Policy Research in Macroeconomics

If the god Janus were an economist, he would work for the IMF

By Ann Pettifor

From PRIME, July, 2010: “Fiscal consolidation does not ‘slash’ the debt, but contributes to it.”

The economic consequences of Mr Osborne, by Professor Victoria Chick and Ann Pettifor, July, 2010.

From the IMF, January, 2013: “We find that forecasters significantly underestimated the increase in unemployment and the decline in private consumption and investment associated with fiscal consolidation.”

Growth Forecast Errors and Fiscal Multipliers by Olivier Blanchard and Daniel Leigh, IMF Working Paper, 3 January, 2013. P. 5

In our 2010 report, Professor Chick and I warned explicitly and on the basis of a century of publicly available data, that in a slump, fiscal consolidation increases unemployment and cuts private investment.

An institution with a staffing of about 1100 professional economists (most of whom have PhDs) and an overall personnel budget of about$800 million– failed to make that correct call.

Instead, the IMF now admits that it ‘significantly underestimated’ the impact of public spending cuts on employment and investment.

Getting macroeconomic forecasts and policies wrong has consequences: in the low income countries in the 80s and 90s the consequences of the IMF’s failed policies were bankruptcy and impoverishment for many nations.

Millions of people lost a future – and the opportunity to thrive.

Today, in Greece, Portugal, Spain and Italy – the economic, social and political consequences are not just degrading for the people of those countries, they threaten wider global stability.

So a mea culpa from this powerful institution is long overdue. But while the mea culpa is welcome, the shape and tone of it seemed to my eye, disingenuous.

The multiplier wrongly defined

First, the Blanchard and Leigh paper defines the multiplier as: “the short-term effects of government spending cuts or tax hikes on economic activity.”

But that is not a correct definition of the multiplier. It’s perversely the very reverse: economists craning their necks backwards and trying to calculate the impact of their unwise advice to governments to cut public spending at the height of a banking crisis, and thereby start private debt deflation and slump.

Explaining poor advice from orthodox economists in terms of the multiplier is wrong, if not disingenuous. Masking this poor advice and his institutional mea culpa in what the Washington Post calls “a deep pool of calculus and regression analysis” does not make things right. All it does is provide evidence of what Keynes called a “failure in the immaterial devices of the mind” to fully address and solve an economic problem.

Keynes’s multiplier

Keynes proposed and explained the multiplier in terms clearly understood by the British public and policy makers in The Means to Prosperity’ in 1933. He did so with the help of some arithmetic, but without using a single equation. He substituted the proposition that “supply creates its own demand…” with the proposition that remains uncomprehended by today’s economists and policy-makers: “expenditure creates its own income.”  (CW XXIX, p.81)

He showed – and a centuries-worth of macroeconomic evidence proved – that to spend borrowed money in a slump to invest in economic activity, i.e. employment, would multiply the income generated by the investment, and that the investment would pay for the borrowing.

Of course Blanchard and Leigh are right to argue, as Keynes did, that “there is no single multiplier for all times and all countries. Multipliers can be higher or lower across time and across economies.”

But it is also true that in a slump, at a time of economic failure, the impact of borrowed money on investment and employment is higher than at times of macroeconomic stability. Much higher.

However today we have all been led to believe that it is impossible for governments to borrow – for fear of bond market wrath, and interest rates rising.

But governments like that of the UK, Japan and the US with central banks that issue a fiat currency, do not have to appeal to the bond markets in order to spend. Their central banks – and indeed their nationalised, publicly guaranteed and subsidised commercial banks – can provide credit, at very low rates of interest, to government, to finance the borrowing.

That borrowing, if invested in sound income-generating projects (i.e. generating wages, profits, tax revenues…), pays for itself.

Buried knowledge

Knowledge and experience of the multiplier and its efficacy are well known to economists. But thanks to “immaterial devices of the mind” this knowledge has been buried.  IMF economists do not challenge the ideologues who buried the multiplier. They are not even willing to admit publicly to the ‘implicit multipliers’ in their forecasts.  IMF economists do not have the courage to dig up the work of Keynes and others on the multiplier, and to acknowledge and apply its wisdom.

This is reflected in the disingenuous words used in their conclusions. First this acknowledgement:

 “If…forecasters underestimated fiscal multipliers, there should be a negative relation between fiscal consolidation forecasts and subsequent growth forecast errors. In other words, in the latter case, growth disappointments should be larger in economies that planned greater fiscal cutbacks. This is what we found.” (My italics.)

However, Blanchard and Leigh then undermine this finding with the following conclusion:

 “…our results should not be construed as arguing for any specific fiscal policy stance in any specific country. In particular, the results do not imply that fiscal consolidation is undesirable.” (My italics).

 If the two-faced god Janus had been an economist, he would have approved.

5 Responses

  1. This seems to be an odd result. The basic idea behind the multiplier is that a failure of private markets has left productive resources (like human and physical capital) idle. If the government sends money to people, it has not done anything to increase their productivity. The purchasing power may increase aggregate demand, but at the expense of discouraging employment. As Casey Mulligan explains , the economic effect of spending on roads and bridges is likely to be far different from transfer payments like unemployment insurance because these payments are “contingent on work and production: the people cashing the checks received them by virtue of producing something the government values.” By contrast, unemployment insurance or means-tested transfer payments either pay people not to work or actually reduce benefits if people work too much. This perversity generates costs that are not accounted for in the multiplier framework.

  2. In a letter to Roosevelt, Keynes also said that it didn’t make any difference whether the money spent was borrowed or printed (a point I agree with: I prefer the print option). He said government should “create additional current incomes through the expenditure of borrowed or printed money.” See near top of 2nd page here:

    Milton Friedman and Warren Mosler have also advocated a system in which there is no government borrowing (a system I agree with). For Friedman, see para starting “under the proposal.. (p.250) here: http://nb.vse.cz/~BARTONP/mae911/friedman.pdf

    For Mosler, see second last para here:


    1. Those are excellent references. I would have followed on to the subject of officially issued money in place of credit with privately owned banks but had already written too much!

  3. I am not an economist but an accountant.
    When Keynes stated that “expenditure creates its own income”, he took one step beyond the basic accounting rule that every payment has an exactly equal receipt. If I pay a barber to cut my hair, my expenditure is the barber’s income. However, if I buy your home, I would consider that I had made an investment and neither you nor the tax authority would consider that you had received income but rather a capital receipt. The accounting concept of current and capital transactions is also important to economists. If I had a plot of land and paid builders to construct me a home, then my expenditure would be the builders’ income. The builders, just as the barber, would likely spend this income (unless they saved it) whereas you would most likely use the proceeds of the sale of your home to buy another home, to repay mortgage debt or to hold as capital.

    A corollary of the basic accounting rule is that for all saving, there is exactly equal borrowing. If a household saves £100, then the combination of all other persons and bodies must borrow exactly this £100. In the first instance, the business sector will borrow it because a firm paid wages but the business sector as a whole did not get it back. However, if firms are unable or unwilling to borrow this money and if foreigners will not borrow it in order to buy and export firms’ production, then the government must borrow it whether they want to or not because they are the borrowers of last resort. Governments have no option but to borrow exactly the sum of the net saving by everybody else (the combination of the business sector, the household sector and the rest of the world). Austerity might reduce the size of a government, but it cannot reduce its deficit unless that austerity reduces the level of saving which it won’t. Saving is particularly high at this time because households are repaying excessive mortgage debt and firms are repaying the debts that they incurred while they financed their pension schemes and while they acquired one another. It is often forgotten that one must save in order to repay debt.

    You state that governments with central banks that issue a fiat currency do not have to appeal to the bond markets in order to spend. Central Banks can indeed provide unlimited credit but they can only provide it to those who have an account with them. In effect, it is only commercial banks that have such accounts. Governments can either borrow from savers in the bond market or through their central banks from commercial banks. The UK, Japanese and American central banks have borrowed huge amounts from commercial banks through the process known as Quantitative Easing but they have not spent this money to provide income but have rather used it to buy back their own debt and other financial securities in the secondary market. These are capital transactions and will only boost current spending if those who sold these securities choose to spend their proceeds rather than buy more financial assets. That is why QE has not worked and will not work. The UK Government, through the Bank of England, has borrowed £375bn from commercial banks but appears now to have realised that it has not boosted incomes.

  4. “that to spend borrowed money in a slump to invest in economic activity,”
    But that is the economic description from the 1930s – without the free floating exchange rates of today.

    So to put it in those terms is to accept the framing of fixed exchange rates and the starting point of the spending cycle using the ‘b’ word.

    Expenditure doesn’t just create its own income via taxes. Expenditure creates its own income by generating savings. Savings in excess of private investment that the government then has to actively sweep around to keep the circulation up.

    The government only borrows in the same sense that the bank borrows when you get your salary paid in every month. The borrowing is a passive action that accommodates the active action of saving.

    There’s no cap in hand required. The government owns or controls the central bank and therefore *is* a bank. A bank with no capital restrictions.

    The more saving with the government sector, the more the government sector must spend .

    The same panic to get the private banks to lend should apply to the bank of government as well. It is the borrower of last resort!

    The narrative ‘spending on investment’ is similarly over-stated as well. Once again that is first order thinking. The government just needs to spend *strategically* – which may very well be supplementing consumption. Increases in consumption then cause private investment and employment levels to rise as they respond to the increase in sales.

    Arguably that private investment will be better targeted then excessive central investment spending.

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