Paul Ormerod

Co-operation and Competition

2012-02-13T13:27:00.002Z

Ed Mayo, ex-head of the New Economics Foundation and now of Co-ops UK, has an interesting blog (here) on the importance of co-operation in our economic system rather than competition. This is a really challenging and difficult topic.
Co-operation is extremely important to the successful functioning of the market-oriented economies of the West. But this is not because of co-operation as an organisational structure. The dominant form of corporate structure for over 100 years has been the shareholder-based joint stock company, and not organisations based on co-operative lines. But nevertheless, co-operation between firms is essential.
The most important reason for this is very simple. Complex economic systems contain many linkages between the different component parts. In an evolutionary context, we can think of a competitive relationship between two firms being expressed by a negative connection between them. If one does well, the other is likely to lose out, and its fitness is reduced. In contrast, a co=-operative relationship is positive. If one does well, the fitness of the other is increased, and vice versa.
Economic theory focuses exclusively on the competitive links. But these are dominated by the co-oerative ones. The structure of production is the reason why. Most economic activity does not involve the final consumer, the individual. It is business to business. So if a firm learns to produce something more efficiently, or if it innovates successfully, the companies to which it supplies benefit.
More generally, co-operation is needed to agree institutional structures in which economic activity can take place. And it is the basis of most contractual agreements. It is impossible to specify in complete detail most business-to-business contractual relationships – look at the massive difficulties caused by Brownite thinking on this in terms of the relationships between regulators and the regulated in the relevant sectors of the UK economy. A strong element of trust is required.
But all this co-operation, which pervades successful capitalist economies, has nothing to do with the organisational form of companies. It can, and indeed has, shown itself in a system dominated not by co-operative but by joint stock firms.
I have been interested in this for some time, and here is a very technical paper which examines what happens in an evolutionary system when most of the linkages are competitive and not co-operative.

Minsky Mania: a Raincheck

2011-12-29T12:04:00.000Z

The American economist Hyman Minsky is currently very fashionable, especially amongst those who are sympathetic to the idea of more government intervention in the economy.

Minsky argued that financial crises were an inevitable feature of capitalism, unless governments stepped in through regulation and central bank action.

He hypothesised that in prosperous times, when the corporate cash position became strong, exuberance developed which translated into a speculative bubble in asset and property markets. Private sector debt rose as borrowing increased to fuel the speculation, and at the ‘Minsky moment’ a crisis would occur. Following this, banks tighten credit, and even companies which are fundamentally sound may be driven out of business because of an unwillingness to roll over debt.

His theory is very seductive in the light of the experience since 2007.

But the theory does not explain why, over the past 80 years, we have only had two major financial crises, the early 1930s and the recent one from 2007. It is the dog which has not barked which causes fundamental problems for the hypothesis as it stands.

For example, in the United States, private sector debt relative to the size of the economy reached a peak of 2.1 in 1932. From a low point of only 0.4 in 1945, it rose almost without interruption to a new peak of nearly 2.2 in 2001. But there was no crisis. It reached 2.6 in 2006, much higher than its peak in the 1930s Great Depression. But again, no crisis.

The Minsky story is good at telling us after the event what happened in a crisis. It does not tell us why crises do not happen, even when the objective facts suggest they should.

Why are markets so volatile?

2011-11-16T11:08:00.000Z

Mainstream economic thinking has considerable difficulty in explaining the massive degree of volatility of financial markets over the past few months. Both shares and bonds exhibit large fluctuations on an almost daily basis.

The problem is particularly acute for the concept which is fundamental to a great deal of modern macroeconomics, based on the so-called ‘representative agent’. This would not matter if it were purely a piece of esoteric reasoning, but models which embody this concept proliferate in central banks and international financial regulatory bodies.

The simplifying assumption is made that the workings of the economy can be explained in a model in which there is just a single decision maker, deemed to ‘represent’ the behaviour of everyone.

The ‘representative agent’ is certainly a curious assumption to make in the light of the financial crisis, when much of the focus is on the differing behaviours of creditors and debtors. In the Euro area crisis), for example, it makes no sense at all to speak of the ’representative agent’, the German government has quite different behavioural rules and constraints from that of, say, the Greek and Italian administrations.

Kenneth Arrow, a Nobel Laureate, wrote in 2004 that the representative agent assumption cannot explain the fundamental existence of markets at all! ‘if we did not have [agent] heterogeneity, we would have no trade’. In other words, if people did not have different opinions about the value of a share or a bond, why would trade take place at all?

Keynes put it a different way. If all traders think identically, market prices will fluctuate between zero and infinity!

And here we have the explanation for market volatility. The more that traders follow the herd, the more the market as a whole begins to think as a single agent. And so prices fluctuate more.

Traders form their views on a mixture of their private opinions and on market sentiment. You may think the Italian government’s finances are sound, but if most other people disagree, it takes a very brave soul to stick to his or her private opinion.

In the current circumstances, when there is considerable uncertainty, traders are giving much more weight to market sentiment than to their private opinions. The more the world looks like the world of mainstream economic theory, the more volatile it becomes!

expansionary fiscal contraction

2011-11-04T09:56:00.001Z

To many people, this phrase is an oxymoron. How can fiscal contraction be expansionary?

But the evidence suggests that this is exactly what has been happening in the United States.

In terms of national output, GDP, the trough of the trough of the recession was reached in the second quarter of 2009 (2009Q2). We have now had nine successive quarters of positive growth, and in 2011Q3 the level of output is above that of its peak level before the recession started. Growth has not been as strong as would be desirable, but there has been consistent growth. On any measure, the recession is over.

Where has the growth come from? Not from public spending! Between 2009Q2 and 2011Q3, current public expenditure in real terms fell by $38 billion, or by some 1.5 per cent.

The private sector grew, the public sector contracted. Private consumption rose by $450 billion, nearly 6 per cent, and capital spending by firms rose by $200 billion, or nearly 13 per cent. There was a slight deterioration in the net export position, but overall the private sector delivered growth.

The employment figures tell the same story. Employment changes tend to lag what happens to output, and the lowest level of total employment was not reached until February 2010, when 129,200,000 people were employed.

Between then and September 2011, public sector employment fell by nearly 500,000. But private sector employment rose by over 2.5 million, to give a net increase of almost 2.1 million.

The lessons for Europe are to have a co-ordinated fiscal contraction.

Why is economic growth stalling? May be it is Ricardian equivalence!

2011-08-02T15:45:00.003+01:00

The British and American recoveries do seem to be stalling. The recovery profile is by no means as strong as is usually the case after recessions, even after pretty major financial crises like that of 2008/09.

One of the insights of complex systems is that the impact of any particular factor may differ dramatically according to circumstances. So think, say, of a network of firms or consumers and ask how optimism or pessimism might spread across the network. Each decision maker will for his or her view in part upon the views of others to whom he or she is connected i.e. pays attention. And each agent (decision maker) will have its own level of persuadability. In other words, how easy is it for other agents to get the agent to change its mind?

A well established result is that changes in the opinions of a small number of agents can have dramatically different outcomes in terms of how far they spread across the system as a whole. Most of the time, changes of mind by a few agents won’t get very far. But occasionally, they can infect, as it were, almost the whole network.

Ricardian equivalence is an esoteric concept which much of the time has little or no impact. But it might be doing now.

David Ricardo was a great English economist who wrote in the early 19th century. He made millions in the City and was also an MP. During the Napoleonic wars, government expenditure grew phenomenally. Ricardo asked: does it matter how this is paid for?

One way is to put taxes up now. The other is to run a deficit and issue government debt (bonds) to pay for it. Ricardo said it didn’t matter how it was done. The latter way implied a future stream of interest payments on the debt, and rational agents would anticipate that taxes would go up in future to meet these payments. So they would cut back their spending now to save for the increases in future taxes. Their spending would fall by just as much as if they were taxed now. The two methods are equivalent.

The current massive emphasis on government debts and deficits certainly alerts consumers to the idea that taxes might have to rise to pay for them. So they are cautious about spending. Companies, sitting on piles of cash, observe this caution and postpone investment decisions which they can easily afford to pay for.

So the economy stalls. In more normal times, Ricardian equivalence is a pretty odd idea. But it might be why the recovery is weak now. Paradoxically, cutting the deficit more sharply might lead to a much stronger rebound.

Why is economic growth stalling? May be it is Ricardian equivalence!

2011-08-02T15:42:00.000+01:00

One of the insights of complex systems is that the impact of any particular factor may differ dramatically according to circumstances. So think, say, of a network of firms or consumers and ask how optimism or pessimism might spread across the network. Each decision maker will for his or her view in part upon the views of others to whom he or she is connected i.e. pays attention. And each agent (decision maker) will have its own level of persuadability. In other words, how easy is it for other agents to get the agent to change its mind?

A well established result is that changes in the opinions of a small number of agents can have dramatically different outcomes in terms of how far they spread across the system as a whole. Most of the time, changes of mind by a few agents won’t get very far. But occasionally, they can infect, as it were, almost the whole network.

Ricardian equivalence is an esoteric concept which much of the time has little or no impact. But it might be doing now.

David Ricardo was a great English economist who wrote in the early 19^th century. He made millions in the City and was also an MP. During the Napoleonic wars, government expenditure grew phenomenally. Ricardo asked: does it matter how this is paid for?

One way is to put taxes up now. The other is to run a deficit and issue government debt (bonds) to pay for it. Ricardo said it didn’t matter how it was done. The latter way implied a future stream of interest payments on the debt, and rational agents would anticipate that taxes would go up in future to meet these payments. So they would cut back their spending now to save for the increases in future taxes. Their spending would fall by just as much as if they were taxed now. The two methods are equivalent.

The current massive emphasis on government debts and deficits certainly alerts consumers to the idea that taxes might have to rise to pay for them. So they are cautious about spending. Companies, sitting on piles of cash, observe this caution and postpone investment decisions which they can easily afford to pay for.

So the economy stalls. In more normal times, Ricardian equivalence is a pretty odd idea. But it might be why the recovery is weak now. Paradoxically, cutting the deficit more sharply might lead to a much stronger rebound.

Recovery is not always smooth

2011-07-26T14:44:00.002+01:00

There has been huge media attention about the 2011 Q2 UK GDP growth figures released today. The estimate of 0.2 per cent shows only very weak growth. It is bound to be revised either up or down as more information comes to light. But at the moment, recovery looks very weak, after more rapid growth in previous quarters.

But recovery paths are rarely smooth. The charts below show what happened after the recessions of the early 1980s and 1990s. Recovery is erratic on a quarter by quarter basis. Just before the economy was about to launch into the boom of the mid/late 1980s, for example, there was a fall in output in 1984Q2. This caused panic in government circles at the time, a panic which proved wholly unwarranted

Hard problems in economics

2011-06-30T09:41:00.000+01:00

This is a summary of a presentation I gave in Zurich earlier in June to FuturICT, one of the candidate flagship European Union research projects, each worth 1 billion Euros.

1. Financial markets is a very hard problem, issues of agent heterogeneity, networks, learning, financial innovation, regulation – all these and more are important. Mainstream economics has largely avoided the topic, content to believe in the efficient markets hypothesis. A great deal of distinguished work has already been done by econophysicists.

2. Inequality: where does it come from?

This is not just a matter of the distributions of income and wealth. A major concern of policy makers on say, outcomes in health care or education across hospitals and schools, is that such outcomes are ‘unequal’ in the key sense that they differ at any point in time. This seems inevitable in any complex system of interacting agents, but it is often a major concern to voters and hence to politicians.

3. Shortages: food/water/energy – how do we avoid/mitigate these key social, economic and security-related problems

Both these very hard problems require trans-disciplinary teams. For example, Elinor Olstrom showed how societies evolve ways of dealing with the ‘problem of the commons’ to give outcomes which are quite different to those predicted by economic theory.

4. What does it mean for an agent to be rational in the world of the 21^st century?

We face a stupendous number of choices, many of which are complex and difficult to evaluate and distinguish between them, and we are increasingly both aware of and influence directly by the behaviour and decisions of others across networks. A sub-theme of this is: how do agents cope with the massive explosion in information and turn it into useful knowledge.

The old concept of rationality is no longer in general valid.

This has very deep and widespread policy implications. Almost all existing policy is based on a view of the world in which autonomous agents maximise subject to constraints. In a world of interconnected agents where maximisation does not make much sense, what becomes the basis of policy? How will agents react? What are better ways to get them to react in ways which policy makers want?

This involves matters such as, individual learning, social learning, the evolution of self-image, networks (the relevant topology; how they evolve; who/where/when agents might copy)

So a very hard task is: what is the new paradigm for agent behaviour, one which in principle is general across the social sciences.

The economic recession: where are we now, and how bad has it been?

2011-06-29T18:49:00.000+01:00

The world economy as a whole is roaring away. The 5 per cent real GDP growth on 2010 is almost the highest annual growth rate seen over the past 20 years. And even in 2009, world output fell by only 0.5 per cent.

The problems have been almost exclusively in the developed world. Looking at annual growth rates in 17 countries since 1871, the current recession can be placed in the context of 140 years of data.

Quarterly data is now routinely available, but for most of this period, this was not the case. It only started in a few countries in the late 1940s, and gradually spread. But for long term comparisons, we have to rely on annual data.

We can define a recession in two ways. First, the successive periods in which (annual) real growth is less than zero. Second, the periods in which the level of GDP is below that of its pre-recession peak.

I published statistical analysis of recessions 1871-2010 in Risk Management in 2010, which is on the papers section of the website, and I have extended it for a conference in Kiev in honour of Simon Kuznets in the ‘new’ section of the site. So details are available there.

Looking at the economies of Western Europe, Canada, the US, Japan, Australia and New Zealand, the falls in output started to happen in the period from the third quarter of 2007 (2007Q3) to the second quarter of 2008 (2008Q2). In almost all the 20 economies, growth had resumed by 2009Q4, and often earlier in 2009. In Portugal and Spain growth resumed, albeit very haltingly, in 2010Q1, leaving Ireland as the only exception.

So on this conventional definition, the recession was short, entirely in line with historical experience: over 90 per cent of all recessions last no more than 2 years. The size of the recession across the sample of 20 countries varied substantially, but overall it was a pretty big one, with the average fall in output being arouind the third quartile of all recesssions.

Despite the size of the recession and the financial nature of the crisis, in 9 of the 20 countries, by 2011Q1 (the latest data), the level of output had exceeded its previous peak value. This group includes America and Germany.

This perspective indicates that the recession was a serious one. Even on this measure, very few recessions last for longer than 3 years, yet it has already lasted this long. Some economies, such as France and the Netherlands, are close to their previous peak output levels. There is a group (Denmark, Finland, Italy, Japan, Portugal, Spain, UK) where the level of GD remains 3 to 6 per cent below its previous peak – Ireland again is the exception.

But overall, even the economies of the developed world have demonstrated great resilience in the face of a financial shock which had the potential to turn into a repeat of the 1930s.

What a good job Keynes didn’t believe in forecasting

2011-06-06T14:41:00.007+01:00

Keynes is in many people’s minds at the moment, as uncertainty about the course of the economic recovery is high.

In May 1933, at roughly the same stage in the cycle as we are today, Keynes wrote in the Times: ‘Confidence has been restored and cheap money established both on long and on short term [the equivalent of zero interest rates and quantitative easing from the Bank of England today]. Yet unemployment has not declined. Where are we to look for the explanation? Not in the international sphere; for our net foreign trade position, though still bad, is much improved [the equivalent of the increase in net exports caused by the 25% depreciation of sterling since 2007].

We can find it nowhere, I suggest, except in the decline in our loan expenditure, as the result of our no longer borrowing for the dole and of our restraining the capital expenditure of all public authorities’.

Keynes made the case for tax cuts and infrastructure spending to boost growth and reduce unemployment. He made it clear he had little time for fiscal masochism, noting : ‘Unfortunately the more pessimistic the chancellor's policy, the more likely it is that pessimistic anticipations will be realised and vice versa. Whatever the chancellor dreams will come true!’.

Here is what happened to growth and unemployment:

So, yes, no sooner had Keynes written these words that confidence was indeed restored. The economy boomed and unemployment nearly halved.

one swallow...

2010-07-23T15:22:00.004+01:00

Of course one swallow doesn't make a summer, but the second quarter 2010 UK GDP figures released today show output growing at an annual rate of over 4 per cent, much higher than the consensus.

I wrote a piece for the Financial Times last summer arguing that 'The historical evidence reveals a typical pattern of recession and recovery which suggests that, just as economic forecasters were far too optimistic about prospects for 2009 even as late as the autumn of 2008, they now seem too pessimistic about recovery profiles. Very few recessions last longer than two years. And most recoveries, once they do start, are strong.'

Focusing on recessions since the Second World War, analysis shows that for recessions with only short duration, the typical recovery pattern is rapid. The average growth rate in the year after the recession was 3.5 per cent, and in the subsequent year 3.8 per cent.

So in general once recovery starts it is strong. This is compatible with the view that short recessions are essentially inventory cycles. Once inventories are reduced to satisfactory levels, normal production levels resume, and fixed capital investment expenditures postponed during the recession are carried out.

Even in the 1930s once the recovery began – in different calendar years in different countries – the average rate of growth was strong. GDP growth in the first year after the Great Depression averaged 4.7 per cent, followed by 4.6 per cent in both the second and third years.

The caveat to all this is that the current circumstances are unusual. But so was the Great Depression. There is some evidence to suggest that, beyond a critical duration or cumulative size of recession, exit from the recession becomes harder and more sluggish. Keynes’ animal spirits become depressed. But it takes an awful lot to depress them for more than a couple of years. Capitalism seems a pretty resilient beast.

Limits to taxation? The UK General Election 2010

2010-07-16T10:39:00.001+01:00

The May 2010 election saw a substantial swing against the incumbent Labour government, though the Conservatives were denied an outright victory. In a fair number of marginal seats which they would have expected to win on the national trend, the swing to the Conservatives away from Labour was distinctly low.
There are obviously many possible reasons for this. But there is good evidence to confirm a widespread view that the constituencies which receive a net public subsidy stayed Labour, and those which pay for the subsidy through a net export of their taxes voted Conservative.

A readily available proxy for this is the percentage of the population of working age which is in employment . Ideally, income per head should also be taken into account, but this is only available at local authority level and not by constituency. However, it is very plausible that such data would strongly reinforce the message of the employment data. Income per head in, say, Beaconsfield is distinctly higher than in Bootle. Further, the proportion employed in the public sector is also relevant. But as a first pass, the employment data itself is revealing.

On average, the percentage of the working age population in employment was six percentage points higher in Conservative seats than in Labour ones (for the record, the Lib Dem position was in between the two, though somewhat more similar to Conservative seats than to Labour). Six percentage points may not seem a lot, but across the country as a whole it amounts to more than 2 million people.

So, in almost three-quarters of Conservative seats more than 80 per cent of the working age population were in employment. But in more than three-quarters of Labour seats, less than 80 per cent of the working age population were working.

A potential counter to the general point is that the votes simply reflect regional preferences, with for example the North of England and Scotland showing a definite preference for Labour and the South for the Conservatives.

However, the employment differences are reflected within the regions. Not all regions can be looked at in this way because of the dominance of one or other of the parties, but here is the data for the more ‘mixed’ regions.

Average percentage of working population in employment
Region Conservative Labour Difference
North West 80 75 5
Yorkshire 82 77 5
East Midlands 83 75 8
West Midlands 82 73 9
London 78 74 4

As noted above, the analysis should ideally take into account income per head and the percentage employed in the public sector, and a further refinement would be to allow for the proportion of pensioner households. But as an initial broad sweep through the results, the employment data does suggest that the areas which, through their high employment rates, pay more tax than they receive in subsidies decided that Gordon Brown’s government had gone too far in extracting money from them.

extreme events, hill running and financial markets

2010-07-10T17:48:00.000+01:00

I am currently in the Scottish Highlands for ten days or so, and my outings on the hills have made me reflect on extreme events. The fact that they lie so much outside the perceptions which people have about the world makes it very hard to appreciate that they occur at all. I’ve just finished reading Gillian Tett’s account of the financial crisis, Fool’s Gold.

As I plod up and down the soggy hillsides – it has rained almost all week – I have reflected on the similarities of extreme events in financial markets and extraordinary feats of hill running. These almost literally defy belief.

For example, on the Isle of Skye lies the most rugged set of peaks in Britain, the Cullins. The Cullin Ridge is probably the single most demanding outing in the British hills. It is only 10 miles or so in length. It involves 10,000 (ten thousand) feet of ascent and descent. But the most demanding aspect of it is that there are several rock climbs up to Very Difficult/Severe standard, prolonged bouts of exposed scrambling, and hardly any flat terrain at all. Over much of the length of the Ridge, a slip could prove fatal. Now, on firm, broad tracks which involved simply putting one foot in front of the other, a strong walker would be pleased to cover such a route in 8 hours. Most casual hill walkers could not even contemplate an outing of this kind.

Yet, incredibly, the record time for the Cullin Ridge is 3 hours 29 minutes, with no climbing aids used at all. One of the peaks involved symbolises the difficulties. The Inaccessible Pinnacle is a bizarre fin of rock attached to the ridge. A rock climb is needed to gain its sloping ridge, which is for the most part about six inches wide. As you climb, you are faced with exposure such that, in a popular description, there is a vertical drop on one side and an overhanging and infinite drop on the other! Certain death awaits anyone who falls unroped. At the summit, there is a Difficult 75 foot down-climb required to get off the peak. Elite Ridge runners go up and down this peak in under four minutes – four minutes!

There are ultra-marathon hill challenges such as the Bob Graham Round in the English Lake District, for example. This is 72 miles long with 26,000 – twenty six thousand – feet of ascent and descent. Seventy two miles is almost a triple marathon. The record time is 13 hours 54 minutes.

Now, without knowledge of these feats, someone familiar with the terrain involved would find it almost impossible to imagine that such times could be achieved. They are so far outside ‘normal’ perceptions.

Humans seem to find it hard to imagine extreme events in general. With much more dramatic consequences for us all, the same inability to contemplate the existence of extreme events occurred in financial markets, traders, senior bank management, regulators, central banks. We were very well equipped to withstand a ‘normal’ shock. But not the extreme event which actually took place.

was there a double dip in the 1930s?

2010-07-01T10:15:00.002+01:00

There is a lot of comment at the moment about the risks of a 'double-dip' recession, citing evidence from America in the 1930s. Well, here is the annual growth rate of real GDP in the United States in the 1930s:
1930 -8.9
1931 -7.7
1932 -13.2
1933 -2.11
1934 +7.6
1935 +7.7
1936 +14.2
1937 +4.3
1938 -4.0
1939 +8.0

So: there was a gap of 5 years between the recessions, and betwene these the economy grew by nearly 40 per cent. Not exactly a double-dip!

This is not forming a view on the current situation, just putting forward some simple evidence on what actually happened in the 1930s

World Cup: increasingly random outcomes

2010-06-27T14:53:00.001+01:00

The most striking feature of world soccer is that it has become far more egalitarian in terms of performance. The gap between good and bad teams has narrowed dramatically over time. An obvious measure of this is the average number of goals scored each game in the World Cup finals. Large differences in ability will be reflected in games in which teams are defeated by many goals.

The average was 3.89 in the first competition in 1930, rising to a record 5.38 in 1954. There was then a sharp fall to 2.78 in 1962, and ever since then it has fluctuated around 2.5, with the 2002 finals averaging 2.52 goals per game.

This is despite a big expansion in the number of teams in the final. At first there were only 13 teams, and from 1954 to 1978 just 16. The 1982-1990 competitions saw 24 teams, and in the last three there have been 32.

This trend to greater similarity of performance amongst teams is reflected in the qualifying rounds. In 1934, the first time there was a qualifying tournament to get into the finals, only 27 games were played. In 1990, there were 314 games, and for the 2006 finals no fewer than 847 games have already been played to decide which teams are in the finals.

The highest average goals per game was 5.22 in 1934 itself. After the Second World War there was a gradual fall to 2.74 in 1974, and it has since stayed around that level, with the 2006 qualifying rounds seeing an average of 2.91 goals per game.

Many matches are decided by a single goal, even between teams many places apart in the world rankings. This relatively narrow gap between teams implies a substantial element of randomness in success or failure. But perhaps this is part of the persistent appeal of an essentially trivial game which has few possibilities for innovation.

cutting the deficit

2010-06-10T18:26:00.001+01:00

The new Government's plans to reduce the deficit much more sharply than most people expected. Will this stimulate or depress the economy?

Not surprisingly there is a fierce debate about this.

But it is a situation in which econometric evidence is not going to be of much use at all in arbitrating the dispute. So much depends upon sentiment, upon mood.

Obviously, a reduction in public expenditure - sacking some public sector workers to take a clear example - takes spending power and demand out of the economy. On the face of it, it is an open and shut case that cutting spending depresses the economy.

But here is where sentiment comes into play, in several dimensions:

1. Suppose the cuts lead to the interest rate on long dated Government bonds ('gilts') being lower than it otherwise would be. This is likely, but we don't know by how much

2. This leads to an increase in the value of existing bonds, held by individuals, companies and pension funds. So wealth increases. It may also stimulate the commercial property market, for example. Investors compare yields on property with those on bonds, so property becomes more attractive, prices rise, and the debt problems of developers are eased

3. Firms in general may become more optimistic as a result of lower long rates - their 'animal spirits' are more buoyant: this is Keynes' phrase, he set great store by the long run rate of interest as a determinant of sentiment. If this happens, investment increases, jobs are created

4. Household wealth rises, so consumption may rise

The extent to which all these sentiment-related effects operate - from the amount by which long rates are lower than they would otherwise be to the household wealth effect - the impact of cutting public expenditure will be offset.

There is a further offset, rather esoteric but which might apply in the current circumstances. Deficits mean higher taxes in the future, and some people might save in anticipation of this. A lower deficit may encourage spending not saving.

But all of this is a matter of judgment, of appraising sentiment, not of formal economic modelling.

2010-06-10T18:25:00.001+01:00

opening round

2010-06-10T14:33:00.000+01:00

I've just opened this blog and will be posting on a variety of topics from time to time