Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 11 April 2014

Austerity, journalists and the financial sector

The argument that current growth (since 2013 in the UK and maybe from 2014 in the Eurozone) vindicates austerity is ludicrous. Anyone who comes to the debate without existing baggage can see that developments in the UK and Eurozone have been entirely consistent with what academic critics of austerity have been saying. So rather than go over the arguments yet again, let me ask why some people continue to make or support this ludicrous argument.

In some cases asking this question does not tell you a great deal. For George Osborne, for example, you could simply say ‘he would, wouldn’t he’. Still I think there are two interesting points to note: first, here is a Chancellor who feels no inhibition in allowing sound bite to trounce economic logic, and second, he feels confident that he can get away with it, which tells you a great deal about the UK media.

Which brings me to the Financial Times (ex Martin Wolf). Now, to be pedantic, the FT tends not to say outright that current growth vindicates austerity, but instead that George Osborne is justified to claim that it does. Yet this subtlety aside, why do they pursue this line? It would be easy to lump them in with the politicians, but I think that would be both wrong, and miss some important points.

I thought about this partly because of the latest Chris Giles article on the issue (HT Alan Taylor), but also because of Paul Krugman’s comment on my earlier post that discussed the weakness of the European left on macro policy. He makes the point that Obama also showed similar weakness on austerity, and explains this in terms of the influence of what he terms ‘Very Serious People’ (VSP), “whose views on economics tend in turn to be driven largely by the financial industry.” Now at this point I usually add a caveat that there are some good economists who work for financial institutions, but generally the sector’s view on austerity is that it is necessary, and often that it is unlikely to have much impact on domestic output.

Why does the financial sector (the City, or Wall Street, or whatever the equivalent name is in other European countries) have this view? There are probably many reasons, but one that I think is very important is the 2008 recession. This recession should have been disastrous for the influence of finance: the activities of part of the financial sector brought the economy as a whole to its knees, and parts of that sector had to be bailed out with huge amounts of public money. Economists, the public and possibly some politicians began to question whether the continuing financialisation of economic activity might be detrimental rather than helpful to economic growth. No amount of expensive hospitality should have been able to repair that blow to its reputation and prestige.

Of course attempts were made to blame it all on US monetary policy, or global imbalances. The intellectual basis for these alternative stories was pretty thin, but also beyond the academic debate they did not resonate. What was really required was to change the story. The 2010 Eurozone debt crisis was therefore a godsend to finance. The focus was now on the dangers of high government debt, and the necessity of austerity to end this new crisis. Here was a story that certainly did resonate (just look at Greece), and was also an ideal distraction from the problems caused by the financial sector.

I’m not suggesting that one crisis was manufactured to distract from the other. What I am suggesting is that those working in finance understood the importance of changing the story. There was a clear party line, which fitted the dominant ideology. The state bailing out banks is terrible for neoliberalism, while a story based on the evils of excessive government spending fits the ideology perfectly. For VSPs, economic journalists or politicians it was natural to turn to the prophets of finance during the debt crisis, and so any distrust VSPs might have had of these prophets as a result of the financial crisis faded away. Although the level of economic analysis within the FT is generally high, they were perhaps also bound to follow the City/Wall Street line.

On Chris Giles’s article specifically there is much to say, and Jonathan Portes has the patience to say it once more. So let me make just one point. Chris as a good economic journalist recognises that the ‘growth vindicates austerity’ line is nonsense, so instead he tries to accuse the other side of equal mendacity. To see how silly this idea is, consider the following quote:

“It was precisely the chancellor’s fiercest critics who were themselves unable to distinguish between correlation and causation during the period of stagnation and have thereby legitimised Mr Osborne’s rhetorical victory lap. They have only themselves to blame. The lesson to learn is that the economy is complicated and everyone should be deeply sceptical of anyone drawing strong conclusions from simple links that appear momentarily true.”

Of course it is completely the other way around. If there is a simple idea here, it belongs to those who support austerity, and it is the view that monetary policy can always control the level of activity. It was austerity’s critics (beginning with Paul Krugman) who emphasised the complication of nominal interest rates hitting a lower bound. Analysis of austerity based on complex macro models almost always supports the critics view (e.g. here). Criticisms of austerity are rooted in long established theory, while the idea of expansionary austerity or the 90% critical debt level relied on simple correlations.

So Chris, there is no symmetry here between Osborne and most of his economist critics. One of the reasons I started this blog is that I found, perhaps for the first time in my adult life, finance ministers arguing positions which directly contradicted the received wisdom I was teaching undergraduate and graduate students. In an ideal world economics journalists would also recognise when this happens, and tell people about it. 


  1. "Chris as a good economic journalist recognises that the ‘growth vindicates austerity’ line is nonsense, so instead he tries to accuse the other side of equal mendacity."

    Prof. Wren-Lewis is too polite to use a more specific term. Chris Gile's piece was pure propaganda.

  2. The reason the FT is considerably better than other newspapers is that if you are interested in making money you just want the best reporting and commentary you can get. Ideological slants just get in the way of that. The grauniad and torygraf are dire by comparison.

    Similarly, if you work in finance you are interested in making money. That is it. Ideological baggage just gets in the way.

    Imputing to those in the financial sector who disagree with you bad motives and/or a large scale silent conspiracy is one of the more implausible claims of this blog. On the same level as the repeated claim that in 2014 the populace is brainwashed by the press.

    1. Some explanation seems required about why the consistent line taken by much of the media when dealing with macroeconomic does not accord with the received wisdom being taught to undergrads and grads. I take it your explanation would be that it's all accidental (or that what is being taught is wrong)?.

    2. No.

      My explanation is that the premise is paranoid rubbish.

      Who are these people who claim that tightening fiscal policy leads to higher short term growth?

      Point me at these fictional bogeymen.

    3. To what is the answer 'no'?
      That what is being taught is wrong.
      That a substantial section of the media have supported the idea of 'expansionary austerity' and the G.O. approach.

    4. Spinning Hugo

      Well for a start, here's a Govt Minister banging the Expansionary Austerity drum back in 2010.

      Nice try to re-spin history along the "We ALL knew that growth would stalk under Austerity, but it was done for the long-term good" line. That wasn't in any way how it was played in 2010.

    5. Yes, that is the example Portes always gives.

      Not exactly evidence for widespread support for the obviously crackpot expansionary austerity in the "financial sector" is it? One bonkers Tory MP.

      S W-L makes it too easy for himself (as does Krugman, and Portes) by attributing to those who disagree obviously stupid views.

    6. SH

      Then there was the president of the ECB telling us categorically that Austerity wouldn't lead to depressed economic performance.

      I've spent a good long while searching for the ex-ante (there are plenty of ex-post) examples of people from the financial sector (or from the political Right) publicly stating that austerity depresses short-term growth.

      I've spent longer searching for their excoriating put-downs of those (Hancock, Trichet, Cameron and Osborne are four who come to mind) who told us that Austerity would not depress short-term growth.

      Maybe you know where those articles are. Your attempt to re-write the record would be a hell of a lot more convincing if you pointed them out.

  3. I think it's true that most financial sector economists saw austerity as necessary, but not that they thought it would have no effect on output. Based on unscientific sample of encounters through friends, former colleagues and subscriptions to their scribbling. In their views about effect on output they have every incentive to get it right since they are helping their traders or clients' traders predict interest rates and bond yields.

    1. This would assume that (keeping) their job/bonus is dependent upon them getting it right. But as with the fund management industry, maybe there is no disincentive to getting it wrong, so long as your mistake is merely a reflection looks no different from your peers.

      As to the prediction of interest rates ect., you do not need to posit an ideal macroeconomic view, but rather how you think interest rates ect will behave based upon how policy makers will react

  4. For most in finance, their views on government finance is The Treasury View, and they have not updated their views based on the unsound Keynes. This does not matter for 99% of the people in finance, as they can at least appear to be doing their jobs correctly even if their macro views on interest rates are incorrect. For example, if you are trading corporate CDS, who cares what happens to interest rates?

    And if you are in a position that involves interest rates, you learn to keep unsound Keynesian analysis to yourself.

  5. I think the truth is we get very confused messages from academic economists. Why bloggers do an enormous service to the public, the academic literature is full of abstraction which makes it look irrelevant. The dominant macro-paradigm seems to be that policy is ineffective anyway. Really dig deep into Lucas and Sargent and no doubt about it - they are die hard monetarists. It would be different if the subject over the last 40 years was dominated by the works of people like Angus Maddison and Robert Gordon, work that is historically and statistically well informed. Maddison was talking about secular stagnation in the 1980s and warned about the consequences of the developing new orthodoxy in economics. We will see how macro-economics develops in the future. Picketty looks promising.

  6. I think the reason we get austerity policies now is the former model failed. The Portes model was neo-liberalism: for me that means an economy open to capital, trade and labour flows, with a social welfare net. I think this type of economics was informed by macro-theory connected with the neo-classical synthesis (IS-LM with some concessions to the Chicago School monetarists - eg. an independent central bank) and micro-theory that was heavy in classical theory - eg free trade and deregulated markets are unambiguously good. What this type of economics was not was historically well-informed. If it was they would have been very cautious about the pace of some of the liberalisation. We are relearning big lessons about financial deregulation. And the pace of liberalisation of EU labour inflows from the sudden expansion of the EU good end up being very costly for this country in terms of our relationship with the EU. The model also proved ineffective in dealing with growing inequality.

  7. Come on Simon: let's get the theory right.

    Standard New Keynesian models say that when the ZLB is a binding constraint, the second best policy is temporarily to *reduce* the *growth rate* of government spending. And in a hybrid Old/New Keynesian model, where some agents are hand-to-mouth and non-Ricardian, they also say we should temporarily *increase* the *growth rate* of taxes. Both these policies would increase the natural rate of interest, and relax the ZLB constraint, according to those models.

    Whether these results are correct is another question, but that is what NK models say. NK models support "austerity" in *rates of change* (as opposed to levels, which don't matter in NK models). If we teach NK models, that is what we should be teaching our students. If we don't like those results, we should find a different model.

    1. Nick. The optimal fiscal policy at the ZLB is to jump up the level of government spending, and then let it decline. See, for example, the paths I show at
      based on the Werning paper.

    2. Simon: OK, but in the real world G is not a jump variable. Governments cannot get the news of the ZLB and immediately announce an instantaneous jump in G followed by a declining path in G. The best they can do in practice is to announce that they will start cutting G as soon as possible, and keep on cutting G until the ZLB is no longer a binding constraint.

      Plus, even if the government can make an instantaneous jump in G, followed by a declining path, it is the declining path that is needed for macro expansion, according to NK models. You would only do the jump for micro reasons.

      And, if the government had perfect foresight, and could foresee future ZLB, the optimal policy would be for no jumps at all, and to have rising G when not at the ZLB, and falling G when at the ZLB. Again, very different from Old Keynesian models.

      I know it sounds crazy, but what the UK government actually did with "austerity" should have been expansionary, according to NK models.

    3. Nick: Of course G can jump, given the relevant time frame. That is effectively what happened in the UK and US in 2008/9. You have to work backwards. If the steady state involves the optimal level of G, then to have G falling must imply an initial jump. Your idea of cutting G and then after the ZLB constraint ends raising it back to the steady state would not work - the tax savings generated would only lead to a marginal increase in consumption. You need the initial jump in G to generate the extra demand.

    4. Well no. Adding liquidity constraints makes gov spending stimulatory, pushing up growth and so inflation and so relaxing the ZLB. Pretty standard stuff

    5. Simon: the natural rate of interest at time t is a negative function of Gdot(t), and is independent of G(t). The time path of G(t) will deviate from the first best optimal if the ZLB constraint is binding, but the second best path will not involve G(t) always being above or equal to the first best path.

  8. At Project Syndicate:

    1. Brad DeLong's Jun. 28, 2013 'Starving the Squid' has very good numbers for the problems with the size of the US finance industry.

    2. Robert Shiller's Sep. 20, 2013 'The Best, Brightest, and Least Productive?' gets into the numbers of graduates going into that sector.

  9. The fact is Osborne is doing precisely what macro-economic theory is telling him to do. Lucas and Sargent argued that the Government must demonstrate "credibility". They mean by that a commitment to containing money supply growth and budget balance.

    Osborne is only doing what the orthodoxy in macroeconomic theory is telling him to do.

    1. You need to update your theory.

    2. Remove the math and the implausible assumptions and there is probably not a lot more left to the New Classical revolution.

  10. Austerity in UK would not be working unless we did not have the Keynesian Help to Buy scheme which pumps about £15.5bn into economy and the £16bn payment protection insurance rebates from the banking sector.

    If we think of PPI rebates as a tax imposed on the private sector with a low propensity to consume (banks), shifting it to the private sector with a high propensity to consume (individuals in debt) we see how powerful these Keynesian policies can be.

    Recovery has nothing to do with austerity!

    Together they amount to about 2% of GDP! So economy would be flat without it!

    Help to Buy

    PPI rebates

    1. Keynesian Help to Buy scheme.

      No, this is a New Keynesian scheme.

  11. My economic theory is that basically, the economy is like any other resource: be it a gold mine, a labor pool, a robot, a feed stock, an energy source etc. They key point here is that what you want to do is exhaust the resource until you've extracted all the value and then toss it into the trash bin.

    In this way, the economy is a lot like other natural phenomena. Take the climate, for instance. Its another resource. It acts as a receptacle for economic waste generated by civilization. But its capacity to store the waste while at the same time acting as host to the species is being depleted. The climate, like the economy is being exhausted and is ready for the land fill.

  12. Cheeky bit of Bulverism

  13. I think the proper technical term is: Ballance The term may be copyrighted by Robert Waldman so you may have to ask permission to use it.

  14. 'This recession should have been disastrous for the influence of finance'


    'What was really required was to change the story.'


    'The 2010 Eurozone debt crisis was therefore a godsend to finance.'

    BECAUSE you guy's didn't watch out.
    You let them - (conservative) 'Finance' - turn the discussion into 'all about monetary policies' . instead of another case of the irresponsibility of finance!

    AND then - adding insult to insury - some right-wingers used the Euro crisis as their major argument for: 'Socialism doesn't work'!

    How sad and sorry of a performance by the economists on my side of the political spectrum!

  15. AND it also has to be said here: It would have been so damn easy to turn the Eurozone crisis into a godsend for us liberals - especially with Greece and the fact that some corrupt Wall Street dudes even helped them to lie and deceive - just like at greedy home...

  16. Can you provide any support for the assertion that the financial sector has favoured austerity? Seems to me that City opinion has not been in favour. Albert Edwards at SG very firmly against, Stephen King HSBC broadly against, Gerard Lyons (ex Standard Chartered) against. No time for a full survey but I don't think it's a well founded assertion.

    1. The recent FT survey asked "Has George Osborne’s “plan A” been vindicated by the recovery?" I cannot imagine any critic of austerity answering Yes to this question, while I can imagine many in favour of austerity still answering No. (After all, the right answer is No whatever!) The survey included many more city economists than academics. Chris Giles interpreted the results as a narrow majority saying yes. I think its not quite so clear, as I discuss here:

      but at best I think you would say city economists were split down the middle. And this question as an indicator of support for austerity is biased downwards.


Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time. In addition, I cannot publish comments with links to websites because it takes too much time to check whether these sites are legitimate.