[nhaehnle]

1. What makes you believe that the UK government has a debt problem?

As long as the UK government emits gilts in pounds, they will never become unable to pay the resulting obligations. So: where exactly is the problem? Where are the Emperor's clothes?

2. What makes you believe that unusually high inflation would result if the UK government reversed its austerity stance and implemented some kind of public works program?

Inflation is largely the result of the normal processes in the economy whereby the relative valuation of different goods changes, and different actors in the economy strive to increase their share of the total income. If you actually look behind the scenes how the various inflation measures are computed, you will see that the different types of goods in the baskets used usually show quite different behavior. Most of the time, a few goods and services will be decreasing in price while the majority increases in price, though at (often vastly) different speed. So what you are really seeing is changes in relative price, which reflects changes in how goods are valued. Without this process, the market could not function properly.

This process is biased towards larger nominal prices on average for a number of reasons - mostly because it is rare that somebody voluntarily decreases their profit - but there is nothing inherently bad about that. You could think of it as the Red Queen Hypothesis of economics.

It is clear that, beyond those processes, inflation can be pushed higher by excessive aggregate demand or by increasing resource prices - price increases in the last months were dominated by energy prices.

So I could rephrase my question as: What makes you believe that turning away from austerity would create excessive aggregate demand in the UK? Keep in mind that the current context is one of high unemployment and idle factories, i.e. there is more supply capacity than is currently being used.

As a final note: I think it is quite disingenuous to jump directly from "there could be higher inflation" to "1920's Germany". Those scenarios are entirely different beasts.

[djm]

Perhaps my comment didn't make my thoughts clear enough.

First of all, I think we are working on different definitions of 'inflation'. There seems to be two schools of thought on this: some people think inflation is driven by prices and some people think prices are driven by inflation.

Your comment suggests you are in the first camp and I am in the second. I define inflation as simply being 'when the government prints more money'. Prices increase when the money supply increases. Businesses have to raise prices when this happens because otherwise they will reduce the buying power of their profit.

I wasn't talking about the UK specifically. I was just trying to say that, in general, I think the outcome in terms of social unrest is going to be about the same whether you reduce the amount of money you give people or whether you give them money that is worth less.

To be clear, I didn't say that reversing the austerity measures would result directly in hyper-inflation or that we'd end up like 1920's Germany. I'd agree that that kind of scenario is a long way off.

[nhaehnle]

I define inflation as simply being 'when the government prints more money'.

I would posit that this definition is useless in a fiat currency. Under a gold standard, the government printing money was relevant because that increased the amount of money, which in turn had some meaning because of the gold-to-money ratio. But in a fiat currency no such meaning exists.

Furthermore, has whether the government printed more or less money actually ever affected you directly, provably in your personal life? I bet that it hasn't. [1] But I bet that the Consumer Price Index does affect your personal life. So CPI as measure for inflation is actually useful, unlike your definition.

Finally, it would be nice if you used clearer language to describe what you are talking about. I'm sure that it is obvious to you that the government literally printing money is completely irrelevant. But your use of such language makes it hard for me to understand what you are actually talking about (I just appreciate a clear conversation on the matter).

Are you talking about the government spending more money? Clearly you can't be saying that government spending is always inflationary, can you? And if you did, I hope you'd at least acknowledge that it's just the spending part that matters, i.e. it is irrelevant whether we're talking about government, foreign, or private spending.

Are you talking about the Fed increasing the size of the Monetary Base, as happened with Quantitative Easing? In that case, hasn't that QE/QE2 demonstrated clearly enough to you that there is no causal link from the MB to Consumer Price Indices?

Are you talking about the government increasing the amount of money in terms of M1-M3? In that case, you'd be woefully misinformed, since that amount largely depends on bank lending, and so the government has basically no direct influence over it.

Are you talking about something else that I've missed?

I wasn't talking about the UK specifically. I was just trying to say that, in general, I think the outcome in terms of social unrest is going to be about the same whether you reduce the amount of money you give people or whether you give them money that is worth less.

There is actually an interesting technical argument against that stance that dates back to the days of Keynes. Basically, what progressive economists were (and still are) arguing is that for most people, X% inflation is better than an X% decrease in income. The reason is that most people have long-running contracts forcing them to pay nominally fixed amounts, such as rents or mortgages.

Here's an illustrating computation with very simple numbers. Say I earn 1000# per month, of which 500# are committed to such contracts. 500# are available for "discretionary" spending (food, clothes, etc.). I now have the choice between 10% inflation and a 10% reduction in income.

In the case of 10% inflation, I still have 500# available for discretionary spending, only it's worth the equivalent of 450# of the old money.

In the case of 10% reduction in income, I earn 900# with my contractual commitments remaining the same, so I only have 400# left for discretionary spending.

Clearly, inflation is better for me. The situation is different for people with significant net financial assets of course, but the majority of the population does not fall into that category.

[1] Unless by printing money you mean spending money and you are a government contractor.

[yummyfajitas]

Basically, what progressive economists were (and still are) arguing is that for most people, X% inflation is better than an X% decrease in income. The reason is that most people have long-running contracts forcing them to pay nominally fixed amounts, such as rents or mortgages.

No, this is not the reason Keynesians argue for inflation. Keynesians believe that nominal wages are sticky - people will not work at a nominal wage lower than their pre-crisis wage.

Inflation is a way of reducing real wages (a necessary step in the recovery) while allowing people to maintain their prior nominal wage.

Strangely, a large number of people who support Keynesian economics also support measures aimed at increasing wage stickiness (unionization, minimum wage laws, etc). This last fact is something I can't figure out.

[nhaehnle]

There are actually two separate arguments here. What you are saying is one argument: that people resist nominal price decreases (e.g. workers resist nominal wage decreases). What I was saying is the other argument: people are right to resist nominal price decreases, because inflation is better for them than the alternative. Both arguments have been made (the second argument may be less known) and I would agree with both of them.

There really isn't a conflict between being supporting Keynesian-style anti-cyclical government behaviour (this is what most people mean when they say they support Keynesian economics) and resisting nominal wage decreases.