Home > Uncategorized > Liz Truss. Or: how not to pay for the war

Liz Truss. Or: how not to pay for the war

The Dutch September HICP inflation rate was 17,1%. One year ago it was 3,0%. Below, I will argue that this is a sign of kind of war economy, not of a cyclically overheated economy. Ways to mitigate inflation were pioneered by the English economist John Maynard Keynes in his ‘How to pay for the war‘. it’s useful to go back to his ideas.

The first version was published in three parts in The Times of november 1939. It was partly based on his experiences in World War I and partly on the new system of national accounting (extended and improved by Keynes). The ideas weere based upon the idea of a monetary economy where consumer spending and consumer prices, production and producer prices and the use of factors of production and factor prices (wages, profits, interests, rents) are intertwined. During a war, this system could lead to consumer and producer price inflation resulting in war time profits on one side and poverty on the other. He proposed changes to the system which would mitigate producer and consumer price inflation as well as war time profits. Fun fact: it’s about the opposite of the Liz Truss UK budget. The central idea of Keynes: we have to understand inflation not just as an increase of consumer prices but as interconnected changes in consumer, producer and factor prices, financed by income as well as borrowing/(forced) saving. Especially during a war, the connections will change in unwanted ways, policies to mitigate this can be enacted as long as we understand inflation as a system of interconnected expenditure, output and factor prices. Fun fact: Keynes acknowledges ‘Prof von Hayek’ for the idea of a post war levy on capital.

is it, at the moment,worthwhile to use such ideas to analyze the present situation? The first question to be answered is: ‘are we, as Isabella Kaminska suggests, in a war economy‘? Answering this requires a definition of ‘war economy’.

Googling for definitions leads us to Investopedia. Key words: rationing, defense spending, (higher) taxes, ensuring vital domestic consumer demands (rationing, production), government intervention (sometimes quite extensive), rapid technological progress. To this may be added the ideas of Keynes, who did not only look at consumer and product prices but also to factor prices (wages, profits, interest rates, rents). I would like to add: disruption of supply chains, changes in exchange rates, export and import controls and attempts at reshoring. A characteristic of war economies: large increases of some product prices (energy, food) coupled with (the other side of the transactions) our of control increases of profits, but not of wages. On the price policy side: interest rates and rents might be kept flat. Aside: my Ph.D. (and some subsequent publications) covered the first and second world war.

When we look at the present situation (the war in Europe, the fully predicted emanation of the climate disaster, the Covid pandemic plus the related policy reactions) we do see, in my opinion, a kind of war economy. Mutually reinforcing disruptions to energy and food supply chains caused by climate change and a major war (sometimes up to 1,000 casualties a day, if I read the signs right) contribute to high energy and food prices. The pandemic led, partly because of lock downs and other policy measures but also, as is beyond doubt by now, also because of long Covid, to additional disruptions of supply chains. Aside from supply chain problems, droughts and floods contributed to food price increases: Pakistan, Europe, USA, East Africa. Military spending of NATO countries has been increased by a lot, governments are forced to enact policies to sustain household incomes. The energy sector, but also some sectors of agriculture post record incomes and profits (while horticulture, which uses a lot of energy, is going bankrupt). There ‘western’ labor market is (at the moment of writing, but we may already have seen the peak) at its tightest for about fifty years – but wages are still not increasing too fast. It all sounds a ‘war economy’. Central Banks try to increase interest rates but the Bank of England has already experienced some problems with this policy. Energy prices are capped, governments are forced to interefere with production (for instance by not closing nuclear reactors). I can go on, the situation checks quite some war economy boxes.

But the point: we need coherent policies instead of ad hoc solutions. A kind of ‘How to pay for the war and the climate disaster as well as the pandemic while at the same time sustaining household purchasing power and admitting that inflation is more than just an increase of consume prices and can better be understood as the interconnected changes of a number of price levels inside one economy, changes and connections which are highly dependent on government policy‘ policies. We’ll have to speed up the New Green Deals, invest much more in medical and energy technology, cap house rents and central bank interest rates, admit that global agriculture is, at the moment, not a ‘degrowth’ but a ‘growth’ sector, make sure that (international) supply chains work as best as we can manage, introduce war profit taxes (including, life happens fast, taxes on large scale solar) and put more people in one house. Key to this is however to understand inflation not just as an arithmetical change in consumer prices but as sometimes idiosyncratic changes in the system of interrelated expenditure, factor and producer prices. Putting caps on some prices (rents, interest rates) can mitigate the amount of idiosyncrasy as well as contribute to less disruptive random shocks to household incomes. I’m not a fan of ultra low/negative interest rates. But at this moment, forced increases are unwise. Just like massive tax breaks for a very limited number of extremely rich people. Which reminds me of the main motive of Keynes to write the treatise: social justice which, according to him, was inherent to a free society.

  1. Patrick Newman
    October 1, 2022 at 2:46 pm

    I think Truss and Kwarteng have engineered an economic, monetary and fiscal crisis to drive in extreme Right wing social and economic policies affecting workers and social welfare, but maybe they have started something that has wildly got out of control. They can’t even be sure they can achieve parliamentary approval for the large unfunded tax cuts, which includes a big windfall tax cut for the have yachts. It is the trickle down tribute show!

  2. Romar Correa
    October 1, 2022 at 3:38 pm

    merijntknibbe continues to educate! Just an aspect of the ‘old’ New Deal in How to Pay for the War. The political economy was a time-bound truce to be called between capital and labor with a timetable of deferred wages for the latter.

  3. gerald holtham
    October 4, 2022 at 11:50 pm

    Truss and company are ideologues completely sold on the Chicago view that prosperity just requires government to get out of the way, deregulate and cut taxes. They look at their principles/prejudices not at the actual situation. Unfortunately for them they came to power in a country running a large public deficit, with a large external current account deficit of 8 per cent of GDP, a country where the rise in energy prices was hitting poorer households very hard making them choose between eating and heating. Moreover inflation was rapid, public services were already in a state of decay with millions on waiting lists for health services, the criminal justice system seizing up with barristers (advocates) on strike and an educational system en route to be the worst in Europe.
    Large unfunded tax cuts on top of the unavoidable energy price subsidy were always likely to spook the foreign lenders on whom the UK relies. Tax cuts were always likely to require brutal expenditure cuts to collapsing public services leading to political unrest. Just in case they didn’t Truss and cronies fired the top two public servants in the Treasury and refused to let the independent Office of Budget Responsibility (roughly similar to the CBO in the US) forecast the consequences for growth and debt. A crisis in the government bond market and a swoon in the pound were among the easier forecasts to make in my professional experience but somehow the government didn’t see them coming. The UK is in a truly dreadful state, exacerbated considerably by Brexit.
    If there is one consolation it is this. By trying to implement extreme Chicago-style right-wing ideas at the worst possible moment, Truss and co might well have destroyed their electoral credibility for a generation. We can but hope.

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