Economic Jargon

A rise in either property prices or the stock market as opposed to CPI inflation. Inflation in the latter sense is regarded as bad, whereas asset price inflation is ignored by most economists and policy makers, and enjoyed by those who hold assets. This is a major problem when it comes to putting the UK economy on a sustainable footing.

Average wages or salaries per person. How do we arrive at “the average”? There is a key difference between “average or mean” earnings and median earnings. Mean income is the figure derived by taking total wages and dividing by the number of wage earners. Median income reflects the income that lies midpoint between the highest and lowest income; it is closer to what the majority of wage earners actually receive. It could be argued median income is a more realistic measure because, with the huge and rising levels of inequality in the UK, the mean wage is skewed upwards by the vast incomes of those at the top of the scale.

Any open economy (one that trades with others) buys and sells goods and services with the rest of the world (ROW). The tally for this is called the Current Account. The UK, since 1983, has every year bought more from abroad than it sells, imports have exceeded exports. This is called a balance of trade deficit. How can a country buy more goods and services than it sells? The deficit is paid for by a corresponding surplus on what is called the Capital and Financial accounts. The precise makeup of these accounts has been redefined over the years, but they are, as the name states, capital and financial flows going to and coming in from abroad. The overall balance of payments, the sum of the current account and the capital/financial account combined, has to balance; they add up to zero. The current account is subdivided into goods and services, often referred to as visibles and invisibles respectively. The UK usually has a surplus on invisibles, but this is smaller than the deficit on visibles, hence the UK’s Current Account Deficit.

(or commercial bills): A bit like a post-dated cheque, used in international trade. The drawer has to pay the drawee a sum of money at a certain date in the future.

See Government Bonds and Gilts.

See Balance of Payments.

See Current Account Deficit.

The percentage of productive capacity within an industry which is being used; when an economy is not running near full capacity it has an output gap. Empirical studies in the USA and UK have shown, contrary to the assumptions of many economists, that even when the economy is not in recession and there is apparently no output gap, industry usually operates at only 70% to 85% of capacity. This is one factor that supports the export-led growth potential espoused in this book.

This is possibly the most confusing word in economics because it’s used to refer to many different things. What do all these things have in common? They tend to provide some form of future income, but it’s better to be specific to context.

1. Physical Capital. When you start studying economics, you’ll be told capital is a factor of production: things are produced using two factors, Capital and Labour. Here economists are using capital to mean machines, factories, infrastructure. We can call this physical capital.
2. Money Capital. When talking about firms and markets, economists will talk about capital meaning the money value of company stocks, shares and corporate bonds. As companies raise money by issuing bonds, they are borrowing money, so these corporate bonds may be referred to as debt capital.
3. Human Capital. When economists talk about workers or businessmen having skills, and improving these skills by training, they refer to this as Human Capital. So an economy with low levels of education, skills and training may be said to be poor in terms of human capital.
4. Balance Sheet Capital. A firm’s balance sheet consists of two columns: what it has (its assets) on the left, and what it owes (its liabilities) on the right. Confusingly, on the right-hand side at the bottom you have a figure equal to the assets less the liabilities: this is referred to as the firm’s capital. This applies to banks as well as firms. Banks are meant to ensure they have some capital in hand, so that if their assets suddenly fall, they have capital to bridge the gap. If the capital isn’t enough, when added to their assets, to equal their liabilities, then the bank is insolvent and cannot trade.
5. Capital Flows. Capital flows refer to currency changing ownership, but sound like currency moving from one country to another. When capital “flows” it is the ownership that changes, rather than the location of any hard drives. If a UK company exports something, the foreign buyer converts their own currency to pounds to pay; the UK company has received pounds previously owned by a foreigner. If lots of foreigners who own UK pounds decided to sell them, the price of pounds on the international exchange markets would fall, a depreciation (a capital outflow). If loads of foreigners start converting other currencies into pounds, the value of sterling would increase (a capital inflow): but these pounds would still be owned by foreigners, so in that sense there has been no capital inflow into UK account holders’ accounts.

Structured asset-backed security: developed for the corporate debt markets, prior to the GFC (Global Financial Crisis of 2007–2008) CDOs had evolved to encompass mortgages. A security is a financial product designed to give the buyer an income. If it is asset-backed, this implies it is based on some real asset, for example, when the security is a mortgage, it is backed by the value of the property purchased with the mortgage. If the borrower cannot meet their repayments, the property can be sold. This system breaks down if lots of people default, resulting in lots of houses being put on the market when no one is able to buy; the value of the collateral may then fall below the money lent. When different mortgages were bundled together and sold on to a third party, they were called collateralised debt obligations; again, the collateral is the property on which the original mortgage was granted.

This is the State Theory of Money, written by Georg Friedrich Knapp, who adopted the term which derives from the Latin charta, meaning a token or ticket. Chartalism says that money is a creature of law, not a commodity.

Alfred Mitchell-Innes held a similar view, saying that the state issues debt in the form of its money and imposes a tax which citizens have to pay; when they pay the tax, the government debt is “redeemed”. Innes said this was the law of coinage. Again, money derives from state law, not from people swapping commodities. He wrote this in 1914 in The Credit Theory of Money, published in the Banking Law Journal.

The theory was reinforced in 1947, when Abba Lerner wrote his famous Money as a Creature of the State.

A theory of international trade that originated with David Ricardo in the early 19th century. It is used today to extol the virtues of globalisation. A country will specialise, through international trade, in those products which it produces relatively most efficiently. It may produce these less efficiently (in absolute terms) than its trading partner, but trade will produce a win-win situation for both countries if the less efficient economy just produces what it is least poor at producing, while the efficient economy just produces what it is best at. So the world benefits when countries specialise in what they are least bad at producing.

The theory has been challenged: it is corporations and consumers that trade with one another, not countries per se. In addition, the theory assumes a supply-constrained economy, is this realistic? There is a danger in moving from an assumption that some land is innately more fertile than other land, to assuming that countries always have an innate advantage in some sector. Such natural advantages are not immutable; they are often man-made rather than natural. For example, a country with less fertile land, if it has better fertiliser and better agricultural machinery than another, might end up with a comparative advantage in food production. So over time comparative advantage can shift.

Created by banks, and given to borrowers. If money borrowed is someone else’s savings, it is not new money. But when banks make loans, they are not usually lending existing money but creating new money. This creates new demand in the economy. If banks are creating more new loans than are being repaid, the money supply will be increasing; if money being repaid exceeds new money being created, the money supply will be decreasing. After the GFC both corporations and households cut back on their borrowing, causing a drop in demand and recession. When Prime Minister David Cameron told everyone to pay back their credit card debt, he was effectively encouraging behaviour that would deepen the recession; someone must have explained this to him, because he later “modified” his exhortation. See Credit Squeeze.

Occurs when a central bank decides to buy riskier assets. For example, if mortgages which look like they are not going to be repaid are bought by a central bank, the risky mortgages will sit as assets on the central bank’s balance sheet and the seller of the mortgages will have got cash. This puts more money into the economy and helps to stop asset prices from falling.

Banks don’t feel confident enough to issue new loans and credit, suspecting borrowers may not be able to repay. This may dramatically slow down economic growth.

When exchange rates are fixed, a fall in the currency is called a devaluation. When exchange rates are not fixed, they are said to float. Sterling is floating, so if it goes down in value this is called depreciation.

A government that issues its own currency cannot involuntarily run out of it. The real constraints on public spending are inflation and real resources, never funding.

A country imports more goods and services than it exports. Since the early 1980s the UK has had a CAD. It exports more services than it imports, but this surplus is outweighed by a larger deficit in goods.

A group of states that have agreed to charge the same import duties on goods and services from outside the union, while usually allowing free trade (no export/import duties) between themselves. The EU is such a union: every country has to impose the same tariff on agricultural goods from outside the EU, and there are no tariffs within the EU, so it is a Tariff-Free Zone.

The total accumulated amount of money owed by an individual, company or other organisation to banks or other lenders is their debt. The money owed by government is the public debt. Every year a government spends money and has money given back to it in taxes collected. If in any year it spends more than it collects, it has a deficit. The government deficit is a figure for the year in question; the government debt is the accumulation of past deficits. Post-GFC, the government has thought it important to reduce the government debt, but it has gone on increasing; what has reduced is the annual government deficit. So the debt has been increasing, but not so rapidly as before, when the annual deficits were not decreasing.

Debt is worrying if there are signs that it cannot be repaid; the interest rate determines the cost of repaying any given amount of debt, and the income of the borrower determines whether they can afford this. For a country, the really significant measure is the debt, private or government, as a percentage of GDP. A crucial metric for evaluating the burden of debt is whether the economy is growing faster or slower than the debt is growing. If debt cannot be repaid and debt repayments are sucking money out of the economy, it is a “burden”.

The collateral securing a loan (or another form of debt) falls in value, for example, the value of a house used to secure a mortgage.

High levels of debt which become difficult to service can lead to falling asset prices. As people find they can no longer meet their interest payments they sell off assets to repay their debt. As more people sell, the value of assets falls and no longer covers the money borrowed; for mortgage holders this creates “negative equity”. For businesses, and even whole countries, it means having to sell off more and more assets to pay creditors. Asset prices fall but the nominal value of debt remains the same; therefore the Debt-to-GDP ratio increases. Some heterodox economists argue that debts that cannot be paid won’t be paid, and that the solution is for debt to be written down or written off, the way to escape the debt trap.

As borrowing falls back, investors and consumers cut their spending. This leads to loss of jobs and a vicious circle of falling wages, falling demand and falling asset prices. The cost of goods and services may start to fall, negative inflation. With incomes and prices falling and unemployment increasing, overall production can fall. GDP starts to fall but the debt is still measured at its original price, so the debt burden increases. After the GFC, corporations and households reduced their borrowing and so spent less, a downward spiral. If the government had not allowed its own borrowing to increase, the downturn would have been even more severe. To halt the spiral the UK government also used QE (quantitative easing) to prop up asset prices; this, however, has its own negative consequences (see QE).

When a government, business or household spends more in a given period of time than it generates in income, it has a deficit. A deficit must be financed with new borrowing, or by running down previous savings.

A decline in the overall average level of prices.

When the level of output and employment is limited by the amount of overall demand for its products. See also Effective Demand.

The loss of value, due to wear and tear over time, of plant and machinery (and at a national level the whole infrastructure, transport system, school and hospital buildings). A company or country must invest continuously just to offset depreciation, otherwise its capital stock will erode away. Long before Brexit, the UK’s net investment per person was close to zero. If, for example, total (gross) investment is 14% of GDP but depreciation is 11% of GDP, there is only 3% net investment. If the population is expanding, this can mean virtually no real increase in investment per head.

A bad recession! High unemployment, of over 10%; growth doesn’t return.

The extra amount of additional dollar receipts required by a country to pay for goods imported from the USA, or from other countries that wanted payment in US dollars. After World War 2 the supply of US dollars wasn’t enough to meet the demand for them from overseas buyers.

(see also Marshall-Lerner Condition): Elasticity refers to the extent to which the volume of sales of a good or service will alter due to a change in price or in the income of purchasers. If a good is a must-have good with no substitutes, and especially if it is addictive like tobacco, it is price inelastic, people will go on buying it even if the price increases quite a bit. More specifically, price elasticity of exports is the ratio between the increase in value of export sales and the change in prices at which they are offered: if a 1% fall in price produces a 2% increase in sales volumes, the elasticity is 2 (vice versa for imports). The condition which has to be fulfilled for a devaluation to produce a better trade balance is the Marshall-Lerner condition: the sum of the elasticities for exports and imports (ignoring any negative signs) must be more than unity.

When economists build models of the economy, they may refer to endogenous or exogenous variables. If something is endogenous, its value is determined within the model; if it is exogenous, its value is regarded as outside the model, “a given fact”, not determined within it. An important controversy is whether money itself is created endogenously or exogenously (see Money).

See Neoclassical Economics in the overview above.

Company assets “owned” by shareholders. A company’s equity is equal to its value less its debt owed to bankers, bondholders and other lenders. Importantly, equity can quickly go up and down in value, whereas the other source of finance for a company, debt owed to banks and bondholders, is stable.

The nominal exchange rate is what you see when changing currency to go on holiday abroad. The real exchange rate is the price of one country’s goods and services in terms of another, it is the nominal exchange rate times average prices. The real effective exchange rate takes the real exchange rate and weights it across all the currencies a country trades with, according to the proportion of trade done in each. A nominal exchange rate change does not take account of variations in inflation between the devaluing country and world currencies, whereas changes in the real exchange rate do.

The debate: for the UK over the last thirty years, official figures show that the nominal sterling exchange rate and the real effective exchange rate move closely together. So if the nominal exchange rate moves down, our exports become cheaper; if it moves up, our exports become more expensive. For some countries including the UK, changes in inflation do not offset or wipe out changes in the nominal rate; neoliberal economists ignore or deny this. For other economies, such as small emerging economies with less diversified production, devaluation can cause serious inflationary problems.

Benefits and costs of an economic activity that do not show up in the accounts of that activity. For example, a farmer may make a profit selling corn, but might not have had to pay for the loss of income caused when fertiliser leaches into rivers and kills fish, a negative externality. One person’s gain may have a bad effect on others not involved. Similarly, one person’s or company’s gain may have a multiplier effect on others, a positive externality. If a company trains its workforce in new methods, output may increase, the methods may involve less pollution, and trained workers may impart their knowledge to others, so “knowledge transfer” finds its way into other parts of the economy, creating new production and new demand: a virtuous circle. See Multiplier.

Keynesians like this concept, what’s true for the individual in a group is no good for the group as a whole. If you are in a cinema and can’t see the screen because of a tall person in front, you could see it by standing up, but you would block the view of those behind you. Provided nobody in front of you stood up, you would personally gain. But if everybody stood up because their view was also impaired, then nobody would see the screen any better. The moral: if one or a few individuals do something they may benefit, but if everybody follows suit, nobody gains. While it may make sense for one person to reduce their debt if they are in financial trouble, if everyone reduces their debt no one gains, because one person’s spending is another’s income: if we all stop spending, no one will have any income (the Paradox of Thrift). Austerity, as a way of reducing the debt-to-GDP ratio, may therefore be a flawed recommendation.

Monetary purchasing power, typically created by a bank or other financial institution, which allows a company, household or government to spend on major purchases (often capital assets).

The trend under neoliberalism through which real production in the economy is accompanied by an increasing degree of financial activity and intermediation (including various forms of lending, financial assets and securitization). One way to measure financialisation is by the ratio of total financial assets to real capital assets in an economy.

When a bank gives you a mortgage in exchange for the upfront money you receive, you are obliged to make future repayments which, with interest, add up to more than the money you received, they provide a future income for the bank, which is said to have a claim on the borrower. Financial securities are claims such as these being traded in financial markets. Instead of keeping the mortgage on its books, the bank may sell it to someone else who pays a big sum up front in exchange for the future income stream.

Stocks or shares give the holders a claim on a firm: they may get dividends, or the value of the share may rise (capital growth). However, with debt the borrower is legally obliged to repay, whereas with shares there is no guarantee of a return. More complicated are derivatives, which are bets on the future value of other financial securities or of commodities (wheat, copper, etc.). Betting something will fall in value is called shorting it; betting it will rise is called going long.

The use of government spending and taxation to influence the economy.

An investment by a company based in one country in an actual operating business, including real physical capital assets such as buildings, machinery and equipment, located in another country.

This is when banks are required to hold back a proportion (fraction) of assets; they can lend more than they hold, but only up to a certain multiple. This means they lend money they have not actually got, restricted by the reserve ratio. In reality it is now accepted by the Bank of England, and emphasised by Post-Keynesian economists, that banks lend as much as they can and find the reserves afterwards; they know that if the central bank refused to create the reserves the whole system would collapse, and the central bank, afraid of this scenario, will always provide them. Some economists still deny this.

An agreement between two or more countries to trade without export and import tariffs on each other’s goods and services. Countries often put other obstacles in the way to protect home producers, specific rules and regulations that they know their competitor will find tricky to meet. These are called “non-tariff” barriers.

When everyone who wants a job can get one. There will always be a number of people out of work between jobs; time taken job-searching and matching people to vacancies is called frictional unemployment. Structural unemployment is when the jobs on offer require skills that workers do not have (the skills mismatch); the solution is meant to be better training and better matching. Finally there is cyclical unemployment: when the economy slows or contracts, job vacancies are fewer while the number of job seekers remains the same. Since 1979 the UK has made several revisions to the way it calculates the employment/unemployment figures; if the pre-1979 method were used today, the unemployment figure would be much higher.

This term is used differently by different economists, as explained in The Money Sham.

In his 1943 article “Functional Finance and the Federal Debt”, Abba P. Lerner argued that government fiscal policy should be judged by how it functions in terms of its economic effects, not by whether the budget is balanced. A currency-issuing government should use spending, taxation, borrowing and money creation to achieve public purposes such as full employment, price stability and economic stability. If unemployment is too high, it should spend more or tax less; if inflation is too high, it should spend less or tax more. The budget balance itself is not the goal.

See Global Financial Crisis.

As per 2008–2009, things came to a head when banks stopped lending to one another because nobody knew for sure who could be trusted. Sub-prime mortgages had been sold on from one agent to another, so when mortgage payers began to default and property prices started to fall, these financial agents didn’t know what anything was really worth. Many would argue the crisis was the inevitable result of a long period of financial deregulation that began under Thatcher and Reagan but continued under Bill Clinton. The author has argued that incorrect exchange rates played a key role: with the West’s exchange rates overvalued there was increasing unemployment and/or lack of wage demand; central bankers countered by setting extremely low interest rates, which did not kick-start investment but instead facilitated a build-up of unsustainable private debt, which necessitated a build-up of public debt.

UK government bond; the government issues these to people who want a reliable form of saving. Mainstream economics tells us it issues them to borrow money. More realistically it offers them to take demand out of the economy. The famous example in the UK is War Time Bonds in WW2. The government was spending a lot of money into the economy to support arms production and the wages of the armed forces; the war caused a drop in production of peacetime goods and fewer imports, so the extra spending was inflationary. The bonds took spending power out of the economy, reducing inflation. The government offered a decent interest rate and appealed to patriotic self-interest, but in reality it had already spent the money into existence, and the bonds were a way of keeping a lid on inflation.

A statistical measure of inequality. A Gini score of 0 implies perfect equality (everyone has the same income); a score of 1 implies perfect inequality (one person has all the income). Gini scores for the UK, and for the vast majority of countries, have increased since the end of the Keynesian era (circa 1972).

The process of more economic activity taking place across national borders. Forms include international trade (exports and imports), foreign direct investment, international financial flows, and international migration. In terms of goods, this took off after the Vietnam War with the use of containers to transport goods back to the West; with the advent of the internet, corporations now find it easier to communicate and organise across great distances.

The value of all the goods and services produced for money in an economy, measured in market prices. The “measured in market prices” is significant: GDP may exclude services we all value, such as giving birth or cleaning the kitchen hob, anything that is unpaid. Secondly, as manufacturing becomes more efficient it produces more output with the same or less input; this rise in productivity raises living standards, but paradoxically causes prices per unit of output to fall, which tends to reduce the measured value of manufacturing relative to other sectors where productivity is harder to raise. This leads many to underestimate the importance of manufacturing to a country’s overall standard of living. GDP is calculated by adding up the gross value-added at each stage of production.

GDP divided by the population of a country or region. Changes in real GDP per capita over time are often interpreted as a measure of changes in the average standard of living, although this is misleading: it doesn’t account for differences in the distribution of income across factors of production and individuals, nor the value of unpaid labour, nor the segment of GDP devoted to investment rather than consumption.

See Value Added.

Not all the income the UK enjoys is generated in the UK; some comes into the economy from abroad, for example, profits from UK companies based abroad. Such income streams are added to GDP to give the Gross National Income. In recent years, transfers from abroad, which throughout UK history have been positive, have turned negative: more money is being sent abroad than is coming in. This contributes to our balance of payments problem. See Balance of Payments.

Government debt is issued in Treasury Bills (T-Bills) or Gilts. The chart below shows the features of this debt:

Government bonds are money in bank accounts that pay interest when they mature and which, unlike money in “ordinary” accounts, can be traded. Governments issue promises (on pieces of paper, or entries on hard drives). For T-Bills they sell the promise for less than its redemption value at maturity; for Gilts they promise to repay the face/par value at a specific time (the maturity date) and to pay interest (the yield or coupon rate). Government bonds are thus tradable interest-bearing tax credits, held in an account at the central bank. The money used to purchase them is created by prior government spending. Many economists incorrectly believe the government has to issue these bonds to get the money it needs to spend; in reality the government alone can create its own money, so it is borrowing from itself, which is why it is a misnomer to call government “borrowing” borrowing, even though in accounting terms it is correct to do so.

Economists like to divide us into two main groups: Firms or Corporations that make stuff or provide services, and Households. Households offer labour supply to the labour market, earn income, make consumer purchases, and care for each other through unpaid labour within the home. Another group is the Capitalists, who own the firms. As individuals we can be part of a corporation by working for it, part of the consumer group when we shop, and part of the capitalist group if we own a firm. Can you see a missing group? There should be a fourth group, the Bankers, as banks are the only non-government-owned part of the economy that can legally create new money.

The nub of this idea is that the present is path-dependent, and events may persist long after their original cause has departed the scene.

The term was coined by Sir James Alfred Ewing, a Scottish physicist and engineer (1855–1935), to refer to systems, organisms and fields that have memory; the consequences of some economic events are experienced with a time lag. Iron, for example, still retains some magnetization after it has been exposed to and removed from a magnetic field. Hysteresis derives from the Greek for a coming short or a deficiency.

In economics, hysteresis is the idea that something can happen that causes a second thing to happen; then the original cause stops, but the second thing continues. It applies especially to unemployment and international trade. Say an overvalued exchange rate, or a lack of demand caused by over-taxation, causes industries to go bankrupt and results in mass unemployment (the situation in the UK after 1979). Later, demand increases because the exchange rate depreciates or taxes are reduced, but the unemployed are not rehired, because employers don’t want to hire people who have been out of work, or because the new jobs require new skills. The unemployment persists. It applies to international trade too: when the factors that made a country uncompetitive are relieved, the other countries that were trading successfully have moved on in leaps and bounds. Hysteresis has a lot to answer for.

See Incremental Capital Output Ratio.

This can be confusing as it’s a bit counter-intuitive, a higher ICOR is bad, and a lower one is better. The ICOR measures how much the capital stock must increase by to get a 1-unit increase in output; so the less capital you need to produce one extra unit of output, the more efficient your capital is. The Social Rate of Return on Capital is the reciprocal (for which the higher the rate, the better).

Government policies to help the domestic development of particular desirable or productive industries, in order to boost productivity, create higher-paid jobs and enhance international trade performance. Tools can include measures to stimulate investment in targeted industries; trade policies (tariffs, export incentives, or limits on imports); and technology policies. Britain’s Achilles Heel argues that a competitive exchange rate is an absolutely integral requirement of industrial policy, without which none of the strategies mentioned will work.

Inflation refers to rising prices, but there are different ways of measuring price rises. One way is the Term Structure of Prices: buyers can buy stuff now for delivery in the future, and the future cost depends on the costs the supplier bears in between, including storage and interest. Take a commodity such as wheat and assume interest rates are zero (as in Japan for a long time): the price of buying wheat will not rise, all things equal. If interest rates are 5%, the term structure of prices will rise by 5% per year, all things equal.

It follows that low interest rates mean lower inflation, all else equal, and higher interest rates mean higher inflation, the opposite of mainstream theology, which holds that the way to get prices down is to increase interest rates. Slightly bananas.

Normally, commentators just compare the price of a bunch of goods now with their price in the past, the year-on-year change. The idea is to make up a shopping basket the average household is likely to have, but a wealthy household’s basket is very different from a poor person’s. Poor people pay a much higher portion of take-home income on accommodation and utilities, so a CPI based on an “average basket” may show a much lower increase than a poorer household actually experiences (as in the post-pandemic cost-of-living crisis).

Three common price indexes used in the UK:

• CPI – Consumer Price Index, does not include the cost of housing or Council Tax; it is a geometric mean and is usually lower than the RPI.
• ONS GDP deflator, also takes into account improvements in efficiency in the public sector (tricky to calculate, hence controversy).
• RPI – Retail Price Index, includes the cost of housing, such as mortgage interest and council tax; it is an arithmetic mean and is invariably higher than the CPI.

Bank-created money, as opposed to government-created money (Outside Money).

A model of the economy by John Hicks that purported to explain what Keynes was on about. IS stands for Investment–Savings, LM for Liquidity Preference–Money Supply. The IS line represents the market for goods: as interest rates fall, investment increases because it’s cheaper to borrow. The LM curve represents the money market: as businesses expand they need to attract more money from savers, so interest rates rise. The IS curve slopes down, the LM curve slopes up, and where they cross is the mythical equilibrium point. Keynes realised that when times are uncertain people hold cash instead of investing it (their “liquidity preference”). It is not clear whether Keynes realised that investment does not necessarily come from savings, banks create the money for firms to invest when they grant loans. We now have enough historical data to note that the IS/LM curve is wrong, not just as an interpretation of Keynes, but also empirically.

An investment bank is different from a high-street commercial bank. It is an intermediary that carries out a variety of financial services. It arranges for investors to pool their savings and invest in firms; this process does not create new money (unlike a commercial bank extending a loan). When a firm wants to raise capital by issuing securities such as shares, the investment bank provides the expertise to assess the project, structure and price the shares, and attract investors.

There can be a conflict of interest between the advice given by their advisory divisions (for which they get paid fees) and the profit and loss of their own trading divisions; the two are meant to be kept separate. Clients include corporations, governments, hedge funds, pension funds and other financial institutions. Global investment banks include JPMorgan Chase, Goldman Sachs, Morgan Stanley, Citigroup, Bank of America, Credit Suisse and Deutsche Bank. Services carried out include financial advice to large institutional investors; facilitating mergers and acquisitions (estimating the value of a potential acquisition and helping negotiate a fair price); and research divisions that review companies and write reports with buy, hold or sell ratings.

There are now millions of working-age people in the UK who are out of work or underemployed. While fiscal policy will ensure the economy operates near full employment, the government offers a paid job to those who are between jobs or laid off during downturns. The jobs are funded by central government but locally designed and run. This pool of employed labour replaces the deliberate policy of a pool of unemployed labour; it acts as an automatic stabiliser and a price anchor. It is cheaper than the current cost of £125,000 for each young person out of education and employment. It improves mental health and social well-being, prevents a race to the bottom in wages, and will permanently increase the share of the national cake going to those who work rather than to those who live off the ownership of existing wealth.

(see Elasticity and Marshall-Lerner Condition): Linearity means a relationship can be represented by a straight line. Economists often start by assuming that one variable changes in a steady, proportional way when another changes. They may assume linearity in their models, ignoring that relationships are often non-linear, or that they can be linear for a time until a tipping point is reached.

This states that for a currency devaluation/depreciation to reduce a current account deficit, the sum of the price elasticities of demand for exports and imports must be greater than unity (one). Elasticity refers to the degree to which the sale or purchase of a good or service responds to a change in price or income.

If UK export goods have high income elasticity of demand, then if income in countries we export to rises, a lot more of our exports will sell. If they have high price elasticity of demand, a lower price results in a lot more sales. For imports the same applies in reverse. The issue, in terms of reducing a deficit, is whether for exports a fall in price (less money per unit) is more than compensated for by the increase in volume. If the sum of the elasticities of exports and imports is greater than 1, the deficit will reduce.

Opponents of devaluation say export and import price elasticities are low but income elasticities are high. This led economists such as Thirlwall to argue the UK could not solve its trade deficit through devaluation, but must restructure its economy through supply-side measures. This book regards price elasticity of demand as non-linear and context-specific.

Elasticity is non-linear. The response of export sales to a fall in price is not constant. If the cost of producing a food-blender for export fell by 20% but blenders are available elsewhere at 23% below the UK’s cost, there might be no increase in export volumes, a price elasticity of precisely zero. But if the price fell by 26%, UK blenders would be cheaper than those selling round the world, and export volumes might increase. Elasticity would now “kick in”. A graph of this would not be a straight line, it would be non-linear.

A pre-capitalist economic theory and practice: you got rich by exporting far more to other countries than you imported, aiming for an ongoing trade surplus and making up the difference by accumulating gold. The more gold the better. Free traders pointed out that one person’s surplus is another’s deficit; eventually deficit countries would not be able to find the resources to go on importing from the surplus countries. This is topical today when countries such as Germany, Switzerland and China keep persistent trade surpluses and are sometimes accused of neo-mercantilist policies. This author is concerned about these imbalances and how they can be rectified.

See A Broad Look at Economics in the overview above (under the heterodox schools).

We should restrict the money supply to control inflation. Monetarism is arguably the rebirth and development, in the late 1970s, of an old establishment preference for focusing on money and prices rather than on production. Its most famous advocate is Milton Friedman (see Monetary Targeting). Inflation is held to be a purely “monetary” phenomenon, caused by too much money being issued into the economy, which can always be stopped by reducing the money supply. It puts money supply as the cause of inflation, rather than the other way round (that rising prices cause the increase in the money supply). Modern “quasi-monetarists” agree inflation is a major danger, but now use high interest rates (rather than monetary targeting) to indirectly regulate the money supply.

The use by government and government agencies (especially the central bank) of interest-rate adjustments and other levers (such as banking regulations) to influence the flow of new credit into the economy, and hence the rate of economic growth and job-creation. A “tight” monetary policy tries to reduce the growth of new credit (through higher interest rates); a “loose” monetary policy tries to stimulate more credit creation and hence growth.

A policy, as per Friedman, which tries to directly limit the growth in the total supply of money in the economy. It was the main policy tool used by strict monetarists. This approach failed in the 1980s, when it became clear that the supply of money could not be directly controlled by a central authority.

Broadly speaking, money is anything that can be used as a means of payment (for example, to settle a debt). It includes actual currency (notes and coins), bank deposits, credit cards and lines of credit, and various modern electronic means of payment. See M0, M1, M2, M3.

Economists divide money into different “types”.

• M0, Central Bank Money, High-Powered Money, monetary base, or narrow money. The notes and coins produced by central banks or by the Mint. Where is it? In our pockets, piggy banks, safes and under our beds; some waiting for us in cash machines and banks; the rest in the central bank.
• M1, the notes and coins of M0, plus money in sterling current accounts. This exists on a ledger in banks’ computer drives and can be converted on demand into cash. M1 accounts today in the UK for only around 3% of money.
• M2, M1 plus money in sterling deposit accounts of up to three months’ notice or up to two years’ fixed maturity. These cannot immediately be converted into cash.
• M3, M2 plus repurchase agreements, money market fund units, and debt securities up to two years (consistent with M3 as measured by the Eurozone).
• M4, M3 plus deposits at UK building societies.

M1, M2, M3 and M4 together are referred to as broad money. Commercial banks create new money whenever they make a new loan: having decided the borrower is creditworthy, they type the value of the loan into their own account (an asset) and into the borrower’s account (a liability/deposit). The bank has added the credit money out of nowhere because it chose to do so. When Chancellor Geoffrey Howe tried to reduce the money supply by putting up interest rates, he found he could not, and later abandoned the policy.

Looking only at the nominal value of money and not its real value. For example, if your wage increases by 5% you are happy, until you notice prices are up by 6%. You are deluded because your real wage has gone down. You are suffering from Money Illusion.

An initial stimulus to spending (new business, consumer or government purchases) usually results in a larger final increase in total spending, production and employment, this magnifying effect is the multiplier. Its strength depends on the type of initial spending, the importance of imports, and the amount of unused capacity. Made famous by Keynes, who showed an initial increase in government spending has a knock-on effect as it is spent not once but many times. Wage earners have a higher marginal propensity to consume than firms; the higher the proportion of an extra pound they spend, the greater the knock-on effect. If consumers have a high marginal propensity to save, the economy can slow right down, after the GFC, when UK consumers started to pay down debt, the multiplier effectively collapsed, helping to create the recession.

See Non-Accelerating Inflation Rate of Unemployment, and Natural Rate of Unemployment.

The accumulated debt “owed” by the government, it consists of all the money spent into existence by the government that has not been redeemed through taxes. It is the accumulated net financial assets of the private sector. In mainstream economics it is only called debt when it has been converted into gilts or bonds; bank deposits and central bank reserves are not called debt, even though they are a government IOU. It can be owned by the government, by people within the country, and by overseas holders. In accounting terms, holders of debt are defined as “lenders”.

This so-called national debt is usually presented as if it were a burden owed by “the nation” to some outside creditor. This is misleading. Government debt is a liability of the state, but it is also an asset of whoever holds it: the government’s liability is the non-government sector’s financial asset. The national debt is best understood as the accumulated stock of sterling-denominated financial assets left in the non-government sector as a consequence of past government deficits.

Gross Debt, Net Debt and Public Sector Borrowing

• Public Sector Net Borrowing (PSNB) is the annual deficit, how much the public sector borrowed in a particular year because spending exceeded receipts. In ordinary political language, this is “the deficit”.
• Public Sector Net Debt (PSND) is the accumulated stock of public sector debt, after deducting liquid financial assets. This is the UK’s most commonly quoted headline debt measure.
• Gross debt counts the public sector’s liabilities without deducting financial assets. International comparisons (IMF, Maastricht) often use gross general government debt, which is one reason different sources give different debt-to-GDP ratios for the UK.
• Public sector net worth attempts to compare the public sector’s total assets, including some non-financial assets, with its total liabilities. Roads, schools, hospitals, land and public buildings are real assets, but many are not readily saleable and should not be treated as money in a bank account available to pay off gilts.

Who Owns the Debt?

UK government debt is mostly made up of sterling liabilities, especially gilts and Treasury bills, held by a mixture of domestic and overseas investors. The exact ownership shares change over time, especially because the Bank of England bought large quantities of gilts under quantitative easing and has since begun reducing those holdings. Under QE the Bank bought gilts largely from private financial institutions; the sellers’ banks received new central-bank reserves and the sellers received bank deposits. QE changed the composition of private-sector balance sheets (fewer gilts, more deposits and reserves); it did not make the UK “better funded”, nor provide money the government could not otherwise create. It was an asset swap.

Foreign-Held Debt and External Debt

It is important not to confuse foreign-held government debt with external debt. Foreign-held government debt means UK government liabilities (gilts) held by overseas investors. External debt is much broader: it includes public and private liabilities owed by UK residents to non-residents, including debts of banks, financial firms, companies and government. Because the UK has a large international financial sector, its gross external debt can look very large, but this does not mean the UK government is in the same position as a country that has borrowed heavily in a foreign currency.

The real vulnerability is not debt in the abstract. The key question is: is the debt denominated in a currency the issuer can create, or in a currency it does not issue and must obtain from elsewhere? The UK government issues debt mainly in sterling, its own floating currency, so it is not financially constrained in the same way as a household, a eurozone member state, or an emerging-market state that has borrowed in dollars. That does not mean there are no constraints: the real constraints are inflation, productive capacity, imports, the exchange rate, distributional conflict and ecological limits. But the UK cannot involuntarily run out of sterling the way a household can run out of money, or Turkey can run short of dollars.

Why Currency Denomination Matters

A country is more vulnerable when its liabilities are denominated in foreign currency, because it cannot issue the currency required to service those debts. If confidence falls, the exchange rate falls, and the foreign-currency debt burden can rise sharply in domestic-currency terms. The UK is in a different position: overseas investors may hold sterling assets including gilts, but those assets are denominated in sterling, and the UK state is the monopoly issuer of sterling. This is why “the national debt has to be paid back” is misleading, maturing gilts are paid by crediting bank accounts. The question is not whether the UK can find the sterling (it can), but what level and composition of spending, taxation, credit, imports and investment is consistent with price stability, full employment and ecological sustainability.

A rough balance-sheet comparison between state liabilities and state-owned assets, using the latest ONS balance-sheet table (2026):

In a two-country comparison, Turkey is vulnerable because it cannot issue foreign currency: more Turkish people hold foreign-denominated assets than foreigners own Turkish lira assets. Turkey’s external debt is 60% of its GDP; the UK’s is 337% of its GDP, but it is Turkey that is vulnerable. For the UK, the central constraint is not the availability of sterling but the availability of real resources: productive capacity, imports, labour, energy, infrastructure and ecological space. Money is a creature of the state, but real wealth consists of the resources, skills, institutions and productive capacities that money can mobilise.

According to neoclassical economics, the wage rate is determined by a process of labour-market clearing (workers and employers competing so that labour supply equals labour demand). Why, then, do we observe unemployment? Neoclassical theorists argue that observed unemployment reflects frictional, structural or disguised effects consistent with labour-market clearing, this “natural” level of unemployment is, in fact, full employment. It is fruitless, in this view, to try to reduce unemployment below this natural level; attempts to do so only create inflation. Unions, minimum wages and other “market-inhibiting” measures will tend to increase the natural rate. The monetarists developed this into the NAIRU: if governments try to increase employment above the natural rate, inflation results.

See A Broad Look at Economics in the overview above.

Nominal gross domestic product measures the total value of all goods and services produced and traded for money in the formal economy, evaluated at their current money prices. Nominal GDP can grow because of an increase in actual (real) output, and/or because of an increase in average prices (inflation).

A variant of the neoclassical Natural Rate of Unemployment. As in natural-rate theory, NAIRU advocates believe unemployment cannot be reduced below a certain level without sparking a continuous acceleration in inflation. Unlike the original theory, however, NAIRU does not strictly define this position as “full employment”. The policy prescriptions are practically identical: don’t try to reduce unemployment through demand-side measures, but instead attack unions and minimum wages so labour markets function more “efficiently”. Neoclassical economists tend to blame unemployment on labour-market rigidities (unions, minimum wages, employment protection, unemployment benefit) rather than deficient effective demand.

See Elasticity and price elasticity.

Some products cannot be transported over long distances, or otherwise sold to consumers from far-off locations. These (including some goods and most services) are considered non-tradeable, they must be consumed near where they are produced. Non-tradeable products include most construction, some manufacturing (highly perishable or extremely bulky products), most private services, and nearly all public services.

To hit its desired interest rate, central banks buy and sell government bonds (Treasuries or Gilts) on the secondary markets. The primary market consists of the central bank and the commercial banks chosen to purchase new government bonds; the secondary market consists of the government, via the central bank and Treasury, buying and selling bonds from non-bank institutions. When a central bank buys bonds from non-banks it increases the money supply, because the seller gets a deposit in its bank account (a liability of its bank), matched by government reserves on the asset side. If the central bank sells a bond to a non-bank, the recipient loses deposits and gains a bond. Whether we regard selling bonds to the non-bank sector as reducing the money supply depends on how we have defined money supply.

Money created by government when it spends.

(see also Fallacy of Composition): An individual household, business or government may attempt to save money by reducing current expenditure. However, those attempts to save, once amalgamated at the level of the overall economy, may reduce aggregate spending and hence output and employment, undermining overall growth or even causing a recession. If this occurs, the revenue of households, businesses and governments will decline, and overall saving may end up no higher (and potentially even lower) than before. Because of this paradox, it is not usually possible to improve economic performance by boosting savings.

The proportion of working-age individuals who decide to “participate” in the labour force, by either being employed or actively seeking work. The precise definition of “actively seeking work” varies from one country to another, and over time, so comparisons are tricky. Governments can underestimate unemployment by ignoring those who are not actively seeking work because they are demoralised and know from experience the chances of getting work are remote, or who haven’t the money to travel to job interviews.

An abstract assumption, central to neoclassical economics, in which companies are so small that none can influence total output or price levels, none can differentiate its products from competitors (products are homogenous), and none can anticipate or interact with the actions of competitors. The textbook criteria are: 1) firms sell an identical product; 2) firms are price-takers; 3) firms have a fairly small market share; 4) buyers have perfect information about the product and prices; 5) new firms can enter and existing ones exit freely. Textbooks often cite a vegetable market as an example. Critics argue perfect competition is rare in real life, it is a theoretical assumption developed to support the internal logical integrity of neoclassical economic theories.

A tangible tool, building, machine or other productive asset which is used to produce other goods or services.

See A Broad Look at Economics in the overview above.

Most economic statements about poverty are not absolute but relative, they are derived from a ratio: for example, the percentage of households that have less than 60% of average household income.

The purchasing power of a currency refers to how much currency is needed to purchase a given unit of a good, or a common basket of goods and services. It is determined by the relative cost of living and inflation rates in different countries. One euro will buy more in China than in Germany, because the cost of living is cheaper in China. When we compare the GDP of different countries by converting into a common currency, it can exaggerate the difference in real living standards. To get a better comparison, we compare how many actual goods and services can be purchased with average GDP per head in each country. Purchasing power parity means equalising the purchasing power of two currencies by taking these cost-of-living differences into account.

Asserts that with free markets, the price of goods in different countries, measured in a common currency, should be the same. If prices differ, the countries concerned do not have equilibrium exchange rates. Economists have tried to find evidence that in the very long run there is a trend to purchasing power parity; the evidence is weak and/or contested. In reality, exchange rates do not usually move towards equilibrium, and costs and standards of living can vary enormously for sustained periods in countries that are trading with one another.

The government instructs or allows the central bank to buy assets, such as government bonds, to influence the yield and borrowing costs across the economy. The idea is that when commercial banks sell their government bonds to the central bank, they use the money received to lend to businesses. But the money they receive is central bank reserves, which can only be used to settle accounts with other banks; they cannot be lent out to businesses or consumers. When central banks do QE, the banks lose their interest-bearing bonds and get reserves which pay less interest. No new money for buying houses, consumer goods or investment goods enters the economy. The idea is that banks will try to boost profits by making new loans, but after the GFC, businesses were risk-averse and/or banks did not trust them, so the increase in reserves did not result in more lending. Banks instead bought existing assets, including property and shares, increasing equity prices (a buoyant stock market) and fuelling property prices. Critics argue the policy sustains a bubble that needs to be deflated.

The value of total gross domestic product (all the goods and services produced for money in the economy) adjusted for the effects of inflation.

The interest rate on a loan, adjusted for the rate of inflation. The real interest rate represents the real burden of an interest payment. Real interest rates must be positive for the lender to attain any real income from the loan.

The value of wages, adjusted for the level of consumer prices. If the nominal value of wages is growing faster than consumer prices, then real wages are growing, and hence the real consumption possibilities offered to workers are improving.

Imprecisely used; usually a sharp slowdown in growth, or an actual contraction in the economy for two quarters or more. See Depression.

When real GDP begins to grow again, following a recession.

A repurchase agreement (repo) is a form of short-term borrowing for dealers in government securities. A dealer sells government securities to investors, usually on an overnight basis, and buys them back the following day at a slightly higher price; that small difference is the implicit overnight interest rate. Repos are used to raise short-term capital and are a common tool of central bank open market operations. For the party selling the security and agreeing to repurchase it, it is a repo; for the party buying and agreeing to sell, it is a reverse repurchase agreement. The seller is effectively borrowing and the buyer lending. The implicit interest rate is known as the repo rate, a proxy for the overnight risk-free rate. Repos and reverse repos are typically used for short-term borrowing and lending, often with a tenor of overnight to 48 hours.

Business profits which are not distributed to shareholders (through dividends or other payouts) but are retained within the company to finance future investment or other expenditures. In times of recession most investment is done from retained earnings rather than from new borrowing.

A measure of business profitability equal to net after-tax income divided by the average level of shareholders’ equity in the business.

See Inflation.

Human labour, skills, know-how, organisational efficiency, raw materials and natural resources and, above all, energy. The real constraints facing an economy.

Bank deposits held by banks that they use when they make payments to each other. They can only be issued by the central bank, and the public cannot obtain them; only the banks can hold them, which they do in their accounts at the central bank. They used to be called clearing balances.

Across three sectors, government, private domestic, and foreign, the surpluses and deficits sum to zero. Government deficits create exactly equivalent net surpluses for the other two sectors combined.

Fed swap lines. When the US Federal Reserve enters into a swap line with a non-US central bank, it swaps US dollars for that central bank’s currency, for example euros, at the prevailing market exchange rate. The non-US central bank sends euros to the Fed and receives dollars in return; both parties agree to reverse the transaction at the same exchange rate on a future date, and the non-US central bank pays the Fed a fee. Because the reversal rate is agreed in advance, the Fed does not normally bear exchange-rate risk.

Dollar funding. In 2018, non-US banks and offshore financial centres provided approximately $12.8 trillion of US dollar funding, raising the question of where these dollars originally came from. Cross-border flows can become fickle in a crisis, as 2008 demonstrated, which is why central banks need policy tools to backstop dollar liquidity during stress.

Central bank swap lines are agreements between central banks to exchange their currencies, ensuring one central bank can obtain another’s currency when needed. For example, the ECB can obtain US dollars from the Federal Reserve and lend them to banks in the euro area. This allows a central bank to provide foreign-currency liquidity to domestic commercial banks without drawing down its foreign-exchange reserves.

Why they are needed. Originally used to help central banks fund market interventions, swap lines have become important tools for preserving financial stability. During the crisis following the collapse of Lehman Brothers in September 2008, dollar funding markets dried up; euro-area banks found it difficult to obtain dollars to fund dollar-denominated assets, so the ECB and the Fed used a currency swap line to provide dollars to banks in the euro area.

The network. In 2011, the ECB, the Bank of England, the Bank of Canada, the Bank of Japan, the Federal Reserve and the Swiss National Bank established a standing network of swap lines. The ECB also created arrangements to provide euros to Denmark and Sweden, and temporary arrangements for Hungary, Poland and Latvia (before Latvia joined the euro in 2014). In 2013 it established a currency swap agreement with China.

In practice, a euro-area bank that needs dollars can normally obtain them in the market; but if dollar funding costs become too high, or the market is disrupted, it can turn to its national central bank, which obtains dollars through the swap line with the Fed. In return, banks must provide high-quality collateral, marked to market and reduced by a “haircut”. Many of these agreements act as safety nets and have never been activated.

Liquidity lines. There are two main types: swap agreements (one central bank obtains another’s currency in exchange for its own currency as collateral) and repo lines (the borrowing central bank obtains foreign currency for a period in exchange for financial assets as collateral). During the COVID-19 crisis, the ECB reactivated existing swap lines and established new ones, and created new bilateral repo lines with several non-euro-area central banks. In June 2020 it established the Eurosystem repo facility for central banks (EUREP), later used in response to the uncertainty caused by Russia’s invasion of Ukraine. These euro-providing lines operate as backstop facilities, intended to address euro liquidity needs outside the euro area during market dysfunction and to prevent problems abroad from affecting euro-area financial markets.

A tax imposed on the purchase of imports. It is usually imposed in order to stimulate more domestic production of the product in question (instead of meeting domestic demand through imports). The firm importing the goods has to pay the tariff to the domestic government.

See Tariff and Customs Union.

Debt imposed on the population by their government.

• Capital Gains Tax, tax on an asset that goes up in value, paid if you sell it; applied to company dividends too.
• Direct Taxes, tax deducted from your income (payroll taxes, National Insurance in the UK).
• Excise Duties, special extra purchase taxes, on tobacco, petrol and products whose consumption you want to reduce.
• Indirect Taxes, taxes on goods and services (Purchase Tax, Value Added Tax / VAT).
• Inheritance Tax, tax on your estate when you die.

The ratio of the average price of a country’s exports to the average price of its imports. In theory, an improvement raises a country’s real income (it can “convert” a given amount of its own output into a larger number of consumable products): although in practice it depends on how those gains are distributed. When the real exchange rate appreciates, a country’s terms of trade improve, and Modern Money Theory argues the better the terms of trade the better off you are. However, if currency appreciation means your exports become uncompetitively priced, this apparent improvement may damage the economy by hitting export production and firms’ ability to remain profitable; firms producing tradable goods may close. Service firms selling to the domestic market are not directly affected, but tend to have less opportunity for productivity increases than manufacturing. When exporting industries are made uncompetitive by currency appreciation, growth falls and consumers and firms buy more and more imported goods. This is fine for as long as the country can export its currency to pay for its imports.

A product (a good or service) is tradeable if its purchaser can buy it far away from where it is produced. Most goods (other than perishable or extremely perishable products) are tradeable, and some services (tourism and specialized financial, business and educational services) are also tradeable. The prices of non-tradeables react less to currency changes than tradeables.

Governments redistribute a share of tax revenues back to groups of individuals in the form of various social programs (welfare benefits, unemployment insurance, public pensions, child benefits). These supplement the market income of the households which receive them. In the UK, fiscal transfer occurs when taxes collected in wealthy areas are transferred to poorer parts of the economy. In the Eurozone there is no federal government with sufficient tax to distribute to poor areas; without their own currencies the poor countries cannot devalue to become more competitive, so they need fiscal transfer, which is not forthcoming.

How much an employer pays for the labour required to produce each unit of a good or service. It can be calculated by dividing a worker’s hourly (or annual) labour cost by the amount they produce during that hour (or year): the ratio of labour costs to productivity. Companies try to reduce unit labour cost, either by increasing productivity (the denominator) or reducing labour costs (the numerator). With regard to the exchange-rate hypothesis advanced in this book, it is vital to appreciate that it is not unit labour costs across the whole economy that determine export competitiveness, but the unit labour costs in the goods that an economy exports or might wish to export, which do not necessarily move in tandem with unit labour costs in general.

See Sterilised Intervention.

The value added in a particular stage of production equals the value of total output, less the value of intermediate products (including capital equipment, raw materials and other supplies). Value added is ascribed to the various factors of production (the wages paid to workers, the profit paid to a company’s owners, and interest paid to lenders). Value added in the total economy equals its gross domestic product (GDP).