Economics - Again

A few days ago, I had a brief discussion with a student of History about my views on Economics and the Econocracy, referring him to the website of the Post Crash Economics Society where I first saw the very apposite term, Econocracy. On our next encounter [in the pub where he earns a crust as a part-time barman] he told me that he had mentioned my stance to a friend who is studying Economics; and the friend had vehemently disagreed with me. Perhaps we will be able to have a face-to-face discussion some time. In the mean time, I will post here today the briefest summary of my views.

I had the great good luck to go up to university when classes were small - my year in Politics and Economics comprised just 12 students - but teachers were good and libraries well resourced. The era of electronic access to data had not yet arisen, so we had to read: and we read voraciously.

At that time what we now call neo-Keyesianism was in the ascendancy, and models of the entire economy had been constructed in the National Institute for Economic and Social Research [NIESR], in the Treasury and in various universities. Given the state of development of computers at that time the models were crude and simplistic, and they could only be manipulated laboriously. Nevertheless, estimates could be made of the impact on the modeled economy of the policy options that were available to governments. These options came in two categories, monetary policy and fiscal policy. Monetary policy involved the creation of money; implicitly by the Bank of England on behalf of and with the authority of the government that owned the Bank. Banning the creation of money was a means of limiting the rate of growth of the economy; and encouraging the Bank to create money to lend to the trading institutions in the economy was a way of stimulating the growth of the money supply more generally. It was taken as a sign to the commercial banks that they could risk making more loans of their own money [deposited by their customers] whenever the Bank of England was stimulating the money supply; thus the amount by which spending could increase was very much greater than the amount by which the Bank increased the supply. Any commercial bank could borrow money from the Bank of England at a 'bank rate' [later called the 'base rate'] which was publicly announced; and lending by commercial banks was made at rates higher than the bank rate. The banks charged their customers rates of interest that varied according to the perceived riskiness of the loan. When the Bank of England had the nod from the government, it lowered bank rate; which was a clear indication to all the banks that they could drop the rates they charged to their customers, and perhaps risk extending the range. Thus a drop in bank rate, accompanied by an increase in the Bank of England's willingness to lend, signaled that banks and their customers should invest to expand the economy; thus expanding trade generally and stimulating economic growth and job opportunities in many sectors of the system could be increased.

However, at that time there were major constraints on the expansion of credit extended by banks. Their customers were required to pay cash deposits on durable consumer goods, and were only allowed to borrow a set percentage of the purchase price. Thus the spread of TV sets, washing machines and other desirable consumer goods was slowed down by the legal requirement for would-be buyers to save up for the deposit before they could enter into a hire-purchase agreement under which [having paid the deposit] they could pay off their borrowing while they had the use of the device. The firms that made the television sets were protected from foreign competition by import tariffs and controls on the amount of foreign currency that businesses could buy: so the system of monetary policy operated within a physically controlled system of protection. The present situation, where consumers can borrow huge amounts of credit and thus create the 'consumer demand' that 'drives' the economy was unthinkable. The world in which neo-Keynesiansim appeared to thrive was utterly different from the world in which we live now; and over the next few days I will outline how that change happened.

I try to keep my blogs at a modest length, and hope that anyone who becomes interested in my ideas will word-search through the archive.