Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday, 17 April 2015

Osborne's failure

I've mentioned before the coalition economics website, where the academic economists who analysed the Labour government's economic record for the Oxford Review do the same for the Coalition. My analysis of the Coalition's record on fiscal policy is now up.

It starts by noting three similarities between how Brown and Osborne started their time in office. First, they both made important and progressive institutional changes: Brown established the Monetary Policy Committee and Osborne set up the Office for Budget Responsibility. Second, they both established fiscal rules that improved on past practice. Third, they both started with significant fiscal contractions.

So why will history judge Osborne so much more harshly than Brown? Why did Osborne's policy cost each UK household on average at least £4,000, while Brown's (inherited) contraction had no similar cost in terms of lost resources?

The answer, of course, is that the macro contexts were very different. Brown's fiscal contraction happened when the economy was relatively strong, and interest rates were above 6%. Osborne's austerity happened when the economy was just starting a recovery from a deep recession, and interest rates were at their then Zero Lower Bound (ZLB) of 0.5%. Mainstream macroeconomic theory says that these different contexts make all the difference: when interest rates are at the ZLB, monetary policy cannot counteract the negative impact of fiscal austerity on output.

Why did Osborne ignore this basic piece of macroeconomics? Was his policy based on an alternative macro theory? A remarkable speech he gave at the RSA in April 2009 suggests not. In that speech he said that his macro framework was based on New Keynesian theory, because that theory implied monetary policy should look after macro stabilisation and fiscal policy should focus on debt control. Yet New Keynesian theory also says that monetary policy becomes ineffective at the ZLB, and cutting government spending in that situation reduces output. Incredibly the speech makes no mention of the ZLB problem, even though UK interest rates had just hit 0.5%!  

Could it be that Osborne, or his economic advisers, had simply not done their homework properly? One simple piece of evidence suggests not: his proposals for more austerity after 2015 risks making exactly the same mistake again, with interest rates still at or near their ZLB. A much more plausible explanation for his actions were that the macroeconomic risks were understood, but were put to one side for political and ideological reasons. First the possibility of hitting Labour with a populist concern about the deficit was too great a temptation to resist for a Chancellor for whom political tactics are everything. Second, austerity was a means of implementing an unpopular policy of reducing the size of the state by the back door.

Now you may cynically say that in a contest between economics and politics/ideology, politicians will always choose the latter. However much that is true or false, when that choice costs each household at least £4,000, it would be very strange if that politician survived the judgement of the electorate.  


  1. Brown will be remembered for selling gold at its historic low point and leading Britain into the largest ever crash having claimed to have ended 'boom and bust'.

    If you think the UK economy is doing that badly, try talking to the many young French staff at the technology companies around Oxford and ask them why they are here.

    1. Actually I don't think selling gold at a low price will be what Brown is remembered for. The largest estimate I have seen for how much more he could have got if he had waited until 'peak gold' is a fraction of the resources lost through Osborne's austerity. In addition, in one case you are expecting a Chancellor to successfully play the markets, while all I'm asking is for a Chancellor to take note of mainstream macro theory.

      Brown 'leading Britain into the largest ever crash' is right wing propaganda: if the Conservatives had been in power, they would have also done the same, and with worse consequences.

      I have never argued that the UK is doing worse than France, and I certainly would not want to import some of their labour market rigidities. I just think Chancellors should be accountable for when they go against mainstream opinion with disastrous results.

    2. Cheer up.
      This is looking more like a very 'microeconomic' situation rather than a macro one: public sector employee argues for more government spending. Next we will see claims that more money spent on university economists will result in better forecasting!
      You may claim that the Tories would have done the same, which may or may not be the case, but it was Brown's government that was holding the baby when it got dropped on its head, and they will be remembered for it. That's life.
      Same with the gold. It may be reasonable to argue that the govt. shouldn't be holding large gold reserves, but you look a bit of a fool if you decide to unload it at its lowest ever value.
      As for France: well, they voted-in an anti-austerity administration so it is fair to look across the channel and compare notes.

    3. "This is looking more like a very 'microeconomic' situation rather than a macro one"

      Our current problems are micro rather than macro in nature? Is that a joke? Have you never come across the terms "zero lower bound" or "liquidity trap" before?

    4. Would I be right in thinking that the people who regret the government sale of gold are the same people who celebrate every time other national assets are sold?

      Gold is virtually useless, it brings in no income at all, and its value is purely notional. However public assets such as Royal Mail, the railways, the power stations, and the water industry, are immensely valuable and will continue to be so long after all the current politicians are dead. The amount of money lost to the exchequer by the sale of those assets, in the form of dividends and profits not received, far exceeds the notional "loss" in the value of gold which would have been doing nothing but lie in bank vaults.

    5. Other examples of "virtually useless" investments that bring in no income at all (they don't pay dividends) include Berkshire Hathaway, Google and Amazon. I doubt anyone cares that Brown sold the gold, simply his spectacular ineptitude by managing to dispose of it at a 30 year low.
      As for the public assets that were privatised, you might have mentioned BG Group. It was only by freeing them of government control that huge value was added, leading to the proposed £47 billion acquisition by Shell.

    6. Stephen H, how can you compare a lump of useless metal with incredibly successful businesses which have greatly increased in value since 2003, whereas gold has only increased in price? The value of gold is just the same as it has been for centuries, while its price can vary greatly based purely on sentiment. Those businesses are creating wealth, but gold is just a drain on resources since it is expensive to mine and store.

      As for BG Group, perhaps we could at look the Norwegian Statoil company, which is still two-thirds owned by the state, and is bringing huge wealth to the people. Indeed all the middle eastern oil companies are state owned. It is utter rubbish to suggest that companies controlled by governments cannot have huge value.

    7. I was merely addressing your point that an investment that doesn't bring in any income is not necessarily useless, capital growth is also a consideration (as in my examples above). I'm no gold-bug, but it has been a reliable store of value for over 4,000 years and I doubt keeping it in the vaults of the Bank of England is a significant expense.
      Of course Statoil has brought immense wealth to Norway-they have a tiny population and huge natural gas reserves. BG group has only a small proportion of its business within the UK so is not remotely comparable to them, or Saudi Aramco. They've had to search the world for profitable Oil and Gas investments, not had them handed to them on a plate.

    8. The UK economy has not gotten back to the GDP/capita that it produced prior to the crisis so by that standard; the British economy is not doing well. But then again, that does not mean that France is doing well either.

  2. “Next we will see claims that more money spent on university economists will result in better forecasting!”

    What's so implausible about that?! Just don't like the idea of spending more money on those (lefty) university economists? Well there's a way to improve forecasting that should cheer you up: spend less money on the crack den economists!

    1. How dare you make such an erroneous accusation of our Chancellor?

      He's no economist...he's a history grad!

  3. Obsorne and his advisors do not value the well being of the unemployed as much as the wealthy special interests that support him. The wealthy spend much effort and lobbying to reduce social spending. They see fiscal policy at the ZLB as a threat to undo all they have accomplished. So of course, they reject fiscal stimulus as a path and look for more palatable (to wealthy special interests) options. The conservatives are not about helping the poor. They are about helping the wealthy make more money and capture a larger economic share. Values are important in decide which policy path to pursue.
    -jonny bakho

  4. Where do you get the £4000 number from?


    2. A fantasy number.

  5. Niche article,,,,,,Obsorne and his advisors do not value the well being of the unemployed as much as the wealthy special interests that support him. The wealthy spend much effort and lobbying

    Seputar desain rumah

  6. Prof. Wren-Lewis,

    Enough said on George Osborne - we know what you think of him.

    But what about the new example of American imperialism?

    President Obama just declared in a press conference after meeting Italian prime minister Renzi:

    Greece should collect taxes, reduce bureaucracy and flexibilize its labour market.

    That sounds like Schäuble, except that the US have not been helping Greece ( or only through the IMF, which wants its money back - no debt restructuring).

    By your standards, that is a clear case of disrespect for the democratic decisions of a sovereign people.

    So please speak out!

  7. What a crazy idea, people should be law abiding and pay taxes . Obama's comments were'nt covered much here. I think the point with Greece is it's a tiny economy mucking world markets. Imperialism.? We Americans wish Greece would just go away, peacefully.


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