Pandemic of inequality

The Levy Institute has just published a short paper on the inequalities associated with the Covid-19 pandemic in the US. It can be found here. A summary of the paper is below.

The costs of the COVID-19 pandemic—in terms of both the health risks and economic burdens—will be borne disproportionately by the most vulnerable segments of US society. In this public policy brief, Luiza Nassif-Pires, Laura de Lima Xavier, Thomas Masterson, Michalis Nikiforos, and Fernando Rios-Avila demonstrate that the COVID-19 crisis is likely to widen already-worrisome levels of income, racial, and gender inequality in the United States. Minority and low-income populations are more likely to develop severe infections that can lead to hospitalization and death due to COVID-19; they are also more likely to experience job losses and declines in their well-being.

The authors argue that our policy response to the COVID-19 crisis must target these unequally shared burdens—and that a failure to mitigate the regressive impact of the crisis will not only be unjust, it will prolong the pandemic and undermine any ensuing economic recovery efforts. As the authors note, we are in danger of falling victim to a vicious cycle: the pandemic and economic lockdown will worsen inequality; and these inequalities exacerbate the spread of the virus, not to mention further weaken the structure of the US economy.

The authors focus on the greater likelihood of ill health among the poorest in the population, and how they are more likely to suffer serious complications should they contract Covid-19.

They also repeat the case often made in papers from the Levy Institute, that high levels of inequality have weakened aggregate demand and growth, not least in the US. This has been associated with high levels of household and corporate debt, and played a major role in the historically weak recovery from the 2008 crisis. If steps are not made to reduce inequality, not least in access to healthcare, the US economy is likely to continue to perform poorly over the long term. This will be in addition to the shocks resulting from the response to the pandemic itself.

Hyman Minsky explains his financial instability hypothesis

In this rare video, Hyman Minsky explains his financial instability hypothesis. The video dates from 1987, but Minsky was prescient in originating a theory that characterises capitalist economies with developed financial systems as inherently unstable and requiring the intervention of ‘Big Government’ (counter-cyclical fiscal policy) and a ‘Big Bank’ (the central bank acting as lender of last resort). His FIH has become much more widely known since the advent of the 2008 financial crisis.

Minsky was influenced by his teacher at Harvard, Joseph Schumpeter, as well as by John Maynard Keynes and Michal Kalecki. His work falls under the post-Keynesian tradition, emphasising the role of finance and the importance of effective demand in the economy, with the former a major cause of instability in the form of booms and busts. His thinking also incorporated ideas on institutions such as households, firms, banks, and governments, and explored how their balance sheets of assets and liabilities evolve over business cycles.

Michael Hudson on Balance Sheets

JisforJunkEconThe evolution of balance sheets are key to the economics of Hyman Minsky, who described an economy with a financial system as one of ‘interlocking balance sheets’. Similarly, Richard Koo, originator of the concept of a Balance Sheet Recession, has written much on its implications for government deficits during the crisis of 2008 and, before that, during Japan’s Great Recession, which led to two decades of economic stagnation.

Until recently, balance sheets tended to be ignored by the mainstream majority of economists. The revival of Minsky’s ideas, alongside the ideas of Koo and post-Keynesians such as Steve Keen and Wynne Godley, have perhaps begun to shift the tide. The work of Michael Pettis, another economist influenced by Minsky, also deserves to be more widely influential. Continue reading

UK debt reduction: how can ‘Spreadsheet Phil’ do it?

Money-poundsLast week the UK government’s new Chancellor of the Exchequer, Phillip Hammond, known to some as ‘spreadsheet Phil’, gave his first Autumn Statement to parliament. This outlines the state of the UK economy and the government’s finances, and announces new policies on government tax and spending.

The forecasts of the Office for Budget Responsibility for the UK economy’s likely trajectory over the next few years were somewhat gloomy, and laid much of the blame for this at the door of the decision to leave the EU, or Brexit. Growth will be slower, investment weaker, and public borrowing and debt higher than otherwise.

I will avoid reiterating details regarding the Autumn Statement that were covered in last week’s press, and instead focus on the potential for debt reduction and overall economic performance over the next few years, which the government is trying to manage and improve upon: the Prime Minister wants an economy that ‘works for all’. Fine aspirations indeed. Continue reading

Hyman Minsky’s contribution to economics: a book review

Here is a link to my review of the recently published book Why Minsky Matters by L. Randall Wray, posted on the Rethinking Economics website. Anyone who wants a better understanding of the Great Financial Crisis needs to be familiar with Minsky’s ideas.

His work has been made more widely available by the Levy Economics Institute, where he worked for some years before his death in 1996. However, he is not an easy read, and this book, aimed at the intelligent general reader, goes a long way to putting that right.

Mitigating recession: how far should government policy go?

Among Keynesian economists, it is generally accepted that governments should intervene in the economy to manage the business cycle using fiscal and monetary policy as tools of macroeconomic management. During the post-war boom until the 1970s, full employment used to be considered not only desirable but also feasible. Continue reading

Another example: Richard Koo’s ‘Yin and Yang’ and fiscal policy

Following on from the theme of my previous post, the economist Richard Koo offers another example of where a changing economic environment changes the appropriateness of a particular policy, in this case fiscal policy. This is particularly relevant to the UK and US, as well as economies in Europe, where the mantra of fiscal austerity, or aiming to balance the government budget, seized the consciousness of politicians quite soon after the Great Recession of 2008. Continue reading

How the UK economy can reduce its public and private sector debt

The UK’s current account deficit recently made the economic headlines, hitting 6% of GDP in the third quarter of 2014. Indeed, the BBC’s economics editor Robert Peston has been worrying about it for some time and commented on this statistic in his last blog before Christmas. As he says, the UK chancellor of the exchequer George Osborne and the Prime Minister David Cameron, publicly obsess about the public sector deficit, claiming that it is the UK economy’s major problem, but choose not to mention the current account deficit, which has been over 5% of GDP for 15 months. Continue reading

The Keynesian solution and the problem of politics

More than four years on from the financial crisis and more than five from the start of the credit crunch, we still are not out of the woods by some margin. The turn to austerity in the UK from 2010 has at the very least proceeded too rapidly, and the economy shrank again in the final quarter of 2012, although the statistics are of course subject to revision. Austerity fever has gripped the governments of many countries across the world. Some, such as Spain and Greece, probably had no choice, but the UK, with its own currency and central bank did have a choice. A chorus of respectable opinion, comprising economic commentators to the chief economist at the IMF, have suggested that if the UK economy continues to stagnate, then it is time for a change of policy. But the government refuses, blaming the mess they inherited from the previous Labour government and insisting that the answer to dealing with your debts cannot be more debt ie increasing the deficit. But these arguments, though appealing, are simplistic and ignore the dynamic links between public debt and private debt in a national economy.

There seems to be a certain kind of obvious logic to saying that ‘the answer to dealing with your debts cannot be more debt’, but some basic economics moves us beyond the conflation between private debt and public debt that this argument creates. The large budget deficit and rising public sector debt in the UK and other economies was largely caused by the recession and the consequent collapse in private sector spending as households started to save more of their income and reduce their exposure to debt. When private sector spending collapses and there is not the prospect of a healthy global economy beyond national borders to generate growth from net exports, the only spender of last resort remaining is the government. When interest rates are already so low that they basically cannot be cut further, then monetary policy is exhausted and fiscal policy plays a vital role in mitigating a balance sheet recession of the kind that we are still going through. Attempts to cut government spending when private sector balance sheets remain weak and firms and households are still saving and paying off accumulated debts will only cause the economy to stagnate or stay in recession, as we are seeing in the UK.

So it would seem to be that part of the answer to economic stagnation in the UK is a temporary fiscal stimulus in the form of increased public investment on infrastructure repair and construction. The stimulus should help the private sector repair its balance sheets and pay off debt at an increased pace and thereby bring closer a real recovery in economic activity. No-one knows how long this process would take, but the sooner an economic recovery begins in the UK and across the developed world, the less suffering in terms of unemployment, underemployment and poverty there needs to be.

So why no major U-turn on the part of the UK government, to continue the austerity policy example? One possibility is that they really believe that they are impotent to improve matters, and that austerity is the only possible course of action. Another is that they are still worried about what Paul Krugman calls the ‘invisible bond vigilantes’, the risk that increasing deficits will only drive up interest rates and the policy will be entirely self-defeating as the private sector is put into an even worse situation. But if the current low long-term interest rates are more the result of economic weakness, rather than due to credibility won through austerity, then there would certainly be room for an effective fiscal stimulus which would work as described above. It is more likely that the government has mistakenly looked at the situation in Southern Europe and become convinced that if we don’t restore economic credibility by reducing the deficit then we will end up in the same situation. It is mistaken because we are not part of the euro, and have our own currency and exchange rate which can bear any necessary adjustments.

It is pretty clear that any public abandonment of fiscal austerity until the economy is recovering strongly would represent a major U-turn and lead to a massive loss of face by the government. So political reputations and non-existent credibility are put ahead of national well-being, growth and employment. But the Labour opposition have not proposed abandoning the policy, only a slower pace of adjustment. It seems that the chancellor has already begun this, as he is failing to meet his targets for reducing the deficit. So austerity is to be extended into the next parliament until 2017-18! He is also blaming international factors such as the eurozone crisis for the UK’s poor economic performance, which is a convenient story but one which is wrong. Exports to the eurozone are simply not a large enough part of our GDP to make them the key factor in the continuing stagnation. While deleveraging continues, private sector spending will remain weak and fiscal policy should support aggregate demand until this process is completed, and private sector borrowing, investment and consumption can rise at a rate strong enough to allow austerity to take place without causing economic and social damage. Once the private sector recovery is underway the deficit will fall even without extra spending cuts or tax rises.

The government’s strategy is exactly the opposite of what should be done. And to the extent that the eurozone crisis is not helping, this is partly due to significant austerity policies on the continent, which the UK government supported.

Labour is in a difficult position as they have a low level of economic credibility due to their being in government when the financial crisis began. And it would be easy for the opposition to argue that nothing has changed on their part if they argue for abandoning austerity policies. It is therefore likely that the austerity will continue, and UK economic performance will continue to be poor for a number of years, and unnecessarily so.

Changing balance sheets, public and private

A fall in aggregate effective demand and expenditure in an economy is the major feature of a recession. Private consumption is usually the largest component of aggregate demand, and it falls in the downturn, while consumers try to collectively increase their saving; that is, the income they do not spend.

Graphs of the saving rate in major economies over the economic cycle tend to show it falling during booms and rising in recessions. So an increase in the desired saving rate does lead to a rise in the actual rate.

In the current recession, consumers in many countries have seen a collapse in their personal wealth, due to a fall in asset prices, particularly in housing and stock markets. This is a further reason for them to cut borrowing and consumption and increase saving, as a way to rebuild their personal balance sheets.

At the same time, banks, other financial intermediaries and non-financial firms are also rebuilding their balance sheets by restructuring their financial positions ie reducing their exposure to debt.

The debt of households and firms is growing much more slowly than before the recession and household debt even recorded a recent fall in the US. As the economy returns to growth, however slow, it will be necessary for private debt to grow more slowly than income for some time, until balance sheets become more healthy. This is likely to slow  private sector investment and consumption and hence overall growth, particularly in heavily indebted countries.

The rebuilding of private sector balance sheets can be seen as a debt-deflation process, which is one way of looking at the process of such a deep recession in many countries. While private sector debt as a percentage of national income has been falling, public sector debt has been rising as governments have run increased fiscal deficits, partly as automatic stabilizers have taken effect, but also as a result of stimulus packages aimed at mitigating the fall in aggregate demand.

Public sector balance sheets have in many cases worsened, notwithstanding the funds used to bail out the banks by injecting capital, which include the purchase of assets which, one hopes, will ultimately recover in value and eventually show governments, and hence taxpayers, some profit.

Conservative opinion seems to dislike debt and especially public debt. It may seem perverse to some for the government to be increasing its own debt while the private sector becomes increasingly thrifty. But an essential insight of macroeconomics is that governments can help to stabilize an economy using fiscal policy. Especially in such a deep recession as this one, such damage limitation is necessary to prevent unemployment from rising even further, with all the social ills that go with that phenomenon.

In fact, rising government debt may allow the private sector to pay down debt more rapidly and speed recovery from recession over the medium term. The process is unlikely to be smooth or mechanical, but during the period in which the private sector is increasing its saving and paying off debt in aggregate, and certainly reducing debt relative to income, the multiplier from a rising public deficit may be somewhat reduced, but a rising deficit can still in this instance mitigate the recession and speed recovery.  For a time public debt may rise at an unsustainable rate. One hopes that the private sector can recover before public debt reaches unsustainable levels, whatever those might be.