Keynes never left Canada, and intends to stay

Nick Rowe has a post where he points out that the outgoing Conservatives did not abandon Keynes during the Great Recession. He takes a graph of government spending from an article by Matthew Klein, but we can make the same point be looking at the underlying primary balance. (As I have noted many times, no measure of fiscal stance is ideal. If you want a more detailed analysis of the Canadian macro position than I will give here, read the Klein article.) According to the OECD, this moved from a surplus of 2% of GDP in 2006 to a deficit of 3.2% of GDP in 2010. We saw a similar countercyclical swing in fiscal policy in the US, but whereas that swing was sharply put into reverse in the US, in Canada the deficit was still 1.8% in 2013. (The UK was like the US except the peak deficit was in 2009, and the reverse was well under way by 2010.)

So we saw a classic Keynesian fiscal policy in Canada. Partly as a result, Canadian GDP only fell by 2.7% in 2009 and grew strongly in the next two years. That in turn meant that short interest rates only stayed on their floor for just over a year, and rose to 1% during 2010. So it all looks like a textbook New Keynesian policy, and close to the one recommended in Portes and Wren-Lewis: fiscal expansion helped get interest rates above their lower bound.

That was then. More recently GDP has been falling, and interest rates have been cut to 0.5%. So is it time for a tight fiscal policy, or instead some additional deficit financed public investment? Ask the man on the escalator, the new Canadian Prime Minister. In the election Trudeau played a classic Keynesian card (Labour leadership please note). Both his two opponents criticised this deviation from a balanced budget policy. Trudeau won, so Keynes remains in Canada. While interest rates may not have yet hit their lower bound, it makes sense to borrow to invest when rates are low and when there is a significant risk rates could hit ‘zero’ (Osborne please note).

Unlike governments in Europe and the US, Canada did not dash for austerity just as the recovery was beginning and while interest rates were still on their floor. They had a clear choice a week ago to allow a deficit to finance investment or go for a balanced budget, and they chose the more sensible fiscal policy. I think there are two lessons beyond Canada. First, right wing governments do not have to make major macroeconomic policy mistakes with fiscal policy. Second, voters do not always suffer from deficit fetishism.

Linking tax credits and the fiscal charter

I have made fun in the past about Labour politicians and supporters who in public trip up once the word borrowing is mentioned. An interviewer only has to ask ‘but if Labour reverses this cut it will mean more borrowing’ and the interviewee stumbles around in a way that shouts to anyone watching that Labour have a vulnerability here.

It is a vulnerability that helped lead to the disastrous decision under the interim leadership not to oppose Osborne’s cuts in tax credits, and to McDonnell’s embarrassing initial decision (now reversed) to support the charter. But now that Labour has sorted itself out on both issues, it needs to stop avoiding the borrowing question. Take this otherwise assured performance by Owen Smith on Newsnight last night (27 minutes in, HT Owen Jones).

Here is what Owen Smith should have said when asked whether reversing the cuts to tax credits would lead to more borrowing.

“The Chancellor has said he needs to cut tax credits to meet his new fiscal charter. Labour oppose this charter, because it makes no economic sense. Osborne cannot find a single economist who supports his plan. Imposing a work penalty to pay borrowing off more quickly is just counterproductive, because discouraging people from working makes the economy weaker. This was supposed to be a government that encouraged work, yet here is the Chancellor doing the opposite in order to meet a charter that only his MPs support.”

If the interviewer persists with “so you will borrow more”, say

“Labour would not need to cut tax credits because we would balance current income and spending, leaving room for the country to invest. Labour would borrow to invest, whereas Osborne is paying for the little public investment he is doing by cutting tax credits. What matters is government debt in relation to GDP, and our policy would mean that debt relative to GDP would fall under Labour.”

I am sure those skilled in spin could sharpen this, but you get the idea. The days when deficit fetishism gripped voters are coming to an end. Labour needs to change its rhetoric to reflect this, and paint Osborne into the ideological corner he occupies.  

Fiscal councils: births, and the trials of youth

                Fiscal councils, or independent fiscal institutions, are growing in popularity. In the last year or so they have been established in Portugal, Ireland, Australia and most recently, Slovakia. (See my fiscal council web page for details.) They provide an independent check on the fiscal numbers produced by government. The councils differ widely in focus, structure and remit (see Calmfors and Wren-Lewis, 2011, for a comparison), with some concentrating on the macro numbers, and others also doing substantial microeconomic project costing along the lines of the Congressional Budget Office in the United States. For just one example of why independent analysis is useful, see here.

                Establishing a fiscal council is only half the battle. Almost by definition, fiscal councils will be an inconvenience to governments. They are also highly vulnerable, as the government provides their funding. This is particularly true in their earlier years, when councils have not had time to build up public support. A contest between a fiscal council and the government is a David and Goliath encounter where the only weapon the council has is public support. A cynical view might be that therefore they are unlikely to be truly independent – why annoy the hand that feeds you? However experience suggests otherwise, largely as a result of the integrity of those that lead them.

 A recent example comes from the Parliamentary Budget Office (PBO) in Canada. The PBO has had a number of antagonistic brushes with government. The latest involves government departments refusing to disclose data. Now it appears a no-brainer that a fiscal council needs data to do its job – but then, as an active supporter of fiscal councils, maybe I’m biased. So read this report and this blog, and make up your own mind.

As the only weapon fiscal councils have in battles like these is public opinion, then it is very important that economists do what they can to provide their support when appropriate. I was shocked at the ease with which in 2011 the Hungarian government effectively closed down their two year old fiscal council (see here for details). Economists have long been champions of the independence of central banks, but independent fiscal councils are just as important, and arguably they are far more vulnerable than central banks.