This is where I, belatedly, see the benefits of nationalising the banks instead of letting them go bust. The final step in replicating the beneficial effects of a devaluation is to use state banks to give soft loans and forgive portions of debts. I’m surprised at myself for suggesting this, but I don’t see any alternative.

This obviously requires massive government borrowing, but if we can’t have inflation we need the government to borrow money to forgive debts and to fund stimulus.

We shouldn’t borrow to subsidize overly large pay packets, as it will further harm competitiveness. So that means that debt forgiveness looks more realistic if we want Keynesian style stimulus and if we want to, in effect, devalue.

Aaron - amateur armchair economist - don’t take me too seriously

we would have to offer huge interest rates to attract bond investment (and be beside luminary economies like argentina/venezuala/iceland etc.) paying for the high rates by printing money and thus huge inflation. for every country which recovered with increased money supply there are three who didn’t get it right and exploded with inflation (yugoslavia, turkey, germany, zimbabwe etc.) which leaves only one other option - deflation

In any case, whatever your views on Keynes, it is interesting to re-read Chapter 19 of the General Theory with these issues in mind. He discusses a number channels through which the economy could self-correct via wage deflation.

He notes the competitiveness effect as follows:

“If we are dealing wih an unclosed system, and the reduction in money-wages is a a reduction relative to money-wages abroad . . . it will intend to increase the balance of trade. This assumes, of course, that the advantage is not offset by a change in tariff, quotas, etc. The strength of the traditional belief in the efficacy of a reduction in money-wages as a means of increasing employment in Great Britain, as compared with the United States, is probably attributable to the later being, comparatively with ourselves, a closed system.”

On the increased real value of debt, he says:

“On the other hand, the depressing influence on entrepreneurs of their greater burden of debt may partly offset any cheerful reactions form the reduction of wages. Indeed if the fall of wages and prices goes far, the embarrassment of those who are heavily indebted may soon reach the point of insolvency, — with adverse effects on investment. Moreover the effect of a loe price-level on the real burden of the National Debt and hence on taxation is likely to prove very adverse to business confidence.”

As it occurs just above this quote, I can’t resist quoting one more passage. I think the following nicely dovetails with your call for a flexible system of national wage bargaining to secure needed reductions in the wage level:

“Since a special reduction of money-wages is always advantageous to an individual entrepreneur or industry, a general reduction (though its actual effects are different) may also produce an optimistic tone in the minds of entrepreneurs, which may break through the vicious circle of unduly pessimtic estimates . . . and set things moving again. On the other hand, if the workers make the same mistake as their employers about the effects of a general reduction, labour troubles may offset this favourable factor; apart from which, since there is, as a rule, no means of securing a simultaneous and equal reduction of money-wages in all industries, it is in the interest of workers to resist a reduction in their own particular case. In fact, a movement by employers to revise money-wage bargains downward will be more strongly resisted than a gradual and automatic lowering of real wages as a result of rising prices.”

@Ciaran ‘generated by wage cuts and efforts to cut markups through more aggressive competition policies’ wage cuts are mentioned seperately, efforts to cut markups would imply that it is general market rather than employment specific cuts that are being talked about. I would hold that public sector pay etc. is one thing but the general market must be allowed to function without state distortion.

@Jeremy - if we were not part of the EU the IMF probably be here right now.

I would also, for political reasons, impose a cap on all wages in organisations paid for in whole or in part by the tax payer, which at this stage obviously includes the banks and other high profile bodies. 200K seems like a very generous cap to me, one could obviously make the case for a much lower one.

The policy intervention required is for partnership to be scrapped and for firms to start properly managing (i.e. cutting) their pay bill.

Also, the public pay levy announced yesterday will be tax deductible for pension relief! Surely this pension relief, for earners paying higher rate of tax (and especially those older) is a shocking waste of taxpayers money.

The lack of talk in the press about eliminating distorting tax subsidies is alarming.

if wages and demand reduce will the market not set itself right on prices as there is less money chasing a product/service and thus the price will drop to meet that demand?

I think that unemployment will go far beyond initial expectations of a maximum of 10% and that will cause quite a slump in demand across the board so no policy intervention is required.