Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday 10 May 2012

Polarising Essays

                Its sometime in the 1970s. Inflation is rising, and the monetary authorities are failing to raise interest rates by enough, so real rates are failing. A large number of academic economists are urging governments or central banks to raise rates by more. But other economists argue otherwise, and partly as a result, policy appears unresponsive.
In that context, an eminent economist writes an article looking at what they see as the key structural problems that have been developing in the economy over the last few decades. But they start the piece by saying that excess demand is not the most important problem right now. Instead inflation reflects deep structural imbalances in the economy that have been building up for years. They write that governments cannot use unemployment as a way of regulating inflation: the relationship is all over the place, and raising productivity would be a more effective way of reducing inflation.
                Articles like that did get written at the time and look a little foolish today. But as some of you will have guessed, I’m trying to make a point about what I see as a similar thing happening today, except its fiscal policy at the zero bound and unemployment, rather than monetary policy and inflation. If it was really true, as Rajan writes, that “this narrativethe standard Keynesian line, modified for a debt crisisis the one to which most Western officials, central bankers, and Wall Street economists subscribe today”, and if policymakers were acting accordingly, then I doubt anyone would get too upset by what could be discounted as a rhetorical device to catch attention. But instead governments are implementing austerity around the globe. This article is not an isolated case: see this($) recent FT piece by Sachs .
                I really do think we should try and keep discussions of long term trends and short term problems distinct as far as possible. If economists are good for anything, it is in abstraction of this kind. To the extent the issues are linked then they are more likely to be complements than substitutes. In the UK, according to the OBR, public sector investment fell by 13% in 2011, as the initial thrust of the government’s austerity programme. This included abandoning plans to rebuild dilapidated schools.
                Tyler Cowen suggests they are competing stories because “any given dollar must be spent somehow and “the stimulus model” and “the long-term investment model” are indeed competing visions for the allocation of resources.” The above example suggests they need not be competing. In addition my fictional writer from the 1970s could have made the same point. Higher interest rates are raising the cost of government borrowing, they might say, which is squeezing resources for tackling our longer term structural problems. That would be a very bad argument for not raising interest rates in the 1970s, just as I think ‘where is the money coming from’ is a bad argument against stimulus today.
            However I agree with Tyler when he writes: “Any Martian visiting the economics blogosphere, or for that matter Krugman’s blog, could tell you that most of micro is a more or less manageable topic, whereas macro induces economists to start thinking of each other as idiots and fools.” I have written about why this might be elsewhere, but as long as a large section of the profession, and the majority of policymakers, appear to ignore what mainstream macro tells us, then any writing that encourages this amnesia will get some of us annoyed.


  1. I really wish people would use examples other than (re)building schools as areas of potential government investment. The question of whether or not there are plenty of worthwhile capitol projects which a government if so inclined could start pouring money into is truly an important one and one that I would very much like a detailed answer to. But in the specific case of schools my only experience is that in the city of Sheffield there is hardly a secondary school that was not rebuilt or renovated during the Labour years. Perhaps this is far from representative of the national situation, but it makes me suspect that Britain is not full of dilapidated old schools ripe for renewal. If there really are lots of worthwhile projects for the government to invest in then mention one of those and I personally will find your argument more convincing.

  2. Mr Blair, I don't know much about Sheffield schools, but given that the uk govt can borrow at negative real rates, surely the difficult thing is to find things that aren't worth spending on?

  3. This piece is useful, but the first paragraph credits economists with too much influence on policy.

    In the 1970s profits were low and falling. The "median policy influencer" (to use Steve Randy Waldman's label) would have seen an interest rate rise as something that would cut profits further, and therefore something to be resisted.

    In the 2010s, the profits of the median policy influencer have been OK. From its point of view, if there's a deficit, the problem must be that the government is spending too much. If people are unemployed, it must be that they don't have any skills, or at least the right skills. Each person's individual problem, either way, and not the domain of government policy.

    This story is simpler and more direct than a story of second-order confusion arising from the arguments of academics, who, after all, always argue, and therefore are ignored.

    The next two paragraphs suggest that economists are influenced by policy influencers rather than the other way about. This should be cause for self-examination by leading economists and journal editors.

    Cowen's confusion about stimulus likely arises from his automatically equating stimulus with transfers, either direct or in the form of tax cuts. If the problem is unemployment, as it is in the US where GDP is doing fine, then the direct solution is to employ people. And on what else should they be employed before investments?


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