Friday, June 12, 2015

Running a Surplus in Normal Times is Keynesian

In a recent letter to The Guardian, a coterie of mainly English academics has criticized George Osborne's Mansion House speech in which he proposed to run a budget surplus in normal times. 
Mansion House
According to the letter writers, 
The chancellor’s plans, announced in his Mansion House speech, for permanent budget surpluses [my italics] are nothing more than an attempt to outmanoeuvre his opponents (Report, 10 June). They have no basis in economics. Osborne’s proposals are not fit for the complexity of a modern 21st-century economy and, as such, they risk a liquidity crisis that could also trigger banking problems, a fall in GDP, a crash, or all three.

I have searched for details on the Osborne plan, but they are sketchy. There is no mention in the speech of 'permanent budget surpluses'. Instead, the Chancellor proposes that the Treasury should run surpluses in 'normal times'. He suggests that the Office for Budget Responsibility, should define what 'normal' means. The OBR may not be the best independent body to fulfill this role, but I can certainly see a role for some independent body to recommend when it makes sense to run a current account deficit.

As far as I can see, Chancellor Osborne is proposing to relinquish political control of the fiscal reins in much the same way that Gordon Brown relinquished control of the monetary reins when the Bank of England gained independence in 1997. There is a clear temptation for elected governments to spend in response to electoral cycles and some kind of independent body that keeps that temptation in check is, in my view, a good idea.

Sensible fiscal policy demands that a government should be prepared to run deficits in recessions, but that during normal times, expenditures on non-capital items should be in surplus. Interpreted in this way, the Chancellor's proposal is one that is very much in line with Keynesian economics. 

Keynes' views on fiscal policy are summarized in Volume 27 of his collected works, to which I do not have immediate access. The following is a second-hand quote from the article by Brown-Collier and Collier, "What Keynes Really Said about Deficit Spending", published in the Journal of Post-Keynesian Economics.

Keynes distinguishes public investment, which he wants to be chosen on a cost-benefit basis, from current expenditure, which should not be financed from deficit spending.

Lets not judge the Osborne plan before it is fleshed out in more detail. Running a surplus in normal times is, after all, an essentially Keynesian proposition.  


  1. Roger, Osborne is proposing to run an absolute surplus not just a current one. So no borrowing for investment.

    1. I prefer to see the plan spelled out before judging it.

  2. Don't get duped by Cameron, like the voters were. Read Simon Wren-Lewis, he can say it much better than I can.

    1. Simon has written some excellent posts. I don't always agree with him.

  3. Republicans,Conservatives and Democrats like Obama confuse being out of a recession with "normal times." If the economy is below potential output and there is an output gap, then the economy isn't in "normal times." If the central bank is trying to help the economy, then these aren't "normal times."

    They shouldn't do fiscal consolidation when inflation isn't a threat even if the economy is growing again. This seems very basic but they ignore it because of politics.

  4. There is far too much 'politics' on both sides. I prefer to judge a proposal on merits: not by which side of the aisle it comes from.

  5. If the public sector is in surplus then the private sector won't have the income to purchase all of the goods and services produced; they must be sold as net exports, or else net holdings of financial assets must decline. This might work for a country with a persistent trade surplus, or it might work in unusual times, when the economy was over-heating and needed to be cooled. But in normal times we should expect roughly balanced trade and a gradual *increase* in net financial assets held by the private sector, growing roughly at the same rate as the overall economy -- a modest deficit.

  6. Roger,

    Fascinating post! You write, “Keynes distinguishes public investment, which he wants to be chosen on a cost-benefit basis, from current expenditure, which should not be financed from deficit spending.”

    A quibble: doing a cost-benefit analysis (C-BA) on a public investment still leaves open questions about the right assumptions to use in such a C-BA. The simplest, and still popular, Treasury View very roughly holds that the “inputs” required for the public investment - labor, materials, borrowed money, etc. – will be displaced from other, mainly private investments and uses.

    But this begs the question: if there’s a lot of slack in the economy, won’t the foregone opportunities be much smaller than they’d be under conditions of full employment? (I reject the RBC claim that the term, “slack,” like “involuntary unemployment,” has no meaning, and I believe you do too).

    The same problem arises in estimating the benefits of a public investment. When there’s lots of “slack,” public investment expenditure will generate additional benefits via the multiplier. If the economy isn’t perfectly competitive, so that p > mc, then additional output yields net benefits (leaving aside the distribution of these marginal benefits.)

    Suppose that, all else equal, in a “Keynesian C-BA,” the net benefits of public investment tend to be higher under “slack” conditions than under full employment. The next question is how should we pay for public investment. Ignoring Barrovian claims of Ricardian Equivalence, it seems reasonable to assume that public investment should be debt-financed during hard times. Here are two reasons: 1) debt financing during hard times will most likely increase total expenditure because firms want to sell more; and 2) it will alleviate the tax burden on current taxpayers during difficult times, a kind of consumption smoothing.

    Now, leaving aside the somewhat narrow, public deficit vs. public surplus dichotomy, the question is whether, during good times, a higher portion of public investment expenditure should be financed from current revenue. One answer, which could perhaps be drawn from Keynes’ colleague, Frank Ramsey, is that the optimal long-term deficit/surplus time profile is the one that maximizes the expected PV of utility across all people over some period of time. But I doubt this would have been Keynes’ fully considered conclusion on the subject.

    Some details here:

  7. Keynes aside, some of the modern inheritors of Keynes (MMT) take a distinctly different view. They observe that the normal condition of developed countries like the US and UK is to be in trade deficit, which means someone has to run a budget deficit domestically, either the domestic private sector, or the government. Better the government, or else recession becomes continuous. Then there is simple economic growth- where is the money for that supposed to come from? Out of thin air? No, again, the government provides the net high-powered money through its deficits, allowing the other sectors to grow and accumulate wealth. So the bit of Keynes as cited is insufficient to meet modern conditions- he would have been running "special" deficits all the time to correct contractionary tendencies.


Note: Only a member of this blog may post a comment.