The Prime Minister said this on BBC Breakfast yesterday about
forward guidance:
"But I think what is good about what Mark Carney is saying
is that he is effectively saying look, the Government is doing the right thing
by taking difficult decisions to get the deficit down and therefore we can have
an aggressive monetary policy until unemployment falls even further."
Now perhaps I have missed something, but I can find no instance
where Mark Carney either said or implied that “the Government is doing the
right thing by taking difficult decisions to get the deficit down”. All I did
see was his strenuous efforts to avoid saying anything about fiscal policy, in line with his previous practice (ignore the headline, just read the quotes).
Was there something in the Inflation Report? You will find on
page 22 this
“The IFS estimates that the additional fiscal tightening each
year is equivalent to around 1% of nominal GDP on average from 2008/09 to
2017/18, and the pace of consolidation is planned to be broadly similar in
2013/14 to that in 2012/13. Although it is difficult to know what would have
happened in its absence, the consolidation is likely to have weighed on output
growth over the past three years and will continue to do so.”
Carefully chosen words, but no hint of “the Government is doing
the right thing”. Now if the UK was in the same position as the US, with
inflation below target, then this ‘weight on output growth’ could well prompt
the Governor to say that fiscal policy was making the MPC’s life more
difficult. In the UK, however, it appears that it is inflation rather than
(maybe?) the (perceived?) inadequacy of monetary policy instruments which is
restraining further monetary stimulus.
However, in the February 2013 report you will find an
interesting analysis of the impact of government decisions on inflation. In a
box on page 36, there is a discussion of the impact of administered and
regulated prices (prices either directly or indirectly set as a result of
government or regulatory decisions). To quote: “The likely contribution of
administered and regulated prices to CPI inflation in 2013 and 2014, at around
1 percentage point, is about ½ percentage point higher than its average between
1997 and 2006.” Over half of this ½ percentage point is due to higher student tuition fees brought in by this government. Not helpful when you are trying to target
2% inflation.
On the basis of this, maybe I could just about get away with
claiming that the Bank is ‘effectively’ saying the government’s fiscal
decisions are making it more difficult for the MPC to do its job. There is just
no way that I could get away with claiming that the Bank, or this Governor, said “the Government is
doing the right thing by taking difficult decisions to get the deficit down”.
You may remember that the Prime Minister has form when it comes
to putting words into other people’s mouths. Both he and Osborne were fond of
claiming that the OBR in some way supported the government’s austerity
programme, and that austerity was not harming growth, until it became too much for the OBR to stomach, and Robert Chote
wrote the Prime Minister a rebuke (see my before and after posts, and a forecast of mine that was -
happily - immediately proved wrong). That episode clearly has not led the Prime
Minister to kick the habit, perhaps because he is sure he can get away with it
this time. But it says something about the confidence the government has in its
policy, when it has to make up the support for it.
Osborne on the BBC a few weeks ago said that his plan was working, especially if you compared it to that of France.
ReplyDeleteWhich was great, other than he (and Evan Davis doing the interview) either did not know or didn't care to say that the French government can borrow more cheaply than the UK's. And given that Osborne seems to think that a low rate of government borrowing is a sign of success rather than the reflection of a weak economy, you would have thought that Evan Davis would have picked him up on this (or even acknowledged his error in my complaint, which he didn't).
I haul Brad DeLong's blog comment on Nick Clegg after the loss of the AV referendum May 06, 2011:
"Nick Clegg Sold His Birthright for a Mess of Pottage...and then did not get any pottage. Alternative vote goes down to defeat in Britain. Not only did he sell his birthright, he sold his honor, his party's policy preferences, his self-respect, and any claims he may have had to be addressed as a sophont as well. Now he needs to resign, apologize, give all he has to the poor, and take up a life of anonymous service to others."
To reiterate a point made in the original post my personal experience at a BoE agent's inflation report presentation the other day when I asked what the BoE's view of fiscal consolidation was, was for them to immediately distance themselves from the IFS analysis quoted in the report, indulge in aggressive obfuscation, then present a weak "bond vigilante" arguement. So no BoE support for current fiscal policy isn't especially clear cut
ReplyDeleteMy response http://uneconomical.wordpress.com/2013/08/09/the-mpc-exists-to-make-difficult-decisions/
ReplyDeleteThough I could just quote Friedman on the "weight on output growth" problem:
"In a good year, when things are good, when the economy is booming, you will read that the Federal Reserve by its wise policy – by its efficacious management of money – has produced this fine situation. However, let things get bad, and all of a sudden the tone of the annual report is different. Then you discover that despite the best efforts of the Federal Reserve outside forces combined to produce difficulties"
Thankfully, Friedman's type of thinking has "vanished from the policy scene", otherwise our economy would really be screwed.
You really should stop trying to defend the current government on macro policy. For a start you agree with my point that Cameron is taking liberties. Of course you can find examples of where Carney says that the budget deficit needs to come down (we need fiscal rebalancing), because it clearly must come down! It is all about timing. For all I know Carney might support what the government is doing in private, but he is shrewd enough to know that he should not take sides in public. The previous governor got into trouble with some MPC members when he did this (see http://www.theguardian.com/business/2010/nov/25/mervyn-king-support-cuts-excessively-political)
Deleteand Carney wants to avoid clashes like this so soon in the job. He has had plenty of opportunities to simply say ‘I think the government is doing the right thing with austerity’, and chose not to take them.
You clearly believe that the MPC should be going for more stimulus even though that means overshooting the inflation target, and I fully support that view. I am much less confident than you about how successful they would be if they did that, but they should at least try. However what is holding them back is inflation targeting. And in the UK, the target is set by the Chancellor. So we could both get our wish in an instant if the Chancellor said ‘I have decided to temporarily raise the inflation target’. He has chosen not to do that. In these circumstances, I think it is quite understandable (though regrettable) that the MPC feels it cannot go for higher inflation. You should direct your criticism not at them, but at the man in charge.
"You really should stop trying to defend the current government on macro policy."
DeleteI'm not sure that flies. The Coalition has never, to my knowledge, said that growth was their one and only priority. Instead, they have said that they are following policies that will produce growth eventually, after stabilizing the markets in the short to medium run, and whaddyaknow, that seems to be what's happening.
Things really are not so simple and clear-cut as you make them out to be. The public were not born yesterday, and they remember the "boom and bust" we used to get when Chancellors opened the spigots and let the economy rip.
Cameron are tapping into a deep and rich vein of the public's suspicion of excessive stimulus. And you know, as elected officials, it's really not their job to take risks just to prove Krugman et al. right.
The day that you can prove that alternative policies would have led to much better outcomes will be the day to crow. But so far all I can see is Krugman taking two countries following quite similar policies, running similar fiscal deficits, tapering about about the same rate and crowing "UK growth is slow, so I win".
There can be all kinds of reasons why the UK recovery has lagged the US, but celebrity economists only seem willing to address the question of "stimulus, yes or no".
There is no evidence that 2010 austerity was required to stabilise the markets. Outside the Eurozone, interest rates have been both low and remarkably similar across countries with very different debt and deficit levels.
DeleteThere is plenty of evidence that 2010 austerity has damaged growth (see http://mainlymacro.blogspot.co.uk/2013/04/an-understandable-mistake.html for example). What is more, basic macro theory says it will. So people who try and deny this generally have an ulterior motive.
The charge against the government is simple. Focusing on reducing debt and deficits is fine, but not in a ZLB recession, when its a disaster. Basic economics tells you that. The only excuse can be the fear of a funding crisis. That might have applied in 2010, but it does not now. Given the harm the policy is doing: in the UK, the Eurozone, and now even the US, this is a crime that should not go unreported.
If fiscal policy is not necessary for growth, then fiscal tightening can be offset by monetary policy, and vice versa fiscal stimulus will be offset if it pushes inflation outwith the central bank's target range. That's simply a matter of the institutional structure of UK macroeconomic institutions.
DeleteSo the question that macro needs to answer here is whether the antecedent (that fiscal policy is not necessary for growth) is true. If it's false, then a good case can be very easily mounted against the coalition's fiscal policies. It would be true if monetary policy could always offset the contractionary effects of tighter fiscal policy, because it's already agreed that monetary policy can "pull on a string" i.e. offset fiscal stimulus.
So what does "basic economics" tell us? In particular, what does "basic macro theory" tell us?
"3. Monetary policy can be highly effective in reviving a weak economy even if short-term interest rates are already near zero. We have recently entered a world where inflation is not always the norm. Japan, for example, recently experienced a
period of deflation, when the price level was actually falling. One common view is that when a central bank has driven down short-term nominal interest rates to near zero, there is nothing more that monetary policy can do to stimulate the economy. The transmission mechanisms of monetary policy described here indicate that this view is false. As our discussion of the factors that affect the monetary base in Chapter 15 indicated, expansionary monetary policy to increase liquidity in the economy can be conducted with open market purchases, which do not have to be solely in shortterm
government securities. For example, purchases of foreign currencies, like purchases of government bonds, lead to an increase in the monetary base and in the money supply. This increased liquidity helps revive the economy by raising general
price-level expectations and by reflating other asset prices, which then stimulate aggregate demand through the channels outlined here. Therefore, monetary policy can be a potent force for reviving economies that are undergoing deflation and have short-term interest rates near zero. Indeed, because of the lags inherent in fiscal policy and the political constraints on its use, expansionary monetary policy is the key
policy action required to revive an economy experiencing deflation."
Who wrote this? Scott Sumner? David Beckworth? Alan Walters? Tim Congdon? Anna Schwartz? Surely, it had to be one of those fringe monetarist-types.
Of course, it wasn't. That's lifted straight from Mishkin's "The Economics of Money, Banking and Financial Markets" (7th edition).
So if basic macro is textbook macro and Mishkin's textbook is representative of textbook macro, then the antecdent is not false. I have no reason to think that Mishkin is unrepresentative and I can't imagine why macroeconomics would teach something OTHER than basic macro in their textbooks, so consequently I'm going infer that basic macro tells us that fiscal contraction at any time has no demand-side effects on growth.
Now, basic macro may be wrong about that, but I'm certainly not going to infer "ulterior motives" into people who take macroeconomists like Mishkin at their word and therefore think of public finance in terms of public finance, even at the ZLB.
(Given what's happened in Japan since 2004, Mishkin's assertions about the potency of monetary policy look a lot better now than they did then. Maybe there's something right in basic macroeconomics?)
Nice try. I agree that if the ZLB did not matter, then fiscal policy would be irrelevant, and all we would be talking about was monetary policy and the inflation/output trade-off. Where I disagree is what we mean by basic textbook macro.
DeleteBasic textbook macro is not what someone writes in one paragraph or two in a textbook. Its the model that lies at the heart of most of the analysis. That model involves monetary policy stimulating demand by reducing real interest rates.
So, when nominal interest rates hit the ZLB, that raises a problem. Now many would argue that this is not a critical problem, because by printing money you can raise inflation expectations, which reduces real interest rates that way. You will find that argument not just in the reference you quote, but also in Mankiw. But that will not work if monetary policy involves inflation targets. Which nowadays it does.
So it the combination of the ZLB, and a monetary policy that is constrained by inflation targets, that is the real killer. When the UK government announced austerity in 2010, interest rates were at the ZLB, and we had an explicit inflation target regime which the government did nothing to relax. So the government was in effect (through austerity) reducing the natural ('full employment') real interest rate, while putting a floor on the actual real interest rate. Which, given the model of monetary policy in the textbooks, is a really risky thing to do.
I think we're moving towards agreement. My original complaint was that "basic macro" tells us that-
Delete"Focusing on reducing debt and deficits is fine, but not in a ZLB recession, when its a disaster."
No mention of inflation targeting there. Now you say that-
"So it the combination of the ZLB, and a monetary policy that is constrained by inflation targets, that is the real killer."
- and inflation targeting becomes an essential part of the argument. It's not that monetary policy makers can't offset austerity's effects on growth, it's that inflation targeting gets in the way. I agree with your position as you now phrase it.
Let's take an interesting counterfactual: it's June 2010 and George Osborne announces two measures, (1) a much more severe deficit-reduction plan, let's say twice as severe and (2) a 5.5% NGDP level target taking 2007 as the base year. If it's not too much to ask, let's assume that the deficit reduction has no effect on the SRAS or LRAS curves.
Does a disaster happen? Not in basic macro, as far as I can tell. We get more deficit reduction, more growth, and lower unemployment than what we've had. And so the initial proposition with which I took issue is false.
The coalition has got macroeconomic policy wrong, but not because its fiscal policy necessarily leads to low growth. The mistake of the coalition back in June 2010 was not to announce an NGDP target.
The critique of the coalition's deficit reduction plan as "killing growth" is like blaming bath-water for an electric shock when one puts a live electricity wire in one's bath: it's the water AND the electricity that creates the bad mix.
It's no argument against having water in the bath, when one bathes, that "Water and electricity causes electric shocks". It's not true that "Water always causes electric shocks". The proviso about inflation targeting makes a big difference: the difference between my thinking that you're a bad Old Keynesian and thinking that you're a good New Keynesian.
To conclude: I don't disagree that textbook macro tells us that "the combination of the ZLB, and a monetary policy that is constrained by inflation targets, that is the real killer". What I do deny is "The charge against the government is simple. Focusing on reducing debt and deficits is fine, but not in a ZLB recession, when its a disaster. Basic economics tells you that. The only excuse can be the fear of a funding crisis. That might have applied in 2010, but it does not now. Given the harm the policy is doing: in the UK, the Eurozone, and now even the US, this is a crime that should not go unreported."
With your additional conjunct, I think we're basically in agreement. I disagree with your phrasing and I do think that clarify matters, because opaquacity can close off alternatives from discussion, in this case deficit reduction + NGDP targeting. It is dangerous to suggest a false choice between growth and "austerity", which has been the sebaceous mire of British macroeconomic debate over the last 4 or so years.
(To reiterate, I'm not an apologist for the coalition. I think the "charge" against the government is "For neglecting to introduce an NGDP target", and I lay that charge against every government since (at least) the late 1950s, but the charge gets more severe as time goes by and macroeconomics gets better.)
The idea that, without an inflation target, monetary policy is able to overcome the ZLB with either unconventional policy and/or NGDP targets is a conjecture. I was careful to say before 'Now many would argue..' Its in Mankiw's textbook, as part of a discussion of Friedman's views about the Great Depression, but he also puts it as a conjecture, rather than as a core part of the model. So maybe, maybe not. We really have no clear evidence.
DeleteGiven that, what I say about fiscal policy is correct. Austerity for sure reduces growth. Maybe monetary policy could offset its impact at the ZLB, absent unchanged inflation targets, but its a big risk. So why take the risk?
I think that is the key difference between someone like myself and Krugman, and someone like Britmouse and Scott Sumner. They are supremely confident about what monetary policy can do at the ZLB, while I am not.
Please, see the all video... if you do not have time please see from minute 1 to minute 2!
ReplyDeletehttp://www.youtube.com/watch?v=7p8fPRGACUQ
Greetings from Finland,
But you should also read this: http://mainlymacro.blogspot.co.uk/2012/10/was-financial-crisis-fault-of-dsge.html
DeleteThe 'its all the fault of those DSGE models' message is not credible if taken literally, and has to be interpreted in a more subtle way (like, central bankers started believing financial markets were inherently stable).