Can Britain afford to abandon austerity? Maybe

Perhaps only Brexit is a more important political issue in Britain than austerity – the policy of restraint in public spending that is causing acute stress in parts of the public sector. It might surprising, therefore, that the quality of debate is so low as to be nonsensical. But then again, when things get important, truth is the first casualty. So let me attempt a dispassionate overview.

First let’s look at the case made by government supporters in favour of continued austerity. This runs at the level of household accounting. The government is outspending the revenue it collects. This means it is piling up debts which future generations must pay. How irresponsible! “There is no magic money tree,” says the Prime Minister, Theresa May. But one of the first things you learn in economics is that running a government budget is nothing like a household one. And the government does have a magic money tree – it’s called the Bank of England. It is perfectly safe for a government to create money to pay its own bills, in the right economic circumstances. Japan has being doing this for a couple of decades. Plus spending government money in the right way may generate the means to pay it back – through bringing spare capacity into the economy, or through investing in projects that generate a return. Or even both at the same time. The case made by government ministers is simply irrelevant. But that doesn’t make them wrong.

The case made by the left has more economic sophistication – and it is even nominally supported by authoritative economists like Joe Stiglitz, an American Nobel Laureate (who wrote a useful textbook on public economics). The main argument they make is often referred to as “Keynesianism” after the great Liberal economist Maynard Keynes, who offered it a the time of the Great Depression in the 1930s. Keynes pointed out that if there is spare capacity in the economy, such as during a recession, extra public spending will not displace other activity, and it will (or should) therefore cause the economy to grow, and pay for itself. But this argument is made by left-wingers regardless of the economic climate. Find me a trade unionist that has ever, ever said that because the economy is overheating, government spending restraint is required. It’s like finding a businessman who says, in any given economic conditions, that interest rates should go up. They are like barristers making a case, no matter how ridiculous. What should judge and jury think?

Two pieces of evidence may be offered in favour of Keynesian expansion now. First is that economic growth since the great financial crisis of 2007-2009 has been lacklustre, and behind many of Britain’s peer economies. Surely it needs a kick up the backside? Second is that inflation is low and looks stuck. Actually, inflation has been creeping up a bit, but that is due to the pound falling. Pay inflation – surely the critical point in this case – remains low. In classical economics high inflation is the surest sign of an overheating economy.

But two pieces of evidence can be offered against Keynesian expansion. First is that unemployment is at near record lows for recent times, and overall employment is very high (unlike in the USA, there don’t appear to be a lot of people who have dropped out of the labour market and so not treated as unemployed). Second is that Britain has a high current account deficit – at 3.1% of income it is one of the highest in the developed world, though it has been coming down since the pound fell. That means that Britain needs foreigners to pay it in its own currency, or Britons need to acquire foreign currency to finance foreign debts. This means that the country depends on “the kindness of strangers” as the Chairman of the Bank of England put it. Among other things that takes some of the magic out of the money tree owned by the Bank – and is a contrast with money-plucking Japan, which tends to run big surpluses. Money trees need net savings (or current account surpluses) to nurture them, or else their fruit turns bad, as many a horror story from South America will attest.

So there should be public debate around what these pieces of contradictory evidence mean. Unemployment is low, but the quality of many jobs is low – so would people work more productively under the right pressure? Britain has a trade deficit, but most debt (including government debt) is still denominated in Sterling, reducing risks substantially. There is much to explore, but few take the trouble. Easing austerity could simply raise growth; it could cause us to borrow in currencies that the Bank of England can’t print; it could cause inflation; it could simply stimulate more low paid immigration; or nothing much might happen at all.

The important message, though, is that it matters how any extra government money is spent. This rather goes against the flow of the usual macroeconomic debate, which likes to deal in quantities rather than qualities. But if you read carefully you will see that trained economists brought into oppose austerity policies are quite careful about the type of extra spending they advocate. They want more investment. If the government invests in things that generate financial returns by making the economy more efficient and productive, then the question of whether or not the economy is running at full capacity is side-stepped. The Labour manifesto at the general election offered this line of reasoning, and that is doubtless why the likes of Mr Stiglitz felt able to endorse it. Labour also wanted to put taxes up albeit mainly on the rich – which, nominally, at least, should reduce excess demand.

Unfortunately this can lead simply to politicians labelling all public expenditure as “investment” – a favorite trick of former Labour Prime Minister Tony Blair. We need to look at matters case by case. What if the government gave NHS employees a pay rise, which some say they are due after years of pay restraint? Some of the extra money would come straight back in taxes; some would be spent creating demand which might help local economies to grow. But some might be spent in businesses that will just put their prices up; some might simply be saved (which has no short-term economic impact) or spent on things like foreign holidays that just add to the current account deficit. Unless balanced at least some extent by tax rises the economic case for this looks unconvincing (where those tax rises should fall is not a simple question either…). But there are other benefits to increasing pay. Would it make it easier to recruit and retain top quality staff that would make the service more efficient? That mean the service could run on fewer temporary staff and make cost savings by heading off medical complications? Well that’s the key, and it depends on strong management. These benefits don’t just happen.

But what of devoting more money to public health? If done properly, this will head off demand for health services, and reduce the costs of poor health elsewhere in the economy. The case for funding this from borrowing is much easier to make. A similar case can be made for schools funding – though again this depends on good management (though personally I am more confident of that in schools than in hospitals, if only because the former are much simpler to run).

There is a lot of extremely interesting debate to be had around the economic implications of different sorts of public spending. Would forgiving student debt be a financial catastrophe? Or might it provide an economic boost in exactly the right places? We need some dispassionate analysis.

Instead we have a Conservative Party that will not engage in arguments of any economic sophistication, and is allowing some of its cost savings to do lasting damage to society. And though the Labour Party understands this, it seems uninterested in the discipline that will be needed to ensure that extra government spending and borrowing does not drag the economy down, rather than boost it. Each party is sponsored by advocacy groups who think that the overall outcome for the country is somebody else’s problem. Such is modern British politics.


22 thoughts on “Can Britain afford to abandon austerity? Maybe”

  1. Most of this is OK. I’d say we need a measure of potential economic capacity to be able to determine just how close the economy is towards overheating. Traditional measures which relied on rates of unemployment are no longer valid when we have so much underemployment and poorly paid employment. So, maybe some economist would like to devise a new index which could be more useful?

    The index could be regional as well as national. If the index for London and the SE was, say, in the 90s (out of 100) we’d know the area was overheating. But if we had, say, 70s in Northern Ireland and the regions we’d know we could spend there without causing an inflation problem.

    You still seem to have a bit of a problem with overseas trade balances though.

    ‘…………..Britain needs foreigners to pay it in its own currency, or Britons need to acquire foreign currency to finance foreign debts. This means that the country depends on “the kindness of strangers” as the Chairman of the Bank of England put it.’

    Nothing to do with kindness at all! If Germany, or anyone else, wants to run a permanent surplus it has to buy UK govt debt. If it doesn’t then the pound falls and trade will naturally move closer into balance as you previously acknowledged.

    If you’re buying or selling something on eBay and the seller/buyer is someone in France , does either of you care? Providing there’s agreement on the postage, why should you? Does it matter in the slightest that the buyer is paying in euros and the seller wants pounds, or vice versa?

    There’s no need for any concern. The exchange rate , automatically handled by Paypal, takes care of all that.

    1. Yes I am being a bit paranoid about currencies. In normal circumstances amongst mature economies there is little to worry about. My concern is that under stress this breaks down. Breakdowns occur. Currency can become unobtainable – often because authorities have to slap on urgent controls. I’m sure I’d be safe selling a few secondhand books to somebody in Turkey over eBay. Would I sell them an airliner priced in Turkish Lira? I’d have to look hard at the risks. Would I buy Turkish government stock (and Mark Carney was presumably talking about selling gilts or other bonds)? Only if I was a professional, and I think most professionals would take some convincing. Britain is much further from financial instability than Turkey (another big deficit country). Still, when trouble strikes it strikes quickly. The issue about abandoning austerity is that that we are increasing the risk level, so we need to explore how much stress the system can take… hence I think a little paranoia is in order.

  2. . Among other things that takes some of the magic out of the money tree owned by the Bank – and is a contrast with money-plucking Japan, which tends to run big surpluses. Money trees need net savings (or current account surpluses) to nurture them, or else their fruit turns bad, as many a horror story from South America will attest.

    Let’s just have another think about this. Let’s consider how it all works in a country which runs a net surplus. It exports more stuff than it imports and acquires foreign currencies which it can’t spend. So it buys overseas Govt debt, usually pounds or dollar based, which keeps those currencies high and depresses its own currency.

    By what about its own exporters? They want the internal currency to settle their own accounts. Where does that come from? It has to be just created by the central bank so a net exporter has to be just as much a dreaded “money printer” as anyone else. They acquire foreign reserves to sort of balance the books but they can’t spend them otherwise they wouldn’t be net exporters any longer.

    A net importer is in a better position. It might have internal net savers but it also has external net savers too. The Bank of China or the Bundesbank are net savers with the BoE.

    If government can borrow money cheaply , like now its less that 1% for 3 year bonds, there’s really no need to create any more which would be interest free. QE is really more about manipulating longer term interest rates downwards than any real need to shake the magic money tree for more funds. Reducing interest paid will have an effect on the exchange rate. That’s probably the main downside to QE. If the Govt wants a high pound that is. There’s arguments for having a lower pound.

    Horror stories from South America? Normally Zimbabwe and the Weimar Republic are introduced into the argument at some point! Sure, if your economy is stuffed for any reason and isn’t capable of producing anything then just creating more money is going to lead to hyperinflation.

    So Govts need to know what they are doing. Considering the mess we’re in, we do have reason to doubt they do!

    1. Well that’s fair. QE is not being used to allow governments to spend more – and that means that there is very little financial risk attached. But it surely does make government budget deficits easier to manage. There are plenty of good reasons that a country can be in deficit, and if some countries insist on export surpluses, you could argue that this presents an opportunity for economic gain. But run up over long periods it does lead to financial risks. More to the point, it can be an indicator that an economy is overheating. At 3.1% and falling, with the pound where it is, that argument is a lot weaker than it was 18 months ago, it must be admitted. Still I think there is an awkward asymmetry in international finance: current account surpluses reduce financial risk (even if you surplus holdings of overseas bonds and currencies gets wiped out, that won’t cause many lost jobs); current account deficits are riskier – even if they allow higher levels of consumption than would otherwise be the case.

      South America. Zimbabwe is an overused case. Argentina and Venezuela are good recent examples. Going further back you have Ecuador (which was forced to abandon its sovereign currency), Brazil and no doubt many others.

  3. QE is not being used to allow governments to spend more

    It depends what you mean by “spending”. I think it might have been after the GFC especially if you include the costs of bailing out the banks.

    But it surely does make government budget deficits easier to manage.

    There’s a bit of a problem over how debt (even though liabilities is probably a better word) is defined by the mainstream. If the BoE creates cash it isn’t included as ‘debt’. If it then buys up bonds which are classed as ‘debt’ the ‘debt’ can be made to magically vanish! So QE actually reduces debt!

    The deficit is just the rate of change of ‘debt’ so that’s affected by the definition too. The Americans have a similar problem. Apparently they don’t include the coinage as debt so all they need to do, in theory, is create 20 x trillion dollar coins and hey presto! No more Federal debt!

    It’s all a hangover from when coins were made from gold and currency was backed by gold – apparently.

    It’s really most unscientific and more evidence of a very poor level of understanding/thinking about just what money is by the economics profession.

    1. Actually quite a tricky accounting problem. I’m not actually sure how I would classify bailing out banks as spending. It was a balance sheet shuffle that did not involve the government buying things or paying people’s salaries. it did mean taking on extra interest payment obligations on the national debt. It didn’t add to aggregate demand, though it was done to avoid the collapse in demand that a bank failure would lead to.

  4. “Can Britain Afford to Abandon Austerity”

    Just what does “afford” mean in the context of a sovereign currency issuing country? We can’t measure our own wealth, as a nation, in terms of the number of pounds we have. We can create as many as we like. Or even what an individual pound is worth on the Forex markets.

    We can measure our economic success by levels of production, though they aren’t everything. Austerity means that we have people hanging around doing nothing or working in poorly paid part time jobs. There’s a cost in lost output to be considered.

    A more valid question would be “Can we afford to KEEP Austerity”?

    1. Indeed – though my worry is the damage being done to public services, and what the knock-on consequences will be. Support for disadvantaged families is being cut back in way that is massively short-sighted. And I’m sure there are a lot other examples in different places. I’m agnostic on your argument over austerity and aggregate demand. I do worry that budget deficits may lead to financial instability and the damage to people’s lives that results – and how difficult it is to understand how great the danger is. I think well-designed tax rises may be appropriate to sustain higher levels of public spending.

  5. I do worry that budget deficits may lead to financial instability and the damage to people’s lives that results – and how difficult it is to understand how great the danger is.

    I can understand this concern. I’ve come around to thinking that the budget deficit probably does matter more than I think it should, if only because others, like yourself, think that it does matter a lot.

    Ideally if we let the pound float and the economy does OK with sensible fiscal management then we can let everyone save as much as they like. The big savers are our overseas trading partners who like to run surpluses with us. At some point they may well decide to not save with us. The pound will fall and deficits – both internal and external will fall too. So maybe the next best thing is make this happen sooner rather than later.

    Whatever, the budget deficit of government will always be equal, to the penny, of everyone’s savings. If we want to reduce the budget deficit we have to reduce those savings. This means tackling the trade deficit.

    I don’t really have a problem with that. But is this what you really want to do? Maybe nudge the pound down a bit more?

    The problem with tax rises , especially VAT and lower rates income tax, is that they’ll depress the economy creating ever more disadvantaged families. You won’t get the revenue you think you will. You’ll then think that you can’t spend what you’d planned in any case! If you think household economics – that is.

    1. As you may have gathered, I have a slightly different model in my head. A budget deficit will tend to lead to a trade deficit. That will lead (usually) to the accumulation of external financial balances which can lead to a crisis if confidence in fiscal management is lost by foreign creditors. What happens clearly depends on movement in net savings in the private sector too. If those net savings are high, the governments have more room for manoeuvre. And a private sector deficit will likely lead to financial stability almost regardless of what the government budget position is.

      Of course the whole point of raising taxes is to depress the economy – or to prevent excess demand. You could argue that taxing the rich is pretty pointless because they are likely to simply reduce their savings in response. But there is healthy demand (the type that leads to a more efficient use of resources) and unhealthy demand (the sort that leads to inflation, excess foreign balances or (arguably) immigration). The key to fiscal policy is understanding this and adapting your tax and spending policies accordingly.

  6. As you may have gathered, I have a slightly different model in my head. A budget deficit will tend to lead to a trade deficit.

    Technically this is true. So if the Govt, by applying enough brute force, cut spending and raised taxes they could balance the budget. This would mean that everyone became poorer as the economy plunged into recession. They wouldn’t be able to afford so many imports so the trade balance would close. They wouldn’t be able to afford to save so the sectoral balance equation would still hold good. Is this what you really want? It would be Greek type solution. Better to tackle the problem from the other end IMO.

    That will lead (usually) to the accumulation of external financial balances which can lead to a crisis if confidence in fiscal management is lost by foreign creditors

    If anyone overseas has pounds they can save them or they can spend them in the UK. There aren’t any other options. If they don’t want to save, they have to spend which would boost our exports. Wouldn’t that be a good thing? If demand for exports ever became excessive we could apply an export tax.

    I can’t follow your argument in the rest of the first paragraph. It’s probably much easier for Govt to negotiate a suitable time scale for foreign owners (mainly Govts) of UK bonds to reduce their holdings in a sensible timescale. Internal holders will be politically much more difficult to control and negotiate with.

    I don’t think we should excuse the rich their taxes on the grounds you suggest. But at the same time we need to be wise to the effect on the economy of different targets of Govt taxation.

    1. So if the Govt, by applying enough brute force, cut spending and raised taxes they could balance the budget. This would mean that everyone became poorer as the economy plunged into recession. They wouldn’t be able to afford so many imports so the trade balance would close. They wouldn’t be able to afford to save so the sectoral balance equation would still hold good

      Of course not. Firstly my point is to explain how the trade deficit happened in the first place, by a government growing the budget deficit. That increases domestic demand, which, for whatever reason, is not satisfied by increased domestic supply, and so is spent on imports, hence an increase in the trade deficit. And what happened in the UK prior to the great financial crisis (the excess demand also sucked in lots of East European immigrants, but that’s another story). Of course there were other factors that caused the crisis (excess private borrowing and reckless management of Britain’s banks) – but I digress. And the picture you paint only applies when, like Greece, the private sector is flat on its back. If HMG had applied austerity policies (e.g. not cutting income tax) in the noughties, it is most unlikely that this doom loop scenario would have occurred. Context is all.

      If anyone overseas has pounds they can save them or they can spend them in the UK. There aren’t any other options

      Or they can lend them back to UK citizens. In fact, unless the punds are piles of banknotes, these pounds are actually liabilities, ultimately owed by British people or institutions. I’m not concerned with how ultimately these might be wound out, but the power over elements of the British economy to people not under british jurisdiction. Moving this money around a bit too rapidly is what financial crises are about. Essentially they amount to a loss of confidence in the financial system. For example the pounds might be bank balances in NatWest. Suddenly the accountholder worries about the stability of NatWest and shifts them to HSBC, causing a run. Or they might be in Gilts. The holders decide the BoE is printing too much money, fears for inflation, dumps them and Gilt prices crash, interest rates rise, etc.

  7. Lending them back to UK citizens is the same as saving them. This happens via the banking process which will probably involve an overseas central bank . Or, the UK Govt ends up borrowing them but someone in the UK has to do the borrowing if overseas holders want to save.

    If these overseas holders aren’t happy with their sterling based holdings they’ll try to switch them to another currency which would cause the exchange rate to fall. But someone will end up holding the sterling holdings who will have the same two choices.

    If Gilt prices fall the Govt can instruct the BoE to enter the market to bid them back up again. So interest rates will always be what the Govt wants them to be. They can never be held hostage over interest rates.

    What I was saying before still applies. The one thing that the Govt can’t do is force the exchange rate to be as high as it would perhaps like it to be. If the exchange rate is low it is a sign that overseas holders of sterling aren’t happy about saving and want to start spending. There really are only two options.

    So if the Govt wants to reduce its own deficit it needs to encourage all savers to think that they should stop being savers! Deliberately deflating the economy isn’t going to close the gap at all easily and should only be done if inflation needs to be reduced.

    1. I don’t disagree with the fundamentals – I think you underestimate the capacity for the adjustment process to be disorderly (i.e. for their to be a financial crisis) if the stock of foreign savings is high. It all depends on confidence. You have too much faith in the efficiency of financial markets, I think.

      Governments with deficits can find themselves in a dead end and faced with a choice between inflation and then austerity, or a short-cut straight into austerity because of the way foreign holders of the country’s savings choose to behave. This might happen when the foreigners no longer want their surplus any more because they consider their holdings in the country’s currency to be worthless. The suppliers won’t be paid in local currency and their banks won’t sell the buyers the currency they want to be paid in. So people can’t buy imports; businesses slow down because supply chains break down and they cut wages or sack people, etc. Domestic savings aren’t increasing because people are being chucked out of jobs; foreigners aren’t playing ball – so the government budget balance is forced down, with inflation if they don’t cut fast enough.

      This may seem improbable, but it is another plausible way to play the equations. Even if it is illusory, surplus countries don’t like to think they are exporting for sheer charity. They must have confidence that the currency they are acquiring will be usable.

  8. “Of course the whole point of raising taxes is to depress the economy – or to prevent excess demand. ”

    I’d probably try to avoid using the word ‘depress’ but I think we’re in agreement. The assumption you’re making is that the excess demand is in the home market. We don’t like that. We recognise that it causes inflation. We do like excess demand in the export market though. In other words, we like overseas based spenders but we don’t like home based spenders. Does this really make any sense?

    The other group to be considered are the savers. We like home based savers. They are thrifty. They have all the virtues we encourage in our children. But we don’t like overseas savers. They are the bad guys who want to dump their cheap products on to our market and not spend the money they earn.

    Demand from the export market is just as inflationary as demand for the home market. If a fishing boat lands its catch it will auction off the fish to the highest bidders. If the buyers are French, for example, they’ll set the price.

    So why not treat all demand equally wherever it comes from? This means that we apply taxes to control the demand in the economy, just as now, to prevent inflation, but we don’t necessarily favour demand from overseas buyers with zero rating , for VAT purposes, everything they want to buy. If they happen to live overseas and they want to buy UK property then we might well want to tax them at a higher rate than UK residents.

    Similarly with savers. We treat them all the same wherever they happen to live. We control the extent we’d like everyone to save, and borrow, by varying interest rates. Just as part of our strategy to control overall demand in the economy to prevent excessive inflation.

    1. I don’t really disagree. However zero-rating of VAT is an attempt to treat them as the same, as overseas buyers can’t reclaim their VAT, but will have taxes to pay on the border. VAT is best understood as a tax on consumers, not businesses. And as I consumer I am paying it on all goods, whatever its origin. And other countries operate in equivalent ways – they are unlikely to offer imports a tax advantage.

      1. OK but we don’t really care if an overseas company can or can’t reclaim its VAT paid on products bought in the UK. Maybe we can sign reciprocal agreements with other countries which would allow them to do that. At present anyone can buy up a whole wardrobe full of clothing from UK shops, then claim back the VAT on their way out of the country.

        But this isn’t the main reason for introducing less discrimination into the tax system. You’re worried about what might happen if our overseas holders of sterling based assets “lose confidence” ? Why should we care? They, or whoever else ends up holding them can only cash them in and spend them in the UK. So a “loss of confidence” means that demand for exports could rise beyond the capability of the UK economy to supply without causing high inflation.

        So we do what we always do with spenders who want to spend too much. We rein in their spending capacity using the taxation system. What’s the problem?

        1. They buy that wardrobe tax free, only to pay import taxes (often VAT) when they arrive home. Or this is the case when buying business to business transaction that surely comprise the bulk of demand (tourists no doubt mostly get away without paying tax). All I’m trying to say is that the VAT zero-rating is meant to reduce discrimination, not increase it. If, post Brexit, BAe had to charge VAT on its wing assemblies to Airbus, which Airbus couldn’t reclaim, I don’t think we should be jumping for joy because inflationary pressures here would be reduced because BAe has to shut down its factories or cut its workers’ wages. Of course we could develop treaties allowing VAT to be reclaimed, but the zero-rating system was developed because in the end it’s a lot simpler and more consistent with national sovereignty.

          The problem with a loss of confidence is that foreigners don’t want to sell their stuff to us any more, except to the extent that we can pay them in their own currency – which they will not sell to us for pounds, so we can only acquire from exports or foreign currency borrowing. That would sort out the trade deficit quickly enough – but might cause a downward spiral in our own economy. It means either the private sector has to spend less, or the government applies austerity. Or inflation if they don’t.

    1. An overly hasty free trade deal… I’m sure Mr D. trump has something like that in mind when he says we negotiate something with the US really quickly.

      My point is that if we charged VAT on exports, importers would potentially pay our VAT plus import taxes on stuff they bought from us, and just their own (reclaimable) VAT on stuff they bought domestically. Hence exemption. Exporting within the EU, the importing country slaps its own VAT on anyway, just as we do for imports from the EU. They did try to work it that we could reclaim foreign VAT, but it was decided that this way was simpler.

  9. I’m not suggesting that we suddenly apply 20% VAT to all exports. That’s too much of move to be made as a single step and would cause too much alarm. We’d have to move cautiously. We could perhaps start off by replacing VAT on fuel with duty so that the price at the pumps remained the same but it wasn’t recoverable by the exporters. This would increase overall revenue at little or no political cost – if you want to look at it in conventional terms.

    A stealthy approach, keeping open the options of some reversal, is always the best option. You’ve said yourself that taxes are solely to regulate aggregate demand. ‘Loss of confidence’ by foreign holders of sterling assets can only mean that they will be more inclined to spend them than save them. So, as those assets increase, which are also our liabilities and which we start to fret over, we should start to move to cautiously protect ourselves by treating overseas demand closer, but not necessarily exactly equal, to home demand for taxation purposes. The alternative is pandering to them ie offering them ever higher levels of interest on what they hold. We don’t want to forever have to second guess what they might do when we do whatever it takes to keep the economy in good order.

    It’s nonsense to say that no-one will ever take pounds. If sellers want euros its just a matter of putting the exchange rate into a calculator and working out the price in pounds using a few key strokes . The exchange rate is the key. And if the economy is healthy that will look after itself.

    1. OK. I’m all for giving things a fresh look… and flexibility is a good idea if you want to stay independent.

      If foreigner lose confidence in the pound they will either write their sterling holdings off, or try to swap them into real assets – such as UK property or shares. There won’t be much direct effect on demand – depending on what the sellers of those assets want to do with their winnings, of course. There will no doubt be an effect on demand, but suspect quite a small one. But it may hold up asset prices. This indeed seems to hold true for life since Brexit. Asset prices have been solid, but demand less so.

      Things would certainly have to get extreme before people refuse to take pounds – basically they would do so either because they think the exchange rate will fall further, or that the transaction costs for handling pounds become prohibitive. Markets aren’t entirely rational – the idea of momentum in price movements is not rational, but it has a demonstrable effect on market behaviour. That means reducing the exchange rate can make the currency toxic when rationally it should make it more attractive. And markets aren’t linear – they are a complex phenomenon where disaster can strike quickly. So I think the risk is out there. An interesting question is whether there is a linear counterpart to what I’m suggesting – that a currency becomes less popular, and the costs of handling it go up as a result, and people choose to avoid using it. I don’t know about that.

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