Saying the obvious

Give any student who has just done a year of economics some national accounts data for the US, UK and Eurozone, and ask them why the recovery from the Great Recession has been so slow, and they will almost certainly tell you it is because of fiscal austerity. And they would be right, as I set out in this recent VoxEU piece. There I present some back of the envelope calculations, but they are confirmed by model simulations: not just those I quoted in the text, but also others that I did not have space to mention.

When writing that piece, I kept having doubts. Not about the analysis, but just that this was all so obvious. It uses basic models (DSGE or more eclectic) that we teach undergraduates and postgraduates. It is supported by the clear majority of empirical evidence. I felt like I was telling people the macroeconomic equivalent of a rise in the demand for apples will mean an increase in their price.

The reason I put those doubts aside are also familiar. The fact that at least half the world’s politicians and mediamacro continue to ignore the obvious. The fact that too many economists continue to look for other reasons to explain this malaise (or pretend there is no malaise), because somehow they think acknowledging that fiscal policy can influence demand is old fashioned, or left wing, or something. These facts and that I was in good company.

While there are too many academic economists who want to deny that fiscal policy is largely responsible for the weak recovery from the Great Recession, I also suspect there is a majority that know it is true. This is why I wrote a post about the lessons to draw for the future. Although we teach students all about time inconsistency and say at the same time what advantages independent central banks can have, I suspect we also know that the case for independent central banks is broader than issues to do with commitment.

Economics is always in danger of being corrupted by politics and ideology, and macroeconomics seems particularly vulnerable in this respect. (I have still not entirely convinced myself if and why macroeconomics is special in this respect. Sometimes things that are actually micro, like financial regulation or labour supply responses to tax changes, seem just to get labelled macro when they become controversial or have macro consequences!) Some say that this corruption is inevitable and that we should embrace it, rather than attempt to avoid it through delegation to institutions like independent central banks. I disagree: demand management is basically a technical issue with political implications. If we did not have independent central banks today, I suspect we would be seeing the US congress voting to raise interest rates. And of course there would be a few economists with their models saying it was a good idea, even though the vast majority thought otherwise.

The reaction to my earlier post, both from comments and elsewhere, was that this weak recovery caused by fiscal austerity was not just bad luck caused by a misreading of the Eurozone crisis, but the result of a more fundamental political economy problem. We therefore need to rethink how stabilisation policy is done at the Zero Lower Bound (ZLB). Of course we also need to think about whether we should try and minimise these ZLB episodes, by either raising the inflation target, or by reformulating how monetary policy is done, or some other means. However the risk of large negative demand shocks will remain, so it would be prudent to complete the delegation of macroeconomic stabilisation policy that was begun by making the operation of interest rate policy independent of political control. Doing that would also be a good opportunity to revisit the arrangements that can ensure independence is compatible with accountability and some degree of democratic oversight.