. And that is why those heuristics are so dangerous.
Those heuristics have, in that case, to be replaced. But rebuilding heuristics takes major effort. Have we the time to do that? The wellbeing of billions of people ultimately depends on us doing so.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Underlying Martin Sandbu’s thinking after centuries of brain-washing is the subconscious mentality that the government is the devil incarnate! This is why Hayek never effectively responded to Keynes’s arguments in Keynes’s 1936 book the “General Theory…” Pathetically he just spent the rest of his life arguing government was the pits and democracy over-rated!
Great article. What strikes me is the way we see money as the thing itself rather than what it represents – work done by people. We need to begin seeing people working not money being spent. So, how can we afford to care for older people becomes how many people do we need to be caring for older people. Whatever is spent doing that isn’t put into a big pit and burned, it’s given to people who will spend it on other things. Focusing on money hides what’s really being talked about. Saying there’s no money for whatever, is actually saying “I don’t want people to spend their time doing/making that”. I remember with the situation in Greece/Spain with unemployment at 25-30% thinking how weird it was that although the number of people available and wanting to work hadn’t changed, and that all the things that needed doing han’t changed, millions of people had stopped doing those things. This catastrophe was entirely a human creation. Nothing else had changed, except that an elitist desire to cause grinding misery and death had been unleashed. I see all the things on your list used as excuses to crush people’s lives to dust. I think we’re at a point in history like no other – no matter which way the wealthy turn to increase their wealth, a cataclysm looms for everyone, themselves included. They (and everyone else) are in a corner, and cornered animals are at their most dangerous. Sad to say but I think Zizek was right when he said that people find it easier to imagine the end of the world than the end of capitalism. The awful irony may be that both end together.
It is this deliberate waste / abuse of lives that has always been a motivation fir my interest in economics
Why shouldn’t we want each person to live to their best potential?
Neoclassical economics hates that idea
Hi Richard,
I’ve been following you for a while now, and I think I understand the arguments behind MMT (and I’ve also read Stephanie Kelton’s book), so I have a question about tax.
I make things, which can be sold world-wide for money. The people who employ me pay me well, yet the government tax away 1/3rd of my income before I even see it. That’s money that I would spend in my local economy, which surely would be to the benefit of anyone trading there. It is certainly not going to go to any tax haven.
So what might be the reason for this? Is it to make even well-paid people financially insecure, bearing in mind that there are vast numbers with an even more precarious financial position?
I will fully admit that this is a question that I’ve not fully thought through, yet right now, I’m thinking seriously about taking up a job offer in a European country with a tax regime where I would literally be £1,000 better off per month on a slightly lesser salary (in fact with nearly £10,000 drop, not including bonuses and other good things).
Given that you’ve said that a lack of demand is going to be a big problem going forwards, which I’m inclined to agree with, I do wonder what the hell the government is playing at.
Anyway, do appreciate your sensible postings. Please keep it up – you are hopefully converting more people to see things through the MMT lens.
I am intrigued as to the country you intend to go to. Few tax less than the U.K., overall, and offer any kind of useful social infrastructure
And if you pay a third of your income in tax you are on reasonable earnings
As MMT makes clear, government created cash must be withdrawn from the economy if inflation is to be avoided
As I have made clear, I think some need tax cuts right now. I am nit suggesting the better off do
Wh6 do you think you are over taxed? How else do you suggest a fiscal balance be created? I am curious to know
Hi again Richard,
Czech Republic, for what it’s worth.
And it’s not that I think that I pay too much tax – I’m trying to understand if there is a way to explain how much is determined in a way that would make sense to the non-economists among us (of which I am one), since the tax pays for Government spending is the more, shall we say, intuitive idea for most people, and constantly reinforced by Government and the media. Mr Warren (above) has put this much more clearly than I can.
“As MMT makes clear, government created cash must be withdrawn from the economy if inflation is to be avoided”
This makes perfect sense, however it is not just the government creating cash. Personally I’d prefer to use income to be economically active with, not credit created by the banks.
“As I have made clear, I think some need tax cuts right now. I am not suggesting the better off do”
I agree, although I’m not entirely sure who would get to determine who is “better off”, and at which point they become so, bearing in mind that this might change at any time.
But thank you for engaging. I think the hardest thing about these discussions is that even though these things seem straightforward and logical in the abstract, relating them to personal experience is where it is easy to lose people, and the opposition have all the emotive arguments going for them. And let’s be honest – “your tax pays for things of value to society” is a much easier sell than “the Government wants you to have less money to spend so prices won’t go up, despite you having worked for it” when it is fairly obvious in some very important areas that, even though inflation is pretty low at the moment, prices do go up, but income, not so much.
So would you wish for capital controls on banks?
I have not had a problem with these for some time – and have been saying so since at least 2011
It’s the weekend, and I don’t expect you to take all my nonsense seriously.
I’m asking stupid questions, because I am probably your average non-economist person who is interested in the subject, but does not have the background in the subject that you have.
My apologies if I am asking you to go over old ground.
Apologies from me – I admit I am in lethargic mood
It does not happen often
‘Saying there’s no money for whatever, is actually saying “I don’t want people to spend their time doing/making that”.
Thankyou for making the point so clearly and succinctly. I had been searching for the words to explain this Govt’s prevailing ideology and you have provided them here.
Sandbu’s article is a bit of curate’s egg, good in parts, and pretty dire in others. He recognises that cuts have had bad consequences, that certain groups have profited from the mantra of “fiscal responsibility” – ie “the asset rich and those …controlling capital” but then gets muddled about debt, higher taxes and public spending. Finally, he realises that there will be a battle over where taxes are to fall, if they are to go up, and undoubtedly the usual suspects will (are) arguing that taxes will fall on those at the bottom of the income/wealth profile.
But following his logic there will be no money to kick start the most urgent task of all, dealing with climate change through a Green New Deal. The impending disaster seems to have slipped off the radar, and in fact policies such as the UK Govt’s latest freebie to house building firms, via Planning changes, actively militate against meeting even the modest targets already agreed.
The problem is not heuristics. Heuristics is almost all economics has in the locker, because it is not a science with a body of theory that actually works. It is not hard science. It is probably the worst of all social sciences (a much lower standard of rigour then physical science) in making predictions.
There is only one principle that justifies a heuristic. Does it work. It is the nature of heuristics that even when they work their range of application in time is short. What worked this month does not work naext month, because some factor in the world not covered by the heuristic, changed.
The problem is that people confuse heuristics, which are rational experiments to use, when the knowledge is imited (it always is in economics, the world is just to complicated for the discipline, which over-simplifies absolutely everything), with intuitions. Heuristics are supposed to be used and discarded, as required. Old heuristics should be repalced by ones that work better. It is a continual system of change.
Unfortunately it is just too easy to find a heuristic that in some limited case confirms an intuition, and from there its short-term success turns it, and the intuition into a ‘law’. The problem is just how badly economics has been abused by neoliberal ideology, which has exploited over-simple intuitions, when ordinary people are looking for simple reassurance. Neoliberalism has simply asserted sole ownership of the household budget intuition. The houshold budget is a powerful intuition, and it lends itself to simple heuristics. Neoliberalism is only too eager to take advantage of them. Whatever the catastrophe neoliberalism brings in the wake of its endless failures, its constant disastrous folly; the household budget intuition survives. Neoliberals hang on to it for dear life. It is all they have, and it allows them to mislead the whole world, and serve the appalling values of bottomless greed and irresponsibility, and the cruel vested interests it was designed to serve.
MMT can’t do this; it at least has some standards.
But surely we do need better heuristics, and understanding if them, in that case?
Eh, yes; I wasn’t actually criticising heuristics. My opening sentence was: “The problem is not heuristics.”
Sorry if I misread….
Or my comment was badly written. Hmmmm…….
No…..
“Heuristics is almost all economics has in the locker, because it is not a science with a body of theory that actually works. It is not hard science. It is probably the worst of all social sciences (a much lower standard of rigour then physical science) in making predictions.”
This is probably the main argument in Robert Skidelsky’s book “What’s wrong with economics”. He also says that in aspiring to be regarded as a “hard” science it has inappropriately gone down the mathematical route in a forlorn attempt to apply rigour to variables which are not susceptible to mathematical analysis.
I rather like this quote, finishing with an aphorism from “The Master”: ‘For mathematical modelling you need tight priors from which you can deduce precise quantitative conclusions. With any other approach you fall into — God forbid! — political economy. To this objection Keynes gave an answer which to me is irrefutable: in matters of public policy it is better to be approximately right than precisely wrong.’
You will see that this influenced a tweet this morning
And a lot of thinking
So thank you
I think John S Warren is right on this one.
This is a great post by the way but I just ended being depressed after it.
Yet again, the onus is on the progressives to try even harder to prove that they have a point. It’s always our fault. Ignorance and orthodoxy are spared yet again from a day of reckoning. Great…………………….
Quite rightly we need new heuristics, but the only way we can get them is to use them to direct us in the first place and then find whether or not they work. All I see is this odd reluctance to step into the unknown, a lack of courage even, when we have been going around in circles for so long , generating the same awful results.
And yet, here we are, with derivatives still under regulated, and a freeing up of the planning regulation being mooted even though we know that 2008 and all that was caused by under-regulation!!
With heuristics, you’ve got to be willing – someone has got to be willing – to make the journey in the context of new lines of enquiry in the first place . I see this in University at good BA and MA levels, where you are not just taught a subject – you are also given lines of enquiry and encouraged to go off and ‘find out’. Needless to say, the most enthusiastic students get the most out of it.
The oddness of us as a society not trying MMT or going for full employment and re-defining taxation can only be the result of one thing: the deliberate indolence of those who like things as they are. And as such, we are denied new lines of enquiry and new heuristics.
I think that is where the battle is – the vested interests of those who peddle economic bullshit and delinquent heuristics – starting with my missive in response to Lancaster University’s recent foray here and criticism of the language of MMT – too many universities themselves help to hold back new lines of thought and heuristic discovery in economics, thus literally in my view anyway – contradicting their own learning ethos. In doing so, they give intellectual credence to ideas that are already not actually credible anymore – even at places like Oxford and Cambridge.
And then there are the politicians and their mates in the media all too willing to repeat robotically the same bullshit.
All I’m saying is that, how we express the ideas of a courageous society is not the problem in my view; it’s about how we fight the current malignant orthodoxy. We have the ideas; we have the means to sell to people what the benefits are or could be – we’ve thought it through.
But we somehow – now – have to be heard. That is the problem as I see it.