Did the UK really almost go bankrupt?

I normally publish posts in the first half of the week, but two separate attempts were overtaken by events, and they will have to wait for another day. I finally wrote something for the Guardian on the Governor’s interview that led to nonsense headlines about the UK almost going bankrupt. The piece explains why they are nonsense, but I should note here that the headlines are classic mediamacro, appealing to the idea that governments are like households.

Frances Coppola makes the same point a different way. You could describe what happened in March this year as a short term liquidity problem. There is no suggestion the UK is insolvent. And the thing about countries with their own currencies is that they never have a liquidity problem because they create money. She also notes that no headlines talked about the fragility of our commercial banks around the same time. You would think, after the GFC, that would be the big news. Here is a quote from Frances’s blog:

“I found the interviewers' constant focus on government financing a serious distraction from what was an important story about the Bank's vital responsibility for ensuring the smooth operation of financial markets. When financial markets melt down as they did in 2008, the whole world suffers. Central banks saw the same thing happening again in March 2020, and acted to stop it. And their action was extremely effective. It seemed to me that this was the story Bailey really wanted to tell, but the interviewers were intent on pushing him towards the issue of monetary financing and the Bank's independence.”

This episode was not, as some have suggested, an example of fiscal dominance. To make that clear, I give an example of what fiscal dominance would be in the article, where the Bank is forced to monetise borrowing against its better judgement. Dealing with market disorder in a pandemic is not that. But, rather more controversially, I do suggest that fear of fiscal dominance may make central bank governors not that objective when discussing fiscal policy.

So why does the media hype up some short run disorder in markets to be something it isn’t? Perhaps it all goes back to mediamacro’s view that government deficits are bad, whatever the causes. (I stress here that not every journalist thinks like mediamacro.) We have seen huge increases in these deficits as a result of the pandemic, which some in the media have written up with horror rather than as only to be expected. So maybe the media is looking for the markets to validate their view. I would be interested in what media folk think about why his interview was written up the way it was.

What lockdowns do and what they don’t do

Just a short post to advertise my Guardian article ‘Fear of coronavirus, not lockdown, is the biggest threat to the UK's economy’. The key point I make is that the economy would suffer badly even if there was no lockdown. People, once they realised the extent of the threat, would stay at home. The three reasons I give for imposing a lockdown are classic reasons in economics for state intervention.

1. The state has an information advantage
   
   The government, because it talks directly to top scientists, can see the pandemic coming a lot faster than the majority of people. That didn’t work out too well in the UK, where people were leading the government, but if the state functioned well this would be true.
   
   
2. The state deals with externalities
   
   While the majority of people would stay at home in a pandemic, many others might take risks. Whether the state should allow individuals that freedom is an interesting question, but that is not the point here. Because risky individuals can interact with others who are rightly being cautious, they create an externality which a lockdown avoids.
   
   
3. The state supports individuals in a recession
   
   There is a classic Keynesian role here. In this case it goes further, because it allows people to stay at home who might otherwise feel compelled to work and endanger themselves and others.

A benign government would lockdown quickly and hard, and get new infections down to a sufficiently low level such that the vast majority of people feel comfortable resuming their social consumption. It would have a local and well trained track, trace and isolate regime (TTI) in place to deal with any new flare-ups once lockdown was lifted. That would enable lockdown to be lifted once daily new infections were low.

That optimal strategy leads to a short sharp economic downturn, but an equally swift recovery that should be V shaped. The UK has departed from this optimal strategy in almost every respect. It delayed the lockdown, which automatically means that the lockdown is going to have to last longer. It failed to deal with externalities by not properly protecting health and care workers. It farmed TTI out to an inexperienced private contractor, so the TTI infrastructure will not be fully operational until September/October! It is chipping away at the lockdown before new infections are low enough, which raises R and prolongs the lockdown. The result is more deaths, but also a bigger and more prolonged recession, and a slower recovery.

My article came out at the wrong time, with the media full of pictures of lines of people waiting to shop. And I could be wrong. Maybe there is enough pent-up consumption and risk taking out there to keep not just shops but pubs and restaurants and other parts of social consumption going. Maybe the government will be lucky, and infections will continue to gradually fall despite its easing of lockdown. But given the pretty big risk that I am right, no responsible government should follow the current governments path. We don't want a government to gamble with our lives and our economy.

Guardian article on flooding

A very short post linking to my article in the Guardian on flooding. Long time readers will probably remember that I have written about this before. I even naively thought at one point, after the floods at the end of 2013, that this would be Cameron's Katrina. It wasn't, and my naivety was about the UK media. That is why my Guardian article talks not just about a political failure of successive Conservative governments, but also a failure (with only the occasional exception) of the broadcast media.

Some on the left might dismiss this as political bias in the broadcast media, but it is more complex than that. In the article I write

“An obsession with breaking news has crowded out memory and background research. Flood victims ask why this keeps happening to them – but ministers simply respond with statistics that their interviewers have not been briefed about. No interviewer asks ministers why they have ignored the Pitt review, because they don’t know that the Pitt review ever existed.”

You cannot hold politicians to account if the broadcast media collectively forgets the past. Each episode of flooding will be treated as if nothing like this ever happened before. In addition there is an inability to handle numbers. Any reporter who looks at the numbers on flood defences (available here) should immediately notice the large increases in spending in 2008/9 and 2009/10. Why is that they should ask. That in turn should lead them to the Pitt review, or they can just ask someone who knows about this stuff.

That process does not happen. The journalist doing the interview has been sent off at the first opportunity to a flooded area, and crucially no one has been feeding them background research. As a result any minister that is available for comment will talk about how the money allocated for flood defences has increased, and the interviewer knowing no better will move on. If by chance any journalist is reading this, the killer fact is that spending in 2018/9 is a lot lower as a share of GDP than at the end of the Labour government, when it should have been much higher given the correct predictions in the Pitt review.

What has happened, it seems to me, is that broadcast media has farmed out background research to the press. Which might work, if the press was unbiased and was not battling to stay afloat. This is all part of a process of disconnecting the media from any source of expertise. As the last line of my article says

“If much of the media is bereft of the information that can hold the government to account, then don’t be surprised when people elect governments that ignore experts.”

The result of this media failure is countless flooded homes that might have been kept dry, if the media had done its job in holding the government to account.

If the UK and EU can do a deal is everything now fine?

In case you hadn’t seen it, here is my article that was published in the Guardian yesterday. It was my luck that on the evening of publication, and after it appeared that Johnson had put a hopeless deal to the EU, his talks with Varadkar suddenly sounded positive. But is everything as it seems?

The obvious point is that one set of bilateral talks do not make a deal. Both parties had reason to sound positive. The EU does not want to be blamed for obstructing a deal, and Johnson wants grounds for going into the forthcoming election with the prospect of a deal. Cummings rhetoric is quite consistent with that, as they want to make No Dealers believe that will be what eventually happens and they also want Dealers (not least MPs in his party and cabinet) to think a deal is possible. He also wants to have grounds for boycotting any Public Vote in the unlikely event parliament tries to vote for that before an election.

But let’s suppose there is substance behind what happened yesterday. What would that substance have to be? It is highly likely it avoids any kind of hard border on the island of Ireland, which in turn means a completely different set of trading arrangements in Northern Ireland compared to the rest of the UK. Or in other words, all customs checks shift to between Northern Ireland and the rest of the UK.

I suggested around the time Johnson became PM that this would be an option he might take. The almost universal reaction to my suggestion was that it would not get past parliament, because the DUP and other MPs would vote against. But of course Johnson wants a General Election. He is a Prime Minister with little power at present. So he might hope that if he got a larger majority than May had after 2017, and with the help of Labour leavers, he could get such a deal through.

Speculating about that when we don’t know the details of the deal are pointless. The key issue I want to address is whether such a deal would make my Guardian article look stupid. As it talked about no deal, of course. But in substantive terms, you could write something similar about a Johnson deal that solves the Irish border problem in this way. Obviously concerns about peace in Northern Ireland disappear. Whether Scotland will get independence is also more problematic. But the UK would still have to spend a lot of political time negotiating a free trade deal with the EU, and that would be more difficult than it would have been with May’s deal.

The reason is that currently Johnson’s proposals for a free trade deal abandon regulatory alignment. They want to reduce workers rights and consumer protection and environmental protections, and that will mean a far less extensive trade deal with the EU than under the backstop. That in turn means that the long term economic costs of any deal will still be large, although obviously not so large and we avoid the short term disruption.**

But the core of the article, that this is going to be something imposed on a majority by a minority, still applies. And it remains true that only a few thousand people will benefit for a deal of this kind, and everyone else will lose. So in that sense the core message of the article applies whether Johnson gets a deal or not.

** Postscript (12/10/19) Chris Giles crunches the number here 

Different kinds of fiscal stimulus

Newspaper day. In the Guardian I have a piece that looks at how we should regard any tax cuts that Boris Johnson may announce as part of the forthcoming election. And make no mistake tax cuts are coming (we already know they intend to cut the tax on petrol), because the spending review signalled that the governments rule will change, as Chris Giles discusses in a good article in today’s FT in which I among other economists are quoted. .

In the Guardian piece I argue that tax cuts are a bad idea because in the context of us leaving the EU they will almost certainly produce unsustainable increases in the deficit without much of a compensation in higher output. As I say in the Giles FT article, policies that if unchanged would lead to steady and permanent increases in debt to GDP are not a good idea. That in turn will mean that at some stage either taxes will have to rise or we will be back to austerity.

But why did I also imply that Wednesday’s spending review was to be welcomed? Are not spending increases and tax cuts not two sides of the same fiscal stimulus coin? There is the obvious point that in many areas public spending cuts have gone way too far. But there is a macroeconomic point as well. Spending increases directly raise aggregate demand by the same amount. Things like income tax cuts, particularly if they go to the better off, are largely saved. (A number of around a third is commonly found in empirically studies for the amount actually spent.) So you get less demand stimulus for your money.

According to calculations done in a separate article by the Financial Times, Labour’s likely plans will also raise the ratio of debt to GDP. But if you look beyond the ‘scare’ headline, the reasons are quite different. Labour will still meet its fiscal rule for current spending, but the amount of investment planned could lead to the ‘falling debt to trend GDP’ part of the rule being breached. These calculations need to be taken with a pinch of salt, because they assume the additional investment produces no increase in GDP, and therefore no higher tax take. Even the IFS when they evaluated Labour’s election plans in 2017 allowed additional public investment to boost GDP. Which is just one reason why the FT’s analysis annoyed the large number of economists, including me, who signed this letter published in the FT today.

I didn’t like the FT write up for another reason. It seemed to be designed simply to be one more fiscal scare story. If I had been writing this I would have asked whether, if the policy did in fact break the debt to trend GDP part of the rule because of more public investment, that part of the rule made sense. A company increasing investment would happily increase its debt to sales ratio if it did a lot of investment, as would an individual increase their debt to income ratio when buying a house. Perhaps that part of Labour’s fiscal rule is a hangover from the days when mediamacro thought government borrowing was a bad thing, even when it was additional investment?

That is the key difference between Labour and the Conservative policies. If the debt to GDP ratio rises because of supposedly permanent tax cuts, that leads to steadily increasing debt to GDP and so cannot be sustained. Running public investment at high levels because you are restoring the public capital stock and as part of a Green New Deal may be prolonged but it is not permanent, and temporary increases in debt to GDP to finance investment make sense.

Signing letters

The Guardian today publishes a letter from 79 economists, including yours truly, about George Osborne’s plan to outlaw government budget deficits in normal times. I’ve written two recent posts on this, so I will not go through the issues again here, but I thought I’d say a couple of things about the business of signing letters and whether they are worth the effort.

The first is whether the reader or potential signatory should worry about the details of the text of multi-signatory letters. You might think the letter could be better written, and someone asked to sign it might think they could have put it much better themselves. The person asked to sign might agree strongly with the overall message of the letter, but could have some misgivings about particular sentences. The problem of course is that, because the letter is signed by X number of people, where X is large, having all X making their own attempts at redrafting becomes a nightmare in coordination. So these letters should never be read for the details of the text, but instead for their overall message.

The second is whether there is any point in these multi-signatory letters from economists. Alan Manning makes a number of good points here. When these letters involve issues where there is genuine division among economists, then a letter followed by a counter letter just encourages further jokes about economists never agreeing. (But because there is some news value in getting in first, letters on this type of issue keep coming.) The letter format is also too short for making proper arguments: other forms of media are better in that respect.

That argument does not I believe apply to this particular letter, or to the other which I recently signed on the Greece-Troika negotiations. In both cases there is probably a clear majority view among economists. Multi-signatory letters then have an important information value to both readers and political commentators.

This brings us - inevitably - to perhaps the most famous example in the UK of such a letter, from 364 economists protesting at Margaret Thatcher's 1981 deflationary budget. It is also a good example of not worrying too much about the text, as I’m sure many/most who signed that letter would have found at least one sentence objectionable.

If you have previously heard about this letter it may well have been accompanied by a comment on how the letter is now ‘generally regarded’ as reflecting badly on economists. The reasons for this view are in themselves interesting. Ask anyone on the political right, and they will tell you this is because Margaret Thatcher was correct and the economists were wrong. But you can equally well make the opposite claim. The economic strategy at the time was monetary targeting, and that policy in itself failed dismally: monetary targets were hopelessly missed and the policy framework was abandoned shortly after the letter was written. In terms of overall outcomes, it took two decades before UK unemployment returned to pre-1981 levels.

So why is it ‘generally regarded’ as reflecting badly on economists? Essentially because many supporters of Conservative governments - some economists but also many politicos - have gone out of their way to say so. (I go into more detail in this post.) As we have witnessed recently, the political right tends to be much better than the left at rewriting history for its own purposes. But that in itself is a form of flattery. Why bother to spend time and effort rubbishing a letter from 364 economists unless that letter, and any similar letters that might follow it, had some impact? So maybe letters from economists on issues on which most economists agree are important and can have some small influence.  

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