Should we demand ‘fully costed’ programmes?

Chris Dillow says we should not, and indeed that journalists who constantly ask ‘where is the money coming from’ are pandering to the idea that the height of economic competence for any government is to balance the books. I think his argument makes some good points, but taken at face value it is untenable.

To see why it is untenable, imagine a political party that promised to increase public spending, cut taxes, cut back on borrowing and let the central bank control inflation. Should journalists simply let that pass, as if the government budget constraint no longer existed?

You could respond by saying that a government that promised the earth would obviously not be credible. The problem with that argument is that a majority of the British people recently voted for a plan that would damage trade with our largest trading partner and most of that majority still believed they would be no worse off as a result. It is part of a journalist’s job to remind the public that basic trade-offs and constraints exist.

But I think Chris is right about individual policy measures. It makes little sense to require that each item of addition spending is matched to a measure to raise additional revenue, because this is not how fiscal policy actually works in any country. Whether all taxes should be tied to particular items of spending (hypothecation) is an interesting issue well beyond the scope of this post. Given this is not how current fiscal systems work, journalists and politicians should not encourage a belief that it is.

But if Chris is right about individual policy measures, when do we get the discussion of the overall fiscal picture that I argue is necessary? The answer is a simple demarcation. If an individual spending minister or shadow minister is proposing a particular measure, don’t ask them how it will be paid for. Instead ask them whether that measure makes sense on its own merits, and why doing something else within that minister’s remit would not be more preferable. For example ask an education minister whether it wouldn’t be better to avoid coming cuts to school budgets rather than spending money on grammar schools or cutting tuition fees.

On the other hand, if the actual or potential Chancellor is being questioned, it makes sense to ask whether the programme as a whole would increase or decrease borrowing. Chris is right that all a Chancellor can do is plan for a particular level of borrowing, but that alone is insufficient grounds for not asking about their plans. Instead what it suggests is a good line of questioning for journalists: if the deficit unexpectedly increases/decreases what would you do? With any luck that sort of discussion could involve some macroeconomics that went beyond bookkeeping.

It is here that we can judge macroeconomic competency. In the current context, for example, any politician that fails to note that we are in a liquidity trap (interest rates are close to their floor and the central bank is increasing the extent of its unconventional monetary policy) and that therefore some temporary borrowing on current account would be a good thing is either not competent or is for some other reason still attached to austerity. Any politician that says we must target the overall deficit rather than the current deficit and thereby hold back public investment despite real interest rates being approximately zero is not competent.

A really intelligent way of helping the electorate judge these issues during elections is to enable the OBR to cost the programmes of the main political parties, as the Netherland’s fiscal council does. All it would need is a modest increase in resources for the OBR, which would be a small price to pay to improve the level of public debate. Ed Balls asked for that in 2015, but Osborne refused. It was typically short sighted, because at the same time he could have given them the remit to cost the implications of leaving the EU. That would have allowed the OBR to tell us that Brexit would cost the government around £15 billion a year (Table B1) before rather than after the vote. If the assessment of the economic costs of Brexit had come from the independent OBR rather than the Treasury, that alone might have been enough to change the result.

Avoiding Fiscal Fudge

There has been some recent disquiet in the UK about politicians before the election failing to offer voters a clear account of how they would achieve their fiscal plans. The Financial Times has taken the lead, but others have concurred. A point I have stressed is that each party’s aggregate fiscal plans are quite different, even though Labour in particular seems to want to hide this fact. But the complaint I want to focus on in this post is about something different - it is about failing to make it clear how plans will be achieved in terms of detailed policy changes.

While I think journalists and bloggers are right to complain, I think it is even more productive to suggest what can be done about it. Politicians do what they think is most likely to get them votes. In a time of austerity, they have calculated that any bonus they might get by being transparent will be more than offset by votes they will lose from coming clean on specific cuts or tax increases. This is hardly a unique UK phenomenon - the phrase ‘magic asterisk’ comes from the US, and Paul Ryan managed to fool quite a few ‘serious people’ by deploying it before the last US election. If the factors that enter this calculation do not change, neither will the behaviour of politicians.

In 1996 I wrote a paper with the title of this post. It was the first time I proposed setting up an independent fiscal institution, or fiscal council, like the OBR. One of the few examples of such a body at the time came from the Netherlands. Those who complain about lack of transparency on fiscal matters before elections should really examine what happens today in that country. There the Dutch equivalent to the OBR offers to cost the fiscal plans of any opposition party before an election. They take up this offer, because failing to do so would be seen as a clear sign that plans were not credible. The detail that the Bureau for Economic Policy Analysis (CPB) go into is extraordinary, as I noted at the beginning of this post: here (pdf) is an example.

So in the Netherlands we have a situation where the fiscal plans of each party before an election are transparent, detailed and independently costed. There is no fiscal fudge. To use a bit of economics jargon, it is a political economy equilibrium which each individual party finds it too costly to depart from. In most other countries we have an alternative equilibrium that involves plenty of fiscal fudge, from which it would be too costly for any individual party to try and break. Is there something peculiar about the Netherlands that means their set-up could not work elsewhere? I have heard excuses along those lines, but none which I find convincing.

So how might we get from where we are now to something like the Dutch example? Well it so happens that in the UK we have a unique opportunity if Labour forms the next government. Ed Balls recently asked the OBR to cost their post election plans, but this would involve an extension of the OBR’s current mandate, and George Osborne did not want that to happen. Of course political advantage was behind both the request and the refusal. However, given the request, if Labour forms all or part of the next government, it will be very difficult for them to reject extending the OBR’s remit in this way. Those who complain about lack of fiscal transparency should help make sure this happens. Of course the details of how the OBR might do this need to be worked out, and it may not be appropriate to do it exactly as they do in the Netherlands. But the UK also has another piece of good fortune on this front: the previous director of the Dutch fiscal council, Coen Teulings, is currently a member of the economics department at Cambridge, so is easily on hand to give advice. We should not miss this opportunity to end fiscal fudge.  

Taylor rules: the ZLB and Euro Diversity

John Taylor originally suggested his rule as both a good guide to what central banks actually do and also one that “captures the spirit of the recent research”. It has been used ever since as a yardstick by which to measure monetary policy. However there are well understood reasons why it is likely to be a poor yardstick in a severe recession.

First some theory. In a world of certainty, when inflation expectations are equal to the inflation target, the optimal interest rate to set is one that delivers what is called the ‘natural’ real interest rate. You can describe this as the real interest rate that would achieve a level of demand and output which eliminated the output gap, and put unemployment at its natural rate. At that point, there should be no pressure from the domestic economy for inflation to rise or fall.

In this context it becomes obvious why the output gap (or deviation of unemployment from the natural rate) appears in the Taylor rule. Yet in reality our estimates of the output gap are poor, so it also makes sense to include the difference between inflation and its target in the rule. Finally the rule also contains a constant, which is an estimate of what the natural interest rate would be if inflation was at target and there was a zero output gap. As to the coefficients on inflation and output, you want those to be modest to avoid overreacting to false signals and to allow for lags between interest rate changes and their impact on inflation.

The best way to think about the Taylor rule is as a simple ‘horse for all courses’. It is designed to be a robust rule for all situations: booms as well as busts, small as well as large deviations from target, and where we have no additional reliable information.

In the current recession we know a number of additional things. First, the natural real rate of interest is likely to be a lot lower than the constant in any Taylor rule. There are a number of reasons for this. In the short term a balance sheet recession means that consumers want to save much more than they would normally, so the natural rate has to be unusually low to offset the impact of this on demand. In the longer term we have the issue of secular stagnation, which is one reason why policymakers in both the UK and US say that even when the economy recovers interest rates are likely to be lower than they have been in the past. (Austerity is another.)

There are other factors as well. At low levels of inflation, inflation appears to be less responsive to excess demand. On its own this means that the coefficients on excess inflation in a horse for all courses Taylor rule will be too low when inflation is below 2%. (The possibility of hitting the Zero Lower Bound can also imply the same thing.) If forecasts indicate that inflation will remain below target for some time, that can also suggest we can afford to react to inflation being too low by more than the Taylor rule would suggest.

If you want a practical illustration of all this, consider this post from Zsolt Darvas at Breugel. It uses a typical Taylor rule for the Euro area, and finds that interest rates set by the ECB have been below the level implied by that rule every year since about 2001! That is a clear illustration of the problem of assuming a constant long run natural real interest rate, in this case beginning with Bernanke’s savings glut. Exactly the same points arise in trying to assess whether US monetary policy was too expansionary in the mid-00s. This same rule also implies that the ECB raised rates by too little in 2010/11, which is clearly silly in the light of what subsequently happened. (Again we had more information, in this case about austerity.)

However the Breugel post is not really about how appropriate the ECB’s monetary policy is for the Eurozone as a whole. Instead it focuses on what the rule tells us monetary policy might have been in each individual Eurozone economy, if they had retained their own currency and had floated. Or to put it another way, it tells you for which countries the ECB’s policy is too tight, and for which it is too easy. Used in this way, the analysis is a handy way of combining information on inflation and unemployment diversity across the Eurozone.

Where is the ECB’s policy too tight? There are the obvious countries: Spain, Portugal, Italy and especially Greece. But there is another, which is the Netherlands. There is no mystery here: CPI inflation is currently (May) 0.8%, the harmonised rate is 0.1%, and unemployment has been over 7% this year, compared to an average of below 4% from 2000 to 2007. As the Netherlands does not have an independent monetary policy, it desperately needs a countercyclical fiscal policy, yet instead it is locked into the austerity trap imposed by the Eurozone’s fiscal rules. All of this was horribly predictable, which is why I wrote these posts: May12, Sept12, June13, Dec13.

These fiscal rules are not going to be abolished anytime soon, even though their intellectual rationale has disappeared. The best that we can hope for is that their impact can be softened or partially circumvented by allowing additional public investment spending: see Reza Moghadam from the IMF here, or Wolfgang Münchau here and here, Guntram Wolff here, or Mariana Mazzucato here. But if in the future anyone wants to see the clearest example of where these rules led to large and completely unnecessary social costs, just look at the Netherlands.

    

Here we go again

1) Government embarks on austerity, to try and maintain the confidence of the bond markets. We must preserve the AAA rating for our government’s debt, says the finance minister.

2) Austerity reduces demand, helping create flat or negative growth.

3) As a result, deficit targets keep being missed. Additional austerity is imposed, and growth declines again.

3) Country loses its AAA rating, and the credit rating agency gives concerns about poor growth as an important factor for the downgrade.

4) This confirms our fears, says the finance minister. We must redouble our efforts to reduce our debt.

This will sound familiar to UK ears, but it is also what has just happened in the Netherlands.

I do not like using decisions by the credit rating agencies as an excuse to write posts, because when it comes to the major economies they have no particular expertise. (Typically markets show no reaction to the ‘news’ that a country like the Netherlands has been downgraded.) This useful post by Bas Jacobs (HT MT) argues that the S&P analysis for the Netherlands does not deserve any serious attention. On credit rating agencies generally, see Jonathan Portes. The media report what these agencies say because downgrades are convenient hooks to hang existing stories on, and it is a shame and a continuing source of puzzlement that officials and politicians bother with them.

So why am I writing this post? Because it seems important to record the progress of another country beside my own that is going down a depressingly predictable path. When I last wrote about the Netherlands, some positive growth was expected for 2014, but the OECD’s latest forecast shows GDP flat next year. These forecasts also have consumer price inflation below 2% in 2014 and below 1% in 2015. The output gap is currently over (negative) 4%, and is expected to reach -5.5% in 2015. Unemployment, which was only 4.3% in 2011, is expected to rise to 8.1% in 2015.

Like the UK, the Netherlands is a country with no problem selling its debt. It has no macroeconomic need to achieve an expected (by the OECD) underlying general government surplus by 2015. As Jacob’s notes, there is no question of an unsustainable long run fiscal position. The only major lever the government has to do something about lack of growth and rising unemployment is fiscal policy, yet it is using this lever in completely the wrong (pro-cyclical) direction, making everything worse.

A crazy policy. Yet it is followed by both centre-left and centre-right parties, even though this means these parties are haemorrhaging support to those further left and right. It is a policy supported by the central bank, which was one of those voting against the recent cut in ECB interest rates. The CPB, the country’s fiscal council that used to be a voice of sanity on fiscal matters, appears silent on the issue. Everyone can blame the Eurozone’s Fiscal Compact of course, but among the political centre they do not.

Coen Teulings, the former head of the CPB, speculated about why politicians seem so attached to austerity, when it is so clearly doing their popularity such harm. They seem to be stuck in an equilibrium (the ‘austerity trap’) where they fear that if any of them broke free, by declaring austerity harmful, they would lose out because other parties in the centre would declare them irresponsible, or ‘not serious’ to use Paul Krugman’s language. Yet they would all be better off, in terms of not losing support to the further left or right, if they could simultaneously break free of the austerity trap. Within any single Eurozone country the ‘irresponsibility’ charge is reinforced by the Eurozone’s Fiscal Compact, which in turn keeps the Eurozone as a whole in the austerity trap.   

The Centre Cannot Hold?

Everyone knows about the return of extremist politics as a result of austerity in Greece. (Paul Mason’s reporting has been particularly strong over the last few years.) The link between economic depression and far right extremism in the 1930s is also well documented. Yet I suspect there is a tendency to assume that this kind of thing only happens in ‘immature’ democracies.  This assumption is wrong, as both the Netherlands and the UK currently show.

The Netherlands has been run by a parliament since at least 1848. Coalitions are the norm rather than the exception, and there is a general desire to achieve consensus on important political issues. Before the formation of the Euro, the extreme right in the Netherlands could be described (pdf) as marginal, which was not the case in France for example. Yet recent opinion polls suggest that if elections were held now, the far right Freedom Party would become the largest party in parliament. The left wing Socialists have also been taking support away from the centre-left Labour Party. What the two extreme parties have in common compared to the mainstream is opposition to further fiscal austerity.

So far, there has been a depressing consensus among the more centrist political parties in the Netherlands that they need to follow the Eurozone’s fiscal rules.  The economy is in recession: GDP fell by 1% in 2012, and will probably fall by a similar amount this year.  Unemployment is rising: the Chart below shows OECD forecasts and also OECD estimates of the output gap. Of course this has increased the budget deficit, and so we have had a series of austerity measures in an attempt to keep the deficit at 3% of GDP to stay within the Eurozone’s fiscal rules. [1] When the Freedom Party, which was part of a right wing coalition, refused to support these cuts in 2012, they were passed by a coalition of the centre, egged on by the European Commission.

OECD Economic Outlook Estimates for the Netherlands

Of course the Netherlands, unlike Greece or Ireland or Portugal, has no problem funding its budget deficits, so here austerity is very much a political choice. Recent polls suggest the public has had enough, and that as a result support for the Euro itself is suffering. The union movement has been active in its opposition, but more recently prominent business organisations have also begun to question austerity, although predictably their opposition has focused on tax increases rather than cuts to welfare.  Coen Teulings, who departed as head of the highly respected CPB in April, was vocal in his opposition to recent cuts, but the central bank has been much more supportive of austerity.

The UK has also seen the emergence of a politically successful far-right party: UKIP. This is also unusual from a historical perspective: since Oswald Mosley the UK has a proud tradition of resisting parties of the far right. UKIP’s popularity is not normally linked directly to austerity, but instead to widespread hostility to both immigration and the European Union. As a result, the Conservative Party has taken economically damaging positions on both issues in an attempt to reduce UKIP’s appeal. Chris Bertram at Crooked Timber recounts in detail the sorry state of the UK ‘debate’ on immigration. Yet the link between concerns about immigration on the one hand and unemployment and low wages on the other is fairly obvious. Despite all the valiant attempts by Jonathan Portes and others to focus on the evidence, this is one of those cases where the combination of tabloid media hype, partisan political advantage and ‘common sense’ normally wins, and as a result the UK Labour Party seems to spend much of its time trying to ape the Conservatives.

Why has support for the far-right grown in the UK and the Netherlands, while in France for example the far-right did not make a breakthrough in 2012? No doubt a complete answer would be quite complex. However it is worth noting that the UK and the Netherlands have both experienced sharp falls in real wages in the recent past. The OECD expects real compensation per employee to have declined by a total of about 4.5% in the three years 2011-13 in the Netherlands, and by about 5% in the UK. The decline in the Euro area as a whole has been much smaller, at less than 2%. In France real wages have increased a little in all three years. Figures recently calculated by the House of Commons library show a similar picture, with only Greece and Portugal doing as badly as the UK and Netherlands since mid-2010. [2]

In both the UK and the Netherlands we have recession and fiscal austerity, where the recession has been associated with marked falls in real wages as well as increases in unemployment. In both cases I would argue that there has been no effective opposition to fiscal austerity from the political centre, which helps encourage support for the political extremes. But that is probably as far as the similarity goes, because the position of the centre-left Labour Party in the two countries is very different.

In the UK the Labour Party is in opposition. It seems their general tactic on issues like austerity or immigration is not to question the underlying assumptions on which government policy is based. Perhaps the idea is to avoid being branded as irresponsible (austerity) or out of touch (immigration), while hoping to retain the support of those who do strongly oppose government policy. This position has so far been tenable partly because there is no strong party to the left of Labour. We may have to wait until 2015 to see if this strategy is successful.

The position of the Labour Party in the Netherlands is more immediately problematic. It is now part of the coalition enacting cuts.  The Socialist Party, which is to the left of Labour and which does not support austerity, has moved ahead of Labour in the polls. In April there was a ‘social accord’, where the unions and business groups signed up to the budget deal proposed by the government. Further cuts are now required beyond those agreed in April to meet the fiscal rules, and the unions (and perhaps business leaders) are now actively campaigning against austerity.  Yet it will be hard for the centre-right to ask Brussels for a reprieve, as their leader and Prime Minister, Mark Rutte, has followed Germany in taking a hard line on the 3% deficit limit and the Commission’s enforcement of it.  The reasons for Labour to back additional austerity are much less clear.

So in the Netherlands and elsewhere in Europe, on the issue of the stupidity of pro-cyclical fiscal policy, it is only the views of politicians on the far-left or far-right that matches those of the majority of macroeconomists.  Given the social, economic and political consequences of declining real wages and rising unemployment, which fiscal austerity only makes worse, this is both a very sad and rather dangerous state of affairs.

[1] Yes, this is the actual balance. The OECD estimate that the underlying primary deficit was 1.4% of GDP in 2012, will be 0.1% in 2013, and in surplus in 2014. I think those economists who suggested that the new Eurozone Fiscal Compact would be more enlightened than the old rules need to ask themselves why that has not happened. 

[2] Of course Germany has also avoided falls in real wages. In Germany there is a clear consensus among the parties of the centre for imposing austerity on others! While Merkel’s position is well known, Andrew Watt discusses here how the macroeconomic position of the centre-left SPD goes from bad to worse.

Does the Dutch central bank employ any macroeconomists?

Did you think that the policy of fighting recession by increasing austerity was now intellectually bankrupt? No one seems to have told the Dutch central bank. (Hence the deliberately provocative title of this post.) The latest forecast by the Bank says

• The economy will shrink by 0.8% this year, followed by growth of 0.5% next, “accelerating” to 1.1% in 2015
• The unemployment rate will rise sharply, reaching a peak point at 7.2% of the labour force midway through 2014.
• The budget deficit will increase from 3.5% this year to 3.9% next.

What should the government do about this? The central bank says “"The forecast course of the factual and structural deficit in 2014 does not meet the recommendations given in May by the European Commission to correct the excessive budget deficit in the Netherlands. Extra consolidation measures are therefore necessary."

Unfortunately the central bank is being entirely predictable in continuing to urge austerity as the economy weakens. In earlier posts (here and here), I noted how the central bank’s advice was rather different from the Dutch CPB (Bureau for Economic Policy Analysis), which clearly does employ macroeconomists. What is just so depressing is that the central bank seems oblivious to the increasingly overwhelming evidence that austerity during a recession is the complete opposite of what you should be doing in a country without its own monetary policy. Unlike some other Eurozone countries, there is no market pressure forcing policymakers’ hands in the Netherlands.

If you think this is excessively rude, please read my own checklist on the subject. I am not disdainful of those in 2010 who thought austerity was necessary because either a debt crisis was around the corner, or economic recovery had been assured, and have subsequently done what Keynes suggested should be done when the evidence becomes clearer. I think they were wrong back then, and said so, but it was an understandable mistake, and even the best economists make mistakes. But I’m afraid to continue in 2013 to advocate a course of action which anyone can see is doing immense harm to so many people is just inexcusable. If you understand this, and are a macroeconomist working for this or another European central bank with similar views, then you have my sympathy. If you work for one of these banks and think I’m being too harsh, please tell me why in comments. But more importantly, let’s hope that Dutch politicians treat this advice, along with the recommendations of the Commission, with the contempt it deserves.

Why politicians ignore economists on austerity

I have written before about fiscal policy in the Netherlands. I have done so in part because that country has a strong macroeconomic tradition, and I regard their long standing fiscal council (CPB) as a model of how to try and get good economic analysis and evidence into the policy debate. It is therefore an indication that something is very wrong when the political consensus there follows the austerity line.

The key target for policy in the Netherlands appears to be the 3% budget deficit number that was at the centre of the old Stability and Growth Pact. The latest CPB forecasts are for deficits of 3.3% of GDP in 2013, and 3.4% in 2014. The main reason is that the economy is in recession: GDP is expected to fall by 0.5% this year (following a fall of 0.9% in 2012), and grow by only 1% in 2014. The governing coalition includes the Labour Party, and its leader Diederik Samsom says it would be unwise to sharply cut government spending in a recession. What he means by this is that they will not try and hit the 3% figure this year, but instead do so next year!. After announcing austerity measures of over 2.5% of GDP in the autumn, the coalition has recently prepared a list of additional cuts totalling  0.7% of GDP. These include tax increases, a pay freeze for public sector workers and extra charges on industry.

So we have a discretionary procyclical fiscal policy, in an economy without its own monetary policy to offset its impact. The one ray of hope is that the trade unions, who have previously been prepared to discuss the details of austerity, no longer wish to do so. The FT reports  the largest labour federation as describing the cuts as “stupid and ill-advised”. The Labour Party is urging the unions to take part in discussions about the cuts, so they can - as one report puts it - “seize the opportunities offered by new measures to stimulate the economy”. This sounds a bit like asking a Christmas Turkey to talks about the recipe for the stuffing. The unemployment rate, which was 4.4% in 2011, is expected to rise to 6.5% in 2014.

So why are politicians, in the Netherlands and elsewhere, pursuing a policy that most economists regard as an elementary error? This was a question raised by Coen Teulings, who is the director of the CPB, the Dutch fiscal council. He was commenting on an IMF sponsored conference in Sweden, at which most economists argued against short run austerity when the economy was weak, and instead advocated dealing with budgetary problems through long term structural reform. The politicians in the audience, led by the Swedish finance minister Anders Borg, disagreed. He summarises their view as follows: “Politicians lack the ability to commit today to austerity measures to be implemented tomorrow. Hence, the only option is to take action straightaway.” (Borg was a driving force behind setting up Sweden’s own fiscal council, but his subsequent interaction with it has been more difficult, as Lars Calmfors and I describe here.)

Tuelings does not take this argument seriously, for good reasons. Instead he provides three suggestions as to why politicians are ignoring the economists. The first is a memory of the 1970s, when Keynesian policies were pursued because many failed to see the structural impact of the oil crisis. Politicians do not want to make the same mistake again. The second is that economists neglected countercyclical fiscal policy for too long, and therefore have failed to provide politicians with a clear guide to what policy should be, like perhaps an equivalent to the Taylor rule for monetary policy. Third, while both structural reform and short term austerity have political costs, politicians can sell the latter more easily, and success can be demonstrated more quickly.

The last argument can be partly seen as the austerity counterpart to the common pool explanation for deficit bias: structural reform can hit particular groups hard, while generalised austerity spreads pain more widely (or perhaps hits particular groups who have a small political voice). There may be something in the second argument, but there is a chicken and egg issue here. As someone who has written papers evaluating fiscal rules for a number of years, I have not noted much interest from European policymakers.

I suspect, however, that most of the interest in Taylor rules for monetary policy comes from central banks rather than politicians. I think this is a key problem with fiscal stabilisation policy: the lack of an institution that fosters research of this kind, that consolidates knowledge and pools wisdom. In my dreams I imagine a linked set of national fiscal councils that could play that role. What is unfortunately very clear is that central banks (or at least those running them) cannot do for fiscal policy what they have done for monetary policy: just look at the detailed and well formulated analysis of austerity in this recent speech (section 3.1) by the president of the Bundesbank. Returning to the Netherlands, it is no secret that the CPB is not part of the austerity consensus, while the Dutch central bank certainly is.

Democracy in the northern Eurozone: you can choose austerity, or austerity.

Imagine that before the US election the Congressional Budget Office published a detailed analysis of the economic implications of each candidate’s policies for different categories of government spending and taxation, and their impact on GDP, unemployment and much more. These were based on detailed and comprehensive accounts provided by both parties, and not unspecified aggregate numbers with no policies attached such as in the Ryan plan. You would have to agree that this would give voters a more informed choice, but you might also say that it was politically impossible in any country. Well have a look at the Netherlands, which will hold elections on 12^th September. That is exactly what happens there, with the analysis provided by their fiscal council, the Bureau for Economic Policy Analysis (CPB). (If you are at all interested, the detail provided in the CPB’s analysis is extraordinary (pdf) – for example, it predicts what impact each party programme will have on greenhouse emissions.)  

That is the positive news. The not so good news is that unemployment is expected by the CPB to rise by 1% over the next two years, and almost none of the major parties are planning to do anything to try and stop this. How could they stop it? Being part of the Eurozone means that fiscal policy is the only aggregate policy tool available. As a result political parties should be planning to raise budget deficits – increasing government spending or cutting taxes – on a temporary basis to keep demand rising in line with supply. Yet only one major party is planning to do this: the far right ‘Party for Freedom’, whose refusal to vote for the deficit reduction plans of the previous coalition brought down the government and sparked this election.

Now increases of 1% in unemployment may seem small beer compared to what is happening in Spain, for example. But unlike Spain, there is no market pressure in the Netherlands to reduce budget deficits. Instead the pressure comes from the Eurozone’s fiscal rules. And it matters because if countries like the Netherlands and Germany are reducing output and increasing unemployment by trying to cut budget deficits, then this makes the task for countries like Spain much more difficult.

General developments in the Eurozone are proceeding as I thought they might when I recklessly forecast that the Euro would survive. Because the process involves a power struggle between different economic ideologies, and countries, it is slow and painful and full of potential hazards and uncertainties: will the conditionality imposed on Spain and Italy to obtain ECB help be light enough to be politically acceptable to these countries, for example. (Paul Collier has an interesting post on this here.) I still worry that Germany might demand Greek exit as a token victory, but I’m relying on wise heads, and the IMF, to make sure that does not happen. However survival will still come at the price of a prolonged Eurozone recession, and here the fiscal rules are the central problem, as the Netherlands illustrates all too clearly.

The voters of the Netherlands are being given some choice, as Matthew Dalton points out . The Liberals (right of centre) want to cut the deficit by reducing spending, while the socialists want to raise taxes on high earners, and would increase the deficit compared to baseline in 2013 (but not 2014). However according to the CPB: “For almost all parties, unemployment will increase, compared to the baseline.” The exception is the right wing Freedom Party: it has the only programme that raises growth (slightly), and it is the only party that plans to increase the deficit in both 2013 and 2014 (all relative to baseline). So voters can vote against what I have previously called budget madness, but only by voting for a party that wants to abolish the minimum wage and halt immigration from non-Western countries.

I started this post with the CPB, so let me finish with them as well. The CPB is in a delicate position, as it wants to retain the trust of all the political parties for being impartial. However, in the FT (£) in February (also available here), the Director of the CPB Coen Teulings wrote an article entitled “Eurozone countries must not be forced to meet deficit targets” (jointly written with Jean Pisani-Ferry).  The Dutch central bank, on the other hand, has been calling for the urgent ‘rationalisation’ of the public finances.  (Its head was appointed by the previous coalition that proposed deficit cuts.) Which goes to show that fiscal councils tend to be wise, but central bankers talking about fiscal policy can be – well - not so wise.

Budget Madness in the Netherlands

                While all the current focus is on the challenge to austerity thrown up by the French and Greek elections, it may be salutary to look at an equally recent challenge that failed. Towards the end of April the Dutch conservative coalition government collapsed, when the far right party refused to discuss further budget cuts. The Prime Minister resigned. And yet a few days later other parties rallied round to give their support to a similar package of austerity measures, which now have majority support in parliament.

                This austerity was not required by the bond markets. The government can borrow at very low interest rates:  2.3% on 10-year bonds. (Predictably a ratings agency made noises about the country losing its triple AAA after the government collapsed, although not the same one that infamously downgraded US debt last year.) It is definitely not required by the state of the Dutch economy: GDP is expected by the IMF to fall by 0.5% this year (that’s a -0.5% growth rate), with unemployment rising from 4.5% to 5.5%. So what could have led a government to try and cut spending and raise taxes at such a time to the extent that it brings the government down? The answer is the ‘Excessive Debt Deficit Procedure’ (EDF) of the EU’s Stability and Growth Pact. The budget deficit as a percentage of GDP was 4.7% in 2011, down from 5.6% in 2009. Without these measures it would probably have stabilised at around 4.5% of GDP, and the objective of these additional cuts is to bring it down to 3% by 2013.

            This is worse than trying to balance the budget in a recession – it is trying to reduce the budget deficit in a recession. (A small caveat – part of the package is an increase in VAT, which if delayed and phased could stimulate demand in the short run.) Now these measures, like raising the retirement age, may be perfectly sensible from a longer term perspective. But, VAT aside, they should not be introduced in a recession. What is really depressing from a Eurozone perspective is why the package appears to have been implemented now at such great political cost. The timing is all about the EU’s deficit limits, and a belief that Netherlands has to show the rest of Europe an example. The finance minister said the plan would send Europe “a signal of solid government finances”.

            An irony here is that the Netherlands has a longstanding and very well regarded fiscal council in the form of the Central Planning Bureau (CPB). One of things the CPB does is cost both government and opposition budget plans before an election, something Simon Johnson has recently suggested the CBO could do in the US. So the argument that austerity has to be implemented now rather than later because institutions are weak is even flimsier in the Netherlands than elsewhere. Unfortunately, it appears the CPB has not managed to educate the majority of politicians about the foolishness of pro-cyclical fiscal policy.

            From a Eurozone perspective this is a disaster. The Eurozone is cutting its cyclically adjusted deficit faster than the US or even the UK and heading for a second recession, and possible political disintegration. As I and others have discussed, with Germany there is at least an argument that with unemployment falling there is no scope for any fiscal stimulus there. Yet unemployment is rising in the Netherlands. There is no, and I repeat no, good macroeconomic reason why a stimulus package should not be implemented here. And yet we get exactly the opposite.

            "This is an unbelievable achievement," the now caretaker Prime Minister told MPs after clinching the new deal.