The Media and the Public

If you take note of the growing evidence that the partisan media can influence public opinion rather than simply reflect it, then this new book by Mike Berry (full title ‘The Media, The Public and the Great Financial Crisis’) is a must read. At its heart is content analysis (what the media said) and audience studies of two key periods: the Global Financial Crisis (GFC) and Austerity.

There is a wealth of fascinating material here, which I couldn’t possibly summarise with any adequacy in a single post. Instead I want to focus on the two final chapters. The first helps explains why large sections of the public were so receptive to the 'Labour profligacy caused the crisis' myth. The second involves discussions with journalists.

I have written in the past (and also in my own book) about why the suggestion that Labour profligacy caused the deficit is simply untrue. The deficit was unremarkable in 2007, and exploded because of the GFC. I have focused on how this untruth was repeated endlessly by Coalition politicians and the right wing press, and how it was not challenged by the broadcast media or the Labour party.

What Chapter 6 of Mike’s book shows is why this idea of Labour profligacy caught on so easily. Between the early 2000s and 2010 the right wing press (in Mike’s sample the Telegraph, Mail and Sun) began to publish more and more stories about public sector waste. Now defenders of the press might argue that there was more waste because of a Labour government, but the number of stories in these papers increased over the period by 600%. A much more plausible explanation was that these papers were trying to undermine what the Labour government was doing, particularly as it was popular.

In this way readers of these papers were primed for the idea that Labour was being profligate. As a result, something that was clearly false could be sold as true. The idea that the media is ‘only reflecting the views of their readers’ is so obviously false in this case, because any journalist worth their salt could look up deficit figures, see that the recession caused the deficit to rise, and inform their readers. In reality these papers promoted the lies, and the non-partisan media did not bother to correct them.

I found the chapter where prominent journalists were interviewed fascinating. Again I will focus on austerity. One of those interviewed was Kevin Maguire, political editor of the Mirror. He talks about how the real reasons for the deficit were presented in the Mirror, but

“You very rarely saw full appreciation of it on TV or heard it on radio and you felt you were running uphill with heavy boots whenever you made the argument”

So why did the broadcast media start obsessing with the need to reduce the deficit? What is clear from Mike’s interviews with Robert Peston and Evan Davis is that the broadcasters really believed a large deficit was a problem of the utmost importance that needed to be tackled. The book contains extracts from his interview with Evan which I abbreviate here.

Evan: “Simon Wren-Lewis comes with a very strong Keynesian view, which is I think incidentally perfectly sensible …. But that’s quite different from saying that we should just blithely come and just say don’t worry about the deficit”

Interviewer: “Do you think you fairly represented all of these opinions, because he thinks you focused far too much on …

Evan: “Yes, but … people who hold a strong and rigid position on an issue find it very difficult not to see that we’re biased against them on anything, and Simon Wren-Lewis is in that …

Mike then writes

“However as the analysis in Chap. 2 demonstrated during the sample period in 2009 when the deficit became a major political issue there were no sources - outside of Labour - who were given space to put the Keynesian view in comparison to a range of sources who put the case for a faster pace of fiscal consolidation.”

A journalist might say gotcha. So it wasn't the imagination of a 'rigid' Keynesian: the BBC really did promote austerity. You can see why I also treat BBC claims that they told everyone that more than 90% of economists thought Brexit would be harmful with a large pinch of salt.

If you want to understand political developments since the GFC you have to understand the media, and that means collecting and analysing hard data in the way that Mike and others media studies academics do. What Mike does so successfully in this book is show how stories in the press were reflected in people’s attitudes and how this can have a profound influence on the political climate and therefore what politicians do.

The biggest economic policy mistake of the last decade, and it had nothing to do with academic economists

"The biggest policy mistake of the last decade" is the title of an article by Ryan Cooper, and the mistake is of course austerity. (It is a very US focused piece, so Brexit is not on the map.) Cooper goes through all the academics who gave reasons why austerity was necessary and how their analysis later fell to bits. (How much they fell to bits is still a matter of dispute as far as these authors are concerned.)

Here is his concluding paragraph:

“As we have seen, the evidence for the Keynesian position is overwhelming. And that means the decade of pointless austerity has severely harmed the American economy — leaving us perhaps $3 trillion below the previous growth trend. Through a combination of bad faith, motivated reasoning, and sheer incompetence, austerians have directly created the problem their entire program was supposed to avoid. Good riddance.”

There is a lot I could say about the details of the article, but this conclusion is essentially correct, and it applies at least as much to the UK and to the Eurozone countries. With Trump’s large tax cuts for the rich paid for in large part by borrowing, the Republicans can no longer credibly tell everyone austerity is essential. In contrast the political right’s enthusiasm for austerity in Europe remains strong.

Reading the article brought back memories of my first year or two writing this blog, where I became part of a mainly US blog scene of mainstream academics opposed to austerity, lead by Paul Krugman and Brad DeLong. We were trying to take down the academic arguments for austerity, and we succeeded. As Cooper’s article suggests it was not a very difficult task. Sometimes very senior economists who should have known better made simple mistakes of the kind I discussed here. On other occasions, like the predictions of massive inflation from Quantitative Easing that Cooper discussed, events quickly proved the Keynesians correct. Only in the case of the studies from the two pairs of Alesina and Ardagna and Reinhart and Rogoff was additional research required to challenge their conclusions.

As far as us Keynesians were concerned, the intellectual battles were won by the end of 2012 if not before. In particular Paul De Grauwe’s influential analysis of why Eurozone countries were experiencing a debt crisis, pointing to the lack of a sovereign lender of last resort, put an end to the academic credibility of ‘we are going to become like Greece’ stories. When the ECB introduced OMT in September 2012 and the Eurozone debt crisis came to an end De Grauwe was proved right. In 2013 Krugman wrote of austerity:

“Its predictions have proved utterly wrong; its founding academic documents haven’t just lost their canonized status, they’ve become the objects of much ridicule.”

What we didn’t know for sure then was the lasting damage that austerity would bring, and which Cooper notes.

I want to add two important points that Cooper’s article does not cover. The first is that although by 2013 most academics had become convinced about the austerity mistake (it was always a minority view anyway), economic journalists in the non-partisan media could not recognise that because the politicians were continuing to implement the policy. Here is Robert Peston in 2015:

“And before I am savaged (as I always am) by the Krugman crew of Keynesian economists for even allowing George Osborne’s argument an airing, I am not saying that the net negative impact on our national income and living standards of cutting the deficit faster is less than their alternative route of slower so called fiscal consolidation. I am simply pointing out that there is a debate here (though Krugman, Wren-Lewis and Portes are utterly persuaded they’ve won this match – and take the somewhat patronising view that voters who think differently are ignorant sheep led astray by a malign or blinkered media).”

We now know that voters were indeed being led astray by a malign or blinkered media, or at least a media that did not have the courage to call the result of the academic debate.

The second point is that this academic debate had zero impact on politicians. In that sense Cooper’s article is of purely academic concern. Austerity was not begun because politicians chose the wrong academic macroeconomists to take advice from, and the fact that the Keynesians won the debate therefore had no impact on what they did. The academic debate was in this sense a complete sideshow. I think many Keynesian academics understood that: it was a fight we had to win but we were under no illusions it would change anything. I wrote in 2012 that if all academics were united we might have an impact on public opinion, but that illusion did not last very long and Brexit showed it was indeed an illusion.

I think this lack of influence that academic economics can have is not understood by many. It often suits some heterodox economists to pretend otherwise. Economists can be influential, but only when politicians want to listen, or the media is prepared to confront them with academic knowledge. For example politicians have not done nearly enough to ensure another financial crisis does not happen, but that isn’t because economists have told them not to or have not shown them how to do so. It is because politics prevents it happening.

The reason why economists like Alesina or Rogoff featured so much in the early discussion of austerity is not because they were influential, but because they were useful to provide some intellectual credibility to the policy that politicians of the right wanted to pursue. The influence of their work did not last long among academics, who now largely accept that there is no such thing as expansionary austerity or some danger point for debt. In contrast, the damage done by austerity does not seem to have done the politicians who promoted it much harm, in part because most of the media will keep insisting that maybe these politicians were right, but mainly because they are still in power.  

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.

Bad business

This post mainly uses examples from the UK, but I suspect much the same story could be told in many countries. The reaction to Obama's criticism of Wall Street was extraordinary, until perhaps you realise that in the US political support is sometimes a commodity that corporations and the wealthy can buy. I return to the US at the end of this post.

I am sure the employment regime that existed at 'Sports Direct' would horrify anyone. A system of discipline that penalised taking time off sick such that ambulances responding to emergency calls were regular visitors to the factory. Many of the staff were not paid the minimum wage. This is what can happen when the majority of workers are not represented by a union, and local jobs are scarce, or other employers are not much better. We know about it because of the work of investigative journalists, but there are few of them left so how many other cases do we not know about?

A long time ago the Conservative party represented business, and the Labour party represented employees through their links to trade unions. In the 1980s the power of the trade unions was significantly reduced, and Labour leaders even thought they could gain votes by attacking some union actions. Since then, Labour have avoided ever siding with workers in industrial disputes. This continues under the current leadership: Labour did not even endorse the junior doctors strike. As a result, we can ask who represents employees against exploitation by employers within the workplace, and who represents society against rent seeking by employers at the national level?

The Conservative party was and still is the party of business. As Aeron Davis notes, even in 1997 only 7% of the business community voted Labour and 69% voted Conservative, despite all of Blair's efforts to show Labour was business friendly. In the last election business leaders did all they could to support the Conservatives, both financially and with explicit support. When this tight link between a political party and business is combined with an ideological belief among many in the party that regulations such as those that support employees are 'red tape' that needs to be cast aside, we get a mix which is potentially dangerous for employees and society.

We have seen many examples of bad business behaviour since the 2015 election, such as the emission test scandals. In some cases governments, being ‘business friendly’, actively helped with that deceit. Other examples are here, or here, or here, or here, or here(FT)/here/here/here/here, and that is not even counting the financial sector. It is estimated that over 200,000 employees are paid less than the minimum wage they are entitled to (HT Jo Maugham).

The links between the party and business, and an instinctive dislike of regulations on business, does not of course necessarily mean a Conservative government will automatically create an environment where abuses of employees and customers can flourish. As George Osborne showed when he increased the minimum wage, politicians can act against type. But it would clearly help in avoiding business exploitation if the Conservatives faced an opposition that felt free to be critical of business.

That is what Ed Miliband tried to do when he was Labour leader. He put the issue of producers versus predators, or as an economist might put it wealth creating versus rent seeking, at centre stage. Labour also proposed some relatively mild measures to reduce inequality (e.g. the mansion tax). The latter in particular were unpopular with CEOs. Partly as a result, we saw near universal endorsement of the Conservatives from business leaders.

An interesting question is why this should be seen as a problem for Labour. The answer has to be that approval by business is seen by many voters as a mark of economic competence. Of course economists know that running a business is very different from running the economy. In addition, as I think Justin Wolfers said, when a businessman claims economic expertise, remember: business is about enriching yourself, economics is about making us all better off. But the media environment encourages a rather different view. Economic issues, unless they are of major importance, are typically discussed in business sections or segments.

I have personally never understood the prominence that business news has in all parts of the media. For example, are there really that many people who want to know the daily movement in stock markets around the world every hour on BBC 24 hour news? More worrying is how often business leaders and business representatives get media coverage compared to representatives of employees, particularly at the BBC. (Business leaders also seem to beat economists at the BBC, as Justin Lewis noted about the 2015 election. This has been repeated during the referendum campaign. This is despite the public trusting us more than business leaders. [1])

The result of all this may be that Labour wants to avoid appearing anti-business. The Blair/Brown regime went out of their way to cultivate business, and were famously relaxed about the large increase in inequality at the top that occurred before their time. It is not totally ludicrous to claim that the UK financial crisis, the biggest example of business mistakes adversely effecting society for many decades, might have been partly a result of this.

The current Labour leadership is unlikely to repeat that mistake. But the problem remains that the Conservatives will throw the anti-business charge the moment Labour adopts any measures that restrict business freedom or threatens the incomes of business executives, and business leaders – for reasons already explained – will back them up. If this leads to a significant number of voters concluding that Labour are not competent to run the economy, we are in danger of hard wiring bad business. As Luigi Zingales observes in this perceptive article, although there is a deep distrust of crony capitalism among many Republican supporters, they still elected a crony capitalist.

[1] In Justin Lewis's article, he notes that “newspaper partisanship directly influenced the broadcast news agenda”. Perhaps this is the most plausible explanation for many of the BBC's biases, together with – ironically – a fear of being too left wing, as Jack Seale reports with a great quote from Robert Peston.

Nonsense on data revisions

Following publication of revised GDP figures today, Robert Peston writes:

"a particular school of Keynesian economists may choose to re-examine their contention that only a fool or a liar would say there is a legitimate debate about whether George Osborne's policies were good or bad for the recovery."

Sorry Robert, but this is just nonsense: complete and utter nonsense. This "particular school" has never based their assessment on observing what is still the weakest UK recovery since anyone can remember and looking for something to blame. They based it on what macro theory and the great majority of empirical studies tell us would be the impact of the fiscal austerity that happened. At the conservative end of such assessments is the OBR, who calculate austerity reduced GDP growth by 1% in each of the financial years 2011 and 2012. Estimates of this kind are completely independent of data revisions for one period in one country. We might doubt such estimates if they implied that without austerity we would have had implausibly rapid growth, but for this recovery they do not. 

The other point completely missing from Peston's account is that the UK's growth performance even with these revisions is still terrible. As I have often pointed out, high inward migration in recent years means you really have to look at GDP per head to make comparative statements about this recovery. As the ONS point out, this new data still shows that only in this year has GDP per head exceeded its pre-recession peak. Assuming recent data revisions have not changed this, average growth in GDP per head between 1955 and 2008 was about 2.25%. Any recovery from such a deep recession should have seen growth rates well in excess of this. Instead the revised data give us 1.1% growth in 2011, 0.5% in 2012, 1.5% in 2013. Only by 2014 had we got near the long term average growth rate. This is still an absolutely terrible performance for a recovery.

That is not some "particular school" talking. That is just basic stuff that any good economic journalist should point out: see Ben Chu for example. I suspect it would also be what Robert Peston would point out if this was not all so political and the government were not breathing down the BBC's neck. The mediamacro problem is still very much with us.

The academic consensus on the impact of austerity

In discussing the forthcoming UK budget, Robert Peston writes:

“And before I am savaged (as I always am) by the Krugman crew of Keynesian economists for even allowing George Osborne's argument an airing, I am not saying that the net negative impact on our national income and living standards of cutting the deficit faster is less than their alternative route of slower so-called fiscal consolidation.

I am simply pointing out that there is a debate here (though Krugman, Wren-Lewis and Portes are utterly persuaded they've won this match - and take the somewhat patronising view that voters who think differently are ignorant sheep led astray by a malign or blinkered media).”

I do not want to disappoint, and as I was about to write something on the macroeconomic consensus on austerity anyway, let me oblige - not in savaging (I leave that to my American colleague in arms!), but in justifying why I think there is such a consensus in the places that count. By consensus I do not mean that everyone agrees - of course not - but that a very large majority do, which probably counts as consensus in economics.

Unfortunately we do not have a great deal of information on what academic economists as a whole think about austerity, but we do have two important survey results which are pretty conclusive. In the US, there is the IFM Forum, which regularly asks a group of distinguished economists - including many macroeconomists - their views on key policy issues. The last poll I have seen suggests that 82% of that panel thought the 2009 Obama stimulus had reduced unemployment, while only 2% disagreed. In the UK, the CFM survey asked a similar question to a smaller group of academic economists, most of whom are macroeconomists. Only 15% agreed that the austerity policies of the coalition government have had a positive effect on aggregate economic activity, while 66% disagreed. That consensus is not universal - it would not apply in Germany for example - but I doubt if anyone would disagree when I say that US economists call the shots as far as academic macroeconomics is concerned. 

This is why economists the world over continue to teach Keynesian macro to undergraduates, and normally not as one ‘school of thought’ but rather as an initial approximation of how the economy actually works. As Amartya Sen so forcefully reminds us, the experience of the last hundred years has earned Keynesian theory this central role.

However we have another, more indirect, source of evidence. If you asked whether there was a standard model for analysing the business cycle among economists in academia and in policy making institutions, the answer would have to be the New Keynesian model. I want to include economists in central banks in particular because they have to put theories of the business cycle into practice on a regular basis. The key macromodels that central banks use to forecast and to analyse policy are Keynesian, and many are New Keynesian. Having worked a great deal with New Keynesian models myself, I also know what they imply about temporary changes in government spending in a liquidity trap (see this paper by Mike Woodford, for example). It may be possible to adapt these models to give you expansionary austerity, but no such adaptations command general or even partial support.

The models used by pretty well all central banks would therefore imply that temporary cuts in government spending were contractionary, absent any monetary policy offset. The governors of the central banks of the UK and US say this publicly. European central bank governors do not tend to say this, and instead continue to advocate austerity despite deflation. The reason why they might do this despite what their models tell them will be the subject of a later post, but I suspect it has little to do with conventional macroeconomics (but see also the point about German academic views above, and Sen’s article). If temporary cuts in government spending are contractionary in a liquidity trap, it follows that it is much better to delay this form of austerity.

I could add repeated arguments from economists at the IMF (e.g. here and most recently here), and now also the OECD (FT here, or ungated here). Of course there are some academic economists who continue to argue that the impact of austerity is expansionary or at least minor - I suspect there always will be, as long as this remains an intense political debate. They would be joined by many City economists, but they are neither unbiased nor the source of any particular expertise on this issue.

This is why, among economists with expertise, there is a clear majority view that fiscal austerity is significantly contractionary in a liquidity trap. That does not automatically mean that the 2010 policy switch was wrong, or that it had a big impact on the UK in 2010-2012: there are additional issues here which I have discussed many times. How damaging to the macroeconomy any additional austerity from Osborne will be also depends on whether we are or will be in a liquidity trap. But the fact that we might well be means that additional austerity now is a big mistake, and on this I believe the great majority of academic macroeconomists and those macroeconomists working in policy making institutions would agree.

As far as the media is concerned, I cannot believe that Robert Peston would disagree that a large section are ‘malign’, given how political this issue is. When I have talked to journalists who have some freedom to report the facts rather than what their editors want them to report, the argument I most often hear is that because this issue is political, they have to report it as a ‘debate’ come what may. I have never had the pleasure of talking to Robert Peston (he is welcome to email at any time), and I would be very interested in how he would respond to the evidence I have laid out. As for the public, the word sheep is his not mine. Would he really argue that the public are independently well informed on these matters, or unaffected by the media’s presentation of this and similar issues? Which is why I will continue to - as he might say - bang on about this, even though my audience is tiny in comparison to most journalists.

Economists vs. Business Leaders?

Today illustrated very clearly why the monthly CFM survey of mainly academic, mostly macro UK economists was such a good idea. (And something that I should have included in this discussion.) I have often written that I thought austerity was only supported by a small minority of UK macroeconomists, but my evidence for this has been much thinner than I would like. Today CFM published their latest survey which asked: “Do you agree that the austerity policies of the coalition government have had a positive effect on aggregate economic activity (employment and GDP) in the UK?”

The response was clear: 15% agreed, 18% neither agreed nor disagreed, and 66% disagreed. As CFM reported: “Ignoring those who sat on the fence, 19% agree and 81% disagree with the proposition. This ratio is unaffected by confidence weighting.”

That was welcome confirmation of my prior, but what was much more important is that the survey came out on the same day as the Daily Telegraph published a letter from 100 business leaders saying exactly the opposite. To quote: “We believe this Conservative-led Government has been good for business and has pursued policies which have supported investment and job creation.” Now of course a letter (organised by whom?) is not a survey, and it is hardly news that Labour has policies that are unpopular with business leaders. Yet the letter was nevertheless the lead item on BBC news today.

However in at least some of the reports I heard that led on the letter ‘news’, the CFM survey was also mentioned. I myself participated in Radio 4’s World at One (about 11 minutes in) as a direct result of the survey. Robert Peston went as far as to ask: “Who to trust - business leaders or economists?” I liked the way he introduced his post:

“Neither business leaders nor economists have a monopoly of wisdom on what's good for Britain or are free from political bias. But it is perhaps therefore all the more important to remember that those paid to think about how best an economy should be run don't necessarily agree with those paid to run companies.”

He might have also added that, probably without exception, we are paid a lot less than business leaders, so the danger that our opinions might be influenced by Labour policies like reintroducing the 50p income tax rate or introducing a mansion tax is perhaps also smaller!

Robert Peston, Mr Market and me

Paul Krugman picked up on my post commenting on the views of Robert Peston’s pals in the bond market, and Robert Peston has now responded. To characterise this as a debate would I think be wrong. Being the excellent journalist that he is, Peston is reporting the views put to him, rather than taking a particular side. In his response, he does a reasonable job of presenting Paul and my views, and does not argue too hard against them. I have two significant clarifications, and one key point.

The first clarification is that Peston still downplays the importance of having your own central bank and borrowing in your own currency. He says that is ‘partly’ why the UK has avoided the fate of the Eurozone PIIGS. I would argue that is entirely why the UK (and the US, and Japan) have done so. Both Paul and I would argue that fiscal policy should have been expansionary and not contractionary in 2010 [1], and in my view this would have had no detectable influence on any risk premium. The recent IMF self-evaluation that I discussed here also argues at a global level that the switch to fiscal contraction ('austerity') in 2010 was a mistake caused by a misreading of the Eurozone crisis.

Second, I think what he writes at the end could be misleading. He says: “Now to be clear, there are economists who attack the idea that the deficit and debt can be cut by growing the economy with all the vehemence of Krugman's and Wren-Lewis's lampooning of me and Mr Market.” The minor point is that I did not lampoon either him or the market, but simply what his pals thought about how the market worked. But more seriously, the argument that debt could eventually be lower as a result of growing the economy through fiscal expansion - advanced for example by DeLong and Summers - is different from the point that Paul and I make about the irrelevance of default risk for the UK or US and the consequent foolishness of trying to cut the deficit when interest rates are at their zero lower bound.

Those clarifications apart, the main thing I wanted to say was this. Of course he was just quoting what was said to him by his pals in the bond market, and I would not want him to suppress those views, although I did get some feedback from others in the markets that their own view would have been rather different to his pals. My complaint was that he did not talk to some academic macroeconomists as well, and I explain here why their opinion on issues like this may be at least as useful as some players in the market. If he ever wants my opinion, he just needs to email!

 

[1] See for example Paul’s recent book, and Jonathan Portes and my recent paper.

Bond market fairy tales part 1

In a recent post I argued that the days when budget deficits mattered because of concerns about default are over. In 2010 it briefly looked as if deficits could be so large that default was a real possibility, but we now know that was never true for the US and UK, and within the Eurozone it was only true for Greece, and since then austerity has (unfortunately) brought deficits down substantially. In most countries deficits are now around sustainable levels, by which I mean that they can be financed and sustained at close to current tax rates and spending regimes. 

Which raises the question, why isn’t this common knowledge? Why in mediamacro do people act as if we were still in 2010? In this respect BBC journalist Robert Peston has an interesting post. Robert Peston is no fool, and his coverage of banking issues in particular is rightly famous in the UK. In his post, he notes correctly that there is a huge gap between the amount of austerity planned by Conservative and Labour after 2015. Let me quote what he says next.

“And here, of course, is where we need to ask Mr Market what he thinks of all this….The Tory view is that those [low] interest rates can only be locked in if the government continues in remorseless fashion to shrink the state and net debt. What Labour would point out is that countries in a bit of a fiscal and economic mess and currently refusing to wear the hairshirt that the European Commission thinks necessary, such as Italy and France, are also borrowing remarkably cheaply."

So what Mr. Market should tell Robert Peston at this point is that France can borrow more cheaply than the UK not because the French government is more credible and less likely to default - these are no longer important issues. The reason is that expected future short rates in France are lower as a result of the Eurozone recession. This means that because the Conservatives will cut back on spending more (than Labour), this will tend to reduce demand and output more, which in turn will mean expected future short rates will be a little lower under the Conservatives than Labour (as monetary policy tries to undo the impact of greater austerity). What Mr. Market actually told Robert Peston is as follows:

"And here is where Mr Market may be capricious, according to my pals in the bond market. They say the UK's creditors would probably be forgiving and tolerant of George Osborne borrowing more than he currently says he wishes to do, in that his record of reducing Whitehall spending by £35bn since taking office in 2010 has earned him his austerity proficiency badge. But Ed Balls has never been chancellor, although he was the power behind Gordon Brown when he ran the Treasury and much of the country, both in the lean years from 1997 to 2000 and the big spending Labour years thereafter.

So Mr Balls has yet to prove, investors say, that he can shrink as well as grow the apparatus of the state.”

What Robert Peston's pals in the bond market seem to be telling him (assuming that nothing was lost in translation) is that it is all about Labour's lack of credibility at being able to shrink the state. My immediate reaction: ?!?!? I have two problems.

1) Why the talk about credibility? Talking about credibility makes sense if we are worrying about default, but there is no chance Ed Balls is going to choose to default. You might worry that Labour will not cut the deficit by as much as they plan, which will intensify the mechanism working through monetary policy that I outlined earlier. If that is what his pals meant, why didn't they say this, and why does that involve the markets being capricious?

2) What is this about shrinking the apparatus of the state? Shrinking the deficit yes. But in what world does the return on bonds depend on the size of the state?

So it seems that my understanding of how the bond markets work is worlds apart from the understanding of Robert Peston's pals. I suspect that for mediamacro there really is no choice here: why would you believe an academic economist in their little old ivory tower rather than the guys who are directly in touch with the markets you are trying to understand. The fact the explanation they give you could have been drafted by someone in No.11 Downing Street (the UK Chancellor's residence) just suggests that George Osborne is in tune with financial realities.

Part 2 of this post will be why this logic is wrong.