Monday, 16 December 2013

Austerity's Catch-22

Remember this piece by Joseph Heller that sets out the problem for a scared fighter pilot trying to get grounded in WW2? 
………There was only one catch and that was Catch-22, which specified that a concern for one's safety in the face of dangers that were real and immediate was the process of a rational mind. Orr was crazy and could be grounded. All he had to do was ask; and as soon as he did, he would no longer be crazy and would have to fly more missions. Orr would be crazy to fly more missions and sane if he didn't, but if he were sane he had to fly them. If he flew them he was crazy and didn't have to; but if he didn't want to he was sane and had to.  Yossarian was moved very deeply by the absolute simplicity of this clause of Catch-22 and let out a respectful whistle.....
Keep your feet on the ground

Perhaps Joseph Heller has had a hand in designing the current recession:
Recovery in advanced countries where high levels of debt have coexisted with negative real interest rates for many years must require increased public spending, tax cuts, QE or other measures that may well, in the medium term, cause interest rates and rise choke off growth.  So, like Yossarian in Catch-22 one can only let out a respectful whistle at the perfect symmetry of our predicament.  To escape this vicious circle of low growth, no growth, etc - there have been two standout tactics and both are a kind of madness, they are:

1.       Abenomics, which begs us to temporarily forget our debts whilst throwing the kitchen sink at reflationary measures.  Before turning to the tricky issue of reducing the debt –the big question is will he need to service the debt drive up interest rates before growth takes hold?
2.       Austerity, which begs us to temporarily forget growth whilst hammering down on public sector debt.  The big question is will shrinking the state reduce demand to a point where lack of confidence in the economy makes it difficult for governments to service their existing debts without increasing yield and interest rates in the debt markets
In many parts of the world there has been a strong desire to step in a “do something” and in most instances this has been the cause of further pain.  The story of austerity in Europe is pretty well known and the likely outcome for Abenomics is becoming more certain (it won’t end well).  The economies that have had a pretty neutral programme: US, UK and German we can see that either recession has been less deep or recovery has arrived earlier.  In comparison the Eurozone has been plagued with uncertainties around: banking defaults, debt reduction and sovereign bail-outs and even the future of the currency.  This is not a conducive environment for recovery and growth, but it may point the way forward. 
In the UK we have fudged the issue and adopted policies of loose monetary policy (just one of Abenomic’s three arrows) coupled with “austerity light” we have seen some improvement in consumer demand and subsequently a little growth.  The current government does not seem to have a plan but at least inertia creates some stability and stability is perhaps they key to recovery.  If households and businesses know where they are and can plan ahead with some degree of confidence and then, in time, things will improve.
The single biggest lesson of the recession is that governments need to promote certainty in policy even if that policy is to do nothing!    Governments in the Eurozone have had to offer a future that is highly uncertain and this has killed off recovery and confidence.  Most other governments have had a total disregard for missed forecast and have changed policies on the fly to the detriment of growth.  Politicians could learn a thing or two from Mark Carney, who came up with the approach "forward guidance", which tries to create confidence on the future level of interest rates.  Governments could extend forward guidance in all kinds of ways cover levels of taxation, public spending.  More transparency would help us all to navigate through difficult times and would certainly promote growth.  Some will say that governments already do this be setting budgets and forecast, but these plans are routinely changed and missed and no one trusts them – so my plan for recovery is simple :
·         Budget for two years not one
·         Aim to reduce deficits through inflation and growth rather than austerity
·         Minimise extraordinary measures like QE, massive public spending and weird credit schemes
·         Provide forward guidance on interest rates and a range of other monetary fiscal measures
·         Don’t change too much and limit structural change to one or two programmes

My guess is that this kind of approach would allow any decent economy to dust itself off and recovery at the optimal pace.  The truth is we need to trust in our western economic model, which has proved so successful over the last 200 years.  There is no history of economic gimmickry being successful it comes down to time, patience and consistency of approach.   Further proof of this is the track record of liberal economies that have a consistent approach compared to those that are continuously changing direction; the UK is an example of an economy that has had the same approach to economic management (whatever Mr Osborne tells us) for nearly 30 years, compare this to France and on this basis I rest my case!

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