In an article in the Independent today I argue that what goes for a
‘credible’ economic policy among politicians and the media is
often very different from what an academic economist might describe
as credible. Which invites the obvious response: who cares, what do
academic economists know anyway? So I look at what I regard as the
three major macroeconomic policy disasters in the UK over the last 35
years, and one success.
The success was the decision not to join the Euro in 2003. It is
pretty clear that this was the right decision, and it was made after
what may have been the most extensive academic consultation ever
undertaken by the Treasury, coupled with substantial macro analysis. (I
talk more about this here.)
The Prime Minister Tony Blair was initially in favour of joining, but
the analysis helped persuade him otherwise.
The first failure was Mrs. Thatcher’s monetarism, which was
famously opposed by 364 economists. Those on the right have tried to
spin this as a failure by the economists, but the actual policy
framework of money supply targets was a complete disaster and was
quickly abandoned, never to be tried again. (Here
is a discussion, and here
is an account from one of the two movers behind the letter.)
Current austerity we all know about: if not, read this.
The third disaster was the UK’s entry into the European Exchange
Rate Mechanism (ERM) in 1990 at an overvalued exchange rate, and the
subsequent recession and forced exit in 1992. My argument that this
went against macroeconomic analysis needs some justification. At the
time I was in charge of macroeconomic research at the National
Institute (NIESR) in London, and I undertook with colleagues what was
easily the most extensive analysis of the consequence of entry into
the ERM at different exchange rates. This was subsequently published
in 1991, but all the material was first presented before we entered
the ERM.
We concluded that the UK’s actual entry rate was 10-15% above the
equilibrium rate. The implication was unavoidable: either we would be
forced out, or trying to stay would lead to a recession as part of an
‘internal devaluation’. I remember Sam
Brittan,
one of the main writers at the FT at the time, saying that he thought
we had won the intellectual argument, but that his instinct was still
that we should enter at a high rate.
After entry into the ERM the UK entered a recession, and we were then
forced out just two years later. Our analysis was vindicated. It is
true that the whole system eventually collapsed as a consequence of
the tight monetary policy that followed German unification, but it is
no accident that the UK was the first to go (Black
Wednesday).
On leaving the ERM sterling depreciated by 10%, and the UK recovered
quickly from recession.
There is no doubt that had the Treasury taken our advice and entered
at a lower rate, less jobs would have been needlessly lost. I have
often wondered if I could have done things differently to make a more
persuasive case. But honestly I doubt it: the almost macho appeal of
entering at a ‘strong’ rate was too great, together with the idea
that the market knew best. As I say in The Independent,
macroeconomists are far from perfect, but the UK evidence suggests
that you ignore their advice at your peril.
