It’s the economics, not the politics

A reflection on rereading an old paper

Regular readers will have noticed that I’m not a great fan of the current government’s economic policies, or its Chancellor (with the very important exception of setting up the OBR). Some will assume that this reflects a political bias - indeed those who are political animals often cannot conceive that everything is not politically driven. If you are looking for evidence either way, this post is about that.

Yesterday I received an email advertising ‘The Economics of Austerity’, which is a collection of essays published by Edward Elgar and chosen by Suzanne Konzelmann. There are 47 in all, but as this includes pieces by Hume, Smith, Ricardo and Mill, you can see that this collection aims to give a historical perspective on the subject. To be honest the email might have got lost in my in-tray if I hadn’t noticed it started ‘Dear Contributor’. Sure enough, in the eight essays dealing with the period after the financial crisis, there was my name alongside others, including some guy named Krugman.

I should have been flattered, but instead my heart sank. The selected paper was originally published in OXREP in 2010, and I remember it now as being hopelessly optimistic. It was written before the Euro crisis, so before austerity became almost universal. Little over a year later I wrote a paper with the title ‘Lessons from failure: fiscal policy, indulgence and ideology’, which seems much more appropriate in the current environment. Yet I thought I ought to reread my OXREP article, to confirm just how dated it had become.

Actually it really is not that bad. The key points are still things I believe. The financial crisis was primarily a crisis involving financial regulation rather than monetary policy or global imbalances. The idea that the Great Moderation was due to improved monetary policy was sound, but it always came with a caveat involving large negative shocks, because of the zero lower bound (ZLB). The ZLB could be mitigated using what I now call a ‘forward commitment’ to higher future inflation, but time inconsistency would make central banks reluctant to pursue that. The obvious alternative was expansionary fiscal policy. If concerns over debt where a constraint, then an effective measure was balanced budget increases in government spending.

This last point is so important, yet it can get lost in the debate. If you want to plug a demand gap at the ZLB, temporary increases in government spending financed by temporary increases in taxes work, because a lot of the tax increase comes out of saving rather than consumption. As the tax increase is temporary and only happens while there is widespread unemployment, concerns about the incentive effects of higher taxes on labour supply are at worst irrelevant. This is basic macroeconomics. But then I wrote this:

“The main problem with fiscal measures to expand the economy which do not raise debt is political. Higher government spending, even if it is temporary, raises taxes and temporarily increases the size of the state, which is unpopular on the right of the political spectrum. Fiscal transfers that move money from unconstrained savers to those who are credit constrained also tend to involve transfers from the rich to the poor. Although useful from the point of view of stimulating effective demand, they may not be politically acceptable.”

Quite. What was missing was an equivalent paragraph saying that, even if there was no economic problem with raising debt, debt financed fiscal expansion might be resisted for political reasons. However, I now want to return to where I started. The OXREP paper was written before the current coalition was elected. It set out how I saw the macroeconomics. At the ZLB you could use unconventional monetary policy, but in addition you should use fiscal stimulus, whether debt was a constraint or not.

It was politics - and ideology - that got in the way of good macroeconomics, which is why the UK and global recession has been so prolonged. And it is that tendency that is personified by George Osborne. Even if debt was erroneously thought to be a constraint, we should have had tax financed increases in public investment rather than cuts. This extra investment could have been on politically neutral things, like flood defences.

Unfortunately austerity turns out to be part of a pattern. There is another example from the OXREP paper. When talking about an environment of low real interest rates, I noted the danger of housing bubbles, but also how specific fiscal instruments could be effective (relative to raising interest rates) in dampening these bubbles. A corollary, of course, is that these same instruments used in reverse can be used to make bubbles much worse, or indeed to initiate them, as in Help to Buy. House prices are now above their previous 2008 (bubble?) peak. Maybe this is good politics, but it is lousy economics.

So I do not think the complaint of political bias stands up. What you could perhaps argue is that I’m being politically naive: that all Chancellors maximise political advantage at the expense of national economic interest. The fact that Gordon Brown’s scorecard seems much better (including resisting Blair to stay out of the Euro) could just reflect opportunities and circumstances rather than anything else. It is certainly true that the position George Osborne inherited, as a result of the financial crash, was much more difficult than Brown’s inheritance. But go back to the time I wrote the OXREP article. At the end of 2008 Labour did undertake fiscal expansion, and it was opposed by Cameron and Osborne. As I noted here, Osborne in April 2009 argued that monetary policy should “bear the strain of stimulating demand”, seemingly oblivious to interest rates being as low as they could go. So Labour’s policy was consistent with the arguments in my OXREP article (which in turn reflected basic macroeconomics), while Conservative policy just ignored them. 

So thank you Dr. Konzelmann, for including me in such good company. But also thank you for making me reread the paper and revise my memory of it. [1]

[1] I fear I cannot also thank the publishers, who tell me that unfortunately I cannot have a complimentary copy, because of the large number of contributors. I’ll leave it to Hume, Smith, Ricardo and Mill to complain directly. I guess Keynes, who has 5 essays in the book, probably got a copy!