I was talking to two decidedly non-economists yesterday. The subject was tweeting. They wanted to know why I was tweeting about economics. The question was "has anything happened in the world of economics in the last week that's worth tweeting about?" And, for one, the answer is a decided yes.
Last week the IMF published a new World Economic Outlook. Let's cut through all the verbiage. The key point in it was that, as Wolfgang Münchau has noted in the FT:
The claim that most forecasting models underestimate the multiplier by 0.4 to 1.2. This implies that it must be in a range between 0.9 and 1.7.
Now that may sound just a little technical. It is. It may even be wonkish to be excited about it, but I can assure you it matters.
Duncan Weldon has done a good job explaining multipliers, here, but I'll offer my own stab anyway. The multiplier is a measure of the impact of government spending. So, if an additional pound of government spending increases GDP by £1 then we say the multiplier is 1. If it only increases GDP by 50p then it is 0.5 and if it increases it by £1.70 then it is 1.7.
I hope that immediately gives some perspective to why that one revaluation by the IMF is so important. They had assumed for several years - right throughout the crash in fact - that the multiplier was 0.5. So, they argued that extra government spending did not boost the economy much. More than that, they argued that cutting government spending by £1 only shrunk the economy by 50p so it was worth doing if the overall priority was to tackle the deficit. Let's again cut out the verbiage: that's exactly why Osborne claimed legitimacy for his austerity programme. His argument, as Duncan has shown, was that the IMF said it was right, and it had to work because they said it did precisely because they'd estimated the multiplier to be 0.5.
But now they don't estimate it as 0.5 anymore. They've realised that what the multiplier might be when the economy is growing fast, when there is a boom in asset prices and when economies are not far from full employment or can easily afford the unemployment they've got (which is much the same thing for these purposes) is very different from what the multiuplier might be in a downside. You'd have thought that glaringly obvious.
Put it like this, a metaphor might be watering a pot plant. If the plant is in good health and growing well, the soil is damp and nutrition levels high the benefit of any additional water is going to be low. Most will drain away and be wasted, you could actually have a negative effect: you could waterlog the plant and impair growth. The multiplier effect of watering is going to be low. That's the IMF's 0.5.
Now suppose we have a plant in near dry soil, with low nutrition and weak growth. A good watering can in the vast majority of such cases then do a power of good. A little knowledge has to be applied: there are of course exceptions, but as a rule of thumb you can be pretty sure water will in such cases revive the plant, be almost entirely taken up by it and growth will follow. Little or no waste will result: indeed, the plant growth will more than compensate for the cost of the ater that's been added. That's where we are now. The multiplier is well over one.
Belief in what the multiplier is has therefore been key to suggested approaches to economic debate in the last few years. When in 2008 the Green New Deal group suggested major investment as a way of tackling the then forthcoming economic crisis we did so because we agreed between us that the multiplier was likely to be very strong: we discussed 1.6 or 1.7 at the time which just so happens to be the point that the IMF is reaching now. And we agreed between us that in that case the argument that Larry Summers and Bradford de Long have now embraced, that spending could pay for itself was logical. We explicitly said so. We've never waived from it. We were right, all along.
We'd have been a lot better off the world had agreed with us then. Right now we would a result be in the midst of a major social housing building programme, a massive insulation programme, a big programme of enhancing flood defences, a major investment in low carbon energy and real spending on related new technologies. Instead we've lost four years.
Now we know this can pay. For every £1 spent at least £1.70 of income is generated That results in over £70 of tax paid: the net cost is 30p in government spending., But save benefits and that rapidly disappears and if the spending is on investment that has import substitution effects as green technology will then the benefits keep on rolling and that's even before the social and environmental factors are taken into account.
I can't resist saying "we told you so". Because we did.
Now the only problem is persuading Osborne he's wrong. That, I fear, is a bigger problem.
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Yep.
You’re not going to persuade someone as arrogant, as mistakenly confident in his own abilities as Osborne, that he is wrong.
This is an amazing admission of error by the IMF who really should have come to this conclusion years ago about the fiscal multiplier. Austerity was inflicted on many developing countries and in most cases the results were disastrous. It is probably an example of not thinking outside the box because that would have involved a paradigm shift.
George Osborne’s miscalculation may be laid at the feet of the IMF or it may be that ‘austerity’ was the convenient vehicle for justifying the end game in the complete dismantling of the post war settlement, as Margaret Thatcher and the Washington Consensus intended. As you have pointed out repeatedly, Osborne’s policies look designed to increase the deficit and hide debt-reduction. He certainly appears to be an ‘economy-wrecker’.
In fact, the ‘new tories’ are quite overt in saying that wages are too high, and public services too expensive, for the UK to compete with the BRICS countries.
As it is relevant, I hope that you won’t mind me posting a link to Think Left’s attempt to explain Edward Fulbrook’s RWER analysis :
http://think-left.org/2012/10/14/plutonomy-invasion-of-the-political-body-snatchers/
Tweeted!
R
Richard, I like your analogy of the potted plant. I tend to think of a coal fire – anything can be thrown on when it is hot and burning brightly, but the job is to get it going when the coal is poor, the kindling damp and there is no draft.
Why do we spend so much time listening to these economists and statisticians? No doubt the IMF building is full of them but still they make basic errors. As we know, economists will argue for ever about the merits or failings of Hayek or Keynes, but they formulated their thoughts years ago – long before instant electronic communication, high speed electronic trading, shadow economy hedge funds etc.
Imagine lying on the operating table awaiting a heart operation and two cardiologists were arguing vehemently about how to carry out the operation, or the pilot and co-pilot of an airliner arguing about whether or not they can land in a thunderstorm. These professionals live and work in the modern world – they are not relying on text-books based on the technology of a previous era.
It’s tempting to suggest that as the IMF weren’t howling “icebeerrrrggg!!!” at the top of their voices in 2007 we shouldn’t be listening to them anyway but… something in this apparent change of heart doesn’t ring true. What’s their real game, I cannot help but wonder, what are they really up to?
This is one of the reasons why I’ll be joining the TUC march on Saturday.
What really matters is not whether the fiscal stimulus pays for itself – but whether it brings down the debt/GDP ratio.
Why?
We have an entirely affordable national debt level
And QE has written off a third of debt already
I think you really are wholly missing the point
How do you persuade an idiot that he is wrong ?
He’s got money.
Everyone he knows has money.
Having money is normal.
Those with no, or little, money do not matter.
Now I note the subject of “poll tax” is resurrected again……pardon me for thinking we are now at the “get your own back” stage of politics ?
“That results in over £70 of tax paid: the net cost is 30p in government spending., But save benefits and that rapidly disappears”
But wouldn’t the benefits have had a multiplier effect as well, so saving the benefits cuts the GDP growth back and lowers tax. So we should be looking at the net government spendings impact.
I like your analogy of the pot plant, but wonder if in 5(10?) years time when the economy is booming again, you will be arguing that it is time to stop the watering!
Of course
That’s what good Keynesians do
On the other hand – if there is clearly over supply in the private sector and unmet need in the public I might demand more tax as well to reorganise the economy
That’s something good Keynesians also do, but they are different
‘For every £1 spent at least £1.70 of income is generated That results in over £70 of tax paid: the net cost is 30p in government spending., But save benefits and that rapidly disappears and if the spending is on investment that has import substitution effects as green technology will then the benefits keep on rolling and that’s even before the social and environmental factors are taken into account.’
Sorry Richard I am a real newbie layman (woman!) at economics and not great at maths. This is really important interesting information and am trying to understand it. I get the multipler bit which you excellently explain and the flowerpot metaphor. Just having difficulty getting the figures and terminology in the paragraph I’ve copied:
-How did you calculate the £70 in tax paid and the net cost of 30p?
– What do you mean by ‘save benefits’? Do you mean not cut benefits as in welfare, or does benefits have another meaning here?
-What is an ‘import substitution effect’?
I’m sorry if these questions are a bit GCSE level..and if you think any of the answers really require a module of teaching to explain, I would be grateful if you could you refer me to a good book 😉
Looks like I have slipped currency units in error!
All either in £ or ps but not a mix of both
Sorry….
In haste
Hi Richard, Now the IMF has changed it’s mind will anyone listen.BSCParty have been tweeting exactly what you say above for 15 months.Without all the clever .5s & 1.7s etc just useing Common sense in business, And knowing that GDP is flawd
If you had been following us as we have been following you, you would have known this.Also you would know that Cameron has his own agenda. see skwalker1964 blog O-Canada.the wealthy companies are deliberatly destroying the western economies.
It’s not only the IMF who have been wrong.In fact the IMF are probably part of the “AGENDA” THe principle of free markets is Disasterous.
Perhaps you can tell me how & when the Banks became able to “CREATE MONEY” this is a function of Central Banks like the Bank of England ONLY.
Perhaps this change in Banks function is the cause of Derivatives Trading getting so out of hand.Best regards Robin
[…] Aditya is, of course, right to highlight just how aberrational these cuts are. No one has tried to do anything like this before in history; not just here, but anywhere. And Aditya’s right to also note that non one can as yet get their heads round just what the impact of this will be on government services and those who rely on the state. But I think there’s something Aditya did miss out on – and that’s to forecast the impact of this in the light of the IMF’s new realisation that right now changes in government spending have a very strong multiplier effect. As they’ve acknowledged, that effect could be as high as 1.7 times the spending, or cut. I explained what this means, here. […]