Thursday, 7 March 2013

Looking for a Robust Defence of Austerity


So, driving home today, I was told by the BBC that the Prime Minister had just made a ‘robust’ defence of his government’s economic policies. One definition of robust (for an object) is ‘sturdy in construction.’ Well let us see, by looking at some of the sections discussing the fiscal strategy.

(1) First, the deficit. This deficit didn’t suddenly appear purely as a result of the global financial crisis. It was driven by persistent, reckless and completely unaffordable government spending and borrowing over many years. By 2008, we already had a structural deficit of more than 7 per cent – the biggest in the G7.”
UK GDP fell by 1% in 2008. Here is OBR data on public sector net debt before the recession.


As I suggested here, it would have been better if the Labour government had sustained the reduction in debt they achieved in the early years. However this chart does not look like a “reckless and completely unaffordable” policy. But if the Prime Minister says it was, I guess he must have robust reasons for saying so. [a]
(2) “There are some people who think we don’t have to take all these tough decisions to deal with our debts. They say that our focus on deficit reduction is damaging growth. And what we need to do is to spend more and borrow more. It’s as if they think there’s some magic money tree. Well let me tell you a plain truth: there isn’t.”

People and companies borrow all the time. I do not think they believe in a “magic money tree”. People and firms borrow more when the cost of borrowing is very cheap – that is common sense. The government is trying to encourage individuals and firms to borrow more. So why is it good for the private sector to borrow more to invest in good projects when the cost of borrowing is cheap, but when the government does the same thing it involves believing in magic? Strange, but our Prime Minister says it is so, and he is saying it in a robust manner.

(3) “As the independent Office for Budget Responsibility has made clear……growth has been depressed by the financial crisis……the problems in the Eurozone……and a 60 per cent rise in oil prices between August 2010 and April 2011. They are absolutely clear that the deficit reduction plan is not responsible. In fact, quite the opposite.”

If this were true, then one would seriously wonder about the competence of the OBR. There has been much recent debate about the size of multipliers, but not the sign: greater austerity almost surely reduces growth. The theoretical plausibility and empirical evidence for expansionary austerity is practically zero: for more on the former see this short account by Campbell Leith of joint research with Eric Leeper and Huixin Bi recently published in the Economic Journal.
However, as far as I am aware, the OBR has never said that austerity has had no impact on growth. What they have talked about is why growth has been lower than they expected back in 2010. As they had austerity built in to their forecasts of 2010, then they have naturally looked elsewhere for events they were not expecting. [b] So this statement deliberately misrepresents what the OBR has been saying, to imply that the OBR believes in expansionary austerity. But the Prime Minister knows that the OBR will let this misrepresentation of its views pass – which is a shame. [Update - the OBR did not let this pass: see this subsequent post. ] I guess you can robustly misrepresent.
(4) “Last month’s downgrade was the starkest possible reminder of the debt problem we face. If we don’t deal with it……interest rates will rise, homes will be repossessed and businesses will go bust…”
Interest rates might rise if the markets thought that the UK government might default on its debt or if the UK was about to enter an inflationary spiral, but there is no sign of that (in fact, quite the opposite), for very good reasons. Interest rates might rise if the MPC decides they should. At the moment all the talk is whether the MPC will go for more, not less, stimulus, and if the FT is to be believed the government will give the MPC more room to act in this way. So no sign that interest rates might rise on that account either, but I guess there must be a robust logic to this assertion somewhere, otherwise why would the Prime Minister be so certain?
 (5) “So those who think we can afford to slow down the rate of fiscal consolidation by borrowing and spending more are jeopardising the nation’s finances……and they are putting at risk the livelihoods of families up and down the country. Labour’s central argument is exactly that. They say that by borrowing more they would miraculously end up borrowing less. Let me just say that again: they think borrowing more money would mean borrowing less. Yes, it really is as incredible as that. The Institute of Fiscal Studies has completely demolished this argument.”
The argument that by borrowing more you may end up borrowing less has been set out by DeLong and Summers. If you search for references to these authors on the IFS website, or for both on Google, nothing comes up, so I do not know what demolition is being referred to here. [c] Perhaps the Prime Minister has seen something I have not. In any case, given what the Prime Minister has said, I’m sure DeLong and Summers will now retract their patently wild and obviously non robust proposition. [Update - Jonathan Portes finds that in fact the latest IFS Green Budget says almost the complete opposite of what the Prime Minister suggests.]
(6) “But we are making the right choices. If there was another way I would take it. But there is no alternative.”
The resort to TINA is the ultimate ‘reveal’: if the arguments for the policy being pursued have been lost, the evidence is stacking up against you, and there are plenty of perfectly feasible alternatives, then assert as dogmatically ('robustly') as possible that you are pursuing the only possible path. Of course the smart thing to do is to assert this at exactly the time that you actually change your policy in favour of one of the alternatives. Well, we can always hope, although I fear to hope in this way would not be a robust thing to do.


[a] The following quote from the IFS February 2012 Green Budget (page 52) makes the key point:
“To assert that the Labour government should have done even more before 2008, while accepting the latest official estimates for the output gap up to 2007–08, one would have to believe that it should have been able to forecast more accurately the path of trend output growth beyond 2007–08. Over the period from 2007–08 to 2016–17, the OBR’s latest figures imply that trend output will grow on average by just 1.2% a year. This compares with the 2½% a year that underpinned the official public finance forecasts produced prior to the crisis. While at the time Mr Darling’s assessment of the path of trend growth was not seen as being particularly cautious, it also was not widely seen as being unduly optimistic either.”


[b] The OBR could have concluded that they underestimated the size of multipliers in doing their original forecast, and as the numbers they use for the mulitipliers are low (substantially less than one), this would be a reasonable conclusion, as the much quoted recent research by the IMF suggests. (For more details, see Jonathan Portes here.) But the OBR were never assuming negative multipliers, as this passage in the speech suggests.
[c] The 2012 IFS Green Budget does discuss hysteresis, with no refutation of this idea that I could see.


26 comments:

  1. Andrew Maclaren8 March 2013 at 01:42

    It's ironic that David Cameron was an outstanding student of PPE at Oxford. He surely knows his speech is drivel, but thinks sticking to austerity is his best chance for reelection.

    Personally I think this is a miscalculation. A bit more reflation now should see growth stronger by 2015 and it will also make it hard for Labour to offer a better alternative.

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  2. I have to see the policies being about a deliberate attempt to reduce the size of the state, a long term policy of the party. It explains selling off many assets during the Thatcher years as well as austerity now.

    The current financial climate is just the pretext.

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    1. That's what the Republicans in the US do part of the time. (Now they've mostly moved on to crazier policies based on end-times theology, though.)

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  3. Its even more worrying that the is happy that people can buy houses with 5% deposit and low interest rates.
    On one hand he does not want to borrow more but the same time he is pushing people into negative equity just to support the housing ponzi scheme..

    If anything else, this behaviour will overinflate the existing inflated market and the crash would be even more severe.

    Short-termism is the name of the game.

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  4. Yes, if you borrow more now, you may need to borrow less in the future. Is that so strange? Yes, if the government borrows more now, households need to borrow less. Is that so absurd? One "borrowing" is not another "borrowing". In fact, the PM started his argument by saying that more borrowing in the past somehow should result in less borrowing now, so that's a case in saying that it does make a difference when you borrow. But yes, if you leave out crucial qualifications in your description of "facts" than those facts tend to sound absurd. But that does not mean they are absurd, it means your argument is absurd (or disingenuous).

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  5. But there is a magic money tree ! Where does the money for QE come from, if not the magic money tree ?

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  6. Alessandro Mennuni8 March 2013 at 04:46

    How big and PERSISTENT the spending multipler has to be to make expansionary fiscal policy not a burden in the future?

    I put enphasis on persistence because it should also be taken into account that government spending increases are very hard to cut in the future, so this increased spending would stick around. Therefore, the desirability of expansionary fiscal policies does not depend only on the impact spending multiplier, much talked about, but also on the future response to current and persistent spending increases.

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    1. That would be why just about every advocate of stimulus spending who's ever lived has advocated either well-defined (and preferably necessary) infrastructure projects, or robust automatic stabilizers, as the stimulative instruments of choice, in large part because those are self-limiting.

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  7. The OBR have just announced that the PM misrepresented their views on impact of austerity on growth. Hooray for semi-independent fiscal councils!

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  8. Maybe OBR read SWL and have been stung into a reply by such a blatent misrespresnetation of their views. Nice thought.

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  9. I know now that academic standards are being eroded and not by the 'state sector'. I doubt if DC's arguments would have got a pass in PPE prelims 50 years ago!!

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  10. The graph should say that the figures are Percent GDP.

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  11. "it was driven by persistent, reckless and completely unaffordable government spending and borrowing over many years.". Spending, which, of course, Cameron and Osborne promised to match in 2007; see http://news.bbc.co.uk/1/hi/uk_politics/6975536.stm

    Not much of an advert for Eton and Oxford, is he ?

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  12. This is a very useful article, thanks

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  13. Awesomeness: "As they had austerity built in to their forecasts of 2010, then they have naturally looked elsewhere for events they were not expecting."

    Bravo!

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  14. >So why is it good for the private sector to borrow more to invest in good projects when the cost of borrowing is cheap

    With corporations awash in cash, the only reason for corporate borrowing is the tax advantage. Which, of course, hurts tax revenues but maybe there is still a reason for it.

    Governments do not obtain a tax advantage from borrowing because they do not pay taxes.

    (Job creation without government spending or inflation: http://jobcreationplan.blogspot.com/)

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  15. >The argument that by borrowing more you may end up borrowing less has been set out by DeLong and Summers.

    Having borrowed $16 trillion already, it is difficult to see why the US should need to borrow any more at all. If growth from fiscal stimulus is 'permanent' we should be able to attribute the entire US GDP to previous deficit spending. If it is not permanent then the argument completely falls apart (which is what the CBO assumes when projecting debt-to-GDP in the event of fiscal stimulus, or when calculating the time scale of different types of fiscal stimulus events).

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    1. I don't know what you mean by growth being "permanent". This is an odd argument indeed: a bit like saying if a building is built properly it ought to be indestructible even if you subsequently send in a demolition crew to knock it down.

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    2. "If growth from fiscal stimulus is 'permanent' we should be able to attribute the entire US GDP to previous deficit spending."

      Say what? Why should that be? Explain!

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    3. "If growth from fiscal stimulus is 'permanent' we should be able to attribute the entire US GDP to previous deficit spending."

      There is actually a strong long-term argument that this is true -- all of US GDP is dependent on previous money-printing, of one sort or another.

      Most business activity requires money to circulate, and that requires someone to print or coin money. The modern form of that is "deficit spending".

      It's really that simple.

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  16. Skidelsky in his column 'Models Behaving Badly' (at Project Syndicate) quotes the OBR as saying “the average [fiscal] multiplier over the two years would have needed to be 1.3 – more than double our estimate – to fully explain the weak level of GDP in 2011-12.”

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  17. What does the chart you posted in the first point even mean and why are you comparing the structural deficit with 'net debt'?

    Surely you are not going to deny that in the early years of Labour they carried on with the plans they inherited from the conservatives before turning on the taps in 2000??
    How does this then differ with what the PM is saying? Did they or did they not go on a spending spree from 2000?
    Instead you have chosen to spin this as 'the reduction Labour achieved in their early years' sigh.

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    1. The claim that it was Labour profligacy, rather than the financial crisis, that left a terrible legacy must apply to the level of debt, or the level of the deficit, in 2007. The chart shows it applies to neither.

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    2. Ok that's fine.

      Still we cannot run away from the fact that running a deficit all those years when the economy was doing pretty ok meant we couldnt muster a half decent response to the financial crisis.

      Nobody comes out of this well. The Tories plan isnt all that clever but in fairness to them they did inherit a terrible problem (the reason why the public kicked out Labour in the first place, if inconclusively).

      Plus your chart shows figures in percentages(?). This doesnt tell us much because in a situation where a recession knocks off 4/5 years worth of growth from GDP, percentages wont tell us very much.

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  18. As Martin Wolf pointed out, there IS a magic money tree.

    It's called the Bank of England and it prints money. Magic! Or, not magic at all.

    Cameron is an idiot. Can you get rid of him somehow?

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  19. It is beginning to look like there are signs of the start of a U turn on austerity judging by the budget leaks today.

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