The government’s economic recovery policy consisted of two tracks: one, a vastly expensive “fiscal stimulus“, involved ramping up spending at a time when tax revenues were falling by borrowing at unprecedented levels. Even Alistair Darling expects borrowing to reach £175 billion this financial year, around 12% of GDP, leading to a possible downgrading of the UK’s credit rating from AAA. Others think borrowing might be even higher. Yet the effectiveness of fiscal stimulus was largely dismissed for two decades prior to the recent crisis, during which time it also failed to lift Japan out of the mire despite massive public works projects during the 1990s.

Thank heavens, then, for quantitative easing (QE), the other track of the government’s policy. This, at least, was broadly supported by most mainstream economists: both neo-liberal and Keynesian. Milton Friedman built his reputation on A Monetary History of the United States, 1867-1960, where he argued (along with Anna Schwartz) that the Great Depression was caused because the Federal Reserve contracted the money supply at a time of deflation, whereas it should have flooded the economy with money to ensure that prices remained stable. This argument has become fundamental to macro-economic thinking.

So it is rather a surprise to discover evidence that suggests quantitative easing is not working as planned. According to the Bank of England, its £200bn programme of QE has been accompanied by a decline in broad money (M4) of 5.3% over the past three months; not the annualised growth of 6 to 9% that Mervyn King was looking for. Lending to business has also declined (by 3% over the same period). What seems to have been achieved is a roaring housing market and a stock market up over a quarter in a single year.

This seems to question mainstream economic theory, though it corresponds nicely with Murray Rothbard’s suggestion that, during the Great Depression, the Federal Reserve actually did expand those monetary levers over which it had control, but that the market nonetheless shrank the money supply because government could not fully control broad money.

Whatever the truth about the economic history, the economic practice in 2009 has arguably been disastrous. It seems £200bn has flooded into the money markets to achieve little but asset bubbles in the midst of a recession; and £175bn has been added to the public debt on the basis of dubious Keynesian theory. The twin tracks of the government’s economic recovery plan appear to have failed.

26 thoughts on “Government’s recovery plan is a train wreck”

  1. Posted 02/12/2009 at 11:11 | Permalink

    You are WAY too bright to confuse (a) the size of the deficit with (b) the size of the fiscal stimulus. And way too honourable to confuse those less bright than you.
    The UK stimulus (see IMF) is amongst the smallest. Failing to collect tax revenues owing to a dependence on frothy assets is NOT the same as stimulating the economy.
    In the case of Japan, I think you are failing to consider the counterfactual. Have you read Richard Koo? What would Japanese GDP have been absent that fiscal behaviour: or do you think that (even more) exports would have rushed in to fill the gap? Or that monetary policy could have been (even more) loose?
    Otherwise, I agree on QE. What would you do?

  2. Posted 02/12/2009 at 11:13 | Permalink

    […] My latest article at the IEA blog spells out why. Tags: keynes, quantitative easing, stimulus package This entry was posted on Wednesday, December 2nd, 2009 at 12:12 pm and is filed under Economics. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site. […]

  3. Posted 02/12/2009 at 12:08 | Permalink

    Maybe the Austrian School is due for a comeback?

  4. Posted 02/12/2009 at 12:23 | Permalink

    I thought, for the IEA, that it never went away?

  5. Posted 02/12/2009 at 13:18 | Permalink

    You will find the fiscal stimulus data on a country-by-country breakdown for G20 countries in the IMF staff position note (The State of Public Finances: A Cross-Country Fiscal Monitor) dated Jul 30, 2009, page 27 of the paper (see).

  6. Posted 02/12/2009 at 13:22 | Permalink


    The problem with the counter-factual is just that it is counter factual. It is easy to argue that things might have been worse. The fact remains that Japan tried fiscal stimulus and lost a decade. An equally counter-factual argument might be to suggest that slashing public spending and cutting taxes would have boosted domestic demand, leaving Japan less reliant upon exports.

    I’m sure, incidentally, that Brown and Darling would use counter-factual arguments to defend QE: “M4 would have fallen even further” etc. I’m not sure that a new bubble economy is justified by the suggestion that the UK would have deflated even further had they not sown the seeds of the next disaster.

  7. Posted 02/12/2009 at 13:55 | Permalink

    Why exactly with asset prices falling as hard as they were, would it be reasonable to assume that the correct counterfactual would have been everyone opening their wallets and spending? Richard Koo’s position – that the Great Depression is a more reasonable counterfactual – sounds more convincing.

    I personally think Goodhart or Posen’s view on QE is more accurate: it helped to oil the wheels of a bank deleveraging. And as for bubbles; we might get there (FTSE 6000 perhaps) but not yet.

  8. Posted 02/12/2009 at 14:51 | Permalink

    I’ve not read Koo so I can’t comment. However, even if the Japanese save, the money must be invested. This is in fact one of the main differences between the 1990s and the 1930s (suggestion the Depression isn’t so germane). We tend not to hoard money by buying gold; rather we invest (either directly or via savings accounts) in productive assets. So the alternative to the Japanese opening their wallets and spending on consumption goods is their saving and so facilitating spending on production goods.

  9. Posted 02/12/2009 at 14:54 | Permalink

    I’m not sure I’d be so quick to dismiss bubbles in the Stock Market, by the way, or to suggest that FTSE 6000 (only 13% above the current level) would count as frothy whereas FTSE 5300 (c.25% above last year’s level) would not.

  10. Posted 02/12/2009 at 15:02 | Permalink

    ‘if the Japanese save the money must be invested’

    HUH? Who says so? Fallacy of composition, paradox of thrift, all that . . . who will go out and invest it? The indebted companies? S is made to equal I through Y falling, not I rising like a magic angel is there to help it. Personally, I think you’ve got your causality the wrong way round: enjoy this

    We are 25% above the previous level of the FTSE – and I wish I’d spotted it coming – but who says it was at the fair value down there?

  11. Posted 02/12/2009 at 16:54 | Permalink

    Wow. And I thought my posts were long. 2,347 words would definitely not get passed Richard Wellings’ editorial eye.

    But I’m afraid I don’t buy the “Paradox of Thrift”. It’s just anti-savings nonsense. “Who will go out and invest it?” is an absurd question when business is crying out that there is not enough lending in the economy.

    As for the FTSE being at “the fair value down there”, the only measure of “fair value” is that at which two parties voluntarily exchange. It was “fair” then and is “fair” now. But rapid rises are usually accompanied by bubbles, especially when artificially low interest rates mis-price borrowing and skew industrial time horizons.

    Anyway. Home time!

  12. Posted 02/12/2009 at 17:47 | Permalink

    Even Keynes thought the paradox of thrift was nonsense, it’s an idea his acolytes seem to have latched onto.

  13. Posted 02/12/2009 at 17:52 | Permalink

    […] Green Wing, Masters Degrees, Music, The Killers. Leave a Comment I have been arguing with Tom Papworth on the IEA blog.  Tom believes that if savings increase, they are invested. I don’t.   I rudely sent him a […]

  14. Posted 02/12/2009 at 19:53 | Permalink

    Gosh, Richard, that is an Argument from Authority out of leftfield. Of course, you don’t rely upon such arguments, I am sure you can argue for what happens INSTEAD of incomes falling, when everyone simultaneously decides to forego consumption. Last autumn, it looked like prices and output fall, but maybe that was an illusion.

    I read the GT this year: considerable chunks seemed to be about the PoT. And these chaps think Keynes believed it:

    (from GT p 84)
    Maybe all those many national accounts economists who add up sources of demand when making GDP forecasts are mistaken. For now, it sounds like you believe this because you need to

  15. Posted 03/12/2009 at 16:03 | Permalink

    Tom, Giles, Richard,

    Some facts are too prominent to ignore.

    One is Chinese saving. The Chinese saved a lot. They saved so much that they did not invest it all in China. They invested a good chunk in US Treasury and Treasury-backed securities. Did the US government use these extra funds for investment, or for current spending?

    If the Japanese (or the Chinese) save, somebody gets a chance to spend: that is the relevant accounting identity. That somebody may buy technology or toffee, caveat emptor.

  16. Posted 03/12/2009 at 18:02 | Permalink

    […] has also come up when thinking about this thread on the IEA blog, where Richard seems ideologically unable to accept the idea of a paradox of […]

  17. Posted 04/12/2009 at 12:55 | Permalink


    Page 11 of the Bank of England’s November Inflation Report shows over 25 years that growth in Broad Money (M4) lags nominal GDP into contraction or recession, but may lead it towards the peak of an expansion. The largest gaps in growth rates between the two, with M4 accelerating faster, point to impending recessions.

    The graph shows that broad money’s decline in 2009 has halted well short of the nadir of GDP contraction. M4 has usually followed GDP into a deeper low point in previous recessions. How do you account for this descrepancy?

    The governments’ recovery packages; the car scrappage schemes have almost doubled new UK private car registrations this year,(p19).

  18. Posted 07/12/2009 at 23:37 | Permalink

    “Gosh, Richard, that is an Argument from Authority out of leftfield.”

    Agreed, for some stupid reason I got the paradox of thrift mixed up with the liquidity trap (which Keynes thought was nonsense). Apologies.

  19. Posted 08/12/2009 at 10:06 | Permalink

    That is admirably big of you Richard, thank you. I understand though cannot cite my reference that Keynes was less sold on the liquidity trap, and often posed monetary solutions before deficit spending. Though Tom’s original post, yonks ago, would disagree with either, no?

    There seems to be a neat division into three:

    – People who think aggregate demand need boosting by Keynesian methods
    – People who think AD need boosting by monetary methods
    – Austrians who think AD was too high and should not be boosted, it just suckers us into more wrong economic behaviour

    I am a mix of the first two.

  20. Posted 09/12/2009 at 22:25 | Permalink

    I wouldn’t say Austrians think that AD is too high, rather there is overinvestment in capital goods and underinvestment in consumer goods caused by artificially low interest rates. Any attempt by the government to boost spending during a recession merely props up industries or businesses that should be allowed to go bust.

  21. Posted 10/12/2009 at 10:22 | Permalink


    This is the first time that I have really heard an argument for letting industries go bust during this recession be made; though many have gone under. There were very few, if any, voices advocating this approach at the height of the credit crunch in autumn 2008.

    Should a Free Market think tank like IEA not strongly have advocated and continue to argue that RBS, HBOS, Bradford & Bingley, Freddie Mac, Fannie Mae, AIG etc should all have been allowed to go to the wall?

    Should the IEA not also be arguing that the US Treasury made the correct decision in letting Lehman Brothers go bust and criticising the other government bale outs? How would the fiscal position look? Unemployment?

  22. Posted 10/12/2009 at 10:38 | Permalink

    Jonathan Harris

    Well, according to some libertarian wishful thinkers, business would have gleefully rushed in to fill the void, gladdened by government no longer laying its dead hand upon the economy. Investment would have flourished. Public sector drones would have transmuted into private sector risk takers. In their view (read Norberg ‘Financial Fiasco’), the Depression was CAUSED by the government intervening in wages. Yes, all those ragged unemployed were just asking too much.

    Of course, its nonsense. Bleak expectations would have become bleaker. Finance scarcer, growth slower, deflation worse.

  23. Posted 10/12/2009 at 18:03 | Permalink

    Giles – These libertarian ‘wishful thinkers’ are correct. Far better to get the adjustment process over with in one go, rather than prolonging the agony with counter-productive stimulus programmes and bailouts that do immense long-term damage.

  24. Posted 11/12/2009 at 12:10 | Permalink


    The financial disruption was not some sort of calibrated signal about the ideal levels of investment in the economy. It was a blind panic throwing the good out with the bad, the solvent with the feckless, businesses with sound plans with those (minority) punting on asset markets. This is not an adjustment process like MiniDisc players falling because of iPods. This is money being stripped from every enterprise because in a world of assymmetric risks, zero rates and insufficient information, every long term investment project looked bad.

    Somehow, the UK economy grew faster in the years since the War than it did in 100 years of Industrial Revolution. Some ‘long term damage’

  25. Posted 11/12/2009 at 23:32 | Permalink


    On the subject of public intervention stimulating economic growth. How does one explain the West German post-war Wirtschaftswunder, without the Marshall Plan?

    By 1985 Germany was one of the most successful economies in the world.

    How would the Austrian economists account for that one, Richard?

  26. Posted 15/12/2009 at 15:34 | Permalink

    […] Churchill to prove Keynes wrong is quite bizarre. Even more biizarre, Richard has recently been quoting Keynes to prove that the liquidity trap is wrong.  Which argument from authority are we likely to […]

Comments are closed.