If you read any number of self-improvement books, you will come across ideas such as ‘what you think, you will become’. Over, 2,500 years ago, the Buddha said: “All that we are is the result of what we have thought. The mind is everything. What we think we become.”
When overused these positive thinking mantras can become a bit tiresome. But, maybe there is still some relevance to modern macroeconomics. Not least, we have the phrase of ‘talking ourselves into a recession’. The idea that if key people in the economy keep talking about a recession, this can become a self-fulfilling prophecy. With a threat of recession, people spend less, firms invest less and this creates falling aggregate demand. Cynics may say, people wouldn’t talk about a recession unless there was some economic justification so it will be hard to attribute it all to merely negative talk. Nevertheless, it does show the potential of strong opinions having a significant bearing on the outcome.
If you wish for Austerity, you tend to Get it
The next thing that springs to mind is the recent attitude to the economy and debt. We could characterise the EU and UK’s attitude as ‘austerian’. Generally austerians take a very pessimistic view towards the economy. They are deeply worried about levels of debt and government borrowing. They fear bond markets will very soon penalise these high levels of debt. Austerians spend a lot of time telling the electorate how the economy is in a bad shape and we need to respond with strict spending cuts and tax increases. There is also a sense of morality attached to this austerity approach. ‘Debt got us into this mess, we can’t use debt to get out of it.’
The consequence of austerity measures has generally been higher unemployment and lower economic growth. In the Eurozone, austerity policies have generally failed to reduce debt to GDP ratios because of the recession. Therefore, with budget deficits failing to fall, austerians take this as evidence to cut spending more deeply. Again it is accompanied by a sense of morality. “We almost deserve a period of austerity in response to the previous lending boom of the mid 2000s.” ‘We can’t spend money, we don’t have’. Those of an Austerian nature have an instinctive dislike to the idea of printing money – even though all evidence of the past five years is that increasing the monetary base has not caused any significant inflation. Perhaps it’s related to the idea ‘we don’t deserve to create money from nothing, but we do deserve a recession.’
Austerity policies directly impact on aggregate demand, but they also effect consumer and business confidence. If the government is saying we will be living under a cloud of austerity for the next five years, it discourages firms investing and consumers spending.
In short, if you feel we deserve austerity – if we feel the economy is broke, this is what we tend to get. The desire for austerity is largely self-fulfilling. If you pursue austerity policies in a liquidity trap and deep recession – you get the bad economy you feared in the first place.
Alternative View
Suppose you took the alternative view of the UK economy. Suppose you thought, the UK economy has great potential. GDP has nearly doubled in the past 20 years, there’s no reason why, with the right economic policy, it can’t do it again.
If you don’t worry about debt in the short term, but prioritise the economic growth you expect, then it is more likely to happen. If the government / Monetary authorities talk optimistically about a return to strong economic growth and put effort into creating this, it improves fragile confidence and can become self-fulfilling. If you believe the best time to reduce debt is when the economy is sufficiently strong and robust, then you don’t resort to panic self-defeating austerity. There are plenty of examples of countries who have reduced debt during periods of economic growth. It is much harder to find examples of countries who’ve reduced debt to GDP in the middle of a recession.
Limits of Positive Thinking
You can’t create GDP by getting lots of economists chanting ‘Higher GDP, Higher GDP’. You can’t create confidence when economic fundamentals are diametrically opposed. But, there is a lot to be said for economic policy makers holding a positive optimistic vision.
Different Approaches after World Wars
In 1945, British UK debt was nearly three times higher than it was now. In the 1940s, Britain really was nearly broke. It would have been very easy to repeat the mantra ‘We’re broke and we need austerity now!’ Rather than a radical programme of creating a National Health Service and welfare state, the British state could have retreated into its shell and slashed spending. But, if we had adopted a policy of radical spending cuts in the 1940s, growth and demand would have been much lower. As it happened, the long post war economic boom enabled a reduction in the UK national debt – without resorting to a recession inducing policy of panic austerity.
This contrasts sharply to the UK’s experience in the 1920s. In the 1920s, the UK again was broke after the First World War. But, the orthodox view of the Treasury was that the highest priority was to reduce the deficit. Combined with the inappropriate gold standard exchange rate, deflationary fiscal policy created a decade of unemployment, deflation and stagnant growth. The vision of a bankrupt economy lasted until the start of World War Two.
Vision
You really would like to have policy makers in UK and Europe, to be very bold in stating they see how to improve the performance of the economy. Rather than getting stuck in deflationary spiral, they should make a commitment to prioritise economic growth and pull out all the stops to achieve it. Also rather than penny pinching on necessary infrastructure spending, there should be a feeling we can afford infrastructure which ultimately improves the state of the economy and improves tax revenues. It’s better than repeating a mantra of ‘austerity now!’
Related
- Confidence fairy explained
- Britain is not Bust – at New Statesman