Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday, 23 August 2015

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.



37 comments:

  1. This comment has been removed by the author.

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  2. The Labour party have nearly five years, probably, to gain "credibility". I was intrigued recently by the news that the ECB is going to have to broaden the range of bonds it's willing to buy [1]. If the same thing is needed in the UK, then we might find that more "imaginative" forms of QE are implemented in the UK sooner or later anyway, regardless of which party is in power.

    The Labour Party would look a bit silly opposing such moves now, if the Tories find themselves forced to implement their own innovative QE proposals. As I understand it, Osborne's Living Wage is higher than the minimum wage proposed by Labour, allowing people to think that Osborne is on the side of the normal people. Labour shouldn't allow themselves to be outflanked like this. Much better to clearly be on the side of stimulus, thereby forcing the Conservatives to either tank the economy to distinguish themselves from Labour or else to implement Corbynomics - either way the credibility passes from the Conservatives to Labour.

    A bit speculative. And even if I'm right, the Tories will find a way to repeat their trick of the last few years.


    [1] “The shortage of certain assets is likely to require the ECB to react, which could take the form of an expanded list of eligible bonds.” http://www.bloomberg.com/news/articles/2015-08-18/ecb-s-market-dilemma-is-what-happens-when-bond-supply-dries-up-

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  3. Obviously "economic credibility" does not and never has equated to "what the majority of macroeconomists think" for a wide variety of reasons, not least of which is that macroeconomics requires a great deal of knowledge and thought and has many aspects which, to a large proportion of the population, are deeply counterintuitive.

    However, I suspect that you are using this as an excuse to avoid supporting Corbyn, even though you think that he is broadly correct, or at least better than Osborne/the Tories, on macroeconomic matters, and I don't really know why. If it's electability - do you honestly think that any of the 3 ABC's are more electable?

    Firstly, as George Monbiot pointed out, Labour accepted the Tories' premise on economic matters before the election, and offered, at least rhetorically, an exceptionally half-arsed opposition to it. If they are going to oppose austerity, they should be offering a full-throated opposition and refusing to accept the ludicrous Tory propaganda about spending on public services causing the global financial crisis. There are plenty of slogans - e.g. Corbyn's dig at the Tory on AQ this week asking whether nurses caused the financial crisis - that chime well with the electorate and Labour would do well to make use of them.

    Secondly - Labour's problems at the moment aren't the Nuneatons of this world, they're Scotland and the north of England, i.e. their base. The SNP painted themselves as anti-austerity - forget about whether their plans were substantively different to those of Labour - so clearly it is at least possible to do so and still win an election. However, no-one in Labour seems prepared to have a good hard think about why they lost there. Instead, they seem to be focussing on "blaming" the SNP for winning. As it happened, I went to live in Scotland for a while after the GE and most of what I heard was a) we hate the Westminster/corporate machine, b) Labour have sold their soul, c) austerity is awful, d) we wish the indyref had gone the other way and e) Labour can't expect us to vote for MP's when they clearly have no interest in their constituencies. How does having Burnham, Cooper or Kendall in charge change any of those? At least Corbyn can credibly counter points a), b), c) and to an extent e), although not d). Labour will not win on a 1997-2005 era strategy because the political map has changed so radically since then.

    Thirdly, one of the main problems that Labour had during the last election was that the right wing noise machine were easily able to paint Miliband as a bit weird and out of touch. Now, I think that they will always find something to attack a Labour leader with, but nominating any of the ABC's is just asking for a continuation of that narrative. They're all weird, they all talk like robots and they're all Westminster machine politicians. Furthermore, none of them have generated anything like the enthusiasm that Corbyn has, and while I recognise that energising your base ≠ being elected, Labour would surely be foolish to do anything other than embrace this, especially given that they would risk becoming irrelevant to a generation of young voters by rejecting it.

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  4. disappointed you didn't sign!

    True Corbyn also ignores the mainstream by neglecting arguments for delegating monetary policy. To my mind this is less of a(n economic) mistake than cuts in a recession: one could somehow make PQE conditional on the ZLB.

    But if no one understands the complex social and political process that defines economic credibility, you would have to admit that it is not clear that Corbyn's populist progressive agenda is the wrong stance for Labour.

    It's no good retreating to the ivory tower each time a politician departs from the mainstream.

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    1. I think I understand a bit about these processes. One thing I understand is that it is difficult to get something thought of as credible if it goes against the interests of the financial sector or central banks. PQE clearly has that problem. When that happens, you have to have the rationale for your change nailed down, and Corbyn's QE does not.

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  5. Simon - for someone keen to challenge conventional wisdoms and what passes for ‘economic credibility’, it is surprising that you appear to have swallowed the case for central bank independence hook line and sinker. Why are you so uncritical of this social convention?

    The case for CBI was always deductive, never empirical. It derives from work of Kydland and Prescott in the 1970s (amongst others). The basic narrative is that politicians cannot be trusted with monetary policy. They will promise high interest rates over the long term, but in the short term they have an incentive to maintain rates too low for too long – especially in the run up to elections. Thus, it would be better to place monetary policy beyond democratic control.

    An independent central bank, so the argument goes, will have the requisite political insulation to promise – and deliver - anti-inflationary policies over time. Better still, because the public knows all this, they will expect inflation to be lower over time. Lower inflation therefore becomes a self-fulfilling prophecy.

    But how much of this narrative fits the historical record? Did the Labour government grant independence to the Bank of England in 1997 because of rampant inflation? Or did they do it to look ‘credible’ in the eyes of international investors and financial technocrats (many of whom were employed by central banks and had an obvious self-interest in promoting the case for central bank independence)?

    Conversely, what are we to make of the record of independent central banks in recent years? They’ve had rates pinned to the floor for almost six years, all the while promising that rate rises are just around the corner. I’m not arguing that rates should rise now, far from it. But this is hardly an example of ‘time consistent’ behaviour.

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    1. "The case for CBI was always deductive, never empirical." No - the simple cross country correlations popularised by Alesina were at least as influential. I agree that the textbook rationale for central bank independence is overblown. Its much simpler - politicians cannot be trusted not to distort what are technical decisions for political ends. I have seen no evidence to suggest that has changed, and a lot of evidence that it has not.

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  6. Alessina demonstrates that fiscal consolidations are expansionary. You should do some relevant reading before posting again.

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    1. Firstly, there's one 's' in Alesina. And here's a review of 2013.

      Krugman blog, September 23, 2013, 'Where Are The Austerian Economists?'

      "Alberto Alesina, once the guru of expansionary austerity, is still defending his earlier research, but not playing a major role in current policy debate. Reinhart and Rogoff, whose 90-percent cliff was once gospel, are defending their professional reputations while trying to move on, but aren’t lending their voices to calls for continuing austerity. Who’s left?"

      Krugman blog May 3, 2013 'Playing Whack-a-Mole With Expansionary Austerity'

      "The rise and fall of Alesina-Ardagna didn’t make as much of a public splash as the Reinhart-Rogoff saga, but in a fundamental sense it was the same thing. An academic paper purported to show something austerians very much wanted to hear – in this case that slashing spending in a depressed economy would actually create jobs; the authors were immediately feted and the paper promoted to sacred status; but then the result fell apart under both intellectual scrutiny and the weight of real-world experience. Unlike R-R, however, A-A didn’t crash and burn, it just sort of quietly slunk offstage. And as a result, pieces of their story are still embedded in what all the Serious People know. In correspondence, Kevin O’Rourke points me to Mario Draghi admitting that fiscal consolidation is contractionary, after all, but claiming that it will be less contractionary if it takes the form of spending cuts rather than tax increases. Where is that coming from? Why, Alesina-Ardagna, of course. And as it happens, the IMF study (pdf) that debunked A-A also had something to say about this result. It found that when you measured austerity right, it was contractionary, not expansionary; it did, however, find that spending cuts were less contractionary. But why? Careful further analysis suggested that much of the explanation lay in the behavior of central bankers, who for whatever reason were more likely to cut interest rates to offset spending cuts than to offset tax increases."


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    2. See www.rooseveltinstitute.org/sites/all/files/not_the_time_for_austerity.pdf

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    3. Krugman has no credibility when it comes to fiscal macro. You might want to find a better source next time :)

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    4. "Krugman has no credibility when it comes to fiscal macro. You might want to find a better source next time :)"

      And your credibility is? Your source is? You have correctly predicted the results of austerity and of QE (no inflation etc.) and Krugman has not?

      Do you have a credible data source refuting Krugman's criticisms of A-A? Or a model that does the same?

      Strewth.

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    5. An empirical model, yes. It will be published soon and I'll be sure to let you know so you can retract your smarmy and smug comment at the time.

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    6. Original comment: I have written many posts on the empirical evidence on fiscal policy. There you will find that the overwhelming majority of studies reject expansionary austerity. You should do some reading before making comments again.

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  7. Good post in part, if I may say so, acknowledging clearly as it does that the impression of fiscal rectitude any successful democratic politician has to convey for success has little relation to what economic orthodoxy requires, or indeed very much with what you can do once in office.

    What rather undermines your critique of Osborne's dastardly undermining of the Low Pat Commission is that it was Labour policy at the last election to similarly abandon its ability to authoritatively set the level of the minimum wage.

    I rather like elected politicians making the decisions, and taking responsibility for them.

    What undermines these ridiculous pro- Corbyn letters that are circulating is that they cherry pick one good bit of Corbynomics (eg Corbyn's rejection of enshrined surpluses) whilst ignoring the bonkers bits.

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    1. They cherry pick. And you don’t?
      The ‘intellectual’ basis for the real right’s (not Labour’s) departure from economic credibility as defined, is of course, never let a crisis go to waste – since ABC would desire nothing other than to appear credible, they’re on the sidelines of today’s political game, which thankfully is overtaking them.

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  8. Simon, what are your views on the recent record July budget receipts? Do they support the "credibility" of Osborne's policies and undermine the argument against the latest cuts (notwithstanding their regressive nature) or is it that it's too early for the recent budget cuts to feed through?

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    1. Any framework that attaches any weight to monthly budget numbers is hopelessly wrong! Deficits are pretty random on a monthly basis, and should in any case be a shock absorber.

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  9. About Corbynomics and central bank independence, Richard Murphy directly compares their People's QE with the Bankers' QE. The Bankers' QE was only done during the recovery when there's still an output gap, unemployment is above target and inflation is below target.

    It isn't that much more independent to give new money to the banks and people with mortgages, then to give it to public investment projects. As you have written, the govenrment could set up a National Investment Bank in partnership with the central bank.

    Murphy and Corbyn's message was simple: instead of a bankers' QE we should do QE for national infrastructure. Possibly they could do both plus helicopter money?

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    1. Corbyn's QE could be translated into something sensible, as I outline here:

      http://mainlymacro.blogspot.co.uk/2015/08/peoples-qe-and-corbyns-qe.html

      Maybe best to sort this out before going public?

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  10. http://www.interfluidity.com/v2/5561.html
    There is a good post here on the obsession with price stability.

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  11. Wait, it's economically credible to reserve the right to nationalize industries with no compensation no less?
    I guess it's pretty credible in Venezuela.

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  12. The political right own all the media, that's where they get their appearance of credibility from. There's no proper political opposition established as yet as the right own most of politics too.

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    1. Yes. The mainstream media bubble is wholly right aligned; so the first action necessary to begin to shift the argument is to get people to move away from it. Completely. Only then will any sort of alternative have a chance of winning any argument with the mass of voters.

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  13. "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."

    Very convenient interpretation of events. You should become a preacher.

    Well, most of the world was following "mainstream" macro-theory up until 2009. And sticky price rational expectations adjusted optimisation models. And wasn't that a great help.

    Sure, post 2009 we saw the return of the General Theory. That seems to be mainstream when it suits the profession - usually after a crisis when it should have been avoided in the first place.

    'Unconventional monetary policies' were called that for good reasons. Conventional or mainstream economics did not bring anything to the table to help with the design of these. It was historical experience in Japan and an historically literate Fed Governor familiar with the inter-war experience that did.

    Friedman did suggest such uncoventional policies for Japan back in the 2000s. But Friedman, although a Chicago economist, is not in the Lucas-Sargent mould in his approach to analysis. A Monetary History being a prime example.

    We really need someone to do a proper-historical analysis here. If we allow mainstream economists to start interpreting history like this, we are not going to properly learn from this experience, exposing us to more problems in the future.

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    1. New Keynesian models suggest fiscal stimulus at the ZLB, so I'm not sure what your point is.

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  14. I don't see why a NIB would mean that the Bank of England comes under any more pressure than it faces now. Treasury and Bank often meet now and swap staff, but the Bank is independent by virtue of the apppoitments and tenure process, if that is robust then decisions of PQE to the NIB are no more threat than when Treasury and the Chancellor object to Bank policies now. The NIB would identify public investment with good returns, that is perhaps the more iffy bit, and the Bank would decide when, and if, it provides it QE funds to the NIB, otherwise the NIB just borrows conventionally and lives within means dictated by Treasury. The important thing, as with OBR, NICE etc and all the other technocratic ideas you support for good reason, is that the Bank and NIB is not at the behest of politicians, that is more constitution than economics

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    1. I agree, and I think that is consistent with what I wrote here:

      http://mainlymacro.blogspot.co.uk/2015/08/peoples-qe-and-corbyns-qe.html

      But policy innovations need to be well thought out if they are to avoid being labelled as 'not credible', and I do not think Corbyn's QE was.

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  15. What matters a great deal when it comes to winning elections is not being in Government when the most enormous bubble in economic history goes 'pop'.
    US Republican Party and UK Labour Party both found themselves out of office for two terms.
    Third time up will be interesting and the US has a go first.

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  16. To sum up "economic credibility" does not imply competence, and vice-versa.

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  17. So what will be the negative economic consequences of raising the minimum wage?

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  18. "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. "

    Perhaps that is because most of the academics that teach in those universities refuse to take part in the debate, or to actively engage in economic policymaking for the Labour Party. Where are the left-leaning economic think tanks in the UK that can provide a counterweight to the IEA, Adam Smith Institute or Centre for Policy Studies? The Fabian Society and IPPR concentrate too much on social policy issues rather than economic ones.

    Of course heterodox schools like the Post-Keynesians do engage in policy proposals and objectives like reducing inequality and returning to full employment, but they get sidelined because they are not mainstream. In part this is the fault of the Labour Party for not engaging with them. If the Party did then the heterodox would inevitably become more mainstream. So there is fault on both sides.

    I note that Syriza has appointed two economics professors in succession to the post of finance minister. That would never happen in the UK.

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    1. "refuse to take part in the debate" ?? Before the election, I wrote a great deal about the key issue of whether the last Labour government was profligate. To my knowledge Labour did not use this material once. I wrote one paragraph on the SNP's line on austerity, and got quoted by the SNP. I think the failure does not lie with academics here.

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  19. "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. "

    Or alternatively, you could just approach the problem iteratively, and slowly raise the minimum wage until the negative effects (inflation, unemployment) begin to outweigh the positive ones (reduced inequality, lower transfer payments) while also considering GDP growth, and debt ratios. Then you stop. At the end of the day the optimum position you seek is based on your political opinion not an economic one, so in that respect Osborne was right to over-rule the LPC. The Labour governments of Blair and Brown should have had the courage to do the same and raise the minimum wage faster than they did.

    Fundamentally I disagree with your assertion that setting the right level (whatever that is) for the minimum wage is a "delicate balance" that requires detailed "empirical knowledge that labour economists have gleaned. " It isn't and it doesn't. The economy is resilient enough to adjust to small deviations from the optimum without crashing. It is the large deviations that you need to worry about.

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    1. Unfortunately, you need both time and repeated experiments to learn this way. By which time many people may have been thrown out of work. That is why it is better to use the evidence we already have.

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  20. Well I always thought Osborne's austerity was entirely about getting the business cycle in sync with the electoral cycle even if that intensified the business cycle (which it certainly did). And you have to say he succeeded wonderfully.

    The key insight here is that it is not the level of GDP or employment that matters electorally but short-term changes in both. As Hobbes said "felicitie consisteth in prospering, not in having prospered". All that economic output that is now lost forever simply does not change any votes.

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  21. ABC is not original. It used to sound for anything but Clinton. Not surprisingly, given its considerable US influence, this has been adopted as a New Labour tactic.

    Myself, I say 'anything but Cooper'.

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