Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 14 May 2015

Why are some central banks so coy about the impact of fiscal policy?


The Bank of England’s inflation report is a mine of information about what has and might happen to the UK economy. There are fifty pages on the prospects for demand, supply and inflation. Yet when it comes to fiscal policy, the latest report contains just one paragraph:
“The MPC’s projections are conditioned on the tax and spending plans outlined in the March 2015 Budget, which incorporates continued fiscal consolidation. The Institute for Fiscal Studies estimates that a little over half of the Government’s planned fiscal consolidation, relative to the March 2008 Budget, had taken place by the end of the 2014/15 fiscal year. The remaining consolidation is expected to be achieved primarily through reductions in government consumption.”
The report does not even say the obvious, which is that fiscal policy will therefore act as a significant drag on growth over the next few years. How much of a drag? The OBR estimate that past fiscal consolidation has reduced GDP by around 2%. We could therefore infer from this paragraph that future consolidation will tend to reduce future GDP by a similar amount. But this assumes that the Bank agrees with the OBR’s assessment about the past, and the Bank says nothing on this.

There is a lot more that could be said. If fiscal consolidation comes in the form of cuts to welfare rather than government spending on goods and services, will this make a difference to the demand impact? If, given the promises made during the election campaign, some of this deficit reduction does not take place, how much earlier would we expect interest rates to rise? These are at least as important as the other issues considered at length in the report.

So why the silence on the impact of fiscal policy? I guess it is deemed politically sensitive to talk about such things. But silence is not a neutral position in the current political context. Silence suggests that the demand impact of fiscal policy is somehow unimportant, or perhaps particularly uncertain: both of which the Bank knows are untrue. This is not about monetary policy makers trying to avoid treading on the toes of fiscal policy makers. It is about monetary policy makers supporting a political position which chooses to be economical with the truth about the impact of fiscal policy. The Bank being coy is the Bank colluding with those who are being economical with the truth.   

50 comments:

  1. Finally we are learning who is the lord of central bankers

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  2. It was interesting this morning that, on the back of the BoE report, the BBC radio news finally found out that the economy is not in such a good shape and that low productivity is a potential disaster. A week too late. How convenient.

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    1. How would you go about improving productivity in the service sector, by far the most dominant in our economy?

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    2. It's an unimaginative argument that relies on the "inevitability" of poor performance. International comparison would suggest that, while more difficult, productivity gains can still be made in the service sector. But, more importantly, I'd seek to invest in those parts of the economy where productivity gains are more likely - the so-called and fabled re-balancing of the economy.

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    3. To James in London, here is the example they gave in the article off the bbc:

      "Take computerised lathes, hi-tech equipment that costs hundreds of thousands of pounds to buy. You might think that British and German workers with such a piece of kit would make the same number of widgets or car parts or whatever.
      But they don't. Experts tell me there are two main reasons. German workers are more highly trained, so get more out of the machine. The second is that when it breaks down or needs reprogramming, they can do it themselves. British workers turn off the lathe and wait for an expert to come and fix it." -Jonty Bloom, BBC Business Correspondent

      So you can see the problem in the UK is clearly lazy manual labour. ;) But seriously, once again the BBC can't even look in the right direction.

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    4. But it's also important to recognise that productivity figured aren't necessarily perfectly representative of what's going on. Just because it takes the same amount of time now to produce a service or a good as it would have taken a couple of years ago, it doesn't mean that productivity is stuck at chronically low levels; the quality of the goods and services provided are increasing all the time, and productivity figures are too rudimentary to take this into account. By extension, if investment and development was to pick up, products would improve yet productivity wouldn't. Is it really that much of a problem?
      Cookie

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    5. No one understands what productivity means these days, and neither do I. It's a red herring. Jobs matter. And the brute fact is that the UK has done well, despite an increase in supply to cope with too.

      It's a curse for many people, work, but it has to be done. "Productivity" will come as long as the labour supply gets used up to the max, and beyond.

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    6. Productivity is more a function of investment than "using the labour supply to the max". But why invest when demand is low and labour supply is so high?

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  3. I had a graph somewhere of UK public expenditure and change in GDP growth rate for the years leading up to the crash.
    The two showed remarkably little correlation, let alone causality.
    Maybe the Central Bankers are following the evidence.
    MrSauce.

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    1. This comment has been removed by the author.

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    2. A correlation does not show a causality, so I fail to see how this point is valid.

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    3. If there is causality there is correlation.

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    4. There is always a correlation. The question is, what degree of correlation is there, and is it negative or positive.

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  4. Well said.

    The IFS are also party to this conspiracy of silence, as you document here:

    http://mainlymacro.blogspot.co.uk/2015/04/a-criticism-of-ifs.html

    I suspect one of the mechanisms here is career concerns.

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  5. Silly question from a non economist.

    If the Minimum wage was raised progressively in quarterly intervals to the Living Wage, what affect would that have on inflation? Bearing ion mind we are damn near in deflation? Secondly the effect of removing the tax subsidy of some welfare payments and placing it where it was created?

    As I said I am no economist and a brad stroke answer would be interesting.

    Thanks

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    1. "If the Minimum wage was raised progressively in quarterly intervals to the Living Wage, what affect would that have on inflation? "
      Not much. Inflation is mainly because of resource constraints. If you hit up on real resources and things are at full capacity or e.g. a shortage of oil.
      Wages are both a cost and money spent on sales. Business leaders often forget this.

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    2. Thank you Random, I thought so.

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    3. You could expect some as Aggregate Demand increases..however this is just a sign of a strengthened economy, and when inflation is at such low levels this is not a huge trade-off.
      The increases real national income and consumption would definitely make it worth while. And more importantly improvements to peoples living standards.
      Plus it costs the government nothing to increase minimum wage, but they will see large increases in tax returns, so it would even help shut the Tories up.

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    4. Are you two related?

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  6. I think it's fairly obvious as to where most of the deficit reduction will take place, now that the Tories have won the election and managed to get away with their policy induced GNP damage. Their thinking will be whats another few % lost in GNP growth when they can attack the poor and the sick and blame all our economic ill's on them , cut back on the hated "nanny state" and our core vote remains stable. There is also the upcoming EU referendum and the uncertainty that will produce and what effect that will have on growth till it's over.

    As for the poor productivity growth, would I be right in thinking that in a normal crash unlike 2007-8 unemployment should rise hugely as companies cut costs and get rid of staff, then they would restructure and productivity would remain at a similar level but with fewer staff. The skilled redundant staff would get picked up by new companies and expanding companies and within a couple of years we would have seen substantial productivity growth. This did not happen this time wages seem to have fallen and productivity growth also, but unemployment (even allowing for severely massaged figures) has not risen to the huge levels predicted. I'm mystified as to how this has happened. Is it because their is so little real manufacturing left.

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    1. Robert Loughrey14 May 2015 at 16:50

      No, I don't get it. Also, if productivity has flatlined, and productivity is output per worker-hour, and if employment is up, then surely output is down? Also, if productivity has flatlined, why aren't we importing much more?

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    2. If you move someone from a Government job costing £30,000 a year including all social and pension costs into a new privatised job doing exactly the same work but which only costs £25,000 a year why wouldn't productivity fall by one sixth?

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    3. Ronert Loughrey15 May 2015 at 00:28

      So productivity is not increasing because moral is low? I can relate to that: my partner kept her job, but had to sign a new contract with less pay and holiday, and plenty of people where I work had to reapply for their own jobs. But is that the solution - people are pissed off and just not working as hard? That isn't what normally happens in a recession, is it?

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    4. There are problems with zero inflation to deflation..

      Because we have no general inflation, it becomes very difficult to change job from an established position; certainly in my field changing jobs will often involve taking a pay cut. If inflation had evaporated mortgages and/or meant that annual pay rises were normal this would not be a problem.

      It's also a problem for employers - they cannot (for instance) limit pay rises to 2% and see 4-5% inflation make them more real-terms competitive if they are having problems. The only way to cut the wage bill is to sack people, and if you don't want to do that because you still need the work done, stagnate. Wages don't go down easily in nominal terms, which is another reason why deflation is bad.



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    5. Robert Loughrey15 May 2015 at 04:06

      Ah, I see. Workers are insecure and are paid less. Maybe output per pound spend on wages and salaries is up, then? So in money terms, British companies are still competitive? Because people (understanably and rightly) resist pay cuts, investment is down as well. Companies are keeping up by recruiting more people, not by investing.

      Well, that's certainly a sustainable long-term way of running the economy!

      Thanks for straightening me, together.

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    6. Robert, productivity is supposed to be the quantity of output divided by the quantity of input. Provided output is measured the same way in the privatised job as in the original job (which may not be true in practice) then in your example productivity is unchanged.

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    7. Measuring output is too difficult in a service sector economy to be sure about this. Nominal GDP is relatively simple but the deflator is very tricky to calculate to get GDP.

      Weirdly, it seems to me when I read how the ONS actually tries to calculate GDP it tries to calculate real output first, and the inflate it to get the nominal figure. But the "output" they use seem pretty flaky for the large service sector areas of our economy. I'd encourage others to read the methodology and see what they make of it. Nerdy, but vital to understand the issue.

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    8. OK, I thought I had it; it seems not. Mikep says all input, not just that of labour, is included; but since IIUC we're not measuring this in money, I don't see how that's possible. X kg of flour plus Y worker hours makes Z cakes, giving a productivity of ... well, nonsense.

      Is it that all this is supposed to be measured in money? But then (as someone above says) buying cheaper flour will increase productivity; and that doesn't seem right either. Anyway, when do you price everything - when you buy the flour, pay the workers, make the cakes, or sell the cakes?

      JiL then says none of this is measurable in the service sector anyway. So the question is, is the stagnation in productivity that Mr Carney was talking about on the radio the other day a real thing, something that maybe is difficult to measure but is actually out there in the world, or is it just a result of the (it seems to me) arbitrary decisions taken in the way productivity is defined?

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  7. Good point by SW-L. Mind, Bernanke has been dropping heavy hints that fiscal stimulus would be beneficial.

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  8. I have always wondered how independent of the government the BoE is.
    Answer: not very.

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  9. Maybe it's not, or at least not only, political partisanship, but also the drive of a bureaucracy to make itself more important. In this case, the central bank bureaucracy would like to make itself more important by pushing fiscal policy into the background.

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    1. Well, that is what bureaucracies tend to do.
      MrSauce,.

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  10. Keep the pressure on. An independent and transparent central bank should not have any hesitation in straight out stating out its view of the effect of the prospective stance of fiscal policy on GNP; obviously this is crucial.

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  11. It looks like monetarism is alive and well in the BOE. This is a bad sign - it shows what happens when a right wing government gets a clear mandate (albeit falsely as a result of FPTP). All civil servants, and even academics, will find it increasingly difficult to fight this ideology (remember what happened to those who opposed Thatcher/Reagan and the Monetarists/New-Classicalists in the 1980s/90s). The way up is to find theories and explanations that are convenient for the Government.

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  12. I've looked at the figures in terms of real govt spending, % of GDP, and borrowing requirement, and I cannot find evidence that any of these changes to public spending have a recognisable influence on GDP.
    Certainly not in the 21st Century UK economy.
    MrSauce.

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    1. Well, I'm glad that's cleared up. Should we fire all the economics professors now?

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    2. Perhaps we should ask for some more evidence for their assertions.

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    3. "and I cannot find evidence that any of these changes to public spending have a recognisable influence on GDP."

      Are you on something? There could be an argument about whether there are large multiplier effects (by historical standards) but if government, which is part of GNP expands, how can it not influence GNP? You can have crowding out effects (controversial, but maybe) but how can it not be influenced?

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    4. Try it for yourself.
      Look at the data for government expenditure and see if you can spot a correlation between changes in that and changes in the rate of growth.
      I was surprised when I saw the data. It only works if you ignore the times when it doesn't.
      "Changes in government spending do not govern changes in the rate of economic growth" seems to be a fair description of the situation.

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    5. Data please! Here's the opposite argument with some data:-

      http://www.businessinsider.com/how-bill-clintons-balanced-budget-destroyed-the-economy-2012-9

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    6. Your argument is tautologous. If G in Y accounts for say about 30 per cent of an economy's gross activity, if you expand G, so does Y, by definition. If you have four bricks and you increase the size of one of the bricks, you have more brick! (Unless you believe in insane representative agent economics (macro in a micro constraint bound framework) which argues from the standpoint that price (goods and credit price) increases immediately act to negate any overall increase in output, and/or you believe in Say's Law.) Over the long term there is a argument about whether it contributes to sustained growth - that is where differences in political views come in and really that depends how close the economy is to capacity, and more importantly than that, on the "quality" of the G increase - ie is it going into productive investment that pushes potential output in the future out further. However in current conditions this question should not even arise.

      But in the short term at least, an increase in G can only increase Y.

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    7. There is an old literature on this (I first came across it in a book written in about 1970). There was a very nice diagram to illustrate why correlations of acutal Y and G tell you nothing about the effects of G on Y. Unfortunately I am hopeless at drawing diagrams in blog replies, so will do my best with words. Consider the case where private spending fluctuations would, on rheir own, lead to fluctations in Y. The government then does perfect counter-cyclical spending to completely off-set the private spending swings. Y is then constant, and there is zero correlation between measured actual Y and G. (The correlation between a constant and a variable is zero by the defintion of correlation.) G has had powerful effects but this does not show up in the correlation.
      In this very simple example you can get positive correlations of Y and G if the government over-does it and more than compensates for the swings in private private spending; and negative correlations if the government does not do enough (so that its spending reduces the magnitude of the swings but does not fully offset them).
      Basically, to decide on the effects of government policy, you have to know (or correctly estimate) what would have happened to Y in the absence of the government policy. Almar

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  13. Mark Carney was on R4 this morning. I was driving so a bit distracted, but if I heard it right he was clear on this point (to my surprise) that austerity was a drag on growth, I think he confirmed it twice.

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    1. Let Mark Carney try telling that to the electorate who voted Tory and haven't a clue their sovereign government can create money in its own right and doesn't need to automatically reflux all it creates. They think government spending comes out of their individual or household budgets. They fell for the Tories' "perception scam" poster like lab rats being let out of their cages for a day's holiday "Don't let SNP grab your cash."

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  14. Working age employment is above pre-crash levels while inflation remained above target for 4 years after 2009. Meanwhile your colleage finds a positive market reaction to Conservative victory despite Labour commitment to less drastic deficit reduction. Why is belief that UK output is not far from potential (and so there is no large multiplier) such an unreasonable position?

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2605533

    http://noahpinionblog.blogspot.com.es/2015/05/department-of-huh-yourself-british.html

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  15. Shame that politician's don't understand modern money,functional finance and appreciate their role in facilitating economic growth. Benefit for BOE they'd get what they want-positive inflation and increased rates.

    But then banks wouldn't rule the world and don't want that idea to disseminate!

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  16. Christine Desan, the Harvard Law professor, has a lot to say about how the current partnership in money creation between a sovereign government and the licensed private banks with the central bank staff torn and confused which of the two agencies to support.

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2321313

    She has a paperback version of her book "Making Money" coming out shortly which will hopefully shed some light on how the confusion of roles can best be sorted out.

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  17. Do you think the Tories will go for low growth that will arise from expenditure cuts? My guess is that they will go for tax cuts which will stimulate GNP growth.

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  18. "The OBR estimate that past fiscal consolidation has reduced GDP by around 2%. We could therefore infer from this paragraph that future consolidation will tend to reduce future GDP by a similar amount. "

    I've been reading econblogs for a while now but this kind of thing still bothers me.

    Don't conservatives (or their enablers) understand that if they waited to consolidate until after they had captured that 2 percent of GDP, then they could, say, use the extra revenue earned from the extra 2 percent of GDP to balance out cuts to the taxes on the rich and banks?

    Or is it just that they want smaller government and lower taxes no matter the cost to general prosperity?

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  19. The Tory victory should not be seen as a vindication of austerity. Not from an economic viewpoint anyway. C4 people interviewed working class people who voted Tory and asked them why. The answer is they feel more prosperous and that there are more jobs around. They see things getting better. For them it meant austerity has worked. However what economists need to explain with evidence, which then left wing parties need to explain (with evidence, not silly models that people will not trust) to the media and the electorate, is that austerity policies during a recession are not the best means to effect recovery. You need to delink recovery and austerity. Get it out of people's mindsets.

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