Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday, 23 September 2014

Let it roll!

Both the IFS and the Resolution Foundation crunch the numbers, and come up with a broadly similar assessment of the different UK political parties fiscal plans post 2015 to the one Giles Wilkes, Steven Toft and I independently arrived at a few months ago. Essentially if for some reason (?) you want to bring debt down quickly and are not worried about a further dose of austerity and possibly repeating the mistake of 2010, vote Conservative.

Are Labour and the LibDems shouting about this really important difference as a way to gain votes? Exactly the opposite is true - they want voters to think that they are as ‘tough’ as the Conservatives on the deficit, but just a little more compassionate in the way they will reduce it. We are in the world of ‘mediamacro’, where ‘responsibility’ is code for fiscal austerity (which, in the real world of the liquidity trap, is of course irresponsible), and ‘credibility’ is code for the policies that business ‘leaders’ and the financial ‘priesthood’ like.

What I want to focus on here is an unusual but welcome piece of forthright opinion in the IFS assessment. To quote:

“.. the current government’s fiscal mandate is explicitly forward looking with a rolling five-year target, while each of the three parties’ proposed new targets for borrowing seem to relate to a fixed date – that is, all of them refer to achieving the objective during the next Parliament. There are strong arguments in favour of forward-looking, rather than fixed date, targets and all the parties would be well advised to consider rephrasing their objectives in this way.”

As I noted here, this is one of the things this government got right, and it would be a shame (and dangerous) to take a step backwards. So the IFS is correct, but the argument appears strange at first, so it may be worth spelling out.

Having a deficit target to be achieved within the next five years, where that five year period remains as time moves on (a rolling target) seems far too easy. There is never a date by which we can unambiguously say that the target has been achieved or not. It would seem much better to have a target for a fixed date e.g. current balance by 2020.

The problem with this logic comes when we approach 2020, and some unexpected shock occurs. Rather than adjusting to that shock gradually over the next five years, adjustment has to be very rapid. This breaks the first rule of fiscal management, which is that the deficit should be a shock absorber, not a rigid target.

In fact we are used to a similar idea from monetary policy. This attempts to achieve the inflation target within the next two years or so. (In the UK this two years used to be set in stone, but less so now.) The reason often given for this is that it takes some time for changes in interest rates to have their full influence on prices, but this is only part of the story. Interest rates have some impact on prices quite quickly, so it would in principle be possible to try and meet an inflation target with a shorter time horizon, but the reason this is not attempted is that it would lead to damaging variability in interest rates and output.

The inflation target that most central banks have is also a rolling target: no central bank says it will aim to achieve its target by 2016. This does not stop central banks being accountable for their actions. If inflation is not on target by 2016, and there were no unexpected shocks over the previous two years, the central bank will come in for plenty of criticism. However if oil prices unexpectedly rose substantially in 2015, we would not want or expect the bank to do everything in its power to keep to its inflation target in 2016.

The same logic applies to fiscal policy. It is true that rolling targets do give the fiscal authority the possibility to cheat, and as Jonathan Portes and I argue (here or here), if the government has in the past always cheated and there is no institutional arrangement to stop this happening, then fixed date targets may be an unfortunate necessity. However we also argue this is not the case in the UK for two reasons. First, in the past UK governments have proved to be quite capable of taking the actions required to meet fiscal rules - what has often derailed them has been unexpected shocks like recessions. Second in the OBR we have an effective fiscal council which in this respect acts as a watchdog.

So let us hope that the fact that current plans are expressed as fixed date targets reflect the desire for easy communication just before an election, and that whoever gets elected reverts back to rolling targets when in government. Let us hope that achieving fiscal targets by 2020 does not become part of what mediamacro thinks is responsible and credible. 


  1. The received wisdom is completely entrenched now. A few nights ago, I was arguing with a couple of basically apolitical friends who insisted that, because there is growth now, the coalition's economic policy has been a success. Labour were to blame, they said.

    I tried in vain to give them the basic facts, but they were having none of it. They're scientists, so I thought I'd try convincing them with models ... explained a little IS-LM to them. They understood it, and thought it was interesting, but weren't convinced ... they "just knew".

    1. Anyone can produce a model even astrologers. The question for me is not "is there a model" but how good is the model at predicting the future

    2. Stadius: Agree...and have noticed the same phenomena - especially relating to your first paragraph.
      I 'tested' this on a good friend by recalling the growth figures of the final few quarters of the last government’s final term in 2010. Irrespective of how those successive quarter’s positive growth were achieved (this was not part of the discussion/test), he looked at me in astonishment at the very suggestion that there had been growth at all - and even more so when the relevant debt and budget deficit figures pre-crisis (2007, as a % of GDP) were mentioned - both were lower than when Conservative finished in 1997 (2007 deficit = 2.4 per cent of GDP; 1997 = 3.4% of GDP. And national debt 2007: 36.5%; compared to 1997 = 42.5% of GDP). Again, there are perfectly valid arguments to be made regarding fiscal management and size of these figures pre-crisis (they could/should have been lower), but the discussion/test here was purely about basic facts/data – which were dismissed out of hand – he ‘just knew’ they (Labour) were entirely to blame, there had been no growth before 2013 until the Tories rescued the economy, and Labour’s debt and deficit figures in the relevant periods mentioned above were infinitely worse than the Conservatives…hence they caused the crash. Mention of the banking/financial sector (including sub-prime and CDOs) as a root cause of the global crisis and wider economic down-turn was met with similar incredulousness. The discussion soon ended - as it had to when one person (an intelligent person in this case) cannot even acknowledge the basic, published facts or that certain events even occurred at all.

  2. Nice article. One quibble: I’d replace the word “priesthood” – in blue at the end of the 2nd para - with “witch doctors”..:-).

    Next, I don’t even accept that a rolling target for the deficit makes sense. There is only one valid target: maximising employment within the constraints posed by inflation. E.g. given a drop in demand (perhaps due to increased household saving or reduced exports) a larger deficit would be needed. I.e. I see no excuse for enduring excess unemployment so as to meet some random deficit target plucked from thin air.

    As to what the target rate of interest should be, I suggest governments should pay a zero or near zero rate on govt debt. Anything more, and we’re just rewarding foreign holders of UK debt, plus interest is funded by the average taxpayer / household and ends up in the pockets of the rich. In fact Milton Friedman once advocated a “zero debt” regime: a regime under which the only liability issued by the government central bank is base money. I agree with him.

  3. So I read that Osborne is going to miss the deficit reduction targets again and that weak tax receipts are to blame. So there have to be more cuts or higher taxes... Something is really wrong there because UK unemployment numbers are actually ok, tax receipts should increase.

    1. Not if wage levels are suppressed and a high proportion of the newly employed are, in fact, self-employed, with incomes not likely to worry the Revenue.

  4. I emailed Ed Balls about 3 years ago to ask him what he thought the multiplier was - at the time views seemed to have settled on roughly 1.5.

    He didn't reply.

    I wondered if he thought I was a journalist trying to catch him out in the game he is clearly playing with the electorate, which would be sad and ironic.

    I mentioned the truth once, but I think I got away with it.

  5. Please can you tell me what will happen if we fail to reduce the government budget "deficit" and consequently increase the "national debt"?

    How will this harm our economy that uses a sovereign floating fiat currency called the Pound? Who will attempt to harm our economy and what financial weapons will they use?

    Are our financial enemies aware that Pounds are issued by the monopoly supplier, the British Treasury and its wholly owned subsidiary, the Bank of England? Are they aware that these two entities can never run out of Pounds; can pay any invoice presented to them in Pounds; can never become insolvent in their own currency; Pounds.

    MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

    Corollary 1: The funds to pay taxes and buy government securities, come from government spending.

    Corollary 2: Taxes function to regulate aggregate demand, and not to raise revenue per se.

    Also, please can you tell me what is the point of "rating agencies", issuing ratings on sovereign fiat currency economies, that can never go broke in their own currencies. I could understand it if they were, stupidly, borrowing in foreign currencies, which there are practically no reasons for them to do.

    Please Note. Answers that contain metrics referring to Japan; and, why it has not defaulted on its massive public debt; despite "economists / astrologers" predicting it was imminent every month in the last two decades; will gain extra marks.

    All the best Acorn.

    1. BTW, I forgot to mention. The Foreign Exchange market has finally caught the attention of the Prosecutors. Particularly for fixing the four o'clock fix, used for settlement of world trade transactions on the day. This scam is virtually the same as the "high frequency" computer trading scam called "front running" or to give it its proper criminal label, "insider trading". Alas, this is not a crime in the Spiv City of London, but still is in the USA thankfully.

      World trade between countries in the WTO, needs about $23,000 billion equivalent a year of foreign exchange to function. That is equivalent to four and a half days foreign exchange dealing. The rest of the days are pure casino bets on pairs of currencies, racing each other up and down. This serves no public purpose whatsoever.

      ATB Acorn

    2. But we'll turn into Greece I tells ya! The Markets will turn on us if they think we're not being 'fiscally responsible' and we'll only be able to borrow at an interest rate of at least 624%...that is if there's anyone left in the world interested in UK treasury bills! Don't forget there'd be hyperinflation which would make Germany's experiences of the early 1920s look paltry. Remember, it was government debt that caused the crisis and eliminating debts and deficits must be the panacea for all our economic woes! Don't you know anything???

  6. JF: Increase spending, yes. And have the Bank of England put the debt instrument that finances the spending directly on to its books, arguably the public owes itself then not some private individual. Stop giving highly tradeable securities to high net worth individuals instead of a tax bill - you are only increasing their wealth now at the expense of the future economy's ability to pay. That is a very, very good deal for them, this is a reason why high net worth individuals like deficits, and will take them anyway they can get them, and like it when economists call for them. Increase spending, but also move prudently to match revenues and expected spending. Common sense please.

  7. Who bets on he Pound? The World's largest FX market: London bankers. Who brought the World economy down in 2007/08? New York bankers selling rubbish debt to London bankers. And who pays for much of the Conservative party to function? London bankers. But of course, it's all the fault of the Labour Party: after all, George Osborne and David Cameron said so and I read it in the tabloids so it must be true!

    It doesn't matter what "mediamacro thinks is responsible and credible" if the man in the street is told otherwise by people in authority; and currently the other parties have nobody of any authority in the leadership.

    As for the love for the austerity model, is it perhaps something to do with the large numbers of Monetarists that joined the Treasury in the Thatcher years?

  8. I wish that Labour and the Lib Dems would talk a bit more about their fiscal plans, because then I'd at least have a good sense of what the Tories would do if they are in government. Labour's fiscal plans were a good guide to what the Coalition has managed in practice.

    Similarly, I doubt Labour would have reduced inflation to 5% by 1984 as they planned in 1979, but that was a perfect prediction of where inflation would be under Thatcher by that point.

    At their most determined, the Tories are about as tough as Labour say they will be.


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