Austerity is an integral part of the Greek tragedy

Too many people, including many in the Troika, see the Greek struggle as just about transfers from one debtor nation to lots of creditor nations. That is why they perhaps saw the Greek referendum as an unhelpful move, as just inflaming nationalist sentiment. As Dani Rodrik puts it “What the Greeks call democracy comes across in many other – equally democratic – countries as irresponsible unilateralism.”

It is, however, not just about transfers, or what economists call a zero sum game. It is also fundamentally about austerity, as Dani Rodrik, Thomas Picketty, Heiner Flassbeck, Jeffrey Sachs and I say in this letter jointly published in the Guardian, Le Monde, The Nation and Der Tagesspiegel (and thanks to Avaaz for making this happen).

I think many people believe that a debtor country must somehow inevitably suffer large scale unemployment as a result of having to pay back at least some of its debts. But this comes more from a moralistic view than thinking about the macroeconomics. In an open economy, the real exchange rate (competitiveness) will adjust to ensure ‘full employment’ is preserved, whatever primary surplus (taxes less non-interest spending) a government needs to service and pay back its debt.

Under flexible exchange rates this competitiveness adjustment could happen immediately. Things are not quite so simple in a monetary union: competitiveness cannot immediately adjust because of wage and price rigidities. A period of ‘excess unemployment’ will be required to push wages and prices down if the country is uncompetitive in relation to required primary surpluses. However the excess unemployment can be relatively modest. In fact, because of the structure of the standard Phillips curve, it is much more efficient to achieve gains in competitiveness gradually through a measured increase in unemployment than quickly through a rapid rise in unemployment, for reasons I outlined here when talking about Latvia.

To achieve this efficient outcome may well require the government to reduce its primary deficits gradually, because without this fiscal support while competitiveness adjusts output could fall rapidly. This in turn will require more government borrowing, and if the government cannot do this from the markets, the IMF or other governments should step in to ensure this efficient adjustment can take place and avoid the waste and suffering of unnecessary unemployment.

This is what failed to happen in the case of Greece. Whether this was just the result of poor Troika calculations, or a consequence of feeling that creditor bankers were more of a priority (see, for example, Mark Blyth), need not concern us here. Once the mistake became clear, perhaps creditor voter fatigue meant additional loans were not politically possible. But to demand primary surpluses (i.e. to take money out of the country) while unemployment remains so high - as the Troika continues to do - is unforgivable in my view. It clearly makes the unemployment problem worse - see here, footnote [2]. At best it indicates an impatient creditor with no concern for the welfare of the debtor, but given the responsibility the creditor has for the debtor’s current position it is far worse than that.

That is not the only reason Greece’s story is about austerity. Its problems were made worse by the austerity across the Eurozone as a whole, and the deflation which that has brought. Deflation increases the real value of nominal debts. It also makes competitiveness adjustment more difficult because of a well known non-linearity.

Even those that have a great dislike or distrust of Syriza should recognise that Syriza is also a product of acute austerity, a point which the referendum reaffirmed. As economists might say, Syriza is endogenous.

That the Greek economy now lies broken is not the inevitable result of imprudent borrowing a decade ago, or structural weaknesses, or a left wing government elected just a few months ago. It is also the result of the actions of those who effectively ran the economy from 2010 to 2014, and their imposition of draconian austerity. Greece long ago recognised the folly of its borrowing, and has made a start on addressing its structural weaknesses. The Troika has yet to acknowledge its own part in making this tragedy.

Do politicians need to pander to myths?

About UK politics, but raising some general issues about politicians and popular prejudices

Paul Bernal has a powerful post (HT Chris Dillow) where he says Labour lost the election long before 2015, by pandering towards three big myths: the myth that Labour created a huge deficit which required austerity in the midst of a recession, the myth of the ‘scrounger’, and the myth that Labour made a mistake in allowing excessive immigration. I obviously agree about deficits, I’m appalled at the hostility to welfare recipients stoked by the right wing tabloids and the harm done by inept reform, and I’m dismayed that politicians shy away from putting the positive case for immigration. For that reason I should agree that in England at least one of the three major parties should be standing up against all these myths. The Conservatives and Liberal Democrats helped manufacture the first myth, and the Conservatives contributed to the second and pander to the third (although some of their supporters would not favour costly immigration controls). Labour failed to combat all three.

The media have, predictably, reached a consensus about why Labour lost: it was too left wing, it was anti-business, it failed to be aspirational (it wanted to raise some taxes on the rich) blah blah blah. But as Peter Kellner and others have pointed out, there is no clear evidence for these assertions. Instead, they just happen to represent the things that much of the media dislike about Labour’s policies. Watching at least some of Labour’s potential future leaders, who the media as a whole describe as ‘modernisers’, fall in line with the media’s diagnosis makes the Parliamentary Labour Party look pathetic. Perhaps it is?

And yet, Peter Kellner also points out that being tough on scroungers and immigration is very popular. And these issues mattered for many voters. In a tweet about Bernal’s post, I asked was it better to lose telling the truth than lose being complicit in a lie? But it would be better still if a political party could tell the truth and win! Yet that seems a hopeless task. Jonathan Portes has championed the evidence on immigration, but as the BBC’s Nick Robinson put it, he would not get elected in any constituency as a result.

It is tempting at this point to blame the media for this state of affairs. In one sense I agree: I think newspapers should have a responsibility to tell the truth, rather than pander to prejudice when it suits their owners to do so. But in terms of practical politics this does not get you very far. One of the depressing conclusions that will be drawn from the election result is that it is fatal to stand up to Rupert Murdoch. [1]

Is it also true that cutting the deficit is widely popular? Here I think the evidence is less clear. I agree with John McDermott that perceived competence is vitally important, and not only in relation to self-interest. That is why Labour made a strategic mistake in not challenging with more force the coalition’s blatant myth making on the deficit issue. As Jonathan Hopkin and Mark Blyth point out, it is incredible how the blame for our current problems has so easily been transferred from the finance sector to fiscal profligacy, and not just in the UK. (But not so incredible if you follow the money, and take media power seriously.) 

Perhaps I can also make a very personal point here. As one of only a few academics who have written an academic paper on the Labour government’s fiscal record, which concluded that Labour profligacy was a myth, you might have expected Labour at some stage to have used some of the many words I have written on this to support their case. As far as I know they did not. Perhaps they were put off by some of the my criticism of other aspects of Labour’s programme. But this didn’t put off Alex Salmond, who was happy to quote my support of the SNP’s line on austerity, suggesting it had all the more force because I was not an SNP supporter.

Talking of which, I think there is one more piece of received wisdom that needs exposing, and that is Scottish exceptionalism. As I hinted at the beginning, there was one major UK party that did campaign against austerity, was pro-immigration and supportive of welfare. No doubt other factors also led to the huge success of the Scottish national party, but their position on these three issues didn’t seem to do them any harm, and in some cases probably helped a lot. This example suggests the answer to the question posed in the title is a clear no. 

It is generally presumed by the media, both sides of the border, that this is all because Scots are inherently more left wing than the English. But the evidence suggests differences in social attitudes between Scotland and England is not that great. The question Labour (or at least somebody) should be asking is why the SNP can avoid pandering to these three myths and win decisively, when the consensus is that doing the same in England would be electoral suicide.   

[1] Some people who comment on this blog say that when I voice concerns like this I’m being a bit passé, but on other occasions I’m accused of being anti-democratic! Somehow a politician choosing to delegate macro policy to experts reduces democracy, but allowing rich media barons to control the information that much of the electorate receives, and as a result have a considerable influence on politicians, is just fine.

We want helicopters, and we want them …

Not now exactly. In the UK, for example, the MPC has scope for some further reduction in interest rates. (I think they should use that scope now, but that is for another day.) But, as Mark Blyth, Eric Lonergan and I argue in the Guardian, if something serious goes wrong in the next year or two, or if another financial crisis happens in the next decade or two, monetary policy is under equipped.

Does this mean that I no longer think it is a good idea to have a fiscal stimulus in a recession when nominal interest rates are at their floor? Of course not, because helicopter money is essentially just like a tax cut. What is true is that helicopter money is not my ideal form of fiscal stimulus, partly because there is some uncertainty about how much of it will be spent. I would much prefer additional public investment, for which there is a strong microeconomic as well as macroeconomic case. [1] Michael Spence [2] is one of a huge list of eminent economists, which includes Ken Rogoff, who think additional public investment across the OECD would be beneficial.

We should continue to urge governments to recognise this, but we also have to accept the awkward fact that they are not listening. In political terms, the need to reduce deficits trumps pretty well anything else. (Perhaps things are turning in the US, but until the Republicans start losing power I’m not counting chickens.) One of the many depressing things about the Conservative election victory in the UK is that it looks like deficit obsession is an economic strategy that can win, as long as the austerity is front loaded, which is why Osborne fully intends to do it all over again. 

Because helicopter money is mainly a form of fiscal stimulus, and because the case for fiscal stimulus in a liquidity trap is largely agreed by most academic macroeconomists, the debate over helicopter money is essentially an issue in political economy. Persistent demand deficiency is clearly preventable, and represents a huge economic cost to society. Politicians will not do what economists call a bond financed fiscal stimulus because spreading scare stories about public debt is a vote winner. That leaves us with a money financed fiscal stimulus, of which helicopter money is one form. With independent central banks, that means giving these banks the power to undertake helicopter money.

I think the biggest obstacle to helicopter money is probably central banks themselves. This is for two reasons. First, they seem far too optimistic about the efficacy of creating money to buy financial assets (QE), even though they almost certainly need to create far more money by this route than they would through helicopter money, with a far less certain impact. Second, there is this residual worry that creating money now will mean they will lose the ability to control inflation in the future, as if a modern government in an advanced democracy would ever refuse to provide them with the assets they need.

The consensus among macroeconomists is that independent central banks are a good idea. The belief is that the business of macroeconomic stabilisation is best achieved if the task is delegated. But making central banks independent is not the same as completely delegating the task of macroeconomic stabilisation, because of the problem of the lower bound for nominal interest rates. Indeed independent central banks made the obvious way of getting around the lower bound problem, which is a money financed fiscal expansion, more difficult to achieve. Helicopter money is a way of making the delegation of stabilisation policy complete. 

[1] I have suggested how (see here and here and here) we could have ‘democratic helicopter money’ that could encompass additional public investment, but I’ll happily settle for the plain vanilla kind for the moment.

[2]  HT Diane Coyle