The Osborne problem
George Osborne, 17 August 2010:
There are some political opponents who claim that in setting out our decisive plans to deal with the deficit we have a taken a gamble with Britain’s economy.
In fact the reverse is true. The gamble would have been not to act, to put Britain’s reputation at risk, and to leave the stability of the economy to the vagaries of the bond market, assuming investors around the world would continue to tolerate the largest budget deficit in the G20.
Yeah, right.
Paul McCulley, PIMCO, one of biggest bond market traders in world, 17 August 2010:
When the economy suffers from Post Bubble Disorder, and fat-tail risk of deflation, conventional monetary policy is not enough.
The Osborne problem is not stupidity.
Osborne knows what bond traders really think of ‘Britain’s reputation’, and that they understand perfectly well the risks of renewed recession from Conservative ‘conventional monetary policy’.
Osborne knows that most bond traders advocate sensible fiscal policy which avoids the dangers of a 1930′s-style depression.
The Osborne’s problem is not stupidity.
The Osborne problem is that he’s a devious, lying bastard intent on bringing misery to millions in pursuit of embedding his class’s power over us.
1) Mr McCulley says ‘conventional monetary policy is not enough’, suggesting he thinks more needs to be done.
2) He’s talking about inflation, in which case he’s certainly right. Conventional monetary policy isn’t enough if deflationary expectations get built into the system. A government’s challenge is managing those expectations.
3) Luckily it probably will be enough, as deflation is remarkably unlikely in the current climate. The IMF has recently published some research on this, which was picked up by Paul Krugman, if you follow any of what he writes.
4) No no, most bond traders would love Osborne to do more. The UK has sold its biggest ever bond offerings since the coalition came into power, and they are constantly oversubscribed. Bond markets love tight budgets.
Bond traders expect more QE. Not because they want it but because they recognise that is what the BoE is likely to do.
Osbourne just doesn’t understand the current macro-economics – it’s hard enough to understand as a neutral and he’s has too much unconcious bias towards the politically acceptable interpretation at present. And as today’s polls tell us the electorate are supportive of cuts.
If our politicians understood the current macro-economics they would be explaining the realities of a liquity trap to the electrorate. They are not doing this. Low inflation and low interests are most likely with us for several years – potentially decades if we are unlucky. Think Japan.
David @1:
What evidence is there that McCulley’s talking specifically about inflation?
‘Bond markets like tight budgets.’
They also know when fiscal expansion is needed. Here’s McCulley’s colleague Bill Gross:
Fiscal tightening, while conservative in intent, leads to lower and lower growth in the short run. Tougher sovereign budgets produce government worker layoffs, pay cuts, reduced pension benefits and a drag on consumption and the ability of the private sector to accept an attempted hand-off from fiscal authorities. Recession becomes the fait accompli, and the deficit/GDP ratio moves ever higher because of skyrocketing risk premiums and a plunging GDP denominator. In many cases therefore, it may not be possible for a country to escape a debt crisis by reducing deficits!
It’s a convenient fiction to say the markets favour austerity and short-term fiscal balance. They’ve not favoured that approach in Ireland.
Jamie @2: I couldn’t agree more. The inflation move at the moment is confusing matters certainly, and inflation may be driven by raised commodity prices etc., but long term lack of growth remains the obvious scenario from Osborne et al’ ideology of stupidity. Mind you, I do think he understands macro-economics well enough; it’s just in his interests not to act responsbily on that understanding.