A new mandate for monetary policy

John McDonnell wants to raise UK investment not by cutting corporation tax but by diverting funds from parts of the financial sector away from property to new investment by UK firms. That is a laudable aim. But giving the Bank of England that task with a 3% productivity target is not the best way to do that. However that is not because I think central banks cannot influence productivity.

The kind of toy model many people work with is that monetary policy is all about stabilising the business cycle, but that stabilisation has no impact on the medium term level of  output and productivity. That is because productivity is determined by the ‘supply side’ of the UK economy. And this toy model worked particularly well for the UK economy, which from the early 1950s until before the GFC seemed to always bounce back to an underlying trend rate of growth for GDP per capita of around two and a quarter per cent.

However over none of that period did we experience a recession where nominal interest rates hit their lower bound and fiscal policy turned from stimulus to austerity before the recovery had begun. In other words in none of these periods did we have a persistent period of deficient demand with growth never exceeding its long term average. I have argued that it is wrong to see the UK productivity puzzle as a period of uniform gloom since the recession, but rather there were periods of growth which were set back by uncertainty following two additional major policy shocks: austerity and the EU referendum.

Yet if you ask UK monetary policymakers whether they think they have done a good job over the last 10 years, they will say (in public at least) that they think they have. They do not say they have failed because of shocks they couldn’t control, which would be a reasonable position, but rather they have done reasonably well at controlling the economy. In the context of the slowest recovery for at least a century, with a consequent permanent hit to output (output is over 15% below previous trends), that degree of public self-satisfaction indicates a major problem. And if you ask them how they can possibly be satisfied they will talk to you about inflation.

This is a clear reason to question the inflation target. Although in toy models controlling inflation should also mean controlling output, the real world is much more confusing. By making the bottom line inflation, we are bound to make policymakers worry too much about inflation relative to output. The clearest case for me was 2011, when the ECB and almost the MPC raised rates when the recovery from recession was only just beginning.

For that reason I have long supported a more US style twin mandate. Yet although the US had a better recovery than the UK or Eurozone, the Fed still seems to be giving inflation much more weight than employment. But you cannot ignore inflation completely. The mandate I propose for monetary policy is this:

To maximise output growth subject to maintaining inflation within 1% of its target by the end of a (rolling) 5 year period.

Another thing we have learnt from the Great Recession is that policy has to change once nominal interest rates hit their lower bound. So I would, following Ben Bernanke, add to this mandate a ‘lower bound adaptation’ where the moment interest rates hit their lower bound the inflation target would be converted into an equivalent path for the price level. That would mean that if inflation undershot its target during the recession, it would have to overshoot it before rates could be lifted above their lower bound. I would also require central banks the moment they think rates will hit the lower bound to say publicly that fiscal stimulus is now required to meet its target.

This is a dual mandate, but one that puts the emphasis on output rather than inflation. [1] Why the 1% tolerance? Because it echos current UK arrangements (when the governor has to write letters) but in practice will raise average inflation. This is a feature rather than a bug: another lesson of the last recession is that there is a strong case for a higher inflation target, but in a situation where the Chancellor sets the target it is very difficult to formally raise the target because many people think higher inflation means lower real wages.

Tasking central banks to maximise output subject to an inflation constraint is certainly better than setting a probably unattainable target for productivity growth when we have no idea what the maximum productivity growth rate is. My suggestion is a dual mandate that puts the emphasis on output and makes clear inflation is a medium term concern, making it easier for central banks to see through temporary shocks to inflation like one-off depreciations. The nature of the target recognises that policy has to adapt when nominal interest rates hit their lower bound. Comments very welcome.

[1] What is the logic of giving inflation zero weight in the short run and total importance in the long run? The answer lies in asking what the costs of inflation are. Modern analysis looks at how when prices are sticky but set at different times, inflation distorts relative prices. But inflation due to changes in flexible prices is costless. Now it is not easy to distinguish between the two types of prices in price indices, but inflationary shocks that impact on flexible prices are likely to be short lived, while those that impact on sticky prices will be more prolonged. It therefore makes sense to ignore temporary changes in inflation (those that die out within five years), but because of the vertical long run Phillips curve have a medium term inflation target.     

Voting Labour isn’t going to turn the UK into Venezuela

but mainstream economists should make sure they are getting a hearing

It is tempting to laugh at the rhetoric of Conservative politicians or journalists when contemplating a possible future Labour government. As John Elledge writes, it isn’t long before Stalin or Trotsky or Venezuela is mentioned. As he notes, this is not a terribly clever tactic, particularly as many of the measures proposed by Labour are (by design) pretty popular. As Stephen Bush points out, the problem for the Conservatives is not that ‘young people’ have not learnt about the evils of communist regimes, but that this group are not impressed by Brexit or their wages and for many buying a house is something their parents generation did.

Yet this kind of hyperbole is not confined to politicians or journalists on the right. When John McDonnell, Labour’s shadow Chancellor, said at their party conference that they were ‘war-gaming’ for eventualities if they gained office like a run on sterling, I thought this showed mild paranoia. I was wrong. After I wrote that sterling was far more likely to rise at the prospect of a Labour government (standard macro: more fiscal, higher rates imply stronger currency), Buttonwood of the Economist wrote that there were at least five reasons why sterling might collapse, most of which involve some form of capital flight.

Although Buttonwood was careful to base analysis on measures that Labour proposed in 2017, I’m sure I was not imagining a subtext about what else could hard left politicians do. You can read much the same from some on the centre or soft left, who have learnt through experience to be wary of the hard left. Nick Cohen knows better than to call Labour’s new mass membership all militant entryists, but instead he says they are innocent (but should know better) lambs flocking towards wolves.

With language like this flying around, it is best to look for solid ground. In parliament Labour is a centre left party led by the hard left, to use popular labels. For that reason it would be impossible for it to pursue a hard left programme, and the leadership knows that. Contrast this with the current governing party: half soft, half hard right, with the latter having the upper hand because of the membership. The Conservative party’s ethos is such that the hard right have imposed a ruinous policy on our country without challenge, which actually did produce a collapse in sterling. Fortunately many Labour MPs have less loyalty and perhaps stronger principles, and would not allow anything similar if they were in power. As a result, I find pandering myths about Venezuela dishonest to be frank. If you want to fret about deselection, I suggest you talk to Nadine Dorries.

As far as City scare stories are concerned, as I indicated earlier and Ben Chu confirms, you will always be able to find those predicting doom. One of the refreshing things about this Labour leadership is that they do not cower defensively at such attacks, but come out fighting. As Corbyn’s video could have added, it was City economists who told us that austerity was necessary because otherwise there would be a flight from UK government debt. They were horribly wrong then, as interest rates on debt fell, and they are likely to be wrong again with new stories about capital flight under Corbyn.

While talk of Venezuela is ludicrous, there is a more interesting question about where the influences on future Labour policy are coming from. To set the scene, there was a recent prank outside the LSE designed to suggest heterodox economists were the Luther to economic mainstream Catholicism, and this was followed by a column from Larry Elliott in the Guardian. Now there are plenty of things to criticise about economics, but these are not them. As Frances Coppola recounts, the ‘economics reformation’ document is embarrassingly bad. If you want to read a short but to the point and well written response, see here.

So, in case you thought otherwise, mainstream economists do not spend their time attacking any form of market intervention, but instead try to design efficient market intervention. As I have argued many times, most mainstream macroeconomists did not endorse austerity, for the simple reason that textbooks and state of the art models suggest it would be a very bad idea. But there are some (not all) heterodox economists who would like you to believe otherwise.

What has this got to do with a future Labour government? Christine Berry presents a comprehensive account of who is shaping future Labour policy. It contains the following paragraph.

“John McDonnell’s Council of Economic Advisors, set up during the first days of the leadership, was a valiant effort to give the party’s economic policy some heavyweight academic backing. But many of its members were not natural Corbyn supporters, and ran alarmed from the public ridicule heaped on the leadership in the early days – resulting in the Council being largely disbanded. Academic input now seems to be ad hoc rather than systematised.”

That is not how it happened. It is true that some of us had to suffer some public ridicule when we joined, but that just reflected badly on those doing the ridiculing. The breakup of the Council was inevitable after the EU referendum. It is hard for any group of serious economists to publicly advise in such a forum any political party that appears to support a Brexit policy that is doing (see Chris Giles here) so much damage and could do much more.

The understandable wish of many heterodox economists to have an influence on Labour policy does mean there is a potential competition for influence. Will Labour policy be based on policies derived from mainstream analysis, or those favoured by some heterodox economists? It would be wrong to exaggerate this competition: most mainstream economists agree with most heterodox economists about austerity, for example. But there are some clear differences. (In some ways you see something similar on the right, where City economists compete with mainstream economists for influence on Conservative party policy, which is one reason Conservative macroeconomic policy can produce major disasters.)

Ann Pettifor has an article about why business would do well under Labour, which invokes some of the points made in an earlier Financial Times piece. Once you discount the scare stories, I agree with Ann that the economy and therefore businesses will do much better under Labour than under the Conservatives. But her article contains an interesting remark which I think tells us something about the current leadership. Ann’s says

“Here I must acknowledge a disagreement with Professor Simon Wren-Lewis, of Oxford University, who advised Labour to adopt a fiscal rule that once again prioritises monetary policy …”

Ann follows the heterodox MMT school that favours using fiscal rather than monetary policy to stabilise output and inflation. Of course both Ann and I were on Labour’s Economic Advisory Council, and so it is obvious that there was a similar discussion in this group.

The fact that McDonnell chose a more conventional but still innovative approach (which happened to be the one I put forward), and has also stressed the importance of central bank independence, shows us two things: he has a distinctly conservative streak, and he wants Labour not only to win but to be successful in economic terms. But while McDonnell may have opted for a mainstream approach on monetary and fiscal policy, there is still plenty to play for in other areas. I am not suggesting that mainstream economists should always win when conflicts occur, but it is important for mainstream economists not to arrive late to these battlefields, or worse still wait for politicians to read their papers.

Mediamacro is alive and well, unfortunately

I didn’t see Andrew Neil’s interview with John McDonnell which seems to have started the media’s obsession with interest on government debt, and how it would increase under Labour. But I did see the Peston interview where he was asked a similar question (see here). McDonnell’s answer was good, but the fact that Peston felt obliged to ask it told me that mediamacro was still alive and well.

But before I come to that, I need to link to the piece I wrote in the New Statesman that tries to explain why the question is a silly one (and what a much better question would be). It wasn’t the first time I had come across the power of this debt interest idea to fool people. I remember I did a debate with Oliver Kamm in Prospect, and the then editor said she thought I was getting the better of the argument but that Kamm’s point about debt interest finally swayed her. I remember thinking what!? How can you be so foolish. That was in my younger days (look at the photo) when I was still learning about mediamacro.

So why did Peston feel he had to follow up on Neil’s question? I think it is pretty simple. When McDonnell did not answer Neil’s question, the reaction of journalists was not to think maybe that was a silly question, but instead here was some weakness that the journalist had found. Journalists love catching politicians out: it means that the interview when it happens gets repeated and repeated and the journalist gets congratulated by their peers. It is just a numerical version of political gaffs. And most of the time it is just as childish.

There may be some point in doing this when there is a real issue involved. If you managed to show, for example, that a politician really didn’t know the difference or relationship between debt and the deficit, that would tell us something meaningful. (I can remember one Chancellor who did need helping through such things.) But that normally requires a knowledge most interviewers, who might talk about paying off the deficit, do not have. (Even fact checking sites can confuse rather than enlighten: in this case here. The BBC's site in the past has made similar errors.) Not being able to remember numbers is a memory test more than testing whether someone is numerically minded. I’m pretty numerically minded, but ask me what the size of UK GDP is on a bad day and I’d get it wrong.

But asking a prospective Chancellor about what the debt interest will be on any borrowing they will do for investment possibly four years ahead is a silly question, as my New Statesman article makes clear. I’m sure Peston knows this, but he nevertheless felt obliged to follow a mediamacro theme. Which is how a lot of journalism works. Attack lines dreamt up by right wing newspapers or journalists become questions of public interest that every journalist feels obliged to ask. Even when they know better, they are not going to upset their colleagues by saying I’m not going to ask that question because it is a nonsense question and instead ask something more intelligent. As a result, the mediocrity that is mediamacro persists.

A Labour run on Sterling?

The news that John McDonnell was looking at a scenario where the election of a Labour government was met with a run on Sterling was all over the news yesterday. The Conservatives, who of course know all about runs on Sterling having created one just a year ago with the Brexit vote, immediately grasped the political gift they had been given.

Paranoia on the left meets prejudice on the right. But what would really happen to Sterling if Labour were to win the next election? Given announced policies, the answer is quite clear: Sterling would appreciate. The main reason is that under Labour there would be a large fiscal expansion: for certain in term of public investment and to a lesser extent with current spending. (I assume by then interest rates will be above their ZLB: if they are not, the fiscal expansion could be even larger.) There would also be a balanced budget fiscal expansion: even if government spending increases are financed by tax increases, this is likely to be expansionary to some extent because some of the tax will come out of savings.

This fiscal expansion, together perhaps with other labour market measures, would put upward pressure on inflation, prompting higher interest rates from the Monetary Policy Committee of the Bank of England. It is the prospect of those higher interest rates that would make Sterling appreciate. How much inflation rather than output would rise depends on how pessimistic you are about the supply side. If the MPC were doing their job properly, that increase in interest rates plus the appreciation would stop inflation rising very much. We will finally get the rebalancing between monetary and fiscal policy that we should have had for the last decade.

If we are also in a transition period for Brexit, with the final destination unclear, then Labour being elected would also lead to an appreciation because Labour are softer on Brexit than the Conservatives.

So where does the run on Sterling idea come from? The idea that all those traders in currency will get together and engineer one because they do not like a Labour government is nonsense. They may not like a Labour government, but they dislike losing money even more. Capital flight? You might see the share price of power or rail companies fall, but that is not going to be enough to move a currency like sterling. Any depreciation in sterling would be the equivalent of pound notes waiting to be picked up in the City and Wall Street: with higher expected interest rates and a likely future appreciation, who wouldn’t buy sterling?

The only way I can see that you could get a run on Sterling is if enough traders in the markets came to believe that Labour was going to abolish BoE independence because it wanted to keep interest rates low. In that case you could get significantly higher inflation under Labour, which would justify a nominal Sterling depreciation.

Which, of course, is why McDonnell committed to keeping Bank of England independence as one of the first things he did. And which is also why he was very foolish to say what he said, because it might lead some to speculate that he might renege on that commitment. Something tells me he is missing his Economic Advisory Council.

The Kerslake Review of the Treasury

This review, published today, was commissioned by John McDonnell but is entirely independent. Although it is ultimately Lord Kerslake’s review, it is the product of a small panel of which I was a member, and also reflects submitted evidence and meetings of invited experts. I can say that in my area, macroeconomic policy, this external evidence was very influential and let me thank again all those involved. This post just focuses on these macroeconomic aspects of this review of the Treasury. [1]

The obvious place to start is to think how the role of the Treasury has changed in the last two decades. In 1997 setting monetary policy was delegated to the Bank of England. In 2010 the forecasting aspects of fiscal policy were delegated to the OBR. To a government obsessed by cutting the size of the state that might suggest that the Treasury did not need to have a large macroeconomic capacity, But if you think about the major macroeconomic disasters if the last decade, that view is completely misguided.

One way of thinking about these disasters is that they reflect a failure to consider potential risks to the economy, and what might be done to both mitigate those risks and respond to them if they occurred. No one was ever going to predict the exact time and date of the financial crisis, but someone in government should have been thinking about what risks a rapidly expanding banking sector might pose. There were not many who warned about the risks, but enough to warrant a risk analysis. As I have said before, I doubt that this could have avoided a crisis - the banking lobby is too strong - but at least the government would have given some thought about what to do if it happened before it happened.

When it came to austerity, everything would have been relatively unproblematic if the economy had grown at the pace at first expected in 2010, because monetary policy would still have had control. (Interest rates would have been above their lower bound.) But someone should have been focusing on what happens if things turned out to be less rosy, and making sure ministers had to address these risks. At the very least that analysis would have pinpointed the need to change fiscal policy the moment that more pessimistic outcome came to pass, but perhaps also thinking about this risk might have injected a note of caution into policy before this happened. In a secret Treasury that might not have stopped a determined politician, but if this risk analysis had been made public?

Who in government should have been doing this risk analysis? The obvious institution is not the central bank, which can be far too tentative in the area of fiscal policy and too biased on financial policy, but the Treasury. The Treasury, to use a phrase suggested at one of our evidence gathering meetings, should be “the country’s risk manager of last resort”. The Treasury is uniquely capable of getting information from all the parts of government, including the Bank, and putting it together within a consistent macroeconomic framework.

But this isn’t the only reason why the Treasury still needs a strong macroeconomic capacity. It sets the rules by which fiscal and monetary policy operate, and the danger of not having this capacity is that the rules get determined by political whim, or don’t change through inertia. And it also needs the capability to undertake large pieces of complex analysis very quickly, as we have again seen over the last two decades.

What do I mean by capacity? Above all people: people who have the ability to do and understand state of the art macro analysis. If you compare the number of macroeconomists at the Treasury and the Bank there is a huge imbalance which is not conducive to good policy making. It is absurd to think that you need suites of models to set interest rates, but virtually nothing to set monetary and fiscal policy rules and analyse the impact of potential risks to the economy.

None of this is guaranteed to stop the Treasury become obsessed with the deficit and ignoring macro analysis, but the stronger the macro team is in the Treasury the less likely this is to happen. One other way that is often suggested of combating this danger, and which we considered, involves splitting off from the Treasury key aspects including macro policy into a new Economics ministry. My own view, which is similar to that expressed in the report, is that such a split just runs the danger of institutionalising the dominant role of balancing the budget in policy making.

There is one final benefit of enhancing the macro capacity of the Treasury, and that would be to provide the potential to increase openness. I take it as given that greater openness would be a good thing, and also being an essential way of utilising existing expertise around the country. It is far from clear why risk anaysis has to be secret. To take just two examples, the Bank makes a concerted attempt to find out what is being done in UK universities that might be useful to it, and it publishes a regular blog where their economists can flag interesting data and analysis. It would be good if the Treasury had the capacity to do something similar.

[1] There is a great deal more in the report, both about macro policy and issues around devolution, working with other departments, the overall goals of policy and much more. I also feel I need to note one area where I disagree with how Bob talked about the report yesterday (on Peston’s show and to the Guardian). While I’m sure it is true that the Treasury has lost trust as a result of its incorrect pre-referendum short term forecast, by highlighting this in the context of this report you inevitably give the impression that it did something unprofessional. But both assessments were signed off by Charlie Bean. and the Treasury were hardly alone in expecting negative short term impacts from Brexit. Worse still, it risks suggesting that their long term analysis is suspect.

Blanchflower on the Economic Advisory Committee

David Blanchflower has an article in today’s Guardian about his experience on Labour’s Economic Advisory Committee (EAC) which was chaired by John McDonnell. I agree with a lot of what he has to say in the article, but not with the picture painted of how the committee was used. He ignores the formation of Labour’s fiscal credibility rule which is an important and tangible consequence of the committee’s advice, and Mariana Mazzucato’s work featured strongly in John’s speeches. (More details here.) By ignoring these things he allows some critics to conclude that we were being used just for our reputations: that is simply false.

He also fails to mention the groups John McDonnell established to look at particular economic policy areas: groups that were quite independent of the EAC and the Labour party. The one on the Treasury chaired by Bob Kerslake (details here) will probably report at the end of this year, and if our discussions are anything to go by it should be of great interest to anyone concerned about this key part of the UK’s machinery of government. David himself was chair of a similar group on monetary policy (of which I, Adam Posen on John McFall were also members), and again preliminary discussions were very positive, so personally I regret David ended that at the same time as he resigned from the EAC.

I have seen so much nonsense written about how we only met twice (largely our choice), and about who attended (the only person not to attend either meeting was Thomas Piketty, and he resigned before David Blanchflower because of the pressure of other commitments). I and other members did not resign from the EAC: see the joint statement from 5 of us here. That statement was critical of Labour’s inability to prevent Brexit: I give my own reasons for making this criticism here. As David notes in the article, I feel strongly that for Jeremy Corbyn to continue after 172 MPs voted no confidence in him as leader would be disastrous for the Labour party. However I also believe John McDonnell should be praised for openly involving academic economists in policymaking, and in being prepared to use their advice.   

What Owen Smith needs to do

The betting odds suggest Jeremy Corbyn is a clear favourite to beat Owen Smith, even if those are based on thin information. But if comments on my last two posts, and personal conversations, are anything to go by Corbyn will be very hard to beat. People are always reluctant to hear that their preferred strategy is not working. After all it happened to Labour MPs when they believed they had to triangulate to the right to win elections, even after the 2015 defeat. Now it is happening to Labour party members who still believe they can create a mass social democratic party without the support of Labour MPs. Just as hope will not win out against reality for Labour under Corbyn after the no confidence vote, nor will it do so for Owen Smith’s campaign if he does not address the concerns of Labour members. [1]

The first thing Owen Smith can do to change this is to acknowledge Corbyn’s greatest achievement: building an enthusiastic activist base for the party. This achievement was only possible because of Labour’s previous failure to do so. To read some you would think that Corbyn’s support is largely made up of ex Trots or SWP members, but this is nonsense. It is similar to the support that the socialist Bernie Sanders received, and the rise of new left movements elsewhere. It is the activist base that Labour desperately needs to help counteract the influence of the media.

One very real reason why this base does not want to let Corbyn go is their fear that without him they will lose all influence. Corbyn’s nomination in 2015 was an act of generosity by some MPs, and members fear with justification that this will not be repeated. As a result, they believe any prospective candidate from the left will never be on the ballot. When I wrote earlier that the left within Labour would be in a better position after a poor general election loss in 2020 if that loss occurred under Smith rather than Corbyn, this point was quite justifiably made. Owen Smith could counter this fear by pledging to lower the number of MPs required to nominate a candidate for leader, or by some equivalent means to ensure that members can always vote for a candidate from the left.

Many of those opposed to Corbyn will be horrified at this suggestion, which is precisely why it would be a strong move for Smith to make. My impression is that most Corbyn supporters regard all the 172 MPs as essentially tainted by the antics of the original anti-Corbynistas. In that sense, my warning that the tactics of this group of overtly anti-Corbyn MPs would completely backfire has proved correct. Many members also see all those MPs as deeply sold on New Labour triangulation, and are reluctant to believe that only a year after the 2015 defeat and Corbyn’s victory, and because of recent events, that election strategy has become history. Smith should disown this election strategy explicitly, but by making it easier for a Corbyn successor to become leader again Smith will effectively be saying to members that they can always be in a position to prevent any future backsliding. If Smith wants Labour members to trust him, he has to show that he also trusts them in the future.

The other area where Smith needs to clarify his views is on immigration. At the moment he seems to be living in the same land as some leading Brexit campaigners: saying we need to stay in the EU single market but also that immigration in some areas is too high (although he has also condemned Conservative type controls). There is a real debate on whether Labour needs to advocate controls on unskilled migration to preserve its working class vote (see my short dialog with Martin Wolf here). As I suspect most Labour party members care a lot more about staying in the single market than they do about controlling immigration, it is important for Smith to signal where his priorities lie.

Smith has already outlined a series of measures on economic policy. There is a lot to discuss and a lot to like here, and I suspect it is not very different from what policy might have been under a Corbyn leadership. Which suggests an obvious move, which is for him to say that he would offer John McDonnell to continue as Shadow Chancellor. (See his newsnight comments on any offer to Corbyn.) If that position has already been promised to Angela Eagle in exchange for her stepping aside, then some equivalent offer should be made.

There is a common theme to the first and last points. To defeat the Conservatives, Labour needs to be a broad church. It has to have a strong, effective and largely united set of MPs, but also a vigorous activist base. (Labour membership rose substantially around 1997.) It needs to develop policies that can appeal to both left and right in the party, which has to mean both left and right being involved in policymaking. Smith needs to convince party members that he believes in that and can implement that to have chance of winning in September.

[1] Just to be clear, I think Labour members should vote for Smith whether he takes up these suggestions or not, because under Corbyn after the no confidence vote Labour are heading for at best a disastrous defeat in 2020 and at worst a split party.

Avoiding political discourse

When PoliticsHome interviewed me about what the Blanchflower review of monetary policy might come up with (which will not report for some time), I couldn’t help but end with a plea.

“My biggest fear is that some people may try and put their political spin on anything we recommend, even when those recommendations come from an analysis of the technical academic literature. When I accepted an invitation to be on Labour's Economic Advisory Council, one or two people did suggest that this would damage my reputation as an economist. Given that being a member placed no restrictions on what I could do or say in public, or any obligation to support party policy, I thought it was an extraordinary accusation to make. Can you imagine a medic being told that they had damaged their reputation by advising policy makers about medical research?”

I used the example of medical research for reasons outlined here, and because I like comparing economists to medics.

As the economist Paul Romer has noted (see also here), political discourse is not like scientific discourse, and it is a problem when academics sometimes adopt a political way of thinking in their day job. In political discourse it is critical whose side you are on. If you are on one side anything that favours or helps the other side is presumed wrong. So when I agreed to be on Labour's Economic Advisory Council (EAC), many of those that were opposed to Corbyn’s leadership naturally assumed that I must be a Corbyn supporter. When I said that if George Osborne set up an equivalent of the EAC and invited me I would agree, and that I had indeed given advice to his Treasury and his advisors, the accusations changed from being the enemy to aiding and abetting the enemy. [1]

We were aiding the enemy because I and other EAC members are ‘providing legitimacy’ to the new leadership: we are being used for our reputations. And sure enough, here is John McDonnell doing exactly that in a recent speech:

“We’ve enshrined these commitments in our Fiscal Credibility Rule, drawn up with help from the world-leading economists on our Economic Advisory Council.”

Except that is exactly what happened: I gave a paper at the first EAC on what I thought the fiscal rule should be, it was discussed there, McDonnell’s team then developed it internally, discussed their version of it with Labour’s shadow cabinet and the rule was made public.

Labour’s new fiscal rule, as far as I know, is the first fiscal rule that sensibly responds to the possibility that monetary policy can run out of reliable ammunition (QE is much less reliable than fiscal policy), and I hope that sets an example that others will follow. [2] I also think politicians should get credit for listening to economists and adopting sensible rules or creating useful institutions. That is exactly what Gordon Brown did in 1997/8, and what George Osborne did in 2010 in establishing the OBR.

In my view the EAC is a useful innovation in economic policy making, because the link between academic economics and policy has become weaker in recent years for various reasons. The EAC is unusual in part because it makes the politician who set it up vulnerable. Any member of the EAC can, if they wish, publicly criticise Labour policy and get additional media coverage as a result of EAC membership. And academics being ideas people rather than political people might be particularly prone to do that. That is a level of vulnerability that many politicians would avoid. (See this for example.) That is one reason why it is misguided to suggest that we should have given our advice in private rather than through a public body like the EAC.

Some who are enmeshed in political discourse say that policies are two a penny and can be put in place in an instant: it is only leadership and winning that matters. I suspect much the same is true for many (not all) political commentators, who often see policies as simply weapons to attract voters. As Gaby Hinsliff remarks, many political commentators have a bias to those they see as winners. But I don’t want a world where academics only give policy advice to politicians who they support or who they think will win. It politicises economics, and that can damage the credibility of the subject.

Because academic economists, or academics of any kind, give advice on their policy area to politicians should never have to mean that those academics support those politicians. People enmeshed in political discourse find it hard to understand that, but I refuse to accommodate them. My job is economic policy, and I while I will do what I can to try and get politicians to adopt policies based on sound economics, those means do not include adopting a political discourse.

[1] For the record, no one in the Labour Party from 2010 onwards asked me for my advice on any occasion. This was despite (or maybe because of) everything that I wrote opposing George Osborne’s austerity policies and defending the Labour government's fiscal policy on my blog (which started at the end of 2011). Had they done so, I would have gladly given it.

[2] Those who might be tempted to see the zero lower bound knockout as just a 'loophole', you just betray your mediamacro mindset. Those tempted to say anyone on the left would have adopted this type of rule, go read some MMT. 

Some thoughts on Paul Mason’s McDonnell road show talk

John McDonnell has got quite a collection of talent to give talks on economics around the country, and the latest is Paul Mason. His talk is wide ranging and certainly not academic in tone, as befits the occasion, and I agree with the broad thrust of it, although not all the details. Here are a few thoughts.

The impending second crisis.

There seems to be a general presumption in certain circles that we are heading for another crash. (Perhaps I could call it ‘the end of capitalism is nigh syndrome’.) This is always a possibility (of course), but I do not think it is a probability. In the UK, do not be fooled by the referendum blip (or pause). I think it is quite likely that Prime Minister Osborne will by 2020 be presiding over strong growth, as everything that was put on hold before the referendum comes on stream. I also think we may see rapid Eurozone growth before then.

On a related theme, there is also a widely held view that after the referendum the Conservative party will fall apart - it is the Corn Laws all over again. I would put that probability much smaller than the chance we might vote to Leave, or that Boris gets to be our next PM.

Fiscal rule

I’m glad he likes Labour's new fiscal rule. He writes: “There’s a school of thought among Labour supporters, and some academics, that the deficit is irrelevant, that “taxing the rich” solves all your problems. It does not.”

‘I did not know you could do that’

His reference to the Macdonald government coming off the gold standard is certainly apposite. Too often the centre left gets trapped by what it sees as unbreakable economic or political convention, only to see the other side break it (think minimum wage).

Monetary policy

What is said in this central section sounds radical, but I think it is meant to be read in the context of the impending next recession that I talked about earlier. What I think he is worried about is that, in that context, any fiscal action would need monetary support, and with the current regime it might not get it. In other words the economy tanks, the next Labour government wants to stimulate but inflation stays close to 2%, and the Bank of England does not cut rates to allow the fiscal rule's knock out to apply. For this reason he supports the proposal, which has a number of notable advocates, that the inflation target be raised to 4%.

I would agree this could be an issue: what economists called the ‘divine coincidence’ (that inflation would always provide the appropriate signals) just does not seem to work very well any more. Whether raising the inflation target to 4% is the best way of dealing with the problem, as opposed to for example an intermediate NGDP target, I’m less sure about but I’m open to persuasion. I agree with Paul that this is a problem involving the central bank's mandate, rather than its independence.

He also supports Corbyn’s original Peoples QE proposal. He cites me as opposing it, but in fact I did not oppose the idea as an alternative to the QE that the Bank would want to do otherwise. What I thought was wrong with Corbyn’s QE was that it appeared either to negate central bank independence, or make a National Investment Bank conditional on the Bank wanting to do QE. In the past I have talked (here, or via Tim Harford here) about how governments and the central bank could cooperate to do money financed fiscal stimulus. In other words Corbyn's QE is fine as an alternative to conventional QE in the context of recession fighting, but not as a general way to finance an investment bank.

I suspect he is also just a little bit worried that the bond vigilantes might finally arrive. I think there is no way that will happen, but we have some history of a central bank governor who worried that it might and gave the wrong advice as a result. If that happened again, we would want monetary policy makers to offer monetary finance of any fiscal stimulus (in exchange for a government commitment to always recapitalise the central bank on request), rather than urge fiscal constraint. Perhaps one way to do that would be to make the central bank’s ability to do unconventional monetary policy conditional on that money finance offer being made.    

Is evidence based policy left wing?

The answer in principle is of course not. In practice, not so clear. This is something I talked about back in October 2013, and there are no signs that things are getting better. Alex Marsh makes the same point in the context of the latest budget. This antagonism to ‘unhelpful’ evidence is out there in plain sight for all to see in the UK government’s current attempt to deny academics in receipt of public funding the ability to talk about the policy implications of their work. I talked about this in terms of the misuse of the term ‘public money’ a few weeks ago, but it is also a pretty direct attempt to suppress unhelpful advice. (Note that ministers have the power under this proposed legislation to revoke this ban in individual cases, presumably when evidence is ‘helpful’ - to them.)

Of course we are not talking about a hostility to evidence based policy by everyone on the right on all occasions. In a THE article by Ben Goldacre, where he also highlights the dangers of the government’s proposed legislation, he details the extent to which he is talking to ministers about evidence based policy. But that interest does not seem to extend to big macro decisions. I was reminded in reading this about what I regard as a triumph of evidence based policy making in my own area: the UK Treasury analysis of Euro entry in 2003. (Disclaimer: my little contribution is the fourth one down in the picture of the reports.) Why didn’t this government do something similar for both the Scottish referendum and the EU referendum?

Everytime I mention the 2003 exercise someone responds that it was just a smokescreen for a power play between Brown and Blair. I think this is an overly cynical view, a view that evidence never changes anyone’s mind. Ramsden’s own view is that the civil service, using the evidence, “ultimately persuaded both the Chancellor and in particular the Prime Minister that it wasn't right to join." It was also the right decision. With both recent referendums we have seen proponents of change putting out documents suggesting that change will not be economically damaging, when most evidence shows pretty clearly that it will be. With the EU referendum in particular, would it not have been better if the government had asked the Treasury to do a similar exercise to 2003, using outside experts where appropriate to provide or validate the technical analysis?

Ben Goldacre’s piece reminded me of my own recent place on John McDonnell’s Economic Advisory Council (EAC). From Ben’s tweets I knew that he was not the greatest fan of this government, and in particular their current treatment of junior doctors, so I asked him whether he had received any negative comments from doctors or others about him giving advice to the government. I was not surprised to hear he had not. Who could object to him taking the opportunity to argue for better use of data and trials in medicine and elsewhere with people who just might do something about it?

It is a shame that some people did not take the same view when I agreed to be on the EAC. I would lose credibility as a macroeconomist, I was told. When McDonnell did his U-turn about supporting the fiscal charter, some suggested this reflected badly on me, even though he had turned in the direction I thought was correct! One charge in particular was levelled at the time. We were being used to make the leadership look respectable, but our advice would in practice be ignored. A couple of weeks ago Labour adopted a fiscal rule which is based on my own work with Jonathan Portes, and in particular by a presentation I made to the group. Mariana Mazzucato’s own work has also featured strongly in Labour party speeches, with good reason.

At the end of the day, policy makers need to look at evidence. If they do not we need strong mechanisms that allow them to be confronted by this evidence. Policy makers that make space for evidence and take decisions based on it need to be congratulated for this, rather than being told their efforts were just a smokescreen. They should be congratulated because letting evidence in often involves a risk: not just to the policy maker’s priors or preferences but also for scrutiny of past actions. Equally we should regard policymakers who knowingly ignore evidence with great suspicion, and those that try to deliberately keep evidence out of the public domain should be condemned.

Time to rewrite a bit of oral history

I have written at great length about the myth that the Labour government created the need for austerity, or as George Osborne likes to put it, how he has had to clear up the mess that Labour created. Here he is again, in an exchange with Yvette Cooper yesterday. And I long for the day that after he, or any other Conservative, repeats this line, someone has the courage to reply: “that is total bollocks”. This bit of oral [1] history has survived for too long.

I will not go again through all the details (for that see these two posts), because a simple picture tells you all you need to know. Here is the UK government deficit, as a percentage of GDP, since 1970.

The deficit in the five years before the global financial crisis was around the average over this whole period. It shoots up in 2008/9 and 2009/10 for one simple reason: the UK, like most other countries, experienced the largest recession since WWII. Osborne has been clearing up the mess left by a major recession, which left UK GDP around 15% below its pre-recession trend. And the real irony is that he has done nothing to fix that very real problem, but instead obsesses about one of its symptoms.

Yet as long as this myth continues to go unchallenged, Osborne can portray Labour as unfit to run the national finances. As long as it goes unchallenged, a large section of voters will continue to believe that austerity was Labour’s fault. I think most people now agree that Labour made a huge tactical mistake when they failed to combat this narrative five years ago. But as this little exchange from yesterday shows, the damage to Labour the myth has done is not going to go away because the Conservatives will not stop repeating the myth.

I therefore have a suggestion. John McDonnell should send a copy of this chart to every Labour MP and tell them to always keep a copy with them. The next time the ‘clearing up the mess they left’ line is repeated, they should respond not by changing the subject or looking sheepish. They should produce the chart and say that it is just not true. The deficit went up because of the recession following a global financial crisis, and this chart proves it. [2]

[1] I know I'm abusing the meaning of 'oral history' here, but I do so because the written history is very different. The few scholarly papers on fiscal policy under the Labour government are consistent with the data and facts.

[2] I am also happy to suggest simple knock downs to possible responses. For example:

C: The recession was caused by inadequate financial regulation during Labour’s watch.

L: But you were constantly arguing for less regulation at the time.

C: IMF/OECD data show huge cyclically adjusted deficits in the pre-recession years

L: Extremely dubious (the OBR who use real data to cyclically adjust do not have this, and few signs of a huge boom at the time), and pure hindsight (both groups suggested otherwise at the time).

C: Everyone knows Gordon Brown bent the rules and missed his targets

L:  George Osborne has missed 3 of his own targets. Of course policy was not perfect under Labour, but that does not change the fact that the deficit more than tripled in size between 2007 and 2009, and that was all down to the recession.

C: Labour did nothing to tackle the deficit in their last two years in office, when George Osborne was saying they should.
L: You are right, and we make no apology for it. In 2009 the UK, along with the US, Germany and China, undertook a fiscal stimulus, which George Osborne argued against. Every serious economist agrees that helped prevent the recession being even worse than it was. Which means if Osborne had been Chancellor in 2009, UK unemployment would have risen by more and real wages would have fallen even more.