G20: Hard Right Turn to Austerity and Finance as Usual on Road to Toronto

In line with a major shift in thinking at the OECD and the IMF on the most appropriate timing for “exit strategies” from fiscal stimulus, the G20 finance ministers dropped the usual call for continued stimulus through 2010 from their June 5 communique, and highlighted the need for more or less immediate fiscal consolidation. God knows what lies in store for us in Toronto.

This sharp turn of course follows publication of the May, 2010 Economic Outlook of the Organization for Economic Co-operation and Development (OECD) which said that “(e)xit from exceptional fiscal support must start now, or by 2011 at the latest, at a pace that is contingent on specific country conditions and the state of public finances.. (i)n those countries that have not yet begun the consolidation process, public finances need to start being brought credibly onto a sound footing by next year at the latest.” (Editorial and pp. 9-10.)

The May issue of the IMF  Fiscal Monitor http://www.imf.org/external/pubs/ft/fm/2010/fm1001.pdf has also called for fiscal retrenchment to begin no later than 2011, and for immediate measures in countries experiencing either a rapid recovery (eg. Canada?) or “facing acute financing pressures.” For the IMF, the gross debt level should be brought back to 60% of GDP over the next 20 years. This is calculated to require a combination of spending cuts and tax increases amounting to almost 9% of GDP on average in advanced countries, on top of which governments will have to fund underlying increases in public health and pension costs amounting to 4-5% of GDP. In short, balancing the books now is seen as but a prelude to long-term austerity.

As Paul Krugman has argued in his column  http://www.nytimes.com/2010/05/31/opinion/31krugman.html and recent blogs, abandonment of stimulus at a time of continued high unemployment will barely dent medium term public debt accumulation in the advanced economies while inflicting  a lot of unnecessary suffering in the process. Neither the OECD nor the IMF make any pretence of arguing that a  job market recovery is at hand (indeed the unemployment rate is still at a recession peak in the US and the EU.) The only possible rationale is appeasement of the markets, which are apparently demanding cuts as the price of continued funding of deficits and debts.

Krugman’s ball park estimate is that cutting spending by 1% of GDP at a time of high unemployment will raise unemployment by .75 percent, but reduce future debt by less than 0.5% of GDP. The markets might be demanding cuts,  then, but they don’t really make sense in terms of bringing government books into balance so long as the G20 advanced economies – including the US, Europe and Japan, – are operating so far below capacity.

That same argument – that the effect of cuts on debt accumulation will be largely offset by the costs of continuing high unemployment and slack capacity in terms of lower GDP growth  – has also been put forward in a detailed policy brief by the International Institute for Labour Studies affiliated with the ILO. http://www.ilo.org/public/english/bureau/inst/download/promoting.pdf

What makes this hard right turn to global fiscal austerity especially hard to take is that the charge in the run-up to the Toronto G20 festivities is being led by Flaherty and Harper. As host leader, Harper has written a letter to all G20 members asking them to come to Toronto armed with concrete fiscal consolidation plans.

This follows, of course, the great media hailed “Canadian victory” in heading off the dreaded global bank tax (irrespective of any specific form which it might take, including those endorsed by the IMF.) Harper had dispatched a squad of Canadian Ministers to fan out to G20 countries to lobby against UK, European and US support for the tax. (The cynic in me suspects that the support may have been a little thin to collapse so swiftly.)

The Canadian media seem to have swallowed the line that there should be no tax since “our” banks were not bailed out.

This line surely fails to take into account that Canada was very much hit by the global financial crisis, and that we clearly stand to gain from bringing back some sanity to global financial markets. The financial transactions tax is intended to do just that. By evading the need to limit out of control speculation in the financial markets, the G20 have made themselves all the more vulnerable to ill-informed market demands for fiscal discipline.

And revenues gained  from a global bank tax – not least in Canada – would offset some of the pain of the fiscal austerity about to be imposed upon us in 2011 federal and provincial Budgets.  Harper and Flaherty are silent on why the costs of the crisis should  not be fairly shared.

For the record, on top of Bank of Canada measures to secure liquidity for dodgy bank assets, the federal government added $60 Billion to its debt to fund CMHC purchases of residential mortgages from the banks. One can argue that this is a wash in terms of net debt since the mortgages carried a guarantee,  but don’t tell me that extraordinary action was not needed to shore up the Canadian banking system in the wake of the collapse of Wall Street and European Banks. If Canada was not an island of stability, how can Canada reasonably refuse to be part of a global solution?

And don’t tell me that  the right-wing in Canada had anything to do with the relative stability of our banking system. If they had had their way in the mid 1990s, bank mergers would have gone ahead and the big Canadian banks would have expanded their US operations, and US banks would have been entered the Canadian market.  Without a concentrated, oligopolistic, widely-held national banking system, the capacity to effectively regulate would have been dangerously undermined.

It is a sad day when it is hailed as a victory for Canada when the G20 agenda is being driven so far off course.


  • Here here Andrew- how we are all cheering for Canadian banks and the loss of a FTT at the G20 is part of the whole ploy in spending 1 billion on the G20. I am sure the banks are so pleased with the artificial lake in downtown Toronto, (no not Lake Ontario, although it is pretty much artificial now) mirrors the banks transparency in the eyes of the public. I still say we need to have a banking sector investigation. Just wait until the housing market and debt levels get overly burdensome and a bit scary for these supreme beings we call Canadian bankers.

    The storm is coming and we are going to be caught so off guard.

    i JUST CANNOT COMPREHEND 1 BILLION DOLLARS FOR G20 AMIDST GOVERNEMENT AUSTERITY AND PROTESTS AND POVERTY ACROSS THE WORLD. These tories are so out of touch with reality, maybe the opposition should have just let them govern with a majority to me they would have never lasted as long as they have, given their incompetence at actually doing anything. Canadians would have eventually seen through the ultra neo con policy they would have brought in.

    This fake plastic government has been molded and massaged by the libs and Ndp into something that lasted.

    stick a fork in the bankers, I dont think they are done quite yet.

    I think Lou Reed said that.

  • Steve Hanke’s piece that the National Post carried today is the most cogent argument for the supply-side case for fiscal consolidation that I’ve ever read. Not that I agree with it, but:

    “The possibility of a negative fiscal multiplier rests on the central role played by confidence and expectations about the course of future policy. If, for example, a country with a very large budget deficit and high level of debt (estimated U.S. deficit and debt levels as a percentage of GDP for 2010 are 10.3% and 63.2%, respectively) makes a credible commitment to significantly reduce the deficit, a confidence shock will ensue and the economy will boom, as inflation expectations, risk premiums and long-term interest rates decline.”


    Hanke provides some examples which he says validate his argument: the “Danish fiscal squeeze of 1983-86 and the Irish stabilization of 1987-89”.

    Any comment, Andrew?

  • Andrew Jackson

    To jdean – Thanks for the comment. This is a serious point and others should join the discussion. My view is that Krugman’s logic holds up as more or laess a matter of national income accounting so long as there are no crowding out effects on private investment or realistic threats of inflation. Also, as I have blogged before, deficits should become much more investment oriented to increase the GDP denominator as the debt numerator grows.

    German austerity as announced yesterday strikes me as nuts when surplus countries have to expand to rebalance global demand and supply, and will worsen the euro zone debt crisis. See Andrew Watt from ETUI. The US would be nuts to go down that road anytime soon, and the peculiarities of being the most powerful capitalsit nation on earth mean they don’t have to. But yes under current conditions there is a tension between what financial markets wants and what governments should do – which is why we need to seek out means to restrain the market constraints. Not that the ftt is the complete answer to that..

  • confidence expectation in an economy vs Keynesian fiscal management.

    It is a bit hard to eat confidence when you are a worker who loses a job.

    The only way I can see any merit in the expectations and confidence is on the business investment side, assuming they have a savings rate or there is a willing ness to debt finance investment.

    Lets look at the consumer side- if confidence goes up, but there is no investment, then there are no jobs no matter how much we have confidence.

    From the business investor, if there is no consumption coming from consumers, where do they get there confidence from.

    How does confidence get the economy going and sustained?

    Government spending helps get the confidence of the investors up, by providing social transfers and publci spending.

    Then potentially if the confidence of business investors raises and investment are made in critical innovative areas you may get a fire started.

    I really don’t see how you have any matches based on confidence alone. It is a fatal flaw in expectations.

    Just because you expect them to build it, does not mean they will come, you have to build some of it first.


  • Let me reword some of that I kind fumbled on the words.

    On the consumption side- if confidence goes up, because for some reason we start fighting the deficit, somehow there will be some capacity expansion new investment, shuttered plants reopened, workers rehired. But the question is what is that brings on this investment and capacity expansion. Somehow negative multipliers bring on a boom. I just don’t get it all. Somehow it is like some kind of uncanny upside down world of neo con logic.

    The way to get out of a recession is not to will your way out. It requires action and belief into new demand, not less. Somehow there has got to be signals generated for investors and companies to invest and to expand capacity and production.

    Fundamentally I would argue that a true Keynesian would say that targeted investment by both public and private investors would bring about innovation and increased consumption using fiscal tools. Whether the innovation targets higher productivity, of new products, say for example the the IT boom of the mid 90’s created a sustained growth period. It was new products new, services, increased productivity that brought us out of the recession and stagnation of the early 90’s. For all the dot com meltdown, I do believe it left its mark in terms of qualitative and quantitative changes to core of productive assets. Was it brought about by fiscal policy in the 90’s. Well we ran up some serious deficits during that period, we were not fighting deficits until we were well into recovery. This also was secured by some healthly doses of fiscal spending in terms of education, EI, training, and a whole host of early 90’s measure that helped sustain the economy while some new investment came online.

    In the case of now- arguing that we need to have austerity is like shooting the elephant in the room, hoping he/she will go away.

    Expecting that elephant to go away is not a what I would call a confidence building exercise.

    We need people like this “economist” to advise Harper and for sure his term in office will finally come to an end. Phrack that is so irresponsible and to see it in print blows me away.

    Investment leads the way- not hope

    We need a green economy, it is not going to come around by hoping it will.

    I meant to say- just because they hope we build it doesn’t mean they will come, you actually have to build it first.

    Why am I so caught on his article- mainly because it has got to be so far away from the truth in terms of policy that is needed right now it is pathetic.

    WOW lets quote that again.

    “negative fiscal multiplier rests on the central role played by confidence and expectations about the course of future policy. If, for example, a country with a very large budget deficit and high level of debt (estimated U.S. deficit and debt levels as a percentage of GDP for 2010 are 10.3% and 63.2%, respectively) makes a credible commitment to significantly reduce the deficit, a confidence shock will ensue and the economy will boom, as inflation expectations, risk premiums and long-term interest rates decline.”

  • Let’s consider the following quote from Mr. Henke’s article: ”Suppose a country has a very large budget deficit. As a result, market participants might be worried that a further loosening of fiscal conditions would result in more inflation, higher risk premiums and much higher interest rates.”

    Mr Henke expresses concern that market participants will lose confidence because ”fiscal loosening” will cause inflation and higher interest rates. The concern he speaks of regarding interest rates is based on a model that assumes the money supply is fixed. Accordingly government demand for money increases its cost, i.e. the interest rate. The downside within this model is that the higher resulting interest rate causes private investment to decline, in effect ”crowding out” private investment. This causes the economy to stall.

    On this score Mr. Henke may put his mind at ease. It is simply not true. The amount of money in the economy can be increased by private banks and government spending. It is definitely not fixed so interest rates won’t increase in the way he fears.

    In fact a basic knowledge of the monetary operations of central banks shows that government spending puts downward pressure on (short term) interest rates, not upward pressure.

    A second concern Mr. Henke has is that ”fiscal loosening” will cause inflation. This is certainly a possibility when the resources of a country are nearly fully employed. However this is not currently the case in the United States where about 17% of workers are either unemployed or underemployed. In addition, the inflation rate there is in fact very low so it’s hard to understand his concern.

    A counter example to Mr. Henke’s model is found in Japan where the gross debt stands at 200%, yet inflation and interest rates are very low, respectively 0% and 1.5% (for 10 year bonds). These numbers cannot be explained by Mr. Henke’s view of the world.

    Clearly the United States and many other countries are suffering from deficient aggregate demand. Households are spending less as they reduce their debt mountain and businesses are reluctant to invest given the depressed state of the economy. Under these conditions only government spending is able to increase demand in the economy in a reasonable time frame. The spending should be directed to support the most disadvantaged, enhance social programs and build an economy respectful of the environment.

    Reducing government spending under current circumstances will prolong the economic slowdown and possibly plunge some countries, especially in Europe, into an economic depression.

  • I’m posting from the UK, given that our new ConDem government is so keen on the 1990’s Canadia model of austerity.

    It seems obvious to us that the final phase of the bankers ‘con-trick’ is due to begin, bankers ruined the economy by issuing vast amounts of debt, government’s transferred that debt to their accounts and borrowed to bail out the banks and for increased welfare payments due to the recession the same banks caused. Now the ConDems want to make us pay by repaying the debts through cutting public services and jobs.

    Cameron announced on Monday morning the era of public sector pain http://www.guardian.co.uk/politics/2010/jun/07/cuts-change-british-way-of-life-david-cameron in his speech he claims that the looming cuts would affect Britain’s entire population as he laid out the lie of taking “the whole country with us” in dealing with the so called debt crisis. He did not give details on how the cuts would be implemented.

    Cameron is not telling the whole story, because firstly the cuts will not hit the bankers and the rich they will fall mainly on public sector workers and working class communities. Secondly he is not telling us the truth about government debt and how the debt could be repaid without the pain.

    Governments borrow money by issuing ‘gilts’ these are pieces of paper that promise to pay the money back with interest. They are sold at auction to the bankers, who then trade them on to our pension funds and insurance companies. 80% of UK government debt is owed to pension funds and insurance companies, split 50/50 between UK and global funders. So it’s our pension funds that fund government debt, so when Cameron says jobs must be lost to pay back the debt, ask the question who is the government paying back?

    Answer you and me via our pension funds.

    What Cameron fails to tell us as well is that the government could pay back the debt by issuing its own money, without debt, to pay back our pension funds and others. Governments have the power to issue money without debt and they did this to rescue the banks. How did they do that? The Bank of England just credited each bank’s account electronically with an amount, just the same as a bank credits your account with a loan or mortgage.

    The lessons of history are stark if the austerity-minded ConDems wish to press hard to balance budgets, (as occurred prior to the Roosevelt administration during the 1930’s in America) then a deeper recession will be the only outcome, unless we demand a different approach of to money supply.

    Cutting back on government issue money, either recycled money from pension funds or new money from bank created credits for the newly issued bonds will plunge economies into recession/depression. In a debt based money supply economy there is no other choice other than to issue more debt.

  • It’s worth noting that Table 1 in Appendix 2 of the IMF report shows a required 4.4% fiscal adjustment for Canada, less than half the average for the advanced G20 countries of 9.3%.

    The UK and US, along with France and Japan, are pulling the average advanced G20 requirement up considerably.

  • Fiscal adjustment should have happened a long time ago. Being 30, I find it unfair that in the near to medium future we will have to either raise taxes on my generation or go into debt (ie. taxing the next generation) in order to pay for the retirement and health care of the baby boomers, rather than taxing them more (and keeping public debt lower) during their prime income-earning years.

    That being said, I agree completely with Andrew’s response, especially that stimulus should be directed to sound public investments and to the needy, and also that the “crowding out” effect is not a factor when the economy is operating below capacity.

    That being said, I’d like to make another comment in the thread of “arguments by right wingers that I find interesting”. I recommend that people go and listen to Russ Roberts’ podcast, called EconTalk. In one of the latest podcasts, Roberts discussed his paper, “Gambling with Other Peoples’ Money: How Perverted Incentives Created the Financial Crisis”, which is sort of his meta-analysis of the causes of the “Great Recession”. He pretty much traces it back to past government bailouts (such as the S&L crisis, Mexican debt, Long Term Capital, and now TARP) which gradually convinced creditors that if things got REALLY bad the government would bail them out, and the fact that this decreased their incentive to monitor the behavior of those they lent money to. I found the argument very persuasive and not at all incompatible with a progressive view of economics. I listen to Roberts’ podcast often and don’t always agree, but if ever I was wavering on whether the TARP bailout was a necessary evil, Roberts convinced me it was actually a huge tragedy.

    It reminds me of the adage about public policy, that you should identify what problem you’re trying to solve, and not solve some other problem instead. If they were worried about credit markets seizing up, create some method to keep short-term credit moving; if they’re worried about defaulting mortgages, help homeowners renegotiate their mortgages (my favorite was Dean Baker’s idea to allow judges to renegotiate mortgages to let owners become renters in their own houses). Instead they massively bailed out creditors who hadn’t been careful enough about who they lent money to, and further reinforced the idea that they’ll do it again next time.

  • Bernanke, the Federal Reserve chairman, spent years rationalizing the housing bubble. He infamously claimed the subprime mess was contained, just before it nearly overwhelmed the U.S. economy. He has 1-10 forecasts of the past 2 years that has been correct. His credibility has been shatterred.

    The Fed chief said in testimony before the House budget committee Wednesday that “the federal budget appears to be on an unsustainable path.” Not for the first time, he urged Congress to take action to close “a structural budget gap that is both large relative to the size of the economy and increasing over time.”

    The problem isn’t just that the United States is on track to run a budget deficit worth a tenth of its economic output this year, or that the gap will close only gradually in coming years.

    The bigger issue, Bernanke notes, is that the workforce isn’t growing nearly fast enough to pay for all the people who stand to retire over the next two decades

    That’s not a workable formula, and Bernanke urged policymakers at the very least to work out some plans for restoring fiscal balance.

    Bernanke apparently share his veiws with Steve Hanke that such plans as Bernanke on Wednesday repeated a sentence he used in his testimony before the budget committee last June: “Unless we demonstrate a strong commitment to fiscal sustainability in the longer term, we will have neither financial stability nor healthy economic growth,” he said

    People seem to overlook that fact that Federal Reserve Chairman Paul Volcker pushing nominal interest rates to 19%, in the 1980s when Gold it its all time inflation adjusted record of 850$. In the years following gold, prescious metals collasped as an investment(where in investors buy in advance to hedge agaisnt percieved inflation, which is any investors right or wrong), and the economy roared.

    The last time gold to dow ratio was 1:1 was 1929s, 1980s and it will happen again unless nominal interest rate are adressed. Since 2000 the DOw was 1:43 gold ounces, now it is currently floating around 8 to 9 ounces.

    Art Laffer right or wrong explaining that the deferring of taxes increases to Jan. 1, 2011, will cause companies to push profits into 2010, making 2010 appearing very good and making 2011 appear awful, perhaps even creating an economic collapse in 2011.

    1981, Ronald Reagan—with bipartisan support—began the first phase in a series of tax cuts passed under the Economic Recovery Tax Act (ERTA), whereby the bulk of the tax cuts didn’t take effect until Jan. 1, 1983. Reagan’s delayed tax cuts were the mirror image of President Barack Obama’s delayed tax rate increases. For 1981 and 1982 people deferred so much economic activity that real GDP was basically flat (i.e., no growth), and the unemployment rate rose to well over 10%.

    Deficit spending leads to inflation and growth, which leads to greater employment and rising GDP, which makes debt payments much easier to bear in relative terms. Is the true falsehood.

    Krugman believes that inflation is the best cure for burdensome debt problems, like other that central banks, and supporters.

    To prove his arguments, he points to the course followed by the Unites States in the decade after the Second World War. In 1946, due to unprecedented military spending during the war, U.S. public debt as a percentage of GDP came in at a staggering 122 percent – which is even higher than the 113 percent currently weighing on Greece.

    Krugman endorses U.S. policy at the time which, he claims, concentrated on fostering growth instead of taking measures to drastically cut the post-war debt.

    He notes that by the end of 1956, the federal debt had not diminished in nominal terms, but had become much easier to bear because of the decade of GDP growth that inflationary policies had created.

    He neglects to mention that during the five years from 1945 to 1949, federal spending dropped by 58% and taxes fell by 12%. Meanwhile, the budget deficit fell by 66% in 1946 and was in surplus from 1947 to 1949.

    In other words, although we did not pay down our nominal debt in the decade after the war, we did succeed in massively shrinking government and the burden that it places on society

    Paul Vockler recently added that high government budget deficits will continue to restrict growth.

    “If we need any further illustration of the potential threats to our own economy from uncontrolled borrowing, we have only to look to the struggle to maintain the common European currency, to rebalance the European economy, and to sustain political cohesion of Europe,” Volcker said.

    Volcker, a special adviser to President Barack Obama, said many western and eastern developed economies were becoming aware of the hazards of running “unprecedented levels of public debts” as they emerge from the global recession.

    Volcker, who conquered runaway inflation and minor debt issues in comparison to now from the 198o is increasingly skeptical.

    Last Friday we received the latest indication that the real economy is not recovering in the slightest.

    The Labor Department reported that non-farm payrolls increased by 431,000 jobs in May.

    In a press statement, the President himself crowed at the news, noting that the official employment rate fell to 9.7% from 9.9%. However, just inches below the headline, red flags were everywhere. Only 41,000 of those jobs were generated in the private sector – far below the median forecast of 180,000. Even more troubling was the fact that the Census Bureau alone accounted for 411,000 new jobs, which were almost exclusively temporary positions.

    Rather than a recovery, the jobs data seems to indicate that we are still mired in the first economic depression since the 1930s. Back in 1931, two full years after the Crash of 1929, there were still very few people who thought that the recession then underway would one day be called the Great Depression.

  • Andrew Jackson

    From Martin Wolf’s column in today’s FT

    “Against this background, what would a big tightening of fiscal policy deliver? In the absence of effective monetary policy offsets, one would expect aggregate demand to weaken, possibly sharply. Some economists do believe in “Ricardian equivalence” – the notion that private spending would automatically offset fiscal tightening. But, as Mr Posen argues of Japan, “there is no good evidence … of strong Ricardian offsets to fiscal policy.” In developed countries today, fiscal deficits are surely a consequence of post-crisis private retrenchment, not the other way round.

    This is all very well, many will respond, but what about the risks of a Greek-style meltdown? A year ago, I argued – in response to a vigorous public debate between the Harvard historian, Niall Ferguson, and the Nobel-laureate economist, Paul Krugman – that the rapid rise in US long-term interest rates was no more than a return to normal, after the panic. Subsequent developments strongly support this argument.”

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