In this post I claimed that 2010 should be counted as one of the major errors of UK macroeconomic policy. In fact the claim is much more general, because 2010 was the year that the consensus among policymakers in the OECD area shifted from enacting stimulus to pursuing austerity, with damaging consequences in many countries. A number of comments and a couple of blogs added to my speculation on why this error might have occurred. Here I want to consider more generally what role academics and economists can play in preventing policy errors, and why this may depend on the reasons for those errors.
Before coming to that, let me address one common objection to my view that 2010 was a major policy error at the time, and not just in hindsight. The objection is that the slowdown in 2011 was due to factors other than austerity that could not have been foreseen. There are two problems with this argument. First, the projected speed of recovery even before these adverse shocks occurred was pitifully slow. What the IMF described in late 2010 as ‘solid UK growth’ was actually 2.5% per annum into the medium term, which on their own admission only gradually closed the output gap. The OBR’s June 2010 post-budget forecast also had GDP growth of 1.2% in 2010, 2.3% in 2011, and never above 3% thereafter. Considering GDP was estimated to have fallen by 5% in 2009, this was a tepid recovery.
The second, and more important, flaw in this argument is that it ignores the fact that good policy should allow for risks. As I elaborated here, because of the zero bound for interest rates there was no insurance policy if bad shocks did occur (as they did). In contrast, if positive shocks had led to a recovery that was too rapid, monetary policy could have been used to cool it down. To put it more simply, austerity was a huge and unnecessary gamble, and the gamble did not pay off. Much the same could be said for many other countries.
One class of explanation for this kind of policy error focuses on hidden agendas. The most obvious in the case of austerity is a desire to reduce the size of the state, as Chris Dillow suggested. As Mark Thoma put it: “The notion of "expansionary austerity" was the cover, but so long as government shrinks as a result of the policy, the expansionary part is secondary.” Chris has recently suggested even darker motives. I put forward another, more mundane, explanation that is specific to the UK: get the cuts out of the way well before an election, and hope the electorate have short memories. Perhaps an explanation specific to the US might be that it suited those opposed to the President that the economy failed.
If this type of explanation is correct, is there anything that can be done to prevent or expose this kind of subterfuge? In this post, I was rather pessimistic. I suggested that it required near unanimity amongst academics before the media would begin to question the cover stories. Without unanimity, the cover story would just be described as controversial.
Brad DeLong has persistently railed against ‘opinions on shape of the Earth differ’ type reporting. All too often journalists appear to have only two categories - either something is objectively true or it is controversial. Anything controversial requires evenly balanced reporting. A tragic example from the UK would be the debate over the MMR vaccine. As Lewis and Spears document, a single paper in the Lancet suggesting a link with autism was hyped by the media, despite widespread scepticism among health experts and overwhelming scientific evidence that the vaccine was safe. As a consequence, take up of the vaccine declined and outbreaks of measles increased. (Here is a good account of this episode from a US perspective.)
Even with academic unanimity, there is the possibility that moneyed interests could manufacture controversy through think tanks, as has happened with aspects of climate change debate. [Update 20/2/12 - on this see George Monbiot.] Of course the debate is still worth having, but it is unlikely to change things very much or very quickly.
This pessimism may be a little overdone, however, in the case of austerity. Politicians, above all, want to be re-elected. For that reason the cover story view does require a belief that the harmful impact of (early) austerity will not last long enough for it to matter at the next election. If that is not the case, academics might be able to convince politicians that it may not be in their own interests to undertake the policy.
Which brings me to another class of explanation, which is policymakers fooling themselves. The hidden agenda may still be there, but the difference is that politicians convince themselves that the cover story is also true. In the case of austerity, there are a number of stories politicians can tell themselves. They can believe in expansionary austerity, of course. They could believe that Quantitative Easing will be enough, although I would hope any central banker would tell them that they had no idea what impact QE might have. They might have believed that the recovery was well under way, so any damage done by austerity would not be noticeable.
Does this case also require near unanimity amongst academics to convince the policymaker they are fooling themselves? There are at least two reasons to suggest it might. First, (macro)economics is not held in the same regard as other sciences, for good reason. I would not go quite as far as one comment which said scientists proclaim facts while economists give out opinions – I think we are somewhere in between these two, but still. Second, the two way link between ideologies and economics makes it too easy for the politician to dismiss views they do not like by believing they are politically motivated, and it also makes it too easy for the politician to find academics who will tell them the stories they would like to hear.
A third class of explanation for policy mistakes is that they are genuine mistakes. Events may arise which come as a surprise to most academics as well as policymakers, so there is genuine uncertainty. In terms of 2010, I think the probability of Greek default with possible Eurozone contagion was important at changing attitudes among those who might otherwise have been sympathetic to more fiscal stimulus/less austerity. In the case of the UK, it may have been crucial in persuading Nick Clegg and the LibDems to support greater austerity as part of the coalition. As I wrote here: “What finance minister can sleep easy when there is a chance that they too might be forced down the road being travelled by Greece, Ireland, Spain, Portugal and Italy?” Now I go on to argue, following Paul De Grauwe, that this crisis was a crisis of the Eurozone, and not the precursor to a generalised government debt panic. Although that view is gaining increasing acceptance as interest rates on government debt elsewhere continue to fall, at the time this proposition was neither obvious (governments with their own currencies default through inflation and depreciation, and lenders will fear that) nor widely argued.
In situations of this type, academics can in principle have much more influence. Furthermore, the blogosphere allows for an immediacy that might just be able to influence opinions before mistakes are made, and positions become entrenched. In the case of 2010 and austerity, I do not think it would have been enough. The political forces pushing for austerity, the hidden agendas, were too strong, and the panic induced by events in the Eurozone too great. But academics should never become so pessimistic about their potential influence that they give up trying.
I can't help thinking you are over-egging the pudding a bit when it comes to describing 2010 as a policy error. There seems to be an implicit premise that inflation-targeting is an undesirable policy and should be replaced by discretion.ReplyDelete
The fact is inflation has been above target since early 2010. The Bank has some leeway to allow inflation to be above target before it has to explain itself. Having exceeded that leeway it has been forced to write to the Chancellor to explain why it has failed. In my view, inflation targeting is only credible if in such circumstances the Bank can point to circumstances which were outside its control and unexpected that caused inflation to overshoot. Having established that inflation was systematically exceeding the target (having to continually write letters to the Chancellor) the Bank should have been admonished and it should have set about tightening in an attempt to meet the target within a reasonable time-frame.
Now, we could argue that in the circumstances of the past 2 years it would have been unwise to raise interest rates or reverse QE, and indeed in the absence of more QE inflation would probably fall below target next year. Thus, perhaps it was right that the Chancellor allowed this to happen and accepted the Bank's explanations. But it can't have been wise to add fuel to the fire by adding fiscal stimulus that would further increase inflation. If that happened the either the Bank would raise interest rates or we would send the message that the UK had abandoned its inflation target completely. This could well lead to a sterling crisis as we have seen before.
Obviously, its easier to make the case that the US and Eurozone have committed policy errors, but I think there are as many economists who think UK policy was right (or too inflationary) over the past 2 years as agree with you that it was too tight. An interesting experiment would be to ask economists their view of this issue along with their political views. I suspect economists who favour the centre-right might be more sympathetic to the present government's policies.
I did a post on this; it's not entirely clear what the BoE are doing, even using a "target the forecast" model a la Lars Svensson. There is certainly scope for saying monetary policy was too loose (looking forward) in 2010, based on the 2-year CPI forecasts, but by Q1/Q2 of 2011 policy looked "about right", bordering on too loose. The MPC votes in the first half of 2011 were close to tightening.
On a "target the forecast" basis, the fiscal tightening, which started in earnest in 2011, was not obviously problematic in Q1 or Q2. The inflation forecasts only fell off in Q3 and Q4 of 2011. It is hard to blame fiscal policy for that directly.
And... this is the post: Forecast to Fail?Delete
2010 inflation was cost-push inflation from high energy and commodity prices, not demand-pull inflation.Delete
A central bank cannot control cost-push inflation. It can only control demand-driven inflation.
If you have a chronic lack of demand, you can't raise interest rates to stop cost-push inflation.
Yes, sorry, I meant to say policy was too tight in 2010, because the CPI forecasts looking 2/3Y out were all below 2%, as my post makes clear.Delete
2010 was indeed a policy error, and one which was warned of by Gordon Brown. As he left his advice was to give the VAT reduction time to work before reversing it. Advice ignored!ReplyDelete
But you are right that ambiguous advice from economists is unhelpful; the most worrying aspect of this, to me, is what I see as the false negative issue.
Macroeconemics by definition looks at aggregates. It says that things have to balance, and mostly there are several things in the balance. Out-of-balance cannot happen - some times for mathematical reasons, a consequence of how things are defined, some times for practical reasons - nobody goes for a lose-lose option, and sometimes for a combination of these.
But it tells you quite powerfully what cannot happen. You can't work your way out of debt if you haven't got a job, and society can't work its way out of debt if it has to fund an increasing pool of jobless citizens. But it is a false negative to then say that monetary stimulus is the answer. Just as a vehicle cannot move without fuel, but fuel alone is not enough to get it on its way. It needs a functioning engine, it needs to be pointing in the right direction, and it needs all its controls to be working properly to complete its journey.
Too much of the macroeconomic debate has been about austerity or stimulus. The inescapable logic of needing to get the economy going without knowing all of the things you need to know to get it to work, against the impossibility of getting anything going if you end up being milked for 5% and increasing of your decreasing GDP by the people you have been borrowing from.
This problem, faced in miniature by an increasing number of families, will be solved by them without the help of economists. It will be solved, possibly increasing debt charges to cover getting and getting to work, and a lot of hard work. The way out is clear - cut out waste, get what you need by borrowing if necessary, then use it to dig your way out.
And if instead of arguing over different -isms all the economists would agree on this simple non-academic, practical solution, the politicians might know what to do.
I'm not an economist but a scientist and don't want to comment on the economic aspects of your post, but I am intrigued by your observation about the media and academic unanimity. My area is climate science, where we struggle with exactly the same problem: even with near unanimity in the scientific community, climate "skepticism" is still strong in the media, because journalists put it into the "controvery" box. It seems that academics in all fields are in a similar situation here.ReplyDelete
As a citizen, I find this failure of the media problematic. In science I don't usually have to rely on media, but we all need to be well-informed about fields outside our own speciality. So, when it comes to economic questions, I find it very difficult to get any understanding of the economic situations or possible paths of action from mainstream media reporting, and to work out which suggestions are based on empirical data or detailed projections, and which are just intuitive ideology. Blogs like yours are valuable as they give background and a direct insight into academic thinking. Still, I believe we need to work towards some kind of reform of the mainstream media so that they serve the need of society better.
There is another similarity between your field and mine. In climate change, there is also a failure to act on the evidence. It seems to me that, on a political level, in most regions of the world (certainly Europe and China) with the possible exception of the US and Canada, this failure is NOT due to misinformation or a lack of understanding - in my experience, many politicians seem quite well informed about the relevant issues in the science. The failure to act decisively is more due to competing interests that can be stronger than the need for long-term sustainability. Whether this is true in economics too, I do not know, although I assume that governments must have access to solid economic modelling and advice, so I can't really believe that policy errors are due to lack of economic understanding.
My new blog, and the first post was a follow on to your own post above...ReplyDelete