Mediamacro myth makers fight back

This may also be the first in a series!

In a recent blog, David Smith of the Times writes

“One of the most enduring claims about the British economy in recent years is that the then coalition government abandoned austerity in 2012. It is a claim that gives comfort to those who see everything that has happened to the economy through the lens of fiscal policy. Only when austerity was abandoned in 2012, some argue, did the economy begin to recover. Unfortunately it does not fit the facts. It is a myth.”

Chris Giles of the FT tweeted: “The shocking thing about this excellent post is the misinformation that forced @dsmitheconomics to write it”.

Now the reference to myths might make you think David Smith is having a go at yours truly, but I would never be so narcissistic. I know this cannot be the case because I have never said that austerity was abandoned in 2012. In fact I cannot think of anyone who did, but clearly I’m not reading the right people. Of course this could be another example of the straw man trick: to defend position X (plan A continued) against position Y (the pace of austerity slowed), create a third position Z (austerity abandoned) which is a silly exaggeration of Y, and show that Z is false. Ergo X must be true. Remember how critics of austerity had to be wrong because they claimed a recovery would never happen.

What David concludes, of course, is that the pace of austerity slowed from 2012 onwards, which is obvious if you just look at the data. So why does he think this is such a problem for critics of austerity? Again we need a straw man: someone who “see[s] everything that has happened to the economy through the lens of fiscal policy.” Now I’m sure I have never met anyone like that, but if such a person existed then the 2013 recovery would be inexplicable, because austerity was continuing (albeit more slowly).

This is terrible stuff. Every macroeconomist besides those of David Smith’s imagination knows that the economy is influenced by all kinds of factors, or which fiscal policy is but one. So a recovery is perfectly compatible with austerity being a drag on growth, particularly if monetary policy is highly expansionary.

One way of thinking about the impact of a fiscal contraction is that it has its maximum impact on the level of GDP when it happens, but this impact dies away as other forces, like monetary policy, bring GDP back to its ‘natural’ level. Whether that is the right way to model the impact of fiscal policy in a liquidity trap is debatable, but that is how the OBR treats the impact of fiscal policy, and from his post I’m glad to see that David thinks the OBR is an authority on these matters.  

Here is a chart from this OBR document.

The orange bars show the impact the original 2010 plan would have had, and the blue bars what actually happened (and what will happen) as seen in March 2014. The blue bars are the basis for my conservative estimate that austerity cost every UK household on average £4000 worth of resources. Even though in both cases austerity continues through 2012 and 2013, the impact on growth dies away (or even becomes positive), because the negative effect of any new austerity is offset by the impact of earlier austerity dying away.

Harmful austerity does not need to be abandoned before a recovery can happen. Slowing down austerity clearly makes a recovery easier, but that is not the main reason why the mediamacro myth that ‘Plan A’ continued is important. As I wrote here: “Not making it clear that the plan had changed was a serious failure. If that call had been made, the Chancellor would have had to account for why he had allowed deficit reduction to stall, and that in turn would have established quite clearly that previous austerity had delayed the recovery.”

It really is very simple. George Osborne campaigned in 2010 that Labour’s plan to cut the deficit by half in five years was much too slow, and so began a much tougher austerity programme. More rapid deficit reduction was at the centre of that plan. But deficit reduction was allowed to slow from 2012. Why did the media not challenge Osborne on why this was happening? Why did it go along with the fiction that the plan was unchanged? The media has no problem asking Labour politicians to account for why they borrowed too much (allegedly), but when George Osborne borrows much more than he planned, having previously stressed the importance of cutting the deficit quickly, this suddenly becomes unimportant. Strange that.