I was happy to agree to be on an advisory panel for Shadow Chancellor John McDonnell MP. There are only two reasons why I would say no to any major political party who asked me to give them their advice. The first is if this restricted what I would otherwise write on this blog or elsewhere. No such request has been made, although if you are hoping that I will reveal in posts accounts of what happens at panel meetings you will also be disappointed.
The second reason why I might have said no is if I thought the advisory panel was for presentation only, and all advice would be ignored. I have no reason for believing that in this case, and some grounds for thinking the opposite, which I discuss today in the Independent. In particular their position on fiscal policy is similar to the one I suggested here, although getting the message clear probably requires some work.
One rather sad comment on the formation of this group is that those joining it will be forever tainted by associating themselves with a "hard left dinasours". Or to put it another way, its members should have said no to the Labour party leadership because they now have pariah status. As I pointed out in the Independent article, the current leadership will have to come to some kind of accommodation with the rest of the parliamentary party, and so Labour policies are unlikely to be the kind of far-left platform that many in the media seem happy to imagine. As Labour are the main opposition to the current government, and I think their macro policies are pretty awful, it would have been bizzare indeed if I had said no to this invitation.
Robert Peston has a short blog post on this new panel. He asks a very good question, which is why previous party leaderships have not done anything similar. I would quibble about one phrase in his post though, and that is this group is designed "to establish an economic ideology outside the mainstream". As I have often said, my own macro is pretty mainstream. What has happened since 2010 is that macro policy has departed from that mainstream.
Monday 28 September 2015
Friday 25 September 2015
The path from deficit concern to deficit deceit
I have always
written that the arguments in 2010 for focusing fiscal policy on
reducing debt were understandable. They were wrong, but you could
understand why reasonable people might make those arguments. In
particular at the time the problem of the recession appeared to be
over, recovery was under way, and the Bank of England seemed
confident in the power of unconventional monetary policy. It seemed
reasonable to move attention to the deficit.
So when 20
economists and policy makers wrote
in February 2010 apparently supporting George Osborne’s deficit
reduction plans, I was not surprised. The majority of
macroeconomists, like me, disagreed, and we were right, but I could
understand where they were coming from. One of those signing that
letter was Lord
Turnbull, head of the Civil Service and Cabinet
Secretary between 2002 and 2005. By August 2012 around half of those
that signed the letter had the good sense and honesty to backtrack
on what they had written. The Chancellor may also have (wisely)
revised his original plan to end the current deficit within 5 years,
but his zeal to bring down debt rapidly by cutting government
spending had not disappeared. When he was re-elected in May, it was
for a programme of renewed austerity.
But the story does
not end there. A few days ago Lord Turnbull had the opportunity to
question the Chancellor on his drive for further austerity. This is a
part of what he said.
“I think what you are doing actually, is, the real argument is you want a smaller state and there are good arguments for that and some people don’t agree but you don’t tell people you are doing that. What you tell people is this story about the impoverishment of debt which is a smokescreen. The urgency of reducing debt, the extent, I just can’t see the justification for it.”
A former head of the civil service, who had initially supported
Osborne on the deficit, was now accusing him of deliberate deceit.
Big news you might have thought. And quite a turnaround in just 5
years.
Yet it is not surprising. Osborne’s fiscal plans really have no
basis in economics. That leaves two alternatives.
Either Osborne is just stupid and cannot take advice, or he has other
motives. George Osborne is clearly not stupid, which leaves only the
second possibility. It is therefore entirely logical that Lord
Turnbull should come to agree with what some of us were saying
some
time ago.
What a strange world we are now in. The government goes for rapid
deficit reduction as a smokescreen for reducing the size of the state. No less
than a former cabinet secretary accuses the Chancellor of this
deceit. Yet when a Labour leadership contender adopts an anti-austerity
policy he is told it is extreme and committing
electoral suicide. Is it any wonder that a quarter of a million
Labour party members voted for change.
Monday 21 September 2015
What do macroeconomists know anyway?
In an article in the Independent today I argue that what goes for a
‘credible’ economic policy among politicians and the media is
often very different from what an academic economist might describe
as credible. Which invites the obvious response: who cares, what do
academic economists know anyway? So I look at what I regard as the
three major macroeconomic policy disasters in the UK over the last 35
years, and one success.
The success was the decision not to join the Euro in 2003. It is
pretty clear that this was the right decision, and it was made after
what may have been the most extensive academic consultation ever
undertaken by the Treasury, coupled with substantial macro analysis. (I
talk more about this here.)
The Prime Minister Tony Blair was initially in favour of joining, but
the analysis helped persuade him otherwise.
The first failure was Mrs. Thatcher’s monetarism, which was
famously opposed by 364 economists. Those on the right have tried to
spin this as a failure by the economists, but the actual policy
framework of money supply targets was a complete disaster and was
quickly abandoned, never to be tried again. (Here
is a discussion, and here
is an account from one of the two movers behind the letter.)
Current austerity we all know about: if not, read this.
The third disaster was the UK’s entry into the European Exchange
Rate Mechanism (ERM) in 1990 at an overvalued exchange rate, and the
subsequent recession and forced exit in 1992. My argument that this
went against macroeconomic analysis needs some justification. At the
time I was in charge of macroeconomic research at the National
Institute (NIESR) in London, and I undertook with colleagues what was
easily the most extensive analysis of the consequence of entry into
the ERM at different exchange rates. This was subsequently published
in 1991, but all the material was first presented before we entered
the ERM.
We concluded that the UK’s actual entry rate was 10-15% above the
equilibrium rate. The implication was unavoidable: either we would be
forced out, or trying to stay would lead to a recession as part of an
‘internal devaluation’. I remember Sam
Brittan,
one of the main writers at the FT at the time, saying that he thought
we had won the intellectual argument, but that his instinct was still
that we should enter at a high rate.
After entry into the ERM the UK entered a recession, and we were then
forced out just two years later. Our analysis was vindicated. It is
true that the whole system eventually collapsed as a consequence of
the tight monetary policy that followed German unification, but it is
no accident that the UK was the first to go (Black
Wednesday).
On leaving the ERM sterling depreciated by 10%, and the UK recovered
quickly from recession.
There is no doubt that had the Treasury taken our advice and entered
at a lower rate, less jobs would have been needlessly lost. I have
often wondered if I could have done things differently to make a more
persuasive case. But honestly I doubt it: the almost macho appeal of
entering at a ‘strong’ rate was too great, together with the idea
that the market knew best. As I say in The Independent,
macroeconomists are far from perfect, but the UK evidence suggests
that you ignore their advice at your peril.
Labels:
2003,
364,
academic,
Black Wednesday,
ERM,
macroeconomics,
NIESR,
Sam Brittan,
UK
Sunday 20 September 2015
Haldane on alternatives to QE, and what he missed out
Andrew Haldane, Chief Economist at the Bank of England, gave a
typically well researched and thoughtful talk
recently. The main subject matter was the problem of the Zero Lower
Bound (ZLB): why we may hit it much more often than we would like,
and why QE is not a great instrument for dealing with it. To quote:
“QE’s effectiveness as a monetary instrument seems likely to be highly state-contingent, and hence uncertain, at least relative to interest rates. This uncertainty is not just the result of the more limited evidence base on QE than on interest rates. Rather, it is an intrinsic feature of the transmission mechanism of QE.”
In the past I have emphasised the point about lack of evidence simply
because it is obvious. But as Haldane’s discussion shows, the
problems are more basic than that. Some people argue that we can
always get the result we want with enough QE. Yet if the central bank
and the public never know how effective any amount of QE will be,
then lags make it a poor instrument. It is refreshing to
see a senior member of the Bank finally acknowledge its limitations.
Haldane considers two alternative ways of dealing with, or avoiding,
the ZLB: a higher inflation target and getting rid of cash so that
negative interest rates of whatever size become possible. The first
is obviously welfare reducing, but as Eric Lonergan argues
the second is likely to be as well. (See
also Tony Yates.) But what is really strange about Haldane’s
analysis is what is missing from his discussion.
One omission is a discussion of the possibility that targeting something other than inflation might help. The other omission is any discussion of helicopter money. There are some basic
contradictions in the Bank of England’s views on helicopter money,
but because central bankers tend to talk to each other I suspect they
remain concealed. One argument is that helicopter money will somehow
reduce confidence in the currency, but then the Bank seems happy to
research getting rid of cash and imposing negative rates on money as
if this is all about technicalities. [Postscript - meant to link to John Cochrane's discussion, and here is a reply by Miles Kimball.] I should have referenced Another argument is that
helicopter money will threaten the Bank’s independence because it
will have to rely on government to (if necessary) recapitalise it,
when at the same time the Bank has already obtained an underwriting
guarantee for losses on QE. Also strange is the argument that
independence will be threatened once the Bank does a 'helicopter
drop' because governments will want the money for themselves, as if
politicians had not noticed the amount of money being created under
QE. After all Jeremy Corbyn's proposal was a response to the reality
of QE, not the possibility of helicopter money.
The really ironic argument is that helicopter money is too like
fiscal policy, and that there should be democratic control over
fiscal policy. This is what central bankers mean when they talk about
blurring the lines between monetary and fiscal policy. The argument
is ironic because I am sure that if you actually asked most people
which they would prefer - being charged to hold money, 4% average
inflation, or occasionally getting a cheque from the Bank - the
answer would be emphatic. So we rule out helicopter money because its
undemocratic, but we rule out a discussion of helicopter money
because ordinary people might like the idea.
There is also an element of hypocrisy. It is sometimes argued that
helicopter money is unnecessary because it has a very similar impact
to conventional fiscal policy. This is true, but it deliberately ignores
the fact that governments around the world have gone for fiscal
contraction because of worries about the immediate prospects
for debt. It is not as if the possibility of helicopter money
restricts the abilities of governments in any way. If governments
undertake fiscal stimulus in a recession such that helicopter money
is no longer necessary, it will not happen.
So it is good that
some people at the Bank are thinking about alternatives to QE, which
is a lousy instrument with unfortunate, and potentially permanent,
distributional consequences. It is a shame that the Bank is not even
acknowledging that there is a straightforward and cost free solution
to this problem. My last two posts have involved defending central
bank independence, but with independence comes a responsibility not
to exclude discussion of particular policy options simply because
they break some kind of taboo.
Thursday 17 September 2015
Central Bank Independence and MMT
This is a follow up to my last post on Corbyn and central bank
independence (CBI). No apologies for returning to this topic: not
often do you get to talk about policies that are in the process of
being formulated. One of the influences that is said to be important
for John McDonnell (the new shadow Chancellor) and his advisors is
Modern
Monetary
Theory
(MMT).
A comment I sometimes get on my posts is that my arguments are
similar to those put forward by followers of MMT. I have not read
much MMT literature, but in what I have read I have normally not
found anything I take great exception to. On some issues, like the
way monetary policy continues to be presented
in textbooks, they definitely have good reason to complain about the
mainstream. However their account of the way monetary and fiscal
policy work seems quite a close match to what many mainstream
economists think, which I guess is why my arguments can be similar to
theirs.
One area of apparent difference, however, is CBI. You will sometimes
hear
MMT people talk about CBI being a ‘sham’, whereas mainstream
macro attaches great importance to CBI. So which is right? Part of
the problem here is that CBI in the UK (where the government decides
the goal the Bank has to achieve) is rather different from that in
the US (where the Fed has much more discretion over the choice of
targets) and the Eurozone (where the ECB is largely unaccountable and
has huge power). I’m just going to talk about the UK set up. (For a
MMT perspective on the US, see here.)
CBI in the UK, established by Gordon Brown and Ed Balls in 1997, is
no sham. The Monetary Policy Committee (MPC) decides when and by how
much to change interest rates, and government has no influence on the
MPC. How do I know this? From observation and from a huge number of
conversations with MPC members. Since 2009 the MPC has decided when
and by how much to do QE. Any Treasury authorisation to do QE
was a formalisation that essentially followed Bank wishes, but it
never specified when and how much QE should happen. So a fair
description of the UK set up is that the government defines the goals
and instruments of policy, and the MPC decides how to use those
instruments to best meet those goals.
I would agree with the comment that this set up leaves the government
taking big strategic decisions, like what the target should be. But
CBI as defined in the UK still has two major advantages over the
pre-1997 alternative
-
party political motives for changing interest rates are ruled out. I know such motives influenced at least the timing of rate changes before 1997. (How do I know - same answer as before.)
-
it forces governments to be explicit about their goals, and the relative priorities among these. I personally believe this has an important role in conditioning (but not determining) expectations, which is very useful. (Yes you can call me a New Keynesian for this reason.)
You could add time inconsistency and credibility issues in there as
well if you like. (Giving this to secondary importance perhaps makes
me less of a New Keynesian.)
Are there any negatives to set against this? One argument you often
hear is that CBI is anti-democratic, but I really think this is just
nonsense in the UK context. Government delegates technical decisions
all the time, and as long as there is strong accountability (which in
the UK there is), the right people are on the MPC and they are truly
independent (from government or the financial sector) this works
well. When governments only face elections every 5 years and
elections are won or lost over a whole range of issues, quite why a
Chancellor deciding when to change rates following secret advice is
more democratic is unclear. It also improves democracy because, as Chris points out, the Chancellor is not held to account for the technical mistakes of his advisors.
A more important argument against CBI is that it makes money financed
fiscal expansion much more difficult. A government that is obsessed
by the size of its deficit might not undertake a bond financed fiscal
expansion when a fiscal expansion is needed. It might have undertaken
a money financed fiscal expansion, but CBI prevents it doing this
because the central bank controls money creation. However this
problem can be easily avoided by (a) taking a more sensible view of
government deficits and debt, as MMT would also advocate, or (b)
allowing helicopter money.
It is (a) that makes the debate over Corbyn’s QE particularly
ironic. A National Investment Bank can be set up perfectly well based
on borrowing from the market, and you can ensure it gets the funds it
needs by a government guarantee. The only reason you would avoid trying
to do that is because the NIB debt would count as part of the
government’s deficit, and you were worried about the size of the
deficit. The last people who should be worried in this way are
followers of MMT.
Scott Fullwiler has an elaborate
discussion
of why Corbyn’s QE does not interfere with CBI, but concludes: “As
such, government guaranteed debt of the NIB would be effectively the
same thing as plain vanilla deficits, which as shown above is not
different in a macroeconomically significant way from Overt Monetary
Financing of Government via People's QE.” Which begs the question,
why not go with plain vanilla deficits to fund the NIB. If it is
because you are worried about the political costs of higher deficits,
that will be as nothing compared to the political costs of
instructing the Bank to finance a NIB.
So
where does this apparent antagonism for CBI come from? Perhaps it
comes from a tendency of some from the mainstream to make too much of
CBI. To imply that the more independent a central bank is the better,
regardless of who determines goals, whether there is accountability
and who makes the decisions. Proof that independence is not all that
matters is provided by the ECB. But we should not let the bad drive
out the good. If Labour abandons the innovations made by Brown and
Balls, I think it will be a classic example of the triumph of
ideology over both good economics and self interest.
Monday 14 September 2015
Labour and Central Bank Independence
Sometimes Paul Krugman can be very annoying. On a number of occasions
I have written a draft of a post, and while in the process of
admiring editing it, have found that PK has just
written something rather better. So I bin my post on why Corbyn’s
resounding victory is partly the product of Labour’s failure to
oppose austerity rhetoric: read this
instead.
In any case it may be more useful to look forward to what Labour’s
macroeconomic policy might become under Corbyn and the shadow
Chancellor John McDonnell. There has been some suggestion, encouraged
by what I
insist
on
calling
Corbyn’s QE, that Labour are contemplating getting rid of an
independent Bank of England. I think in macroeconomic terms this
would be a bad idea, and in political terms a terrible idea. It is
best to say this sooner rather than later, before commitments are
made.
In essence all the Bank of England normally does is decide how to
change interest rates to hit a target decided by government. Whether
it is an inflation target or some other target(s) is for the
government to decide. There are plenty of macroeconomists who would
favour a higher inflation target, or targeting a different measure,
so there is a great deal of scope for change here. But once that
target has been chosen, why are politicians better at trying to hit
it than a bunch of technocrats some of whom have spent their lives
studying this one task?
It is vital to appreciate how different the UK set up is from the
Eurozone. Many years ago I was very suspicious of central bank
independence (CBI), because I thought it might lead to just the kind
of deflationary bias that we see today in the Eurozone. Partly
because of decisions made by Ed Balls and Gordon Brown, the Monetary
Policy Committee (MPC) in the UK is quite different. The target is
symmetrical, and the MPC has independent members and is very
transparent and accountable. So what is there not to like which the
government cannot already change?
I fear the situation has become confused because of austerity at the
Zero Lower Bound. What CBI prevents either the government or the
central bank doing is a money financed fiscal stimulus: a fiscal
stimulus paid for by creating money rather than issuing government
debt. The central bank can create money, and has done, but cannot
force the government to spend more or cut taxes. The government
cannot force the central bank to permanently create money to finance
these things.
But this is only a problem if you have a government committed to
deficit fetishism. It would be ironic indeed that a Labour party now
pledged to fight austerity decided it needed to print money because
they were reluctant to borrow more. It would be the ultimate triumph
of austerity, and also just daft.
It would also be a gift horse to those currently implementing
austerity. It would allow them to say that the only alternative to
austerity was printing money which would lead to inflation. They have
already begun to say it. It is spin that can be fatally undercut as
long as CBI is preserved. But if that independence is ended, then you
will create an army of mainstream academic economists who will say
that high inflation is now more likely.
There will be some of those who advise Corbyn and McDonnell who might
be tempted to say what have mainstream economists ever done for us.
But if Paul Krugman is right, and I think he is, one of the reasons
that Corbyn got elected is that Labour party members could see that
the government was pursuing a policy that went against mainstream, as
well as some heterodox, economics. Corbyn and McDonnell will have
enough enemies in the media and the City as it is. It seems just
stupid to create enemies elsewhere by foolishly ending the Bank’s
independence.
Saturday 12 September 2015
Labour lost
As Corbyn’s win is all over the news, it is difficult to think
about other issues. So while watching the result I read ‘Can
Labour
Win?’
by
Patrick
Diamond
and
Giles
Radice.
It sifts through a lot of polling information and conversations with
candidates, and comes up with a large number of recommendations.
There is a lot of good and sensible stuff here, but I cannot help
feel that it - and much similar comment since the election - misses
the key point.
Perhaps part of the problem is that a great deal of this analysis
comes from Labour party people who are, quite rightly, really
interested in policy. So all the analysis is about which policies
were wrong and which way policy should move as a result. We get into
territory that these people are comfortable with: what policy should
be.
The point all this misses is that the Conservatives won. It used to
be said that governments, not oppositions, win or lose elections. Yet
all of the comment is about Labour’s policies. A much better place
to start is why voters voted for a Conservative government. That
quickly leads you to the fact that voters saw the Conservatives as
competent in economic terms. And that is where you should stop.
You should stop because, as I have argued many times, the raw data on
the economy was terrible. If you had asked any pollster or political
scientist whether a government could win on economic competence
having presided over a huge fall in real wages they would have said
no. True things began to look less gloomy as the election approached,
but the position of the Conservatives in the polls well before that
time was not nearly as bad as the economic position suggested it
should be.
The Conservatives won because they reframed the economic debate.
Competence became reducing the deficit, not increasing prosperity.
Labour’s failure was a failure to challenge that reframing. Forget
the details of Labour policy - it is of little importance compared to
this crucial mistake. And that crucial mistake was a symptom of a
more general problem.
There is one telling result from the Diamond and Radice study. To
quote
“despite never using the language of ‘equality’, voters believe the Conservatives are just as likely to achieve equality as Labour in southern England”
This was despite Miliband putting the problem of inequality at the
centre
of his message. I heard it, but most voters did not. Labour just
failed to get its message, any message, across. As I wrote
just after the election, Labour's political spin appeared to be
consistently amateur compared to their opponents.
Corbyn will have some advantages. He will not let Osborne’s deficit
fetishism go unchallenged. But that challenge will only work if the
alternative policy is solid and simple: I agree
with the authors that this must involve balance on the current
deficit (although within the context of a flexible
rule).
What he must not do is provide material for his opponents, which I’m
afraid is exactly what Corbyn’s
QE
did. Focusing on the current balance will allow for a large increase
in public investment, which again can be spun very simply: Labour,
unlike the Conservatives, invests in our future. (It is not afraid to
borrow to do so, just like every successful firm.) Corbyn, and the
team he selects, may not want to call it spin, but if they do not
match their opponent’s ability in this area they will lose.
Friday 11 September 2015
Media myths
At first sight the research reported here
is something that only political science researchers should worry
about. In trying to explain election results, it is better to use
‘real time’ data rather than ‘revised, final or vintage’
data. But as the authors point out, it has wider implications. Voters
do not seem to respond to how the economy actually is (which is best
measured by the final revised data), but how it is reported to be.
(This does not just matter for elections: here
is a discussion of some other research which suggests how the way
recessions are reported can influence economic decisions.)
Just one more indication that the media really matters. I would not
bother to report such things, if this point was generally accepted as
an obvious truth. That it is not, in the UK at least, reflects
various different tendencies. Those on the right know that the print
media is heavily biased their way, and that this has a big impact on
television, so they have an interest in denying that this matters
(while funding think tanks whose job is in part to harass the BBC
about its alleged left wing bias). Those on the centre left often
react negatively to a few of those further left who
discount all awkward facts by blaming the media.
And the media itself is very reluctant to concede its own power.
As an example, here
is Rafael Behr in the Guardian talking disapprovingly about Labour
supporters:
“I heard constant complaints about failure to “challenge myths” about the economy, benefits, immigration and other areas where Labour is deemed unfit to govern by the people who choose governments. The voters are wrong, and what is required is a louder exposition of their wrongness.”
What is really revealing about this paragraph is what is not there.
We go straight from myths to voters, as if no one else is involved. I
doubt very much that many who voice the ‘constant complaints’
Behr is talking about think that voters created and sustained these
myths all by themselves.
The discussion of issues involving the economy, the welfare system
and immigration among most of the ‘political class’ is often so
removed from reality that it deserves the label myth. In the case of
the economy, I provided chapter
and
verse
in my ‘mediamacro myth’ series before the election. It was not
just the myth that Labour profligacy was responsible for austerity,
but also the myth about the ‘strong recovery’ when the recovery
was the weakest for at least a century, and that this recovery had
'vindicated' austerity. Given the importance that voters attach to
economic credibility, I do not believe I was exaggerating in
suggesting
that the mediamacro myth was in good part responsible for the
Conservatives winning the election.
The media is vital in allowing myths to be sustained or dispelled.
That does not mean that the media itself creates myths out of thin
air. These myths on the economy were created by the Conservative
party and their supporters, and sustained by the media’s reliance
on City economists. They get support from half truths: pre-crisis
deficits were a little too large, GDP growth rates for the UK did
sometimes exceed all other major economies.
Myths on welfare do come from real concerns: there is benefit fraud,
and it is deeply resented by most voters. But who can deny that much
of the media (including the makers of certain television programmes)
have stoked that resentment? When the public
think
that £24 out of every £100 spent on benefits is claimed
fraudulently, compared with official estimates of £0.70 per £100,
that means that the public is wrong, and we have a myth. (An
excellent source for an objective view of the UK’s welfare system
is John Hills’ book,
which has myth in its subtitle) As I noted in that post,
when people are asked questions where they have much more direct
experience, they tend to give (on average of course) much more
accurate answers. Its when they source the media that things can go
wrong. It is well known that fears about immigration tend to be
greatest where there is least immigration.
Of course reluctance to acknowledge myths may not be denial but
fatalism. Fatalism in believing that voters will always believe that
migrants want to come to the UK because of our generous benefit
system because it suits their prejudices. Encouraging those beliefs
will be in the interests of what will always be a right wing
dominated press. Some argue that myths can only be changed from a
position of power. But myths are not the preserve of governments to
initiate. According to this,
over 60% of Trump supporters think their president is a Muslim who
was born overseas. [1]
Myths need to be confronted, not tolerated. The initial UK media
coverage of the European migrant crisis played to a mythical
narrative that migrants were a threat to our standard of living and
social infrastructure (to quote
the UK’s Foreign Secretary!). This reporting was not grounded in
facts, as Patrick Kingsley shows.
That changed when reporters saw who migrants really were and why they
had made the perilous journey north. It changed when Germany started
welcoming them rather than trying to build bigger fences. These facts
did not fit the mythical narrative.
The UK government was clearly rattled when it realised that many
people were not happy with their narrative and policies. Myths can be
challenged, but it is not easy. Policy has been changed somewhat, but
attempts are also being made to repair the narrative: to take some of
those who have made it to the EU will only encourage more (a variant
of the previous European policy of reducing the number of rescue
boats), and a long term solution is to drop more bombs. Such idiotic
claims need to be treated with contempt, before they become a new
myth that the opposition feels it is too dangerous to challenge.
Challenging these myths does not imply pretending real voter
anxieties about migration do not exist, but grounding discussion
and policy around the causes of those anxieties rather than the myths
they have spawned.
Yes, the non-partisan media needs to recognise the responsibility
they have, and use objective measures and academic analysis to judge
whether they are meeting that responsibility. But more generally
myths are real and have to be confronted. The biggest myth of all is
that there are no myths.
[1] The probability pedants among you who read the link will know
that I’m actually making an assumption in writing this!
Wednesday 9 September 2015
More (dark) thoughts on interest rates
The following has numbers for the UK, but the logic if not
the numbers also apply to the US: see Mark Thoma here.
Imagine the following lottery. If you win, you receive a total of
£5000 over the next few years. The cost of a ticket? The risk that
inflation will be 0.5% higher than it would otherwise have been for a
couple of years, where inflation includes the rate that wages
increase.
To enter the lottery in the UK you need to cut interest rates. This
lottery is just another way of describing the key argument I made in
Monday’s Independent article
(now complete with chart).
Of course you want to know the odds of getting the prize. The odds
come in the form of a puzzle. What are the chances that the economy
has, over the last ten years, permanently lost 15% of its
normal ability to produce goods and services. Something that has
probably never happened to the UK before. [1] Those are the chances
of you NOT winning.
We can of course discuss those numbers. But in the UK that discussion
appears largely absent. Instead all the talk is about interest rate
increases. We seem to have collectively written off 15% of national
GDP with just a shrug. ‘Oh that must be supply and there is nothing
conventional macro policy can do’ is the general view. That view
may be right, but it is important enough that this should be the
centre of the national debate. Instead we talk about the need to
normalise interest rates, as if the real economy was doing just fine.
Time for a DeLong type lament. If you had told me ten years ago that
a decade hence UK output per head would be 15% below the 1955-2008
trend, inflation was zero and yet people would be talking about
raising interest rates I would have said you were mad. If you had
said that at a time when interest rates and real wages are at record
lows the government was proposing to not invest for the future
because that was the best way to prepare for the next crisis I would
have said you knew nothing about business and economics. If you had
said that just years after a huge financial crisis, followed by a
host of financial scandals, the City regulator would be sacked
because the Chancellor wanted less tough regulation I would have said
you were thinking about some corrupt state and not the UK. If this is
all a bad dream, what will it take to wake people up?
[1] Economies do
appear to suffer some permanent loss to potential output after
financial crises: there is a handy summary of studies here
(table 4.1) - HT Andrew Goodwin
Tuesday 8 September 2015
Making the Eurozone work better: sovereign default
Given the current problems in the Eurozone, it is understandable that
many non-Eurozone economists remind us that they had doubts from the
beginning. That, unfortunately, is not very helpful criticism, except
in so far as it tells us how these problems were originally wished
away.
One lesson from the Greek tragedy is that voters' faith in the Euro
project can survive even under tremendous strain. [1] The Euro was
always a political project, and the political reasons for it have not
gone away. For the governing elite of Europe this is likely to remain
the case. So going backwards is not an option.
Yet while the people and the elite both want to keep the Euro, they
part company when it comes to moving to a complete fiscal and
political union: a United States of Europe. As Philippe Legrain
notes,
ever since the French and Dutch voted No, voter attitudes to further
central control have hardened - and with good reason. If what he
describes as the “Monnet method” (use any crisis to increase
integration) continues, and as Andrew Watt points
out
it is continuing in a big way, the threat to the Eurozone could
become existential. European policy makers have taken far too many
liberties with democracy as it is: they should not take even more.
Which is why I tend to get a little impatient
with economists and institutions that spend a lot of time designed
schemes for further substantial integration.
So the critical issue for now is whether the way the current union is
run can be improved? I see three key unresolved areas here: sovereign
default, competitiveness imbalances and the ECB. I talked about how
to cope better with potential competitiveness imbalances recently.
This post is about default.
I agree with Philippe Legrain that we need to have more decentralised
fiscal control, and less rules from the centre. As I have noted
before,
there now exists in the Eurozone a system that is parallel to
monitoring from Brussels, based instead on national fiscal councils.
Can we design a system around that which negates any need for central
control?
One way of making this work would be to deny any support to any EZ
government that gets into trouble with the market. When the EZ was
set up, its architects worried that market discipline would be too
weak for this to work, so centralised controls were also necessary
(the Stability and Growth Pact). In one sense they were right: the
markets started treating Greek government debt as if it was German
debt. But once a crisis happened they were wrong: governments with
lower deficits than the UK were regarded as riskier by the markets.
What should now be clear is that the debt of member governments of a
monetary union are subject to much greater rollover risk than
equivalent countries outside the union because they do not control
their own currency. That problem has been dealt with (for the moment)
by OMT.
But you cannot have OMT without conditions. For obvious reasons OMT
cannot be a blank cheque to a monetary union member to run ever
higher deficits.
So OMT has to be conditional, but who should set the conditions? Who
decides that a future Greece has to default, but that a future
Ireland should get the OMT guarantee without the need to default? At
the moment the answer is both the other Eurozone governments and the
ECB decide. But Eurozone governments have shown themselves to be
hopeless at this task (see actual Greece), partly because they are
subject to pressure from creditors. To leave this all to the
unelected, unaccountable ECB is just asking for problems, and would
represent too great a strain on ECB independence.
Let’s imagine the following. The Italian government at some time in
the future finds that interest rates on its debt begin to rise well
above average Eurozone levels. We get into a situation where a
self-fulfilling default is possible. Should the ECB supply OMT cover
to end that possibility or not? What conditions should be imposed on
Italy as the price for that cover?
It would be nice if we could write down some simple rules (even
complex rules) that could choose between a Greece and an Ireland.
Fabian Lindner discusses some possibilities here.
The major problem is that a great deal depends on something that
embodies a political judgement: just how large will future primary
surpluses be? Italy, because of its large debt, is used to running
much larger primary surpluses than other countries. How do you judge
what the upper limit is?
This is why ‘leaving it to the market’ is so attractive, because
you appear to be asking a huge number of people to take a bet on the
answer. But that method is flawed, because with rollover risk what
they are actually taking a bet on is what they think other market
participants think about rollover risk. OMT removes that rollover
risk.
So if the market cannot do this, and the ECB and EZ governments
should not do this, who is left? Do we set up a new institution of
experts to decide and set conditions? (Conditions have to be set,
because actions may change after OMT is granted.)
One obvious response is that we do not need a new institution,
because we already have one, and it is called the IMF. It is
imperfect, with at the moment too much influence from EZ governments
on its decisions, but that means reforming the IMF rather than
reinventing it. This may happen as a result of the Greek debacle.
Philippe Legrain suggests using the IMF in a similar role here,
although as a transitional measure while a new EZ institution is set
up. However it is difficult to imagine EZ governments setting up a
new institution that was truly independent of political pressure from
member states.
The proposal would work like this. When Italy got into difficulties,
it would go to the IMF. No EZ assistance would be allowed before
this. The IMF would decide what level of default (if any) was
required. The IMF, and not EZ governments, would set any
conditionality thought necessary to return deficits to a sustainable
level. That would include a path for deficits that the country could
reasonably achieve without creating unnecessary unemployment. (If the
country was uncompetitive, some unemployment would be inevitable.)
If Italy agreed to those conditions, then OMT would automatically be
extended by the ECB. It is quite possible that in those circumstances
Italy would regain market access at reasonable rates. If it did not,
the IMF (and NOT other EZ governments) should provide the finance
necessary to cover transitional deficits.
I suspect this scheme would not be attractive to many Eurozone policy
makers, because they would be losing influence and control. But a
better way to think about it is that the Eurozone contracts out (to
the IMF) the tricky business of deciding whether a government’s
debt is sustainable or not. That seems to me to be a small price to
pay to avoid the kind of conflict between governments that became so
clear in the recent Greek ‘negotiations’.
[1] Of the countries polled here,
only two had more people thinking the euro had been bad rather than
good for their country: Italy and Cyprus. See also Andrew Watt here.
Monday 7 September 2015
The UK as a test case for NGDP targets
In an article
in the Independent today, I argue that it is about time the Bank of
England changed UK interest rates. But they should go down, not up.
The essence of the argument is there remains a significant risk that
we have substantial deficient demand. Even if the probability of this
is below 50%, if it is true the costs of it persisting far outweigh
the costs of some mild inflation overshooting.
One point I do not consider in the article are the implications for
nominal GDP (NGDP) targeting. Here is the picture.
I use nominal GDP per head, because that is robust to changes in
migration flows, which for the UK have been important and variable.
The serious arguments are for a levels target, so I’ve drawn in a
reference path for 4.25% growth. That is a combination of 2% output
price inflation and 2.25% real growth per head, the latter being the
1955-2008 average rate.
If the Bank of England had adopted a NGDP target, as many have
recommended,
the MPC would be tearing their collective hair out right now trying
to stimulate the economy. There would be zero talk of interest rate
increases. So there seem to be just two possibilities. Either
NGDP targeting is nuts, or monetary policy has slowly gone off the
rails by focusing on CPI inflation alone.
Time will tell. But
if the possibility that the UK could really grow quite fast right now
without inflation getting out of control turns out to be true (and
the argument I make in the Independent is just that there is a
non-trivial possibility that it might be true), what will history
say? I suspect they will talk about Goodhart’s
law,
which says “when
a measure becomes a target, it ceases to be a good measure”.
Targeting inflation and ignoring output seemed like a good idea,
because of what is called the divine coincidence. I talked about this
in what I think is one of my better posts.
Goodhart’s law applied to this case says CPI inflation ceases to be a good indicator of
both the state of the economy and maybe also the costs of inflation
when you try using it as a target.
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