All 2 entries tagged Recession

Conversations with Cab Drivers

Since conversations with cab drivers are becoming a minor theme of this blog, let me add two more. In March this year I visited Berlin for the first time. Flying into Schönefeld airport, I had a long ride into the city centre and another back again a few days later.

On my inward journey, the driver was a young man with broken English. (I don't speak German.) I say young, but he seemed aged by anxiety. He was worried about the credit crunch, which at the time was gathering pace. The run on Northern Rock, the iconic event for British readers, was still six months in the future. My driver's worry was not about recession, which at that time lay below the horizon; it was about hyperinflation.

Central banks were printing too much money, he said, and this worried him. To emphasise this he took both hands off the steering wheel and clapped them to his head, which was balding. During our conversation he would do this again any time he was lost for words, or perhaps if he thought I was showing signs of complacency.

I wasn't complacent at all; I'd been concerned about the state of the financial world for some months already. I just thought he was worrying about the wrong thing. I tried to explain that when financial intermediation was unwinding demand would switch from other assets to cash, which only central banks could supply. The danger was that monetary conditions would become too tight, not too loose.

To support his argument my driver gave me a gift, the only one I have ever received in a taxi. This involved his taking a hand off the wheel and both eyes off the road to find his wallet in a jacket on the seat beside him and open it. He collected memorabilia, he told me, of the German hyperinflation after World War I. My gift was a 10-million Reichsmark note of 1923. I thanked him sincerely, and in truth it was kind of him, although I would have been happy for him to wait until he had stopped the car.

On the return journey my driver was wiry, short, and brown as a nut, with sharp eyes and a striking beard, white and very long. Because of the beard I thought at first he was very old, but as it turns out he was most likely younger than me. At first I thought we had no common language, but a few minutes of experimentation showed that we shared Russian. He was ready to talk, and he talked to me calmly and with emphasis. He kept his eyes on the road and his hands on the wheel; all I had to do was ask a few questions, sit back, and listen.

The driver recounted: His family had left Germany for Russia late in the eighteenth century, at the time of the Empress Catherine the Great, settling in the region of Odessa. Caught up in Stalin's deportations of national minorities before World War II, they were exiled to Siberia, eventually resettling in Ekaterinburg. In 1991 Mikhail Gorbachev and Helmut Kohl agreed on the right of ethnic Germans to return from the Soviet Union to Germany. His surviving relatives came first; he followed them reluctantly, after economic conditions in Russia had worsened.

I asked if my driver was satisfied with his life in Germany. He answered firmly: No. In Russia, as a German he had been treated with respect. In Germany, seen as a Russian, he was treated accordingly. Worse, the Germans had forgotten how to be German. Their politicians were corrupt and decadent. They were selling their own country off to the Jews. Their daughters were prostitutes, he said, waving his hand at a group of girls by the roadside. He would take a strap to them. He added, for clarity: not to the girls, but to their parents, who had failed to bring them up properly.

I asked him what he thought of Russia today. Putin, he told me, was doing the right thing for Russia. He was building a strong country that would once more command respect in the world. This was what Russia needed.

He dropped me at the airport in good time and good shape, but troubled. It was symbolic, I decided, that in Berlin, a city at the heart of Europe that already had too much history, I should find a Russian German that hated Jews and Germans and tended the flame of Russian nationalism in his heart.

Mark Harrison : 14 Dec 2008 21:19 |  Tags: Cab-Drivers Recession Russia |  Comments (1) |  Close comments |  Report a problem

We are All Ricardians Now

Writing about web page http://www.economist.com/world/britain/displaystory.cfm?story_id=12707624&fsrc=rss

The country needs a fiscal stimulus. In the economics of John Maynard Keynes there is a clear rationale. The economy is going into a serious recession. When that happens, the government faces a bitter choice. It can stabilize its budget, or it can stabilize the economy, but it cannot do both.

• Stabilizing the economy means cutting taxes and increasing spending in order to compensate for the fall in aggregate demand. In addition to first-order effects, this will put more purchasing power into the hands of consumers, who will hopefully spend it, so multiplying the effect of the initial injection -- but the lower taxes and higher public spending will cause the budget to swing into deficit (in the case of the UK, it was in deficit already).
• Stabilizing its budget means that the government must raise taxes and cut spending, but this will make the recession worse, since households will lose even more purchasing power than they are already losing because of the credit crunch and the recession.

Wisely, the government has chosen to try to save the economy, not its budget. And, in fact, so has the opposition. The difference between them is that the government will spend more, and cut taxes less; the opposition would shift the focus somewhat to tax cuts. In practice the difference may not matter hugely.

In addition to bringing forward some capital projects, the government is cutting VAT temporarily, deferring an increase in corporation tax, making permanent a recent increase in the tax threshold, and increasing pensioners' and children's benefits. The total shift in the Treasury's underlying fiscal stance is a net stimulus of £21.5 billion over two years, the current year and next year. But, because the economy will go into recession anyway, eating away at tax revenues and pushing up spending on benefits, public borrowing will rise by much more.

As a result the ratio of debt to GDP will rise from 36% in the last financial year to 57% in 2012/13 (figures are in this week's The Economist). This is causing huge political concern. Who will pay for it, and how will we pay? At the moment we have only a few clues. The VAT reduction is temporary. National insurance contributions will rise for everyone, and marginal tax rates will rise for the highest earners. The capital spending that has been brought forward will also come to an end earlier than planned. Bankers are rich and unpopular, so the rich are a tempting target, but in the medium term the rich will be fewer and poorer than recently so the average tax payer will probably make the main contribution.

The concern over how to pay for the debt is odd in two ways. First, at 57% the British debt ratio would still be within the limits of the EU Stability and Growth Pact, below the current EU average, and far below today's ratios for France, Belgium, Germany, and Italy. A 57% ratio is also quite sustainable; in steady state, financed at 3%, it would imply a permanent increase in the UK tax burden of about 0.6% of GDP.

Second, the concern looks counterproductive. This is where Ricardo comes in.

Does it matter whether you finance extra government spending by extra taxes, or by running a budget deficit and borrowing to cover it? In Keynesian terms, the purpose of the fiscal stimulus is partly to replace households' lost purchasing power. If taxes rose now, that purpose would be frustrated. That is why the stimulus should be financed by borrowing.

In 1820, David Ricardo asked what difference it would make to finance a given amount of government spending by borrowing or taxation. The burden of taxes required would be £X. Alternatively, the government could borrow £X from the public as a perpetual loan. The only change in the burden of taxes then would be £X times the interest rate -- but this would have to be levied in every future year. The present value of the stream of future taxes, discounted at the same interest rate, would be ... Oh, £X.

In other words, borrowing is simply deferred taxation, and the present value of the two burdens is equivalent, so this idea is sometimes called Ricardian equivalence. (In the 1970s Robert Barro revived the idea as a major contribution to the new classical macroeconomics.) 

In Keynesian economics, households receiving the stimulus of extra government spending feel better off when it is financed by borrowing, since they have more current purchasing power as a result. Therefore they go out and spend more, and there is a multiplier effect that boosts the economy further. If Ricardian equivalence holds, however, rational households perceive that the extra borrowing arising from the stimulus is just deferred taxation of the same value as the government spending, and feel no better off as a result. There is no further boost.

Ricardo did go on to point out that households might not be fully rational; there would be a natural tendency to see £X times the interest rate (say £3) forever as a much smaller burden than £X (say £100) now. And most empirical studies of the postwar period have tended to show that the multiplier does work, in the short run anyway.

Most politicians are unlikely to know anything much about David Ricardo, and only the few that studied economics at degree-level may have heard of Ricardian equivalence. Yet today we see that politicians on both sides, apparently intentionally, are trying to instruct the electorate in Ricardian equivalence. Government and opposition are alike emphasising that today's fiscal stimulus is only temporary and must be paid for with higher taxes in the future.

To the extent that ordinary people are listening, they will surely respond less to the fiscal stimulus as a result; being told to expect higher taxes in the future, they will spend less of the extra purchasing power they receive and will save more of it than if they had not received the warning. The overall effect of the stimulus will be less.

Why are the politicians doing it? The government is doing it in order to manage expectations of its policy can achieve. The opposition is doing it to undermine the credibility of the government. It comes to the same thing. We are all Ricardians now.

Mark Harrison : 01 Dec 2008 14:01 |  Tags: Economics Keynes Recession |  Comments (1) |  Close comments |  Report a problem