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Professor Roger Middleton

Professor Roger Middleton. Lessons of the 1930s British Monetary and Fiscal Policy in the 1930s Chatham House, 29 November 2010.

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Professor Roger Middleton

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  1. Professor Roger Middleton Lessons of the 1930s British Monetary and Fiscal Policy in the 1930s Chatham House, 29 November 2010

  2. [T]oday we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand. The result is that our possibilities of wealth may run to waste for a time – perhaps for a long time. Keynes (1972 [1930], p. 126)

  3. Introduction In seeking to understanding the British version of the Great Recession, beginning 2008.QII and (provisionally) ending 2009 QIII, it has been natural to return to history for lessons as well as to follow closely contemporary experience elsewhere, not least in the US. The much-visited NIESR ‘progress of the current recession’ provides an immediate historical reference point for: four recessions and a depression:

  4. Progress of the current recession Now 1930s

  5. British monetary and fiscal policy Will focus on three aspects of my OXREP paper: • The problem of policy ‘lessons’; • British distinctiveness in a literature dominated by Americans, and where ‘To understand the Great Depression’ – in the words of the Fed chairman – ‘is the Holy Grail of macroeconomics’; and • Fiscal policy, especially the fiscal stance and fiscal sustainability

  6. The demand for and supply of policy lessons • Policy transfer is a staple of a number of the social sciences, BUT • Whilst economic historians are pleased to be part of this process they do warn that: • History SHOULD BE a knowledge base to be scoured, NOT • A rhetorical weapon to be deployed tactically • With the ‘Great Recession’ (2008-201?), and fiscal policy in particular, History invoked in two senses: • As the risk of repeating, or prospect of avoiding, some stylised historical past (Great Depression) if the right policy lessons are not learnt; and • The current situation as either the worst fiscal imprudence of any postwar government or the inevitable and justifiable consequence of a responsible government not overriding the automatic stabilisers, thereby preventing the Great Recession becoming a Great Depression

  7. Lessons from the Great Depression • Bernanke’s four policy lessons; all appropriate: • Economic prosperity depends on financial stability; • Policy-makers must respond forcefully, creatively and decisively to severe financial crises; • International crises require an international response; and • History is never a perfect guide. • Of these the fourth is the most important; indeed: • Even assuming we can surmount the epistemological problem of knowledge transfer, we should be • Open to the strong possibility that the lessons are stronger as negatives than as positives, namely what should not be done in general as against what might be done, this largely situation specific • This leads to our second theme: the distinctiveness of the interwar British economy

  8. Distinctiveness of interwar British economy (1) Britain had a ‘great depression’, not a Great Depression, as can be seen from the path of real GDP • Contraction phase (peak-to-tough): • UK: annual -5.4% (1929-31); quarterly -7.6% (1930Q1-1932Q3) • US: annual -26.6% (1929-33). • Recovery phase • UK: + 16.4% growth 1929-37 • US: + 5.3% growth 1929-37

  9. Comparative real GDP: UK and US

  10. Distinctiveness of interwar British economy (2) Thus, UK had a relatively mild contraction phase and much more pronounced expansion: • Some stylised facts of relevance, especially in relation to US then and UK now: • Rise in unemployment much greater than the output loss (a high employment-output elasticity); • Unemployment had a high political salience before the 1929 downturn; dominating general election campaign (‘We can conquer unemployment’); • Initial demand shock was external and, given UK openness, the transmission mechanism is relevant as is nascent external constraint; • No domestic boom, no asset bubble, no banking crisis; • Fiscal system characteristics quickly translated real economy downturn into a fiscal crisis, culminating in collapse of a government and a ‘gamble’ budget; • BUT British central government exercised very considerable fiscal leverage – thus considerable policy potential

  11. Distinctiveness of interwar British economy (3) Figures 2 and 3 of OXREP paper (reproduced side by side in next slide) show the change in GDP and components for the two economies for the three phases; very different situations, relative policy space and thus potential efficacy for monetary/fiscal policy activism, whether pre-Keynesian or Keynesian-inspired: • Contraction: differential scale; UK export losses dominant, whereas consumption/investment expenditures largely maintained – cf US where 90% of GDP loss for US was consumption/investment. However, unemployment peaks broadly comparable – the labour market thus of interest

  12. Distinctiveness of interwar British economy (4) UK US

  13. Distinctiveness of interwar British economy (5) • Recovery: greater UK-US similarity, but one important difference which suggests a probable differential monetary policy impact: cheap money and the housebuilding boom – cf US and failure of investment to recover beyond 1929 levels, whereas in UK was 27% above that level by 1937; • Rearmament/prewar recovery: much similarity with government expenditure the dominant reflationary impulse, this comprising rearmament for Britain but not for the US until 1941 Now turn to look at fiscal policy

  14. Fiscal policy (1) For the 1930s there are two stories told: • I. Effects of the policies pursued: • Pursuit of budgetary orthodoxy made fiscal policy inherently destabilising; and • More recent story, authorities knew this and tried to lessen impact of this through fiscal window-dressing • II. Possible effects of the Keynesian path not trodden – series of studies from Keynes and Henderson, ‘Can Lloyd George do it?’ (1929), through to present day econometric modelling: • Keynes and Henderson (1929); Keynes (1933): multiplier of at least 2, no crowding-out; • Early econometric history studies (Thomas 1981) multiplier between 1.0-1.5, more sceptical about effectiveness; and • Current, e.g. Dimsdale and Horsewood (1995) , reaffirming a role for deficit-financing and unconvinced by crowding-out arguments

  15. Fiscal policy (2) Concurrently, and especially once policy history begins from late 1960s, a rich history on whether the Keynesian solution was practical given the ‘Treasury view’, this itself highly contestable as it was gravely misrepresented by Keynes and the Keynes.

  16. Fiscal policy (3) Will examine three aspects of the 1930s fiscal policy debate which have resonance for the Great Recession: • Background: debt dynamics, especially how debt hangover from First World War narrowed policy space and had important implications for monetary and fiscal policy; • Implications: fiscal sustainability – what the primary balance tells us; and • Micro-focus on the crisis years: fiscal consolidation and the fiscal stance, 1930-2

  17. Fiscal policy (4): debt dynamics

  18. Fiscal policy (5): fiscal sustainability

  19. Fiscal policy (6): fiscal crisis 1930-2 • Official policy to balance the budget; this made fiscal policy inherently destabilising if a shock to demand threatened the ex post balance, necessitating the authorities over-riding the automatic stabilisers, thereby risking a vicious circle of contraction and tightening; • Recognised this risk and sought partial alleviation through fiscal window-dressing; • BUT over-rode automatic stabilisers in 1930 budget; again in April 1931 and, following the May Committee report, once more with the September 1931 budget • 1931-2: a gamble; coming off gold increased the premium on the appearance of orthodoxy

  20. Fiscal policy (7): fiscal stance

  21. Fiscal policy (8): GDP deviation vs fiscal policy stability

  22. Conclusions My OXREP paper, a much earlier book and a forthcoming Virtual Issue of the Economic History Review (Middleton 1985; 2010a; b) provide a much fuller story, but the 1930s British economy shows: • Problems of stabilising a large open economy amidst a global depression, initially with a fixed rate; • Difficulties of securing fiscal consolidation when unemployment high and strong pressures for public expenditure growth; • Risks of over-riding the automatic stabilisers, themselves pronounced; • Policy was not Keynesian (not even Keynesian passive), deficits were small and viewed from the longer run TPE and TR were relatively stable (OXREP figure 10); • Length of time unemployment can take to return to pre-recession levels (initial starting point was historically high); • Power of military Keynesianism; it was deficit-financed public works that brought Britain back to something like full employment by the eve of the war;

  23. Conclusions (2) • And all of this without the sorts of problems with which the US authorities had to grapple – no bank closures, no domestic asset bubble. • MOREOVER, it could all have been worse: fortunate circumstances, especially a myriad of permissive forces behind the building boom. NB There is no one Britain in the 1930s – why the policy story is a basically a national account, the North-South (Inner-Outer Britain) provides a very different perspective.

  24. References Dimsdale, N.H. and Horsewood, N. (1995) ‘Fiscal policy and employment in interwar Britain: some evidence from a new model’, Oxford Economic Papers, 47 (3), pp. 369-96. Keynes, J.M. (1930) ‘The great slump of 1930’, National and Athenaeum, 20 and 27 December. Rep in JMK (1972) IX, pp. 126-34. Keynes, J.M. (1933) The means to prosperity. Rep in JMK (1972) IX, pp. 335-66. Keynes, J.M. and Henderson, H.D. (1929) Can Lloyd George do it? - The pledge examined. Rep in JMK (1972) IX, pp. 86-125. Middleton, R. (1985) Towards the managed economy: Keynes, the Treasury and the fiscal policy debate of the 1930s. London: Methuen. Middleton, R. (2010) ‘British monetary and fiscal policy in the 1930s’, Oxford Review of Economic Policy, 26 (3), pp. 414-41. Middleton, R. (2010b) ‘Macroeconomic policy in Britain between the wars’, Economic History Review, 63.VI, forthcoming. Thomas, T. (1981) ‘Aggregate demand in the United Kingdom, 1918-45’, in R.C. Floud and D.N. McCloskey, eds, The economic history of Britain since 1700. Cambridge: Cambridge University Press, vol. 2, pp. 332-46.

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