Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 1 December 2013

Here we go again

1) Government embarks on austerity, to try and maintain the confidence of the bond markets. We must preserve the AAA rating for our government’s debt, says the finance minister.

2) Austerity reduces demand, helping create flat or negative growth.

3) As a result, deficit targets keep being missed. Additional austerity is imposed, and growth declines again.

3) Country loses its AAA rating, and the credit rating agency gives concerns about poor growth as an important factor for the downgrade.

4) This confirms our fears, says the finance minister. We must redouble our efforts to reduce our debt.

This will sound familiar to UK ears, but it is also what has just happened in the Netherlands.

I do not like using decisions by the credit rating agencies as an excuse to write posts, because when it comes to the major economies they have no particular expertise. (Typically markets show no reaction to the ‘news’ that a country like the Netherlands has been downgraded.) This useful post by Bas Jacobs (HT MT) argues that the S&P analysis for the Netherlands does not deserve any serious attention. On credit rating agencies generally, see Jonathan Portes. The media report what these agencies say because downgrades are convenient hooks to hang existing stories on, and it is a shame and a continuing source of puzzlement that officials and politicians bother with them.

So why am I writing this post? Because it seems important to record the progress of another country beside my own that is going down a depressingly predictable path. When I last wrote about the Netherlands, some positive growth was expected for 2014, but the OECD’s latest forecast shows GDP flat next year. These forecasts also have consumer price inflation below 2% in 2014 and below 1% in 2015. The output gap is currently over (negative) 4%, and is expected to reach -5.5% in 2015. Unemployment, which was only 4.3% in 2011, is expected to rise to 8.1% in 2015.

Like the UK, the Netherlands is a country with no problem selling its debt. It has no macroeconomic need to achieve an expected (by the OECD) underlying general government surplus by 2015. As Jacob’s notes, there is no question of an unsustainable long run fiscal position. The only major lever the government has to do something about lack of growth and rising unemployment is fiscal policy, yet it is using this lever in completely the wrong (pro-cyclical) direction, making everything worse.

A crazy policy. Yet it is followed by both centre-left and centre-right parties, even though this means these parties are haemorrhaging support to those further left and right. It is a policy supported by the central bank, which was one of those voting against the recent cut in ECB interest rates. The CPB, the country’s fiscal council that used to be a voice of sanity on fiscal matters, appears silent on the issue. Everyone can blame the Eurozone’s Fiscal Compact of course, but among the political centre they do not.

Coen Teulings, the former head of the CPB, speculated about why politicians seem so attached to austerity, when it is so clearly doing their popularity such harm. They seem to be stuck in an equilibrium (the ‘austerity trap’) where they fear that if any of them broke free, by declaring austerity harmful, they would lose out because other parties in the centre would declare them irresponsible, or ‘not serious’ to use Paul Krugman’s language. Yet they would all be better off, in terms of not losing support to the further left or right, if they could simultaneously break free of the austerity trap. Within any single Eurozone country the ‘irresponsibility’ charge is reinforced by the Eurozone’s Fiscal Compact, which in turn keeps the Eurozone as a whole in the austerity trap.   


18 comments:

  1. Still familiar for UK ears that austerity leads to flat or negative growth? I have the impression that OBR will revise coming week its growth forecast up substantially.

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    1. I hope so. Deepening the recession for 3 years was bad enough. If you really think getting growth while austerity continues proves anything, read this: http://mainlymacro.blogspot.co.uk/2013/09/austerity-growth-and-being-economical.html

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    2. Wait, if the growth is positive at any time that policy X is in place, that means that X is the cause of growth increasing?

      If that's the case, there's really no limit to the policy's that can be shown to have increased growth.

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  2. But GO and his mates have just announced that Austerity does work, and everyone (apart from a few economists) knows that because all the media are talking about GDP growth!
    Your last para sums up the current situation here as well as in Holland I'm afraid. Evidence is still not in the frame as a basis for policy. Or perhaps it is if the policy really is to shrink the state.

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  3. I listened to the Radio 4 programme on Monday night about the OECD's PISA (programme for international student assessment) studies, presented by Prof David Spiegelhalter, a statistics professor at Cambridge.

    In the programme, Spiegelhalter said that after moderate results in 2000, Germany, Norway, and Denmark changed their education systems to get better PISA results, a process known as 'PISA-shock'.

    Yet is has been well-known from the beginning that the PISA tests are hardly the most robust, but these countries (and Gove) appear to think they are methodologically perfect.

    Apparently the OECD is reluctant to engage with academic critics of PISA methodology, while Spiegelhalter concluded that scores and ranking of PISA should be treated with 'considerable scepticism'.

    Sound familiar?

    Countries really do seem wedded to these 'independent' views, whatever their method.

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  4. I am not convinced that the austerity trap is the explanation for the politician's behavior, at least not all of them. I am convinced that the liberal party actually believes the austerity nonsense, as well as part of the labour party (including Dijsselbloem.) Otherwise they would have at least try to get out of it through other avenues they had available, like not appointing an austerity-loving head to the CPB to replace Teulings (actually the person who was in charge of writing the original austerity budget.) Having someone like Teulings would have given them cover, but they deliberately did not want any cover. This tells me that they actually believe in it.

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  5. I'm unsure about whether some of the points in this process apply to the UK.

    For example "1) Government embarks on austerity, to try and maintain the confidence of the bond markets"

    Well in real life, governments do things for more than one reason. Austerity in the UK was surely motivated by more than this - the desire to reduce the deficit, for example, and the desire to nudge workers into more productive employment. And really, the UK's austerity was quite selective, since we've seen public spending rise not fall.

    Another example is 2) Austerity reduces demand, helping create flat or negative growth.

    Do we know that austerity reduced demand significantly in the UK? If we do, then I missed the working out. Why could it not have been the desire to reduce debt that did the work of reducing demand? Or stagnant wages v rising prices?

    And there's an apparent belief that politicians are thinking only of popularity when they make policy. Are we so cynical that we believe politicians don't consider a number of factors, and one of these might even be a desire to create a healthy economy in the long term at the expense of short term unpopularity?

    So to sum up, I'm concerned about your assumptions.

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    1. Um, er, austerity, by definition, is reducing the deficit. Saying austerity happened because of a desire to perform austerity doesn't really help explain anything. The expressed reason for doing austerity was bond markets; perhaps there were ulterior motives along the lines I mention below.

      "Do we know that austerity reduced demand significantly in the UK?" Yes, there are several years of data showing this now.

      "If we do, then I missed the working out." Yes, yes you did.

      "Why could it not have been the desire to reduce debt that did the work of reducing demand?" OK, you win, the desire to implement austerity reduced AD because that desire led to the implementation of austerity.

      "Or stagnant wages v rising prices?" Stagnant wages and rising prices do no fall out of trees. Maybe when the government lowers aggregate demand, employers fire people, and more unemployed people puts downward pressure on wages (because people who demand higher wages can be more easily replaced).

      And since when has it been cynical to assume that democracy functions? The cynical worldview is that pols are motivated by corruption. The really hopeful worldview is that they're motivated by democracy.

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    2. "austerity, by definition, is reducing the deficit"

      That may be your definition of austerity. However, it seems to be a definition of the desired outcome. I'm not sure it really works, because in the good times the deficit may fall even when governments increase spending or keep it the same. Under those circumstances, not many people would claim they were practising austerity.

      "there are several years of data showing this now". I see. Is that your assertion?

      "And since when has it been cynical to assume that democracy functions?" Are you stating that winning short term popularity = democracy functioning?

      I see it differently. I think of politicians as motivated by the need for short term popularity, long term popularity (they can implement unpopular measures if the election is years away), venality, and altruism. The idea that they're altruistic is very unpopular these days, but I cling to my naivety.

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  6. Your model only implies multiple equilibria (austerity if everyone else is doing austerity, no austerity if no one else does austerity). It does not automatically lead to the austerity equilibrium, and if everyone is happier at the no austerity equilibrium and everyone knows that they will be, then there's no reason for them to have chosen the austerity equilibrium in the first place.

    Perhaps pols chose the austerity equilibrium because they were misinformed and/or irrational. It's definitely possible, but it's not worth considering before the results of an assumption of full information/rational actors have at least been addressed.

    In that case, they knew (let's assume perfect foresight) that austerity would lead to low growth, which would then lead to the need for more austerity. Why would politicians want that? I'm not that familiar with Dutch politics, but if it were the US, there would be several reasons: campaign contributions increase because pols who embrace austerity show a high willingness to pay bondholders (they'll sacrifice their constituents' interests to do it), which leads to a higher probability of winning an election; sinecures for pols who keep unemployment moderately high (employers like a slack labor market); more of each for reducing the size of government, which wealthy people benefit from G less than poorer people do.

    If the only incentive pols had was to win elections, then those who are not up for reelection should be saying what they really think and throwing a monkey wrench in this entire scheme (no elections means they should be indifferent on the political consequences of speaking out, but I'm generously assuming that they get utility from telling the truth that's greater than 0). Has that been happening?

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  7. Simon,

    This is very clear and simply conveys the truth of the matter in everyday language.

    Thank you.

    As to the views doubting Prof W-L's argument, I would ask them to show us why 'Expansionary Fiscal Consolidation' is not an oxymoron, and how short term pain leads to a long-term healthy economy. Or are you asking us to believe in Paul Krugman's mythical 'Confidence Fairy?

    The unpalatable reality, I am afraid, looks something like this:

    Austerity policy --> massive spending cuts --> destruction of confidence -->slump in demand --> mass unemployment (+underemployment) --> wage cuts --> lower tax take ---> higher deficit ---> more austerity ---> etc etc ad naus et inf.

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  8. Is growth the right statistic to look at?
    Let's compare UK with Netherlands.
    Both supposedly do austerity, but BoE did monetary expansion while ECB did not.
    As a result the UK did reflate the housing bubble, shows some growth, but has higher inflation, eroding living standard.
    Netherlands did not reflate housing bubble, as a result consumption is down, but has lower inflation, not eroding living standard as much.
    So who is better of? And how sustainable is the housing bubble in the UK in the long term? And even if it is sustainable, to what extend does it make houses unaffordable for young people?
    Houses in The Netherlands did become much cheaper, not a bad thing for first time buyers.
    In short: if all you look at is growth numbers, than you can claim policy in The Netherlands is a failure. But households are not interested in GDP growth numbers, but standard of living. And I think a fair comparison between countries looking at standard of living might show a different picture than just looking at economic growth.

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  9. Here we go again, indeed. Government spending in the Netherlands is 91% of peak, while Government spending in the UK is at a peak, and 107% of 2008.

    Apparently, the word "austerity" means anything we want it to mean. As long as the deficit is falling. "austerity" can mean rising government spending.

    The Red Queen would be proud

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  10. This is a typically disingenuous Keynesian criticism of austerity. The purpose of austerity is to reduce the fiscal deficit to at least slow the progress towards, if not move back from, a debt trap, and I have never seen any evidence that austerity does not reduce the deficit. Yes, austerity depresses growth, which offsets the initial reduction of the deficit, but that negative feedback loop just means that deficit reduction is hard, not that it is self-defeating. Yes, politicians make optimistic forecasts about the progress of deficit reduction, but missing those forecasts (which may well prompt credit ratings downgrades if those ratings were based on the government's forecast) is not the same as the deficit increasing. And a country's ability to sell its debt is only relevant to the degree that the debt sold is of the same term as the expected period of indebtedness created by fiscal mitigation of depressed economic growth. In other words, unless we discount the welfare of future generations, fiscal stimulus is only justified if there is a realistic prospect of a future economic boom in which fiscal restraint in sufficient size to unwind the debt generated by preceding stimulus will be appropriate. Unfortunately, so such boom is anticipated.

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  11. Err Tim - Nick's point, expressed in his post, is that there is in in fact NO possibility of a debt trap for the Netherlands.

    Not even the most "irresponsible" Keynesian believes that there is much point in printing more bonds when people don't believe you're going to honour the previous ones. But the measure of that belief is the price they put on your bonds - have a look at those prices and then see if you can keep a straight face while claiming that a debt trap is what is happening in the Netherlands or UK.

    You say " fiscal stimulus is only justified if there is a realistic prospect of a future economic boom". A much better way to state it is that fiscal stimulus is only justifed if there is a realistic prospect of a prolonged recession, which reduces present and future living standards. And that is precisely what the UK and the Netherlands have had.

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    1. I think the point (Nick's? Simon's?) is wider than the Netherlands, but it would clearly be ludicrous to say that there is no possibility of the Netherlands getting into a debt trap, not least because it is definitely, albeit very slowly, heading in that direction as long as its fiscal deficit as a proportion of GDP remains larger than its nominal GDP growth rate, with the result that its debt to GDP ratio has grown by about 15% in the last five years. To do nothing to counter this drift is to assume that "something will turn up", but the experience of the downturn so far is that this is not happening - in other words, the downturn seems to be indefinite rather than, as you put it, "prolonged". As I said, you can forget the yields on bonds of less than ten years' average maturity, unless you have some plan to eliminate the debt over that horizon - now that really would be austerity!

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  12. @Simon: “Coen Teulings, the former head of the CPB, speculated about why politicians seem so attached to austerity, when it is so clearly doing their popularity such harm. They seem to be stuck in an equilibrium (the ‘austerity trap’) where they fear that if any of them broke free, by declaring austerity harmful, they would lose out because other parties in the centre would declare them irresponsible, or ‘not serious’ to use Paul Krugman’s language. Yet they would all be better off, in terms of not losing support to the further left or right, if they could simultaneously break free of the austerity trap. Within any single Eurozone country the ‘irresponsibility’ charge is reinforced by the Eurozone’s Fiscal Compact, which in turn keeps the Eurozone as a whole in the austerity trap. “

    You are merely describing the outcome that must necessarily follow from an establishment consensus that deems contracts agreed with fellow EU insiders in the fiscal pact to be far more important than their contract with the Dutch voter to optimise the economic welfare of the Dutch citizen.

    Oligarchies always operate in this way and groupthink always dominates across parties when government and the politics of the public square are divorced. Accountability has shifted from the ballot box to the EU council chamber – and now the public have begun to notice that if they vote for the mainstream centre left they will get exactly the same pro cyclical policies as they get from the centre right.

    EU politics has often been called post modern – yet in action it all looks like a very pre modern lock out of public opinion. We have seen the future and it is Versailles.

    Our brave new EU is not so much post modern as pre revolutionary …..

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  13. The doubling down on austerity despite the worsening of the fiscal situation it is supposed to address reminds me of George Santayana's famous quote: Fanaticism consists of redoubling your efforts when you have forgotten your aim.

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