This article in the FT by William White, ex public sector banker, makes the point that simple extrapolations of potential growth like this are an oversimplification and macroeconomic policy needs to look beyond short term crisis management.  White argues that some industries will have significant overcapacity caused by above trend growth in recent years and structural adjustment will need to take place to take out excess capacity and allow these sectors to reduce production to lower levels commensurate with lower levels of demand.  The role of fiscal stimulus is to facilitate adjustment, but implicitly the stimulus needs to be moderate and short term, lest we end up zombie economies like Japan.  A good, old fashioned recession is like healthy forest fires which “burn away the undergrowth that might accumulate and make any eventual fire uncontrollable”.

I wonder if Mr White is protected from the economic equivalents of natural selection, which he views so complacently, by a comfortable public sector pension.

His metaphors from the natural world give us a clue as to what drives his muddled thought processes.  I suspect that, like many who apply metaphors from the natural world (”survival of the fittest”) to the social sciences, his world view is unpleasantly Darwinist.

The biggest confusion is between a short term demand deficiency caused by recession (what we are experiencing now across the board) and the need for declining industries whose day has passed to die off and allow reallocation of capital to more productive sectors (true of certain industries at any time).  In a recession short term demand deficiency leads to loss of business confidence.  Via the mechanism of destocking this feeds through to a vicious contraction in economic activity.  When business confidence recovers, inventory is replaced leading to a sharp recovery in economic activity, which usually (though not always) kicks off a return towards long term trend growth.

Unlike Mr White, I would argue that the role of government spending in a recession is to mitigate the worst part of the economic contraction and thereby ensure that economic capacity is not needlessly and wastefully destroyed, allowing a quicker return to trend growth.

There are clear perils to oversimplifying this – for example in the 1970s economists and politicians in the UK arguably became transfixed by early and simplistic analysis of the trade off between unemployment and inflation and lost sight of the long run limitations of managing the economy solely by reference to this relationship.  Associated with this, the need, for instance, for long run fiscal discipline and appropriate microeconomic policies was lost.

But this is not where we are today.  And simplistic analogies from the natural world are crass and misleading.

At least the debate on cutting public spending has started.  God knows why the Tories took so long to get it going, congratulations to Darling for breaking with Brown’s ludicrous strategy of pretending nothing is wrong.  But some commentators are hysterical – for instance Paul Staines has got it all a bit out of proportion.

I prefer nobel laureate Paul Krugman’s more measured (and better informed) view.

But let’s take a slightly later start date: in 1950, federal debt in the hands of the public was 80 percent of GDP, which is in the ballpark of what we’re looking at for 2019. By 1960 it was down to 46 percent — and I haven’t heard that anyone considered America a debt-crippled nation when JFK took office.

So how was that possible? Was it through drastic cuts in defense spending? On the contrary: we’re talking about the height of the Cold War (with a hot war in Korea along the way), and federal spending actually rose as a share of GDP. So yes, it wasn’t entitlement programs, but it wasn’t exactly discretionary either.

How, then, did America pay down its debt? Actually, it didn’t: federal debt rose from $219 billion in 1950 to $237 billion in 1960. But the economy grew, so the ratio of debt to GDP fell, and everything worked out fiscally.

Which brings me to a question a number of people have raised: maybe we can pay the interest, but what about repaying the principal? Jim gets scary numbers about the debt burden by assuming that we’ll have to pay off the debt in 10 years. But why would we have to do that? Again, the lesson of the 1950s — or, if you like, the lesson of Belgium and Italy, which brought their debt-GDP ratios down from early 90s levels — is that you need to stabilize debt, not pay it off; economic growth will do the rest. In fact, I’d argue, all you really need to do is stabilize debt in real terms.

So let’s keep it in proportion.  As David Smith points out today, the economy in the UK has tended to do better in periods when public spending restraint has applied.

Keep calm and carry on?  Or panic and run around like a headless Guido….

This piece of research from Savills is interesting.  The Savills thesis about the UK housing market is that it is increasingly driven by equity rather than debt, as the home owners who bought their houses in the ownership boom of the 197os and 1980s have paid down their mortgages.  One strange effect of this is that wealthy home owners are actually using their clout in the market to crowd out owner occupiers.  Since 1988, when the rental market was liberalised, private renting has grown from 9% of the market to 14% by 2008.  Even in the mad days of the liquidity boom, when the famous 125% mortgages became available and non status mortgages became so common, owner occupation fell in the UK as high prices made it difficult for aspiting homeowners to get a foot on the ladder.  With credit so restricted this isn’t going to change anytime soon.

Limiting bonuses will not solve the deep problems in the banking sector – Telegraph.

I have to confess that I thought that Adair Turner had gone out of his tiny priviliged mind (after all he is the man who until recently didn’t know what an Oyster card was) when I read the coverage of his comments about the social utility of much banking activity.  Roger Bootle is very interesing though on the futility both of much current banking activity and ironically of attempts to ban the  bonuses that it generates.

The bonus debate is contemptible of course, led as it is by grandstanding politicians with no serious intent to reform banking , even if they are driven by a desire to assuage genuine popular anger.

Who would argue with Bootle’s conclusion:

The solution is not intervention to suppress markets and regulate pay but rather intervention to help markets work better.

Roubini: “U-shaped” recovery is possible – Yahoo! Finance.

The most cheerful thing I’ve seen in ages – if he thinks a U-shaped recovery is possible (and not a “W”) then we gotta chance……!