Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 22 September 2016

Explaining macroeconomics to the Swabian housewife

Matthew Bishop has a nice simple post at SPERI suggesting how the ‘economy is like a household’ idea can be tackled. He is correct that this analogy has tremendous power, to the extent that I doubt we would have seen so much UK austerity without it. He uses an exchange between Yanis Varoufakis and a member of the Question Time audience to suggest that attempts to simply explain the economics are ineffective. He suggests that the “problem, as Jonathan Hopkin and Ben Rosamond have suggested (here and here), is that you cannot fight ‘political bullshit’ with facts”.

I want to make some observations, in ascending order of importance.
  1. I think he is right that economists can usefully point out that households do not always balance their budgets. But all the examples he gives help explain why it may make sense for the government to borrow to invest. Indeed he could have added comparisons between governments and firms in this respect. That is why it is easy for economists to now argue that governments should be borrowing more to invest. I’m sure most economists would use exactly these analogies: after all most do try to teach this stuff.

  2. However these analogies do little for the issue the audience member thought we were dealing with. He thought the analogy was exactly the case of spending too much on excessive drinking, and needing to sober up financially. While the examples Matthew quotes get you over the simplistic idea that governments should never borrow, they do not explain why (a) it is OK in principle to keep the ratio of government debt to GDP constant (governments live forever), and (b) why it makes sense for governments to borrow a lot more in a recession (the automatic stabilisers), or even (c) why the government should go out of its way to borrow even more in a recession when interest rates are at the Zero Lower Bound. We can try and get these ideas across as simply as we can, as I have tried many times (and suggestions on how to do it better are always welcome), but it is very difficult to do so in a minute or two on Question Time. It is sufficiently difficult that before the General Theory it was not understood by most economists.

  3. I think the suggestion that economists are too busy trying to be correct and therefore too scornful of simple analogies is a little unfair. Only a little: in a live public appearance there is always the concern about what your colleagues in the department will say afterwards. Economists are also aware, as Chris Dillow points out, that partial analogies used in one context can easily backfire in others. However I doubt very much that most economists do the equivalent of mocking “every grammatical error made by friends practising their holiday Spanish”.

  4. The big difference between economists and scientists at CERN is not that economists are less respectful of lay people’s mistakes. It is (a) they have politicians repeating false analogies about their subject as if they were facts, and (b) large sections of the print media doing the same, and (c) most of the rest of the media too clueless to challenge these falsehoods.

  5. This is why, for an evidence based discipline like economics, the response ‘economists know that the economy is not like a household in important respects and here is why’ is not at the end of the day arrogant or dismissive. If Brian Cox was asked on Question Time ‘what is all this about the Earth moving: it is obvious that everything moves around the Earth’ we would not blink an eyelid if he replied ‘No, scientists know that is not true and it only seems that way to you because..’.

  6. What austerity tells us, just as the climate change denial tells us, is that in today’s world respect for science is fragile. In the US public opinion about climate change is sharply divided along political lines, despite the near unanimity among scientists. It is this that should really worry us, and not how climate change scientists can better communicate with the public, desirable though that might be in itself. A world where the scientist has to compete on equal terms with the ignorant polemicist is not a healthy world.



31 comments:

  1. I don't really see what's so hard to understand about the idea that for most of us our income does not depend on our spending, but when you are the government it does.

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  2. "I think he is right that economists can usefully point out that households do not always balance their budgets. But all the examples he gives help explain why it may make sense for the government to borrow to invest. Indeed he could have added comparisons between governments and firms in this respect."

    It would be a good analogy if you were trying to make a political point. Firms are a currency user. Government is the issuer of the currency. So you can't compare government with firms.

    Imagine that the government does all its spending on its credit card. If you do, you’ll be pretty close to the truth.

    There are differences with the sort of credit card you hold. A sovereign government has power over its own domain and can insist on a credit card deal you can only dream of.

    It’s a Super-Platinum Credit Card, with the following unique benefits:

    * Unlimited Spending

    * Repays Itself - government can can pay the credit card bill using the same card

    * The Best Cashback Deal in Existence:

    The key benefit is the cashback deal. You may get a measly percentage on your credit card when you spend money at Asda. Yet when the government uses its credit card at Asda we see how magnificent the cashback deal is:
    first it gets a large cashback percentage immediately:

    * when Asda pays its staff, the government gets another percentage
    * when the staff buy beer at the pub, the government gets a further chunk
    * when the staff at the pub get paid, the government takes a cut
    And so on until all the initial government spend turns entirely into cashback.

    For the government this is a cracking deal. It means that for every £100 the government uses to buy things, it always gets £100 back in cashback. Each time, every time. We have a name for this cashback process. It’s called ‘taxation’.

    So with this magical cashback deal in place, it will never have a balance on its credit card. Unless, unless people out there decide they have bought enough, and will put a little of their earnings to one side instead.

    We have a name for that. It’s called ‘savings’.

    So if people don’t spend all their earnings the government ends up with a balance on the credit card. In other words, when people choose to save it causes a balance on the government’s credit card.

    We have a name for the balance on the credit card. It’s called the ‘national debt’, and the change in the balance is called the ‘government deficit’. But the cause is the still the same — people saving.

    So that is what government is really about — procument and supply of public goods and services. The fiscal limit for government is reached when the government runs out of things it wants to buy at the price it is prepared to pay.

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  3. "It is (a) they do not have politicians repeating false analogies about their subject as if they were facts, and (b) large sections of the print media doing the same, and (c) most of the rest of the media too clueless to challenge these falsehoods."

    I note the irony. "Government as firm."

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  4. Already if you made a simple example of an economy consisting of two households A and B producing and selling goods to each other, also on credit, you could easily show what excessive saving by household A to reduce its debt would do to its own income from selling goods to B

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  5. "Everyone is entitled to his own opinion, but not his own facts."

    Daniel Patrick Moynihan

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  6. But importantly given the negatives associated with the word spending why continue to use it? It’s what the government chooses to buy and what it chooses to stop the population buying that matters.

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  7. Minor technical quibble: I’m not sure about SW-L’s claim that “it may make sense for the government to borrow to invest.” If an individual or firm wants to invest and it has the necessary cash, it makes sense for it to spend the cash rather than borrow. And in the case of the state, it has a limitless source of cash: first the taxpayer, and second it can print money (appropriate if demand is inadequate).

    Re the idea that borrowing spreads the cost across generations, that’s not true: reason is that if the state makes an investment in 2016, it’s a physical impossibility for the costs not to be born in 2016 or earlier: you cannot build a bridge in 2016 using steel produced in 2026, and I don’t accept Nick Rowe’s rebuttal of that argument.

    And finally, Milton Friedman advocated zero government borrowing in his American Economic Review paper “A Monetary and Fiscal Framework…”.


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  8. I very much doubt that the member of Question Time whose views Varoufakis criticised, left the Programme believing or understanding why he was wrong in comparing his household budget to that of the UK government.
    The analogy is seductively powerful and economists would be well advised to avoid it completely.
    I think that if Varoufakis wanted to help the Questioner understand the falsity of the analogy he would have asked him where the ten pound in the questioner's pocket originated. He might then have pointed out that the Government via the Bank of England creates money whilst private citizens go to jail if they attempt the same. He could then have pointed out that the Bank of England can never out of pound notes (and that Liam Byrne's silly note was just that)
    The failure to understand how money is both created and used by Government that lies at the root of the confusion.
    Perhaps it is just another "assumption" that economists are wont to make

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  9. As a professional in communication but also strongly acquainted with social sciences and philosophy, I would suggest the following lines of work: (i) visually, we need a dynamic pwp with a few infographic slides, which of course should include an historical case as sample; (ii) verbally, to reduce the argumentation to only two or three strong short sentences ('Fasting is harmful if you are starving'); (iii) a series of joyful or witty jokes helping to direct minds, through Whatsapp or Twitter, to the most elaborate macroeconomic theory (vg. 'Keynes's ghost told students in a King's College corridor he is now seriously considering to re-encarnate as a female German Chancellor', or 'In a worst case scenario, we have to choose between government mis-spending and financial market money-burning', or 'Growth needs prodigal politicans, not only profligate bankers').
    I'm sure there are in UK good professionals for succeeding in these tasks.

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  10. I'm torn between old school Keynesian and NewKeynesian economics. In many NK models the multiplier of government spending is rather low. So, what do you tell a politician? It depends on which model you choose?

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  11. «the response ‘economists know that the economy is not like a household in important respects and here is why’»

    The important respect is which "the economy" is indeed like a household is the balance of trade. Foreign suppliers want, quite selfishly, to be paid in hard currency, not in drachmas :-).

    Currently the UK has an overall rather expansionary stance with a 5-6% budget deficit and a 6-7% trade deficit. It is much easier to dismiss the budget deficit than the trade deficit.

    Also, the combined effect of the budget and trade deficits is probably to boost GDP by 10-15% over what it would be with a less expansionary debt-fueled position.

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    1. Trade deficits reduce growth if not offset silly.

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  12. What about this for an idea ? ALL University courses should include a short course on scientific method and basic economics. This I think is something Universities could start doing now without Governmental approval.

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  13. What has to be explained, but seldom is, is that a country can print fiat money at zero cost. If money is used to increase demand for goods and services and this put to work idle capacity (plants and persons), additional output is created without additional costs.

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  14. The problem with the 'state as household' analogy goes deeper than the argument that sometimes it's good for households to take on debt. While that argument has legs if you can convince the listener of the importance of the government expenditure multiplier, or the sense in using otherwise idle resources, there is still a risk that the listener will believe (and may have heard from other economists) that even so the risks - to the pound, or to future generations - are too great to do that right now.

    As you're well aware the key issue is the fallacy of composition. It seems Dr Bishop thinks that's too 'expert' to expect ordinary people to understand. If economists and informed people can't get across the relatively straightforward point that one person's debt is another person's surplus - and more importantly vice versa - then we probably do have to fall back on the 'trust me I'm an economist' theme with all its obvious weaknesses.

    For what it's worth I occasionally had success with friends/family who propounded the household model by countering with variations on the babysitting circle - if there is a limited number of tokens for circle members to pay each other with, and every member of the circle tries to make sure that he (or she) earns a surplus of tokens, then the circle will eventually collapse because no one is willing to spend the tokens they have. This can be extended to the economy by explaining that if government runs a surplus, then someone else must be running up a debt: and if your job is uncertain then it probably won't be you.

    But simple assertions of the kind 'sometimes borrowing is worthwhile' do not get the message across, in my view.

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    1. You can make it even simpler by positing an economy consisting of just two households like I suggested above. Already with that you can show the fallacy of composition very concretely. A's spending is B's income and vice versa.

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  15. I would say:

    1. There is no example in history where being in a liquidity trap has seen borrowing rates rise if the government borrows to invest.

    2. There is no economic model that says you will get anything but better growth from ZLB borrowing.

    3. Osborne changed from plan A to plan B in 2012, and by borrowing more the economy grew more rather than hardly growing with his 2010-2012 austerity.

    4. Yours is the worst economy recovery since the BoE was set up; does that not embarrass you that you are part of the thinking which has led to a once in ten generations blowout?

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  16. Consolidating HM Treasury with the Bank Of England and using the ways and means account as an overdraft would be a good start.

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  17. Put the ways and means account as an overdraft in your model and just charge on the reserves and there is no need to borrow.

    Borrowing is just another black stain left over from the gold standard that is no longer required.

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  18. What austerity tells us, just as the climate change denial tells us, is that in today’s world respect for science is fragile. In the US public opinion about climate change is sharply divided along political lines, despite the near unanimity among scientists. It is this that should really worry us, and not how climate change scientists can better communicate with the public, desirable though that might be in itself. A world where the scientist has to compete on equal terms with the ignorant polemicist is not a healthy world.

    This problem is especially big in the USA and much less in continental Europe. Given these large difference between countries it would be surprising when science communication were the problem. The science is the same in every country and the science communication is similar in every country. If anything the American colleagues are more active and more knowledgeable about science communication, because they have to.

    Big differences are money in politics and the Murdoch press. We will not solve it with better or more science communication, but we have to fight the real problems behind it. That "we" is not just scientists but everyone who like to live in peace in a democratic country.

    It would be surprising if it were different for economics.

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  19. A family has a life cycle. A young family borrows to buy a home, furniture, car, etc. A mature family saves for their retirement. An elderly family spends their assets. Even so, the individual small business owner in a down-cycle will #1 try to stay in business, and #2 try to buy productive assets at fire-sale prices for future expansion.

    A nation (hopefully) does not have a life cycle. It is assumed to be immortal. It borrows to build for the endless future. In a downturn, it needs to build GDP, not reduce borrowing, to improve the debt to GDP ratio. Cutting the numerator of this ratio is a death spiral.

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  20. More mediamacro this week as a BBC News correspondent waxed lyrical about how the IFS had shown that Brexit had had much lower impact than predicted. No context was given that Brexit had not happened yet. No context given about BoE QE softening the impact.

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  21. It is very powerful, but isn't the solution merely to extend the analogy?
    What do we do when we want to own a house?
    We borrow. We get a mortgage.
    What is a mortgage?
    A mortgage is a loan that enables you to invest in your future.
    What do we do when the house falls into disrepair?
    We borrow, often by extending our mortgage to fix it. Your home is your infrastructure and every now and then it needs to be fixed.
    Why do we borrow to fix it?
    Because we want to maintain its value and live in comfort.
    What happens when we've finished paying our mortgage?
    We sell our home and, if we've invested in maintaining it over the years, we are likely to see a profit.

    These are just a few ideas I've scribbled down, but that's surely the way to go, isn't it? As you say, people don't listen to economic arguments, largely because, (and it saddens me to say this, but having lived in Finland for 5 years I can confirm it's true) we have a poorly educated population. What saddens me more, is that successive governments have ensured that we have a poorly educated population because structural inequality is the root cause of poorly educated populations.

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  22. You often give climate change as an analogy. I was very impressed with this presentation that the late David Mackay made about climate change http://www.inference.phy.cam.ac.uk/mackay/presentations/html/Climate2015.html . It tackles the issues head on. It doesn't pretend that none of the data is messy or difficult to interpret. It just says it as it is. To me it is an exemplar of how to deal with any sort of politicized intellectual controversy.

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  23. Weak, very weak.

    By the way, Swabians are great housebuilders. A favourite saying there is "Schaffe, schaffe, Haeusle bauen!" (Work, work, build a house). And they know that they cannot buy or build a house without credit; there many building societies in Swabia. What they object to is going into debt for consumption purposes, and that is what most government spending is used for.

    Another point is that in Germany at least confidence in governments' ability to invest sensibly is gone. The Hamburg concert hall cost 11 times as much as estimated. The great new Berlin airport has been mismanaged and will cost three to four times as much.

    With such governments, the Swabian housewife is right.

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    1. As compared with VW and the deutsche Bank of course.

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    2. As Chris Dillow would say - it is not so much government that doesn't know what it is doing, it is managerialism.

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  24. Isn't the real problem that nobody ever poses the question that people should really have to confront - money - where does it come from?

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  25. "The big difference between economists and scientists at CERN is not that economists are less respectful of lay people’s mistakes. It is (a) they have politicians repeating false analogies about their subject as if they were facts, and (b) large sections of the print media doing the same, and (c) most of the rest of the media too clueless to challenge these falsehoods."

    That can only come from an economist. :-)

    The crucial difference between economists and theoretical physicists is that the latter do not assume that their models have an real effect on the daily life of people.

    In contrast, economists - while working with models that blend out important aspects of reality, aspects that influence economic behaviour of people and societies- have no issue with claiming that their models have a high relevance. :-)


    Ulenspiegel

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  26. Oh dear Simon,
    I have been thoroughly disapointed in your response to Paul.

    why are the problems with economics everyone else's fault?

    The main problem with Economics is that while economists know a tremendous amount. Anytime anyone outside the profession points out that despite all the tremendous knowledge, there are still somethings economists do not understand, you get a response calling us all swabian and pulling rank on your superior knowledge of economics.

    we all know that the map is not the territory, we're happy to concede from the outside that economists are superior map makers -
    All we ask is that you concede to those of us on the outside that the territory is not yet fully mapped.

    Not that complicated really, I suspect even a swabian economist could understand.

    Economics has not yet fully modeled and dealt with the issue that the private sector and market based activities are a function of both the fed and fiscal policy; that the fed is a function of both market based activity and fiscal policy; and fiscal policy is a function of both market based activity and the fed (or CB or bank of england or whatever) and each of course are also functions of other inputs as well.
    Its a big daisy chain that economists talk about and theorize on all the time, but have yet to actually model completely.

    Further economists have not fully modeled out that activity today is a function of expectations for tomorrow and we all know that our knowledge of tomorrow is both full of uncertainty AND path dependent; the future depends on fed, fiscal policy and the actual path of market based activity.

    Paul Romer's point is genius. He simply points out that if you want to solve a circular interacting equation like that you need to iterate.
    Paul isn't saying that Econ doesn't know an enormous amount; he's just saying hey the map isn't complete, there is no use in pretending it is, and oh by the way, if you want to continue to make better maps, iterate.

    I say,
    hear hear!

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  27. In most people's minds, "saving" is "the difference between income and spending" - which is not how economists use the term (i.e. to mean "the difference between income and *consumption* "). What most people don't notice is that, by the common definition of "saving," no economy ever *saves* anything. And an individual unit within an economy can only "save" if another unit dis-saves an equal amount.

    Which means that "saving" and "borrowing," far from being opposites, are exactly the same thing: if you want to increase "saving," you must increase borrowing by the same amount.

    One way to put the basic Keynesian insight is: "It is government borrowing that makes private savings possible."

    How to get that across in a sound-bite...well, I'm still pondering.

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