Policy, risks and public discourse

Another post where I use the UK as an example to illustrate a more general point

Along with their normal forecast, the National Institute has also used their model NIGEM to analyse the macroeconomic impact of the different political parties fiscal plans post 2015, which is published in the latest Review. (Chris Giles has a FT write-up.) There is no great surprise here: the more fiscal austerity you undertake, and if monetary policy fails to perfectly offset the impact on demand, the lower output will be.

This is not the main reason why I am against further fiscal consolidation post 2015. If you go back to 2010, the OBR’s main forecast didn’t look too bad: the recovery was continuing, and interest rates were able to rise as a result. But good policy does not just look at central projections, but it also looks at risks. Then the risks were asymmetric: if the recovery became too strong, interest rates could always rise further too cool things, but if the recovery did not happen, interest rates would be stuck at their lower bound and monetary policy would be unable to keep the recovery on track.

In 2010 and beyond that downside risk came to pass, and the recovery was delayed. Fiscal policy put the economy in a position where it was particularly vulnerable to downside risks, which is why it was an entirely foreseeable mistake. Quite how large a mistake is something I discuss in my article in the same Review (see also this recent post). Exactly this point applies to 2015 and beyond. The problem with further fiscal consolidation while interest rates remain at their lower bound is that it makes the economy much more vulnerable to downside risks.

This is something that all economists understand, and economists do their fair share of complaining about how difficult it is to get policymakers, let alone the public, to recognise the importance of risk analysis. However in writing about the role of fiscal policy in creating a weak recovery not just in the UK but the world generally, I was struck by how little public model based quantification of this there was even after the event, let alone before. (For some of the few ex post studies related to the Eurozone, see here.) Central banks nearly all maintain models capable of doing the kind of risk analysis I am talking about, but how much of that work gets into the public domain, or is even seen by fiscal policymakers? In the UK there has definitely been technological regress in this respect, as I note here.

So we have a paradox. In academic macro there has never been so much quantified model based policy analysis, some of it analysing just the kind of robustness to risks that I have been talking about. Yet in public discussion of macro policy, it is quite rare to see this. Central banks tend to keep what they do to themselves, and they appear to have a taboo on analysing alternative fiscal policies. In the UK the OBR, which does the government’s fiscal forecasting, is not allowed to look at alternative fiscal policies in the short term. I think I know why this paradox has arisen, but that will have to wait for a later post.