Reflections on Recovery and Reform

As Greece prepares to reject the fiscal austerity that has been imposed on it for the last six years, here are some thoughts on the process of Recovery and Reform that Greece, and others in the Eurozone, have been undertaking in the past few years. They are not mine: the identity of the writer will be revealed later in this post (though many of you will no doubt recognise the writing style, if not the actual words).
"You are engaged on a double task, Recovery and Reform;--recovery from the slump and the passage of those business and social reforms which are long overdue. For the first, speed and quick results are essential. The second may be urgent too; but haste will be injurious, and wisdom of long-range purpose is more necessary than immediate achievement. It will be through raising high the prestige of your administration by success in short-range Recovery, that you will have the driving force to accomplish long-range Reform. On the other hand, even wise and necessary Reform may, in some respects, impede and complicate Recovery. For it will upset the confidence of the business world and weaken their existing motives to action, before you have had time to put other motives in their place......
"Now I am not clear....that the order of urgency between measures of Recovery and measures of Reform has been duly observed, or that the latter has not sometimes been mistaken for the former. That is my first reflection--that....which is essentially Reform and probably impedes Recovery, has been put across too hastily, in the false guise of being part of the technique of Recovery.
"My second reflection relates to the technique of Recovery itself. The object of recovery is to increase the national output and put more men to work. In the economic system of the modern world, output is primarily produced for sale; and the volume of output depends on the amount of purchasing power, compared with the prime cost of production, which is expected to come n the market. Broadly speaking, therefore, and increase of output depends on the amount of purchasing power, compared with the prime cost of production, which is expected to come on the market. Broadly speaking, therefore, an increase of output cannot occur unless by the operation of one or other of three factors. Individuals must be induced to spend more out o their existing incomes; or the business world must be induced, either by increased confidence in the prospects or by a lower rate of interest, to create additional current incomes in the hands of their employees, which is what happens when either the working or the fixed capital of the country is being increased; or public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money. In bad times the first factor cannot be expected to work on a sufficient scale. The second factor will come in as the second wave of attack on the slump after the tide has been turned by the expenditures of public authority. It is, therefore, only from the third factor that we can expect the initial major impulse......
"Thus as the prime mover in the first stage of the technique of recovery I lay overwhelming emphasis on the increase of national purchasing power resulting from governmental expenditure which is financed by Loans and not by taxing present incomes. Nothing else counts in comparison with this. In a boom inflation can be caused by allowing unlimited credit to support the excited enthusiasm of business speculators. But in a slump governmental Loan expenditure is the only sure means of securing quickly a rising output at rising prices ."
How far removed is this from the policies currently being pursued by governments in Europe under pressure from Brussels and Frankfurt? The SGP and fiscal compact simply do not permit the expansionary fiscal policy that the writer suggests is the fastest way of restoring lost output. No wonder large parts of the Eurozone are in a protracted slump.

But surely monetary policy can do the heavy lifting instead? According to those of a monetarist persuasion, if the central bank increases the base money supply, output will be restored even if fiscal policy remains tight. So the protracted slump is the ECB's fault, isn't it?

The writer doesn't think so:
The other set of fallacies, of which I fear the influence, arises out of a crude economic doctrine commonly known as the Quantity Theory of Money. Rising output and rising incomes will suffer a set-back sooner or later if the quantity of money is rigidly fixed. Some people seem to infer from this that output and income can be raised by increasing the quantity of money. But this is like trying to get fat by buying a larger belt. In the United States to-day your belt is plenty big enough for your belly. It is a most misleading thing to stress the quantity of money, which is only a limiting factor, rather than the volume of expenditure, which is the operative factor.
And I'm sorry, Professor Krugman, but he doesn't have much time for arguments that deliberately raising inflation will magically restore output, either:
Rising prices are to be welcomed because they are usually a symptom of rising output and employment. When more purchasing power is spent, one expects rising output at rising prices. Since there cannot be rising output without rising prices, it is essential to ensure that the recovery shall not be held back by the insufficiency of the supply of money to support the increased monetary turn-over. But there is much less to be said in favour of rising prices, if they are brought about at the expense of rising output. Some debtors may be helped, but the national recovery as a whole will be retarded. Thus rising prices caused by deliberately increasing prime costs or by restricting output have a vastly inferior value to rising prices which are the natural result of an increase in the nation's purchasing power......
......too much emphasis on the remedial value of a higher price-level as an object in itself may lead to serious misapprehension as to the part which prices can play in the technique of recovery. The stimulation of output by increasing aggregate purchasing power is the right way to get prices up; and not the other way round".
 And finally, he has harsh words for those who think that devaluing the currency is a fine way of restoring competitiveness and growth (I'm looking at ALL of those who argue for QE and its relatives on the grounds that it will weaken the currency):
"In so far as an over-valuation of the dollar was impeding the freedom of domestic price-raising policies or disturbing the balance of payments with foreign countries, it was advisable to depreciate it. But exchange depreciation should follow the success of your domestic price-raising policy as its natural consequence, and should not be allowed to disturb the whole world by preceding its justification at an entirely arbitrary pace. This is another example of trying to put on flesh by letting out the belt."
Now, of course, we have all learned SO much since John Maynard Keynes wrote this letter to Franklin D. Roosevelt, haven't we? These days, "Keynesian stimulus" is widely derided. The 1970s taught us that direct government intervention to restore growth is wholly wrong and very damaging, and Keynes was a charlatan to suggest it. We now know that the only thing that will restore growth is for government to remove obstacles to free trade and private enterprise while putting its fiscal house in order - even if this means unemployment of over 25% and rising poverty and malnutrition among the population. Don't we?

But wait. What exactly was Keynes criticising in this letter?

It was FDR's National Industrial Recovery Programme:
In particular, I cannot detect any material aid to recovery in N.I.R.A., though its social gains have been large. The driving force which has been put behind the vast administrative task set by this Act has seemed to represent a wrong choice in the order of urgencies.
Here's what FDR himself had to say about the NIRA:
"Throughout industry, the change from starvation wages and starvation employment to living wages and sustained employment can, in large part, be made by an industrial covenant to which all employers shall subscribe. It is greatly to their interest to do this because decent living, widely spread among our 125, 000,000 people, eventually means the opening up to industry of the richest market which the world has known. It is the only way to utilize the so-called excess capacity of our industrial plants. This is the principle that makes this one of the most important laws that ever has come from Congress because, before the passage of this Act, no such industrial covenant was possible.

"On this idea, the first part of the Act proposes to our industry a great spontaneous cooperation to put millions of men back in their regular jobs this summer. The idea is simply for employers to hire more men to do the existing work by reducing the work-hours of each man's week and at the same time paying a living wage for the shorter week."
The NIRA was a programme of labour market reforms and public works aimed at ensuring full employment at living wages. Those who think that this is what "Keynesianism" is about should study what Keynes actually said. Keynes was no Keynesian.

Now, it is true that Keynes was writing to the President of a currency-issuing sovereign, whereas Eurozone member states have voluntarily relinquished their right to issue their own currencies. But that does not invalidate Keynes' remarks about the importance of government spending. When private sector agents cannot or will not spend, government must enable them to do so. Keynes is not suggesting that government does it FOR them. He is recommending that private sector agents be provided with more money so that they can spend it themselves. He doesn't specify how that might be done, but helicopter drops, tax cuts and additional government spending funded by borrowing (not tax rises) are all possibilities. Anything, in fact, that increases the purchasing power of the private sector. And no, funny money is not a substitute, however cleverly it is designed. Nor is QE, really, since all it does is substitute one asset for another. John Muelbauer's "QE for the people" is far more in the spirit of Keynes than Juncker's scheme.

Keynes' words still resonate today.

"Oh that today you would listen to his voice: harden not your hearts." - Psalm 95

(H/T @NelderMead for the link to Keynes' letter).


  1. Frances,

    Minor technical point…. You claim in your last para that Keynes “doesn’t specify how private sector agents be provided with more money so that they can spend it themselves”. Actually in the 2nd half of his 5th para he says “or public authority must be called in aid to create additional current incomes through the expenditure of borrowed or printed money.”

    Certainly more “printed” money would provide “private sector agents” with more money (though borrowed money of course would not).

    So that’s arguably “specification” of a sort.

    1. Borrowed money would provide private sector agents with more money. The problem is Ricardian equivalence - if people believe that the extra borrowing will require higher taxes in future, they might save the money instead of spending it. Because of unequal distribution of taxation, though, Ricardian equivalence does not fully hold. The more progressive the tax system, the less likely it is to hold in my view.

    2. How come “Borrowed money would provide private sector agents with more money”? If government borrows from the cash rich and spends it, that money ends up in the pockets of a less cash rich set of private sector entities, but the private sector’s stock of base money remains constant doesn’t it? However government does hand out bonds to the above “cash rich”, so the private sector’s stock of paper assets rises. But the rise doesn’t come in the form of more money. It comes in the form of more bonds . . . . unless I’ve missed something.

    3. Where did I mention base money?

      Actually you've missed rather a lot. I've written extensively recently about money creation by the fiscal authority in partnership with banks, so I'm not going to cover it again here.

    4. I realise that government COULD employ private banks to create money. However both Richard Werner and Tim Congdon have advocated that policy for some time, and I can find no hint in the literature they’ve authored that government HAS ACTUALLY done that. Plus I can’t find anything that definitively says government has or hasn’t done that. Do you know of anything?

      That was why I mentioned base money: that is, my understanding has always been that government has not used private banks to create money, and if that’s correct, then any money creation done by government must come in the form of base money.

    5. Ralph,

      Please read my last two posts. I've explained in them exactly how governments use banks to create money.

  2. It seems extreme to claim that monetary regimes cannot debase their currency, as implied by "only a limiting factor". Does Keynes therefore attribute hyperinflation episodes to hyperbolic real output? The notion that monetary policy is measured by discrete movements in the money base is no longer useful. Even Krugman thinks in terms of anticipated aggregates; though he, for some reason, calls this unconventional policy.

    1. Keynes attributed the Weimar hyperinflation - correctly, in my view - to the imposition of impossible reparations on a highly-indebted Germany after WW1. However, he was also strongly in favour of managed currency systems, no doubt because of the hyperinflationary disasters after WW1 - not just Weimar, but also Austria and Danzig.

      Unfortunately there are still a substantial minority of economists who DO think that changing the quantity of monetary base influences inflation and output. Krugman is not one of them.

  3. Dear Mrs. Coppola, correct me if I am wrong but if Greece decided to undertake a fiscal expansion within the EZ, a large part of the expansion would be transferred outside the country in the form of increased imports (same as it happened before the crisis). The fix ER would prevent them to fully benefit from the fiscal expansion and further aggravate the foreign debt problem. In other words, within the EZ a unilateral fiscal expansion of a "peripheral" country would be self-defeating. Or am I missing something?

    1. I agree with you that if Greece tried to go it alone on fiscal reflation it would fail due to free flows of trade and capital. Greece would need to impose import restrictions and capital controls - and that just makes things worse, as Venezuela could tell you.

      But although the context is Syriza's victory, I was not talking specifically about Greece. The whole Eurozone, which is in a slump - including the mighty Germany. That's why the ECB is doing QE. I don't think it will work. Heli drops are needed, and if they raise intra-Eurozone trade, that's a good thing. Redesigning the Eurozone is necessary, but as Keynes says, you need recovery first. Demand across the whole Eurozone, not just in Greece, is too low.

      I've covered the design flaws of the Eurozone ad nauseam elsewhere.

  4. This comment has been removed by the author.

  5. > Mirco Tomasi
    Same thing crossed my mind last night. The same applies to any money in Greece, QE money, private credit money, government borrow and spend money or tax and spend money , if it ends up spent on German imports.

  6. So we jump-start the economy, the engine of goods and services fires into action and the generator of consumption causes money to circulate and all is hunky-dory. Ok provided the engine is capable of running.

    Other problems - too much taxation or the consumption machine draws its input from elsewhere and feeds its money elsewhere - the engine of in-country goods and services will splutter and someone elses engine will race ahead. Keynes' model seems more complicated when international trade is a necessary part of the machine.

    Then the question 'how much is a Greek worth', as a human being just as much as a German, the problem being that the German is better coupled into the world economy - all those nice Mercs etc. But the average Greek is less coupled into the world economy than many Chinese. Until that changes the Greek has to live on a bowl of rice or be subsidised.

    Which brings up the problem of running the entire European economy as if it were Germany - probably not possible at all however much government money is thrown at the minor members. Which begs the question how to accommodate perpetual devaluation or perpetual subsidy for some economies within the Euro zone, how can that be done?

    PS, earlier comments seem to have beaten me to it.

    1. The same way it's done in other fiscal unions (usually sovereign nations), such as the USA or the UK. Is an Alabama resident "worth" the same or is he/she equally "coupled into the world economy" as a New York or California resident? No, but the difference is covered by fiscal transfers.

      Failing that, there should be no "union", and instead let floating currencies take care of the adjustment. It's really that simple.

  7. A reply from John Hearn

    An excellent and scholarly exposition of Keynes and some pleasing separation between Keynes and the Keynesians, but some implied misrepresentation of Quantity Theory and monetarism and some support by implication for the Keynesian interpretation of what Keynes said and no view of the alternative policies that might well solve the impending crisis.

    I can only assume that you are aligning yourself with Keynes, but I know by extensive quotation you are giving yourself a get-out clause if you later feel unable to fully commit to the argument.

    In paragraph 4 you quote that “an increase in output cannot occur unless by the operation of one or other of three factors”. Each of these factors requires demand management and because the solution can only occur as the result of one of these three things you are ignoring any other solution. This is where Keynesians get their idea of deficient aggregate demand and therefore an assumption of cost push inflation at less than full employment. However as I explained to you in tweets all inflations are the result of excessive monetary demand and therefore this argument does not stand up. It has however been used as the basis for almost 50 years of fiscal deficits that have had no positive effect on output and employment and have arguably produced more unemployment and slower growth.

    Now there is an alternative to demand-side policies that you do not consider and they are the only long term solution for the UK and Europe. These are the supply-side policies that can only work effectively with constrained government budgets and sound monetary policy.

    This takes me to the second major point which is the misrepresentation of quantity theory and monetarism by you and your ghost writer: ”a crude economic doctrine” As a basis for monetarism quantity theory says nothing directly about being able to create jobs, increase output or kick-start growth. It provides a framework for controlling inflation. All monetarism, as Friedman said, is based upon the simple proposition that there is a consistent though not precise relationship between the rate of change of money supply and the rate of change of nominal national income. Changes in monetary demand come first and changes in nominal national income come next. Any growth in monetary demand, which is not picked up by an increase in output, will filter through to inflation so that inflation, as described by Friedman, is always and everywhere a monetary phenomenon. So all that monetarism can do is provide a framework to control inflation and stable prices will then create a level playing field for free market capitalism to pick up the slack.

    The road to recovery therefore does not look as Keynes said and you imply. It requires monetary discipline to achieve a 2% inflation target (QE/QT when necessary) and fiscal discipline so that the public sector does not inefficiently crowd-out the private sector`s ability to innovate and grow the economy.

    There is no evidence that Keynesian demand management and fiscal deficits will support recovery. Moreover there is a lot of evidence that it is policy that has failed time after time and the only reason for doing it one more time is that it is what politicians, with a short term election horizon, want to hear. There is no sound economics to back it up.

    John Hearn 26/1/15

    1. I really think you should take into account the historical context of this letter. It was written in 1933. In 1933, there was no inflation. Nor is there now, in the Eurozone. Your emphasis on inflation stems from a different time and a different set of circumstances, just as the policies of the 1920s, when there was inflation, were no longer appropriate in the Depression of the early 1930s.

      The point of this post is that Keynesian demand management DID work in the 1930s. The problem is that it continued when it was no longer needed - hence the inflation of the 1970s. But monetarist solutions do not work in depressions. Fiscal support IS needed to expand output. There is ample evidence for this, including the experience of Germany in the 1930s.

      The mistake that economists who subscribe to one particular "school" of economics make is to believe that their preferred economic approach is always appropriate, at all times and in all places, regardless of the situation. Sadly the world is not that simple.

    2. John Hearn`s reply to your reply

      I agree with most of what you say and the special situation in the 1930`s. However Keynes General Theory was not a general theory but one specifically designed to deal with the monetary contractions and deflations in The UK after WW1, caused by the Bank of England, and that caused by the Fed after 1929.He offered a politically acceptable rationale for restoring monetary demand.
      I have explained elsewhere that a CB is benign in an expansionary way and very damaging in a contractionary way. In the 1930`s Keynes offered a solution that has never been needed again because that situation has never occurred again. How do I know this? It is because we have always had excessive monetary demand measured by inflation. Keynesians misunderstood this and have been reeking havoc in the economy ever since and there is no evidence it has ever worked other than to cause further damage to the economy.
      What you have written gives tacit support to continue very damaging policies.

    3. The depression in the Eurozone periphery, and especially in Greece, is actually now longer and deeper than the Great Depreseeion. So your argument that the circumstances about which Keynes was writing have never happened again is, I'm afraid, empirically wrong. There is no inflation in the Eurozone, whether from excess money demand of from any other cause: there is in fact outright deflation. Furthermore, the currency rigidity in the Eurozone is in many ways akin to the interwar gold standard. The similarities with Germany in the early 1930s are particularly striking: highly indebted, Germany imposed severe austerity in a recession in order to restore its international credibility. The result was the deepest depression in Europe, unemployment at 30% and the growth of a populist (nationalist) moverment. Why are we making all the same mistakes again - and why are you in favour of this insanity?

    4. from John Hearn

      Thank you for your reply. The problem you refer to in the eurozone and the UK was initiated by the G20 meeting April 2009 when they gave free license to fiscal deficits and it is this fiscal indiscipline that has damaged growth and employments prospects. Reducing the size of the deficits is not austerity and there were no signs of a thirties depression until very recently. So what is causing the current deflation and risk of deflation? It is not the reduction of fiscal deficits which needs to continue, it is tight monetary policy that is causing the problem. That is why a QE programme in Europe is necessary. It is too late to solve anything for the next 12 months but better late than never. There is a similar requirement for QE in the UK but the Bank are unable to act and will not do so until we find ourselves close to or in negative territory.

    5. This post is not about the UK.

      The March 2009 meeting has nothing whatsoever to do with the Eurozone crisis. Greece's fiscal deficit long pre-dated that meeting, but it was the only Eurozone country exhibiting such profligacy. Ireland and Spain both ran fiscal surpluses until the Eurozone forced them to recapitalise their collapsing banks, which all but bankrupted Ireland. Spain tried hard to persuade the Troika to recapitalise its banks directly from the bailout funds rather than via the sovereign, but the rest of the Eurozone would not agree to this. Blaming Spain and Ireland's deficits on fiscal profligacy is therefore completely wrong. And Italy runs a primary surplus: the problem there is low growth increasing the debt burden.

      I agree that ECB monetary policy has been seriously deficient. The Greek crisis was triggered by the ECB raising rates in 2011.

    6. From John Hearn

      14th March & April 2nd confirmed for G20 countries that "members agreed to restore growth as quickly as possible by co- ordinated and decisive actions to stimulate demand and employment. The UK added a budget deficit of 179b to national debt and "By the end of 2009 Ireland had a budget deficit of 14.3% of GDP. In Greece it was 13.6%, in Spain 11.2% and in Portugal 9.4%. Combined with accumulated debt Greece was the biggest over-spender with National debt at 115% on GDP and Italy was even higher at 119%"
      So your statement that 2009 meetings had nothing whatsoever to do with the crisis is totally wrong

    7. 1) I have already pointed out that this post is not about the UK. Please respect the context of this post.

      2) Greece's deficit pre-dated 2008 by a LONG way. So did Portugal's.

      3) Spain's fiscal balance turned negative in 2008, not 2009. So did Ireland's. In both cases it was directly due to a property market collapse that wrecked the banks.

      3) Italy has run a primary surplus since 2006. The increase in its debt/gdp is due to falling gdp.

      4) Greece's stated financial position in 2009 had nothing to do with reality. It was the discovery that its financial position was actually far more precarious that was the proximate cause of the Eurocrisis, although ECB monetary policy had a lot to do with it too.

      There is, in short, no evidence to support your assertion.

    8. "As a basis for monetarism quantity theory says nothing directly about being able to create jobs, increase output or kick-start growth."

      This is what the 'Thatcherite' Monetarist and ex? economic adviser to UKIP has to say re QE and he thinks he 'knows' that it will 'work'?

      “In short, although the cash injected into the economy by the Bank of England's quantitative easing may in the first instance be held by pension funds, insurance companies and other financial institutions, it soon passes to profitable companies with strong balance sheets and then to marginal businesses with weak balance sheets, and so on. The cash strains throughout the economy are eliminated, asset prices recover, and demand, output and employment all revive.”

  8. Keynes hadn't arrived at The General Theory (1926) yet, or, at least, he hadn't arrived at Hicks (1937). In the IS-LM model, increased public spending causes increased aggregate demand even if it is financed through increased taxes. Deficit spending has a larger effect, but balanced budget spending increases have a positive multiplier (equal to 1 if the economy is in a liquidity trap).

    You are a bit hard on Krugman who would not advocate a National Industrial Recovery Act (I don't know of any economist who thinks it was a good bill). Increased inflation due to promised loose money in the future is quite different.

    Also the data from 1933-4 tend provide some support for FDR versus Keynes round one (as the data from 1937-8 overwhelmingly support Keynes v FDR round two). Notably deflation ended and investment levels suggest expected inflation increased sharply. Many (including especially Christina Romer and often Brad DeLong) assert that this must have been due to the US going off the gold standard. But the NIRA aimed to cause this to happen, then it happened. The NIRA involved meddling with the price mechanism (indeed allowing and encouraging anti competitive practices). It is generally detested (also by me). But the few data points of evidence correspond to the hopes of those who enacted it.

  9. This letter precedes both the General Theory (published 1936) and Hicks.

    I'm not making a general criticism of Krugman, only observing that increasing the price level "per se" does not restore growth - it is a consequence of restored growth, not a cause. It is therefore the wrong objective in a slump.

    I think the NIRA probably did have some positive effect in the short-term. The problem with that kind of programme is the stimulus is short-lived and is then followed by the deadening effect of labour market rigidities. Keynes' point is different, though: he argued that restoring purchasing power to the private sector as a whole was more urgent than labour market reforms. Demand-side, not supply-side. I put this in for precisely that reason, since the Eurozone econocrats seem to be convinced that supply-side reforms alone will restore growth even when demand is far too low. Keynes would say otherwise, I suspect.

  10. On the advice of Fisher and others FDR sought to end deflation by raising the price of gold by 75%. He succeeded. Prices and the money supply rose:

    1. I think that's what Keynes is criticising when he complains that trying to create recovery by devaluing the currency and raising prices is like trying to gain weight by buying a larger belt.

  11. Any genetic stock collection can represent a few lines to tens of thousands of lines and therefore can potentially offer a challenge, as well as a burden, to genebank managers from the standpoint of storage and maintenance. 


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