Are demand management policies the solution or a mass delusion?

Our first article of 2016 from guest economist and eminent monetarist John Hearn

Here he tackles the subject of QE, expanding monetary demand and mass delusion. The blog was first written in January 2013 and updated 4/1/16.

"In the UK QE has expanded the money supply by £375 billion and the national debt has grown to over £1.6 trillion as yearly deficits in excess £100 billion have been added to demand, and this year there will be a further deficit of £80 billion. In the USA large fiscal deficits and a series of monthly additions to QE are expanding monetary demand. In Europe the ECB is steward over large fiscal deficits throughout the Eurozone and their version of QE. Even Japan has agreed to add money printing to fiscal deficits that have produced a national debt to GDP ratio in excess of 200%.

Why is this happening? The reason is that since the credit crunch and financial/economic crisis, which was beginning to take hold in 2006/7, all the major countries in the world have suffered a rise in unemployment and faltering economic growth. Economists have explained how output gaps have grown in these economies and the theoretical solution is to close these gaps by using demand management policies. Despite the fact that there is no evidence of this ever working, politicians have been sold on the idea that they can spend more money and not have to raise taxes to finance it.

Demand management is talked about across the world as the only solution to a world crisis and if the current expansions in demand are not working then the only solution is that the expansions in monetary demand have not been large enough to reach escape velocity. The new Governor of the Bank of England has been reported as saying that he is willing to see higher inflation for longer to support economic growth. The USA worry about fiscal cliffs and are continually negotiating increases in their, previously agreed, debt ceilings. The UK talks about austerity at the same time as it is likely to add a similar amount to the national debt in 2012/13 as it did in the previous fiscal year. As Oliver Hardy might have said to Stan Laurel "this is another fine mess we have got ourselves into" So is there a real solution to what is described as mass delusion.

It is a counter-intuitive argument that needs careful analysis but it suggests that the demand management policies in the world`s major economies have actually caused unemployment to rise and economic growth to stall. Loose monetary policies have caused inflation to be above target and this has the effect of distorting markets and not allowing them to allocate resources efficiently. Since the G20 conference in 2009 major countries agreed to pursue large fiscal deficits to spend their way out of recession. Increased public spending has created more jobs inefficiently in the public sector and, at the same time, crowded out jobs in the private sector, which probably accounts for the net increase in unemployment during this period.

To deal with this problem requires a change in policy direction that will cause some pain before it starts to improve the current situation. Keynesian demand management policies have not worked and it is necessary to reverse the policies and the thinking. Bank rate needs to rise closer to a market rate and the Central Bank needs to give up interest rate controls and concentrate on the one thing it can control which is the amount of cash in the monetary system.

Also it needs to focus on the 2% inflation target, as this is within its remit, and stop talking about manipulating demand to create more jobs and foster growth as it cannot deliver on either of these. Also a law needs to be passed that limit government`s ability to overspend and recognises that Keynesian demand management is just a theory that does not work in practice. It is suggested that government budgets should be balanced over a three-year term without exception.

The long-term effect will be low and stable inflation, faster economic growth and more employment as was seen in the decade from 1997-2006. The problem is in the short-term as rebalancing the economy will cause job losses in the public sector and that part of the private sector dependent upon government largesse. The recovery will be gradual as more jobs are created in a private sector that begins to trust a government that no only promises sound finance but is legally compelled to achieve it. Overall unemployment will rise before it begins to fall, which is the bad news, but the good news is that economic growth will pick up more quickly.

So it is important that people understand that government, throughout the world, are the cause of slow growth and high unemployment and that Keynesian demand management policies do not improve the situation, but make it worse. It is necessary to fall off fiscal cliffs, tighten monetary policy and contract the public sector. In the UK austerity should be acted upon, not just talked about. Austerity means cutting government expenditure this year by more than £80b to balance the budget, not just talking about cutting it by £20b and then not cutting it at all as the siren voices grow louder.

Also I am not a supporter of budget surpluses as you will see if you read "A balanced budget goodbye fiscal policy". So the current policies and underlying economic theory are not the solution and have produced mass delusion"

John Hearn 4/1/16.