M4 Definition

M4 is a broad money supply measure. Briefly, M4 includes all notes and coins in circulation, deposits at banks and building societies, plus assets which are considered relatively liquid (short-term bonds, commercial paper)

M4 growth is currently negative. M4 lending to private sector is currently 6.0% lower compared to past 12 month (July 2012)

Within this growth of M4, there have been different trends. As this article at FT shows, a major contributor to M4 growth in period 2009-11 has been the impact of quantitative easing (Could UK Money Supply collapse post Q.E ?).

M4 Lending  Deposits

M4 net lending (Bank of England code: LPMVQJY) from financial institutions to the private sector has shown negative growth since July 2010.

Read more

Between 1999 and 2008, there was a rapid growth in public sector employment in the UK. This mirrored a sharp increase in government spending (see: post on spending under labour.)

The justification for the increased public sector employment was to deliver better service in the NHS. However, critics argue that the increase in public sector employment reflected growing bloat in the civil service and management divisions of the NHS.

Since 2009, shortly after the recession began, public sector employment has fallen quite considerably as the government have looked for spending cuts and trimming back previous excesses. Critics of these austerity measures argue that to reduce government employment in the middle of a recession, with falling output and confidence has  made the recession worse and prevented unemployment from coming down. However, others point to the (relatively small) growth of private sector employment as a justification for cutting surplus government jobs.

Read more

This is an article published in the LSE about the Austrian view of the Eurozone crisis ‘The Work of Hayek shows why EU governments can’t spend their way out of problems‘

I’ve attempted to summarise the article, but I advise reading it for yourself:

1. The recent boom and bust was caused by artificially low interest rates and capital flows which caused an inefficient use of resources.
2. The current period of high unemployment and low interest rates means there is much idle capital and labour unused – waiting to work out how best to be used. (analogy use of jigsaw pieces waiting to be put together by the market)
3. Governments always lack the knowledge of how to efficiently make use of these resources, but instead will choose the most electorally popular types of government spending. Therefore, if the government spends money it will inevitably go on the wrong areas of the economy and just make things worse. Therefore, the government shouldn’t intervene.
4. So what can we do? Allow private enterprise to decide how to use these idle resources. The only thing we should do is remove barriers to enterprise and competition, e.g. cut regulation, taxes and state intervention. In a free market, the price signals of profit, loss and prices will enable a return to market equilibrium and full employment. It may take time, but it will happen eventually.
5. ‘Before the advent of Keynesianism, most recessions were very short lived as producers were left free to shuffle the jigsaw pieces into better combinations’

Some things struck me about the article.

• There is a lack of specific examples relating to the current crisis. It is hard to find any examples of a country where government spending has fallen and there has been impressive economic recovery. In fact, the opposite seems to happen, with the deepest recession in those countries with harshest austerity policies.
• The main argument seems to be the unwavering faith in the inevitable failure of any type of government intervention.
• The idea that before the advent of Keynesianism most recessions were very short lived is highly dubious (to be polite). It inconveniently ignores (for example):

• The Great Depression  (1929-37) The great depression did last a long time. The Great Depression only really ended when countries embarked on Keynesianism (mostly in form of military spending). Those countries who embarked on military spending ended recession earlier than others.

• The recession of 1815–1821. widespread

• foreclosures, bank failures and negative market sentiment.

• The tendency to lump all government intervention together is lazy. Keynesianism doesn’t advocate tariff barriers. To impose tariff barriers can contribute to an economic downturn, but just because tariffs can be harmful doesn’t mean it is wrong to pursue countercyclical fiscal policy. It is a very different type of government intervention.
• Keynesianism isn’t about bigger government. A feature of the Keynesian fiscal policy is that it should be countercyclical. For example, in this piece Simon Wren-Lewis argues that EU fiscal policy was too loose in the run-up to the 2008 crisis.

” In my view, fiscal policy in many Eurozone countries outside Germany was insufficiently tight before 2008, but for most not because it implied a build-up of government debt.   The problem was that private sector demand was too strong, encouraged by large capital inflows from abroad and real estate bubbles

Read more

Readers Question: Would a devaluation help Greece?

If you look at the Greek economy, their exchange rate has been effectively overvalued for several years. This overvalued exchange rate has caused Greek exports to be relatively uncompetitive and has caused various economics problems. Combined with efforts to tackle an unsustainable debt level, the over-valuation has contributed to prolonged recession.

Impact of Over-valued Exchange Rate

• Very high current account deficit (over 10% of GDP)

• Falling GDP – output shrinking since 2008.
• High unemployment close to 50%

If Greece was in a floating exchange rate, there is no doubt that their currency would have fallen rebalancing domestic demand and improving economic growth. (see: why Greece would devalue)

If Greece was in a semi fixed exchange rate (such as the old ERM), there is no doubt that they would have reduced the currency peg and devalued the currency.

The problem is that in the Euro, the only option to devalue is to leave the Euro 0 with all the economic uncertainty that leaving the Euro would entail.

For Greece, the choice has always been between the benefits of devaluing and regaining independent monetary policy vs the cost of leaving the Euro and experiencing the capital flight and uncertainty this would entail.

Summary of Greek Devaluation

Advantages

In theory, a devaluation would help increase Greek domestic demand and enable an economic recovery.

• Imports would be more expensive causing demand for imports to fall – instead people would buy more domestic goods.
• Greek exports (and tourism) would become more competitive. Therefore, demand for exports and tourism would rise. A substantial devaluation of 50-70% could create many long-term opportunities to develop new export industries and encourage more tourism.
• This boost to domestic demand would also help create jobs and tackle Greece’s dire unemployment.
• Without devaluation, Greece could face years of depression as they are unable to create any boost to domestic demand in the current situation.
• The current policies of austerity have failed to  tackle the deficit, but have pushed the economy into a very dangerous deflationary spiral with levels of unemployment which threaten the social fabric of the country.

Problems of Devaluation

• A devaluation of 50% would cause a jump in inflation as imported goods go up. This could cause inflation of up to 50%.
• Inflation of 50% will increase the costs of living and reduce living standards.
• Devaluation involves leaving the Euro. Therefore there is a risk of substantial capital flight as Greek savers try to protect the value of their savings by moving into Euro bank accounts rather than lose value. This capital flight would cause banks to run out of liquidity. There would need to be government backed support for banks.
• The devaluation would increase the effective debt to GDP ratio. It could see Greece’s national debt rise to over 200% of GDP. Therefore, there would need to be a substantial default because outside the Euro, bailout funds would dry up.

Overall

Exit would be very painful and difficult. But, staying in the Euro, only seems to be prolonging the economic pain Greece is facing. If Greece did devalue and leave the Euro, they would at least be in a position to avoid the current situation of trying to manage in a single currency which doesn’t work for them.

Read more