Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 29 November 2016

A little English coup

In August 1991, hardline elements in the army and KGB staged a coup against Mikhail Gorbachev, shortly after Gorbachev had agreed to reorganise the USSR as a new confederation. To many this seemed like an end to the reforms that Gorbachev had brought, as the coup leaders appeared to have the support of the whole military. Yeltsin was defiant in Moscow, but those who remembered the Prague Spring probably thought the tanks would win out. Then the coup’s nominal leader, Gennady Yanayev, gave a press conference in which he looked nervous with his hands shaking, and it became clear that the coup leaders were meeting serious resistance. It collapsed shortly afterward.

I remembered this when watching the proponents of hard Brexit shout down any concern about what the government might agree following the EU referendum, and attack anyone who pointed out the difficulties that leaving the single market might bring. They too have carried out a sort of coup against parliamentary democracy, and maybe declaring judges enemies of the people is the equivalent of Yanayev’s shaking hand. They cannot quite believe what they have done, and fear it may all collapse when people realise what is going on. Our Prime Minister has had to draw on her faith in God to enable her to continue leading this coup.

If you think coup is too strong a word, think about what has happened. An advisory referendum decided by a very narrow majority to leave the EU. That is all this slim majority of the electorate decided. They did not vote to leave the single market (SM), partly because most leaders of the Leave campaign told us (correctly) that leaving the EU was quite compatible with staying in the SM. They did not vote to end freedom of movement. Leaving the EU is not one policy, but a whole range of possible policies with quite different effects, and the electorate have said nothing about their preferences among these possibilities. In short, the referendum was about the EU and not the SM, and whatever they say now we know that you can be in the SM without being part of the EU.

Yet a new government, with no mandate from the voters, has decided that only it should be allowed to interpret what leaving the EU should amount to, and the electorate through their representatives in parliament should have no say in the matter. The people, having indicated a change in direction, are to be allowed no say whatsoever in where exactly they are to be led. The differences between these alternative paths out of the EU are immense, and this choice on how exactly to leave the EU will have a huge impact on every citizen. Yet the people and their representatives are not even to be allowed to know what options the government are aiming for. (The OBR was even denied knowledge of how the government intending fulfilling its guarantees to Nissan.) The pretext for this coup, involving keeping their negotiating hand secret, is as thin as the Soviet coup’s claims that Gorbachev was unwell.

Any attempt at parliamentary control over what might happen is described as trying to stop Brexit. Why not seek to stay in the SM? Just asking that question means to the coup leaders that you are trying to stop Brexit (of course it does not). Why not see what might be on offer before starting the clock on being thrown out with nothing? That is just a delaying tactic, they say. Why not have a second referendum on the final deal? Finding out what the electorate thinks once that the exit deal is clear would be against the will of the people, they chime without irony. When you are told that consulting the people or their representatives is against the will of the people, you know there has been a kind of coup.

But I fear that in this case the coup leaders’ nervousness is unwarranted. Three judges have thrown MPs a lifeline, a chance to stop this coup, and MPs look like throwing it right back. Those Conservative MPs who know what damage this will do have decided they can do nothing to stop the Conservative party being taken over by fanatics. The Labour party appears pathetic: its leadership wanting exit from the SM for their own reasons (talking shamelessly about ‘access’ in the hope of muddying the water) and the PLP is more concerned about losing votes than improving their electorate’s welfare (it is the story of austerity all over again). They had a chance of coming together to lead the opposition to this coup and they have blown it. Instead of Boris Yeltsin, we have Tom Watson, who joins in the mantra that opposing triggering Article 50 is going against the will of the people.

And instead of courageous citizens of Moscow we have Labour party members saying it is best to bide time and work within for change. This timidity is obnoxious to see: they should instead be demanding their MPs take back control. It is their prosperity that will be diminished by this coup, their right to work in the EU taken away. It seems to me that approving Article 50 is the last chance for representative democracy to have its say. Once that vote is in the bag, the government can do what it likes and nothing can be certain to stop them. (A vote on any final deal is no choice, because the consequences of saying no will be far worse.)

So MPs are acting like turkeys voting for Christmas. They know that in all likelihood voting to trigger Article 50 will throw away their chance to stop the government ending our membership of the SM, thereby reducing their constituents access to public services and the chance to keep young people’s right to work in the EU. They will be handing all the levers of power to a government that seems to be run by a minority of fanatics. Is this what a once proud country has allowed itself to become? Is this what a parliament that once stood up to kings has been reduced to?



Monday, 28 November 2016

The Autumn Statement and buckets of water

David Willetts, who I have generally found to be pretty sensible, praises Hammond’s Autumn Statement in the FT as casting off Osborne and Treasury orthodoxy. This is the same Autumn Statement that I described as a return of austerity: wasting resources by cutting spending when interest rates are at their lower bound. I think these two different views of the same event can be explained by an analogy.

Imagine four different reactions after a fire breaks out.

  1. The house is fitted with a sprinkler system which puts the fire out pretty quickly

  2. There is no sprinkler system, but the house owners find every drop of water they can, using buckets and hoses, to put it out

  3. The owners get one bucket, but only ever fill it half up because water is not free

  4. The owners do nothing: the fire will soon burn it itself out, they say, and water needs to be conserved.

In case it is not obvious, the fire is a negative output gap - wasting resources - and water is the deficit or debt. David Willetts is praising Hammond for moving from (4) to (3). Instead what he and the Treasury should be doing is (2), and then installing (1), which if you haven’t guessed is analogous to a fiscal rule with a zero lower bound knockout.

I know the Conservatives will not do (1) until this generation of politicians have passed, because it would be an implicit admission that 2010 austerity was a mistake. I also know that Labour is committed to such a fiscal rule.

Hammond may get lucky, and economic growth could be much stronger than forecast such that the MPC soon stops QE and raises rates. In my analogy, the fire might not spread. But policy should always take account of reasonable risks, and the probability at the moment is that we will stay at the lower bound for some time. The official output gap may be small compared to 2010 (although I worry it might in reality be a lot larger), but if you discovered a fire in your house what would you do?

Saturday, 26 November 2016

Whatever happened to the government debt doom spiral

A number of people, including the occasional economic journalist, are puzzled about why government debt at 90% of GDP seemed to cause our new Chancellor and the markets so little concern when his predecessor saw it as a portent of impending doom. I always argued that this aspect of austerity had a sell by date, so let me try to explain what is going on.

The 90% figure comes from a piece of empirical work which has been thoroughly examined, and found to be highly problematic. (Others have used rather more emphatic language.) Part of the problem is a lack of basic thinking. Why should the markets worry about buying government debt, beyond the normal assessment of relative returns. The answer is that they worry about not getting their money back because the government defaults.

If a government cannot create the currency that it borrows in, then the risk of default is very real. Typically a large amount of debt will periodically be rolled over (new debt sold to replace debt that is due to be paid back). If that debt cannot be rolled over, then the government will probably be forced to default. Knowing that, potential lenders will worry that other potential lenders will not lend, allowing self fulfilling beliefs to cause default even if the public finances are pretty sound.

The situation is completely different for governments that can create the currency that the debt they sell is denominated in. They will never be forced to default, because they can always pay back debt due with created money. That in turn means that lenders do not need to worry about forced defaults, or what other lenders may think, so this kind of self fulfilling default will not happen.

Of course a government can still choose to default. It may do so if the political costs of raising taxes or cutting spending is greater than the cost of defaulting. But for advanced economies there is an easier option if the burden of the public finances gets too much, which is to start monetising debt. That is what Japan may end up doing, and what others may also do if QE turns out to be permanent. But this is a very different type of concern than the threat of default. And it does not, in the current environment, lead to the emergence of large default premiums and market panics.

How can I be so sure? Because with QE we have had actual money creation, and it has not worried the markets at all. It seems hard to tell a story where markets panic today about the possibility of monetisation in the future, but are quite sanguine about actual monetisation today.

So for economies that issue debt in currency they can create, there is no obvious upper limit anywhere near to current debt/GDP ratios when economies are depressed and inflation is low. Japan shows us that, and we must stop treating Japan as some special case that has no lessons for the rest of us. (How often did we hear of their lost decade in the 1990s that it couldn’t happen anywhere else.)

It was good that the IFS suggested Hammond has a look at Labour’s fiscal rule. As I explained in this post, Hammond’s new ‘rule’ is pretty worthless. But one key part of Labour’s rule that keeps being ignored but is crucial in today's environment is the knockout if interest rates hit their zero lower bound. It is for the reasons described above that this knockout is there and is perfectly safe: when interest rate policy fails you can completely and safely forget the deficit and debt and use fiscal policy to ensure the recovery. It is the basic macro lesson of the last 6 years that is fairly well understood among academic economists but still remains to be learnt by most people who talk about these things. Whether senior economists in the UK Treasury need to learn it or just keep quiet about it for other reasons I do not know.




Friday, 25 November 2016

The Autumn Statement marks the return of austerity

One of the problems with instant responses is that you miss the big picture. And although everything I wrote immediately after the Autumn Statement was perfectly correct, I too failed to spell out the big picture. The big picture is that austerity has returned. (Credit to Rick for a much better call.)

Let me explain. Unlike some, I do not just define austerity as fiscal consolidation or government spending cuts. Instead I define it as fiscal consolidation that creates an output gap. That should normally only happen for three reasons:
  1. you are part of a monetary union (or fixed rate regime) and the rest of the union is not doing fiscal consolidation (as much).

  2. if interest rates are stuck at their lower bound.

  3. If the monetary authority is incompetent.
I believe it makes sense to define austerity that way, because only then does fiscal consolidation lead to a waste of aggregate resources.

A competent central bankers’ tell (as in poker) for being at the zero lower bound is that they embark on new Quantitative Easing (QE). Central bankers know that interest rates are a much more reliable instrument than QE, so expanding QE tells us we are at the lower bound as they see it. We also know that fiscal expansion is a more reliable instrument than QE. So if central banks are doing QE, it pretty well follows that we have austerity.

Now Hammond could have changed that on Wednesday by announcing a significant fiscal stimulus relative to previous plans. He did not. The increase in public investment, as I said in my previous post and the IFS confirms, was small, as were his other measures. This, as Martin Sandbu points out (who, naturally, also called it right), was a huge missed opportunity. Don’t get misled by actually borrowing levels to judge changes in fiscal stance: most of the additional borrowing was unintentional.

As I have tried to explain on many occasions, the nature of policy pre-Brexit was different from policy in 2010 and 2011. The later was austerity as I like to define it. The former was bad in many ways, one of which was to run the risk of more austerity if we had a negative demand shock. Brexit was a negative demand shock, and so we now have austerity, and Hammond did far too little to rectify his predecessors mistake.

So why did Hammond keep his squeeze on the public sector’s current spending largely unchanged (again, see my previous post for the relevant chart)? Why not give some money to the NHS? Perhaps he too wants to pursue deficit deceit: to shrink the state. Another possible reason is that the Treasury has persuaded him that he should not ‘take any risks’ with public debt. Let me end by saying a bit about that.

Another definition of austerity beside the two already mentioned is an economic policy that focuses above all else on the need to reduce government debt levels. That is the sense of austerity being used in this BBC piece. Needless to say I very much side with Jonathan Portes rather than Michael McMahon on this. But many journalists are puzzled nevertheless: what about all that stuff about the world falling in if debt to GDP reached 90% of GDP? At what level do those who buy UK government debt start to worry about default? I will talk about that tomorrow.



Thursday, 24 November 2016

2016 Autumn Statement




Got back from a trip to London to give my lecture (pics above: thanks to everyone at SPERI and New Statesman, plus Beth Rigby for chairing and everyone else for coming) looking forward to not thinking about economics for the rest of the day, only to find the Chancellor had given an Autumn Statement. Luckily the whole thing appears to be a damp squib compared to the expectations raised beforehand, so here are just a few points. On helping the so-called just about managing, see the ever excellent Ben Chu.

Public investment

Remember all the talk beforehand about substantial increases in public investment? What we got is increases of 0.3% or 0.4% of GDP in each of the financial years from 2017 to 2020. These increases give us figures that are slightly above the numbers we saw from the Labour government in the years immediately before the financial crisis. We should be spending much, much more when interest rates are so low.

Fiscal rules

There was also much speculation that we might return to more sensible fiscal rules, now that Osborne’s had been busted. Instead the new Charter for Budget Responsibility is honestly not worth the paper it is written on. We have a target for the total cyclically adjusted deficit (including investment) for a fixed year. Whatever the number involved, this makes two mistakes: having a fixed rather than rolling date, and by including public investment in that target. It is a recipe for panic cuts in public investment a year or two before the target date.

There is also a target of a falling debt to GDP ratio by the same date. I’m at a loss to understand why you need a target for this as well as a target for the deficit. The change in the debt to GDP ratio is after all just the change in debt (which is the deficit) and the change in GDP. So targeting the change in the debt to GDP ratio just adds to the deficit target some things that you cannot control: GDP growth and your position in the business cycle. I knew there would be no zero lower bound knock out, because that would be a clear admission that 2010 austerity was a mistake. But I did hope for something more intelligent than this.

I fear George Osborne has totally discredited the idea of a fiscal rule. Remember that Labour stuck to its fiscal rules for 10 years, before they inevitably fell victim to the largest recession since the 1930s. Yes there was fiddling at the margin, but the important point was that they did have a strong influence on what the Chancellor did. I now suspect that, by breaking a whole series of rules within a shorter period of years, whatever a Conservative Chancellor says has become pretty worthless.

The fuel duty fiddle

There is this great chart in the OBR’s autumn statement document.




It shows how Conservative Chancellors keep postponing rises in fuel duty. One obvious question is why. But the OBR is also concerned about whether this makes a mockery of its forecasts. Each year they are obliged by parliament to continue to assume that in all subsequent years the government will raise fuel duty after each ‘one-off’ cut. And almost each time the Chancellor announces a ‘give away’ for motorists: they will postpone any increase ‘just for this year’. You can see why they do it: it allows the papers to write favourable headlines. But if they really are going to go on doing this, it means that really their policy is to have no increases in fuel duty. Fiscal forecasts based on the assumption that they will increase fuel duty will be much too optimistic. The government is fooling parliament and the public, but the OBR cannot do anything about it because of the restrictive rules it is forced to operate under.

The cost of Brexit

The big news was of course the higher levels of borrowing. As this table shows, a significant part of that is due to the fiscal costs of Brexit.




Surprise surprise - there will actually be less money available for the NHS and other public services after leaving, rather than more. It is as if that red Leave bus just crashed and rolled over so it is now upside down. The two big factors are lower productivity growth and lower immigration. The OBR has, unsurprisingly, followed their own previous analysis (immigration) and the consensus economist view (productivity growth).

I can almost guarantee that the Sun and Mail will make no mention of this - or if they do it will only be to rubbish the OBR. So, following the theme of my lecture, I really hope that the broadcasters’ nightly news programmes pick this up. Channel 4 news did do so, but I didn’t watch the others (let me know in comments).

The NHS and squeezing the public sector

Not a penny more for an NHS in crisis. Make no mistake, as this blog has shown before, the current crisis in the NHS is simply because it has been starved of resources for the last six years. I really wish Labour (it has to be them, because they are the only party who the media will take any notice of) would run a campaign that busted the myth of a ‘protected’ NHS. But what Hammond’s refusal to do anything about this shows is that this government is continuing the squeeze of the public sector begun by the Coalition. Here is the relevant chart from the OBR. 






Tuesday, 22 November 2016

Populism and the media

Don’t just ask why people are disenchanted with elites, but also why they are choosing the alternatives offered by snake-oil salesmen.

This could be the subtitle of the talk I will be giving later today. I will have more to say in later posts, plus a link to the full text (the writing of which distracted me from writing posts over the last week or two), but I thought I would make this important point here about why I keep going on about the media. In thinking about Brexit and Trump, talking about the media is not in competition with talking about disenchantment over globalisation and de-industrialisation, but a complement to it. I don’t blame the media for this disenchantment, which is real enough, but for the fact that it is leading people to make choices which are clearly bad for society as a whole, and in many cases will actually make them worse off. They are choices which in an important sense are known to be wrong.

Many will say on reading that last sentence that this is just your opinion, but in a way that illustrates the basic problem. Take Brexit. We know that erecting trade barriers is harmful: the only question is whether in this case it will be pretty harmful or very harmful. Some of this is already in the process of happening, as the depreciation reduces real wages. We also know that erecting barriers against your neighbours is extremely unlikely to be offset in any significant way by doing deals with countries further away. This is knowledge derived largely from empirical evidence and uncontroversial theory and agreed almost unanimously by economists.

The moment you reduce it to just another opinion, to be balanced by opposing opinions, as happened in the broadcast media during the Brexit campaign, you allow that knowledge to be ignored when critical choices are made.

A snake-oil salesman is not a perfect analogy, because those championing populist causes often have something to work on that makes some sense to the not very knowledgeable voter. [1] It could be the idea that immigration reduces access to public services, for example. But our media should help people avoid adopting solutions that are known to be wrong, rather than assisting the process by devaluing knowledge. For example, they could continually point out that most economists think EU immigration puts in more resources for public services than it takes out. 

There is another way the media can mislead, by establishing politicised truths, which I will discuss later on. Let me end with a link to a SPERI blog post I wrote to coincide with the talk. It is about the role of neoliberalism in the rise of populism. Although it draws from some of the points in the talk, it is quite separate. I basically argue in that post that a story that recent events like Brexit or Trump are a consequence of neoliberal ideas is potentially a mislabeling, because pushing globalisation is essential a liberal rather than a neoliberal idea. Instead I offer two concrete ways in which neoliberalism, and its emphasis on shrinking aspects of the state and deregulation, did indeed help bring about Brexit and Trump through austerity in the UK and deregulation of the broadcast media in the US.

[1] Postscript 24/11/16 Actually the analogy is better than I thought: see this great post from Chris.         

Saturday, 19 November 2016

The folly of triggering Article 50

Immediately after the Brexit vote, all the analysis I saw argued that Article 50 would not be triggered for some time. They all made a simple mistake: they were thinking rationally about what would be best for the UK. Rick has an excellent analogy that elaborates on one that I and others have used, and it really would be best if you read his blog rather than for me just to repeat it. The conclusion, which this earlier analysis I mentioned had also come to, is that triggering Article 50 without any kind of idea about what any agreement would look like puts the UK in a very weak negotiating position.

This is why the EU were pressing for Article 50 to be triggered as soon as possible. Their real fear is that the prospect but not the actuality of the UK leaving would hang over them for years, and that was the UK’s strongest card. Before playing this card the UK could at least get a clear idea of what the EU might be prepared to offer, and possibly get some commitments that sketch the broad outlines of any deal. Once Article 50 is triggered, the UK will be far more desperate for a deal than the EU. It would only be a slight exaggeration to say it allows the EU to dictate terms. Triggering Article 50 was our best card, yet it is a card that Theresa May is determined to throw away.

Just to emphasise the point, this has absolutely nothing to do with whether you voted to Remain or Leave. Anyone who actually wants a good deal from the EU when we leave should realise that the UK’s negotiating position becomes instantly weaker once Article 50 is triggered. I do not know whether those who have successfully pushed for triggering Article 50 so soon simply live in a deluded state where they think that the UK will be in the stronger negotiating position, or whether they are desperately afraid that if it is not done soon people will go off the whole idea of leaving. But whichever it is, it is an act of folly, whether you want to leave or not. It substantially increases the likelihood of getting a bad deal.

As for Labour’s position, I’m afraid all I can say is you were warned. Jolyon Maugham describes Labour’s position as checkmating itself, but I strongly suspect this is a match the Labour leadership do not want to win. The fact that others in the PLP are content to go along with this does not make it any better. As I wrote at the time, all this was one very good reason for voting for Smith rather than Corbyn.

And if Labour wants to position itself as being the party that can make a success of Brexit, that road spells doom. If MPs think they can avoid losing votes to UKIP or the Conservatives in their traditional heartlands by adopting this line (or trying to be all things to everyone and therefore in reality champion of nothing), they will lose many more votes in their new heartlands than they will save in the old. Many voters feel much more attached to Europe than they do to Labour. This is something I have argued for some time, and this poll suggests I am right. If Labour backs Brexit they will get less votes than the Liberal Democrats. As I also wrote during the Labour leadership election, Brexit changes everything.

But I do not want to get distracted by that. The key point is that triggering Article 50 so soon does not make sense even if you voted Leave.

So if MPs, pro or anti leaving, had any sense at all, and any independence at all, they would vote against. Yes the right wing press will scream and brand you an ‘enemy of the people’, but if have the interests of the British people as your priority rather than your short term popularity that is what you will do. You could even get voters on your side if you explain why you are doing it. This is one of those moments, like the Iraq war vote, where it is utterly obvious what should be done. We are not yet a country that is run by the Mail and the Sun, but triggering Article 50 will make it look suspiciously like we are.



Friday, 18 November 2016

A Mission to Explain

Preparing for my SPERI/NEW Statesman lecture (now sold out I’m afraid), I had a closer look at something that had been in the back of my mind for some time. In the mid 1970s, Peter Jay and John Birt put forward a new philosophy for broadcast journalism. Their first article in the Times started

“There is a bias in television journalism. Not against any particular party or point of view – it is a bias against understanding.”

A lot of the points that I have made in this blog are in their writing: the need to get more economic expertise into reporting, how he said/she said reporting and panel discussion can reduce rather than increase understanding and knowledge.

What became of their initiative? Both had opportunities to put their ideas into practice, and Birt became Director General (DG) of the BBC in 1987 (in rather unfortunate circumstances, with Alasdair Milne being forced to resign because of conflicts with the Thatcher government, echos of which are perhaps still with us today). But Birt’s period as DG seems to have been associated with more centralisation of news and current affairs, and more ‘risk management’, which included pulling programmes that were controversial, and might have increased understanding!

It is tempting to draw the conclusion that the mission to explain fell foul of political interference, but that may be too easy on television journalism itself. It may simply be that the mission to explain worked against dominant journalistic values and culture. The need to generate scoops and headlines, for example, which comes from talking to or interviewing politicians rather than explaining economics. The entertainment value that comes from conflict and debate. The idea that it is more exciting television to have a correspondent embedded with troops in a war rather than calmly explaining the roots of the conflict from somewhere less ‘dramatic’.

But whatever the reasons for the demise of the ‘mission to explain’, it is not exactly the same as what I have discussed in the past. Failing to explain does not account for what I call the politicisation of truth: where something becomes true just because one lot of politicians keep saying it and the ‘other lot’ do not contest it. That comes from insularity, from an excessive focus on the Westminster bubble.

I will talk more about this in my lecture, and subsequently in this blog.       

Wednesday, 16 November 2016

Macroeconomics and Ideology

Jo Michell has a long post in which he enters in a debate between Ann Pettifor and myself about the role of mainstream macroeconomics in austerity. Ann wanted to pin a large part of the blame for austerity on mainstream macroeconomics, and Jo largely sides with her. Now I have great respect for Jo’s attempts to bridge the divide between mainstream and heterodox economics, but here he is both wrong about austerity and also paints a rather distorted picture of the history of macroeconomic thought.

Let’s start with austerity. I think he would agree that the consensus model of the business cycle among mainstream Keynesians for the last decade or two is the New Keynesian (NK) model. That model is absolutely clear about austerity. At the zero lower bound (ZLB) you do not cut government spending. It will reduce output. No ifs or buts.

So to argue that mainstream macro was pushing for austerity you would have to argue that mainstream economists thought the NK model was deficient in some important and rather fundamental respect. This was just not happening. One of, if not the, leading macroeconomist of the last decade or two is Michael Woodford. His book is something of a bible for those using the New Keynesian model. In June 2010 he wrote “Simple Analytics of the Government Expenditure Multiplier”, showing that increases in government spending could be particularly effective at the ZLB. The interest in that paper for those working in this area was not in that this form of fiscal policy would have some effect - that was obvious to those like myself working on monetary and fiscal policy using the NK model - but that it could generate very large multipliers.

This consensus that austerity would be damaging and fiscal stimulus useful was a major reason why we had fiscal stimulus in the UK and US in 2009, and why even the IMF backed fiscal stimulus in 2009. There were some from Chicago in particular who argued against that stimulus, but as bloggers like DeLong, Krugman and myself pointed out, they simply showed up their ignorance of the NK model. Krugman in particular was very familiar with ZLB macro, having done some important work on Japan’s lost decade.

What changed this policy consensus in 2010 was not agitation from the majority of mainstream academic macroeconomists, but two other events: the Eurozone crisis and the election of right wing governments in the UK and US Congress.

Jo tries to argue that because discussion of the ZLB was not in the macroeconomic textbooks, it was not part of the consensus. But textbooks are notorious for being about 30 years out of date, and most still base their teaching around IS/LM rather than the NK model. Now it might just be possible that right wing policy makers were misled by the consensus assignment taught in these textbooks, and that it was just a coincidence that these policy makers chose spending cuts rather than tax increases (and later tax cuts!), but that seems rather unlikely. You do not have to be working in the field to realise that the pre-financial crisis consensus for using changes in interest rates as the stabilisation tool of choice kind of depended on being able to change interest rates!

Moving on from austerity, Jo’s post also tries to argue that mainstream macroeconomics has always been heavily influenced by neoliberal ideology. To do that he gives a short account of the post-war history of macroeconomic thought that has Friedman, well known member of the Mont Pelerin society, as its guiding light, at least before New Classical economics came along. There is so much that could be said here, but let me limit myself to two points.

First, the idea that Keynesian economics was about short term periods of excess or deficient demand rather than permanent stagnation pre-dated Friedman, and goes back to the earliest attempts to formalise Keynesian economics. It was called the neoclassical consensus. It was why the Keynesian Bob Solow could give an account of growth theory that assumed full employment.

Second, the debates around monetarism in the 1970s were not about the validity of that Keynesian model, but about its parameters and policy activism. Friedman’s own contributions to macroeconomic theory, such as the permanent income hypothesis and the expectations augmented Phillips curve, did not obviously steer theory in a neoliberal direction. His main policy proposal, targeting the money supply, lost out to policy activism using changes to interest rates. And Friedman certainly did not approve of New Classical views on macroeconomic policy.

Jo may be on firmer ground when he argues that the neoliberal spirit of the 1980s might have had something to do with the success of New Classical economics, but I do not think it was at all central. As I have argued many times, the New Classical revolution was successful because rational expectations made sense to economists used to applying rationality in their microeconomics, and once you accept rational expectations then there were serious problems with the then dominant Keynesian consensus. I suppose you could try to argue a link between the appeal of microfoundations as a methodology and neoliberalism, but I think it would be a bit of a stretch.

This brings me to my final point. Jo notes that I have suggested an ideological influence behind the development of Real Business Cycle (RBC) theory, but asks why I stop there. He then writes
“It’s therefore odd that when Simon discusses the relationship between ideology and economics he chooses to draw a dividing line between those who use a sticky-price New Keynesian DSGE model and those who use a flexible-price New Classical version. The beliefs of the latter group are, Simon suggests, ideological, while those of the former group are based on ideology-free science. This strikes me as arbitrary. Simon’s justification is that, despite the evidence, the RBC model denies the possibility of involuntary unemployment. But the sticky-price version – which denies any role for inequality, finance, money, banking, liquidity, default, long-run unemployment, the use of fiscal policy away from the ZLB, supply-side hysteresis effects and plenty else besides – is acceptable.”

This misses a crucial distinction. The whole rationale of RBC theory was to show that business cycles were just an optimal response to technology shocks in a market clearing world. This would always deny an essential feature of business cycles, which is involuntary unemployment (IU). It is absurd to argue that NK theory denies all the things on Jo’s list. Abstraction is different from denial. The Solow model does not deny the existence of business cycles, but just assumes (rightly or wrongly) that they are not essential in looking at aspects of long term economic growth. Jo is right that the very basic NK model does not include IU, but there is nothing in the NK model that denies its possibility. Indeed it is fairly easy to elaborate the model to include it.

Why does the very basic NK model not include IU? The best thing to read on this is Woodford’s bible, but the basic idea is to focus on a model that allows variations in aggregate demand to be the driving force behind business cycles. I happen to think that is right: that is what drives these cycles, and IU is a consequence. Or to put it another way, you could still get business cycles even if the labour market always cleared.

To suggest, as Jo seems to, that the development of NK models had something to do with the Third Way politics of Blair and Bill Clinton is really far fetched. It was the inevitable response to RBC theory and its refusal to incorporate rigid prices, for which there is again strong evidence, and its inability to allow for IU.

That’s all. I do not want to talk about globalisation and trade theory partly because it is not my field, but also because I suspect there is some culpability there. I would also never want to suggest, as Jo implies I would, that ideological influence is confined to the New Classical part of macroeconomics. But just as it is absurd to deny any such influence, it is also wrong to imagine that the discipline and ideology are inextricably entwined. 2010 austerity is a proof of that.







Monday, 14 November 2016

Cutting the Mail down to size: welcome to Scotland



For non-UK readers who might be mystified by the picture above, some background. The Daily Mail, a UK newspaper that once supported Hitler and seems to be returning to those good old ways, recently called the three independent judges, who had just ruled that parliament should have a say on triggering Article 50 to leave to EU, “enemies of the people”. In response to this and their remorseless headlines pushing the idea of a migrant threat, a group called Stop Funding Hate asked advertisers to take their business away from the Mail. Lego appears to be their first success.

All the UK tabloids have Scottish editions, but there is one additional Scottish tabloid, the Daily Record. In Scotland the Daily Record has a little under a third of the daily tabloid market. The Scottish Sun has a little over a third. The Mail has only 15%. Contrast this with the rest of the UK, in which if I’ve done my sums right the Mail has a third of the market, the Sun has a third, and the rest is split between the Mirror, Star and Express. So in Scotland, unlike the rest of the UK, the Mail does not dominate the tabloid market.

But everyone knows Scotland is just more left wing and liberal, you might say. But you would be wrong. When social attitudes are measured, Scotland consistently comes out as looking very similar to the rest of the UK.

The idea that the media is just a mirror, reflecting the political attitudes of its readers, is a (dare I say cultivated) myth that falls apart the moment you think about it. It relies on the idea that if a paper does not reflect a reader’s political viewpoint, the reader will stop buying. But most people do not buy newspapers for the politics. Furthermore, the market is hardly flooded with alternatives. These facts give newspapers considerable agency to push their owners views. Of course there are limits to what a paper can do, and Murdoch in particular is very careful not to let his papers get too out of line with its readers, but within those limits they have considerable power. Why else do politicians spend so much of their precious time courting them, if they have no influence? As Murdoch said, when asked why he was so opposed to the EU: “That’s easy. When I go into Downing Street they do what I say; when I go to Brussels they take no notice.”

In the EU referendum we know how the Mail, Sun and Express became part of the Leave campaign. That means that only around 20% of the UK tabloid market argued to Remain. What is more, this 80% pushed their position in a way that can only be described as propaganda. Was this dominance just a reflection of readers views?!

In Scotland however the Daily Record argued for Remain, and the Scottish Sun sat on the fence. (Compare the Scottish Sun’s editorial to the one the rest of the UK saw.) That means that those arguing for Leave were in a slight minority in Scotland. But perhaps more importantly, readers obtained information from newspapers, not propaganda. As we know, Scotland voted by over 60% to stay in the EU.

I listened to this talk (text) by Nicola Sturgeon at SPERI a week ago. She argued, correctly in my view, that leaving the EU but staying in the single market was the obvious way forward after such a close vote. She says that not only did austerity cause significant economic damage, but it also hurt the very fabric of society. She talks about how a fairer society is also good for the economy. None of the leaders of the three other main parties could argue these points. And she argues all these things with calm authority. It is natural to ask why the UK as a whole does not have a political leader of this quality. Perhaps a more balanced tabloid press in Scotland is part of the answer, although there are no doubt many other reasons.

Of course Sturgeon and the SNP can attempt to deceive voters, as they did in the Scottish referendum when it came to the short term fiscal costs. Yet in Scotland newspapers, including the Sun, gave their readers both sides of the argument rather than feeding them propaganda. And Scotland voted to stay part of the UK. It was close, but so was the EU referendum vote in the UK. Whether people get facts or propaganda from their newspapers can make that difference.

Friday, 11 November 2016

Do New Keynesians assume full employment?

I’ve tried to write this as jargon free as I can, but it is mainly for economists

Nick Rowe claims that the New Keynesian model assumes full employment. I think he is onto something, but while he treats it as a problem with the model, I think it is a problem with the real world.

Nick sets up a simple consumption only economy with infinitely lived self employed workers, where we are at the steady state (=long run) level of consumption C(t)= output Y(t)=100. Then something bad happens (what macroeconomists call a shock):
every agent has a bad case of animal spirits. There's a sunspot. Or someone forgets to sacrifice a goat. So each agent expects every other agent to consume at C(t)=50 from now on. ... So each agent expects his income to be 50 per period from now on. So each agent realises that he must cut his consumption to 50 per period from now on too, otherwise he will have to borrow to finance his negative saving and will go deeper and deeper into debt, till he hits his borrowing limit and is forced to cut his consumption below 50 so he can pay at least the interest on his debt.”

To put it more formally: each agent believes the steady state level of output has fallen. That in turn has to imply that everyone makes a mistake about the desired labour supply of everyone else. I assume this is a mistaken belief. If the belief was correct, then there is no problem: the steady state level of output should fall, because people want more leisure and less work.

Nick says that there is nothing a monetary authority that controls the real interest rate can do about this mistaken belief about the steady state, because changing real rates only changes the profile of consumption (shifting consumption from the future to the present) and not its overall level. That is correct. Furthermore if each individual simply assumes what they think is true, and does not even bother to offer his pre-shock level of labour to others, then this is indeed a new equilibrium which the monetary authority can do nothing about.

But people and economies are not like that. Each agent wants to work at the pre-shock level, and will signal that in some way. They will see that the economy had widespread underemployment, and as a result they will revise their expectations about the steady state. I think Nick knows that, because he writes that the NK model needs “to just assume the economy always approaches full employment in the limit as time goes to infinity, otherwise our Phiilips Curve tells us we will eventually get hyperinflation or hyperdeflation, and we can't have our model predicting that, can we.”

He treats that as if it were a problem, but I do not see that it is. After all, we have no problem with the idea that consumers will revise down their expectations of their future income if they unexpectedly find they are always in debt. Equally I have no problem with the idea that in Nick’s economy with widespread and visible involuntary underemployment consumers might think they had made a mistake about others desired labour supply.

Let me put it another way. In a single person economy we never get underemployment. The problem arises because in a real economy we need to form expectations about what others will do. But if there exist signals which help us get our expectations right, that should shift us out of a mistaken belief equilibrium.

Which gets us to why I think Nick is on to something about the real world. Suppose there is a shock like a financial crisis, which for the sake of argument just temporarily reduces demand by a lot and creates unemployment. Central banks cannot cut real interest rates enough to get rid of the unemployment because of the zero lower bound. Inflation falls, but because everyone initially thinks this is all temporary, and maybe also because of an aversion to nominal wage cuts, we get a modest fall in inflation.

Now suppose people erroneously revise down their beliefs about steady state output, to be more like current output. Suppose also that visible unemployment goes away, because firms substitute labour for capital (UK) or workers get discouraged (US). We get to what looks like Nick’s bad equilibrium. Even inflation moves back to target, because the current output gap appears to disappear. We no longer have any signals that there is an alternative, better for everyone, inflation at target equilibrium with higher output.

Now we could get out of this bad equilibrium, if some positive shock or monetary/fiscal policy raised demand ‘temporarily’ and people saw that, because firms substituted capital for labour, or discouraged workers came back into the labour force, inflation did not rise well above target. But suppose policymakers also start to hold these erroneous beliefs, and so do not try and get us out of the bad equilibrium. Could that describe the secular stagnation we are in?



Wednesday, 9 November 2016

Trump: Misleading the People

Introduction (added 10/11/16)

I originally wrote this piece with a start and ending that assumed Trump had lost (yes, I know), and re-wrote it after he had won. I mention that because I think an unfortunate consequence of that is that many will read this as another 'why did he win' piece. It is not that, It is more a 'how did someone who was openly despised by most Republican politicians (included past Presidents), who broke all the normal rules, and generally acts like the dictator of some poor country unused to democracy, get a clear chance at being POTUS' type of question. Whether he won or not is irrelevant to that type of question.

Asking why he won is a whole different type of question, because you are looking at marginal shifts in the way people vote. His appeal to those in the rest belt who were adversely effected by globalisation is clearly relevant in that case.   


So the US has had its Brexit moment. Perhaps the lesson is that if people are promised impossible things and no one tells them they are impossible, you can motivate some potential voters to vote who would not otherwise have done so. But it would be wrong to get hung up on the polls: Nate Silver was clear that there was a good chance Trump could win.

The question to ask is how could the United States elect to its most powerful office not just a demagogue, but someone who lied openly all the time, incited hatred against other religions and ethnic groups, and promised to lock his opponent up if he won. We have to ask how this could happen.

You will hear a lot of talk about those left behind by globalisation, looking at charts like this

        Share of income growth going to income groups from 1975 to 2007. Source OECD



They are remarkable, and they may explain some of the detail of how he swung votes at the margin. But, as Ezra Klein notes in an interesting article in Vox (written when he thought Trump would just lose), Trump support comes from people who are well off, do not live in areas hit by globalisation and are not in areas of recent immigration. They do not explain how a demagogue and liar gets to win so many votes. And they don’t explain how the chart above can lead to people electing a President who now almost certainly will cut taxes for the 1%.

His explanation instead comes from political scientist Julia Azari, who writes “The defining characteristic of our moment is that parties are weak while partisanship is strong.” It is certainly true that the Republican party hierarchy failed to stop Trump, and that a great many of them then went on to endorse him. It is also true that Sanders, an insurgent from the left, did very well in the Democrat primaries. But there the equivalence ends. Sanders is no demagogue who lies openly all the time, incited hatred against other religions and ethnic groups (unless perhaps you count bankers as an ethnic group), and promised to lock his opponent up if he won. He is hardly a threat to the democratic process.

This is one problem that I have with this argument. It implies a symmetry which is just not there. That is because it ignores a key feature of politics in the US over the last few decades, which is a steady march to the right. The threat to democracy comes only from the Republicans and their base. Let me put it another way. Republicans have become more partisan because the believe a centrist, experienced and relatively honest Hillary Clinton is beyond the pale, while Democrats have become more partisan because Republican policies are often mad. (Think climate change, guns, teaching evolution)

The other problem is that the analysis does not spell out why the Republican base has become so extreme, and why plenty of people who are not so extreme will have voted for Trump. You can certainly say that this extremism was encouraged by Republican politicians before the rise of the Tea Party: think of holding the government to ransom when Bill Clinton was President. But I think the biggest factor missing from Klein’s account - as it often is by those in the media - is the media itself.

This consists of two parts, much as it does in the UK. First there is Fox news: a highly partisan news provider with a clear right wing bias. Second there is an inability of the non-partisan media to provide any kind of counterweight when someone like Trump arrives, and in some cases provides help to his cause. I have talked about this second factor before, here and more briefly here, so let me concentrate on the first today.

The story is in fact told better than I ever could by Bruce Bartlett, who worked in the Reagan White House and for George HW Bush, so I’ll just summarise it here. The story starts under Reagan, who provided pressure to withdraw the Fairness Doctrine, which was similar to what keeps UK broadcasters from being partisan. Initially that allowed the rise of talk radio, and then Fox News. Gradually being partisan at Fox meant misinforming its viewers, such that Fox viewers are clearly less well informed than viewers of other news providers. One analysis suggested over half of the facts stated on Fox are untrue: UK readers may well remember them reporting that Birmingham was a no-go area for non-Muslims.

But why is this causal, rather than simply being a mirror on the rightward drift of the Republican base? The first point is that there is clear evidence that watching Fox news is more likely to make you vote Republican. The second is that, like the tabloids in the UK, this propaganda machine can turn on party leaders and keep them from moving left. The third is that it is also a machine for keeping the base angry and fired up and believing that nothing could be worse than voting for a Democrat. It is Fox News that stops Republican voters seeing that they are voting for a demagogue, conceals that he lies openly all the time, incites hatred against other religions and ethnic groups, and makes its viewers believe that Clinton deserves to be locked up. Just as UKIP (and perhaps now the Conservative party) is the political wing of the tabloids, so Trump is a creature of Fox news.

Trump’s election is a disaster for humanity. That may be true in ways we can only speculate about, but we know that he does not believe in climate change, thinks it is a Chinese hoax, will not follow the Paris agreement and will do all he can to support coal. With a Republican congress no one will stop him. When you think about that, remember also that Fox news (like sections of the UK press) encourages climate change denial, and the issue was not mentioned by the non-partisan nightly news election coverage (which obsessed about emails) or raised in any of the presidential debates. If you continue to mislead people in this way, they will continue to make terrible mistakes when they vote.