Why the UK’s 2% inflation target is wrong

Published by Anonymous (not verified) on Wed, 09/05/2018 - 4:12pm in



Earlier this week I suggested “Why Positive Money is Wrong” (read here). Prof John Weeks wrote this post in response, looking at the issue of the 2% inflation target. It was first published on Brave New Europe. John Weeks is Professor Emeritus at SOAS, University of London, and associate of Prime Economics.

The recent article by Richard Murphy clearly and succinctly demonstrated the fallacies of monetary arguments set forward by Positive Money.  I write to elaborate one of his five points, the critique of policy seeking to attain and maintain a specific inflation rate, “inflation targeting”.  Murphy explained the basic flaw, that inflation targeting is dysfunctional and politically reactionary.  My focus is more narrow, that the 2% target of both the Bank of England and the European Central Bank is bad policy because technically unsound.

The European Central Bank aims for a target rate less than 2% of a measure named the Harmonized Index of Consumer Prices, while the Bank of England uses the so-called CPIH measure.  Both measures share the flaw of including of internationally traded commodities, over which neither the ECB nor the Bank of England has any substantial influence.

By definition the rate of inflation equals the sum of price changes for internationally traded goods and services, price changes in constrained markets, and changes of domestic (“non-traded”) goods and services in unregulated prices.  The first category includes all those goods and services whose domestic price is determined in international markets.  The most obvious example is petroleum, as well as almost all producer inputs.  Airline fares and shipping charges are services whose domestic prices closely follow international petroleum prices.

The second category includes all prices set by contract or public sector regulation.  The importance of this category will vary across countries.  Examples are public utility pricing (water and gas), public services and some modes of transport (e.g. railroad and bus fares).  In the third category fall all goods and services relatively unaffected by international markets, public regulation or private contracts.

The inflation target rule requires the sum of the price changes for these three categories be close to w 2%.  A rise in internationally determined prices above 2%, for example an oil price increase, is beyond the control of the ECB or the Bank of England.  Therefore, the prices in one or both of the other categories must rise less than 2% in order to meet the inflation target.  However, many goods and services in the second category have prices relatively inflexible in the short run because of public regulation and private contracts.

As a result all the greatest adjustment must occur for domestic goods and services in unregulated markets.  The lowest-paid workers tend to find their employment in these markets precisely because they are unregulated – employees not in trade unions and many self-employed such as care workers.  The nature of the three types of markets implies that meeting an inflation target tends to reinforce and increase inequalities.

The market structure of every economy also undermines the effectiveness of targeting as an example shows.  If half of all goods and services fall into the first two categories and these prices rise by 3%, then prices in unregulated domestic markets can only rise 1% to meet the ‘less than 2%’ target.  It is likely that the first two categories take a considerably larger share than half in Britain and most continental countries, which means no increase or even deflation in unregulated markets.  Even if international prices transfer only slowly into domestic prices, the principle remains, that the unregulated markets must bear the weight of adjustment.

More serious is that ‘less than 2%’ is an unsound target, for an even more fundamental reason. Twenty years ago the Boskin Commission in the US estimated that new products and quality change account for between 0.8 and 1.6 percentage points in the US cost of living index, taking 1.1 as “best estimate”.  In a world of globalized markets and production, the British and EU estimate is unlikely to be very different.  Therefore, an inflation target below 2% de facto aims for an effective rate of less than 1%.

The benefits of a capitalist economy come from its dynamism, the continuous reallocation of resources in response to technical change and shifts in consumer preferences.  This allocation occurs through price adjustment. For example, workers move between sectors in response to wage changes.  Some wage inflation and therefore price inflation are inherent in the efficient operation of a market economy.  The (less than) 2% inflation target is in theory and practice deflationary, achieved by suppressing the price adjustments essential to economic growth.

Inflation targeting is dysfunctional in principle.  Assigning this dysfunctional rule a target of 2% is absurd and technically unsound.

Radio 4 Programme Next Week on Universal Basic Income in Kenya

Published by Anonymous (not verified) on Wed, 09/05/2018 - 12:50am in

This coming Sunday, 13th May 2018, Radio 4’s In Business programme is exploring Kenya’s Universal Basic Income programme. The blurb for the programme on page 121 says

Anne Soy visit western Kenya, where every adult in nearly 200 villages is receiving $22 a month, no strings attached, for 12 years. Will this kick-start development and bring people out of poverty? The world’s largest experiment in universal basic income is trying to find out.

This could be extremely interesting, as many people feel that this would also be solution to the problem of poverty in the Developed World, and there are similar programmes in parts of Canada.

Announcing the new Goldsmiths Press PERC Series

Published by Anonymous (not verified) on Tue, 08/05/2018 - 11:00pm in

We are delighted to announce full details of the new PERC book series, which we hope will attract interest from readers and authors for many years to come. We’d welcome any enquiries and submissions – all details are provided below.

The PERC book series sits within the new Goldsmiths Press and is overseen by PERC’s Co-Directors, Aeron Davis and Will Davies. To date, it has featured two titles: The Death of Public Knowledge?  and Economic Science Fictions. A third title, Can Markets Solve Public Problems?: An Expedition into Neoliberal Interventions by Daniel Neyland, Vera Ehrenstein and Sveta Milyaeva will appear in autumn 2018.

Political economy begins from the recognition that economic structures are both the sites and outcomes of political struggles, at numerous scales. With that in mind, this book series seeks to publish work that revives, refreshes and reorients the study of political economy. We are seeking work that is not simply inter-disciplinary, but carves new paths between disciplines and different fields of empirical enquiry, bringing unexpected perspectives to the critical, theoretical and cultural study of the economy. At a time of great political and economic turbulence, this series will strive to illuminate the contemporary, for both academic and non-academic readers.

In keeping with long-standing traditions of Goldsmiths, the PERC series is committed to the cultural examination of contemporary capitalism, and to that end welcomes submissions that draw on cultural studies, economic anthropology, science and technology studies, history of economics, media studies and cultural economy. The series hopes to include critical investigations into (inter alia): neoliberalism, financialisation, management, money, inequality and elites, the platform economy, expertise and the economy of the anthropocene. Yet it also aims to create space for alternative economic futures to be identified, mapped and elucidated, seeking possibilities and hope in the crises of the present.

This series offers authors an opportunity to innovate, both in the content and the format of their publication. It caters both for traditional academic scholarship in the field of political economy (publications are peer reviewed and REF compliant) and for more unusual interventions, that are less easily classified. Due to the small size of Goldsmiths Press and the PERC Series, authors will have the benefit of a close working relationship with editors, which can – should authors wish – support books that break new ground in how political economy is imagined, narrated, visualised and published. All Goldsmiths Press titles are marketed and distributed globally by MIT Press.

About Goldsmiths Press

Goldsmiths Press aims to revive and regenerate the traditions and values of university press publishing through the innovative use of print and digital media. Its publishing cuts across disciplinary boundaries and blurs the distinctions between practice, theory, fiction and experimentation. Its list spans publications of diverse formats, lengths and writing styles.

Goldsmiths Press hopes to create a culture around academic knowledge practices that is more inventive and less constrained. As a unique collaboration between academics, writers, artists and publishing professionals, under the direction of an academic researcher, it is already part of a growing conversation around the future of academic publishing.

Goldsmiths Press is the UK’s first green open access monograph publisher, combining open access with a fair and varied pricing model for print books. Its books are marketed and distributed globally by MIT Press.

Submission Guidelines

If you have a book proposal which is ready and suitable for the PERC Series, please follow the submission guidelines as detailed on the Goldsmiths Press website, clearly indicating in the proposal that it is intended for this Series. The template submission forms should be used.

Alternatively, if you would like to discuss a possible title and explore its potential suitability for the PERC Series, please email Will Davies – w.davies[at] – including as much detail as you can regarding the idea. Will, or a colleague at Goldsmiths Press, will be happy to discuss the possible book with you, and how it might fit within the Series.

The post Announcing the new Goldsmiths Press PERC Series appeared first on Political Economy Research Centre.

Sticking plasters will not solve real intergenerational issues

Published by Anonymous (not verified) on Tue, 08/05/2018 - 5:43pm in


Economics, NHS

The Resolution Foundatioin is the latest progressive think tank to issue a sticking plaster report. According to many reports this morning its intergenerational commission is making a series of what, I hate to say, look to be pretty misguided recommendations today.

First it is saying that each 25 year old should get a £10,000 lump sum from the state.

Second it is saying changes to inheritance tax should fund this.

Third it is saying that those who work over the age of 65 should be made to pay national insurance to help fund the NHS.

I am sure there is more to the report than this, but headlines matter and these do not sell well, for quite fundamental reasons.

First, why 25? What’s so magic about being 25? Why not create a right to Universal Basic Capital, to be claimed once in life, of at least £10,000? Then make clear that it has to be used for a purpose: housing, education, creating a business, paying for training or whatever. Of course it could still be abused. But that’s a risk worth taking. And if the application required an explanation as to what the funds were to be used for (with assistance to be provided for those who would need help making such a claim) then that risk would be minimised and the return maximised. And this then becomes linked to oppprtunity, and not just an arbitrary date long used by the families of the wealthy to indicate the time when the younger generation got their hands on their trust funds.

Second, why £10,000? And why in a lump? Why not be considerably more creative - and allow a phased pay down as well if all is not required at once? And why not allow more when the case can be made?

Third, let’s not pretend this does anything very much re housing: it simply does not. Or education debt come to that, where it is mere tinkering. It has to be something else then.

And fourth, please let’s stop the left being obsessed with the ‘How are you going to pay for it?’ argument. Let’s be clear that nearly 35% of any such grant would be paid for by the tax paid when it is spent - because spent it will be, and overall that’s the likely tax that will be paid by the first recipient of the spend. But as they spend the receipt that recovery will grow. This grant does not need to be paid for with Inheritance Tax: it will pay for itself with tax generated by it being spent.

Fifth, if you want to tax inheritances justify it in its own right to reduce wealth and to address the issue of inequality - not to say it pays for something, when it (like all tax) never pays for government spending.

And last, stop the nonsense that NIC pays for the NHS, and stop too the nonsense spouted by David Willetts on the Today programme this morning, who said that it was unfair that the NHS should be paid for by those of working age. Apart from the fact that is it not paid for by them, what he should have said is that it is wholly unfair that work is taxed considerably more heavily in the UK than investment income, which carries no NIC at all, can be diverted into low rate capital gains for which there is a second effective personal allowance a year, and which also has very high rates of non-declaration. Instead of simply piling extra tax on other workers, which bizarrely is the Resolutuon Foundation solution (making it look very non-progressive indeed) the answer is to increase CGT, create an investment income surcharge of 15% extra income tax on invetsment income of more than £5,000 a year (effectively extending the so called dividend tax to all investment income) and to cut the CGT allowance, considerably. Those measures target inequality and would happen to raise considerable revenue.

That would be progressive. Right now I have to say I see very little progressive about the Resolution Foundation propsoals. It is instead another attempt at electoral triangulation that will really not solve any problem, and most likely create new ones needing fairly rapid correction.

We really do deserve some decent thinking on tax. This is not it. Sticking plaster will not do.

Towards a reading list

Published by Anonymous (not verified) on Tue, 08/05/2018 - 5:15pm in



A new commentator has said this morning:

Thanks to your writings on this blog, I am interested in learning about modern monetary theory in some detail. Doubtless your “The Joy of Tax” will contain a fair bit about it (and I will be getting my hands on a copy as soon as I can), but can you recommend any other books on the subject of MMT for the (mathematically literate, in my case) layman? For that matter, do you by chance have any other texts you regard as essential for non-specialists? Thank you very much.

A reading list is one of those things I keep on thinking of doing, and don’t achieve.

I know we have been here before. But suggestions please? And maybe they could then go in the Wiki (which is another thing I mean to do, and don’t get round to doing).

I would nominate my own books. But what then?

Steve Keen, Debunking Economics is my first choice for the vaguely mathematically literate.

Now, what would you add? I don’t want to dominate this, partly for my own interest.

And is there a volunteer who might then like to write it all up? I would be happy to include links to a vendor, but not Amazon, for obvious reasons. Waterstones would do for me: at least it keeps books on the High Street as well.

Macroeconomic modelling,endogenous money and Modern Monetary Theory (MMT)

Published by Anonymous (not verified) on Tue, 08/05/2018 - 3:44pm in



I am pleased to repost this comment piece by my colleague Hector Pollitt from the blog of Cambridge Econometrics Limited, of which company I am a director. The post has a simple goal, which is to explain that macroeconomic modelling  can break out of the confines of its normal constraints and add value in the real world:

Unlike most other macroeconomic models, Cambridge Econometrics E3ME model includes endogenous money as a core feature (including borrowing by government). This difference is important because it allows us to best predict outcomes that might be encountered by our clients.  Find out how…

We get a lot of questions about treatment of the financial system in our macroeconomic modelling – and rightly so, because it is both a key determinant of model results and different to most of the other models out there.

One of the reasons for such interest is that treatment of the financial system in models was brought to the fore following the financial crisis (see my previous blog).

Virtually all of the economic models failed to predict it. The model builders decided that the financial sector was unnecessary and missed a crucial aspect of what they should have been analysing.

To be clear, E3ME is not a tool that can predict financial crises and it quite likely never will be. But it is different from most other models in that endogenous money is a core feature, including borrowing by government.

In this way Modern Monetary Theory and E3ME can be aligned. In this blog I explore how and why that alignment is important.

What is endogenous money?

First, some brief explanations for non-economists. The key principle of endogenous money is that the quantity of money is not fixed and is not determined by the central bank. Every time a commercial bank makes a loan, it provides money that may be spent in the real economy.

Crucially, commercial banks do not need to have all the deposits for which to make the loans (every time someone gets a new $100,000 mortgage there is not someone depositing a similar amount). The central bank provides the necessary reserves, as the Bank of England acknowledges.

Endogenous money is core to post-Keynesian economics; Marc Lavoie’s recent textbook discusses money before the real economy. The issue is prominent in nearly all of Steve Keen’swork and there are many further examples. Without considering money endogenously, it is not possible to consider potential economic stimulus effects.

Any boost to spending would instead ‘crowd out’ other expenditure, usually leading to negative impacts and running counter to the observed reality.

This paper by Jean-Francois Mercure and me explains further why the issue is so important in modelling.

What is Modern Monetary Theory?

Modern monetary theory (MMT) extends the concept of endogenous money to the government sector but with one important difference. That is – if debts are issued in its own currency, a government need never default. The level of public debt does not matter (outside the eurozone), as the central bank can always provide new money to cover the debts.

The idea that the UK could have, for example, gone bust in 2010 which was widely promoted at the time was simply wrong; technically it is impossible for the UK to do that because almost all its national debt is in sterling.

What is widely agreed is that when a government spends more than it taxes, it stimulates demand in the real economy. MMT argues that this is beneficial to the point of economic capacity (e.g. full employment), at which point further expenditure will cause inflation.

This means that the level of government spending can (and many would say should) be adjusted to account for the economic cycle and that public sector austerity is only necessary in a booming economy.

For further discussion see this blog post by Richard Murphy (a non-executive director at Cambridge Econometrics).

So how is this modelled?

In the E3ME model there is no constraint that matches bank loans to deposits. In other words, it is assumed (as is true in the real world) that investment can be funded by new credit and that savings are not required to create that credit.

Investment (which could also be financed retained profits) is determined by expected production levels and the cost of investment goods.

Savings are determined as the residual between incomes and consumption and usually increase when there is lower job security (as e.g. purchases of new cars and other large purchases are pushed back).

Interest rates do change in the model but using a Taylor rule that mimics central bank behaviour based on the real economy rather than trying to balance loans and deposits, which is not what happens in the real world of banking.

The result in E3ME is that when the economy is in an upturn, investment increases while savings decrease, providing further economic stimulus (i.e. multiplier effects) – because banks are willing to lend more across the economy. So, the quantity of money increases and this has real economic impacts.

This result contrasts starkly with equilibrium-based approaches where interest rates adjust automatically so that no stimulus or change in the money supply occurs.

That said, the government sector is mostly treated as exogenous in E3ME, both in terms of tax rates and spending (tax revenues are semi-endogenous as they are determined by activity rates in the tax base as well as the exogenous tax rates).

This, however, is deliberate: it is up to the model user to determine whether the government maintains a consistent balance or provides stimulus/contraction to the economy. There is no constraint in the model that government budgets must balance, either in the short run or the long run.

Different scenarios can then be tested, which we think is important.

Do we model ever-increasing debts?

Discussions of endogenous money inevitably lead to questions about how much debt it is possible for an economy to sustain. MMT tells us that for central government there is no limit, as the central bank can always provide more money, which is also what happens in E3ME. But private sector debt levels may be much more serious.

The key question of interest is: when does a shock convince banks that they may not get their money back? Once the banks stop lending (or even call in outstanding loans) the supply of money can contract sharply, impacting the real economy sharply.

This is what can create downturns and is one reason why quantitative easing was necessary from 2009 onwards: the government had to create the liquidity that commercial banks were withdrawing from the economy by injecting new money using what it described as unconventional monetary policy.

The point at which banks stop lending is often described as a ‘Minsky’ moment after the economist Hyman Minsky. No one, and certainly not the E3ME model, can identify when this moment might occur, but there are indicators (most obviously private debt levels in relation to output) that can give a good indication of problems coming.

Estimating these types of indicators at sectoral level is difficult given the absence of current data, but this is an area that we are working to improve the available metrics in the model.

In summary, endogenous money is a core feature of the E3ME model. E3ME’s philosophy is consistent with MMT in that it is possible to assess the effects of stimulus packages or austerity on the wider economy; this is mainly a question of how the scenarios are designed. That said, when it comes to tracking private debt and the potential for financial collapse, there is much work still to be done.

There is a lot we could learn here from recent models built by Steve Keen, Yannis Dafermos and Gaël Giraud among others. Some of the insights from these tools could potentially be integrated to a model such as E3ME; others may take the modelling at Cambridge Econometrics in a new direction.

The critical point is, however, that we are embracing both the world as we see it and best theory that reflects that world as we and our clients see it with the aim of creating models likely to best predict outcomes that we and our clients might really encounter.  And this, we think, is core to our work.

Hector Pollitt 
Director, Head of Modelling 
Cambridge Econometrics

Why shares are over-valued and the consequences

Published by Anonymous (not verified) on Tue, 08/05/2018 - 3:27pm in


  1. The question

The question this note addresses is ‘what’s the problem with investing in shares?’ By answering that question it also tackles a range of other issues. It has been written in response to a discussion on the Tax Research UK blog, where many commentators said that I was wrong to suggest that investing in shares is now foolhardy and the investing in government bonds or even cash would make more sense. This note explains my reasoning. There is a PDF of it available here.

  1. The story to date

Investors have usually had five investment options into which to place their funds to date:

  • Shares;
  • Corporate bonds;
  • Government bonds;
  • Property;

All other options tend to be derivatives of these. The only question most investment managers have faced is what mix of these assets to use. The mix for UK insurance and pension funds in 2016 is shown on the next page[ii]. Short term assets would include cash and term deposits. Other assets include property and hedge fund investments.

What is notable is that these funds rarely actually invest i.e. they do not fund new assets or employment creating activities: they have instead saved, which is a fundamentally different economic activity.

  1. Returns have been largely risk related

The return on investments is expected to vary:

Low or even negative returns in times of inflation

Averaging more than cash, but because of their security are expected to deliver a low yield.

Corporate bonds
Attracting some risk but clearly more secure than shares but less so than gilts, so having a return between the two

Relatively risky investments, giving rise to the hope of returns significantly higher than those available in any bond, whether issued by government or the private sector.

The return depends heavily on location.

Some data may help. This is long-term data based on information from Barclays Bank[iii]:

Long-term equities appear to win, hands down. Short term the same data source does, however, suggest very different trends[iv]:

The returns are stated after allowing for inflation: gilts have beaten shares over twenty years, but not over 116. Few of us have 116 year planning horizons.

The mix between portfolios in pension funds varies by country[v]:

The ratio has also changed over time in the seven countries noted in the previous chart:

Share investment has declined and been replaced by property and other assets (hedge funds, in the main, which manage derivatives of other assets).

  1. The balance of risks

Managers and maybe individuals invest to balance risks determined by age and risk appetite. The young can take risk, and so their portfolios tend to be biased that way. The older a person gets the more certain they want their returns to be, and they wish to minimise downside potential. They shift to gilts, maybe property and even cash. So portfolios tend to shift depending on the profile of those for whom they are managed.

  1. Market distortions

I believe it is possible that the conventional logics that have long ordained investment norms may need to be reappraised. There are a number of reasons.

What might be called ‘normal markets’ no longer exist. The Global Financial Crisis of 2008 has disrupted what were already abnormal markets. They have not returned to ‘normal’. This is because markets have not acted rationally for a long time and in particular government incentives and taxation have biased returns in many markets in cumulative fashion that may now be deeply significant and potentially unsustainable. I look at each sector in turn.


Property markets have been distorted:

  • Subsidies to home owners or landlords to acquire property via interest relief have distorted prices;
  • The exemption from capital gains for many householders means that there has been a massive incentive to buy a home, and retain it. The exemption has potentially very significantly increased the rate of return on property investment for many, and had commercial spillover;
  • Commercial property markets have also had incentives provided;
  • All property markets have been boosted by the constraints on the shortage of supply of land, not just created by planning but by that of very specific location based demand.


Cash markets have been distorted by the deliberate suppression of interests rates post the GFC: without QE in many major markets rates would not have been low as they have been for a decade. This has reduced the attractiveness of cash holdings in portfolios.


The value of gilts has been distorted by QE; that was its intention. The return has been suppressed but as a result their value has been inflated, these having an inverse relationship with each other.

Corporate bonds

The rate of return on corporate gilts has been distorted by central bank measures to suppress interest rates. This was not the intention, maybe, but by increasing demand for these bonds yields have fallen.


Share valuations have been significantly distorted by a range of policies:

  • QE was intended to encourage investment in higher risk assets than gilts: most shares match that criteria. Their value has almost certainly been inflated as a result;
  • Pension investment has guaranteed a steady flow of new funds into stock markets over 70 or more years. The increase in the value of investment funds managed in the UK is some indication of this trend[vi]:

  • Inflows to pension funds over this period have exceeded outflows: this is the inevitable consequence of a population that has grown over that period because of rising birth rates, lower mortality amongst the young and net immigration by those who tend to be young at the time of arrival. Dependency rates (the number of elderly supported by people of working age in the population) have been broadly stable for more than twenty years but is now rising[vii]:

  • Pension investment has been encouraged by tax relief or government interventions, either compelling investment now or in the past by incentives matched to the withdrawal of state based options. This has expanded the contributor base in advance of claims made by those of pension age[viii]:

  • This has created a net monthly demand for new share-based investments as the portion of the pension contributing population growing fastest has been that with higher risk appetite.

In other words, there has to date been a persistent net, decade-long, buying market for equities as a result. Demand has always been designed to exceed supply. There has as a result been an overall increase in share values over time.

Low rates of tax on non-pension share investment (by capital gains tax) has encouraged this trend.

So too have a wide range of government policies. Amongst these are:

  • The rise of The Washington Consensus, intended to (and succeeding at) increasing the overall share of profits in the national and global economy;
  • Low, and steadily declining rates of corporation tax to boost the net rate of return on capital;
  • Little effective attempt until recently to tackle the use of tax havens that have been used to increase the net after tax rate of return to companies;
  • Deliberate moves to shift the tax burden to labour and consumption and away from capital.

All have increased equity share yields.

  1. The net result

Against this background a number of other trends have emerged:

  • Companies have been accumulating funds in excess of their investment requirements. There are varying reports of the size of corporate cash piles: in the US alone the sum is thought to run to trillions and it is a general trend[ix];
  • Corporate investment requirements appear to have fallen: net business investment has been low as a proportion of GDP despite corporate funds being available for investment[x]:

  • Companies have used the excess funds to buy their shares back, spending much more on this than they do on dividends now, with a marked correlation to share prices[xi]:

  • Buy backs ensure net reducing supply of shares to a net forced buying market, guaranteeing continuing share prices.
  • Share incentive schemes and tax incentive schemes have encouraged this behaviour.
  • There are almost no new net share issues as a result to actually raise capital: share issues are for M & A (which does not raise new net capital) or buying out existing shareholders, usually on IPO. Spotify floated recently and raised no capital at all.

The consequence has been:

  • Wealth inequality has risen, considerably;
  • Access to housing has fallen as wealth inequality has risen;
  • Inter-generational solidarity has been lost;
  • And, bizarrely, pensions are failing because yields on excessive values are so low that increasing life spans cannot be supported by the available return on safe funds used to fund annuities, resulting in increasing pension fund deficits despite massive valuations. The system is not working.

It can also be argued that there has been a failure of the fundamental pension contract i.e. that a retiring generation must leave to the next sufficient physical capital that the next can afford to forego part of its income to sustain that generation now in retirement making use of the tangible capital that they provided to enable them to do so. What has instead been left is financial capital, but that is no substitute for actual assets that generate wealth.

  1. The real changes in the economy that change all pension (and other investment) assumptions.

There are a number of significant changes in the economy all happening almost simultaneously that should now have a significant impact on investment assumptions:

  • Dependency ratios are changing rapidly after being fairly stable for more than 20 years.
  • Life expectancy may be stabilising but still foresees very large numbers of the baby boom generation living to ages previously unimaginable for most.
  • As the baby boom ‘bulge’ really reaches retirement age they will want to swap riskier assets (equities) for safer ones in ever-larger quantities.
  • As a result there will now, for the first time, soon be fewer pension fund investors wanting to buy the equities baby boomers wish to sell than there are new retirees wishing to sell.
  • This is not just because of demographics, although that is an obvious factor. It’s also because of a range of other factors reducing funds to invest such as:
    • Stagnant wages;
    • Enforced pension enrolment but with very low rates of contribution;
    • Increasing student debt repayments impacting an ever growing proportion of the potential investing population;
    • Increased housing costs, whether for rent or mortgage payments, as a proportion of income;
    • Disenchantment with pension saving as available products cannot provide any assurance of a comfortable old age.

Put all this together and what we need up with is a net equity selling market developing at some time relatively soon for purely structural reasons, irrespective of any actual market condition. And what we know is that markets do not know how to manage down sides: they trend to crash.

It should be noted that there is good technical reason for this which has almost nothing to do with sentiment. Stock markets do not value companies: they value the marginal sale of a share in the company that is available for sale at a point in time. If there are going to be persistently more sellers than buyers in the equities market, as I suggest is likely, then the supply of marginal shares for sale will exceed supply and the result is that prices will fall, and maybe heavily, even if the value of the company as a whole does not. This is a simple function of the way the market works for marginal shares - and cannot be overcome in current market structures.

This, though, is not the only reason why share prices might fall. There are a host of other structural changes coming that will also impact share valuations, These include:

The withdrawal of QE

This is already reversing in the USA. The policy is static in the UK. It is still progressing, but slowly in the EU and Japan. If net reversal happens, even marginally, prices of gilts will fall (as now seems to be desired) and this will ripple, quite rapidly, through corporate bond and equity markets as well. That is exactly what it will be intended to do. And as noted, markets are not with good downsides.

Wealth taxes

There are more likely to be wealth taxes in the future. When even the OECD is discussing the likely reality of such taxes[xii] then it is reasonable to assume that they will happen. At even modest rates current low income yields will encourage net asset realisation to make payment. Another downward pressure will be created.

Financial Transaction Taxes

There is at least a chance that such taxes may be imposed as part of a desire to reduce wealth inequality. The aim would be to reduce asset prices, and they would almost certainly succeed in doing so.

Tackling tax abuse

The OECD is finally implementing its Base Erosion and Profits Shifting programme, and country-by-country reporting in particular. Many corporations are suggesting that effective tax rates may increase as a result, and it will certainly be true that tax haven usage will be harder, at least with the tax savings seen in the past. This will reduce net profits after tax and reduce corporate valuations, and so share prices.


Automation is coming: that is a reality. This need not create economic problems if the right reactions are put in place in the economy as a whole, but at present there are no signs of that and if, as planned, companies massively automate very rapidly in economies where there is no alternative government backed policy to create alternative employment the net outcome will be the ultimate example of a fallacy of composition: because it makes sense for one company to automate in isolation cannot mean it does for all to simultaneously to do without compensating policies being in place. The net outcome could, all too easily, be a crash in consumer demand as too rapid a change in employment practice creates a crisis for consumer incomes, and so spending, with consequent massive on costs for companies that see demand for their products fall despite any savings they can pass on from automation.

Peak oil

The reality of oil company valuation is going to hit markets. Oil companies are valued as much on the reserves they claim to have access to as they are on current revenues they make (and which might be projected into the future). Companies argue that they can and will access all their existing reserves and constantly need to find new ones: the fact is that oil and climate experts strongly disagree and suggest instead that large parts of current known oil reserves will have to stay in the ground if we are to have any chance of not frying the planet in the future. This is going to be realised at some point, with consequent knock on effects for other extractive industries. These industries make up a large portion (maybe a third) of the value of many mainstream stock indices at present and the consequence of this will be significant falls in value.

Bank overvaluation

Banks and other financial institutions also have over-valued shares. They have gained enormously from conventional QE. As asset traders they have all gained enormously from artificially inflated asset prices that have benefited a selected few in society (the wealth owners who are their clients) at the cost of increasing wealth inequality. Any unwinding of QE will have impact on the valuation of these assets that has yet to be reflected in bank and financial institution market prices, with significant impact on overall portfolio valuations due to the importance of such companies in most stock exchanges.

The next downturn

Historically we tend to have downturns in the economy every seven to eight years: markets have not really downturned now since 2008. We are overdue for a market adjustment on the balance of probabilities although it cannot be predicted what, precisely, will trigger that event. There are plenty of current situations, from trade war to Brexit to international tensions that might, however, do so.

  1. Put all these facts together

Put together I believe that these scenarios create a pension tipping point because of:

  • the end of QE over-valuation with all its knock on effects;
  • the ill thought through consequences of automation;
  • oil usage changing, and
  • tax and related policy changes.

All are likely to happen. The result is that we face having an extraordinary range of issues arising simultaneously that suggest a substantial change in stock market valuation in a downward direction that is now overdue.

And, of course it may not happen: no one can ever be quite sure about these things and the proverbial ‘black swan’ that could sweep values to new heights may be just around the corner. But companies themselves do not seem to believe that: their whole strategy of share buy backs to reduce the absolute supply of shares and their reluctance to now use equity issues as a form of finance suggest that they too are all too willing participants in a con-trick on the clients of institutional investment houses from which the various forms of finance can still all be winners, but few else will be.

  1. What might happen?

This is the obvious question to ask. There is no obvious answer. All that can be said is that there will be a trigger event. It may in itself appear inconsequential, but when the appreciation of overvaluation arrives it is likely that the realisation will deliver a downturn more serious than any previous post war downturn. This is likely to be 1929 all over again, with the crash not just indicating the end of a bubble (which we have clearly had) but something much more fundamental. It will indicate an end of an economic era. That suggests that no minor transition and no minor bail out (such as QE) will solve this crisis: this time only radical reform will solve the problem.

  1. The end of neo-Keynesianism and the rise of new fiscalism

In the 1930s this was The New Deal. Eventually, of course, it was Keynesianism. But much as Keynes still has value too much of what is called Keynesianism has been tarnished by the neo-Keynesian school of thought that has been far too close to neoliberalism for comfort.

And Keynes did not, in any event, foresee the end of the gold standard worldwide; the universal supply of cost free money created by sovereign currency issuing governments and the end of the shortage of supply of money as a consequence. This new money supply has meant the effective near elimination of official interest rates as governments can no longer charge for what they can create for free, and at will. In other words, what Keynes could not have foreseen was the ending of interest rate policy as a mechanism for controlling the economy, although that is what has actually happened.

This fact is at the very core of the crisis we now face. We have an economy, and systems of economic management, plus policy for managing pensions, that are all built on the idea that because money is scarce interest must be paid for its use. But that is no longer true: money is not scarce. And its price, at least to government, reflects that fact:

As the official price of money has fallen, so too have asset prices inflated. But that’s because money is still seeking what is, in effect, a risk free (or nearly risk-free) interest rate return when there is almost none to be had. This is true even in the case of equity investments: the number of these that actually fail is tiny.

The new economy has to be built on the basis that there is going to be little interest return.

First that means that monetary policy is, and will remain redundant as a tool for macroeconomic policy management. The focus will now be on fiscalism; that is the use of spending and tax to manage the economy. There will be no choice: these will be the only tools we have.

More importantly, this demands a whole change in the way we invest in a way that has not happened in current lifetimes. The focus will now be on investment to meet need.

Some of that need will be met by companies but the focus will be on product creation to meet need, not to leverage returns.

And some of that need will be met by government, and that will make them, through a National Investment Bank, a major focus for future saving in a more formal sense than has been the case in the past.

This is, of course, what the Green New Deal[xiii] has now been saying for a decade. But that’s the subject of another paper.

  1. Endnotes

[i] Professor of Practice in International Political Economy at City, University of London and Director, Tax Research LLP. Contact details available at













2018 Budget: party like it’s 1999!

Published by Anonymous (not verified) on Tue, 08/05/2018 - 7:29am in



A much deeper issue is how the Australian economy can evolve to grow in a more balanced manner and reduce its exposure to falling commodity prices.

Balance the key to CDP bungle

Published by Anonymous (not verified) on Tue, 08/05/2018 - 7:28am in



The 'work-like' activities undertaken by CDP participants creates a façade of employment, which ignores the fact that in the majority remote areas in which the program operates there are very little prospects.

Keen and Mosler on MMT

Published by Anonymous (not verified) on Tue, 08/05/2018 - 12:52am in



I enjoyed watching Steve Keen and Warren Mosler debating last night. They’re both engaging speakers, in very different ways. They both have a lot to offer. It’s unclear that they really disagree on anything fundamental.

I promised to write something quick on one of Keen’s criticisms of a view that Mosler holds:

Some MMT advocates interpret the implication of MMT, that all resources including labor can be fully-employed if the government runs a big enough excess of spending over taxation (I refuse to use the word deficit, given its false negative connotations here), to mean that the government “causes” unemployment.

To me, this is rather like blaming cold temperatures inside a house on the air-conditioning system rather than the weather outside. Yes, the house would be warmer if someone turned the temperature up, but fundamentally it’s cold inside because it’s cold outside.

It also implies that in the absence of government (or equally, if government always ran a balanced budget) there would be no unemployment: in other words, it’s Say’s Law in another guise.

I can’t address this directly yet, but I wanted to write about a related issue. I think it’s important to clarify this issue if we want to discuss Keen’s point here.

Mosler’s article on full employment and price stability makes one thing pretty clear, to me at least. His claim that the state is the cause of unemployment is philosophical rather than scientific. I’ll explain what I mean by this, but I think it explains why many economists (not necessarily Keen) find the claim to be simultaneously unintelligible and disagreeable. One economist I tried to explain it to told me it was ‘mere metaphysics’. As a matter of tone rather than sense ‘mere’ is the wrong word to use in referring to a nobler discipline. But I think it is true that the claim is metaphysical.

Begin with this question. What is the purpose of currency? What is it for? Right away this should strike you as a question that isn’t scientific. No amount of econometric research could settle it. Econometric data reveals trends and correlations but not purposes: think of the difference when the general tendency is for a thing to not be used for its proper purpose. Nor could psychological research on the issuers and users of the currency reveal its purpose. Mosler often suggests that many of the issuers and most of the users of currency don’t know what it’s really for; that was why he wrote his article.

But what does it mean to say that currency is for anything? If this isn’t a claim about a general tendency, and nor is it a claim about the intentions certain agents have, then what is it a claim about? It’s a claim, I say, about the institution’s purpose, as distinct from the purposes of the people participating in the institution. Maybe you don’t think institutions can’t have purposes of their own. But then I think you have no hope of understanding them, and, while I don’t mean to be rude, I have no use for you until you change your mind. Anyway, I know that Mosler believes that institutions can have purposes of their own, because we discussed Robert Pirsig’s Lila, which contains that thesis.

Well here is one thing you might think currency is for. This is the story you find in economics textbooks. Currency is for reducing the transaction costs to private agents that pure barter would involve. It’s the private agents who want the currency for this purpose. Thus most neoclassical monetary models put money into the utility functions of households. A benevolent state creates and distributes this instrument as a charitable act towards its citizens. It taxes the currency in order to monetise it — that is, to guarantee demand for it. And then it puts it into the economy for private agents to use. The textbooks often add that the state must match its tax revenue to its spending over its entire lifetime to sustain the currency’s value. But that is an additional claim beyond the thesis about the purpose of currency.

On this view of the proper purpose of currency, it doesn’t matter how the state gets the currency into the economy. It could pay people a basic income; it could buy labour to provision the public sector; it could make regular payments to people with “von” or “Trumpington” in their names. As long as the currency circulates as a medium of exchange and acts as a store of value, it’s doing its job. If the state buys labour to provision the public sector, the citizens get a bonus: not only do they get a useful instrument for reducing transaction costs, they also get a well-appointed public sector. But it is only a bonus; if the state fails to appoint the public sector well, it is still using its currency properly, so long as the instrument is available for its medium-of-exchange/store-of-value purposes.

On Mosler’s view, by contrast, the purpose of the currency is to provision the public sector. Taxes are imposed to create demand for the currency, so that people need to sell their labour for it. In other words, taxes are there to create demand for paid work in the official currency, and not just demand for the currency as such. The state can then exploit this demand by issuing the currency needed to pay the taxes it has imposed and using it to buy labour to provision the public sector. A well-appointed public sector isn’t a bonus; it’s the whole point of the currency. Moreover if the currency doesn’t serve the textbook purposes — if it doesn’t get used as a medium of exchange and reduce transaction costs — that’s neither here nor there with regard to the purpose of state currency. If the private sector want a medium of exchange they can create their own.

(Nick Rowe wrote a post for me, criticising Mosler’s view of the purpose of currency and implicitly endorsing the textbook view — at least if I’m not reading too much into what he wrote.)

If we take the textbook view on the purpose of currency, we don’t have much scope for criticising the behaviour of current governments qua currency-issuers. They are issuing enough state-backed financial instruments to avoid the transaction costs associated with pure barter. The instruments are widely available, their value is not too volatile; they work at what they’re meant to work at. The fact that there is unused capacity doesn’t show the state to be mishandling its currency. If private citizens want to use up the spare capacity they can always borrow and invest in it.

If we take Mosler’s view, there is much room for criticism. The only point of having a state-issued currency is that the state can provision the public sector. Where there is spare capacity, labour and capital are being offered in exchange for the official currency, but nobody is taking the offer. The state should either reduce taxes, and thus the demand for currency, until there is no more spare capacity on offer, or it should expand the public sector to take up the offers. Since the only point of taxing is to create demand for the currency, and the only point in creating demand for the currency is to provision the public sector, it makes no sense at all for the state to leave the demand for currency unsatisfied by either taxing too much or spending too little for a public sector of a given size.

So a lot of the debate between MMT and the mainstream hangs on this question of purpose. How can we settle it? As I said, it’s not a scientific question. It is in fact partly normative. The question is what currency should be used for. And it seems to me that under the current system it’s important to have both a means of provisioning the public sector and a generally-accepted instrument of exchange/store of value for the private sector to use.

What I don’t see is why they should be the same instrument. Why not have one instrument that serves Mosler’s currency-purpose — used for payments to and from the state — and another instrument that serves the textbook currency-purpose — used for transactions among private agents?

The first instrument could be run on Mosler’s principles. It’s unlikely that people would save very much in a currency that was only to be used for payments to the state. But if they were e.g. uncertain about their future tax liabilities they might do so. The state would make sure to accommodate these savings desires by running a large enough deficit, so that no capacity for sale in the state currency went unsold for long.

The second instrument wouldn’t need to be state-issued. It could be created in a free banking system, with demand for it guaranteed through the liability-matching of the private issuers. They could choose whether to peg to the state currency by holding reserves of it, or peg to each other, or float. But their currency would not be acceptable for tax payments, since this would just get in the way of its usefulness as an instrument of exchange and store of value.

Would that make both Mosler and the textbook-writers happy? Maybe we’ll see. As for Keen’s complaint about the claim that the state creates unemployment, maybe he’d be satisfied if the claim were downgraded to this: the state is morally responsible for unemployment when it misuses its currency. But this claim rests upon the further claim that the purpose of the currency is what Mosler says it is. Since opinions on this are split, I say split the instrument. Then we can all be right.