How UK deficit hysteria began

Laura Basu has a good book just out on UK media coverage of events from the Global Financial Crisis (GFC) until 2015, which I have reviewed for Open Democracy. Among other things, it tells the story of how what Mark Blyth calls the ‘biggest bait and switch in history’ happened in the UK. Laura argues that it can be dated almost exactly to the Budget of April 2009.

That the right wing press would start talking about the horrors of the rising UK deficit is no surprise. Osborne had decided in the previous year to oppose the Labour government’s stimulus measures because he saw in the rising deficit a way to beat Labour. The puzzle is why a broadcast media, ever conscious of balance, pushed the same line, even though it was clearly advantageous to one side politically.

The following story is mine, not Laura’s. Before the GFC, the way that the broadcast media covered budgets had become quite formulaic. Each budget would present estimates of the deficit over the next five years, and with the help of the IFS commentators broadcasters would discuss not only what tax changes had been announced, but also what might be implicit in the projections. No doubt this framework suited journalists well, because it allowed easy analogies with households. If the IFS felt that the projections were over optimistic and therefore fiscal rules might be broken, they said so and that became one of the budget talking points. The state of the economy was hardly ever discussed, because the Bank of England seemed to be doing a pretty good job of keeping things stable.

That all changed with the GFC, when monetary policy ran out of reliable levers to manage the economy. However journalists wouldn’t know that from the Bank of England, who tended to talk as if Quantitative Easing was a close substitute to interest rates as a monetary policy instrument. They would know it from academic macroeconomists, but journalists were generally too busy to make the effort to talk to them. For whatever reason, they did not fully appreciate how much the world had changed as a result of the GFC.

So when in the budget of April 2009 the Treasury showed the full extent of the deficits that the recession (and to a smaller extent the government’s stimulus measures) had created, journalists behaved exactly as they would have done before the GFC. Compared to deficits seen before the financial crisis, the numbers were indeed large. But crucially, because the Treasury estimated that the GFC had reduced the trend level of GDP, fiscal savings were necessary as a result. When these took the form of efficiency savings, the IFS were rightly skeptical.

So the coverage was all about higher taxes and lower spending, and whether they would be enough to close the record deficit. At no point in the subsequent discussion does anyone ask whether the current deficits are large enough to create a strong recovery. The growth forecasts are taken as given, and only their fiscal consequences are discussed, as if the former had nothing to do with the latter: an assumption that is only appropriate if monetary policy is in complete control of the economy. The government’s line that these deficits were necessary to ‘support’ the economy was almost entirely ignored.

Furthermore, the issue of whether the markets would purchase all this extra debt was already being raised. This is City speak, seeing a recession as involving more government debt and therefore perhaps higher rates, rather than understanding that the recession was caused by more saving and less borrowing so there would be plenty of new savings to buy the additional debt.

In other words the broadcasters had a framework for commenting on the budget which was appropriate before the financial crisis, but totally inappropriate after it. What they should have been asking is whether the Chancellor had done enough to ensure the recovery that was forecast, or whether perhaps larger deficits might be needed. In retrospect, that was exactly the right question to ask.

At the time, the reason for these deficits was clearly spelt out by the IFS as well as the Treasury. "The Treasury's assessment of the fiscal damage wrought by the current economic and financial crisis is breathtaking," said IFS director Robert Chote. "It will require two full parliaments of mounting austerity to repair." But in a telling indicator of things to come, the headline paragraph loses the bit about the GFC. As Laura’s book shows, it became so easy for a media prone to amnesia to forget about the financial crisis and blame everything on Labour profligacy, as after a time most voters began to believe. But the fundamental mistake was focusing on the deficit as a problem rather than as an instrument designed to produce a strong economy. The mistake came from the media’s inability to see how the GFC had changed the macroeconomic rules of the game.

Rollercoasters and rules

Chris Giles says today that “there is a gap [between Labour and Conservatives plans] of more than £30bn a year in public spending by the end of the decade, at least 1.4 per cent of national income. This is a bigger political divide seen in any election since the days of Margaret Thatcher.” Chris is absolutely right to focus on this fact, and it is really important that other journalists (including those on the political side) do the same. The reason is that neither Labour nor the Conservatives want to admit this. Labour wants to appear as if they are being ‘tough on the deficit’ and the Conservatives want to turn this into a ‘Labour would put up taxes’ election. With all the noise that these phoney debates throw up, it is important that someone tells people what the consequences of their vote will be.

Chris may also be right that the rollercoaster for public spending set out in the Budget (sharp cuts followed by increases) will not happen. However I think it would be wrong to expect a smooth ride under the Conservatives either. They will have won an election based on an initial two years of substantial spending cuts (particularly to public investment), followed by later years when the overall pace of fiscal consolidation slowed substantially (in part because of Budget tax cuts). If that wins them this election, they will want to repeat that pattern. [1]

The term rollercoaster was coined by Robert Chote, head of the Office for Budget Responsibility. But if the rollercoaster will never happen, was Robert wrong to use this word? Absolutely not - in using that term he was doing his job in a very effective way.

As Chris explains, the reason why the numbers given to the OBR generate a rollercoaster profile is the revised fiscal rule, which says that there should be (cyclically adjusted) balance within three years. Like the old rule, this is a rolling target (but now for three years ahead rather than five), so it means in effect that governments can keep putting off the date balance is achieved as each year rolls past.

If governments start planning their fiscal actions with this in mind, the rule becomes largely worthless: it means reducing deficits mañana. As I explained here, rolling targets are a good idea because they allow policy to be flexible in the face of shocks. But rolling targets can also be abused by an irresponsible government to forever put off deficit reduction.

As I argued here, there was no good reason for Osborne to switch from a five to three year rolling target, and good reasons to stick to five years. The move to three years looked like a political ploy to embarrass the opposition. When politicians start messing around with fiscal rules for political ends, and these rules then produce silly results which politicians have no intention of sticking to, it is important that an independent institution with the words ‘budget responsibility’ in their title calls attention to what is going on. Robert Chote did that very effectively by using the term rollercoaster. 

[1] Where I think Chris is wrong is in describing plans to decrease debt slowly as risky. The opposite is the case. With interest rates near their floor, sharp austerity puts the economy at risk from adverse macroeconomic shocks. 

The government and the OBR: why I was very pleased to be wrong

Yesterday, I commented on the Prime Minister’s ‘there is no alternative’ speech, which included the following:

“They [the OBR] are absolutely clear that the deficit reduction plan is not responsible [for depressed growth]. In fact, quite the opposite.”

I wrote this:

“So this statement deliberately misrepresents what the OBR has been saying, to imply that the OBR believes in expansionary austerity. But the Prime Minister knows that the OBR will let this misrepresentation of its views pass – which is a shame.”

I was wrong. Today the OBR published on its website a letter from its director Robert Chote to the PM. It is very polite: after reproducing the same part of the speech that I highlighted, it said

“For the avoidance of doubt, I think it is important to point out that every forecast published by the OBR since the June 2010 Budget has incorporated the widely held assumption that tax increases and spending cuts reduce economic growth in the short term.”

Actually, I think Robert had to do something like this. I wrote what I did because this was no isolated incident - no momentary piece of over enthusiasm by a speech writer. Just read the first part of the Chancellor’s autumn statement. He milks the ‘look the independent OBR agrees with us’ line all he can. In particular he says:

“One of the advantages of the creation of the OBR is that not only do we get independent forecasts, we also get an independent explanation of why the forecasts are as they are. If, for instance, lower growth was the result of the Government’s fiscal policy, they would say so. But they do not.”

Now the Chancellor was a little more careful. By saying lower growth rather than low growth, he could argue that he meant ‘lower than expected’ growth, rather than the actual growth number, even if this subtlety might have been lost on his audience. For that reason, I can imagine the OBR holding back from complaining at that time. But yesterday the Prime Minister went too far. Robert Chote needed to respond, and in doing so will have done the OBR no harm whatsoever.

When the OBR was established, I and others were concerned that its inevitably close relationship with the Treasury and other government departments (inevitable, because it produces the fiscal forecast) might lead some to question its independence. I was also concerned that its limited remit - it is not allowed to look at alternative policies - would mean that its reputation was too closely tied to its forecasts. And I knew that macro forecasting is a mugs game: as forecasts are only slightly more accurate than guess work, getting things right was largely down to luck. So its own fortunes could become too linked to the governments, which might mean it lost influence elsewhere and might not even survive a change of government. For just one example of this tendency, see this recent perceptive piece by Colin Talbot.

Given its restricted remit, the OBR has done what it can to make links with government as transparent as possible, and argued (convincingly in my view) that these contacts with government do not make it into a puppet of the government. Indeed, one could justifiably argue that the OBR has been pulling the government’s strings. While some have been critical of its forecasting methods, I think its actions have been perfectly defensible, as I argued here. I was however worried about the way the government was misusing the OBR’s analysis. With any luck, the OBR with its actions today has called time on that, and the government will be more careful in future.

In the onward march of fiscal councils, Robert’s letter is just one minor skirmish in one particular battle, but lets celebrate it none the less.