As I commented last week, Christine Romer, key Obama advisor, has defended deficits in a recession and warns against consolidating too soon.

You may also be familiar with the work of Greg Mankiw, a conservative economist, now frequently warning in his mildmannered way against public healthcare, but also on the lookout for dangerous fiscal deficits, and sceptical about their ability to boost economic growth.

Mark Thoma finds a speech from the Chair of the Council of Economic Advisers to the President, which defends running a deficit when there are strong economic headwinds:

Of course, the expansionary effects ... will be offset to some degree by the effects of the budget deficits that arise... Deficits can raise interest rates and crowd out of investment, although I should note that the magnitude of this effect is much debated in the economics literature. The main problem now facing the U.S. economy is not high interest rates...

The Administration would prefer not to have deficits, but deficit reduction is only one of many goals. ... Deficits are worrisome, but not as worrisome as an economy that is not growing and is rapidly shedding jobs. ...

Spot on. 

But the Chair of the Council in question is Greg Mankiw in 2003, not Keynesian Christine in 2009.  Seems that when the deficits come from tax cuts largely enjoyed by the rich,  conservative economists can more easily believe in 'very conventional short-run stabilization policy: You can find it in all of the leading textbooks.' 

If high interest rates were not the problem in 2003, I fail to see how they could be now. 

The next time we have a major structural deficit, it will probably come from a right-leaning government cutting taxes too far.  Things move in cycles -  perhaps the next mistake will be overestimating the positive Laffer-effects from cutting high marginal taxes (though, for the record, I agree with this rather good explanation of the elasticity effects of the 50p rate from none other than Fraser Nelson. Scrapping this band will not cost much money.  Where I doubt we agree is on replacing it with other forms of wealth tax). 

Fraser Nelson has with great pleasure accused Ed Balls of lying, and is now clearly delighted that Balls was so foolish as to call him up, angry, and demand a retraction. 

This is what FN reports EB as 'lying' about:

LIE no1: “We have acted in the downturn, that will mean that the economy is stronger, we’ll have less unemployment, less debt…”
Less debt? No, this was not a mistake. He repeats it here.

LIE no2: “Alistair Darling in the budget set out plans which show the deficit coming down, national debt coming down.”

For number 1, Nelson is clearly wrong: Ed Balls is not lying.  The statement 'less debt' should clearly be taken to mean "less debt than we would have had had we not acted in the downturn".    This is a counterfactual statement: what would the economy look like had the government not acted?  In my view, it would obviously have been in a worse shape, with eventually higher debt and much worse unemployment. Depending on how widely you define the government's actions, the steps they have taken in the downturn include:

• recapitalising the banks;
• cutting VAT temporarily
• bringing capital spending forward
• a myriad of micro-schemes to alleviate aspects of financial distress, such as trade credit drying up

I am in no doubt that these measures have had a good effect on the economy.  The VAT cut is working.  If we had just let the banks collapse, the effects would have been horrendous.   Keynesian spending works when we are well below economic capacity and interest rates are testing the zero-bound.  So Balls is right, and Nelson is being either cynical or incredibly naive in trying to interpret the first statement as "less debt in cash terms in year X+1 than in year X".

I am also surprised by the accusation of Lie Number 2. Nelson justifies his statement by claiming that Balls was trying to fool people into thinking that debt was falling in cash terms. 

No.   In general, you have to describe debt in terms that divide through by the national product.  It is the mechanism by which Policy Exchange, in their very one-sided piece on spending cuts, managed to use the Spectator as a vehicle for claiming that there has been a "second splurge" in spending (in one of the few instances where dividing by GDP provides a misleading impression).   Nelson claims to have the logic of the common man on his side when he says you can't mean the debt-ratio. Why not?  If you don't use the debt ratio, then Margaret Thatcher was an horrendous accumulator of debts:

 No doubt, if he had confronted the Chancellor (and former Spectator editor) Nigel Lawson in 1988, crowing about paying down the national debt, Nelson would have thundered the same words as he has just used on Balls:

"One is money, the other is a ratio. Outside the world of government finance, there is only one interpretation of "debt falling." There is not a person in this country, I said, who doesn't understand the difference between their debt rising, and their debt falling."

and shamed him into admitting that he has burdened the country with HUGE debts, the wicked Thatcherite profligate . . .

Of course not. Debt as a proportion of GDP is the only sensible measure, because it relates reliably to the government's capacity to repay the debt.  If Nelson thinks this is not the standard understanding, he should educate people, rather than opportunistically joining the confused brigade.  To accuse Balls of a monstrous lie because he did not nonsensically use nominal figures to explain fiscal matters (which we think Brown has been doing to confuse the public recently)  is daft.  Or something worse.  It certainly doesn't justify such an extended wallow in moral outrage as this blog descended to.  Unfortunately, it enables the outraged CoffeeHousers to avoid the real point raised by Balls: how much worse would the economy be now had the Tories been in charge,  meant what they said, refused to borrow any more in a recession, and taken the Treasury View Circa 1930 as the model for economic management?

Confronting such questions is not for a partisan publication. As a genuine floating voter, I have always assumed that purpose of the really vituperative right-wing press was obvious: to drive the wavering voter from supporting the Conservatives by nakedly revealing how they really think when allowed to let off steam. Clearly, sponsored by some Machiavellan New Labour type. It worked very well for 12 years.

But from the number of people quite wrongheadedly and furiously agreeing with these columns ("Well, well, well. So here is where we are at, and this is what Germany must have felt like as the Nazis were coming to power." is a typical one), I was in the minority in being so repelled by this sort of unbalanced analysis. This exchange, and the Policy Exchange piece earlier, powerfully demonstrate how much people can be alarmed and confused by misleading descriptions of the fiscal situation.  Our upcoming paper - provisionally entitled "A Balancing Act", will try to act as an antidote.

 This is the policy brief the OECD has put out about the UK.  It seems pretty empty to me - deal with NHS productivity, improve active labour market policies, deal with the malfunctioning planning system - all good supply-side ideas, but no real dilemmas are confronted.   If we get a "W" recession, should we use fiscal policy again?

Philip Stephens kicks back against Mervyn King's power-grab: if the Bank being in charge of systemic risk is such a good idea, why were they so bad at doing something about it before?

Yet another important body reports on what to do in terms of Global Financial Reforms.  The BIS, this time, joins the Bank of England, the FSA, the Treasury, the IMF, the OECD in various ways, the Financial Stability Forum (now Board), and no doubt millions more.  I would link to all of them, but doubt anyone would thank me. 

Brad DeLong and Mark Thoma seem to be defending Greenspan's low rates over 2001-4, against the standard "blame Greenspan for all this" line. 

Willem Buiter points out an essential element of Ben Bernanke's armoury last September: a good length of stout hose, for belabouring the rear end of recalcitrant Bank CEO's.  In it he once again displays his preference for forced debt-equity swaps, and the subsequent creation of a Good Bank. 

Two of the world's most famous economists debate the fiscal-expansion reaction to the recession (video). 

If monetarist solutions really are enough to get the economy out of its recession (like the diamond-pure Scott Sumner does), why has lending growth fallen so far despite Quantitative Easing? What if there is no demand for the funds, and someone needs to be out there buying things?

The FT doesn't think much of Brown's latest relaunch. 

By focusing on headline-grabbing initiatives, the government is trying to avoid addressing the most important issue in British politics: the fiscal crisis. The only way to set out a solution to this problem is to hold a spending review, setting out departmental budgets for the coming years.

Is Angela Merkel really the fiscal hawk she pretends to be?  Now she is into Tax Cuts. 

You think we have political corruption issues?  Imagine if Peter Viggers had spent this much on statues of himself. 

Green Shoots I: difficult to get a good table in Houston.  I don't think there has been much of a consumer recession.

Green Shoots II: Eurozone confidence is rising. 

Green Shoots III:  Nationwide sees house prices rising again.  This is becoming a trend - albeit on no volumes. OK, so the first quarter was worse than we thought.   

David Aaranovitch defends educational centralisation and reminds people that it was not a glorious summer of unfettered learning before. 

Ed Balls designs an Anti Ed Balls style education strategy.

'Flabbergasted' does not do this justice.  There seems to be a cross-party consensus that centralised control of education is not the answer:

"Earlier this month, Balls told a conference of headteachers: "I think the right thing for us to do now is to move away from what has historically been a rather central view of school improvement through national strategies, to something which is essentially being commissioned not from the centre, but by schools themselves."

Michael Gove, the shadow education secretary, said: "If Ed Balls is going to scrap the national strategies in their current form, we will support him. They cost a fortune and do not drive up standards. We want to give teachers more responsibility."

Mystery of the day: what can you spend 50p on that is so embarassing, perverted or wrong that you redact every detail of it but the cost? Ask Phyllis Starkey MP.  HatTip to "TaxTrust", who got it from Dizzy. 

Some great news: Independent Financial Advisors will be decimated by enforced changes to how the swine charge you for poor advice. 

Alan Greenspan is always worth reading.  I would have been much happier to hear that he was planning to go into teaching than Gordon. His emphasis on equity prices is unusual; his fear of inflation is possibly too much, the 'inflation by immaculate conception' that Philip Stephens refers to (in an article that makes those of us in favour of international macroeconomic cooperation still more gloomy).  But to read him is always a useful lesson.

Our housing market is stronger than the US's. This is one reason not to follow Greenspan in worrying about its effect on future growth.  We don't build houses, you see: a cunning way of dealing with the problem. 

Dillow is beautifully provocative: why ask people whether the current state of affairs is just?

"there’s no reason to suppose that public opinion about justice should coincide with what is actually just. After all, if it did we could ditch 2500 years of political philosophy and use opinion polls instead. "

You may find this article by Sam Brittan difficult to understand, because the graph has not made it online.  If this is correct, then things might go far better than people realise.

"We should not rush too soon to base policy on an assumption that trend output has shifted downwards."

Let's hope, because if trend output has NOT shifted downwards, we can grow at 3.5% for a decade without overheating.  Which would be NICE. 

The BOE's semi-annual piece on Financial Stability always attracts interest.  I have not read it yet - amazing, given it is only 3mb.  Thank goodness, Norma Cohen has already summarised it. As the FT's leader makes clear, what needs doing is less controversial than by whom. 

Scott Sumner is a very monetarist thinker and totally fearless in assaulting the prejudices of his liberal opponents. I find his monetarism rather idealistic and impractical - even if the whole slump could be dealt with by unorthodox money ideas, pragramatism dictates that you try everything.  And I still have no idea how an NGDP target will somehow make the real economy confident.  This piece of his savages Woodrow Wilson, Keynes (grrr) and the very invention of the Fed in 1913.

Why stop at Buy American?  Buy Oklahoman. 

Policy Exchange, alongside Reform, are probably closer than any other think-tank to the Conservatives, who may well make up our next government.   What they think matters.  This is why their unrealistic call for an immediate freeze in public spending is so worrying.  For when Policy Exchange write, influential columnists follow - see this by Martin Wolf, for example. With the government utterly failing to set the terms of the debate (partly because their approach is based on obfuscation and wistful nostaligia for 1999), there is a risk that a knee-jerk Right reaction can set the the terms for the debate.

Their document, called "Controlling public spending: the scale of the challenge", goes on for 27 pages, and so this is only a rushed stab at describing their analysis:

"Public Spending has 'surged . . ."

The evidence here is a quite straightforward time-series graph of public spending as a proportion of GDP.  So it grew under Brown during his first phase, and now from 2008-12 it will grow again.  Ergo, splurge.

What is wrong with this?  Well, first, you don't have to be a wingnut from the furthest Right to think that public spending is not the answer to everything. We agree: the politics of the shopping list went on for far too long, and G Brown was a major reason that useful reform was put off. 

But to use this logic to claim it has 'surged' since 2008 is highly misleading.  You can download the figures from previous Budgets, and quickly find that spending plans are not massively altered since before the recession.  Spending for 2009-10 has risen from £646bn to £671bn, entirely because of increased social security/tax credits - an increase that is smaller than that of Mrs T in the early 1980s. 

So what has happened?  Nominal GDP has collapsed, that's what.   When the plans were first made, nominal GDP for 2009-10 was £1550bn.  Now it is to be £1412bn.  A difference in the divisor makes the ratio shoot up.  What Policy Exchange somehow omit to point out is that over the same period the revenues raised - you know, those taxes that we're all meant to be groaning under - have fallen to 35.1% of GDP, a figure lower than any I can find going back to 1970. 

That is why we have a monstrous budget deficit: tax revenues for 2009-10 have fallen from £608bn to £496bn.  But since the Right dominate that discussion, Brown's failure to assure less volatile revenues - a failure just as significant as his hubrisistic spending plans, IMHO - are never discussed. 

" . . and is nothing to do with the recession."

This second claim is either incredibly naive, cynical, or (in the light of a brief discussion of active fiscal policy that follows, and clearly recognises this motivation), a tad confused.  Because it is clear that the reason core spending has remained constant in cash terms (and therefore increasing in Per GDP terms) is precisely because it would be an act of sheer lunacy to launch a round of public spending cuts in 2008-9-10. And since most economic actors plan forward,  from the largest government contractor to the newest nurse, the effect of not sticking to plans would have been like a cut. 

The reason it would be an act of lunacy is what removing so much demand in one go from the economy would do.  Unless you somehow cut taxes by a similar amount (which I doubt any of the fiscal hawks hyperventilating about the debt are proposing), and the tax cuts were (implausibly) spent by a public rendered terrified by rising unemployment and negative equity, the result would be an immediate fall in demand in the economy.  The fall in demand would have a multiplier effect.  Not only would the pay-frozen doctors and sacked nurses/laid off public construction workers spend less, but businesses, building their plans on the basis of future demand in the economy, would also invest less. 

But, 1981??, I hear you ask.  An earlier post has looked at this question (and our paper will in more detail).  Yes, sometimes cutting the government can help an economy in a recession.  It may lower rates, and if high rates are the reason for low private demand/poor investment, then the private sector can flood in to take the government's place.  Then you just have a straightforward fight between those who favour private sector growth or public sector - I would be on the side of the former. However, only the most deluded freemarket idealist could possibly think those conditions pertain right now.  This is a matter of judgement, not dogma. The differences between then and now: the different marginal tax rates, levels of the exchange rate, public sector involvement in the economy, and above all financial market conditions (they had just liberalised in 1981, we have just seen a collapse in lending now) point towards different policies.

In the meantime, the facts about the rise in public spending are:

• When planned, it was scheduled to stay roughly constant as a proportion of GDP, on some albeit rosy assumptions (speaks Harry Hindsight) about GDP growth.  Yes, this meant increasing public spending, though at a lower pace to the admittedly uncontrolled splurge of 2002-7.  For most public spending departments it represented a more difficult time than before, though long overdue in my book. 
• Then the recession happened. In cash terms, all the increase in the plans is pure-recession driven.  
• The increase relative to GDP is all about GDP falling i.e. pure-recession driven.
• The decision not to have it stay steady as a proportion of GDP - i.e. cut it in cash terms the already agreed plans - was driven by a recognition that in such a deflationary recession, Keynesian prescriptions work.  The fact that every other major developed nation has launched a programme of new spending suggests that the Labour government is not out on a limb here.  The IMF recommends fiscal stimulus. So does Martin Wolf, Sam Brittan and other bastions of freemarket thinking

So the idea that the rise in public spending is nothing to do with the recession is plain wrong.  It is all about the recession.  And letting preexisting plans continue to their fruition rather than cutting them is much the same as launching new Keynesian programmes, but somewhat easier.

'Fiscal strategies in a recession'

This section, dealing with a question that attracts so much interesting academic debate (e.g. for one of about 100 articles I have collected on this, go here ) is quite maddening, and I recommend that if you want to understand the topic, read a chapter or two of Blanchard or some other macroeconomics book first.

They write: in a recession "maintaining spending as if the conomy were going to go back to the way it was is an exercise in denial."  That's it - because, long term, economic output will be lower, to put off cutting when demand is in a downward spiral is just denial. So do it now.   

The real discussion about 'active' fiscal policy follows- creating a quite arbitrary distinction between not cutting and actively spending more.  They concede that tax cuts can work, though where they get the idea that in a savings-panic recession like this one a tax-rebate (rather than the wrongly mocked VAT cut) is the best method I have no idea.  The Bush rebate didn't really do much, I believe. The next straw man to be knocked over is the 'public works programme'. Keynes made a rod for his defenders' backs by talking of burying bottles filled with cash in mines.  But the interesting theoretical arguments on this area are instead boiled down to:

"It has historically proved very hard for Governments to time major projects such that they countered the cycle." 

Yes, this is true.  Quite true, which is why I myself am sceptical about ideas like the "Green road to Recovery".  But this is where the false distinction between not cutting and actively planning public works really comes in.  Failing to cut a programme is not the same as actively planning a new one, with all the negotiation and bother that involves.  The Policy Exchange way - suddenly tearing up spending plans halfway through their operation, because NGDP has suddenly fallen, regardless of the knock on effects to confidence and demand - is the one that involves fiddling around with clumsy fiscal instruments.  It is 'active'. Cutting is just as difficult as planning something new. 

 "Why not just freeze public spending right now"

It is worth comparing with the behaviour of those famously crazed spenders, Thatcher and Major.  The left hand axis is the real increase in spending year on year. 

Anyone who thinks that cutting spending on a dime is easy has never really read into previous episodes like 1976, for example (read here).   To achieve the above involved a serious political effort, and an undeniable cost to public services.  Thatcher also had council houses to sell (which equalled negative public spending) and a much higher starting point for the DTI and Defence. 

Public spending can seldom be cut quickly. Contracts have to be maintained or paid off, redundancy payments produced, sometimes even unions need to be negotiated with.  Why, exactly, did the Thatcher government take so long?  Because she was so wet? 

But Thatcher and Major went ahead, because they had a damned good reason.  Which was that interest rates were very high. Not only did high government spending really crowd out the private economy (rather than crowding it in, as Martin Wolf correctly argues is the case now) but the real cost for future governments was really inhibiting. Real rates were 6% or more.  Now they are 2% or less. A finance director who ignored this would be failing in his job. 

I'm running out of space on the Internet. There are some mitigating elements of the paper, once I look through the red mist caused by the cavalier attitude to macroeconomic implications. For example, it is true that public spending being high damages total economy productivity, and useful to have some sources for that. But the OECD also expresses concerns about the permanent loss of output caused by recessions like these if they are allowed to be prolonged - through the deskilling effects of long term unemployment, and lower investment for a period. It is not straightforwardly true that pursuing the fiscal-straitjacket approach always leaves the economy leaner, meaner and better. 

But on the whole it is really worrying that such a paper has got into the public domain with so little criticism of its major conclusion, despite it being so far out of whack with every practical suggestion for short-term fiscal policy.  For the long-term, I quite agree: public spending must fall, as a proportion of GDP, to closer to 40.  Rising GDP will solve some of this.  Efficiency some of the rest.  Some damned hard choices for most of it.  Taxes must also rise, a bit, and be less dependent on a frothy financial sector in future.  Brown has much to answer.  But by using some questoinable arguments this paper may damage the cause.