Clinton’s emails and UK austerity: a sense of context and consequences

The media obsesses over whether Clinton might have sent an email containing confidential information from her personal account while secretary of state, and also wonders about whether Trump tells lies, pays any taxes, bribes officials and assaults women. Anyone who reads these stories can see that there is no equivalence here. But anyone who just reads the headlines would be tempted to think otherwise. The very fact that commentators think a renewed focus on these emails is ‘bad for Clinton’ acknowledges that many people are indeed just reading the headlines. That context matters.

Glenn Greenwald suggests that when Paul Krugman and others make similar points, they are suggesting Clinton should have “a scrutiny-free march into the White House”. But I think this misunderstands Krugman’s point. Impressions matter, particularly just before an election. If the media spend as much time discussing possible Clinton misdemeanors as those of Trump the impression you give is that they are of equal importance. By balancing things that are very different, you create an equivalence that is completely misleading. Failure to take that into account still might have disastrous consequences.

I do not think this is just a problem with the media. Whenever I talk about the false accusation that Labour profligacy caused austerity, I get people commenting that it is not really false because Labour did overspend. This is true, and it was for this reason that I originally talked about a myth based on a half-truth. A half-truth is a statement that conveys only part of the truth, especially one used deliberately in order to mislead someone. But in political terms that concedes too much. If there hadn’t been a recession and the Coalition had had to undo Labour's fiscal excess, I doubt if anyone besides the IFS would have noticed and no one would not have called that correction austerity.

Yet even when I make this point, someone still objects that Labour bears some responsibility because they should have seen the recession coming, or that they were responsible for the lack of financial regulation that allowed the global financial crisis to have such a large impact on the UK. While those claims should be discussed in some contexts, they are beside the point when discussing Conservative charges against Labour. When Conservatives claim that Labour profligacy caused austerity, there is an implicit clause that says ‘and it would not have happened if we were in charge’. The context is who would be better at managing the economy. If the context was an article about the performance in absolute terms of the Labour government those caveats would be appropriate (although both can easily be challenged), but when the context is clearly about the relative competence of Labour and Conservatives they are not. 

When a political party makes a claim, or for press coverage during an election period, everything is relative. In a sense it is a bit like voting. Anyone who says they cannot vote for X because X did or will do something do not understand the game they are in. Voting is about comparisons: not whether X is good in some absolute sense, but whether X is better or worse than Y. So to say, as Ed Miliband sometimes did in defending Labour against the profligacy charge, that Labour perhaps were at fault for not regulating enough, he did himself no favours because he was talking out of context. Compared to the Conservatives he has nothing to apologise for on that front.

We can see this clearly if we think about consequences. The consequence of the US media spending so much time on the relatively trivial issue of emails is that US voters think they can trust Donald Trump more than Hillary Clinton. The consequence of Ed Miliband apologising about not regulating finance enough when defending Labour against profligacy claims is to appear to concede that in some sense the Conservatives were more competent than Labour. Context matters, and ignoring it has consequences.

Postscript (4/11/16) Since writing this I have been surprised by how many on the left seem happy to parrot the idea that the email affair is potentially serious. Here is Matthew Yglesias with a comprehensive account. It has also become clear that the latest news from the FBI tells us more about the FBI than Clinton.

Brexit and neoliberalism

In a recent post I talked about the “neoliberal fantasists who voted Leave”. Here is Ryan Bourne from the influential Institute of Economic Affairs. He notes that “the mood music from the post-referendum Conservative party — with former Remain backers in No 10 and the Home Office overcompensating with a caricatured view of what voters want — is not a good sign for the short-term”. But he still believes that Brexit can be transformed into some kind of neoliberal wet dream, with a bonfire of regulations and a unilateral abolition of UK tariffs on trade.

The economics of this was always fantasy, as John Van Reenen and colleagues painstakingly demonstrate here, but it also seems politically naive. After all the Leave campaign was a success largely because it promised to control immigration as a result of leaving the EU, controls which are distinctly anti-neoliberal. Controlling immigration is not a caricature of what the majority of Leave voters wanted, but instead what most were voting for. It does seem naive to believe that a government after Brexit would try and quietly forget about this, particularly when led by someone who had spent the previous 6 years trying and failing to control immigration. It also seems naive to imagine that this turn against neoliberalism would not go beyond immigration.

And yet, the ‘southern strategy’ was highly successful for the Republican party in the US. This combined an economic policy that favoured finance and corporates, increased inequality and free markets with an identity politics that appealed to race, religion and cultural identity. (I could perhaps add geographical identity here as well: see this article by David Wong.) Perhaps the UK party of the right could follow a similar course, using immigration as a substitute (and for some a proxy) for race, whilst pursuing an otherwise neoliberal agenda?

Is this what the Conservative party tried to do under Cameron and Osborne? Actually I think that is the wrong question, for reasons I will come to shortly. In terms of what the Coalition government actually did, Jonathan Portes summarises it thus:

“The promise to cut net migration to the “tens of thousands” was generally regarded by immigration policy experts as unachievable, or achievable only at an economic cost no sensible government was willing to pay. In practice, the latter course was never tested: resistance from within government from the Department of Business, supported to a greater or lesser extent by the Treasury, meant that even non-EU migration was only reduced very substantially for non-HE students; for most other routes it has stabilised. Non-EU net migration is currently about 150,000 a year, slightly higher than EU net migration

This does not mean the policy changes had no impact: the increase in the regulatory burden on business and the education sector has been substantial, and has certainly resulted in some reduction in skilled and student migration. The most damaging single decision was probably the closing of the Post-Study Work Route. However, overall, any economic damage was considerably mitigated.”

Of course that resistance from the Department of Business came from a Liberal Democrat, Vince Cable, and not a Conservative. Which leaves open the possibility that the economic damage from attempts to hit the immigration target might have been greater if just the Conservatives had been in power. So it is not clear that the Conservative focus on immigration was just so they could win elections with zero cost to their more neoliberal objectives. It still remains the case that, just as Trump exposed the flaw in the Republican’s southern strategy, so Brexit was the critical flaw in Cameron’s emphasis on the problem of immigration and his failure to meet his own targets.

I said it was the wrong question, because I think in this case it was not a political party that was calling the shots but a section of the print media: the right wing tabloids. As Andy Beckett writes in this comprehensive history of this part of the UK media:

“[Brexit] was an outcome for which the tabloids had campaigned doggedly for decades, but never more intensely – or with less factual scrupulousness – than this spring and summer, when the front pages of the Sun, Mail and Express bellowed for Brexit, talking up Britain’s prospects afterwards, in deafening unison, day after day. Two days before the referendum, the Sun gave over its first 10 pages to pro-Brexit coverage.”

And the principle means the tabloids used to obtain this result was the “endless xenophobic nudges of its immigration coverage.” Of course these newspapers will say they were just expressing their readers fears, but when they are reduced to making up stories to encourage this fear any claim to innocence becomes very hollow. Fueling anti-immigration feeling was their version of a southern strategy, and Brexit saw its culmination.

Having achieved this objective, will the tabloids start ignoring the immigration issue, enabling the greater immigration and zero tariffs that Mr. Bourne desires? Or will the influence of these tabloids, perhaps now greater than it has ever been, start to fade away? To the extent that these seem silly questions reveals the political naivety of the neoliberal Leavers. It is highly unlikely that Theresa May will become squeamish about damaging business through immigration controls to enable her to meet her immigration target. The best hope of those who do not want to go down this path is that, as Jonathan Portes expects, the Brexit vote itself starts to reduce the immigration numbers.

Brexit will also put other pressures on May which are likely to move her away from neoliberal policies, as the assurances given to Nissan indicate. As Bourne writes in a recent blog: “if this is a commitment to permanent or semi-permanent support to almost ‘make up for’ changed trade arrangements then it is hugely misguided.” Misguided it may be, but that is the direction the politics will push a Prime Minister determined to be seen as making a success of Brexit. Just as Republican’s have agonised over how to deal with Donald Trump, so it will become clear to UK neoliberals the damage to their cause that Brexit will generate.

Being honest about ideological influence in economics

Noah Smith has an article that talks about Paul Romer’s recent critique of macroeconomics. In my view he gets it broadly right, but with one important exception that I want to pursue here. He says the fundamental problem with macroeconomics is lack of data, which is why disputes seem to take so long to resolve. That is not in my view the whole story.

If we look at the rise of Real Business Cycle (RBC) research a few decades ago, that was only made possible because economists chose to ignore evidence about the nature of unemployment in recessions. There is overwhelming evidence that in a recession employment declines because workers are fired rather than choosing not to work, and that the resulting increase in unemployment is involuntary (those fired would have rather retained their job at their previous wage). Both facts are incompatible with the RBC model.

In the RBC model there is no problem with recessions, and no role for policy to attempt to prevent them or bring them to an end. The business cycle fluctuations in employment they generate are entirely voluntary. RBC researchers wanted to build models of business cycles that had nothing to do with sticky prices. Yet here again the evidence was quite clear: for example data on real and nominal exchange rates shows that aggregate prices are slow to adjust. It is true that it took the development of New Keynesian theory to establish robust reasons why prices might be sticky enough to generate business cycles, but normally you do not ignore evidence (that prices are sticky) until you have a good explanation for that evidence.

Why would researchers try to build models of business cycles where these cycles required no policy intervention, and ignore key evidence in doing so? The obvious explanation is ideological. I cannot prove it was ideological, but it is difficult to understand why - in an area which as Noah says suffers from a lack of data - you would choose to develop theories that ignore some of the evidence you have. The fact that, as I argue here, this bias may have expressed itself in the insistence on following a particular methodology at the expense of others does not negate the importance of that bias.

I do not think this is just a problem in macroeconomics. David Card is a very well respected labour economist, who was the first to present detailed empirical evidence that imposing a minimum wage might not reduce employment (as the standard supply and demand model would predict). He gave an interview some time ago (2006), where he said this about the reaction to this work:

“I've subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole.”

As Card points out in the interview his research involved no advocacy, but was simply about examining empirical evidence. So the friends that he lost objected not to the policy position he was taking, but to him uncovering and publishing evidence. Suppressing or distorting evidence because it does not give the answer you want is almost a definition of an illegitimate science.

These ex-friends of David Card are not typical of academic economists. After all, his research was published and became seminal in subsequent work. Theory has evolved (see again his interview) to make sense of his findings, but unlike the case of macro the findings were not ignored until this happened. Even in the case of macro, as Noah says, it was New Keynesian theory that became the consensus theory of business cycles rather than RBC models.

Yet I suspect there is a reluctance among the majority of economists to admit that some among them may not be following the scientific method but may instead be making choices on ideological grounds. This is the essence of Romer’s critique, first in his own area of growth economics and then for business cycle analysis. Denying or marginalising the problem simply invites critics to apply to the whole profession a criticism that only applies to a minority.

Helping the broadcast media be informative on politicised issues

The broadcast media in the UK, and particularly the BBC, can do an excellent job at providing information in an accessible way. However, the moment a subject gets politicised, this ability seems to collapse. This is because the moment a subject becomes politicised, the non-partisan media puts ‘balance’ above all else, which in turn allows politics rather than reality to define what is understood as true. I’ve called this the politicisation of truth, and have identified four ways this happens:

1. Ignoring facts: ‘shape of the earth: views differ’ type reporting.
2. Ignoring expert pluralities: for uncertain outcomes, failing to mention that one side is a minority view. The economics of Brexit is an example.
3. Allowing politicians to create untruths. Labour profligacy caused austerity is an example.
4. Repeating politically generated untruths. For example 'the 364 economists were wrong'.

Here is an interesting discussion of the first two of these in the context of Brexit. From the discussion you can see that shifting existing practice will not be easy, so in this post I want to be positive rather than just complain.

Before doing so, however, I want to say why this is so important. If the broadcast media do not correct politicians when they lie, they provide an incentive for them to lie. That will quickly become apparent, so even if one side ‘starts it’, the other side will follow. This creates an incentive to tell even bigger lies and so on. In the short term the lies are believed and this distorts democracy, and in the longer term trust in politicians deteriorates even further.

We saw this with Brexit, and we have seen this with Donald Trump. Trump’s stream of well documented lies are ‘balanced’ against seemingly baseless or minor insinuations about Clinton. It is easy for people like those who read this blog to think everyone knows that Trump is a serial liar, but they do not. In fact:

“Trump has his largest edge of the campaign as the more honest and trustworthy of the two major candidates (50% say he is more honest and trustworthy vs. just 35% choosing Clinton)”

If you are reading this in the UK and thinking this could only happen in the US, who do you think was trusted during the Brexit campaign?

There is no one else who can inform the majority of people what the truth is. There are countless media organisations, think tanks and websites designed to present a partisan view. It takes both time and knowledge for people to find sources that can be trusted, and that is time most people will not spend. As Stephen Cushion and Justin Lewis note, people actively want the broadcast media to separate facts from spin, but this popular demand is being ignored because it is drowned out by politicos shouting about bias. As they also note, this information has to come in prime time viewing: doing it only in specialist programming watched by those who are already well informed completely misses the point.

The obvious way to avoid facts being distorted is to correct them. As Jeremy Shapiro says in his discussion above, this has to be done in real time. It is just no good saying we corrected that on our fact checking website a few days later, not only because of the delay involved but also because hardly anyone looks at that website. So, for example, in a debate between two sides, if one side says X and X is not true, the moderator should say so. If in an interview the interviewee says something untrue, the interviewer should say so, even if they want to get on to another point.

This of course immediately gets you into questions of how does the interviewer know what is true and where do you draw the line. Here I have some sympathy with journalists, who are sometimes expected to have everything at their fingertips. What academics in particular need to do is to ensure that this information is easily available from trusted sources, and protest when that information is ignored.

I think those in the physical sciences understand this. For example a few years ago there was a period in which climate change was only discussed by broadcast media in a politicised format, where typically a climate scientist would debate the issue with someone from denial organisations. But with almost all climate scientists agreeing about the fundamental facts, this ‘balance’ gave a completely distorted view of reality. As a result of concerted pressure from scientific bodies (and with help from MPs), the BBC finally recognised this and issued revised guidelines. (Here and here (pdf) is the BBC Trust review.) Their coverage of climate change may still not be perfect (or more seriously may have simply diminished), but at least the BBC recognised there were cases where evidence is more important than balance.

Academic economists as a collective are not so well organised, and we need to become more so. This is not about improving individual economist’s media skills, or getting certain people regularly invited on discussion programmes. It is about having a trusted source that can present what the balance of views of academic economists are, and what the key facts and arguments are, and make sure this appears in the inbox of all the media’s key journalists. It should make letters to newspapers signed by a long list of academic economists a thing of the past, because economists themselves would find out what the plurality of opinion was and make that widely known. If Brexit does not compel academic economists to organise in this way, nothing will. Only in this way will we stop politicians defining the public's perception of what is true and false in economics. 

Neoliberalism and austerity

I like to treat neoliberalism not as some kind of coherent political philosophy, but more as a set of interconnected ideas that have become commonplace in much of our discourse. That the private sector entrepreneur is the wealth creator, and the state typically just gets in their way. That what is good for business is good for the economy, even when it increases monopoly power or involves rent seeking. Interference in business or the market, by governments or unions, is always bad. And so on. As long as these ideas describe the dominant ideology, no one needs to call themselves neoliberal.

I do not think austerity could have happened on the scale that it did without this dominance of this neoliberal ethos. Mark Blyth has described austerity as the biggest bait and switch in history. It took two forms. In one the financial crisis, caused by an under regulated financial sector lending too much, led to bank bailouts that increased public sector debt. This leads to an outcry about public debt, rather than the financial sector. In the other the financial crisis causes a deep recession which - as it always does - creates a large budget deficit. Spending like drunken sailors goes the cry, we must have austerity now.

In both cases the nature of what was going on was pretty obvious to anyone who bothered to find out the facts. That so few did so, which meant that the media largely went with the austerity narrative, can be partly explained by a neoliberal ethos. Having spent years seeing the big banks lauded as wealth creating titans, it was difficult for many to comprehend that their basic business model was fundamentally flawed and required a huge implicit state subsidy. On the other hand they found it much easier to imagine that past minor indiscretions by governments were the cause of a full blown debt crisis.

You might point out that austerity was popular, but then so was bashing bankers. We got austerity in spades, while bankers at worst got lightly tapped. You could say that the Eurozone crisis was pivotal, but this would be to ignore two key facts. The first is that austerity plans were already well laid on the political right in both the UK and US before that crisis. The second is that the Eurozone crisis went beyond Greece because the ECB failed to act as every central bank should: as a sovereign lender of last resort. It changed its mind two years later, but I do not think it is overly cynical to say that this delay was partly strategic. Furthermore the Greek crisis was made far worse than it should have been because politicians used bailouts to Greece as a cover to support their own fragile banks. Another form of bait and switch.

While in this sense austerity might have been a useful distraction from the problems with neoliberalism made clear by the financial crisis, I think a more important political motive was that it appeared to enable the more rapid accomplishment of a key neoliberal goal: shrinking the state. It is no coincidence that austerity typically involved cuts in spending rather than higher taxes: the imagined imperative to cut the deficit was used as a cover to cut government spending. I call it deficit deceit. In that sense too austerity goes naturally with neoliberalism.

All this suggests that neoliberalism made 2010 austerity more likely to happen, but I do not think you can go further and suggest that austerity was somehow bound to happen because it was necessary to the ‘neoliberal project’. For a start, as I said at the beginning, I do not see neoliberalism in those functionalist terms. But more fundamentally, I can imagine governments of the right not going down the austerity path because they understood the damage it would do. Austerity is partly a problem created by ideology, but it also reflects incompetent governments that failed to listen to good economic advice.

An interesting question is whether the same applies to right wing governments in the UK and US that used immigration/race as a tactic for winning power. We now know for sure, with both Brexit and Trump, how destructive and dangerous that tactic can be. As even the neoliberal fantasists who voted Leave are finding out, Brexit is a major setback for neoliberalism. Not only is it directly bad for business, it involves (for both trade and migration) a large increase in bureaucratic interference in market processes. To the extent she wants to take us back to the 1950s, Theresa May’s brand of conservatism may be very different from Margaret Thatcher’s neoliberal philosophy.

News, entertainment and Trump

There seem to be two types of media outlets in both the UK and US. There are those who push a clear right wing political agenda to those who would rather read about celebrities or sport: the Daily Mail or Sun in the UK and Fox News in the US. As President Obama said, if I watched Fox News even I wouldn’t vote for me. And then there is the non-partisan media. What values drive their coverage of political events?

I was thinking about this after reading a comprehensive account by Thomas Patterson of the media’s role in the rise of Donald Trump, based on research by the Harvard Kennedy School’s Shorenstein Center. The basic story is that the media gave Trump far more coverage than other candidates in the crucial pre-primary period. Furthermore, contrary to popular myth, this was not just the cable news channels, but also papers like the New York Times and Washington Post. The rise of Donald Trump owes a great deal to this bias in media coverage.

The other remarkable thing about this excess coverage, even among the established newspapers, is that it was favourable. The term ‘favourable’ needs decoding in this context. What seems to happen involves a two stage process. First, Trump simply gets attention by saying outrageous things. Once his poll ratings start to rise as a result of this publicity, he is talked about in a positive way because he is gaining popularity.

Journalists in the non-partisan media bend over backwards not to express personal views on policy or character. What they do instead is treat political contests as a horse race. It is all about who is up or down, who is rising and falling. On top of that views are expressed on why some candidates are doing better than others. Those who are winning generally require explanations in terms of positive virtues: hence the favourable treatment of Trump. Few journalists dare say that Trump is gaining popularity because a large section of the population is racist!

In other words, Trump played on conventional, non-partisan news values and won big time. He was great entertainment at first, and after that got him noticed he became the news because the additional news coverage helped increase his poll ratings. That news was favourable because his poll numbers were rising. In case you think this could only happen for someone on the right, according to this research the second part of the dynamic was even more true for Bernie Sanders. The candidate who really suffered was Clinton.

That the media should play such a large role in allowing someone like Donald Trump to get so close to the White House should be a big concern for those working in the media. The free press is supposed to help safeguard democracy from quasi-fascists, not make it easier for them to come to power! I wonder if part of the problem is that the non-partisan media is also mixing politics and entertainment. As talking about policy is not entertaining for most, particularly if it has to be done in a ‘balanced’ way, it is more attractive to the non-partisan media to treat politics like sport. I cannot help feeling that if in a real horse race it was shown that the commentary on the race had an influence on the outcome, something would be done to change that very quickly indeed.

Structural Reforms and Greece

Should the Troika - the Eurogroup, ECB and IMF - be concerned about how bread is sold in Greece? You would think they had more important things to worry about, like getting Greece out of the huge recession caused by their own policies. But no, you would be wrong. The Troika decided that standards specifying the weights that loaves could be sold at were a restrictive regulation, and demanded change.

This is one of the examples Joe Stiglitz quotes in his new book on the Euro, which I review in the New Statesman here. Now you might agree that at the very least this represents a misdirection of the Troika’s energies, and more generally that it involves unwanted interference in national sovereignty. But in Joe Stiglitz you have one of the best economists in the world, so he also tells you that there is a long-standing economics literature on how regulations like these can increase competition because they facilitate comparison shopping.

Stiglitz is very critical of many other ‘structural reforms’ that were imposed on Greece by the Troika. The only structural reforms that it might have made sense for the Troika to suggest were measures that would have moved resources into exports, thereby helping an external demand led recovery (see Ireland or Spain). As I note, even here Troika meddling may have had undesirable consequences.

As I said in a recent post, a little knowledge can be a dangerous thing. But of the three parts of the Troika, the IMF ought to have the knowledge to do better. (The ECB has apparently just created a task force to consider economic reforms.) Over 1,500 economists work at the Fund. Whether that knowledge gets to the right people at the right time is another matter. But I suspect the main problem at the fund is politics rather than economics. I have written about this recently, in the context of an Independent Evaluation Office report on the IMF’s Troika role. Here is a more substantive piece by Edwin Truman at the Peterson Institute in a similar spirit.

Greece is currently trapped in a debtor's prison created by the Troika. The Troika insist that debts have to be repaid. The IMF knows the prisoner does not have the ability to do this, but does not have the political will to demand that as a result the prisoner should be released. Debt repayment requires yet more austerity, which kills the chance of the recovery, so even with austerity debts are not repaid. Some debt forgiveness is probably in the interests of everyone, including the creditors, because after a recovery Greece will be in a much better position to pay any remaining debts. But it is politically unattractive for the creditors, so it does not happen.

This is a disaster for Greece, but a bad omen for Brexit. Those who advocated Leave say it is in the Eurozone's interests to agree favorable trading terms with the UK. To do otherwise would be to sacrifice economic interests to make a political point. The obvious irony of course is that this is exactly what Brexit was: sacrificing economic interests to make a political point. But Brexiteers want to believe, in their topsy turvy way, that European leaders would not be as reckless as they are. Greece is an example of how Europe's political leaders can also discard economic logic if it is in their own political interest to do so. 

Brexit and Sterling

Is the Brexit induced decline in Sterling a blessing in disguise? So argues Ashoka Mody, and to a lesser extent Paul Krugman. Their basic argument is that Brexit will hit the City, and it is the City that has created an unbalanced economy and an overvalued currency. Reducing the size of the financial sector is a necessary condition to rebalancing the economy, and Brexit can achieve this.

Ashoka Mody’s disdain for the City is absolutely clear. He writes: “The banking-property complex has been a parasite on the British economy, creating pathologies of financial vulnerability and exchange rate overvaluation.” We can see the overvaluation in the large UK current account deficit. Paul Krugman is less pejorative. The City is just an important UK exporter that Brexit will cut down to size, so we will need to make other UK exporters more competitive to fill the gap.

Neither author disagrees that, because the depreciation of Sterling will raise import prices (in economic speak it will lead to a deterioration in the terms of trade), people in the UK will be poorer. But there is also a difference in mechanisms between the two authors, which has implications for how you view this effect. For Mody the City has caused Sterling to be temporarily overvalued as a result of a “finance-property bubble”. As this is a temporary effect (bubble), sterling was bound to fall at some point anyway. As a result, Brexit has only brought forward the day that UK citizens became poorer.

Krugman on the other hand does not argue that sterling was overvalued in this sense: the City is just an important export industry that will particularly suffer from Brexit. As a result, Brexit does make the average citizen poorer permanently. But he notes that, to the extent that this depreciation also results in a redistribution from the City to more dispersed manufacturing, it might benefit some of the parts of the UK that heavily voted for Brexit.

There is nothing wrong with the logic of both arguments, as you would expect given the authors. The key question is whether they are empirically appropriate in this case. I have argued, prior to Brexit, that Sterling was overvalued, and it also seems that the IMF agrees as well. The key issue is why it was overvalued. If the reason for the overvaluation was something Brexit has ‘cured’, then Brexit has indeed ended that overvaluation. If Brexit has not taken away the reason for overvaluation, then the correction to that overvaluation has still to come.

Paul Krugman’s logic is closer to the one I have also used in arguing that the Brexit depreciation is a result of Brexit making it more difficult for UK industry to export. The twist Paul applies is a distributional one: rather than Brexit making it more difficult to export across the board, it hits one particular industry, allowing other industries to grow. Once again the key issue is whether Brexit does have this distributional effect, hitting the City harder than UK manufacturing.

Suppose there is something in what both authors suggest. I would make a very basic point. If we wanted to cut the City down to size, we didn’t have to achieve this using Brexit. We could instead have imposed much stronger regulations on the UK financial sector (basically higher capital requirements), and watch some of the industry leave in disgust. That way we would have avoided all the additional costs that Brexit will impose (recently restated by the Treasury, but only now considered ‘news’ by the Times), and with the additional benefit of having a financial sector that was not too big to fail. My fear is that after Brexit the opposite will happen: policymakers will go even easier on City regulation in an effort to make up for the damage Brexit will do. So I’m still finding it hard to see any silver lining in the Brexit decision.

Did the Bank of England cause Brexit?

Suppose that by the mid-2000s, immigration from the EU (and the potential for additional immigration) had led to an important shift in the UK labour market. The possibility of bringing labour from overseas meant that old relationships between the tightness of labour market and wage increases no longer held.

You might think that was bad for workers, but that is not so. It would mean what economists call the natural rate of unemployment (or NAIRU) has fallen. Unemployment can be lower without leading to wage increases that threaten the inflation target, because workers fear that the employer can resort to finding much cheaper overseas labour. It reduces the power of workers in the labour market, but also leads to overall benefits. (This is just an example of the standard result that reducing monopoly power is socially beneficial.)

But it is only good news if the Bank of England recognises the change. If they do not, we get stagnant wage growth and unemployment higher than it need be. The obvious response is that the Bank will know there has been a change because wages will start falling faster than they would expect based on previous relationships. However that effect may be masked by the well documented employee and employer reluctance to actually cut nominal wages. Add in the shock of the financial crisis, and this change in the way the labour market works might well be missed.

Here is the big leap. Suppose the above had happened, and the Bank of England did not miss the change. Monetary policy would have been much more expansionary, bringing unemployment well below the 5% mark. Nominal wage growth would have been stronger, and a buoyant labour market would have generated a feel good factor among workers. With more vacancies and less unemployment, concerns about immigration would have begun to fade. The Brexit vote would still have been close, but would have gone the other way.

You may say how could monetary policy be more expansionary given how close we are to the Zero Lower Bound? If that was the case the Bank should have said they were out of ammunition, and placed responsibility with the government and austerity. But for the last two years at least, the Bank could have cut interest rates and has not. You could blame the relentless expectation in the media and financial sector that rates would increase, but the Bank should be able to rise above that.

Of course the Brexit blame game is easy to play when the vote was so tight. The most speculative aspect of this chain of thought is the initial premise about a shift in the NAIRU created by immigration potential. While the possibility makes sense, whether the data backs it up is much less clear. Yet there is some evidence of a structural shift in the UK labour market in the mid-2000s, as Paul Gregg and Steve Machin report.    

Ricardian Equivalence, benchmark models, and academics response to the financial crisis

Mainly for economists

In his further thoughts on DSGE models (or perhaps his response to those who took up his first thoughts), Olivier Blanchard says the following:

“For conditional forecasting, i.e. to look for example at the effects of changes in policy, more structural models are needed, but they must fit the data closely and do not need to be religious about micro foundations.”

He suggests that there is wide agreement about the above. I certainly agree, but I’m not sure most academic macroeconomists do. I think they might say that policy analysis done by academics should involve microfounded models. Microfounded models are, by definition, religious about microfoundations and do not fit the data closely. Academics are taught in grad school that all other models are flawed because of the Lucas critique, an argument which assumes that your microfounded model is correctly specified.

It is not only academics who think policy has to be done using microfounded models. The core model used by the Bank of England is a microfounded DSGE model. So even in this policy making institution, their core model does not conform to Blanchard’s prescription. (Yes, I know they have lots of other models, but still. The Fed is closer to Blanchard than the Bank.)

Let me be more specific. The core macromodel that many academics would write down involves two key behavioural relationships: a Phillips curve and an IS curve. The IS curve is purely forward looking: consumption depends on expected future consumption. It is derived from an infinitely lived representative consumer, which means Ricardian Equivalence holds in this model. As a result, in this benchmark model Ricardian Equivalence also holds. [1]

Ricardian Equivalence means that a bond financed tax cut (which will be followed by tax increases) has no impact on consumption or output. One stylised empirical fact that has been confirmed by study after study is that consumers do spend quite a large proportion of any tax cut. That they should do so is not some deep mystery, but may be traced back to the assumption that the intertemporal consumer is never credit constrained. In that particular sense academics’ core model does not fit Blanchard’s prescription that it should ‘“fit the data closely”.

Does this core model influence the way some academics think about policy? I have written how mainstream macroeconomics neglected before the financial crisis the importance that shifting credit conditions had on consumption, and speculated that this neglect owed something to the insistence on microfoundations. That links the methodology macroeconomists use, or more accurately their belief that other methodologies are unworthy, to policy failures (or at least inadequacy) associated with that crisis and its aftermath.

I wonder if the benchmark model also contributed to a resistance among many (not a majority, but a significant minority) to using fiscal stimulus when interest rates hit their lower bound. In the benchmark model increases in public spending still raise output, but some economists do worry about wasteful expenditures. For these economists tax cuts, particularly if aimed at those who are non-Ricardian, should be an attractive alternative means of stimulus, but if your benchmark model says they will have no effect, I wonder whether this (consciously or unconsciously) biases you against such measures.

In my view, the benchmark models that academic macroeconomists carry round in their head should be exactly the kind Blanchard describes: aggregate equations which are consistent with the data, and which may or may not be consistent with current microfoundations. They are the ‘useful models’ that Blanchard talked about in his graduate textbook with Stan Fischer, although then they were confined to chapter 10! These core models should be under constant challenge from both partial equilibrium analysis, estimation in all its forms and analysis using microfoundations. But when push comes to shove, policy analysis should be done with models that are the best we have at meeting all those challenges, and not models with consistent microfoundations.

[1] Recognising this point, some might add some ‘rule of thumb’ consumers into the model. This is fine, as long as you do not continue to think the model is microfounded. If these rule of thumb consumers spend all their income because of credit constraints, what happens when these constraints are expected to last for more than the next period? Does the model correctly predict what would happen to consumption if the proportion of rule of thumb consumers changes? It does not.  

Very Serious People and the deficit

I'm glad Paul Krugman liked my General Theory of Austerity paper. But he wonders whether I might be missing something, in not explaining why Very Serious People (VSPs) in the US, or mediamacro in the UK, presume that deficit reduction is always a good thing. The constant call for deficit reduction seems to transcends party politics, and furthermore should be something that the wise always promote.

I do talk about the influence of the City/Wall Street and central banks, but perhaps there is something in addition which I talked about in a recent post: deficit bias. Keynes talked about 'practical men' who tended to absorb some of the wisdom of 'academic scribblers' of 'a few years back'. The wisdom in this case was deficit bias: the tendency that many economists discussed before the financial crisis for deficits and debt to tend to rise over time, across cycles.  Perhaps VSPs and mediamacro have absorbed this particular area of academic analysis?

I think you can tell a similar story about academic scribbling of years past when it comes to the roles of monetary and fiscal policy. In the UK George Osborne argued explicitly that the economic consensus was now that monetary policy should deal with stabilising output and inflation, while fiscal policy makers should look after their own deficit. I have called this the consensus assignment. If he, or his advisors, absorbed this piece of conventional wisdom, so may VSPs and mediamacro.

So the headline academic scribbling was governments should control deficits, not the economy, and they are bad at it. Some of the theories put forward to explain deficit bias involve politicians knowingly deceiving voters by pretending tax cuts or spending designed to capture votes were 'affordable', and relying on general lack of understanding of the government finances to not be found out. That gives VSPs and the media more generally a clear role in providing a public service to help counteract the wickedness of politicians. VSPs might even think it was their public duty to constantly advocate deficit reduction to counter deficit bias.

As they say, a little knowledge can be a dangerous thing. Those of us working on the front line of monetary and fiscal interaction, or who had studied economic history or looked at the lost decade in Japan, knew the conventional assignment broke down when interest rates hit their lower bound. We knew that a liquidity trap was absolutely not the time to worry about deficits, and if you did so you would cause tremendous damage. And we were right.

So if you believe this story, the lesson for VSPs and mediamacro is you really need to talk to economists in the front line more often.

Little Englanders

Watching the Conservative Party go full UKIP on immigration must be like watching the Republican Party go full Trump: in retrospect perhaps inevitable but nonetheless horrifying to witness. As Ian Dunt notes,

“During just three days they have pledged to phase out foreign doctors, cut down on the numbers of foreign students, put landlords in jail for not checking their tenants' residency papers and 'name and shame' companies for hiring foreign workers.”

If the UK had a land border with France, you feel this government would have also announced the building of a great wall. (Ireland please note.)

With words and actions from the government like this, I feel I desperately want to say to the many immigrants I know working hard and contributing to this country: this is not the real England. Most of us do not think this way. And in one sense I’m right. The Brexit vote was about many things but it has been taken by the government as an excuse for a hard Brexit and a demonisation of immigrants. But in another sense I am wrong: physical attacks on immigrants have increased sharply, and few in the media are prepared to condemn the government’s words and actions while many cheer. [1]

Instead some prefer to highlight the uncharacteristic sight of a Conservative Prime Minister taking some of Jeremy Corbyn’s best lines: about how those that have suffered as a result of the financial crisis are not those that caused that crisis, about the inequities of crony capitalism and so on. Words that got Ed Miliband labelled Red Ed by the right wing press. But this is also part of the Republican play book of diversion. With the Republicans it is about race and also immigration and religion. With today’s Conservatives it is about immigration with a bit of race and religion. The diversion is to pretend that inequality of incomes and power were somehow achieved through increasing immigration, and can therefore be reduced by controlling immigration.

If May was at all serious about wanting to redistribute, her first policy announcement would have been to replace the cuts to Universal Credit imposed by Osborne, which will hit hard just the kind of families she says she wants to help. Or it would have been to reverse cuts to inheritance tax introduced by her predecessors. Instead her first big policy announcement was to bring back segregation of schooling at 11, a measure that could almost be designed to entrench the poor life chances of working class families.

Even if you thought there was some genuine desire behind this latest version of compassionate conservatism, there is a harder reality which means it will never happen. The Conservative government is on course for a hard Brexit with the worse kind of deal for UK business. The strategy so far has been inept: principally giving away the UK’s strongest negotiating card, which is invoking Article 50. Hard Brexit will shrink the size of the national pie, and require plenty of fiscal ‘subsidies’ to placate business and keep them here. Furthermore cutting back on immigration will also reduce the amount of resources the government has at its disposal. If the strategy was to keep the high tax paying skilled immigrant and control only the low tax paying unskilled, the government is showing a bizarre way of pursuing that: telling overseas doctors they are welcome only for so long as it takes for the UK to train up home grown alternatives.

At the Conservative’s conference there was only one grownup in the room, Chancellor Hammond. He noted the appalling productivity record of his predecessor, yet his home office colleague Amber Rudd makes things worse by making it more difficult for universities to recruit overseas students, one of our more successful export industries. No wonder the markets have, through a depreciation, already substantially cut the real incomes of every person in the UK through sterling’s depreciation.

Which brings us to the real problem with a focus on immigration. It is a policy that will not achieve what the Conservative’s pretend it will achieve, which is to make life better for UK natives. Indeed it will almost certainly make things worse. So where do those, like the Prime Minister, who pretend otherwise turn when things do not improve? As we have seen in the US, they just turn up the volume, or their party of Little Englanders just choose someone else who will shout louder. A party that is openly prepared to say that the position of the millions of immigrants currently living here are their best bargaining chip in the forthcoming negotiations have already started along that road.

If England were a paradise among squalor all this could perhaps be understood. But once you leave our big cities, ironically made vibrant partly through high levels of immigration, that is just not the case. A confident successful nation does not fear outsiders but embraces them. What we have today is a Conservative government protecting a dream about a glorious past as if it were today’s reality. I am reminded of some verses from The Last Living Rose by PJ Harvey:

Goddamn' Europeans!

Take me back to beautiful England

& the grey, damp filthiness of ages,

fog rolling down behind the mountains,

& on the graveyards, and dead sea-captains.

Let me walk through the stinking alleys

to the music of drunken beatings,

past the Thames River, glistening like gold

hastily sold for nothing.

[1] My own view is that it is our UK right wing tabloid press that is largely responsible for the popular intolerance towards migrants that we now see. Yes fear of the ‘other’ is an easy passion to invoke, but a responsible press would not go out of their way to invoke it. Having the ability to day after day plant stories in the minds of those who vote more and probably seek less alternative information than the average citizen remains a huge power, and those with that power use it shamelessly to great effect.