Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday, 19 June 2017

Austerity will only end when our leaders start being honest

Austerity was the underlying motivation for starting this blog. Sometimes I think everything that I, Paul Krugman and many others have written over the last six or more years has fallen on deaf ears. Take two recent pieces of evidence: this FT article by Nicholas Macpherson, ex permanent secretary at the Treasury, and this interview of the Chancellor by Andrew Marr.

In talking about Osborne’s fiscal consolidation that began in 2010, Macpherson says: “With hindsight, there was a case for going further faster.” His rationale is that the public like a dose of austerity, but tire after a time. At no point does he mention the economy (a recovery that stalled from 2010 to 2013, and then only started growing at trend thereafter), or monetary policy (interest rates were stuck at their lower bound). His desire for a shorter, sharper fiscal shock would have almost certainly produced a second recession.

I calculated that the fiscal consolidation that did take place cost the average household at least £4,000 in lost resources. This is based on OBR numbers, and assumes (as the OBR does) that the economy recovers quickly from any fiscal consolidation. This latter assumption looks very shaky indeed. Once you stop making it, the costs of austerity become horribly large. Not a word about this from Macpherson, which allows him to make the ridiculous argument that we should have had a shorter sharper consolidation.

One of the other ridiculous things Macpherson says is that, from 2010 to 2016, the UK did not even experience austerity. He justifies this because the debt to GDP ratio over this period rose. I’ve heard similar things in comments on my blog, presumably because of what Conservative politicians or their apologists say in the press. The statement confuses levels with rates of change, whether you are talking about the impact on the economy or on individuals. This is first year undergraduate stuff.

Philip Hammond said in his interview that a deficit of 2.5% is not sustainable. The normal definition of sustainability is a deficit that keeps the debt to GDP ratio constant. The current debt to GDP ratio is 86.5%. To work out roughly what the sustainable deficit is, divide the debt level by 100 and multiply that by the expected growth rate of nominal GDP. That means that today a deficit of 2.5% of GDP would be sustainable as long as nominal GDP grew at about 3%. So his statement that a deficit of 2.5% is not sustainable simply looks wrong.

You could rationalise this by saying that he believes our current debt to GDP level is not sustainable, and that therefore he wants to reduce it, but if that is what he means he should say so. Instead it seems that he wants to pretend that the government is like a household, and so therefore there is some reason why a deficit of zero is desirable. Of course Hammond does not mention interest rates either. And he knows that, in an interview like this, he can get away with anything involving economics or numbers.

Austerity has been supposedly dying since after the Brexit vote, but that just reflects misleading or dishonest reporting. As Torsten Bell says, for most people austerity means cuts to public spending, and for public sector workers and those on low incomes there is more austerity to come. Hammond also said Labour’s proposed fiscal policy would be “catastrophic for the country”. I suspect this kind of nonsense hyperbole, frequently invoked by the right wing press, has now become counter-productive. In reality at the heart of Labour’s fiscal policy is a fiscal rule which takes the government’s role in the economy seriously, rather than reduce it to the budget of a Swabian housewife. I cannot wait for the day that becomes the UK government’s fiscal rule, and we can move discussion of UK fiscal policy away from numbers 'not adding up' and back into the 21st century.


  1. Historically, hasn't retrenchment of the welfare state required cross-party support (Pierson, 1996)?

    Until now, the Tories have been able to cut welfare spending without becoming deeply unpopular because both the Lib Dems and pre-Corbyn Labour accepted the supposed need for cuts. Even under Corbyn, there have been vocal proponents of austerity within the PLP. And though the Tories stopped talking about austerity, the narrative that justified 7 years of cuts was never properly challenged until the general election was called.

    The leak of Labour's manifesto, which was unambiguously anti-austerity, seems to have played a huge role in the unprecedented shift in public opinion towards Labour and against further cuts. The result of the election, which was a huge win for Corbyn and his platform, has proven that promising cuts is not the only way to convince the electorate. Consequently, MPs such as Harriet Harman, who just two years ago claimed that Labour had lost the argument on austerity, are now promising to throw their weight behind a leftist leader and platform. Even among the Tories, there's now talk of the need to abandon the austerity programme and realign the party on a more positive platform.

    I think this means that austerity actually is dead, at least in the long term. Some Tories, such as Hammond, will remain committed to cutting welfare, and in the short-term they may even succeed, but to pursue these policies now that there is a strong and coherent political opposition to them would destroy the Tories.

  2. I agree with your analysis with regards to austerity at the ZLB, and your blog is certainly an interesting read. However, you also endorse (and indeed helped to create) a fiscal rule that advocates eliminating the deficit on current spending in five years. In order for this to occur, either some aspects of current spending must be cut or taxes must be raised, both of which are forms of fiscal consolidation and therefore austerity. As such, could you please clarify what constitutes austerity in your view?

  3. I’m thrilled to see that someone else on planet Earth (i.e. SW-L) gets the point that the debt is sustainable as long as the deficit as a % of GDP does not exceed nominal growth times the debt/GDP ratio (See SW-L’s 3rd last para).

    I’ve been banging on about that point FOR YEARS on my blog.

    As for the chances of any politician ever getting the point, I’m
    not optimistic. But it might help of all politicians had to learn their two times table…:-)

  4. Of course it falls on deaf ears. Krugman discovered this several years ago in a come-to-Jesus moment, when he realized that GOP policies were serving class interests rather than the public good. If economists would read Marx and good old-fashioned political economy, none of this would come as a surprise. What economists need to wake up to is how their discipline has been co-opted by the likes of the GOP, Tories, et al (and perhaps how there is an ideological bias in their assumptions, e.g. homo economicus, and theories, that has added fuel to the Right and their mistaken policies--just consider economists' horribly simplistic understanding of "structure" or "power," just for starters). The shadow of the Cold War still hangs over the relationship between the Right and economists/economics.

    Maybe you need to look to other social sciences. Take sociology, which economists regularly bash (which more often than not just reveals ignorance). While sociologists might not have the same impact when it comes to shaping policies, they have much more importance shaping discourse. Gender, race, sexuality--these are sociology's home turf, and note that they are also defining issues of our age. Sociologists cannot take full credit for this, or for advances in those areas, but they have certainly made contributions in a variety of ways, from research and teaching those who are on the front lines, to giving inspiration and ideas to other movement leaders, and finally to harping on those issues over the decades, such that they become part of our discourse.

  5. Most of what you say here I agree with; the McDonnell rule would be particularly useful; the investment part of spending should be self liquidating over the long term and therefore not add to the debt burden that we face.

    However, it seems to me that you are a bit harsh on Macpherson and the Schwabian housewife. The reason it seems to me is that there is no clearly articulated rule about this (in McDonnel terms) and that the real reason for austerity are, as you have suggested in the past, the desire to shrink the state not manage the public finances on a sustainable basis. The Macpherson and Schwabian view to me exist because there is a suspicion - well founded - that what we have is a structural deficit which will add to the debt/GDP ratio over time and will eventually impact on the delivery of services because of the need to service past debt.

    Indeed the concerns of folk like Macpherson and the Schwabian housewife may be that, even if we had a perfectly sensible rule like the McDonnell one, the politicians would backslide in the face of popular discontent and that such a rule, as sensible as it is, would not last the distance; and who is to say that they are wrong?

  6. "Franz Neumann famously wrote, “No greater disservice has ever been rendered by political science than the statement that the liberal state was a ‘weak’ state. It was precisely as strong as it needed to be in the circumstances.” An analogous point could be made, I think, about the relationship between ideas and conservatism. While it’s fashionable to bemoan the lack of great thinkers and deep thinking on the right today—the passing from the scene of a Friedman or a Hayek, a Kristol or a Buckley, and their replacement by whatever it is that passes for conservative thinking and writing today—the truth is that conservative ideas are precisely as strong, its thinkers always as deep, as the movement needs them to be in the circumstances."

    (Corey Robin blog, Why are there no great thinkers on the right today?)

    Conservatism has had about forty years of success in the UK.

    Let's hope it shortly gets many decades to think about its errors.

  7. Is Andrew Marr signed up to your blog? Might be a timely opportunity to send him a polite e-mail inviting him to do so.

    He didn't respond either on PH's claim that the Grenfell Tower external cladding was banned here as in the UK, and Us, which if true, is astounding.

  8. «for most people austerity means cuts to public spending,»

    And here we go back to the usual story: that "austerity" used to mean "overall (fiscal+credit+regulatory) policy is contractionary" and clever people who want asset prices to be bigger faster have redefined it to mean just “cuts to public spending” (and regardless of the starting point, so a reduction of public spending from huger to huge levels is still "austerity").

    As if Colin's Crouch valuable insight that anglo-american governments have switched from keynesian government direct borrow-and-spend to “privatised keynesianism” private (but government-backstopped) borrow-and-spend, especially directed at asset speculation.

    «and for public sector workers and those on low incomes there is more austerity to come»

    But the biggest problem for these people is not lower government spending, but enormously higher higher asset prices and rents. That to me seems like "privatised austerity", where in effect government policy favours a massive increase in "private taxes" like rents.

    The damage caused by lower public fiscal spending ends up much smaller than that caused by much higher costs for property to live in and of financial assets for a pension. That's properly called "class war", not "austerity".

    Our blogger does say that more expansionary fiscal policy “would be far better to use this instrument to stimulate the economy in a recession than to raise the inflation target.” in the previous post, and I agree with that, but where we differ is whether even more wildly expansionary monetary/credit policy (“to raise the inflation target”) is better than to do nothing, for at least two reasons:

    #1 It would result in even bigger faster asset prices increases, only a minuscule part of which would "trickle down" through the "even wealthier effect".
    #2 Higher asset prices would make housing and pension even more expensive, with an upward redistributive effect probably much bigger than the "trickle down" from the "even wealthier effect".
    #2 Given the lack of negotiation power of workers, and stagnating nominal wages (at best!) for middle and low income workers, a higher inflation rate translates directly into lower real wages.

    Now #1-#3 are very desirable policy effects for neoliberal Economists, regardless of the stance of fiscal policy, but it surprises me that those effects are presented as being in favour of “public sector workers and those on low incomes” even if using the fiscal lever would be better.

    Let me put it in this crude way, are these the consequences of contractionary fiscal policy or of expansionary monetary policy:

  9. Let me try to put it another way, what's the overall distributional effect on disposable income on middle and low income workers of switching between the following policy mixes:

    #1 “fiscally conservative but monetarily active”, “Hopefully we will get a little housing boom and everyone will be happy as property values go up” (G Osborne).

    #2 “fiscally conservative” but even more "monetarily active" (the Greenspan/Bernanke "put").

    #3 “fiscally conservative” but less "monetarily active".

    Where "monetarily active" is an euphemism for "whichever policy creates a wealth effect".

    The current situation is #1, our blogger advocates #2 even if he would much prefer "not fiscally conservative", and #3 is a "benchmark".

    I reckon that of the three choices #3 would minimize the upward redistribution and leave middle and low income workers better off, and #2 would maximize upward redistribution.

    Now the policy mix myself (and I think J Corbyn and J McDonnell) would prefer is one which has "fiscally active in particular to investment in housing and other infrastructure and R&D, and monetarily conservative to constrain inflation, imports, improductive asset price speculation". That is a mixture of fiscal supply side economics and social insurance and monetary inflation control.

    Because I agree with both what T Blair wrote in 1987 and what a less awful Conservative pointed out recently:
    The fact that we have failed to use oil to build a productive and modern industry for the future is something historians will deplore.
    47% of the UK population live in areas as productive as the former East Germany. Outside the south-east, the UK has a massive infrastructure deficit: per head, its just 40% of the OECD average.

    But it is difficult to see the point of this from the cage of a simplistic neokeynesian (I always feel tempted to call it "noddykeynesian") point of view with its obsessions on "the" interest rate, "the" ZLB, and (fiscal) "austerity".

  10. Professor Lewis, while I do contend that your proposal of austerity being damageable is correct at least so far as the last crisis was concerned, one question I asked on this blog went unnoticed -- and it directly concerns austerity.

    In my last macroeconomics course, we went through new keynesian models and learned to work with simulations to study those models. One thing that seemed like a very robust result is the problem related to countercyclical deficit spending as a means to smoothen out the cycle.

    It seems to me, so far, that if you pick any realistic means of financing that action, you can't produce anything like the effects you have in mind here -- unless, the government privileges investment spending, for instance.

    Do you have an example of a DSGE model where your idea of a costly austerity and its converse the deficit spending with a high multiplier works without it assuming a lump sum tax?

    This has been bugging me for a while, but I don't necessarily have the time to search for the needle in the hay stack myself.

  11. For comprehension by those who deliberately seem cloth eared, perhaps it is necessary to wrap the concept of the stupidity of austerity at the ZRB in a sound bite.
    I've not seen a one liner - does Spend and Tax not Tax and Spend begin to question the obfuscation?

  12. Chin up! At least the OECD has begun producing high (albeit strangely procyclical) estimates of the fiscal multiplier. Unlike the IMF, the OECD has never been willing to say things that are at odds with the beliefs of their member countries leaders so this is definitely a good sign.

  13. Interesting post (so good when I come here and see a post about macro) but I don't fully follow what should be the rule. The UK has grown with almost full employment for the last years. Should we not try to bring the dept/gdp ratio down and create slack for the next recession? The deficit has been bigger (sometimes much bigger) than GDP for almost 10 years now. Even Paul Krugman says that it's time in the USA to create slack. It seems that you never believe there is a time to bring this down. Since we are growing around 2%, our deficit should be below 2%. It would be great if we a good rules for this. If we want to pay more for our public service, maybe we need to raise taxes?

  14. Mainstream economics is basically behind austerity. They gave it a name - cold turkey - and a lot of credibility thanks to the genius of Barro, Fama and Sargent. If you think Europe is suffering, perhaps you would like to know a little about what East Asians had to go through during the 1990s. (And you might be interested to know what Krugman and his mentor Fischer - was actually saying then.) Krugman also did not immediately advocate state spending after the crash of the Japanese bubble, but instead said the state was too large. Thankfully the Japanese did not listen (too much). Now cold turkey is called austerity and suddenly it is bad. Apparently the zero bound makes everything different.

    There is more to this, like the low interest rates, which is a symptom of a bigger problem in modern capitalist societies - and to understand it and tackle it is going to take really imaginative solutions based on much more pluralistic methodological practice.


  15. The Wall Street Journal does run a weekly column by what they would call a leftist, William Galston of the Brookings Institution. Although it sticks out in the face of the other writers, at least the viewpoint is there.

    As you know, the FT's own commentators are reasonable (Martin Wolf, other columnists) but almost as a rule, the op-ed writers (except Larry Summers who should be termed a columnist) pretty much argue for austerity, especially the German writers like Wolfgang Munchau. Maybe you should pitch a regular column to the FT--although they might feel covered by Martin Wolf, so then it could be pitched to another main "London" newspaper. But yes, as an avid reader of the New York Times, it's like Paul Krugman continues to scream into the policy wilderness. (At least the folly of such policy is starting to come to an end in Kansas, although it appears that the State Governor, Sam Brownback, might be "falling up" to a position in the Trump Administration, which prioritizes magical thinking.)

  16. «In reality at the heart of Labour’s fiscal policy is a fiscal rule which takes the government’s role in the economy seriously, rather than reduce it to the budget of a Swabian housewife. I cannot wait for the day that becomes the UK government’s fiscal rule»

    On reflection, because our blogger's writings occasion quite a bit of reflection for me, that involves the role of the "public intellectual who happens to be an Oxford professor of economic policy with a New Keynesian baggage". My impression of that is:

    * Our blogger seems to me to argue that "austerity" (as he defines it) at the "ZLB" (of "the" interest rate as he defines it) is a policy mistake, a technical error, and the Conservative party is making that error, the Labour party is not, so the role of the "public intellectual etc." (and of the BoE) is to point that out from their ivory blog, and that an even looser monetary policy should happen if the "austerity" continues, even if that is far less preferable than ending "austerity".

    * My impression is that there has been little to no overall austerity, but a deliberate upward redistributive political strategy thanks to “A credible fiscal plan allows you to have a looser monetary policy”, and that is a legitimate political strategy, one that has been endorsed by those voters who love "class war" when it is against the lower classes; the role of the public commenter on the blogs of the "public intellectual etc." is to point out that a political campaign is needed against upward redistribution without the distraction of calling it "austerity", and that an even looser monetary policy would likely give even bigger upward redistribution while giving pretty small benefits in terms of "trickle down".

    More on why talking of "austerity" is a distraction, both politically and as to economic analysis: for those afflicted by "upward redistribution" it does feel like (properly defined) "austerity", but to recognize that it is not "austerity" because a large minority of voters are enjoying a boom is essential because:

    * If it were "austerity" affecting everybody, and it were a policy mistake, a much larger constituency would be available to fight it; conversely if it were required by circumstances it would be unwise to fight it or try to counter it with even looser credit and regulatory policy.

    * Since it is actually upward redistribution, an even looser credit and regulatory stance to counter the tighter fiscal side would lead to a net worsening of the conditions of the middle and lower income classes, as a small amount of trickle down would be swamped by the cost of bigger asset prices and rents.

    * In the current institutional conditions even lower real interest rates would not so much boost investment in labour-employing productive capacity, both which are over-abundantly available offshore, but in asset price and rent speculation, as "secured" lending is heavily favoured as is lending to "friends of friends" in the finance industry (who are the ones enjoying "ZLB" conditions), thus building up another "financial stability" failure, the cost of which would then be charged as usual to the middle and lower income classes.

  17. Hi Simon,

    I find myself arguing with Swabian housewives quite often. I am so fed up with the 'government finances are just like a household' analogies that I tried to work out something for myself that was more helpful.

    I am not an economist. I would not claim to be although I have read a lot in the past few years. I suspect this is basic stuff for 1st year undergraduate teaching but I was hoping you could tell me if I'm along the right sort of lines here (Many thanks, AFZ):

    Suppose, I own two fields. For the sake of simplicity I will stipulate that the soil is fertile and doesn’t require much in the way of attention and there will be no natural disasters... Essentially if I plant seed, it will grow and yield a crop I can sell.

    To plant a field will cost me £3000. A full crop, when sold will net me £12,000 per field. So, do I plant one or two fields this year? Well, the problem is that I only have £5000 in the bank, so I can only afford 1 field’s worth of seed.

    At the end of the year, I sell my crop and have a nice £12,000 return and the remaining £2000 means I have £14,000 in my account. Now, I have some very good arrangements with my local businesses so I only have to pay my bills at the end of the year but I have to pay for food for me and my family, transportation etc. etc. For the year this comes to £11,500. So once I’ve paid my bills I have £2500 left. So next year I cannot even afford to plant the whole field…

    An alternative is that I borrow £1000 from my mate next door. I will even be generous and give him a big return on his loan, so it will cost me £1500 at the end of the year. I thus plant both my fields and at the end of the year I have a return of £24,000. I pay all my bills which will probably come to a bit more because I’ve shifted twice as much crop to market but still only comes to £15,000, so I have a return of £9000 minus the £1500 I own my neighbour. So my net at the end of the year is £7500 and I can afford to plant both fields without borrowing at all.
    Example one:
    Cash on hand: £5,000
    Cost of seed / fertiliser etc: £3,000
    Cash remaining: £2,000

    Income from selling crop: £12,000
    Subtotal @ end of year: £14,000

    Costs for the year: £11,500
    Net at the end of the year: 2,500.
    Example two:
    Cash on hand: £5,000
    Loan: £1,000
    Cost of seed / fertiliser etc: £6,000
    Cash remaining £0

    Income from selling crop: £24,000
    Subtotal @ end of year: £24,000

    Costs for the year £15,000
    Loan repayment: £1,500
    Net at the end of the year: 7,500.
    In terms of a modern, developed economy like ours, the empty, unused field corresponds to spare capacity in the economy – that is unemployment, underemployment (people who want to work fulltime but can only find part time work) and poor productivity (UK lagging behind developed world in this regard at the moment).

    Of course the numbers are silly but the concept is vital that spare capacity is wasteful and ultimately austerity makes the economy smaller (in the first example I can’t even afford to plough and seed one field next year).

    That's revenue expenditure where the use of borrowing and government spending in the slump supports the economy. Capital spending would be, borrowing to buy another field (educating our population or investing in a new industry).

  18. All the BBC interviewers have swallowed this line on austerity. They never challenge Conservative spokespeople with the utter failure of George Osborne's policy (using his own target to define "failure"). I have never heard an interviewer suggest that if austerity hadn't been followed the economy might have performed better. the narrative of the interviewer is always "How are you going to fund (whatever) it is?"

  19. As Krugman already noted many times, the real goal of austerity is to shrink the state. It is therefore pointless to argue about the effects of fiscal or monetary policy on growth. To me it is pretty similar to the situation Varoufakis described about his attempt to negotiate with creditors: what do you say to creditors who are not interested in seeing their money back?

    Likewise our governments are obviously not interested in economic growth. If the success of their policies is to be judged by any quantitative measure, I guess it should be by the after-tax income of the rich. This one one seems to have increased substantially over the last years so I guess from this perspective austerity is in fact a success even if the economy as a whole is much smaller than it would otherwise have been.

    Better to have a bigger share of a smaller pie than to have a smaller share of a larger one. Whether this still holds true in the long run is of course another issue. For example you might argue that if you have a frail health it is better to live like the 21th century lower middle class than like the medieval nobility. For this reason it would be in the interest of the rich to promote technical progress. But if most people regularly vote against their own interest, why would the rich be always right?

  20. Macpherson's claim that the UK has not experienced austerity because the debt to GDP ratio had risen made me wonder whether he would also argue that Greece has not experienced austerity....

    Greece has in fact managed to move from a deficit of 11% to a small primary surplus between 2010 and 2016. One wonders whether Sir Nicholas regards this as successful economic policy.

  21. It was Michael Portillo when questioned on the bill going through parliament to privatise the NHS, paraphrased: that said they had no option but to lie because if the public really knew what they were actually doing no one would vote for them.

    The problem we now face is that even with that information, stupid Tory Voters still vote for them, with the exception of the noble few.

    The other small point is this article by George Monbiot that exposes the links to all of these and the forces behind them.

  22. «Greece has in fact managed to move from a deficit of 11% to a small primary surplus between 2010 and 2016. One wonders whether Sir Nicholas regards this as successful economic policy.»

    The greek government has moved from a colossal fiscal deficit and Greece from a colossal balance of payment deficit (both around 25% of GDP pre-bubble) financed by colossal "borrowing" to substantial parity when the "borrowing" ended. SimonWL and others have argued to the effect that rich countries, like the USA and the UK, should then be permanently donating to Greece fiscal transfers for 25% of GDP, but the USA and UK have refused to do so (the UK has even vetoed the use of any EU funds to help Greece, and the USA has practically vetoed the use of any significant amount of IMF funds too).

    The question then becomes: is a "successful economic policy" the ability to get donated fiscal transfers of 25% of GDP, such that not getting those fiscal transfers is a failure of economic policy? :-)


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