Mediamacro melodrama

 

The UK macroeconomy was one of the big stories of the previous two weeks, so you might think this blog post should have covered it earlier. However my guess at the time was that media coverage was a bit like a nervous flyer who, when the plane hits a bit of normal turbulence, decides it's is going to crash and everyone will die. As I’m not a journalist, it seemed better to wait a week to see if I was right.

I’m glad I did. This is what got the media so excited about, and what happened next

From around the 6th January interest rates on UK 10 year government debt rose over a week from around 4.6% to around 4.9%. But then interest rates fell back as quickly as they had increased to around 4.65%.

Was this a UK or global blip? To answer that we need to look at US rates.

We see something very similar, but of slightly smaller amplitude. This tells us that what we saw in the first half of January was mainly a movement in global long term interest rates, with a little bit of UK specific icing on top that largely disappeared once the latest UK inflation data came out.

I’ll come to why this might have happened in a minute. But why did virtually the entire the UK media get this all so wrong? The main lesson here is that data is volatile, and you can have a lot of egg on your face if you treat every short term movement up or down as permanent, or worse still the beginning of a trend. It’s a lesson that all economists know but journalists are increasingly paid to forget. But that is not the only reason journalists got over excited a week or two ago.

Another is the Truss fiscal event. Conservative politicians, and those journalists aligned to them, are desperate for Labour to suffer something comparable to what happened to the Conservatives under the leadership of Liz Truss. So they are tempted to shout fire whenever they see a puff of smoke, even when that smoke looks like it’s mainly coming from a long way away! That then led other journalists to feel they had to cover the same story, and political journalists put a UK political spin on it because that is what they do.

When journalists cover anything to do with fiscal policy, we know from long experience that the language and reasoning they use can be very different from the macroeconomics taught in universities. I call it mediamacro. It involves for example treating the government as if it's a household, treating deficits as a sign of political irresponsibility, and personifying financial markets as a kind of vengeful god. As is often the case, it is much better to read good academic economists, like Jonathan Portes here, than the stuff most journalists write.

The end result of the media's uninformed overreaction and distorted coverage was that many people were seriously misled, and the media almost manufactured a crisis out of nothing. In case you have forgotten, just a week ago newspapers were speculating that Reeves was about to be sacked and who might replace her, all because of largely global movements in interest rates over which she had no influence. I used the word melodrama in the title of this post, but I could have equally used madness.

What caused the upward blip in global longer term interest rates? To be honest, who knows and who cares? When I was much younger I was approached about moving to a much better paid job working in the City, and I said no because I thought worrying about such things would soon bore me to tears. I found real macroeconomics much more interesting, and still do. If, unlike me, you are interested in short term bond market fluctuations, here is the Toby Nangle looking at what evidence we do have, and here is Paul Krugman speculating that it might be all about Trump. It must certainly be true that as a result of Trump becoming POTUS, the degree of macro policy uncertainty has shifted sharply upwards and this will mean longer term interest rate movements are likely to become more erratic.

What about the exchange rate? Sterling did depreciate in January, and that hasn’t been reversed, but the scale of movement is small and therefore not at all unusual, so once again there is nothing of interest here unless you speculate on currency movements.

This whole episode did raise two other issues that are worth discussing.

Fiscal vulnerability

Because Reeves like previous Chancellors has pledged to follow the golden rule, which is that day to day (current) spending should over the medium term be paid for out of taxes. As a result, anything that looks like it will increase spending over the medium term will lead to speculation of what other items of spending will be cut to compensate, or whether taxes will have to rise. Higher long term interest rates mean higher spending servicing the government’s debt.

The most important point here is to again ignore a lot of what you read or hear in the media. First, the fiscal rule that Reeves is committed to looks at the expected balance between spending and taxes in a few years time, so there is absolutely no need to cut spending in the short term. Second, there are all kinds of macroeconomic developments that could have an impact on the government’s current deficit in a few years time, so this kind of thing will happen constantly. As a result, and as this episode clearly illustrates, it is generally better to wait and see rather than react immediately. Third, there is no reason why higher spending in one area has to be met with lower spending elsewhere. It can also be met with higher taxes. That the media tended to talk about spending cuts rather than higher taxes has no macroeconomic justification.

So Reeves was absolutely right to ignore all the media hysteria. However it has to be said that Reeves did earlier make two mistakes that contributed to the way the media covered this aspect of the story. First, the fiscal rule that balances current spending with taxes used to apply to forecasts five years ahead, for good reasons. In the Budget she changed this so it will eventually apply to just three years ahead, which was simply a bad decision. Second after the budget Reeves made the mistake of appearing to rule out significant increases in taxes in the future.

Many react to talk about spending cuts by blaming this particular fiscal rule, but that in my view is a mistake. As long as the golden rule looks far enough ahead, any short term volatility caused by fluctuations in spending or taxes is likely to be reflected in volatile economic reporting rather than erratic economic policy, and it is a mistake to conflate the two. I put the case for the golden rule as a fiscal rule here.

Short term economic growth

The second lesson is about data on economic growth, which was also mentioned frequently in reporting. However monthly or quarterly growth figures are also erratic, so the lesson about not being misled by short term fluctuations in the bond market also applies to growth figures. The Conservatives are currently boasting that they left office with economic growth the highest in the G7, but because that is based on a particular quarterly growth rate it is a meaningless claim.

Equally any impact policy may have in increasing underlying growth normally involves considerable lags. It is very unlikely that anything the new Labour government has done will have had any impact on the growth numbers currently being reported (i.e. end 2024). If policy has anything to do with recent growth numbers, it is the policy of the last government.

To take just one example, you will read a lot about how employers dislike the NIC hike imposed in the budget. Below is the OBR’s assessment of the impact of this on GDP, alongside the impact of the modest increase in public investment also announced then.

They estimate that higher employers’ NICs will reduce the level of GDP by 0.1% in financial year 2026/7. Less than half of that will occur in the forthcoming financial year. These estimates are relatively uncertain, but anything much larger or quicker is pretty unlikely. While it is easy for a journalist to link the October budget to recent growth data, that does not mean that in reality there is any causal link at all. 

What this chart also shows is that fiscal policy can boost demand and therefore growth in the short run, as long as this impact is not offset by a more restrictive monetary policy. We are on more solid ground in quantifying these effects. The last budget was expansionary, and should boost GDP growth in 2025/6 by around 0.5%. To the extent that Labour are ‘kick-starting growth’ this is it, but don’t expect to start seeing it in the data until at least six months time.

Although monthly or even quarterly changes in economic growth are not very interesting, growth in the longer term and the impact the Labour government might have on it are worth discussing. These questions, rather than mediamacro melodrama, are subjects I hope to return to fairly soon.