Muddled Thinking Watch #7: Chuka Umunna on Labour’s pre-GFC Deficit

Chuka makes some valid points in his recent Guradian article:

For example he acknowledges that:

” First, we spoke to our core voters but not to aspirational, middle-class ones. We talked about the bottom and top of society, about the minimum wage and zero-hour contracts, about mansions and non-doms. But we had too little to say to the majority of people in the middle.”

Partially right. “The majority of people” are in the middle. So, in a democracy, to win elections, you have to not only speak to, but also win support from,  “the majority of people”. There’s no getting away from that.

Whether Labour spoke to its core voters is a matter of opinion. I’d argue they may have spoken to them, but they didn’t listen, which is slightly different.

He also makes some invalid points. He says:

“Of course, the last Labour government should not have been running (an albeit small and historically unremarkable) deficit before the financial crash. “

The last Labour government certainly made more than a few mistakes. George Brown famously  made the ludicrous claim that he’d abolished “boom and bust”.  The period  of the Labour government  (13 years) consisted of mainly years of boom, which enabled it to achieve electoral success,  except the last 2 years were years of bust, or trying to recover from the 2008 bust, which brought about its downfall.

But did they make a mistake about the government’s deficit? The boom was caused by too much credit being created by the private sector. I don’t believe there is any dispute on that point. That credit inflated asset prices, firstly shares in the dotcom boom and then property prices in the years up to 2008.  With the benefit of hindsight what should they have done to prevent that credit bubble? They, or their so-called “independent” Bank of England,  should have increased interest rates.  If there’s too little saving and too much borrowing then interest rates should rise. Is there any dispute on that point? That would have stopped the credit bubble. No problem.

But if they’d done that there would have been a problem of the £ appreciating in value. Exports would have become uncompetitive. That, and the reduction in domestic borrowing, and therefore, spending, would have led to less economic activity. Business failures and unemployment would have risen.

So what else would the Labour Government have had to do to compensate? Run a tighter fiscal policy, with a lower deficit, or a looser fiscal policy with a higher deficit?

If you think you know the answer, please email it, with an extremely simple to understand explanation,  to:

chuka4streatham {at} gmail(.)com

PS  I’ll ask Chuka if he can provide a small cash prize for the best answer. 🙂


26 responses to “Muddled Thinking Watch #7: Chuka Umunna on Labour’s pre-GFC Deficit

  1. All very true and straight-forward! But what is being over-looked is the elephant in the room: Too much money creation power in the hands of the commercial banks who are programmed to deliver boom and bust. I’m not convinced that a total ban on private bank powers is necessary – they are needed for SME and private funding but progressively hiking reserve requirements up to 30% as Adair Turner recommends would keep the lid on them. Meanwhile a progressive buy out of government bonds and PFI with new debt-free BOE money with all new infrastructure spending funded with new sovereign money would allow a balanced budget to be achieved without knackering the economy:
    Adair Turner at Philadelphia conference 2013: — although I don’t support Positive Money’s total ban on commercial bank created debt money – 50% might be OK!
    Also I’m not so sure that Ed Balls doesn’t actually know what needs to be done but dare not say for fear of being branded – or rather re-branded – a money printing inflator!:

    • Yes money creation by the private banks is what I call credit creation in the article. What the Positive money group fails to appreciate IMO is that all money is created as an asset/liability pair. So it never debt free in an accounting sense.

      So when the BoE, or the government, create money and spend it into the economy the economy benefits from those assets, until they are taxed away or disappear overseas to pay for imports, but the liabilities stay with government.

      When the Private banks create money the liabilities stay in the Private sector. So when the asset part has been taxed away, or disappears overseas to pay for imports, the liabilities remain to depress the economy.

      I think Neil nails the argument about “sovereign money” in this article:

  2. I don’t follow you here. When money created by banks is called in and destroyed as in a recession then matters are made worse; this is how banks are programmed to create boom and bust. You are confusing government money which is borrowed as gilts and real asset money created by BOE. It is the duty/responsibility of any sovereign state to supply the appropriate amount of debt-free money that allows an economy to function and, if feasible, expand. Too much will cause inflation; too little, recession deflation and on-going depression – which is where we are now!
    The system was already potentially dysfunctional and unsustainable by the time of deregulation in the 1970s by which time only 50% of the money supply was debt free. By 2008 this was down to 2.5%! QE, at the same time as bailing out the banks, has attempted to address this but unfortunately such funds have not been directed into the economy but have cascaded via the banks and investment funds into asset inflation – stocks and property – creating bubbles which at some point will inevitably cause an almighty mess!

    • Busts aren’t caused by banks calling in their loans. If PM are saying that they’ve got it wrong. That tends to happen after a crash so bank calling in its loan is a symptom of the problem rather than a cause.

      Say a private bank issues £1 million to fund a building project. There’s £1million of assets and £1million liabilities created. The liabilities stay in the Private Domestic Sector as debts to be repaid. The assets rapidly start to be removed as money is spent and respent. Wages of building workers attract tax and NI contributions. Then there VAT, corporation taxes , fuel taxes etc. Some of those cretaed assets are going to end up overseas to pay for the net imports the country enjoys.

      In a matter of months half of those assets will have been lost to the PDS. Some of those liabilities will have been repaid but it needs Govt to inject their assets (ie run a deficit) to negate those liabilities. This usually happens at a much slower pace. The Government doesn’t see fit to deficit spend when the economy superficially looks like its doing well. When those liabilities increase to a certain level that’s when the problems start.

      Steve Keen reckons they start when private sector debt levels reach 150% of GDP, but that probably varies according to levels of interest rates and the degree of irrational exuberance a boom period generates.

      • I think you are as confused as the majority of near 100% of accountants, economists, politicians and bankers are! I also admit that sometimes I get bogged down with relating the assets and debits! Those bankers – and others- who do understand and know whats going on don’t want the rest to have an inkling! Lets try and make sure that those who do see the light at least understand the system that is so dysfunctional and unsustainable!

      • I don’t believe I am confused. Let’s take it from the beginning. We’ll consider a case of a 1000 person economy on island who elect their government and start off a new currency. The Crown.

        The government issues 10 crowns to everyone to start things off.

        So the government has a net debt of 10k crowns. The assets of the population are 10k crowns too. The government levies taxes of 5k crowns to establish a demand for the currency.

        The government debt is now 5k crowns. Assets of Private Domestic sector (PDS) 5k crowns.

        A group of individuals set up a private bank. They take in 4k crowns of deposits. They use those 4k of deposits to buy bonds from Govt. Governemnt spends back 4k crowns into economy.

        Government Debt is now 9k crowns. Assets of Private sector 4k crowns in bonds. 5k crowns in cash. (4k crowns in bank saving. Liabilities 4k by the banks to the savers.) Total assets of PDS = Total Liabilites of Govt.

        A new building company asks bank for a loan of 3k crowns. Bank just creates money. “out of thin air”.

        Government Debt is still 9k crowns. Assets of PDS = 12k crowns. Liabilities =3 k crowns. (4k crowns in bank saving. Liabilities 4k by the banks to the savers.) Total assets = Total Liabilites.

        That 3k crowns is spent on a building project. 1k crowns is levied by the government in tax on the spending.

        Governemnt Debt 8k crowns. Assets of PDS = 11k crowns. Liabilities =3k crowns. (4k crowns in bank saving. Liabilities 4k by the banks to the savers.) Total assets of PDS = Total Liabilites of Govt.

        That’s only after the first spending. After all the subsequent spendings and respendings it will all end up back with Govt.

        Government Debt 6k Crowns. Assets of PDS = 9k crowns. Liabilities =3k crowns. (4k crowns in bank saving. Liabilities 4k by the banks to the savers.) Total assets of PDS = Total Liabilites of Govt.

        So we can see that the more money the PDS creates the more it ends up with extra liabilities which are a drag on the economy. This can be fixed in the short term by yet more lending and money creation by the PDS but the liabilities can only be extinguished by direct govt spending.

        So can see that the effect of the PDS creating new money is to make the governments debt look less. The more money it creates the more the liabilities build in the PDS.

        Say some group called “Positive money” notices this and say “it’s all the banks fault”. The Banks are creating money out of thin air.That has to stop. OK so we rerun the scenario again and this time the bank can’t buy bonds. They can’t create new money. They can only directly lend out the 4k they’ve taken in deposits. Does that make any difference? No it doesn’t. The end result is that the Government still is only 6k crowns in debt. And there’s still 3k crowns of liabilities in the PDS.

      • You are still confusing asset based sovereign money and debt-based money acquired by government through selling bonds to institutions who indirectly create money for one another to buy those bonds. Yes there is room – and a need? – for both sources of money but the correct balance is important since it determines how a budget can be balanced and what level of taxation is required to achieve that. Consumer-led economies are not compatible with wholly debt-based monetary systems. Some seem to believe that wealth can only be created through the production of sale-able assets – products or services – or by increasing the productivity of such. However it doesn’t matter how many shed-fulls of efficiently produced goods you might create or services you might offer. If your customers are skint so are you! It is the duty/responsibility of a sovereign state to provide its economy with an appropriate supply of debt-free money that enables that economy to function efficiently. It does not make sense to tax the lifeblood out of that economy just to satisfy some misguided fools’ ideas that all money must be provided as debt created in one bloated parasitic sector of the economy. QE has been an attempt to correct this by injecting liquidity at the same time as bailing out the corrupt sector that fell foul of its own malaise. Unfortunately no control has been maintained to direct that liquidity into the real economy. If what you are saying is correct – that the money created through QE to buy back bonds is still a debt – then who to?
        Those bonds will in due course expire but in the meantime their coupons due for payment by the Treasury are being cancelled by BOE.

      • “You are still confusing asset based sovereign money and debt-based money acquired by government through selling bonds to institutions who indirectly create money for one another to buy those bonds”

        I don’t think so. But lets take it slowly. What is “asset based sovereign money”? There used to asset based money. It was on a gold standard. Not now though. You need to keep up with changing times!

  3. Ok then where did the money for QE arise?

    • The money was created by the Fed in the USA and by the BoE in Britain in the same way that commercial banks create money. That is as asset/liability pairs. The liability for that issued money stays with the BoE which is just another part of government.

      • as long as that “arrangement” is within a central bank and not the state then it’s existence or format is irrelevant – i.e. whether it is a balanced asset/liability or a simple confidence based asset.

  4. Peter Close, currency has value as we have to pay our taxes in it. This creates demand. It is not “confidence backed.”
    As to the banks, there needs to be reform. I favour a credit based system with funding only to capital development and strict regulation.

    • If it’s no longer backed by gold then what is it backed by if not confidence!

      • It doesn’t have to be “backed” by anything. $$ and ££ are tax vouchers. We need to pay our taxes therefore we have to get hold of those vouchers!

        Its really down to the power of the State. If I had the power over you I could demand that you pay me in any currency I chose to issue. Like a “Martin”. Of course you wouldn’t have any “Martins” but you could earn one by washing my car for example. So they’d acquire a value. You could mow my lawn as well and earn an extra Martin to sell, or swap for goods and services, to someone else who also had to pay my tax demand.

  5. I know it doesn’t HAVE to be backed by anything – that’s how Gold has become side-lined but it’s VALUE is still important so that it can be earned through trade or labour and still leave a margin to pay tax so as such there is certainly a confidence element; but OK I was wrong to say “confidence backed”. I’m off to catch a plane to Tuscany for a week – flights for two costing more than a week in a villa at £350! See you next week!

  6. “If there’s too little saving and too much borrowing then interest rates should rise. Is there any dispute on that point? That would have stopped the credit bubble. No problem.”

    I thought MMTers see interest rates as a very poor way of regulating the economy and controlling financial bubbles, and instead advoctate holding the base interest rates near zero?

    • I’d put it as an over-reliance on the use of interest rates is a poor way of regulating the economy. I the past 30 years or so, every time the UK or US economies have needed a stimulus, interest rates have been reduced. So it’s been more than an over-reliance – Govts have relied on interest rates almost exclusively. That can’t happen any longer as they are what economists like Paul Krugman refer to as the zero-bound. They can’t realistically go any lower, to put it simply.

      So, yes, interest rates should be kept at close to zero. The question is how close? Opinion may vary, but I’d say they should be around 2-3% on average. That allows for some inflation to occur, of about the same level, and for savers to be protected against that. It also keeps open the option of the continued use of the the macroeconomic “interest rate control lever’. That’s pretty much useless if it’s pushed to the end of its range.

  7. Peter,
    Ref. your comment May 11, 2015 at 1:25 am. You lost me when with the second part of this sentence… “A new building company asks bank for a loan of 3k crowns. Bank just creates money. “out of thin air”.

    That one-sided description appeals to PM followers as it confirms the belief that bank credit creation is the cause of our ills. But the building company also creates money “out of thin air” at the same time (its IOU, aka loan agreement). Then and only then can both the building company and the bank exchange their money. Result, as for all loans, is private sector net financial assets = zero.

    • When a bank creates a loan it creates equal assets and liabilities.

      So, the bank credits the account of the building company with 3k (crowns) just by editing the numbers.

      Immediately after the loan is issued the position is (not counting any fees or interest)

      Bank Assets = 3k loan Liability 3k for money created
      Building Company Assets 3k in money Liability 3k in repayment to bank.

      Everything sums to zero as it should

      What happens when the money is spent? After a few spendings and respendings those cash assets initially held by the building company end up with government in taxation, or disappear overseas to pay for net imports. So, although the bank is still all square afterwards, the building company have 3k less financial assets once they have spent that money. They still have the 3k liability to the bank. So the net debt in the economy has increased. They have real assets though to compensate, so that it could make sense for them if they end up selling them at a profit. Nevertheless the amount of private debt in the economy has increased.

      If you look at Steve Keen’s website he shows alarming graphs of the build up of private debt in the economy which inevitably led to the GFC in 2008. All that was caused by excessive credit creation in exactly the same way as above.

      • Stephen Ferguson

        Thanks for reply. In my first comment I actually put it a little too dramatically when I said you lost me (you hadn’t, what I meant was your description was inexact). However this time I really am lost!

        You state the building company’s 3k liability to the bank means “the net debt in the economy has increased”. How is that possible?

        I thought that, according to MMT principles, all liabilities have a matching asset and so across the whole (horizontal) private sector everything sums to zero? In other words ‘net debt’ is always zero, and hence by definition cannot increase.

        Yes that individual building company is 3k down, but across the economy, as a result of their spending 3k, others must be sitting pretty as they will be 3k up. That is until the loan is repaid.

        Admittedly the ‘taxing away’ effect occurs, but, as a purely a vertical transaction, isn’t that irrelevant to this ‘horizontal’ 3k?

        Also I know Steve Keen and MMTers are very close, but could this be one area were he and they part company?

      • No I don’t believe there is any divergence between Steve Keen and MMT in this.

        Its all in the sectoral balances. There’s no reason why, as you put it that, “so across the whole (horizontal) private sector everything sums to zero?
        Everything has to sum together over the whole of the three sectors. Not in one sector.


        So, to take the simplest case, if I have a tax bill to pay, and I borrow that money from the bank, the bank just create that new money by editing my account. I pay my tax bill. The government assets increase and my liabilities increase by the same amount. The bank is still all square, so the liabilities of the whole of the private sector must have inceased too. Must they not?

  8. Stephen Ferguson

    Yes all sectors together balance out, but the video makes the same point I made above. Namely (for the domestic sector example) “the ‘inside’ net financial assets…are zero” (see 3:45 mark forward).

    I took your May 17, 2015 at 9:47 am comments that “the net debt in the economy has increased” and “private debt” to mean there was a net debt ‘inside’ the private sector.

    Perhaps we are talking at cross purposes and you meant all along the deficit between the private sector and aggregation of the two non-private sectors?

    • The female character at that point (shortly after 3:45) says:
      ” All internally held and issued assets and liabilites (in each sector) sum to zero”
      The male character then says:
      “So that means for the domestic private sector to have positive financial assets it would have to claims on other sectors”

      He could equally well have said that other sectors could have claims on the DPS. Like tax demands for example.

      So, its only the internally issued AND held assets and liabilities which have to sum to zero within a sector. If they are issued by another sector, or held by another sector, they don’t.

      So, what I was saying before is that when banks issue credit the assets and liabilities initially balance (sum to zero) but after the assets get spent and respent they either end up in with the government, in taxes, or they end up held by overseas central banks as payments for imports. Either way the assets leave the economy (private domestic sector) but the liabilities remain.

  9. Stephen Ferguson

    No confusion, I understood the male character’s point.

    However I can’t recall an MMTer mentioning the “AND held” bit before, but I shall now bear in mind next time I read Bill Mitchell’s etc. writings on this topic. Thanks for that.

    I forgot to mention your point on Steve Keen’s “alarming” graphs of the build up of private debt also persuaded me you were discussing ‘net debt’ purely within the DPS. On that point, as I understand it, Steve is talking from a single-entry bookkeeping perspective of the liabilities of borrowers, whilst ignoring their assets (i.e. Steve’s data has nothing to do with inter-sector balances). Yes there is a causal link, if the government runs a surplus the private sector keeps going by taking out loans with private banks, but given the DPS is almost always in surplus (vis-a-vis the government deficit), whilst at the same time there is a lot of private bank to private sector borrowing, shows the two cannot be one and the same.

    PS “but the liabilities remain” depends on your POV…from bank’s it’s the assets that remain! :).

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