Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 16 January 2015

Osborne's RES speech and proposed new fiscal rule

I suppose I should say something about this, even though I find it painful reading his speeches. Not because they are so partisan - what would you expect? Perhaps I can describe it by comparing it to an academic reading a student’s essay. With something like Vince Cable’s speech last year, you can read whole paragraphs quite happily, and then make a comment at the end like ‘yes, but you have ignored this etc’. With Osborne’s speeches, you feel the need to get the red pen out after every sentence. Each sentence seems as if it is crafted to mislead.

Take, for example, the issue about whether high debt inhibits growth. Now I happen to think that there are good theoretical reasons why high debt might reduce growth. However my reading of the empirical evidence - exhaustively examined following the critique of Reinhart and Rogoff - is that while there may be some (rather weak) correlation between high debt and low growth, there is no evidence of causality running from debt to growth, and more evidence that causality goes the other way. This is what Osborne speech says:

“And the conclusion of the academic literature is that high debt is undoubtedly correlated with lower growth. Even the possibility should give us cause for concern given the huge impact that small growth differentials can have over time.”

Does this give a rather different impression? But read it carefully - does he say anything that is clearly wrong? As I say, it is calculated to mislead, and the speech is full of this stuff. You may think that just means he has very good speech writers, but this makes it hard for an academic to read, and maybe an odd thing to do in an academic lecture. If the invitation was given because the RES was hoping to get something more substantial than the usual Osborne fare, I fear they will have been disappointed.

Still, let’s put that aside and talk about fiscal rules. I have argued that the form of Osborne’s original rule - achieve a particular deficit target over a 5 year rolling horizon - is very sensible for normal times. Here he proposes something that seems different - to start operating once the budget has got to a surplus. He distinguishes between good times and bad times. In good times the budget should be in surplus. In bad times, as called by the OBR, the budget can go into deficit.

How to compare new and old? Could we reframe the new rule in terms of the old, by simply replacing the target of current balance with a new target of overall surplus? I’m honestly not sure - the speech is vague. What he may be doing is thinking about bad times not as your typical economic downturn, but something much worse, like the recent recession. In other words, he may be thinking about the kind of exercise I did here. If he was, we can make the following points:

1)    To allow debt to GDP to go up substantially when there are occasional large negative shocks (which are not followed by large positive shocks), it makes sense to have debt to GDP falling in more normal times. I recommended such an approach in 2009.

2)    This can be done without going for a surplus in normal times, just because of GDP growth. The exercise I did showed that. What is optimal obviously depends on the size and frequency of shocks, and the extent that fiscal policy is actively used to offset the shock. In my exercise, I allowed for another Great Recession in 2040, and thereafter every 40 years. I also allowed for much more fiscal stimulus than occurred under Obama. I assume Osborne would not allow any fiscal stimulus. Despite this, I still had debt to GDP trending downwards, with a target in normal times that was always a deficit.

3)    One interesting and clear difference between his new and old rules is the focus on the overall deficit rather than the current balance. This is also something that Jonathan Portes and I recommended in our paper. It has to be combined with a separate target for public investment as a share of GDP, and in his lecture Osborne said that in the next Parliament capital investment will grow at least in line with GDP.

4)    His proposal appears to give rather more influence to the OBR during these negative shocks. Jonathan and I also suggested an enhanced role for the OBR. In our proposal large shocks would be identified by the central bank suggesting interest rates might hit their zero lower bound, but we also said the OBR should be involved in thinking how deficits might evolve after the shock.

So there are some sensible ideas here, although the failure to acknowledge the problem of liquidity traps remains. There also seems to be an unnecessary obsession with surpluses, but I expect that is just a consequence of his short term goal of shrinking the state.

OK, one last piece of Osborne speak from the speech with relevance to my last post:

“Core inflation ... remains relatively stable and indeed rose slightly in yesterday’s data.”

And here is the data.


  1. As you've no doubt noticed in comments, I have recently attempted to go over Osborne's claims, and there are so many falsehoods, misrepresentations/misuse of evidence, ambiguity and outright deceptions that to address them all might take all day. Sure, politicians of all parties do this, but the degree to which it is done by Osborne is astonishing - its a task to try and find a paragraph or sentence in his narrative which doesn't contain a falsehood or an attempt to deceive.

    Relating to the inflation figures, looking at the PPI (output price) which is down 0.8% over the last 12 months, to what extent are there time lags in this feeding through into retail prices?
    The 'economists views' here,
    ...makes for interesting reading, with many 'city' economist anticipating only a brief period of falling prices, and then predicting a need for a rate rise in August or in the 4th quarter.

    1. Should have added on the end of the above, that with 2yr gilts yielding 0.37% today, thus very low inflation expectations by the market, is there something the aforementioned 'city' economists, in calling for quite a soon rate rise, know that the market doesn't?

    2. This comment has been removed by the author.

  2. "..I happen to think that there are good theoretical reasons why high debt might reduce growth."

    Do these reasons always involve higher interest rates? Are there good reasons why high debt might still reduce growth, even in a world with persistenly low real interest rates? If so, I'd be grateful for any references. Thanks.

    1. You are absolutely right that a major theoretical reason to worry about debt (unless you believe that Ricardian Equivalence holds exactly, which would be silly) is that it crowds out capital, and this happens through high real interest rates. So it is hardly a worry now, and maybe not at all if you believe the secular stagnation stuff.

      The other main concern is that paying lots of debt interest will mean taxes are higher, which will reduce output because taxes discourage work. Now you could argue, as some economists do, that we work too much anyway.

      The conclusion I would draw is that high government debt could, in the long run, reduce growth, but there are lots of interesting issues to debate here.

    2. Thanks,

      I think the issue is whether it ever makes sense to target a debt level, rather than simply worrying about what is happening to interest rates. How can we ever know what the right debt level is? It seems likely that growth of institutional liquid asset pools has significantly extended the private sector's demand for public debt and this may persist for decades. Setting a target for debt that is inconsistent with this demand is never going to work out.

    3. Just one important point to add. A private sector demand for safe assets can be reconciled with lower NET debt if governments are willing to create sovereign wealth funds (SWF). Maybe this is the way to go - I think both Roger Farmer and Miles Kimball have suggested that SWF could play useful roles.

    4. If Temasek is the model for the SWF, that might be a viable proposition.

    5. Crowding out is BS. You need to stop thinking about money and think about resources. The government can crowd out by hiring too many of one type of worker or using all the steel, so there is not enough in the private sector, for example.

  3. “And the conclusion of the academic literature is that high debt is undoubtedly correlated with lower growth. Even the possibility should give us cause for concern given the huge impact that small growth differentials can have over time.”

    It's not obvious that this claim is designed to mislead. If you are sufficiently patient, then you worry a lot about doing anything which would lower steady state growth rates. If you are risk averse, you also worry a lot about anything which would lower steady state growth rates. So you might place a lot of weight on this risk, even if there isn't a lot of evidence for it (in your view).

    1. Osborne categorically states that the academic literature concludes "high debt is undoubtedly correlated with lower growth". The direction of causality implicity made by thatsentence is quite clear...highdebt ==> low growth.
      The question is then how true or accurate is this. As SWL wrote, the academic literature (containing the 'empirical evidence') shows us that "while there may be some (rather weak) correlation between high debt and low growth, there is no evidence of causality running from debt to growth, and more evidence that causality goes the other way.
      This is in stark contrast to what Osborne says the *literature concludes*, so it is fair to say he is being highly misleading.

    2. I'm not sure I would say its highly misleading. Indeed the point I was trying to make is that if you examine the sentences closely, they can be justified. But if you read them quickly - which is all that most people do - they give a different impression. In this example there is essentially a missing sentence that should go in between these two: "The evidence suggests this correlation is because low growth causes high debt, but it could just be that the causation goes the other way."By leaving out that sentence, you mislead.

    3. A shame that he's not doing anything to increase steady state growth rates.

    4. Simon (not SWL): he's talking to an audience of trained economists. They'll know exactly what he means. It's true that many laypeople would confuse correlation with causation; but I doubt many laypeople comb through Osborne's speeches. Journalists can ask trained economists if they are confused - or indeed, read blogs like this.

      I think as soon as we start saying that x is correlated with y "implicitly" says x causes y then we are redefining what the English language can bear.

      His point, at face value, is fair:
      1/ there is a negative correlation between debt and growth
      2/ we can't be sure of any causal link yet (even if most evidence suggests that low growth leads to high debt, we don't *know* that's all that's going on)
      3/ but given that we are very concerned about the possibility of lowering growth rates, it might be "prudent" to err on the side of caution here, and over the long run aim for lower gvt debt as a share of GDP

      Once economists (and in other fields, other technocrats) have presented all the available evidence to politicians, it should be up to them to weigh up the various risks and design policy accordingly. It's perfectly possible to view this passage in this light. And stopping them from doing so would be bad for good governance and democracy.

    5. he's talking to an audience of trained economists
      Osborne is Chancellor of the Exchequer and we're in an election year. He is not talking to the people in the room.

    6. @JD - read the rest of the first paragraph. Laypeople aren't reading. Journalists can ask people who do know.

    7. Of course they can, but by and large they don't. So the impression is created that 1) more debt would be disastrous and 2) inflation is under control, and the general notion that the Tories are competent and a Labour government would be a profligate disaster is reinforced just that little bit more. A normal day in the office.

    8. SWL: I think we agree as in my response I noted "The direction of causality implicity made by that sentence is quite clear...highdebt ==> low growth."
      This, for me, is 'highly misleading' by Osborne.
      As you rightly say, much of the deception lies not only in failing to clarify the direction of causation, but structuring the sentence in such a way as to indicate highdebt ==> low growth.
      If this seems slightly too critical/unfair on Osborne, can anyone imagine his sentence being “And the conclusion of the academic literature is that lower growth is undoubtedly correlated with high debt " ?

      Japan has high public "debt" for years now. Also, include PFI and bank bailouts and the big scary number gets bigger.

  4. I was at a conference yesterday at which a senior ECB linked economist was the closing speaker. In the Q&A session I asked why it was that with Monetary Policy at the ZLB he said (in his speech) that Fiscal policy could not be used to stimulate growth. He replied that you can't cure a problem using the thing which caused it, and anyway, it would only give a temporary and not a sustainable solution for growth. Only restructuring would do that, he said. I really wished you had been there to ask him a rather better and more rigorous question.

    I can see you will have a difficult task convincing the Germans and those who believe in austerity that they need to change. It seems Osborne is one of those. Perhaps they all have a problem understanding the difference between correlation and causality?

    1. You might have fired back with something along the lines of "was it not the banking crisis and then *fiscal consolidation* which has largely got us to where we are, and NOT fiscal stimulus?" (ignoring the wider, numerous problems of a currency union in this instance of course).

    2. True, but his mind was clearly made up on the issue - but then, I'm not an economist so maybe I misunderstood. What was clear to me was the strength of belief in restructuring as being the only solution. He also had very much more optimistic forecast GDP growth charts for 2015 and 2016 than S W-L used the other day so it showed Eurozone GDP growth rising, not flat as S W-L had.

    3. My (glib) answer is that the economy and government spending are not the same things. They are related, but austerity is aimed at the second, and harms the first (unless the economy is strong on it's own). I would suspect that government spending isn't high on the top influencers of economic success for a country (I'd guess investment, work ethics, corruption, materials, trade, tradition, reputation, etc come higher).

  5. A politician making factually unfalsifiable but deliberately misleading statements. Whatever next?!

  6. Link bankers income tax to the unemployment they caused, until we get full employment.

    Take care of Growth; deficit and debt will take care of themselves.
    Easy. Why didn't you think of this?

  7. Great Article, completely irrelevant apart from the "lying" part. What control over anything does the Chancellor have? ZERO NIL NONE NOTHING, these are all empty words to piss into the wind. Money drives the economy, 97% of ALL money is brought into existence by private financial institutions as debt, so why are you discussing debt as if the chancellor or anyone else had control over it? ( how money is created in the modern world) So whats the conclusion? That no matter what the Chancellor "believes" or "says" or "intimates" or "lies" about, he cant change anything until politicos get a grip on money. I am supremely tired of this nonsense that economists and thinkers talk, you are all missing the point when 97% of something is controlled by a particular type of private institution, no one else has any say or control (Not that I condone Gideon, he is a complete idiot) but you are following his idiocy which makes me despair. To change the way money is created is to change the world and we need a new world because this one is broken.


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