Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday 19 March 2015

Fantasy macroeconomics

The prize for the biggest piece of pure fantasy yesterday must go to the Chancellor when he said this: “Today, our goal is for Britain to become the most prosperous of any major economy in the world in the coming generation, with that prosperity widely shared across our country.” In terms of a key measure of our long term prosperity - output per hour worked - we were indeed catching up with the US, France and Germany until 2008, but since then we have lost ground as productivity growth has stagnated.

But the fantasy that was most on display yesterday in commentary about the budget was the idea that the budget deficit was or is our major problem. I watched Robert Peston go into great detail about just how large the budget deficit still was (how much we were borrowing every minute - that kind of thing). I saw Financial Times editor Tony Barber describe what a hole the UK was in when the Coalition came to power, because the deficit was 11% of GDP. [1] The implication in both cases is that these numbers are so large we have to immediately focus on bringing them down.

The hole I remember from 2010 and before was the Great Recession, which in turn was caused by a financial crisis. They really were major events, which had major impacts on people, and which therefore demanded an immediate policy response. The deficit exceeding 10% of GDP had no real impact whatsoever. Interest rates on government debt stayed well below the level of the previous ten years, and over time fell further.

Here is the growth in GDP per head and the public sector net borrowing to GDP ratio going back to 1985. In the early 1990s we had a small recession as we tried to stay in the European Exchange Rate Mechanism at an overvalued exchange rate. Public borrowing rose to 7% of GDP for two years. But the economy recovered rapidly following the 1992 depreciation and associated monetary policy easing, and the deficit came back down. In 2008/9 we had a much larger recession, and as a consequence the deficit ratio rose rather more. But the key point was that this rise in the deficit in both periods was largely a response to the decline in GDP, which helped moderate the recession, and not an immediate problem in itself.

So the idea that in 2010 we were in a deep hole because of the deficit is just fantasy macroeconomics. It replaces something real (a financial crisis and deep recession) with something of little immediate consequence. The problem with living in a fantasy world but taking actions in the real world is that you make big mistakes, like starting fiscal austerity while still in a liquidity trap, which has made each UK adult and child on average at least £1,500 poorer.

For mediamacro, which inhabits the same fantasy world, it means you ignore the important issues. So we had everyone getting excited about the completely meaningless fact that the Chancellor had pencilled in an expansion in spending in 2019 and 2020. (Thank goodness for the OBR, whose use of the word 'rollercoaster' helped expose this circus.) As a result, comment largely ignored the problem of productivity stagnation, the absence of any expected growth in net trade, and more generally the persistence of macroeconomic imbalances that on earlier occasions the Chancellor had said it was vital to correct.

Martin Wolf, who thankfully is very much part of the real world, said the Chancellor had “made the best of what is, in truth, not that strong a hand”. [2] I think Martin is being too generous. The Chancellor asked us to enter a fantasy world, where the fact that living standards just might end up higher than when he came into office is regarded as a success, where employment growth that matches or exceeds output growth is regarded as a triumph, where finally achieving what are no more than average growth rates in GDP per capita during what should be a recovery phase is praised, and where reducing the deficit is all important. It is a shame that too many others seem happy to share this fantasy.

[1] In financial year 2009 the PSNB was actually 10.2% of GDP.

[2] Chris Giles, Sarah O’Connor and Vanessa Houlder at the FT have a nice graphical summary of key variables that backs this up.


  1. Why the monomania about per capita GDP? Japan's done very well on that measure, but is their economy a success?

    What about total numbers employed? What about considering the supply side shock from the greater potential workforce? What should we have done, 5mn less employed but higher productivity?

    A fantasy world, and a wonderful world, would have been current record numbers employed and higher productivity, but there are very few countries that have done that.

    1. Per capita GDP is worth knowing because what interests me - and I think most other rational economic beings, not to mention real people, is how much cake is - how many resources are - available to me.

      5 million unemployed but sufficiently high productivity is potentially - and I emphasise that - a better situation than everyone working flat out but on the bread line. In practice, it's true, we are so bad at distributing income that we have to keep people employed even when we don't need the output in order to have a way of awarding them enough money to live something approaching a decent life. But the purpose of life is not work - in my book - the purpose of work is to enable a better life.

      Is China a better place than us because they have more people (not percentages, we're talking absolute numbers) employed? If we don't have decent productivity then we can't afford the things that make life worth living - education, culture, medicine, even sports.

    2. Do you remember The Clash, too? "Career Opportunities". Great tune, lyrics. I still sing it. But we do have to grow up, eventually.

    3. We are so bad at income distribution . . . yes. The CBO in the U.S. analyzed income distribution for the U.S., $93,900 per household, about 117 milllion households in 2011, and therefore about $11 trillion income for all. That $93,900 per household while the median receives $51,000, while the median worker earns $28,000. And the wealth distribution is worse. We have the same austerity fantasy world with the GOP proposing year after year to reduce by 25% a sector of government amounting to 40% of the government. These services are not needed? They are not worth the expense? Private mechanism of support and distribution will work better?

  2. Ah yes - that FT guy's remark on last night's Newsnight. &_& Watching Labour's Chris Leslie squirming was painful too.

  3. Spoken like a true MMTer. One day, financially illiterate voters and the macro-media, will come to understand, that sovereign fiat currency issuing governments, do not have to borrow in their own currency. And, that taxes don't physically pay for anything per se. The biggest political confidence trick; played on the little people; exposed as the greatest Ponzi scheme of all time. (Acorn).

  4. My favourite comment yesterday came from Lionel Barber on the BBC, ex-FT editor, who said George Osborne had adopted a new haircut so he could look like a Roman and in so doing take the economic crisis more seriously.

    And as for BBC coverage generally, in which Larry Summers ex-student Stephanie Flanders returned to Andrew Neil's show to pass on her anti-liquidity trap knowledge from the pocket of JP Morgan Chase asset management rather than doing as she did previously from the presumably less well paid role at the BBC; the HSBC-farce at the BBC Trust; and Robert Peston who has proven to be a culpable as the rest..well, it does require the patience of Seneca for those who have to observe it all.

  5. Simon, You are completely right about the myth of a government debt problem. But do you believe the collapse in productivity, or do you think we may be underestimating output?

    1. The steady fall in core inflation certainly gives weight to the idea that we are underestimating the capacity to produce more if the demand is there. I'm also dubious about the survey evidence suggesting no spare capacity, but I have not had the time to explore this in more detail. The obvious way to settle these doubts is to expand demand and see how far we can go.

  6. It's one thing to criticise ignorant politicians and 'mediamacro' for their faulty macroeconomics, but what are we to think when the same comes from other economists? I wonder if you would like to comment on the leader in yesterday's FT from Jeffrey Sachs? [1] He's clearly no Keynesian tho' he doesn't say which church he actually belongs to. The policy differences that become apparent are not just a difference of emphasis here or there, but diametrically opposed views on something as basic as fiscal contraction in a recession - something that the generalbpublic could be entitled to expect economic theory to have a reasonably coherent view on by now. It is these fundamental contradictions that open the way for mediamacro and mendacious politicians.

    [1] UK Budget 2015: UK has reason to be cheerful but not complacent -

    1. I agree, but I would add two points. First, if you survey academic economists, they tend to be virtually unanimous that fiscal expansion will raise output in a liquidity trap. It is, after all, what the work horse macro models say. So the economists you may see in the press are a biased sample. Second, this biased sample comes not only from media bias, but from two other things - a tendency to rely too much on City economists, and a desire to always present a 'balanced' view, even when the weight of expert opinion is not balanced.

    2. It's hard to know where to start with Sachs, her uses the phrase "substantial recovery" but it's hard to see how you could use this to descibe the recent recovery. In GDP terms it looks like a very slow disappointing recovery and even worse in per capita terms. There have been more specific predictions made that haven't turned out as expected but the only thing that's really surprised has been employment, which has enjoyed a much better recovery than expected.

      A few other things are just bizzare:

      Yet Keynesians have tended to downplay the role of monetary policy, arguing that once nominal interest rates hit zero, further monetary expansion becomes futile — a theory known as the “liquidity trap”. This was mistaken: even at near-zero interest rates, monetary expansion boosts stock market valuations.

      Why would we judge the efficacy of monetary expansion on stock market valuations? That just seems like a throughly bizzare measure on which to judge a policy. The feeling I get from Sachs is that he's taken a position and is now retrospectively trying to justify that position by seizing on whatever supporting data he can get.

  7. Could I suggest that this is also a contender for prize of biggest work of fantasy:

    "When I first came here as Prime Minister five years ago, Britain and Greece were virtually in the same boat. We had similar-sized budget deficits. The reason we are in a different position is we took long-term, difficult decisions and we had all of the hard work and effort of the British people."

    David Cameron at the EU summit.

    Thank you David for saving Britain,

    1. Ari - do you have a reference for this quote?

    2. The wonder of an independent monetary policy, highly effective, even at the ZLB - although not as effective as it could have been.

    3. Welcome to the Tory fantasy world.


  8. I saw it on here - see 15.06 yesterday:

    I typed into Google to get the full quote, which I found here (a bit of an obscure source):

  9. I've been trying to work out what this 'productivity stagnation' is all about, and finding no clear answers - S Flanders seems to favour using language that hints at lazy workers, M Wolf comes out with rather mealy-mouthed stuff like "An important question is how far the reaction of a flexible labour market to policy-induced weakness in demand explains this dramatically poor productivity outcome."

    Meanwhile the article cited in fn [2] says: "The jobs boom is all the more extraordinary because the economy has grown less, not more, than the OBR thought it would. This means productivity growth has been dreadful and that has translated into very weak wage growth and a five-year fall in real pay."

    None of this helps explain the 'low productivity' phenomenon, and I think this is because it is much more an artefact than a discrete causal factor. The level of labour-productivity is after all derived from two more directly measurable quantities; 1. tital output, and 2. jobs (or hours worked).

    1. The level of total output is not attracting any surprise - an eventual recovery of something like this feeble level was pretty much what would be expected.
    2. The employment figures, on the other hand, attract adjectives like 'stunning', 'amazing', and perhaps most aptly, 'incredible'.

    A sidebar inserted into the FT article from fn[2] has this: "Given the weaker-than-expected economy, low unemployment with poor productivity and wage growth was probably a better outcome than the alternative of high unemployment with decent productivity and wage growth."

    Normally one might suppose it pretty odd to hold constant poor economic performance and then decide whether to apportion it to lots of low-productivity jobs or a smaller number of high-productivity jobs. Assuming the causal order has not been suspended, this is not a decision anyone was ever in a position to make.

    What might make sense from a political point of view would be swell the employment figures by directly fiddling them and/or their reported hours and by forcing people into hopeless attempts at self-employment or non-jobs like workfare placements in charity shops.

    The idea that the employment figures are not really what they seem appears to me the best explanation for the unbelievably high employment figures, and thence also for the unexplained failure of 'productivity'.

  10. It's clear austerity in a liquidity trap is like hammering a nail in one's foot if you have your
    own currency. Why the fantasy? Ideology (we hate the poors, in US you know who those
    folks are, history isn't pretty), morality (we profligates deserve to suffer ), class bias,
    an inability to understand varying macroeconomic conditions merit varying responses.

    But fundamentally what drives right wingers is a profund lack of empathy fuelled by narcissusism. I have wealth, I'm better than you, lemme buy political power.


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