Covid-19 has us guddling for reality

Covid-19 has us guddling for reality

by Eben Wilson
article from Thursday 19, March, 2020

IF YOU HAVE EVER tried guddling for trout you will understand the trials of an observing economist in these strange times.  We’re trained to stand away from received opinion and slowly put together our intellectual feelers, identify evidential reality and then go for a hypothesis. Very often, that reality slips away as one of our earlier presumptions turns out to be unsound. 

The sheer scale of the Covid-19 intrusion across the waters of the economy is huge; delineating between ripples, waves and tsunamis for today and tomorrow is a real challenge. There are, however, models and tools available to us. 

Keynesian model concentrates on demand. It suggests that consumer spending, available savings, investment programmes and government spending drive a form of stability where we all expect tomorrow to be much the same as today; with life more or less continuing as normal if those factors of demand sustain; while improving if they increase. 

Hayekian model would largely concur, but sees this as a description of symptoms rather than causes; hence rejecting the injection of false demand as having unintended outcomes. It stresses that the longer term supply-side factors of capital availability and distribution, fused with entrepreneurial confidence, constrain present day events more deeply than we can recognise through our lack of knowledge of each economic actor. 

A monetarist Friedman model would suggest watching the process through which money demand interacts with supply. Too fast an injection and prices inflate, too slow an injection and prices can deflate; but in each case the sectors that those prices change is near unknowable (echoing Hayek) or often detrimental for example through falsely inflated stock prices (echoing Keynesians). The resulting variably “wobbling” response to monetary policy is politically toxic and often leads to further unhelpful and contrary government intrusions. 

One lesson of the above synopses is that it is wrong to taint economists with the opinion that the do not agree on anything. Rather, it is the assumptions of different models and tools that suggest different outcomes requiring different policy measures. 

Does this tell us anything useful about the impact of Covid-19 and how policy should react to it? I think it may. 

Let’s start with Keynes. If you send half the population home, consumption will (after an initial burst of food buying) decline. In Scotland, around 50 per cent of us have less than £1,000 in savings, with about 15 per cent having none at all. Nearly 40 per cent of those with low earnings have no savings.  The reality is not many people have a great deal in reserve.

Here we can see why Chancellor Rishi Sunak started his measures with support for families; in the high tax regime of the UK, and because we have an NHS and an all-encompassing welfare system, the state by default is our savings bank of last resort. It’s no surprise that within two days, home renters are crying out for more support, the self-employed and gig economy workers also.  If our large-scale state wants to help across the Keynesian parameters above, doing “whatever it takes” means supporting everything and everyone. 

A Hayekian would accept the demand support, but question the notion that it is much more than temporary sticking plaster. There is also an oddity; the second-day support for business was largely based on loans. There is a contradiction implicit in supporting cash flow of businesses distressed through lack of demand by, er, lending them money that will add to this cash flow burden.  It’s a temporary reprieve at best; and for many if not most small businesses managed by those that can count, the choice between adding to future overheads versus cutting today’s by reducing hours or laying off staff is a relatively easy one; cut back, hunker down, and wait.  We should not be too depressed by this; small businesses are by definition finding niche gaps in markets, when the storm passes, they will read the runes in the ripples of the waters and get going again very rapidly. 

And so to monetary analysis. Note here that I do not say “Friedmanite”; Milton Friedman himself said that there could and should be no such followers; monetarism is an analytical tool set based on a specific model(s) of inflationary mechanisms. As such, it does not offer policy recommendations, merely expected outcomes of interventions. In this, the most recent reduction in interest rates by the Bank of England tells an ugly truth; our policy makers still think monetary policy is a tool for positive economic management; it isn’t, it never has been and never will be.  

What monetary policy can do is make the outcome of bad policy measures a lot worse. Oddly enough, the Labour Party’s John McDonnel clearly understood this. His claims that he was committed to “living within our means” were combined with a “fundamental reform of our economic system" which included measures that would have made the control over the monetary tools that the independent Bank of England presently enjoys near enough evaporate.  

I mention this because in the past few days Rishi Sunak has committed £350 billion to help us live beyond our present means given our limited ability to consume and our miserable savings. The crucial question now is whether he has introduced a “fundamental reform of our economic system.” 

Well, in the long term, the answer is “no”.  As a Hayekian I would stress that there are rules to our economic order at the microeconomic level of exchange, supply and demand, property law and human nature that just “are”; markets adjust but they do not fail.  Eventually, they will re-adjust towards these microeconomic rules. 

In the shorter term, the answer is possibly “yes”; we are living on paper money pumped towards us, whether through the financial markets, mortgage companies, councils and landlords, loans to business or down our chimneys. This money allows spending and prevents collapse, but it doesn’t induce sound money based on revenue earning “hard capital” with both an expected and accepted future stream of those earnings. 

As for the medium term, here Friedman the ‘monetarist’ would have something to say. The amount of money and how fast and often it is spent (aka the money supply) must eventually balance against the number of transactions and the price of those transactions in the economy (aka the demand for money).  This truism formulated in the expression MV = PT is like a law of physics, inescapable through time.  Pouring a massive supply of paper money into the transaction engine could potentially lead to a massive inflation as the value “P” takes the strain in a world of transactions “T” that, while presently reduced, could roar back into life as the pandemic recedes. Could HM Treasury slow down its money dispenser fast enough to prevent this? I wonder. 

The difficulty is that we can only be uncertain as to how this immutability will play out; that’s concerning, in this viral invasion we are in a period of uncertainty of unknown severity and duration.  We have public information of a depth and volume that is of uncertain value; especially if the impression is often that there is a “fix” to be made, quickly and easily, followed up by violent criticism that the demanded “quick fix” did not work and things are now worse. 

Politicians react to such inadequacies in analytical knowledge and demands for discretionary action with a form of flailing about, doing this or that just to be seen to be doing something. Like economists, they too are engaged in a guddling exercise, teasing out some reality to grab onto. As we all know, the sign of failure for any guddler is when you create a sudden arc of spray and energetic arm whirling … with absolutely nothing to show for your efforts. 

Much better to quietly tease your supper into your hands and quietly caress it to obey your will. 

Eben Wilson is an Honours Graduate in Economics from St Andrews University. He has had three careers, initially in journalism and broadcasting (including Milton Friedman’s TV series “Free to Choose”), economics (as an associate Scholar of the ASI) and now business (founding various companies).

Image of formula from “The Sceptical Optimist”; photo of Trout by Barbara Jackson  from Pixabay 

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