Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday 13 January 2015

Why did Osborne not try to protect the recovery in 2010?

I see that George Osborne is giving the RES lecture this year. This post might be useful background, just in case what he says goes beyond simplistic electioneering of the '0.5% inflation is welcome news' kind. 

In an earlier post I outlined how a credible austerity plan could have been enacted in such a way as to protect the recovery. This is not what I would have done. We needed fiscal stimulus not austerity in 2010, and the threat from the financial markets was non-existent. However some have difficulty accepting this last point, so what I tried to show in that post was that a worry about the financial markets did not excuse the coalition’s actions.

In particular I noted that public investment could have stayed high, but instead was immediately cut back, even though there was no necessity to do so because it was not part of the coalition’s primary fiscal mandate. According to the OBR net public investment was 3.3% of GDP in 2009, but only 1.9% by 2011. A total multiplier of 1.5 for public investment is quite plausible, so that alone could account for around 3% less GDP. Good projects, like flood defences or school renovation, that were ready to go were instead cut back

Was this just a random (but very costly) mistake, or was there some logic behind it? Osborne has repeatedly talked about monetary activism. In September 2009 he said:

Monetary activism to keep interest rates low and stimulate the economy. Fiscal responsibility to restore confidence and rebuild our battered public finances.”

It is of course true that this assignment does indeed reflect the academic consensus, as long as interest rates are not at or close to the Zero Lower Bound (ZLB). At the ZLB you have Quantitative Easing (QE), but QE is just not reliable in its impact on demand, so it does not make the ZLB problem go away.  

Osborne or his advisors knew this. UK interest rates hit their ZLB in March 2009. Here is a key excerpt from Osborne’s 2009 RSA speech, made shortly afterwards:

[New Keynesian] Models of this kind underpin our whole macroeconomic policy framework – in particular the idea that by using monetary policy to manage demand and control inflation you can keep unemployment low and stable. And they underpinned the argument David Cameron and I advanced last autumn – that monetary policy should bear the strain of stimulating demand….

Now if it is true that New Keynesian models underpinned their macroeconomic framework, they should have also known that the Zero Lower Bound (ZLB) problem is a big deal in those models. Furthermore in basic New Keynesian models QE does nothing. In these models there are ways of mitigating the ZLB problem, but they involve departures from the inflation target, and Osborne has never shown any interest in doing that.

In his Mais lecture of February 2010 he acknowledges the arguments of those that said fiscal consolidation should wait until the recovery was assured. Here is a key passage:

To be fair, a more sophisticated version of the argument for delay also takes into account the complex interaction between fiscal policy and monetary conditions. It says that at the moment, and for as long as policy and market interest rates remain low, fiscal tightening should be as gradual as possible because there is little scope for more accommodating monetary conditions to accompany it, either through lower market interest rates or through the reaction function of the Bank of England. And only as and when monetary conditions begin to tighten can the pace of fiscal consolidation be accelerated.

But even this, more nuanced, version of the case for delay is too complacent. For it brings me to the second consideration: the realities of financial markets.

So there is no attempt to dispute the validity of the ZLB problem. No attempt to argue that with QE the ZLB problem was not real. Instead the argument is that there is a still greater danger, which is that the markets might suddenly lose confidence in UK government debt.  

This suggests to me that Osborne, and the coalition more generally, never really believed in the position that QE alone could deal with the ZLB problem. Taking that position would rationalise what they did – in particular cutting public investment was fine in macro terms because the hit to GDP would be compensated for by more QE. However if that was the case, you might have expected to see that position explicitly stated, and as far as I am aware it has not been.

Instead I think we are being too sophisticated in trying to find a macroeconomic rationale for coalition actions. For what it is worth, I think policy was based on two political, not economic, imperatives. The first was to reduce the size of the state, and the deficit was always a pretext for that. Here he was just copying his US cousins. As a result public investment as well as consumption had to be cut even though this was not part of his main fiscal rule. Second, austerity could not be back loaded, even though that would have made macroeconomic sense, because that would mean doing unpopular things just before an election. As a result public investment had to be cut quickly rather than kept high to protect the recovery.

Under this interpretation, Osborne did what he did for essentially political or ideological motives, and just ignored the risk of potential costs that then came to pass. This is not to suggest that he intended to waste almost £100 billion, but just that he did not give sufficient regard to that possibility. As he lost every adult and child in this country something in the order of £1500 each, he deserves full censure. He certainly does not deserve a reputation for economic competence, unless you are mediamacro and equate competence with deficit cutting. 

What does not seem plausible is that his actions were designed to prevent the financial markets believing the UK would default. If you are still not convinced of this, consider one final, almost bizarre, piece of evidence. He plans if re-elected to pursue almost the same policy again (austerity in the early years of the government) while UK interest rates are at (or at best close to) the ZLB, and when there is not even the hint of any funding crisis for UK government debt. Here is Tony Yates on the folly of this strategy.

Thus those who suggest that the coalition had to undertake 2010 austerity to appease the markets are thrice wrong. First, the UK was never going to default and the markets knew it. Second, if that had been Osborne’s concern he could have designed a much more recovery friendly plan. Third, it now seems clear that he never undertook 2010 austerity for that reason. In the UK, as elsewhere, fiscal austerity justified by an imperative need to reduce the deficit was and remains a massive confidence trick.    


  1. I agree with you that fears of bond vigilantes in 2010 were unfounded, but I'm not sure about the logic behind this and your last post.

    If bond vigilantes were a real problem, why would they have differentiated between investment and other spending? Or to put it another way: Yes, investment wasn't part of the coalition's fiscal mandate, but why do bond investors care about that?

    There's no direct route from this investment to more tax revenue beyond the fiscal multiplier (ie when we build more schools, these schools don't make the government money).

    So for your scenario to hold, you would need the multiplier for investment to be significantly larger than for other government spending. Large enough to make the difference between edging us towards default and not. (All in Osbornes/Bond Investors eyes)


    1. ps - on re-reading, I sound very sure of myself. There should be a few "I thinks" and "would that not means" in there

    2. building schools does not directly lead to money - unless you charge for the school - but the people who build it are paid and spend money, and their neighbors benefit from this spending and then spend, too.

      But if you feel that the government is spending money that they cannot possibly pay back, someone locked the room to the printing presses, then any spending would be looked at with suspicion, i guess, especially if the bond buyers believed that there was no multiplier effect.

      Your analysis better pertains to Argentina or Greece than it does ot G.B..

    3. Hi Rob - That's what I meant by "beyond the fiscal multiplier".

  2. Agree 100%, particularly with your last paragraph. It is interesting that "macro-media" never asks Osborne the fundamental questions.

    What exactly will happen if we do not reduce the deficit to zero by 2018/19? Who exactly can do us any domestic financial harm? How exactly will this harm manifest itself?

  3. > Simon
    In your discussion of market sentiment you only mention default risk ,don't you think that the size of the market needs to be given consideration also.

    1. If the incumbent participants in the bond market can't see a time horizon where they will receive an interest payment from the treasury that they don't fund themselves by buying bonds, and the number of new participants is small then there is a cause for a change in sentiment there.

    2. If there is no default, who cares? And also, there are not a small number of participants in the market.

    3. What do you mean by "default". The interest payments are already being funded by the participants themselves. If you mean the Central Bank is there to step in as lender, then that would upset the bond market entirely, and the government does not want to do that because the Bond market is very useful. so its not that simple.

    4. If you will get all your interest and capital back with certainty, then you do not care how that happens. You say if the central bank steps in that will upset the bond market entirely. Yes if the government finances are unsustainable and intervention would be inflationary, but no one is talking about this for the UK. Of course in the UK the central bank has stepped in and bought a large amount of debt, and interest rates on debt have continued to fall, so this is fact, not conjecture.

  4. Victorian Values Osborne has the same degree I have, in history.

    His approach to the invisible bond vigilante argument has something of an undergraduate's historiographical essay about it: throw a few rival interpretations into the pot and then pick the one you like - or in this case he and his friend's wallets like best.

    I wonder also, given that Krugman likes to use core inflation for the US, whether there is a graph of UK core inflation since 2008?

  5. "[A]usterity could not be back loaded, even though that would have made macroeconomic sense, because that would mean doing unpopular things just before an election. As a result public investment had to be cut quickly rather than kept high to protect the recovery."

    The light has gone on at last.

    That is the problem with trying to use fiscal policy. The only way of overcoming that problem is to take fiscal policy out of the hands of the politicians, but that has other even more serious downsides.

    You also miss out why the mistake was made as to the severity of the impact tightening would have. They didn't predict

    (i) the ez crisis

    (ii) the sharp rise in commodity prices


    (iii) the impact of de facto monetary tightening because of the new banking regulation

    I think everyone has to acknowledge that cutting investment spending in 2010 was a mistake in retrospect, And those who said so at the time have let us know, as they are entitled to do.

    Instead of endlessly rehearsing and re-rehearsing the criticism of why government fiscal policy in the first 18 months of this Parliament was a mistake, it is more productive to try and tell us what you think the current fiscal stance should be. If I am right, your answer is that it needs to be at least as loose as is necessary to lift us from the zlb.

    Like Zeno's paradox, that looks like a point which seems to get closer but will never actually be reached. So, the inflation numbers today indicate to me that we won't have any monetary tightening until October at the earliest. So, presumably, you think that any new government in May 2015 ought to loosen fiscal policy yet further?

    That isn't going to happen.

    We might get lucky, I suppose, and end up with a 1974 re-run, without any effective government because of the way the seats fall. If we have two elections, no government will be tightening before the second one.

    As for the criticism that Osborne's decisions as 'political' or 'ideological', I don't think those words have the negative connotation you intend (see also the word 'academic'). All decisions of this kind are inevitably normative. There are no decisions on fiscal policy that are not political or ideological.

    If the criticism is that the normative basis was hidden or disguised, I don't think that is fair. Osborne has made no secret of the fact that he favours a smaller state. Laws (the Lib Dem member of the coalition most responsible for fiscal strategy at the relevant time - May 2010) and other Orange Bookers also make no secret that they think the state spending 40%+ of GDP is too much.

    What you need to do is show how these 'political' or 'ideological' views on how things will go better are wrong. It isn't good enough to just label them political or ideological.

    That requires you to do something you don't want to do: engage with the question of how large the state 'ought' to be.

    Something on this would have the great merit of being something

    (a) topical


    (b) new.

    1. Are you normally this rude, or only when writing on this (and other) blogs? When you say the light has gone on at last, you are trying to suggest that I didn't hold these views before? I have always thought this. The difference is that you see them as justification, rather than explanation, and when I have not written it before it is because I was talking about justification.

      As to the rest, there is nothing that is not answered in the post itself (as ever, try reading it again). For example, I have argued that his ideological views about the state cost us £100 billion. I have not seen any quantification from Osborne or Laws of the benefits of a smaller state, and I do not see why I should try and invent some on their behalf. I will also carry on writing about this, particularly as it applies directly to 2015 and is therefore highly topical, until mediamacro begins to acknowledge these points. You do not have to read these posts, still less comment on them by telling us how bored you are.

    2. "The difference is that you see them as justification"

      I don't think it could operate as a justification in your (economic) terms no. Rather it is a statement of political reality: if you are going to try to reduce a deficit of the order of 11% of GDP you do that at the start not the end of a Parliament. Gravity doesn't justify rainfall, it is just the way it is. Railing against it not serving much purpose.

      For the 2015 GE what is topical is not what should have been done 2010-2011, but what should be done 2015-16 (and I do know you have addressed this elsewhere). As it happens, I am probably convinced that further fiscal tightening can be delayed, but also think it won't be whoever wins (see also 2010).

      As for

      "I have not seen any quantification from Osborne or Laws of the benefits of a smaller state"

      Well no, anymore than you would expect a politician who rejected their views to produce a cost/benefit analysis of the advantages of a larger state. Just not their job. There are however those in the academic word who have (on both sides of the debate). You can't prove that Osborne or Laws is right or wrong by dismissing their position as political or ideological. There is no such thing as a hard-headed pragmatism that is free of normative presuppositions.

    3. What should be done in 2015 is not to elect a laissez faire neo-liberal party that has an economic ideology left over from when we were on the gold standard. Unfortunately all parties have that ideology to a greater or lesser extent.

      Politicians have to keep the great deception alive, else they would have to work for a living. The deception? That sovereign fiat currency issuing governments have to "borrow" money. And, that taxes actually pay for something. Neither of which is true. Political class needs the proletariat to continue to believe that the government has to borrow money, just like a household; but, as the currency issuer, it doesn't. The private sector is the currency user and does have to borrow to advance its spending plans.

      Government spending, the economy accelerator pedal, needs to maximise the use of resources, especially labour, in each sector of the economy. When bubbles appear government uses taxation as the brake pedal, sector specific if possible. Using an economy wide sledgehammer of monetary policy interest rates, belongs to the dark ages.

      One day, we will be able to elect politicians who actually know, and admit to knowing, how a "sovereign fiat currency economy" actually works.

      I see the IFS has set itself up as Judge and Jury on election party economics. It also still persists with the myth that the government "borrows" money to pay for things mind you. Its that old school tie thing I expect. (Acorn)

    4. SH: Are you sure there isn't any other wisdom and guidance you might pass on to the professor and the rest of us, so we might benefit from your knowledge, insight and clarity or thought? Perhaps you could direct us to your economics blog so we might at least try to improve?
      Excuse the sarcasm, but in all seriousness many of your comments clearly reveal an acute case of the 'Dunning-Kruger' effect, which you really should address so you can then begin to comment in a manner appropriate for this blog (ie. politely, respectively, and of course coherently - even when disagreeing); thus avoiding all of that rudeness, frustration and simmering anger which comes through in your comments.
      - "a cognitive bias wherein unskilled individuals suffer from illusory superiority, mistakenly rating their ability much higher than is accurate...attributed to a metacognitive inability of the unskilled to recognize their ineptitude...the miscalibration of the incompetent stems from an error about the self".

    5. Love the scare quotes around 'borrows'.

      S W-L like PK will drawback from that view of course. NeoLib stooges the pair of them, no doubt.

      What you have in common with S W-L is the view that the world is mainly constituted of rogues and their dupes.

    6. Hmmm, it seems that the patient is more acutely afflicted by the D-K effect than first though! He appears to know with certainty what both SWL and PK will do, what they are, and their views of the world. An interesting case this one....

    7. Simon,
      You'll notice, no doubt that I don't above dissent from S W-L's economic analysis at all. You seem to be confusing me with that mythical beast the 'austerian'.

      As it happens, I am largely persuaded by the economic analysis (as an aficionado of my oeuvre you will no doubt have noticed this). It is the politics I find surprisingly naïve (both in relation to the UK and elsewhere the ez). Hence those occasions when I comment and when I dont.

      No doubt you feel the need to defer to and defend someone with the title of Professor, but I am unclear why you feel the need to do that in areas outside of his expertise. Do you think he just must be cleverer than you, and so should be deferred to? You should trust to your own intelligence more. I am sure S W-L would agree with that. Authority isnt an argument.

    8. Simon, on your last point, my understanding was that PK and S W-L were prominent critics of MMT and so would not endorse "anonymous's" views.

      Charitably, I suppose it is possible that they have changed their minds and I am wrong about what they currently think.

      Doesn't seem very likely.

    9. SH: Not only do you entirely miss the point of this and most of SWLs arguments (which is why he constantly tells you to read the blog again and again), but regards to your response to me and your comments in general, you truly are unaware you're doing (and exhibiting) it aren't you?
      The big reveal was the last 4-6 lines of your reply of 13.46 above:
      Talk of SWLs 'naivety', 'areas outside his expertise', the title of 'Professor' and me deferring to this title and authority'...'being cleverer' and 'intelligence' etc. Tellingly, and consistent with the D-K effect, all of these came from you, revealing (and confirming) the underlying areas of inferiority which you try to counter with a strong tone of (illusory) superiority and rudeness throughout so many of your comments.
      Even if you don't, as you say, dissent with SWLs economic analysis, you most certainly do show unwarranted dissent towards your host:
      Remember when you accused SWL of cherry-picking data, when he hadn't? Just because he had used the FT 2013 survey to illustrate the poorer forecasting results or 'city' economists compared to 'academics'. Really it is his title, academic background, knowledge and insights which only serve to highlight the areas you perceive yourself to be lacking in, hence the transparent attacks and undertones of superiority which characterise your narrative.
      PS. As anyone can see reading this blog, SWL hardly needs me to 'defend' him!
      As I said before using an econ analogy, think of my replies to you as an attempt to mitigate the negative externality that is your commentary on the blog.

    10. @SpinningHugo -- so, because politicians are ideological they can't be criticised for being ideological? Makes you wonder why George Osborne bothered to say stuff like this (as quoted by SWL):

      “[New Keynesian] Models of this kind underpin our whole macroeconomic policy framework – in particular the idea that by using monetary policy to manage demand and control inflation you can keep unemployment low and stable."

      He could have just said:

      "I want to make the state smaller for its own sake. I am an ideologue which is my job. I outsource the rationale to the eggheads. Why am I here right now."

      According to you this would leave him immune to critique?

    11. Nobody can be criticised for being ideological. I am ideological. I believe passionately in the ideology of liberalism. Are you not a liberal?

      Some ideologies are Very Bad. Fascism is one example. But an ideological approach is not in itself bad, it is essential. An ideology is a coherent normative framework. That is much better than the alternative.

      Indeed, without some normative idea of what it is you are trying to achieve, facts and data cannot alone enable you to make a decision.

      I rather doubt whether S W-L would criticise Osborne for endorsing New Keynesian approaches, but I was surprised to find that he expects Osborne to produce the research personally.

  6. As a citizen of Brazil, where the economic debate often takes the mirror-image of that raging in developed economies (i.e., here the government invokes 'keynesianism" to push expansive fiscal policy in the face of high inflation and bulging labor markets), I fail to grasp the appeal of austerity. Why would rapidly cutting investments be popular? It used to be that conservatives railed against fiscal stimuli because populist politicians could supposedly seize on them to charm the masses for electoral purposes (that's been the story in most of Latin America for the past decade). When did that narrative change?

    1. I've been wondering this. Particularly if there's actually a workable policy that involves putting money directly in people's pockets - why the hell is no party leaping on that idea and running with it? As you say, how come that can't be a vote-winner but banging on about inflicting pain for long-term gain does?

    2. I think this is a very good question. I have tried to partially answer it when I have discussed mediamacro and the influence of City economists, but I am sure there are more things to say.

    3. Its about paradigms and models. Edward de Bono asked a TV audience many years ago why they think and after listening to their answers offered his - we think, in order not to.

      Having invested mental effort in understanding, however imperfectly, why people and systems behave as they do, we happily avoid further effort and simply ascribe motives and predict outcomes based on our paradigms.

      And we ignore evidence which upsets them.

      "Osborne's view" of the economy had the great advantage that it aligned with the household finance paradigm shared by many voters. It was and is easy to understand and assimilate. It provided a useful stick with which to beat Gordon Brown in 2010

      I've heard statisticians use the phrase 'all models are wrong but some are useful' to mean that their predictive value is good in some circumstances, Osborne's model was useful to him in a different way, however the effort and more importantly political risk associated with adopting one which would find favour with this blog are too great for him, and that's before the possibility that in his eyes all is going well in the reduction of the size of the state.

    4. All economics is political; all politics is economic, you can't separate them. They even had to invent central banks so politicians had someone to blame for inflation. Hence, inflation is always a central bank problem nowadays. (Acorn)

    5. Osborne had no excuse - he was aware of all the advice he was getting, and took a risk on our behalf because he had concealed political motives. That the public, if not told otherwise, would accept simple comparisons between governments and individuals I can understand. That the media, with economic journalists who had access to academic advice, did the same is less understandable.

    6. Please don't get me started on the quality of economic journalism. Have you ever listened to "wake up to money" on Radio 5 at 05:15; condensed and repeated on the Radio 4 at 06:15. They are all echo chambers for government and corporate press releases. (Acorn)

  7. Simon, I know that you're critical of Osborne here, but I have to confess that as an American I'd give a lot to see a single Republican member of congress here display a fraction of Osborne's economic understanding. Try reading statements from Ron Paul/Mike Lee/Ted Cruz/Paul Ryan on monetary policy and I think you'll be a little more grateful for the UK political scene.

    And I do have one nit with your post. You said Osborne didn't attempt to argue to that QE works at the ZLB. I think that's mischaracterizing what he said. He assumed for the sake of argument that even if there was "little room" for monetary accomodation that the unfavorable fiscal situation in Britain justified austerity. Now, I agree with you that he's wrong about public debt being an urgent problem, but he wasn't conceding what you claim he conceded. Judging by his statements alone, there's no reason to believe he ever lost faith that the monetary accomodation of the BOE could offset the austerity.

    1. I agree with your first paragraph. Can you get the Republican Party to make Osborne an offer he cannot refuse!

      I disagree with the second paragraph, although I agree that we are having (needlessly) to make a lot from very little in terms of interpretation. In the two longer quotes I give, there was plenty of scope to say 'but of course we have QE as well'. He did not, and I think that tells us something. But I have no skin in this game, because if he had said he was a Market Monetarist, I'd be just as critical!

  8. PLEASE stop refering to UK Govt economic policy makers as 'George Osborne'. George Osborne is a politician, he is NOT a policy maker. He doesnt know the first thing about economics. His job is to make speeches and present the Govt's economic policy, NOT to formulate it. The guy couldnt run an ice cream van.

    For the last time this 'auserity' nonsense is simply a smokescreen to disguise wholesale switching of tradition Govt services to the private sector. Im amazed how many people fall for this lame ruse.

    1. I don't think many would disagree with what you say Will, other than to say that Osborne and Cameron are both the 'faces' and the 'voices' of the policies being enacted. Using their names is maybe a way of avoiding a more cumbersome or longer description in such as 'those policy makers in government' etc

    2. Fair enough, i understand what yr saying, the problem being it has the unfortunate side- effect of giving these people far more credit (as intelligent decision-making individuals) than they deserve!!

    3. You're right...besides the bits already mentioned by SWL, check out what Osborne was saying in 2010 in my last comments at bottome of page...

  9. the UK was never going to default and the markets knew it
    This is the part of the argument that I struggle with. Of course the bond market knew that the UK was not going to default: it's impossible. The bond market is only really worried about implied default in the form of inflation, and if the bond market gets spooked about inflation it can have a meaningful impact on rates (this is how it intimidates everybody). To the extent persistent deficits might lead to inflation, the bond market will be worried about deficits. It seems to me that in 2010 there was a reasonable basis for believing that the bond market was worried about the deficit, which in turn was a reasonable basis for seeking to reduce it.
    In putting forward this argument I acknowledge that:
    1. Bond investors emphasising concerns about inflation are talking their book: they have no real concern with the number of people are unemployed so they will naturally favour a strongly anti-inflationary stance (even excessively so).
    2. George Osborne no doubt had other motives and picked the arguments that suited him.
    3. Even to the extent such views were honestly expressed, they appear with hindsight to have been entirely mistaken and many (including you, I assume) were saying so at the time.
    So I can accept that seeking to reduce the deficit in 2010 was wrong, but I struggle with the argument that this was completely obviously so at the time, and that all those arguing for it were fools or liars.
    As I've said before I'm not an economist, so I'm probably making stupid basic errors in this, but I'd appreciate your take. I've discovered this blog quite recently and I've found it very interesting.

    1. I certainly would never, and have never, argued that everyone who worried about the deficit in 2010 had other motives. I have said that such worries were understandable - after all, we had just had the financial crisis, so appealing to what markets should rationally do could meet with obvious skepticism.

      So I do not really disagree with your overall point. I would disagree with the inflation point though: what an inflation panic might do is depreciate the exchange rate, but that would have been useful in 2010. Krugman has written a paper on this:

    2. Thanks. I think the fact that the financial crisis was so recent was a major factor. Many people seem to have forgotten already how terrifying the end of 2008 was. Of course things are very different today.
      I'm not sure I understand your point on inflation. Aren't a depreciation in the exchange rate and an increase in bond yields two manifestations of the same phenomenon (investors selling sterling assets)?

  10. what an inflation panic might do is depreciate the exchange rate, but that would have been useful in 2010
    Incidentally if I were an international investor holding gilts I would not find these words particularly comforting.

  11. In particular I noted that public investment could have stayed high, but instead was immediately cut back, even though there was no necessity to do so because it was not part of the coalition’s primary fiscal mandate.

    The answer is simple: institutions. As a minister you sort of control investment projects in the sense that you can usually cancel them. They come in easily identifiable lump sums, and you can decide to say "no, Barsetshire isn't getting a new bridge" or "make that 8 T-45 ships, not 12, wait, 6".

    But a lot of government current spending is either pre-committed, or is driven by demand, or both. JSA and tax credits go up in recessions. Pensions, NHS operational spending, and basic schooling are driven by demographic trends. Debt interest is obviously driven by the outstanding stock of debt and the average coupon on it. Public sector wages have a contract life, and anyway it's well known that it's hard to actually cut wages. These are the famous automatic stabilisers.

    The civil service's division between AME (Annually Managed Expenditure) and DEL (Departmental Expenditure Limits) captures this distinction.

    1. But I do not see why this is an explanation, unless you agree with me that the idea was just to cut, because cutting investment did nothing to meet the fiscal rule. A Chancellor that wanted to meet his fiscal rule to impress the markets, but also wanted to protect the recovery, would have said I'm not interested in your departmental cuts to capital projects - in fact I do not want them to happen - because it does nothing to meet my fiscal rule.

    2. TBH I think the argument was the Davies-Folk theorem - you can defend anything on the basis of "credibility". Also it's easier to present some cut in public spending as being a cut, and just elide the technical distinction, than to admit you failed to find substantial cuts, especially if the "cuts" bit was intended for one audience and the "AME only" bit for another.

  12. Why did Osborne take the knife to public investment in 2010? Was it an ideological swipe at big government or a "random (but very costly) mistake", or even just the only option to hand. Cutting projects is easy, cutting services more difficult and probably requires legislation - that takes time to get through parliament.

    It's is a stretch believe the cuts were not a necessary signal to the market in 2010, although from the safety of an armchair in 2015 it may seem that way. It is also probably that, in the mayhem of creating a coalition and picking up the pieces from the previous Labour administration, the coalition were forced into cutting back the "low hanging fruit" - not perhaps the best decision but certainly (given the context) not the heinous crime articulated here.

    1. The markets did not care and did not notice. As for an understandable mistake, it lost a family with two kids £6000. If they were told this, they could decide how bad a mistake it was.

    2. You are incredible, more SWP than SWL. The markets would respond, really respond, to strong economic growth. They do certainly notice if growth is weak. They don't "care" because they have no feelings. They respond to NGDP expectations all the time, every day. They move when they think monetary policy has been tightened or loosened unexpectedly. All the time.

    3. The markets did not care and did not notice
      Again, it seems to me that there is an element of hindsight in emphasising this. The point is not whether markets did react, but whether at the time such a reaction could reasonably be expected. Given the near-death experience the financial system had just gone through it seems to me that a fairly extreme precautionary approach to preclude a negative market reaction was quite reasonable at the time.

  13. I think George Osborne had to tread very carefully in 2010. The BoE was very independent under Mervyn King, and not attempting some fiscal austerity would probably have resulted in the BoE giving up on the relatively weak monetary policy they were pursuing. The ECB raised rates twice in 2011, the BoE was on the verge of this too, with 3 of 9 MPC members voting for rate rises from early that year. Things are different when you are in power and have real instutional issues to deal with rather than theoretical ones.

    1. "The BoE was very independent under Mervyn King ..."


      "... not attempting some fiscal austerity would probably have resulted in the BoE giving up on the relatively weak monetary policy they were pursuing."

      This is just an argument against the current arrangement and the judgement of the "experts" at the BoE. Because raising rates would have been a disaster, as the ECB have found out.

    2. Andrew Sentance voted to raise rates in June 2010! I remember his stance seemed a little eccentric even at the time, and even to this non-economist.

    3. "The ECB raised rates twice in 2011, the BoE was on the verge of this too, with 3 of 9 MPC members voting for rate rises from early that year."

      This is a very important point. In the absence of the attempted fiscal consolidation, how much more likely would it be that the BoE would have tightened during the oil blip of 2011-2012?

    4. In fact, given the BoE's behaviour during the period, one could argue that EVEN IF you are a Keynesian, the salient legitimate criticism of Osborne is that he did not do a Brown 1997 and change the monetary policy framework.

    5. I have some sympathy with this view. Imagine if Brown had still been Chancellor, had done much less austerity, and the MPC had then raised rates in 2011. Do you think he would have sat back and done nothing?

      The 2011 MPC argument is fairly weak though. First, 3 members were voting for an increase in rates for only 4 months of 2011. By October QE had started up again. Plus VAT would not have raised inflation. So at most we might have had an embarrassing (for the MPC) blip up in rates, and I think the economy would still have been much better off. (Two MPC members have been voting to raise rates last year!!)

      Of course none of that was anticipated in 2010, so it does not excuse 2010 austerity.

    6. "Do you think he would have sat back and done nothing?"

      Probably. It is rare that premiers involve themselves in interest rate decisions in countries with independent central banks.

      It's certainly a fairly weak argument, in that both sides on the question are highly speculative.

      "Of course none of that was anticipated in 2010, so it does not excuse 2010 austerity."

      At any time, one can predict that austerity reduces (ceteris paribus) the natural rate of interest and thus delays interest rate rises. That doesn't disprove Keynesianisn or anything like that: quite apart from multiple equilibria, even palaeo-Keynesianism is fully consistent with the ability of central banks to pull on a string.

    7. I love the "at most we might have had an embarrassing (for the MPC) blip up in rates, and I think the economy would still have been much better off". A bit like the ECB in 2011, then, and we know how that turned out.

      You have said many times you prefer the certainty of conventional over unconventional monetary policy. The 2011 ECB "blip" is a pretty good data point for you, then. A tiny blip and, whoops, apocalypse!

    8. gastro, you should read the recently released minutes from the Court of the Bank of England from 2007-2009. You wouldn't LOL about the "independence" of the BoE from the Treasury. Especially 2007, 1H2008. They really, really were. And "indpendently" made the financial crisis in the UK so much worse than most other countries.

    9. james - yes, I'd forgotten that in MM lore, the current Eurozone recession is entirely down to that interest rate increase, and has nothing to do with fiscal austerity. Perhaps you would like to tell me what my research is all about next!

    10. @JiL The BoE can talk as "independently" as it likes, but it's the government that decides. Didn't Brown, for example, reduce the inflation target to 2%? Can't another government choose to raise that and instruct them to pursue policies to produce it.

    11. Mainly Macro, I have searched your blog for discussion of expectations and all I find is abuse of the (uncaring) market, it's unreliability, etc. The point was that you said you preferred the far more reliable results observed from interest rate manipulation. I merely gave a good example, the ECB rate rise in 2011.

      gg, they sure can raise the target. Not sure what the point would be when they can't even hit 2%.

    12. Or, rather, they can't even convince the market they can hit 2%.

    13. @JiL So now you're arguing against the efficacy of the MPC?

    14. The MPC can do or not do whatever they want in terms of monetary policy. Like many central banks they seem to have shifted to seeing their IT as a ceiling. Many Market Monetarists have pointed out the asymmetry of IT central banks, who seem very unhappy when inflation is above target, but relaxed when it is below. More's the pity.

  14. And here's some data for you to chew over, in case you missed it.

    1. The theoretical point about differentiating between monetary union countries (but not the Eurozone as a whole, I hope) and others is reasonable. There are other well known problems with correlations of this kind.

      I do have a problem with the data in this alternative scatter plot though. It is not a subset of Krugman's data, clearly. Nor can I reproduce it using government consumption data. Is the government spending data supposed to be real government consumption, real government consumption and investment, or total government expenditure (real, nominal?) - which is very different and an odd choice.

    2. It's total real government expenditure, federal, state and local (deflated by the GDP deflator). It maybe "odd" data but it's what PK used for his infamous, failed, test of MM, eg:

    3. Its clearly not the data Krugman used - look at the two charts. I suspect total gov exp includes transfers.

    4. James, unfortunately a few typo's made : That last sentence should read "it's what PK used for his famous test which MM failed conclusively".
      Remember the test was not whether there would be any growth, it was whether QE would offset the impact on GDP of the fiscal contraction.
      Just in case it wasn't a typo and you simply forgot, a quick copy and paste:
      "Bad news James, by any consideration or measure, MM failed the test you refer to (via PK), and failed convincingly. QE failed to offset the fiscal contraction, which for the US in 2013 is widely estimated to have reduced GDP by approx 1.5%. Moreover, you cannot, by any stretch of the imagination simply cite positive GDP figures and use them to conclude that QE passed the test, since the actual contribution of QE to GDP figures is not only very difficult to quantify, and those studies that have attempted to do so report only a relatively modest improvement in GDP thanks to QE. Certainly no where near enough to offset the impact on GDP of the fiscal contraction, which is what the test was mainly about. Strangely, you write "Growth accelerated even as austerity ticked up." Can you explain why you wrote this falsehood?
      The GDP data shows annual GDP for 2013 to be 1.9%. This is lower than the year before, and lower than 2010. Looking at 2013 quarterly GDP, this was mediocre overall, and unlike your description, it was quite erratic - rising, then falling, then rising, but all at fairly modest levels, and likewise for the first quarters of 2014. Growth did not accelerate, James.
      As the NYT in 2014 says about 2013 overall : "the economy was still performing well short of the so-called breakout speed economists and policy makers have been hoping for. Instead, it continues to muddle along at a steady but disappointing pace. From 2010 to 2013, output expanded at an annual rate of about 2.3 percent, strong enough to lift corporate profits and stabilize many parts of the economy, but not fast enough to push unemployment low enough to lead to meaningful wage increases for most workers. That, in turn, has held back big gains in consumer spending, which is responsible for a large share of overall economic growth.
      Test failed James."

    5. Mainly Macro - I thought you'd were the one who was data driven, but it seems not.

      A general problem with this blog is the blissful, wilful, gleeful, ideological almost, ignoring of "uncaring" markets. The growing consensus in the blogsphere is that monetary policy is the market reaction to central bank action (or inaction). Some big events in monetary policy, like the market reaction to today's dropping of the Swiss peg will pass it by. Or focus on some economic reaction in 1-2 years time. The world is passing this blog by, because the world now understands the interplay between monetary policy and expectations much better - thanks to Market Monetarism.

      Of course, I shouldn't be too harsh, you are only following New? Keynesian "lore" on things. I know you will think this rude, because it seems you can only give it but not take it, as the old saying goes.

    6. James - so I make a perfectly valid point about the data, which if true invalidates the critique (which said it used the same data as Krugman) and all you can do is make a stupid remark. Have you actually looked at the data that Krugman uses. I have, and I have done what should have been done, and you do not get the reported result. So yes I am data driven. Did you look at the data?

      One of my reasons for persisting with these dialogues is that I wanted to make it quite clear to anyone with an open mind how at least some MM supporters, like yourself, were really not interested in trying to understand the world. I think I can declare mission accomplished, and get back to more productive things. Now you can go back to your MM blogs, which virtually no one in academia or central banks read, and stop lowering the level of discussion on this one.

  15. With regard to Osborne acknowledging the possibility of delaying fiscal consolidation in the Mais speech of 2010, he is rather less accomodating of such an idea in the opening lines of the same speech, deploying the usual incorrect, scaremongering reasons in the process:
    "I also want to explain today why starting to build this new economic model is not something we can put off until next year. We have to get on with it.
    There is *no choice* between going for growth today and dealing with our debts tomorrow.
    Indeed we will not have any meaningful growth unless we show we can deal with our debts."
    Now folks, for the big lie:
    "For it is the lack of a credible plan to deal with the deficit that is already pushing up market interest rates, undermining the monetary stimulus that is supporting the economy, and sapping the confidence of investors and consumers."
    This speech was delivered in February 2010.
    First, a quick check of market interest rates at the time, both the rate according to the BofE, and the rates on 10yr UK gilts.
    The BofE rate had fallen to 0.5%, where it had been for a year at the time of the speech. However, to be fair to George, he was of course referring to the 'market' rates. So, these MUST have been rising as he claimed: the graph illustrates, these had been FALLING since mid-2008, with tiny fluctuations, but on a decisive downward trend, even as the deficit was getting dramatically worse over the period. Which appears to be at odds with "it is the lack of a credible plan to deal with the deficit that is already pushing up market interest rates".

    Lie 2:
    "It is the lack of a credible plan that has the credit rating agencies threatening to downgrade us unless action is taken urgently."
    No, the rating agencies downgraded the UK in Feb 2013 on "expectations that growth will "remain sluggish over the next few years", even though the deficit had been significanctly reduced by this point. For the UK at least, it was never about reducing the deficit for those agencies, its the growth outlook and thus expected path of future interest rates.

    "This is the reality of the situation we are facing.Those who say we should simply ignore the markets are siren voices, luring us onto the rocks."
    Would that be 'Siren' - Wren Lewis?

    1. Also worth quoting from his speech..."As Rogoff and Reinhart demonstrate convincingly..."
      He then write scaremongering projection of debt, the fabled 90% cliff, mentions of Greece...and finishes with the chilling, stand alone four words of "We have been warned."
      Great stuff!


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