Running a Surplus in Normal Times is Keynesian

In a recent letter to The Guardian, a coterie of mainly English academics has criticized George Osborne's Mansion House speech in which he proposed to run a budget surplus in normal times. 

Mansion House

According to the letter writers, 

The chancellor’s plans, announced in his Mansion House speech, for permanent budget surpluses [my italics] are nothing more than an attempt to outmanoeuvre his opponents (Report, 10 June). They have no basis in economics. Osborne’s proposals are not fit for the complexity of a modern 21st-century economy and, as such, they risk a liquidity crisis that could also trigger banking problems, a fall in GDP, a crash, or all three.

I have searched for details on the Osborne plan, but they are sketchy. There is no mention in the speech of 'permanent budget surpluses'. Instead, the Chancellor proposes that the Treasury should run surpluses in 'normal times'. He suggests that the Office for Budget Responsibility, should define what 'normal' means. The OBR may not be the best independent body to fulfill this role, but I can certainly see a role for some independent body to recommend when it makes sense to run a current account deficit.

As far as I can see, Chancellor Osborne is proposing to relinquish political control of the fiscal reins in much the same way that Gordon Brown relinquished control of the monetary reins when the Bank of England gained independence in 1997. There is a clear temptation for elected governments to spend in response to electoral cycles and some kind of independent body that keeps that temptation in check is, in my view, a good idea.

Sensible fiscal policy demands that a government should be prepared to run deficits in recessions, but that during normal times, expenditures on non-capital items should be in surplus. Interpreted in this way, the Chancellor's proposal is one that is very much in line with Keynesian economics. 

Keynes' views on fiscal policy are summarized in Volume 27 of his collected works, to which I do not have immediate access. The following is a second-hand quote from the article by Brown-Collier and Collier, "What Keynes Really Said about Deficit Spending", published in the Journal of Post-Keynesian Economics.

Keynes distinguishes public investment, which he wants to be chosen on a cost-benefit basis, from current expenditure, which should not be financed from deficit spending.

Lets not judge the Osborne plan before it is fleshed out in more detail. Running a surplus in normal times is, after all, an essentially Keynesian proposition.  

How to Fix the Banks: Revisited

The bankers are angry. They feel the regulations designed to prevent another meltdown are cramping their style. Their bonuses are down. I agree. Red tape is not the way to save the banking system.

The banks engaged in a freewheeling orgy of unregulated risk taking for two decades. And when the world crashed: they expected, and received, bailouts. But we don't need to bash the banks to save the system.

As a society, we do not have a stake in saving HSBC. We do not have a stake in saving Barclays, or RSBC, or Lehmann Brothers, or Bank of America. But we do have a stake in saving the banking system. Here is a link to a piece I wrote in 2009 on how to do that.

GDP: A Brief But Affectionate Review

For a neo-paleo-Keynesian like me, the first week of an undergraduate macroeconomics lecture is taken up with accounting: Tedious but necessary. What is GDP? How is it different from GNP? National Income? How do we measure it? Does it matter? I've always struggled with outside readings to fill this material out and make it interesting. Now I have one. Diane Coyle has written a timely and very readable little tome about her love affair with national income accounting. It's very short, and you will be able to gobble it down in an afternoon. I did, while whiling away a few hours on a flight.

Why? You say! How could this be interesting? It's interesting because it has a lot to say about the current controversy over productivity. Unemployment is almost back to normal in the UK and the USA. But Real GDP is lagging well behind trend. How could this be?

We have been drinking the index-number cool-aid for so long that we have forgotten how difficult and ambiguous it is to construct a measure of aggregate product in a world where more than 60% of GDP is intangible: as Diane would say, it is weightless.

It is tempting to give up entirely on measuring real GDP and implicitly on economic growth. One might argue that we should be far more concerned about resource utilization than about the number we attach to an increasingly diverse bundle of differentiated commodities. Unemployment matters. What we produce, in a modern market oriented economy, arguably, matters less.

If we are interested primarily in resource utilization, the stuff of business cycles, there is an alternative to standard measures of real GDP. We can divide nominal GDP by a wage index, instead of a price index. Labor has a least a semblance of homogeneity and aggregating the time input of doctors with that of burger flippers is surely easier that adding plum puddings to computer chips. I showed how to do this, in a recent book, by using national income accounting data to estimate the money wage: My wage index data is available here.

I do not want to suggest that we should stop trying to measure growth. Economic progress is an important idea as 1.5 billion Chinese can attest to. If we must be metaphorical bean counters, and there are few alternatives to counting progress, there is no alternative but to bite the bullet and produce the best measures of an aggregate price index that we can. But as Diane reminds us, small revisions to our measurement methods can cause very large revisions of our estimates. Let's not be too concerned when our index numbers temporarily misbehave.

Thought for the Day: Animal Spirits as a New Fundamental

 In IS-LM models there is always something in the background shifting the IS curve.  What is it?  

In my view that 'something' is Keynes' animal spirits that we should add to our models as a new fundamental.

In my work, I close my models by adding an equation that I call a 'belief function'. The belief function is an effective way of operationalizing the Old Keynesian assumption of ‘animal spirits’. It is a forecasting rule that explains how people use current information to predict the future. That rule replaces the classical assumption that the quantity of labor demanded is always equal to the quantity of labor supplied.

Here is a link to the blog I wrote on that topic last year.

Multiple Equilibria and Financial Crises

Models of sunspots and multiple equilibria were developed in the 1980s as an alternative to the dominant Real Business Cycle agenda. For the last couple of decades, these models have taken a backstage role as explanations of the macroeconomy. Now they are back with a vengeance. 

On Thursday and Friday of this week, Jess Benhabib and I are running a conference at the San Francisco Fed that showcases new research on multiple equilibria and financial crises. The papers at this conference trace their roots to an agenda on sunspots, developed at the University of Pennsylvania in the 1980s.

The sunspot agenda began with the seminal paper by David Cass and Karl Shell, Do Sunspots Matter?, the pathbreaking paper on Self-Fulfilling Prophecies by Costas Azariadis and a paper by myself and Michael Woodford in which we developed techniques that form the basis for dynamic models of indeterminacy that are now widely used to understand monetary policy regimes. 

Another important landmark was the 1994 conference at NYU, published in the Journal of Economic Theory as a symposium on Growth Fluctuations and Sunspots.  Here is a link to a survey paper that explains the history of the sunspot agenda and its connection to endogenous business cycles.

I'm looking forward to the dinner talk on Thursday night by Karl Shell and I'm also looking forward to seeing the tremendous range of papers that are moving this agenda forwards in new and exciting directions. Here is a link to the conference papers.