Structural Budget Balance: Analytical Concept or Arbitrary Straightjacket?

1. ‘Structural budget balance’ a well-defined analytical concept or one more arbitrary straightjacket? Post-Keynesian Conference Friday, 23rd May 2014 Jesper Jespersen

2. Why ‘structural’ deficit? EU-regulation: • Has become a part of the European Fiscal Compact: public sector ‘structural deficit’ must not exceed ½ percent of GDP • This is an addendum to the requirement in the Stability Pact that the current deficit should never exceed 3 percent of GDP • Medium term requirement of public sector balance or surplus (does not make sense) Danish fiscal policy ‘rule of thumb’ – more pragmatic 4. ‘Financial Sustainability’ – a constant Debt/GDP-ratio

3. Conventional Economicsshort term Structural budget measures fiscal policy – a balanced SB means neutral fiscal policy. The rule from Bruxelles (max. ½ pct. structural deficit) is severely to restrict the use of (expansionary) fiscal policy in the short run! – independently of the rate of unemployment and other imbalances. The argument is, that the private sector is self-adjusting, does not need support, if the labour market is flexible enough – in any case, persistent unemployment is a symptom of labour market reforms!

4. Conventional economicslong term • Labour market ‘full employment/natural unemployment’ equilibrium • Private sector equilibrium between savings and real investment • Deviations are cleared via the financial capital markets, domestically • Internationally via the balance of payments, capital account (especially within a monetary union without exchange rate risk).

5. These ‘beliefs’ are challenged by post-Keynesian Theory: 1. Any analysis of the public sector budget should always be modelled as a part of the ‘economy as a whole’ Because: • No empirical evidence that the labour market is self-adjusting to anything like ‘full employment’ • Employment in a closed economy depends on effective demand, because private investment is not necessarily equal to private savings at full employment • Effective demand has to be managed (by policies). • Furthermore (private) ‘Balance of payments deficit’ is not automatically financed - not even in Monetary Union

6. Here we are • The Stability Pact limits the working of the ‘automatic stabilizers’ • The Fiscal Compact limits fiscal policy • Which most likely destabilizes the macroeconomic system For what reason? • Are Conventional Economists doing their best? Or they justdon’t trust politicians (Democracy?) • Politicians don’t trust each other: • domestically – the constitution is changed • In the Monetary union – the Lisbon Treaty and independent European Central Bank.

7. Jesper’s methodological ’iceberg’ data clock-work reflexive ‘organism’ agents actors Market System Power, structures, culture Prediction within an ideal market-system Understand reality Inspiration: Martin Hollis Fundamental clash between normative and descriptive economics World 1 World 2 World 3:

8. Conventional Economics The rules of the European Monetary Union Demonstrate how dominant conventional economics is (accepted by 25 out of 27 EU-countries): • Independent Central Bank • Stability Pact • Fiscal Compact Undisputed Recommendations: EU, Berlin and IMF • Balanced budgets in the long run– austerity policy • Labour markets reforms á la Hartz-laws in the short run

9. Where does it comes from? The neoclassical – or dare I say mainstream – macroeconomists’ believe (or fundamental assumption) in the market economic system as a long run general equilibrium system. This believe has not yet been challenged by the mainstream? Macroeconomists.

10. The macroeconomic genealogy Athur Cecil Pigou, 1933 Selfadjusting system:General equilibrium John Maynard Keynes, 1936 Open, indeterment system: trends Old Keynesians (Neoclassical synthesis) ISLM-model Short term Macro Demand & rigid wages John Hicks Post-keynesianisme I Uncertainty Effective Demand Income distribution Joan Robinson Nicholas Kaldor Michal Kalecki Monetarism I Exogenous money supply Vertical Phillips-curve MiltonFriedman Post-keynesianisme II Endogeous money Cost inflation Dynamic method Paul Davidson Hyman Minsky New-classical (Monetarism II) Rationel expectation Representative Agents ‘Policy Ineffectiveness’ ‘Real Business Cycles’ Robert Lucas New-Keynesianism (Monetarisme III) Transaction costs Asymetric information Hysteresis effects Edmund Phelps Gregory Mankiw Post-keynesianismeIII Open Methodology Path-dependency Macro  n * micro Sheila Dow Victoria Chick Wynne Godley Normative economics Positive economics

11. Perhaps, I should stop here This story has been told so many times. That general equilibrium theory is bad as descriptive economics; but easy to ‘sell’ as economics’, because it pretends: individual freedom, neutral markets, rationality and objective analyses. Who can object to these principle? Which leads to an individual/voluntary excuse for unemployment: lack of wage flexibility, social generosity and too high taxes, Government should – like any other household - not have deficits  it burdens future generation etc. etc.

12. Fallacies of composition-arguments are abstract and often unconvincing economics • Higher saving ratios cause total saving to fall • Lower wages cause employment to fall • Public investments financed by deficits are to the benefit of future generations • The welfare state and equality makes everyone better off • Higher Taxes increase productivity These arguments are abstract, difficult to give a popular explanation and for the time being not politically correct! Which facilitates the propaganda of normative economics in populistic settings

13. The outcome: public sector deficits are considered bad politics • Based on normative economics • Intention: to limit expansionary fiscal policy • Probably with the consequence of making economic growth lower than otherwise • Which of course is debatable, but for quite other reasons! • The ‘Dismal Science’