Going backwards on fiscal rules

I was preoccupied when it first came out, but I wanted to note the excellent discussion by Jonathan Portes of the government’s new fiscal rules. It draws heavily on our joint paper on the same subject. (The published conference volume version is now available online for those with access: working paper version here.) Jonathan gives a typically measured analysis, and in my opinion the analysis is fully consistent with the sentiments expressed in the letter I discuss here.

Before some you say what’s new, note that in terms of the form of the rule, our paper and Jonathan’s discussion is rather supportive of the framework that Osborne introduced in 2010 as a way of conducting fiscal policy in normal times. Remember that this aimed to hit a rolling target for the cyclically adjusted current balance within five years. (The target happened to be zero, but there is no reason why the target could not be a number other than zero for the surplus or deficit.) The big problem was to apply this rule in a situation when interest rates were at their lower bound. That aside, the rule makes a lot of sense because it exerts some control while still allowing the deficit to be a shock absorber, which is what economic theory tells us it should be.

As Jonathan points out, and as I have discussed in earlier posts, Osborne’s new surplus rule goes backwards in two major ways. First, it is for the total deficit rather than the current balance, so it puts a squeeze on investment just at a time that investment should be high. (Aside to journalists: I cannot recall reading a single economist who disagrees that now is the time to increase public investment.) Second, even with the get-out clause on growth, the new rule is likely to make the deficit much less of a shock absorber, and so lead to unnecessary volatility in taxes or spending.

The question that naturally arises is how could a Chancellor replace his own (normal times) good rule with such a poor rule? A lot of the credit for the good rule should probably go to Rupert Harrison, and no doubt his background at the IFS probably helped here too. (Even more credit should be laid at his door for the establishment of the OBR.) Harrison has now left, but not before the surplus rule was proposed, so the puzzle still remains, particularly as Harrison must know that in economic terms his/Osborne’s original rule is clearly superior to the new one.

The simple answer is politics. All too often, Osborne’s budget decisions seemed to have been designed to embarrass the opposition (for which, I should add, the opposition have only themselves to blame). Short term political expediency once again triumphs over sensible long term economics. This is one reason we have independent central banks. It also seems to be another example of the failure of the knowledge transmission mechanism that I talked about here.

On this occasion I’m inclined to put some of the blame for this failure on academics. There is quite a bit of academic research which has relevance to fiscal rules, but few academics have tried to translate this into practical knowledge that governments can use. This in turn is because there is no incentive for them to do so: papers like Jonathan and mine are not the kind of thing that normally gets into the top journals. I have always thought that this is an obvious gap which fiscal councils like the OBR could fill, but at present the OBR has no remit to do so.     

The day macroeconomics changed

It is of course ludicrous, but who cares. The day of the Boston Fed conference in 1978 is fast taking on a symbolic significance. It is the day that Lucas and Sargent changed how macroeconomics was done. Or, if you are Paul Romer, it is the day that the old guard spurned the ideas of the newcomers, and ensured we had a New Classical revolution in macro rather than a New Classical evolution. Or if you are Ray Fair (HT Mark Thoma), who was at the conference, it is the day that macroeconomics started to go wrong.

Ray Fair is a bit of a hero of mine. When I left the National Institute to become a formal academic, I had the goal (with the essential help of two excellent and courageous colleagues) of constructing a new econometric model of the UK economy, which would incorporate the latest theory: in essence, it would be New Keynesian, but with additional features like allowing variable credit conditions to influence consumption. Unlike a DSGE it would as far as possible involve econometric estimation. I had previously worked with the Treasury’s model, and then set up what is now NIGEM at the National Institute by adapting a global model used by the Treasury, and finally I had been in charge of developing the Institute’s domestic model. But creating a new model from scratch within two years was something else, and although the academics on the ESRC board gave me the money to do it, I could sense that some of them thought it could not be done. In believing (correctly) that it could, Ray Fair was one of the people who inspired me.

I agree with Ray Fair that what he calls Cowles Commission (CC) type models, and I call Structural Econometric Model (SEM) type models, together with the single equation econometric estimation that lies behind them, still have a lot to offer, and that academic macro should not have turned its back on them. Having spent the last fifteen years working with DSGE models, I am more positive about their role than Fair is. Unlike Fair, I want “more bells and whistles on DSGE models”. I also disagree about rational expectations: the UK model I built had rational expectations in all the key relationships.

Three years ago, when Andy Haldane suggested that DSGE models were partly to blame for the financial crisis, I wrote a post that was critical of Haldane. What I thought then, and continue to believe, is that the Bank had the information and resources to know what was happening to bank leverage, and it should not be using DSGE models as an excuse for not being more public about their concerns at the time.

However, if we broaden this out from the Bank to the wider academic community, I think he has a legitimate point. I have talked before about the work that Carroll and Muellbauer have done which shows that you have to think about credit conditions if you want to explain the pre-crisis time series for UK or US consumption. DSGE models could avoid this problem, but more traditional structural econometric (aka CC) models would find it harder to do so. So perhaps if academic macro had given greater priority to explaining these time series, it would have been better prepared for understanding the impact of the financial crisis.

What about the claim that only internally consistent DSGE models can give reliable policy advice? For another project, I have been rereading an AEJ Macro paper written in 2008 by Chari et al, where they argue that New Keynesian models are not yet useful for policy analysis because they are not properly microfounded. They write “One tradition, which we prefer, is to keep the model very simple, keep the number of parameters small and well-motivated by micro facts, and put up with the reality that such a model neither can nor should fit most aspects of the data. Such a model can still be very useful in clarifying how to think about policy.” That is where you end up if you take a purist view about internal consistency, the Lucas critique and all that. It in essence amounts to the following approach: if I cannot understand something, it is best to assume it does not exist.

A sense of identity

Denis Snower has a provocative (at least for me) piece in Süddeutsche Zeitung in which he writes as follows:

“When the American economist and Nobel laureate Paul Krugman says that the Eurogroup requirements for Greece go “beyond harsh into pure vindictiveness, complete destruction of national sovereignty, and no hope of relief”, he does not derive his judgment from some firmly established economic theorem. When Joseph Stiglitz, another American Nobel laureate, says “What has been demonstrated is a lack of solidarity by Germany”, this is not an implication from some piece of analysis in his textbook. When five leading economists (Thomas Piketty, Jeffrey Sachs, Dani Rodrick, Heiner Flassbeck and Simon Wren-Lewis) write an open letter to Chancellor Angela Merkel, saying that “Right now, the Greek government is being asked to put a gun to its head and pull the trigger,” their perception does not come from rigorous theoretical and empirical analysis. Rather they are all expressing their feelings, which arise from their implicit sense of identity.”

Speaking for myself, I would disagree with the idea that our sentiments, however forcefully put, do not come from rigorous theoretical and empirical analysis. Greece is not the first country to borrow too much. As Jeffrey Sachs sets out here [1], examples from history (involving Latin America, Poland, Russia and Germany herself) show that “believing that indebted sovereign governments should always service their debts is a good working principle nine-tenths of the time, but can be a disaster the tenth time around. We must not push societies to the breaking point, even when they have only themselves to blame for their indebtedness.”

The theoretical analysis comes from not seeing this as just a zero sum game: as just a distributional struggle between Greece and her creditors. As a result of austerity, for every extra Euro that the creditors obtain right now from Greece, Greece loses resources that could amount to 4 Euros. (See here, footnote 2.) There are good macroeconomic reasons for believing that if this transfer to creditors is postponed, the cost to Greece will be much less. As is often the case with the austerity that the Troika demands, it is not evenly spread among the population, and the physical and mental health of Greek citizens has suffered as a result. Perhaps that knowledge influences the language that I and others have used, but it is a big mistake to believe that this passion is not firmly grounded in macroeconomic analysis and evidence.

Snower wants to play the sensible centrist. Unfortunately the current situation is not symmetrical. One side has all the power. One side has been dictating what has happened in Greece for the last five years. When we wrote “Right now, the Greek government is being asked to put a gun to its head and pull the trigger” I think that is a pretty accurate description of the politics. Should the five of us who sent an open letter to Merkel have done the same to Tsipras? What would it have said exactly: best to give in now because the longer you resist the more you will be punished by the Troika?

In the media outside Greece, the discussion is always portrayed as the Eurozone governments lending Greece yet more money. Yet Greece is now in approximate primary surplus, so the negotiations were really all about how quickly the Troika should be paid back. If economists can do nothing else, they should at least make this point in public.

I understand that it is difficult for some economists to go against the nationalist feeling in Germany and other countries. But if your investment advisor had encouraged you to buy some overseas financial asset that later turned out to be worthless, would you refrain from criticising them just because they shared your nationality? Economists in Germany and elsewhere need to start asking awkward questions of their politicians. Why was it necessary for these politicians to use their voters money to bailout the banks and others who had foolishly lent to previous Greek governments? Why, when it was obvious to everyone in 2015 that Greece could not repay all its debt, did the Eurozone group refuse to allow debt relief to be part of the negotiations? And of Schäuble in particular, is it really right that Greece is used as an example so that he can impose his financial will on other Eurozone countries?

Dennis Snower may be correct that what I write about Greece expresses my identity. It reflects my identity as a macroeconomist, and hopefully my humanity in understanding the serious damage that bad macroeconomic decisions can have.

[1] Sachs is writing following a response to our original letter to Merkel from Dr. Ludger Schuknecht, senior economist at the German Finance Ministry.

Economic credibility

The UK’s Labour leadership election has become a two horse race: Jeremy Corbyn on the left, versus ABC. I must admit that it took me a bit of time before I realised who ABC was - it is Anyone But Corbyn. It is quite an achievement not only to become the candidate everyone is talking about, but also to be able to define your opponent as well. The last time I can remember that happening was - well, the 2015 UK general election maybe!

Anyway, a constant refrain of ABC is that Labour can only win if it has economic credibility, with the implication that Corbyn’s economics are a bit wacky. As I argued here, some of Corbyn’s macro proposals are misconceived, and if the implication of them is that the Bank of England would lose its independence then they also go against the view of most mainstream macroeconomists. That, by the way, is why I did not sign this letter, even though I agree wholeheartedly that “his opposition to austerity is actually mainstream economics”.

In the last paragraph I played a little trick that I hope most of you would not have noticed, and that is to equate ‘economic credibility’ with ‘mainstream (macro)economics’. If that seems reasonable to you, think about the following. In 2009, most of the world was following mainstream economics in undertaking a fiscal stimulus to combat the impact of the financial crisis. But in the UK a certain politician decided to ignore ‘economic credibility’, and instead proposed doing the opposite: what has subsequently become known as austerity.

What was the intellectual basis of his departure from economic credibility? Could it have been that fiscal contractions were actually expansionary, an idea that certainly qualifies a whacky. Was it the idea that the central bank, by using a completely untried and untested instrument, had everything under control? Or was it something else. The honest answer is we do not know, which is interesting in itself. But what is absolutely clear, based on surveys and other evidence, is that his advocacy of fiscal contraction in 2009 went against what most macroeconomists thought were the implications of their discipline.

You know the rest of the story. By departing from mainstream macroeconomics, George Osborne arguably won not one but two elections. Does his example show that there is nothing wrong with departing from ‘credible economics’ - it could even win you elections? That is perhaps the lesson some in the Corbyn camp would like to draw. It certainly suggests that there is very little relationship between policies that have ‘economic credibility’ and mainstream economics. Economic credibility, as used by politicians and the media, seems to be something rather different. As Chris Dillow suggests, it can mean acceptable to the Westminster-media Bubble, but that in turn may derive from some concoction of views that serve dominant political interests, and in macro the views of the financial sector and central banks.

If you want a non-macro example, consider the minimum wage. Setting the right level for this is a delicate balance, requiring all the empirical knowledge that labour economists have gleaned. In the UK we have an institution, the Low Pay Commission, to get this judgement right. That same George Osborne threw all that aside in his last budget because it was politically convenient to do. Did he get berated from all quarters for not following ‘credible economics’? Of course not.

Unfortunately, I think ABC are right that something called economic credibility matters a great deal when it comes to winning elections. Also unfortunately, I think they do not realise that economic credibility is something that gets defined in a complex social and political process, and can (and currently does) have very little to do with the economics taught in universities. Right now, in the UK and elsewhere, I think the political right understands that, but the political left of whatever variety does not.

Reform and revolution in macroeconomics

Mainly for economists

Paul Romer has a few recent posts (start here, most recent here) where he tries to examine why the saltwater/freshwater divide in macroeconomics happened. A theme is that this cannot all be put down to New Classical economists wanting a revolution, and that a defensive/dismissive attitude from the traditional Keynesian status quo also had a lot to do with it.

I will leave others to discuss what Solow said or intended (see for example Robert Waldmann). However I have no doubt that many among the then Keynesian status quo did react in a defensive and dismissive way. They were, after all, on incredibly weak ground. That ground was not large econometric macromodels, but one single equation: the traditional Phillips curve. This had inflation at time t depending on expectations of inflation at time t, and the deviation of unemployment/output from its natural rate. Add rational expectations to that and you show that deviations from the natural rate are random, and Keynesian economics becomes irrelevant. As a result, too many Keynesian macroeconomists saw rational expectations (and therefore all things New Classical) as an existential threat, and reacted to that threat by attempting to rubbish rational expectations, rather than questioning the traditional Phillips curve. As a result, the status quo lost. [1]

We now know this defeat was temporary, because New Keynesians came along with their version of the Phillips curve and we got a new ‘synthesis’. But that took time, and you can describe what happened in the time in between in two ways. You could say that the New Classicals always had the goal of overthrowing (rather than improving) Keynesian economics, thought that they had succeeded, and simply ignored New Keynesian economics as a result. Or you could say that the initially unyielding reaction of traditional Keynesians created an adversarial way of doing things whose persistence Paul both deplores and is trying to explain. (I have no particular expertise on which story is nearer the truth. I went with the first in this post, but I’m happy to be persuaded by Paul and others that I was wrong.) In either case the idea is that if there had been more reform rather than revolution, things might have gone better for macroeconomics.

The point I want to discuss here is not about Keynesian economics, but about even more fundamental things: how evidence is treated in macroeconomics. You can think of the New Classical counter revolution as having two strands. The first involves Keynesian economics, and is the one everyone likes to talk about. But the second was perhaps even more important, at least to how academic macroeconomics is done. This was the microfoundations revolution, that brought us first RBC models and then DSGE models. As Paul writes:

“Lucas and Sargent were right in 1978 when they said that there was something wrong, fatally wrong, with large macro simulation models. Academic work on these models collapsed.”

The question I want to raise is whether for this strand as well, reform rather than revolution might have been better for macroeconomics.

First two points on the quote above from Paul. Of course not many academics worked directly on large macro simulation models at the time, but what a large number did do was either time series econometric work on individual equations that could be fed into these models, or analyse small aggregate models whose equations were not microfounded, but instead justified by an eclectic mix of theory and empirics. That work within academia did largely come to a halt, and was replaced by microfounded modelling.

Second, Lucas and Sargent’s critique was fatal in the sense of what academics subsequently did (and how they regarded these econometric simulation models), although they got a lot of help from Sims (1980). But it was not fatal in a more general sense. As Brad DeLong points out, these econometric simulation models survived both in the private and public sectors (in the US Fed, for example, or the UK OBR). In the UK they survived within the academic sector until the latter 1990s when academics helped kill them off.

I am not suggesting for one minute that these models are an adequate substitute for DSGE modelling. There is no doubt in my mind that DSGE modelling is a good way of doing macro theory, and I have learnt a lot from doing it myself. It is also obvious that there was a lot wrong with large econometric models in the 1970s. My question is whether it was right for academics to reject them completely, and much more importantly avoid the econometric work that academics once did that fed into them.

It is hard to get academic macroeconomists trained since the 1980s to address this question, because they have been taught that these models and techniques are fatally flawed because of the Lucas critique and identification problems. But DSGE models as a guide for policy are also fatally flawed because they are too simple. The unique property that DSGE models have is internal consistency. Take a DSGE model, and alter a few equations so that they fit the data much better, and you have what could be called a structural econometric model. It is internally inconsistent, but because it fits the data better it may be a better guide for policy.

What happened in the UK in the 1980s and 1990s is that structural econometric models evolved to minimise Lucas critique problems by incorporating rational expectations (and other New Classical ideas as well), and time series econometrics improved to deal with identification issues. If you like, you can say that structural econometric models became more like DSGE models, but where internal consistency was sacrificed when it proved clearly incompatible with the data.

These points are very difficult to get across to those brought up to believe that structural econometric models of the old fashioned kind are obsolete, and fatally flawed in a more fundamental sense. You will often be told that to forecast you can either use a DSGE model or some kind of (virtually) atheoretical VAR, or that policymakers have no alternative when doing policy analysis than to use a DSGE model. Both statements are simply wrong.

There is a deep irony here. At a time when academics doing other kinds of economics have done less theory and become more empirical, macroeconomics has gone in the opposite direction, adopting wholesale a methodology that prioritised the internal theoretical consistency of models above their ability to track the data. An alternative - where DSGE modelling informed and was informed by more traditional ways of doing macroeconomics - was possible, but the New Classical and microfoundations revolution cast that possibility aside.

Did this matter? Were there costs to this strand of the New Classical revolution?

Here is one answer. While it is nonsense to suggest that DSGE models cannot incorporate the financial sector or a financial crisis, academics tend to avoid addressing why some of the multitude of work now going on did not occur before the financial crisis. It is sometimes suggested that before the crisis there was no cause to do so. This is not true. Take consumption for example. Looking at the (non-filtered) time series for UK and US consumption, it is difficult to avoid attaching significant importance to the gradual evolution of credit conditions over the last two or three decades (see the references to work by Carroll and Muellbauer I give in this post). If this kind of work had received greater attention (which structural econometric modellers would almost certainly have done), that would have focused minds on why credit conditions changed, which in turn would have addressed issues involving the interaction between the real and financial sectors. If that had been done, macroeconomics might have been better prepared to examine the impact of the financial crisis.

It is not just Keynesian economics where reform rather than revolution might have been more productive as a consequence of Lucas and Sargent, 1979.

[1] The point is not whether expectations are generally rational or not. It is that any business cycle theory that depends on irrational inflation expectations appears improbable. Do we really believe business cycles would disappear if only inflation expectations were rational? PhDs of the 1970s and 1980s understood that, which is why most of them rejected the traditional Keynesian position. Also, as Paul Krugman points out, many Keynesian economists were happy to incorporate New Classical ideas. 

People's QE and Corbyn’s QE

Politicians can be adept at co-opting attractive sounding terms to their own cause, even when they distort their meaning while doing so. Osborne announced what was in reality a partial but large increase in the minimum wage, but he called it a ‘living wage’. This was especially devious, as calculations of the actual living wage take into account the tax credits that Osborne was at the same time cutting.

Is Labour leadership contender Jeremy Corbyn’s ‘Peoples QE’ an example of the same thing? It is certainly true that the way that some macroeconomists, including myself, have used the term is different from Corbyn’s idea. For us Peoples QE is just another term for helicopter money. Helicopter money was a term first used by that well known radical Milton Friedman. It involves the central bank creating money, and distributing it directly to the people by some means. It is a sure fire way [1] for the central bank to boost demand: what economists sometimes call a money financed fiscal stimulus.

The idea has been recently revived, most prominently in the UK by Adair Turner, because of the failure of conventional monetary policy (changing interest rates) to bring a quick end to the Great Recession, which in turn is because governments were undertaking fiscal austerity (a bond financed fiscal contraction) rather than fiscal stimulus. In contrast central banks in Japan, the US and UK, and now the Eurozone, have been creating money to buy financial assets (mainly government debt), which is called Quantitative Easing (QE). Hence the term People’s QE for helicopter money: instead of the central bank creating money to buy assets, it creates money and gives it to the people.

The genesis of Corbyn’s QE seems rather different. Corbyn adviser Richard Murphy had previously suggested what he called a Green Infrastructure QE, which is that a “new [QE] programme should buy the new debt that will be issued in the form of bonds by the Green Investment Bank to fund sustainable energy, local authorities to pay for new houses, NHS trusts to build new hospitals and education authorities to build schools.” This in turn is related to two ideas: first a near universal view among macroeconomists that public sector investment in infrastructure should be rising not falling when interest rates are low and labour is cheap, and second that a National Investment Bank (NIB) might be useful in helping to encourage private sector investment. (See, for example, the recommendations of the LSE growth commission.)

The main difference between helicopter money and Corbyn’s QE therefore seems to be where the money created by the central bank goes: to individuals in the form of a cheque from the central bank, or to financing investment projects. I think that is wrong, and to see why we need to ask an obvious question: what is this policy innovation designed to achieve. I think it is here that confusion has arisen.

As I noted above, the idea behind helicopter money is to provide a tool for the central bank to use when interest rate changes are no longer possible or effective. With an independent central bank, that means that they, not the government, get to decide when helicopter money happens. In contrast, if your goal is to increase either public or private investment (or both) for a prolonged period, then its timing and amount should be something the government decides. While QE is hopefully going to be something that is unusual and rare, the goal of an investment bank is generally thought to be more long term, and not something that only happens in severe recessions.

For that reason, Corbyn’s QE looks like one of those ideas that is superficially attractive because it seems to kill two birds with one stone, but on reflection turns out to be a bad idea. If we want to keep an independent central bank we do not want the government putting the bank under pressure to do QE because the government wants more investment, and if that does not happen we do not want the central bank deciding whether extra investment happens. Indeed some of those who dislike the idea of helicopter money have already been using Corbyn’s QE to say ‘I told you helicopter money was a slippery slope that would lead to the end of central bank independence’.

However I think it is unfair and unproductive to leave it there. Suppose that a NIB is created, not on the back of QE but using more conventional forms of finance. (If the government wants to encourage it, just directly subsidise that finance with conventional borrowing. Don’t be put off doing so by deficit fetishism.) Suppose we also like the concept of helicopter money - not for now, but for the next time interest rates hit their lower bound and the central bank wants more stimulus. In those circumstances, it might well make sense for helicopter money to be used not only to send cheques to individuals, but also to bring forward investment financed by the NIB, or public sector investment financed directly by the state. If those investment projects could get off the ground quickly, and crucially would not have happened for some time otherwise, then what I have elsewhere described as ‘democratic helicopter money’ would make sense. [2] This is because investment that also boosts the supply side is likely to be a far more effective form of stimulus than cheques posted to individuals.

So one day, this form of Corbyn’s QE could happen. But we need to get the idea of helicopter money, and the need for public investment and a National Investment Bank, accepted in their own right first. Putting the two ideas together right now is misconceived, and is in danger of discrediting two potentially good ideas.

[1] Unless you believe in complete Ricardian Equivalence

[2] When I put forward the idea of ‘democratic helicopter money’ here to Tim Harford, Tim responded that he thought it was probably the most radical and politically infeasible idea of those he had canvassed. If Corbyn wins, I will have pleasure in reminding him of that!  

German Self-Interest

Michael Burda from Berlin’s Humboldt University has an interesting article in the Royal Economic Society newsletter, which is critical of views that I and others have expressed about the ‘problem with German (macro)economics.’ The key argument Michael Burda wants to make is that there is nothing peculiar or unusual about German economics, and what many of the critics interpret as either economic ignorance or distinctiveness is actually self-interest. To quote from his final paragraph: “It is not ordoliberal religion, but a mixture of national self-interest and healthy mistrust informed by experience that guides German economic policy today.”

Often trying to decide whether policies are the result of self-interest or particular ideas is difficult because both explanations fit the facts. What we really need are examples of German economic policy which follow self-interest but not dominant ideas, or vice versa. Now some might suggest ‘bailing out’ Greece and other periphery countries was a clear example, where the idea of European solidarity triumphed over self-interest. Unfortunately that will not work: the fact that Greece in particular did not default in 2010 and had only limited default in 2012 was in part to protect the interest of other EU banks. You could plausibly argue that Greece has suffered precisely because of German and other EU countries' self-interest.

In fact in many ways Germany has done rather well out of the EZ crisis. Henning Meyer points us to a study which suggests that, as a result of the crisis and Germany’s ‘safe haven’ status, the German government has saved more than E100 billion from 2010 to 2015 in debt interest. As Henning notes, this has helped Germany ‘set an example’ on deficits without having to do anything too painful. That is slightly more than its total loss if Greece completely defaults. It has also not done badly as a result of the profits the ECB has made on its lending.

Perhaps the largest benefit Germany has received from the Eurozone has been as a result of undercutting its fellow members around ten years ago. Everyone knows about the ‘excess inflation’ in the periphery during those years, but the story of insufficient wage inflation in Germany at the same time is not often told. This policy - which if it had occurred via exchange rates rather than domestic inflation would be called beggar my neighbour - may well have been accidental, but it is a key reason why Germany is the only Eurozone economy that has not suffered since 2010. Indeed, one interesting explanation of the general lack of interest in using fiscal policy for demand management in Germany is that for some time the country has been part of a fixed exchange rate system in which, with its particular wage bargaining system, it can fairly easily boost demand by changing domestic inflation.

What about the pressure from Germany on the ECB: first not to undertake the OMT programme in September 2012 which ended the non-Greek crisis, and then not to undertake QE? That is generally put down to extreme fears of inflation and fiscal dominance of monetary policy in Germany. Unfortunately it is also been in Germany’s self-interest. For example, if the ECB had been able to keep to its 2% inflation target, the earlier undercutting of its neighbours would have had to result in a subsequent period of German inflation above 2%. However Germany may well avoid this outcome as a result of Eurozone deflation, so that countries outside Germany will bear the cost of correcting the German competitiveness problem.

That self-interest is key to German policy gets important support from 2009 when alongside other counties Germany enacted a form of countercyclical Keynesian policy. Here we have a clear case where self-interest appeared to win out over a prevalent distrust of countercyclical fiscal policy.

In some senses I’m attracted to Michael Burda’s hypothesis. I once believed that the “problem with German macroeconomic policy is not that it is acting in the national interest, or otherwise, but that it is based on a discredited and harmful set of ideas”. But in my recent discussion on why these discredited ideas persisted, while I threw doubt on some popular accounts, I still failed to come up with a convincing story. There may also be an element of false optimism in focusing on belief in poor economic ideas rather than self-interest, if you also think (hope?) that these beliefs can be more easily changed.

For much the same reason I also think it is futile to try and convince Germany that it should embark on fiscal expansion ‘for the sake of the rest of the Eurozone’, partly because it contradicts self-interest, but also because Eurozone deflation means that we need fiscal expansion not just in Germany, but the whole of the Eurozone, so that ECB interest rates can be lifted above their lower bound. The problem over the last few years has not just been austerity in Germany, but austerity in the Eurozone as a whole.

So perhaps it is all just self-interest. But if that means there is nothing unusual about German economics, it does not let German economists off the hook. Germany was central to creating the second Eurozone recession through its insistence on fiscal austerity everywhere, together with unhelpful pressure on the ECB. Germany was also central in imposing harmful debt levels and austerity on Greece. Mainstream economics tells us this, but few German economists have been prepared to say so in public. German Keynesians who are involved in the policy debate that I have talked to tell me the prevailing climate is definitely anti-Keynesian. It is not the job of German academics to stay quiet about what mainstream macroeconomics tells us just because doing so suits the national interest.

The Corbyn Phenomenon

For readers not in the UK, some background. When Ed Miliband resigned as Labour leader after the 2015 election defeat, the election process for a new leader went like this. You needed 35 MPs (members of parliament) to nominate potential successors, and there would then be a contest over a few months before party members got to vote to choose one of the nominated candidates as leader. 3 people got the required number of MPs to nominate them, but the candidate from the left - Jeremy Corbyn - did not have enough MPs. Some MPs felt it would be good for balance to have someone from the left standing, so they switched their nominations in order that he too got the required 35.

From this you will gather that the left of the Labour party is pretty weak in parliament. It was also thought to be weak among Labour party members: the candidate of the left in the elections of 2010, Diane Abbott, received little support from the membership. So the general expectation was that Corbyn - who is not a particularly charismatic speaker - would also get little support this time. This expectation has proved completely wrong: polls put him in front, his meetings have been attracting growing audiences, and senior party figures are now panicking that he might actually win (in a similar manner to the reaction of Republican grandees to Trump winning their nomination).

Perhaps as a result, a few people have asked me to write about Corbyn’s macroeconomic policies - in some cases in the expectation that I would rubbish them, and in other cases in the hope that I would provide support. But the real question people should ask first is why is Corbyn proving to be so popular. It is nonsense to suggest that the Labour party membership has suddenly become markedly more left wing than it used to be. Corbyn’s popularity has much more to do with how the party in parliament has responded to both election defeats.

On issues like welfare, immigration, business or inequality, you can see Labour as having two impulses: one to go with its natural inclination, and another to try and woo the floating middle or working class voter whose views seem to be nearer those of the Daily Mail or Sun respectively (i.e. much more regressive). In terms of policy, this tended to produce either inoffensive emptiness, focusing on small differences from the government, or simple right wing appeasement. But perhaps more importantly, in terms of style it produced a kind of defensiveness where the chief goal of their leaders was to avoid anything that could be used against them by the right wing press. And not without reason: when Miliband gave a thoughtful speech where he talked about how you could have irresponsible capitalism that just went for the quick buck whatever the long term or social costs, he was forever after dubbed anti-business. This resulted in an opposition seemingly devoid of any clear policy message.

The issue of austerity is indicative. Labour have never adopted a clear anti-austerity line, even during the 2010-11 period of acute cuts. This is because they knew that much of the press would label this as fiscal irresponsibility, and that the BBC follows the lead of the press and the financial markets on these things. Their actual proposals in the 2015 elections involved far fewer cuts than Osborne promised, but because they were desperate to appear to be ‘tough on the deficit’, they either gave out a confused message or tried to talk about other things. Crucially, they failed to defend their record in government. As a result of their 2015 defeat, many senior party figures are now suggesting it is best for Labour to essentially follow Osborne’s macro plans.

The reaction of most of the parliamentary party to the 2015 defeat seems to be that the pre-2015 strategy was right in principle but had just not focused enough in placating the marginal English voter, which they believe means more appeasement and shifting further to the right. The party membership seems to have reacted very differently to the 2015 defeat. The membership appears to believe that the pre-2015 strategy has clearly failed, and it is time to start talking with conviction about the issues you believe in. This is exactly what Jeremy Corbyn does: he is a conviction politician, who is not prepared to try and be someone else to win votes.

Does that mean the choice is between arguing for your convictions and losing or trying to appease the right wing press and maybe winning? No, there is a way through this dilemma, but it is a way that is alien to most of those in the Labour party, and that is to spend much more time thinking about political spin. Labour lost the election because they lost the battle of spin. Labour did not lose in 2015 because they were anti-business, but because they were perceived as anti-business. They did not lose in 2015 because they had been fiscally irresponsible in government, but because they were perceived to be. They did not lose Scotland because their policies were damaging to Scotland, but because they were perceived to be.

Again, lets use fiscal policy as an indicative example. Labour lost because they were perceived to have been, and perceived to continue to be, fiscally irresponsible. That perception did not just arise because of a biased press or bad luck, but also because of good political judgement by Osborne and bad judgement by Miliband and Balls. Before the financial crisis it was generally thought popular support for a higher level of public spending was too strong, which is why the Conservatives had pledged to match Labour’s spending plans. But Osborne was quick to see that the recession changed things, because he could attempt to blame Labour for the deficit that was bound to arise as a result of the recession, and use deficit reduction to achieve their political goal of a smaller state. Labour’s counter to this in the first few years of the coalition government was to focus on the stalled recovery, but that in contrast was poor political judgement because eventually the economy was bound to recover, and at that point Labour appeared weak. In addition by failing to effectively challenge the Osborne narrative about the past, Labour lost a crucial battle of political spin.

As I tried to argue here, if Labour is to have any hope in 2020 it has to start attacking Osborne’s unnecessary and obsessive austerity, as well as getting the past history straight. There are also reasons for thinking that the power of deficit fetishism for voters will steadily decline. In that sense, on this issue and perhaps others, Corbyn seems to have an advantage.

But, and it is a huge but, as I have also argued on the deficit, you can only successfully run an anti-austerity line if you have a clear and robust counter to the irresponsible borrowing charge. You do have to reassure enough marginal voters, and as a means to that the non-partisan political pundits that determine the political tone in a lot of the media. It is not clear that Corbyn will be able to do this. Firing up the base, as Corbyn clearly does, is only part of a successful winning strategy. There is a strong danger that he will lose credibility on the budget through overoptimistic claims on tax avoidance or misguided ideas about monetary financing. You will not shift the Overton window on austerity and other issues if your position is too easily discredited. Blair and Brown won in 1997 partly by imposing strong discipline on the party, which collectively gave out a clear set of messages to the electorate.

Part of Corbyn’s problem is not of his making (unless you take a long historical view), and that is his fellow MPs. It was their majority that chose not to oppose Osborne’s welfare bill, which epitomised the disastrous strategy that I have described above. It is very regrettable that two of the three other leadership candidates have refused to serve under him. If, following a Corbyn win, the party united around him in exchange for Corbyn parking some of his less popular policy positions, Labour could once again become an effective opposition. If instead his leadership is accompanied by constant public division within the party, there is a danger that this will overshadow everything else.

It seems very unlikely that Corbyn as leader could win the 2020 election. Perhaps the most optimistic yet still plausible outcome is that the period of a brief Corbyn leadership will be sufficient to shift the centre of political debate (the Overton window) to the left on a sufficient number of issues like austerity. He would then step down to allow a new candidate from the centre left to take over before 2020, and win enough popular support by appearing to be less of a risk and a more natural leader, while retaining key Corbyn positions like a strong anti-austerity line. Whether that would happen I have no idea. 

Whether Corbyn wins or loses, Labour MPs and associated politicos have to recognise that his popularity is not the result of entryism, or some strange flight of fancy by Labour’s quarter of a million plus members, but a consequence of the political strategy and style that lost the 2015 election. They should reflect that if they are so sure they know what will win elections, how come they failed to predict the Corbyn phenomenon. A large proportion of the membership believe that Labour will not win again by accepting the current political narrative on austerity or immigration or welfare or inequality and offering only marginal changes to current government policy. On economic policy in particular they need to offer reasons for voters to believe that there are alternatives to the current status quo of poor quality jobs, deteriorating public services and infrastructure, and growing poverty alongside gross inequality at the top. That means, whether he wins or loses, working with the Corbyn phenomenon rather than dismissing it.

The Ethics of Helicopter Money

 A lot of the discussion of helicopter money is about macroeconomic mechanisms, which is of course fair enough and - for me at least - interesting. But helicopter money, because it is quite like fiscal policy, also raises ethical issues, and these are taken up in a recent post by Jeremy Stangroom. It is this and related issues that I want to talk about here.

To avoid distractions, let’s focus on a specific type of helicopter money (HM). The state sets up a distribution mechanism (the flight path of the helicopter, if you like) which the central bank is mandated to use if interest rates are in danger of hitting the zero lower bound, and it judges that without using this mechanism it will probably undershoot its inflation target. If at some later date the central bank finds that it is danger of becoming ‘policy insolvent’, the government agrees to recapitalise it. Thus there is no question of abandoning the inflation target in the distant future: HM is being used to avoid undershooting the inflation target in the near future.

This policy is close to being identical to a reverse poll tax. The key difference is that, unlike an actual government cash transfer that is debt financed and therefore appears to be almost surely matched by some tax increase or equivalent later, with HM the future tax increase may or may not happen, depending on whether the central bank does or does not need recapitalising.

The other key difference between HM and a reverse poll tax is that HM is initiated by the central bank. This encounters a form of the ‘no taxation without representation’ argument: redistributions should be made by the democratically elected government. However in the case of HM, the distribution mechanism is set up and endorsed by the government. Many distribution mechanisms are possible, and which is used is the government's choice. The only qualification is that the mechanism has to have a powerful, immediate and reasonably predictable impact on aggregate demand. (Paying for infrastructure investment could only be on this list of potential uses for HM if the investment could be immediate, and not just substituting for investment the government would have undertaken anyway.)

Thus HM is still government sanctioned. In addition the circumstances in which HM would be used are limited and precisely described, and the agent making these decisions - the central bank - should be accountable to the government. Of course many government agencies already make decisions that have huge impacts on particular individuals: in the case of the UK, NICE for example.

An additional argument that I together with Mark Blyth and Eric Lonergan have made is that conventional monetary policy also involves redistributions between savers and borrowers. Here Jeremy Stangroom makes a good point: savers and borrowers undertook their debt contracts knowing that interest rates could well rise or fall. In contrast, no one has contracted for helicopter money.

However I think there is an additional point to be made here. Savers and borrowers generally take out nominal debt contracts, and so they will be affected by movements in inflation. They may well undertake these debt contracts in the expectation that inflation will average the central bank’s inflation target. HM money is a way for the central bank to ensure this expectation is fulfilled.

I also think it is always important to discuss HM in comparative terms, and in particular thinking about it as an alternative to QE. Indeed I think this should become mandatory in discussing HM: after all most people who propose it do so because they think it does the same job QE is meant to do but better. To the extent that the central bank makes a loss on QE (and if QE is temporary they really could make a loss, which is why the Bank of England got the government to cover these losses), it involves given newly created money away. In this case the beneficiaries are those who sold their government debt to the central bank and then subsequently bought it back at a profit. It is not clear that most people would regard those profits gifted by an arm of the state as a just desert. [1]

I think at the end of the day the ethical issue does all come down to the extent that the government can delegate decisions which have distributional impacts on the population. After all, the relevant budget constraint from the private sector’s point of view is the consolidated public sector which includes the central bank. Newly created money has to go to someone. Absent QE the profits the central bank makes are returned to the government. With QE, there is a good chance that the central bank may be transferring this money to the financial sector. With HM, money goes to the public. HM has not been called ‘QE for the people’ for no reason. Arguably the state provides too much support to the financial sector as it is, even without QE.

[1] QE is not about buying assets to make a profit. The central bank buys existing government debt when it is expensive, because QE only happens when actual and expected short rates are low, and then sells it back to the market when short rates are higher (QE is expected to be unwound after short rates rise). This saves the government money on interest payments but also involves a capital loss.