How to predict a crisis

I was sorting through some old papers over the weekend (don’t ask) and I found an article I wrote for the Financial Times on 19th October 1990, which is also the month we entered the European Exchange Rate Mechanism (ERM). The article, based on work I had done earlier with colleagues at the National Institute (final published version here), argues that we were entering at the wrong exchange rate. The final paragraph starts with

“The danger is that the government will attempt to defend the present exchange rate bands at all costs. As a result it may produce, or fail to prevent, a recession on the same scale as 1980-81.”

According the current data vintage, GDP was already falling at that point, yet interest rates were not reduced by enough to prevent a recession because of concerns about pressure on sterling. GDP continued to fall almost continuously until we were forced out of the ERM (Black Wednesday). Leaving the ERM allowed interest rates to be lower and produced a 10% depreciation in sterling, which helped ensure a strong recovery.

I’m sure I wasn’t alone in making this prediction, but we were in a minority and we did produce the best analysis. The Global Financial Crisis (GFC) was of course a much bigger event, and far fewer saw it coming, so quite rightly 10 years later those economists who predicted something like it are getting media attention. They were very different events, so can we draw any parallels between them, or more generally is there anything that links disasters of this kind?

One common factor is using the markets as an excuse to avoid economic analysis. One of the two main excuses to ignore our ERM analysis was to look at the exchange rate at the time as say ‘the market must know what it is doing’.Of course before the crisis too many people who saw the data thought the banks must know what they are doing as they pumped up leverage.

Perhaps another is never let new ideas crowd out the knowledge embodied in older ideas. The other excuse that particularly academics used to disregard our analysis about the ERM entry rate was that the models we were using were a little old fashioned. (I talk more about that here.) Bankers fooled themselves that they had new methods of evaluating risk that meant they could ignore systemic risks. If we think of the other two major UK macroeconomic crises, the same applies. The Treasury predicted the recession of 1980 pretty well, but the analysis was trashed as the work of old fashioned Keynesians by Lawson et al from the Thatcher government. Austerity of course also ignored basic Keynesian truths.

One obvious final question is whether we learn from crises of this kind. Ten years after we left the ERM the Treasury asked me to do their entry rate analysis for possibly joining the Euro, so that at least implies some learning, but maybe being a different government helped. Perhaps Black Wednesday created a general distrust of fixed exchange rate regimes in the UK that helped Gordon Brown argue against joining the Euro.

Have we learnt the lessons of the GFC? Some changes to the banking system have been made, but I think the general consensus is its is not enough, and there still seems to exist a large implicit public subsidy for the major banks. If for no other reason that is why you should take note of what those who predicted the GFC say. In terms of how you recover from a financial crisis we certainly had learnt some of the lessons of the 1930s, but not all. As I argue in my last post, we have hardly begun the process of creating a macroeconomic policy regime that can deal with a future recession, let alone a crisis.

First Stage Reality and Brexiters

Now for the hard part, pronounced various media commentators after the first stage Brexit deal had been signed. The chances of No Deal have diminished, said others. It is strange watching the MSM sometimes. On political issues that involve expertise, like austerity and Brexit, it is generally an expert free zone. With Brexit you have to turn to the Financial Times and Economist who understand what is really going on, or other knowledgeable bloggers like Chris Grey. [1]

It is not difficult to discover how things really work in these strange days. You just need to see what the important facts are, and continue to apply them relentlessly despite what politicians say. The latest important fact that tells you all you need to know is that a Single Market and Customs Union needs a border to, as Martin Sandbu sets out, not just collect tariffs but also check compliance with rules of origin and standards. Therefore to avoid a border in Ireland, you need Northern Ireland to comply with all the tariffs, standards and regulations of the Single Market. The UK has now agreed, as I thought it would, that this must also apply to the UK as a whole.

This logic leads you inevitably to the conclusion that, after Brexit, the UK will to the first approximation [2] continue to obey all the rules of the Single Market and Customs Union. So it will be as if we are still in the EU, with the only difference being that we no longer have any say on what those rules are. Fintan O’Toole quotes Sherlock Holmes: eliminate the impossible and whatever remains, however improbable, must be the solution.

But, you may respond, all the UK have signed up to is that this is a default position, if they fail to find a technological fix for the border, or if they fail to conclude a trade agreement with the EU in stage 2, and what does alignment mean anyway? Here you need a second fact: there are no technological fixes that remove the need for some form of hard border. We also know two things from this first stage agreement: the UK desperately want a trade agreement with the EU and the EU will not allow any agreement that implies a hard border in Ireland. It therefore logically follows that, to a first approximation, any trade agreement will have to involve the UK staying in the Single Market and Customs Union.

Why then are the Brexiters not up in arms? It is partly because the agreement plays on their lack of realism, as I suggested two days ago. The UK government and Brexiters still pretend that they can, through some magical means, avoid a hard border. Given that belief, how can they object to this fall back position? And that will be the line that the UK takes from now into the indefinite future, and because the broadcast media mainly talks to politicians rather than experts that is the line the media will take as well, with some honorable exceptions like those noted above. In may come apart as the cabinet finally discusses what the trade deal might look like, which is why the threat of No Deal has not gone away. Or Brexiters like Gove may decide instead that as May will not be making these trade agreements, it is politically wiser to maintain unity and instead try to win the ultimate prize from Conservative party members.

Why is it important that this deceit continues? Because if everyone was honest, and respected the reality of the border issue, people would rightly ask whether our final destination (obeying the rules but with no say on the rules) is worth having. They would note that being to all intents and purposes part of the Customs Union means Mr. Fox cannot make new trade agreements. People might start asking MPs why are we doing this, and the line that we have to do this because the people voted for it would sound increasingly dumb.

Unless something amazing happens and the MSM do not allow this deceit to continue, we will end up with the softest of soft Brexits. If that is where the UK stays [3] there is a huge irony about all this. The Brexiters’ dream was to rid the UK of the shackles of the EU so it could become great again, but it is a legacy of empire that has brought this dream to an end. All the stuff about bringing back the glory of a once great trading nation will not happen. Instead we will still be acting under the rules of the EU, but because we are not part of it the UK will be largely ignored on the world stage. A rather large country, which nevertheless gets other countries (like Ireland!) to set its trade and associated rules for it, and which it is therefore not worth bothering with in the international arena. A Britain that can no longer pretend to be a world power, not as a result of the actions of some left wing government, but because of the delusions of Brexiters.

[1] To be fair to the broadcast media (as I always am), yesterday I did see interviews with ministers which raised the issue of what the implications of the border agreement are. But for whatever reason these interviewers allowed those ministers to bat away the question with waffle, and I strongly suspect the point will be forgotten in the days ahead.

[2] What do I mean by first approximation? For a start, we will not be part of the Customs Union and Single Market, but instead be part of bespoke versions of both. That may allow wiggle room, which in turn might just possibly allow something that could be called a deal on free movement, although this will probably just mean Free Movement to a first approximation. So a bit like Norway or Switzerland, but with rather less room for maneuver than those countries because both have borders with the EU. For more details see here.

[3] It will not be where it stays. First, there is the question of who May’s successor will be, and what they will do. If a soft Brexit goes ahead, the Brexiters will choose the right time (for them) to cry betrayal. It will only be a matter of time before they make a new attack, arguing that the UK should strike out for true independence. As I argue here, bigger things than just one failure have to happen before the UK rids itself of this particularly British form of plutocracy.  

Project Fear = We have had it with experts

Normally reading the Financial Times you are safe from ‘I cannot believe he said that’ moments. But occasionally you come across something like this, in this case from the normally reliable Wolfgang Münchau:

“Those who campaigned for the UK to stay in the EU are shaping up to be two-time losers. They lost the referendum vote on June 23; now they are losing the battle to keep the UK inside the single market. Both defeats are based on repeated misjudgments.

Their original mistake was to exaggerate the economic effects of Brexit. The long-run consequences are hard to gauge. What we do know, so far, is that the result did not cause an immediate crisis — and this is what matters politically. This is why the consensus within the Conservative party has been shifting towards a harder version of Brexit.”

Forget all the conflicting and unreliable monthly data and surveys, and focus on the two clear impacts that the Brexit vote has already had. The first is a large depreciation in sterling, which makes almost everyone poorer. [1] The second is a cut in interest rates plus a reactivation of unconventional monetary expansion. To imply that these events strengthen the Leave case is just completely and utterly bizarre. It is just another version of the ‘they predicted Armageddon’ trick which I complained about here. Any objective referee would judge the score so far to be

Economists 2 Leavers 0

As for ‘the long-run consequences are hard to gauge’, this homily implies that making trade harder with our immediate neighbours might make us better or worse off. This is wrong. Common sense, along with all the economic models, suggest the uncertainty is all one-sided. Estimates are for a reduction in UK living standards of between 3% and 8%.

Michael Gove was widely derided for saying the UK has had enough of experts. But using the label ‘Project Fear’ is exactly the same. It has been used in the Scottish referendum and Brexit as a way of discounting expert advice. Yet in the political world calling warnings about the impact of either Scottish independence or Brexit ‘Project Fear’ is seen as a successful tactic. If you believe this report, it is why the Labour leadership chose not to endorse (and in fact rubbished) the government’s warnings about the economic dangers of Brexit (although as I note here the suggested involvement of the Economic Advisory Council in that is incorrect). It is true that Project Fear is applied to government warnings about the economic impact of independence/Brexit, but when those warnings are backed by nearly all experts it amounts to an attack on expert advice.

So in the Orwellian world that we are now living in, the tactic of calling something Project Fear is newspeak for saying we have had enough of experts.

[1] If you own a large amount of assets denominated in overseas currency then you could be better off, at least for a time. However even here a permanent terms of trade loss will eat away at any wealth gain when real interest rates are negative. On average the UK is a net debtor, not a net creditor.  

Blaming Keynes

A few people have asked me to respond to this FT piece from Niall Ferguson. I was reluctant to, because it is really just a bit of triumphalist Tory tosh. That such things get published in the Financial Times is unfortunate but I’m afraid not surprising in this case. However I want to write later about something else that made reference to it, so saying a few things here first might be useful.

The most important point concerns style. This is not the kind of thing an academic should want to write. It makes no attempt to be true to evidence, and just cherry picks numbers to support its argument. I know a small number of academics think they can drop their normal standards when it comes to writing political propaganda, but I think they are wrong to do so. Take this paragraph, designed to show how good UK macro performance has been compared to the dire warnings of those Keynesians.

“The UK had the best performing of the G7 economies last year, with a real gross domestic product growth rate of 2.6 per cent. In 2009, the last full year of Labour government, the figure was minus 4.3 per cent. Moreover, far from being in depression, the UK economy has generated more than 1.9m jobs since May 2010. UK unemployment is now 5.6 per cent, roughly half the rates in Italy and France. Weekly earnings are up by more than 8 per cent; in the private sector, the figure is above 10 per cent. Inflation is below 2 per cent and falling.”

The first sentence is correct. But why compare that to 2009, which apart from being the ‘last full year of Labour government’ also happened to be the year of the recession that followed the global financial crisis. As I have mentioned before, growth in GDP per head under Labour averaged 1.5% even though it included this recession, but average growth from 2010 to 2014 was only 1% when we should have been seeing a rapid recovery. The jobs figures are mentioned, but the awful productivity performance that they imply is not. Earnings growth over the whole period is quoted (but without saying it is nominal growth), but only inflation over the last year! Presumably this is done to create the impression of real wage growth, when in reality this period has seen unprecedented falls in real wages.

A paragraph like that might earn Ferguson a job as a speechwriter for a Conservative politician, but if a first year undergraduate wrote it as part of an essay it would have red ink scrawled all over it, no matter whether the marker was an economist or historian. As for the general idea that the election result represented a disaster for the Keynesian model, I wonder whether Ferguson realises that most/all central banks base monetary policy on Keynesian economics? If the idea is that taking an anti-austerity line is a vote loser, why not note that the Scottish National Party adopted a clear anti-austerity rhetoric? (This letter in response to Ferguson’s article from Sam Wills makes much more sense on the election result. My own take is here.)

It is possible for someone to try and make a serious academic case in defence of the coalition government’s macroeconomic record, but this is not it. This kind of nonsense polemic is of course not just the preserve of the anti-Keynesian right. But what this kind of thing does illustrate is how problematic public debate on macroeconomic policy is. It is difficult to think about many other academic subjects where people who seem to have little idea of what they are talking about can write such obvious rubbish in a quality newspaper.

Greece: of parents and children, economists and politicians

Not part of the mediamacro myths series, but in a way related.

Chris Giles has a recent FT article where he describes how non-Greek policymakers (lets still call them the Troika) see themselves like parents trying to deal with the “antics” of the problem child, Syriza in Greece. He splits these parents into different types: those that want to act as if the child is grown up (though they believe they are not), those who want to be disciplinarians etc. As a description of how the Troika view themselves, and present themselves to the public, the analogy rings true. It certainly accords with the constant stream of articles in the press predicting an impending crisis because the Greeks ‘refuse to be reasonable’.

In FT Alphaville Peter Doyle writes about a recent meeting at the Brookings Institution in Washington, the highly respected US social science research/policy think tank. In that meeting Wolfgang Schäuble and Yanis Varoufakis, finance ministers of Germany and Greece, gave back-to-back presentations. He describes how “Schäuble was avuncular, self-effacing, and Germanic, and was tolerated rather than warmly embraced by his hosts.” In contrast “when Varoufakis spoke, eyes burning with anger, his hosts were animatedly engaged.” The audience actively sympathised with the position of Greece, and asked “how it felt to be right but penniless”. He writes “There was no doubt where the hosts’ sympathies lay between their two guests.”

I am not surprised at all by this account. The arguments that many of us have made about how far Greece has moved and what agonies it has endured in order to satisfy the unrealistic wishes of their creditors are I think widely shared among our colleagues. We know that if Greece was not part of the Euro, but just another of a long line of countries that have borrowed too much and had to partially default, its remaining creditors would be in a weak position now that Greece has achieved primary surpluses (taxes>government spending). The reason why the Troika is not so weak is that they have additional threats that come from being the issuer of the Greek currency.

It is important to understand what the current negotiations are about. Running a primary surplus means that Greece no longer needs additional borrowing - it just needs to be able to roll over its existing debts. Part of the argument is about how large a primary surplus Greece should run. Common sense would say that further austerity should be avoided so that the economy can fully recover, when it will have much greater resources to be able to pay back loans. Instead the creditors want more austerity to achieve large primary surpluses. Of course the former course of action is better for Greece: which would be better for the creditors is unclear! The negotiations are also about imposing additional structural reforms. Greece has already undertaken many, and is prepared to go further, but the Troika wants yet more.

As Andrew Watt points out, from the perspective of the Eurozone and IMF, this is all extremely small beer. [1] You would think the key players on that side had more important things to do with their time. The material advantages to be gained by the Troika playing tough are minimal from their perspective, but the threats hanging over the Greek economy are damaging - not just to investment, but also to the very primary surpluses that the Troika needs. So why do the Troika insist on continuing with brinkmanship? Can it be that this is really about ensuring that an elected government that challenges the dominant Eurozone political and economic ideology must be forced to fail?

In a recent post that I (jokingly) entitled ‘Should economists rule?’ I suggested that much of the debate about the delegation of economic policy to economic experts was really an issue about political transparency rather than diminished democracy. Elected politicians normally always have ultimate control. Sometimes ‘delegation’ amounts to little more than making the advice they receive transparent: contracting out the fiscal forecast to the OBR would be an example. [2] All that democracy loses in this case is the ability of politicians to conceal or manipulate the advice they receive, and to fool the public as a result. Greece may be (unfortunately) a good example of how far politicians are prepared to go in misleading their own electorates to cover-up their mistakes and achieve their own political ends.

  

[1] The IMF mainly consists of hundreds of economists, but it is run by politicians, and on issues like this the politicians tend to take control.

[2] With central bank independence they do lose control, but normally with the power to take back control in some way. Furthermore, if the undemocratic central bank persistently made bad decisions, taking back control would be popular. An exception is the ECB, which may help explain why many of its words and actions are seriously problematic.

Should economists rule?

Tim Harford in the FT talks to seven random mainstream economists about their radical ideas for economic policy. (Podcast, not pay walled, here.) Nick Stern wants green cities (with much greater economic autonomy), Jonathan Haskel wants more spent on research (because the returns are very high), Gemma Tetlow wants to merge income tax with national insurance, Diane Coyle wants to reduce boardroom pay, John van Reenen wants new institutions to promote infrastructure, Kate Barker wants changes to how housing is taxed, including capital gains on main residences, and Simon Wren-Lewis wants ‘democratic helicopter money’.

You can find more details about democratic helicopter money here. The democratic bit is that the central bank gives the created money to the government on condition that it is used for a stimulus package, but the form of the stimulus package would be the government’s choosing. I was impressed that Tim managed to turn a very pleasant chat over coffee (while taking few notes) into a coherent account of my argument. The only point I might have added is that my suggestion of turning helicopter money democratic is in part to avoid some of the political difficulties he alluded to.

The common strand in many of these suggestions, which Tim draws out, is a desire to replace direct political control by something more technocratic. Now you could say that this is simply a power grab by economists. However if you think about the examples here, they represent important and widely recognised policy mistakes which tend to be universal and persistent: failure to deal with climate change, failure to invest enough in R&D, unnecessary complications in the tax system, runaway boardroom pay, failure to invest in infrastructure even when borrowing is ultra cheap, a broken housing sector and procyclical fiscal policy. It is not as if the status quo is doing just fine.

I would add just two observations. First, the argument is often not about ‘losing democratic control’, but instead about advice being open and transparent. The alternative to some advisory body, whose deliberations should be publicly available and subject to scrutiny, is often secret advice from the civil service, or worse still from policy entrepreneurs. Second, what is thought political infeasible today may relatively quickly become commonly accepted.

I was quite surprised that Tim thought democratic helicopter money was particularly radical and politically infeasible. But then I remembered fiscal councils. My first published piece advocating (advisory) fiscal councils was in 1996, and for more than a decade this was considered the impractical idea of a few ‘out of touch’ economists, who were obviously anti-democratic. Then, little more than a decade later, the idea very quickly became acceptable. Nowadays, it seems like fiscal councils are everywhere. So the one part of Tim’s piece that I would not take too seriously are his scores for political feasibility and radicalism. Today’s supposedly radical idea can quite quickly become received wisdom.

Growth vindicates Greek Austerity

I cannot resist quoting from this editorial in today’s Greek edition of the FT.

Greek government and Troika’s austerity policy vindicated

Since unveiling its austerity strategy to reduce its yawning budget deficit in 2010, the Greek government together with the Eurozone’s Troika has faced immense pressure to change tack. An alliance of Keynesian economists and opposition parties has accused them of choking off growth. The prophets of doom predicted years of stagnation with soaring unemployment and falling living standards.

After a run of positive growth numbers this year, the Greek government and Troika have reason to feel vindicated. They have won the political argument. True, the Greek economy is still a quarter smaller than its pre-crisis peak. But the current acceleration looks like the beginning of a sustained recovery. The anti-austerians grumble that the upturn would have come earlier had the Greek government and Troika eased up on the fiscal squeeze. This is impossible to prove as economic history offers no counter-factuals. What we do know, however, is that the critics overstated the obstacles standing in the way of a recovery. Their position was too extreme and they have found themselves snookered.

OK, the FT here is the Fictitious Times, but otherwise I have kept pretty close to the beginning of this real Financial Times editorial about somewhere else. The numbers may be different, but the reason why this editorial would be ridiculous are exactly the same as why the original editorial was. And yes, I know I have complained about it a few times, but because the FT is a quality financial paper that generally gets things right, and which other journalists look to for economic expertise, it is important not to forget the occasional lapse from otherwise high standards. And the FT are not the only respected economists who sometimes mistakenly treat growth from a deep recession as an indicator of a successful policy.

What are academics good for?

A survey of US academic economists, which found that 36 thought the Obama fiscal stimulus reduced unemployment and only one thought otherwise, led to this cri de coeur from Paul Krugman. What is the point in having academic research if it is ignored, he asked? At the same time I was involved in a conversation on twitter, where the person I was tweeting with asked

“What I have never understood is what is so great about academic economists? Certainly not more objective.”

They also wrote

“Surely, rather a dangerous assumption to think that an academic whose subject is X > a non academic whose subject is X”

In other words, why should we take any more notice of what academic economists say about economics than, well, City economists or economic journalists?

Here is a very good example of why. The statement that the 2013 recovery vindicates 2010 austerity has a superficial plausibility because of the dates (one is before the other) and both involve macroeconomics. However just a little knowledge, or reflection, shows that the statement is nonsense. It is like saying taking regular cold showers is good for curing colds, because everyone who takes them eventually gets better. But the thing is George Osborne says the statement is true, so this is a test of objectivity as well as expertise.

In the Christmas 2013 FT survey of various economists, one question was “Has George Osborne’s “plan A” been vindicated by the recovery?”. Among the academic economists asked, ten said No, and two said Yes. So two gave the wrong answer, but if you knew who they were you would not be surprised. Among City economists surveyed, the split was about 50/50, with at least a dozen giving the wrong answer. Worth remembering that the next time someone says these guys must know what they are talking about because people pay for their advice. (Some do, some do not.)

And journalists? Well, there are some very good ones, particularly those working for newspapers like the Financial Times. Which is why I found the FT leader with the headline “Osborne wins the battle on austerity” so outrageous. If I also tell you the tweets above came from a well known economic journalist, you can see why I found them revealing.

This goes back to the question Paul asked. If we don’t think that academic economists’ opinions about economics are worth anymore than other peoples’ opinions, why do we bother to have academics in the first place? Now of course for some questions an academic economist’s opinions are indeed worth little more than those of anyone else: questions like what will economic growth be in two years time, for example. In fact academic research using models tells us that answering questions like that is almost all guesswork. (Some people find that puzzling, but can a doctor tell you the date on which you will have a heart attack? But if you have a heart attack, you would want a doctor nearby.) And if you want to know what is wrong with your car, you ask a car mechanic not an economist.

And yes of course academic economists cannot all be trusted, and we do make mistakes. (Not all car mechanics can be trusted, and they also make mistakes. But would anyone tweet what is so great about car mechanics when it comes to cars?) But as Paul Krugman quite rightly keeps reminding us, academic macroeconomists have also got some important things right recently: inflation did not take off following Quantitative Easing, interest rates have stayed low despite bigger deficits, and our models said that Eurozone austerity could cause a second recession.

This post so far has seemed far too self serving, but I think this devaluing of academic expertise is not just confined to economics. The obvious comparison is the science of climate change, where the media often appears to give as much weight to paid up apologists for the carbon extraction industry as they do to scientists. When a UK MP and a member of the House of Commons Health Committee and the Science and Technology Committee has “spent 20 years studying astrology and healthcare and was convinced it could work”, it is maybe time to get seriously worried. What is so great about doctors anyway? 

What the Financial Times got (very) wrong

When an academic, or student, thinks they have found a mistake in an academic paper or book, what do they do? Check their calculations again and again, or course. Ask someone else to do the same, maybe. But then they will write to the authors of the original work, and ask them to comment. What they will not do, in that letter or email, is to give the original author a deadline of one day to respond. That was how much time Chris Giles of the Financial Times gave Thomas Piketty to respond to his long list of alleged errors and unexplained adjustments.

I think it might have been very different if Chris Giles had written a piece about the difficulty of interpreting wealth inequality data, and had wanted to get clarification of what Piketty had done and why. I suspect in that case the paper would have given Piketty more time to respond (what was the urgency?), and the article would have benefited greatly from that dialog.

But that was not the article that Chris Giles chose to write and the Financial Times chose to publish. Instead they wrote an exposé, in much the same way as you would expose some wrongdoing by a politician. (Is an academic making a spreadsheet error the equivalent of a politician having an illicit affair?) The phrase they use in football is playing the man and not the ball.

Now, in the unlikely event that I ever warranted a headline story, I know I would not want to be treated in the way Giles treated Piketty. There were only two possible justifications for writing a story of that kind. One was if the paper had clear evidence that Piketty had fiddled the numbers to get the results he wanted, and it is obvious they did not have that evidence. The other is that they had found so many simple mistakes that this discredited Piketty as an academic. Again this was not the case. [2]

I also get very cross with academics who suggest that, because his book had become a bestseller and he had accepted invitations to talk to White House staff, he somehow deserved this kind of treatment. This seems to me like hypocrisy at its worst. Given this treatment, both Thomas Piketty’s initial response and his more detailed response issued yesterday are remarkable and impressive in their restraint.

So the mistake the Financial Times made was not that they allowed one of their best investigative journalists to look at Piketty’s spreadsheets (which Piketty had, to his great credit, made publicly available). As I said in my earlier post, a FT article that looked at the alternative sources for UK wealth inequality data, and questioned the idea that wealth inequality was inevitably rising in most countries, would have been an interesting piece. [1] The paper’s mistake was to write the story as an exposé.   

Why did the Financial Times want to run a ‘gotcha’ piece in the first place? Of course Piketty has become something of a celebrity, and tabloids love to knock celebrities down. But the FT is no tabloid, and to think it was just about celebrity may be politically naive. As Henry Farrell and Mike Konczal noted in a typically acute pair of posts, a focus on inequality as a central issue in economics is very threatening to some, and many of those who feel threatened will read the Financial Times. 

[1] It is worth noting that if we look at the Atkinson and Morelli database, among the six European countries where there was recent data for the top 1% wealth share, I counted three where there seemed to be an upturn in wealth inequality over the last few decades, and three where data showed no clear trend over the same period.

[2] Chris, in a first response to his critics, says that “Academic economists have got themselves into a bad spot if undocumented data, errors and tweaks are considered by some acceptable research practice.” As my original post pointed out, the best academics make mistakes, although in this case it is not clear any were made. So do the best journalists, and at the end of that post Chris acknowledges one of his own. If you want academic research in economics to scrupulously document every detail, you will either get a discipline that is so narrow as to be useless, or you will have to give academics a lot more resources!

Austerity, journalists and the financial sector

The argument that current growth (since 2013 in the UK and maybe from 2014 in the Eurozone) vindicates austerity is ludicrous. Anyone who comes to the debate without existing baggage can see that developments in the UK and Eurozone have been entirely consistent with what academic critics of austerity have been saying. So rather than go over the arguments yet again, let me ask why some people continue to make or support this ludicrous argument.

In some cases asking this question does not tell you a great deal. For George Osborne, for example, you could simply say ‘he would, wouldn’t he’. Still I think there are two interesting points to note: first, here is a Chancellor who feels no inhibition in allowing sound bite to trounce economic logic, and second, he feels confident that he can get away with it, which tells you a great deal about the UK media.

Which brings me to the Financial Times (ex Martin Wolf). Now, to be pedantic, the FT tends not to say outright that current growth vindicates austerity, but instead that George Osborne is justified to claim that it does. Yet this subtlety aside, why do they pursue this line? It would be easy to lump them in with the politicians, but I think that would be both wrong, and miss some important points.

I thought about this partly because of the latest Chris Giles article on the issue (HT Alan Taylor), but also because of Paul Krugman’s comment on my earlier post that discussed the weakness of the European left on macro policy. He makes the point that Obama also showed similar weakness on austerity, and explains this in terms of the influence of what he terms ‘Very Serious People’ (VSP), “whose views on economics tend in turn to be driven largely by the financial industry.” Now at this point I usually add a caveat that there are some good economists who work for financial institutions, but generally the sector’s view on austerity is that it is necessary, and often that it is unlikely to have much impact on domestic output.

Why does the financial sector (the City, or Wall Street, or whatever the equivalent name is in other European countries) have this view? There are probably many reasons, but one that I think is very important is the 2008 recession. This recession should have been disastrous for the influence of finance: the activities of part of the financial sector brought the economy as a whole to its knees, and parts of that sector had to be bailed out with huge amounts of public money. Economists, the public and possibly some politicians began to question whether the continuing financialisation of economic activity might be detrimental rather than helpful to economic growth. No amount of expensive hospitality should have been able to repair that blow to its reputation and prestige.

Of course attempts were made to blame it all on US monetary policy, or global imbalances. The intellectual basis for these alternative stories was pretty thin, but also beyond the academic debate they did not resonate. What was really required was to change the story. The 2010 Eurozone debt crisis was therefore a godsend to finance. The focus was now on the dangers of high government debt, and the necessity of austerity to end this new crisis. Here was a story that certainly did resonate (just look at Greece), and was also an ideal distraction from the problems caused by the financial sector.

I’m not suggesting that one crisis was manufactured to distract from the other. What I am suggesting is that those working in finance understood the importance of changing the story. There was a clear party line, which fitted the dominant ideology. The state bailing out banks is terrible for neoliberalism, while a story based on the evils of excessive government spending fits the ideology perfectly. For VSPs, economic journalists or politicians it was natural to turn to the prophets of finance during the debt crisis, and so any distrust VSPs might have had of these prophets as a result of the financial crisis faded away. Although the level of economic analysis within the FT is generally high, they were perhaps also bound to follow the City/Wall Street line.

On Chris Giles’s article specifically there is much to say, and Jonathan Portes has the patience to say it once more. So let me make just one point. Chris as a good economic journalist recognises that the ‘growth vindicates austerity’ line is nonsense, so instead he tries to accuse the other side of equal mendacity. To see how silly this idea is, consider the following quote:

“It was precisely the chancellor’s fiercest critics who were themselves unable to distinguish between correlation and causation during the period of stagnation and have thereby legitimised Mr Osborne’s rhetorical victory lap. They have only themselves to blame. The lesson to learn is that the economy is complicated and everyone should be deeply sceptical of anyone drawing strong conclusions from simple links that appear momentarily true.”

Of course it is completely the other way around. If there is a simple idea here, it belongs to those who support austerity, and it is the view that monetary policy can always control the level of activity. It was austerity’s critics (beginning with Paul Krugman) who emphasised the complication of nominal interest rates hitting a lower bound. Analysis of austerity based on complex macro models almost always supports the critics view (e.g. here). Criticisms of austerity are rooted in long established theory, while the idea of expansionary austerity or the 90% critical debt level relied on simple correlations.

So Chris, there is no symmetry here between Osborne and most of his economist critics. One of the reasons I started this blog is that I found, perhaps for the first time in my adult life, finance ministers arguing positions which directly contradicted the received wisdom I was teaching undergraduate and graduate students. In an ideal world economics journalists would also recognise when this happens, and tell people about it. 

On city economists and the FT survey

Tony Yates believes the claim that the 2013 UK recovery vindicates austerity is “twaddle”. It is a politically motivated claim that makes no sense in terms of basic macroeconomics. Yet today we have the results of the FT’s survey of economists, which among other things asked “Has George Osborne’s “plan A” been vindicated by the recovery?”. Chris Giles and Claire Jones report that “A thin majority of 42 to 38 said the chancellor was “vindicated””. (All the FT’s questions and my replies are below.) Confused?

The first point to make is that of the economists surveyed, many gave equivocal replies. For example many pointed out, quite rightly, that Plan A had been put on hold in 2012. So there is a lot of interpretation involved to get that 42/38 split. Second, only little more than a dozen of the economists surveyed were academics: there were far more city economists, plus others from organisations ranging from the Institute of Economic Affairs to the TUC.

So what if we just looked at the replies from academics. Here I counted just two clear Yes responses, from Patrick Minford and Mike Wickens. There were ten clear Nos, and only a few equivocating.

For the much larger number of city economists surveyed, I actually thought the split was more even: as many No as Yes replies, and a large number of neither. Yet that still means that at least a dozen city economists gave a clear Yes.

So this sample clearly suggests a divide in the views of city versus academic economists. Where does this divide come from? Here are some possible answers, with some brief remarks. Sensitive city economists should look away now.

(1) Academics live in ivory towers, whereas city economists work with real data in real time.

(2) City economists are obsessed with short term forecasting, and so find it difficult to take a more considered, analytical view. They may also be more subject to outcome bias.

Remark: I’m biased, but here is a quote from one response: “Certainly, the hysteria among unreconstructed Keynesians about the consequences of “plan A” have been shown to be ridiculous.” And here is the data:

(3) A few city economists may be hired more for their ability to talk rather than for their knowledge of macroeconomics.

Remark: Please note the ‘A few’ in this sentence. Here is another quote: “The return of growth in 2013 … [is] an invalidation of the new [sic] Keynesian assertion that growth could not return during fiscal consolidation.” which would fail in any exam anywhere. A kinder way of making the same point would be that some city economists learnt their trade when RBC models were taken more seriously.

(4) City economists are influenced by the ideology that pervades the city. That ideology says that the financial sector is invariably a force for good, and government generally a force for bad. Advocating austerity fits with that ideology, and also has the advantage of distracting attention away from what caused the recession in the first place, and the massive bail out that the city received.

(5) One idea behind austerity, which is that the markets are poised to punish excessive debt, suits those who ‘are close to the market’ and can therefore interpret its moods.

Here are the FT questions and my replies.

1. Economy To what extent will the UK maintain its recent pace of economic growth in 2014? Will households start to feel better off?

Do not have a clue, and if they are honest neither does anyone else. Consumption, and the associated demand for credit, is the key, and we have very little evidence on this. Whether households 'feel' better off will depend on whether they are better off, which mainly depends on Q5.

2. Sustainability Is the recovery set fair, or will this upswing end in tears? Why?

If by tears you mean hitting supply constraints and inflation rising as a result, I would be surprised if this happens in 2014. My instinct is that there is scope for a substantial recovery.

3. Monetary Policy Will the Bank of England change its forward guidance in the coming year? Should it?

The MPC will change its forward guidance if there is a useful message it wants to get across. If at 7% unemployment there are still no signs of overheating in the labour market, they could well lower this threshold to 6.5% or less.

4. Fiscal policy Has George Osborne’s “plan A” been vindicated by the recovery in 2013 and should the planned pace of deficit reduction continue unaltered?

The economy was always going to recover at some point, so how can a recovery that occurred 4 years after the recession vindicate Plan A? And then there is the fact that the data appears to show Plan A was put on hold in 2012. This is basic economics and data guys - why are you even asking the question? Perhaps you have made the mistake of reading your own newspaper's leaders! 

The second part of the question should therefore be: should policy revert to Plan A now that the recovery has begun? The answer is no, because another dose of austerity will slow the recovery for sure (ask the OBR, the IMF, and pretty well any academic macroeconomist.) As long as interest rates are at the zero lower bound, and there is no problem selling debt, austerity is a major mistake. In 2010 they had Greece as an excuse - what is the excuse now?

5. Labour market and productivity By the end of next year, what are we most likely to be saying about the productivity puzzle?

I hope we will have some more clues about the puzzle, which is really THE issue at the moment. If the suspicions of many in the Bank and elsewhere are correct that this has a lot to do with bank lending to SMEs, we should be asking how we avoid SMEs being so dependent on a few large UK banks in the future.

6. Housing. To what extent does the housing market need to be restrained? If so, what policies might work?

Yes. There are plenty of instruments (but interest rates are not one of them), but a very simple thing both the Bank and the government could do is say that - as the government intends to substantially increase the supply of housing and the MPC will raise interest rates at some point - a large decline in house prices is quite likely over the next decade.

7. Scotland How would a yes vote for independence affect the Scottish economy and the rest of the UK in 2014?

On fiscal matters the negotiating position of an independent Scotland is weak, and as a result arrangements if they keep Sterling will be tough. I would not be surprised if we ended up with a new Scottish currency if Scotland votes for independence. I suspect the SNP know this, but want to avoid admitting it before the vote.

Why no public fury over austerity?

Janan Ganesh has an article in the FT today that made me so cross I just have to write about it, even though I should probably let it pass. The theme of the article is how mature the British have been in accepting austerity. To quote: “For countries menaced by the symbiosis of economic suffering and political turmoil, Britain has lessons to impart.”

Of course I see it rather differently. Austerity is either a major technical error, or a political con. According to very conservative estimates from the OBR, it has already cost around 5% of UK GDP. That is a huge amount of money to waste: resources that wanted to be used to produce goods and income that everyone could enjoy, but which have been kept idle as a result of government action. Of course this cost has not been spread evenly, and has been much greater for some.

If this was just my personal view, or the view of a cranky minority, then there is not much more to be said. But instead it is the view you will find in the economic textbooks, and I suspect among the majority of macroeconomists. So given this, the fact that the policy has been accepted with little protest is not something to be commended (unless you are in the business of manipulating opinion), but a major problem. It is a huge failure for good government, and our democratic system. In fact you see similar failings elsewhere. Austerity as a policy has not been seriously challenged in Europe among mainstream parties, and even in the US I think it would be fair to say that views both within the Democratic Party and from the President have been mixed.

So how can Ganesh have completely the opposite view: that the British have shown “impressive calm” in taking their medicine with little protest, and that the lack of any passionate public debate about austerity in the UK is somehow a virtue? I can think of three reasons, none of which is very flattering.

1) That the “elite dialogue” that did take place on austerity is just so much intellectual hand wringing, and that the public know better what the real score is. I might not be surprised if a government politician took that line, but you would expect that a journalist working at the FT, and previously at the Economist, would know better.

2) That his admiration for George Osborne has distorted his view of the real world. Or, to put it slightly more kindly, if you spend your time talking to people who think austerity is inevitable, you begin to believe the propaganda.

3) That he is trying to analyse how the Conservatives have got away with the con of achieving a smaller state by fueling a panic over debt, without of course admitting that that is what he is doing.

Yet whichever of these is the case, the article seems to miss two obvious points. Could it be that the reason there is not a passionate public debate in the UK about austerity is that there is no one to lead that debate? When the political class, of which he is a member, view austerity as inevitable, is it any wonder that the public takes a similar view (particularly when it is dressed up in terms of household economics). He acknowledges that the trade union movement has been vocal about austerity, but does not examine why this voice is largely ignored by the UK media.

There is also no discussion about how popular anger against the impact of austerity may still be there, but that in the absence of any public debate on the policy, it is manifested in other ways. He writes that “Britain remains gloriously free of a serious far right or far left”, which of course is a put down of UKIP. But although Ganesh may not find UKIP serious, Cameron certainly takes UKIP seriously, and has geared his policy on Europe and immigration with them in mind. Perhaps he sees the current obsession in the media (and government) about welfare cheats and benefit tourists as totally unconnected with the unemployment and cuts in living standards that austerity has helped bring about. (For some serious analysis on these issues, see Alan de Bromhead, Barry Eichengreen and Kevin O’Rourke here.)

But none of that was what made me so cross reading the article. Instead it was its juxtaposition with something that I heard about 4 days ago. A reader of my blog, a retired teacher of A level economics and a LibDem member, is about to give a talk on austerity related themes. The features writer on a local newspaper was interested, and spent an hour interviewing him, later writing 750 words. The article was spiked by the editor, because it was controversial and critical of the government. Perhaps the editor was also showing the “impressive calm” which so pleases Mr. Ganesh. 

Austerity, growth and being economical with the truth

OK, I know that those more seasoned in trying to present simple economic ideas in a politicised environment know this happens all the time. And damn it I knew it was going to happen too, as I clearly predicted in one of my early posts. But still, despite my attempts to mock, the argument that positive growth proves critics of austerity wrong continues to annoy me. So here is my attempt to say why it bothers me so much, but after this post I really will try to move on.

Just in case you have not been convinced by my earlier posts of just how ludicrous this argument is, think about this. US growth became significantly positive at the end of 2009, and has remained so in nearly every quarter since then. So if positive growth proves critics of austerity are wrong, then the austerity debate in the US would be well and truly dead by now.  Those that refused to admit this would be completely ignored. Yet the opposite is true.

So the amazing thing is how the idea that the emergence of growth after years of stagnation proves austerity was just fine could gain a moments traction. Do not get me wrong. There are some arguments in favour of austerity that should be seriously debated. But this is not one of them. Instead the argument is just silly. So how can people get away with making it?

The first point to make is that although the argument is obviously silly to anyone with a modicum of macroeconomic knowledge, to interested people without that knowledge, but who get to listen to (or even interview) people like George Osborne, it is not immediately obvious. It becomes pretty obvious once it is explained (my example of deliberately shutting down part of the economy was designed with that in mind), but you need to be exposed to someone who can explain that. So, for those just interested in scoring political points, there is a temptation to make the argument if they think they can get away with it.

However I do not think that excuses George Osborne, or European politicians who have done the same for the Eurozone. We may pretend to believe that all politicians lie through their teeth all the time, but actually we do expect people like the UK or German finance ministers to avoid talking economic nonsense. At the very least we expect their civil servants to stop them saying things that are nonsense. Well not this time.

But there are limits to what politicians can get away with.  The interesting question is what those limits are, and what governs those limits.

Sometimes politicians can get away with bad arguments because they are based on half truths. The example that comes to mind is the idea that current austerity is required because of fiscal profligacy on the part of the past Labour government. While that myth annoys me because (a) it is used to support a damaging policy, and (b) because having crunched the numbers I know it’s untrue, the existence of the myth does not surprise me in the same way. As I have said before, the half truth here is that Gordon Brown was a little imprudent by being overoptimistic about tax receipts. Furthermore, if he had known in advance that the global financial sector was going to blow up he would have been much more cautious before that happened, so any data that is by construction wise after the event will suggest he was not cautious enough. This all means that for those who want to mislead there is the seed corn with which to grow this myth.

Nothing like this is true for the ‘growth proves austerity right’ idea. Instead it is an example of completely misrepresenting the argument of your opponent. The overwhelming majority (maybe all) of the economists who criticised austerity said that fiscal contraction would reduce the level of output in the short run. They may also have been concerned that this short run deflation might have negative longer term consequences. The deception is to morph that into ‘critics of austerity said that the economy would never grow again as long as austerity lasted’. Now I’m sure you could find some person (call them X) who was foolish enough to say the economy would never grow while austerity lasted. But everyone knows that Paul Krugman, or Brad DeLong, or Jonathan Portes are not X. Yet those making the ‘growth proves austerity right’ argument deliberately talk as if all critics of austerity were like X. It is a deliberate deception. It must be particularly galling for Martin Wolf to find his own newspaper doing this to him.

Economists whose job involves communicating with others, and media organisations that purport to have some economic expertise, have I believe the equivalent of a duty of care. It is their job to make sure people are not misled by arguments that they know are obviously wrong. What makes me cross is seeing some who choose not to exercise this duty of care.

Let me use an analogy. You are a science reporter for a newspaper, or even a reporter working for a magazine like the New Scientist or Scientific American. You have to comment on a politician who claims that because it snowed a lot this winter, climate change is clearly rubbish. What you would do in those circumstances is patiently explain why the politician was talking nonsense, discussing trends and noise and the like. You would not say as a prelude that the politician ‘makes a serious case’. You would certainly not write a leader in your paper saying the politician was absolutely right!

Just imagine it. A leader in the New Scientist or Scientific American saying that politicians have won the climate change argument because of recent heavy snow. So why is that idea inconceivable, but a leader in the Financial Times saying that recent UK growth proves critics of austerity are wrong goes without comment? It has nothing to do with economists being divided about the wisdom of austerity: as I said, there are arguments on austerity that should be debated, but this is not one of them. It cannot be because austerity is so politicised, because climate change is also highly politicised. It cannot be excused by saying that leaders are just opinions: you do not expect opinions in serious newspapers to be based on deliberate misrepresentation. So what is going on here? Would anyone from the FT care to comment?