The
last time I can remember Chris Giles of the FT writing
about fiscal policy, I came down
on him pretty hard. It was the phrase “..the area in which Britain still leads
the international debate is fiscal policy” that really got to me then. So before
taking up something in his latest piece,
let me say two things. First, after my earlier critical post, Chris took the
time to send me a lengthy email defending his position. It didn’t change my
view, of course, but I did appreciate the effort. It confirmed my belief that
Chris is serious about trying to get things right. Second, the article today is
more sensible. It basically takes the IMF view I described recently here,
which is that we need more monetary expansion, and that if things become worse
than expected we should have bond financed fiscal expansion. Not as far as I
would want to go, and I would disagree with his arguments for keeping to current
fiscal plans, but Jonathan Portes takes on that task here.
What I can say is that I approve of his direction of travel, and that he is prepared to make it!
What I
want to discuss now is a remark Chris makes about economists taking sides. The
article starts by chiding the Prime Minister when he claims that low interest
rates represent the result of his tough decisions. Chris argues, as Jonathan
has said many times, that low rates reflect the poor prospects for UK growth. He goes on: “The prime minister must know that what he is saying is silly, so it
suggests he holds the intellectual capabilities of his audience in contempt.” I
have recently expressed
sentiments along similar lines. He then goes on to examine a recent statement by
Labour’s Ed Balls. To quote again: “Blaming changes in deficit forecasts on the
pace of austerity alone is not worthy of a serious politician.” If you take the
statement Chris quotes as implying that the deficit is higher just because of
austerity, then that does indeed make little macroeconomic sense.
It is
what Chris says next that is interesting. “In the current hysterical climate,
economists should be wary of taking sides. We know that austerity hurts, but we
have little idea how much of the current economic pain is caused by deficit
reduction.” If by taking sides he means
trying to argue that everything said by one political party is wrong and
everything said by another is right, then this has to be sound advice in an age
of macroeconomic spin.
However,
I would also argue that in a hysterical climate, economists really should go
public with what they believe to be true, particularly if that belief comes
from years of study. If their view reflects what is taught to students up and
down the land, then I might go so far as to say that they owe it to their discipline
to tell the world what they tell their students. What in my view makes the austerity announced
in 2010 a major policy error was that it attempted to deny this knowledge. We
do know with reasonable certainty that fiscal contraction in the form of
spending cuts will, ceteris paribus, reduce output by a significant amount. We
also know that when interest rates are at their lower bound, what monetary
policy can do to counteract this fiscal impact is highly uncertain. Not all
macroeconomists will agree with these statements, but I would conjecture that
the vast majority do. Given this, it was highly likely that additional
austerity would reduce UK output compared to what it otherwise would have been,
and if this led to weak or zero growth then it was a huge gamble to hope that monetary
policy would put things right again.
It was
in part this belief that macroeconomics had important things to say that current
policy seemed to ignore that started me blogging some five months ago. I’ve
also found that among the macroeconomic blogs I read there is refreshingly
little partisan commentary. OK, maybe that is partly self selection – there is
a popular US blog that I do not read for this reason – but only partly. There
is a bit more ideology in what I read, but unfortunately that reflects the discipline
itself.
I also
agree with the second sentence from Chris that I quote above in the following
sense. Although there has been no growth since the coalition started to influence macroeconomic events, we should never claim that we know that this is all due
to their fiscal plans. There are too many unknowns here – in particular, it is hard
to know how much future austerity might have influenced current expectations
among firms and consumers. I hope that in the past I have simply claimed what I
said above, which is that austerity has just made things worse. To say that we
know precisely what a policy has done to the economy is almost as bad as saying
that we can accurately forecast.[1]
What all
macroeconomists know is that forecasting is a very imprecise game. Study after
study has shown that macroeconomic forecasts are little better than guesswork. Forecasts
are worth doing, because getting things a bit better than guesswork has
benefits that exceed the costs. A corollary of being just better than guesswork
is that whether you get forecasts right or wrong is largely down to luck. So to
infer, as is frequently done – even in blogs – that because the Bank of England
has been consistently overoptimistic about inflation this must reflect some
kind of incompetence is simply wrong. Equally, to assert that the OBR were
overoptimistic about UK growth because they must have been somehow infected by
the government’s beliefs is wrong. Both things are possible but, given what I
know in each case, highly unlikely. Given the state of our current, and in all
probability, future macroeconomic knowledge, forecasts are generally wrong
because the economy is too damn unpredictable. That makes it all the more
important that we do not ignore the things we do know.
[1] It
is only ‘almost’ as bad because conditional forecasting (if something changes by
x, then something else will change by y), involves less uncertainty that
unconditional forecasting (something will be y). Note that my statement about
fiscal policy is much weaker than a conditional forecast, because it just says that
if government spending falls, output will be lower. That is why we can be much
more certain about this kind of statement.
