The Chancellor’s Two Hats

Andrew Brons offers some advice to George Osborne

 

For a Chancellor of the Exchequer to have several economic problems to solve at one and the same time is bad enough. That would simply require ‘multi-tasking’ which should not be beyond the capabilities of a modern government department.

 

However, having to deal with problems that require contradictory solutions is rather more demanding. It is a little like a medical practitioner having to attend to the needs of an obese patient suffering from anorexia.

 

Nineteenth century Chancellors would not have recognised the problem because they saw the role of the Chancellor, simply to make sure that the books balanced – that proposed expenditure would be covered by expected revenue. Mrs. Thatcher ‘The British Manufacturing Industry Snatcher’ was a woman of the nineteenth century if ever there was one, at least as far as what-she-would-have-called her economic policy was concerned. She learnt it by rote from Sir Keith Joseph who copied it from Milton Friedman. Mrs. Thatcher’s contribution was to make a tedious false analogy with household income and expenditure, based on the frugality of her Grantham forebears. The Grantham Roberts family does not appear to have contained many irresponsible party animals. Of course, while the incomes of most private employees and even employers are pegged by forces beyond their control, governments have the power to decide the size of their revenues.

 

Chancellors since the 1930s have assumed, or been assumed to have, a second role: to ensure regular industrial output and something approximating to full employment. Some attribute this change to John Maynard Keynes, whose General Theory was published in 1936, others to FD Roosevelt, still others to Hjallmar Schacht.

 

Modern Chancellors are expected ensure that, in the long run, the books balance and that the economy is run smoothly. So what are the problems that our current Chancellor must face?

 

Well, he faces higher than planned inflation, government indebtedness, a problem that he shares with the ailing countries of the Eurozone – public sector net. Debt being 65.7% of GDP. This would seem to require austerity measures, in the form of reduced government expenditure or increased taxation or both. That would be bad enough.

 

However, he faces the problem of a double dip recession, falling manufacturing output and under-employment – people available for full-time employment but in part-time employment, as well as the prospect of rising unemployment. Dealing with these problems with austerity would be like putting a malnutrition victim on a starvation diet.

 

The problems of recession and unemployment require an increase in aggregate demand for goods and services produced in this country. This means an increase in domestic spending or demand for our exports – visible and invisible. This might be effected by an increase in the money supply.

 

That increase might be the result of the government or the Bank allowing or encouraging the commercial banks to increase their lending and thereby creating money that did not previously exist. Unfortunately, money created in this way might in period 1 be reflationary but when repaid with interest in period  2, it will be deflationary unless replaced by further lending.

 

Alternatively, the Government or the Bank might create money itself, either physically or electronically by what is now called Quantitative Easing. This is seen widely as being inflationary, though that charge must be examined and judged on its merits.*

 

When new money is spent or lent into the economy, it is not spent once, only then to disappear. It (or a proportion of it) is spent repeatedly so that the total increase in spending will be a multiple of the initial injection of money**.

 

Any increase in the quantity of money, assuming that the rate at which money is spent does not alter, will be inflationary unless and until the total quantity of goods and services increases proportionately***.

 

However, the increase in the money supply will have the effect of  increasing economic activity, which will eventually, if not immediately, increase the total production of goods and services. Keynesian economists would argue that if that increase in goods and services is proportionate to the initial increase in the money supply****, the inflationary effect will be minimised.

 

Anti-Keynesian economists point to the practice of  Keynesian stimulation of aggregate demand and conclude that it is always inflationary. It might be successful in reducing unemployment but at the cost of a large increase in the inflation rate. This was exactly the effect of the boom created by Edward Heath’s Chancellor, Anthony Barber in the second half of the 1970-74 Heath Government.

 

This might well be because the increase in goods and services takes place much more slowly than the increase in aggregate demand. This is particularly so if the project on which the created money is to be spent is a large capital project, like a tunnel under a sea or through a mountain or a long bridge spanning a wide river estuary. The tunnel, bridge or motorway will eventually provide an economic benefit to its users by saving time in handling goods. However, that benefit will be felt only when it has been completed. A 99% completed bridge confers no benefit at all. In contrast, the increase in aggregate demand has been occurring steadily for the whole period of its construction – perhaps five years even ten.

 

If we want Keynesian stimulation without inflation, the timing of the increases in aggregate demand must match, more closely, the increases in goods and services. This could happen in two distinct ways: either the capital projects must be of much shorter term before their completion; or payment to workers and suppliers involved in the work on the capital project must be delayed, perhaps until their completion.

 

The problem with the first of these options is that you would be limited to road repairs and resurfacing, repair of sewage systems which could be completed in months or even weeks. However, the benefits will be less obvious; repairing a road that is already in use does not so much confer a benefit as avoid a detriment – the costs to users of not repairing a road.

 

The problem of delaying payment for workers and suppliers on large capital projects is even more fraught with difficulty. In desperate economic times, unemployed workers might be offered no immediate payment beyond a continuation of their unemployment benefit and related benefits such as housing benefit. However, they would be entitled to full payment deferred until the capital project came fully into use and constituted that elusive increase in the total production of goods and services. However, in less desperate times, workers might be less willing to make that enormous sacrifice of delayed payment for their services. Would suppliers of the necessary construction equipment or materials be willing to wait – perhaps years – for payment?

 

In the case of projects that would so obviously constitute an enriching benefit, such as the Dartford bridge and tunnel, perhaps pension funds could be encouraged to invest in them.

 

Our guiding principle must always be: “Whatever is physically possible must be financially possible or there is something seriously wrong with the financial system”. If there is an economic need that can be satisfied by the efforts of unemployed workers, the financial system must be effective in putting those workers into that necessary work.

 

In a command economy, like the Soviet Union, before Gorbachev or even in Britain during the Second World War, that principle would have been observed and the economic need satisfied. However, we do not have a Soviet Bloc style command economy and it is not our policy to transfer our economy into one. We would have to decide how much intervention would be necessary to alleviate the problem. The deeper the recession or depression, the more radical would be the necessary measures.

 

The reality is that austerity measures during a period of recession and unemployment do not solve the problems but only aggravate it. Keynesianism increases production and employment but the injection of money, inevitably precedes the extra production that it was designed to effect. This causes inflation – sometimes spectacular inflation. The answer must lie in some method by which the return to work and the first fruits of increased production precede the full injection of extra money.

 

Inflation is the result of too much money chasing too few goods. Put another way it is an increase in the amount of money before the goods and services have emerged from the production process. That is why textbook Keynesian policies lead to inflation. The problem lies in the timimg.

 

 

 

Footnotes From The Text

 

*Quantitative Easing has been used to offset contraction of the commercial banks’ assets which had resulted from their calling in loans. The Bank of England has done this by the purchase of Treasury Bills which was intended to increase the deposits of commercial banks. It has therefore offset deflation rather than caused inflation.

 

**Any increase in the money supply will be spent repeatedly, by one person after another, with a deduction for amounts saved on each occasion, so that the eventual increase in aggregate demand brought about by the creation of (say) £X will be a multiple of  £X. The multiple will be the multiplier, which is the inverse of the marginal propensity to save expressed as a vulgar fraction. If the average amount saved from each marginal £ created is 1/5 (one fifth), the multiplier will be 5. For every £1 created, aggregate demand would increase by £5.

 

***multiplied by the multiplier

 

 

****Proportionately, that is, to the total increase in aggregate demand resulting from the increase in the money supply multiplied by the  multiplier.

 

 

Additional Footnotes

This article is primarily about deflationary, reflationary and inflationary policies and how they might affect levels of growth in manufacturing industry and levels of employment.

 

One other important influence on our manufacturing industry and indirectly on employment has been the laissez-faire approach of successive governments and an open-door policy to imports of manufactured goods, firstly from other developed economies and then from emergent economies, with which it would be impossible to compete without driving down our wage levels.

 

Another influence on our levels of employment has been immigration on an unprecedented scale. This is often referred to as ‘Eastern European immigration’. However, the majority has been Third World immigration. ‘Net immigration’ (the excess of immigrants over emigrants is still running at a rate of a quarter of a million each year, over years after the General Election at which the Conservatives promised to reduce it to tens of thousands. Of course, if net immigration is around 250,000, gross immigration is much higher. It must also be remembered that whereas most of the immigrants are foreigners and from the Third World,  the emigrants are British people practising ‘white flight’.