The public analyst in crazy times

My eldest granddaughter about a year ago went through that stage where she was always asking why. Now her favourite question is ‘what’s happening’. I thought of this when listening to this talk by Paul Krugman, titled ‘public discourse in a time of crazy’. Paul asks how should people who deal with facts and rational argument cope with a post-Trump world where those running the show appear to attach no positive value to either. [1]

While he says himself he is still adjusting to this new world, Paul suggests in this lecture that there are three paths which should be avoided. He calls them appeasement, emulation and quietism. The last is actually a real word, I discovered, and it means a “calm acceptance of things as they are without attempts to resist or change them”, a kind of retreat. I suspect it is the only one of the three that could tempt Paul himself.

It seems to me that appeasement is a good way to describe what has been happening to the UK’s parliamentary Labour party for perhaps a decade. First we had austerity, which began to be appeased in an apparently mild way while Darling was Chancellor, became stronger with ‘too much, too fast’, and ended up with some arguing after 2015 that austerity was the way forward. We are now seeing the same with immigration. What starts as the innocent ‘recognising people’s anxieties’ has now become ‘well at least Brexit allows us to control immigration’.

Appeasement is wrong for many reasons, not least because it is a terrible political strategy. If you no longer appear to champion anyone’s cause, but instead just become the ‘lite’ party (Brexit-lite, immigration-lite), you stop getting votes. Partly because people can vote for the 'real thing' (non-lite), and partly because you are not credible. This has got nothing to do with moving too far to the left or right, or Corbyn’s original [2] election: just look at Andy Burnham.

Emulation is to attempt to outdo Trump or Brexit in their own world of meaningless phrases and downright lies. But that is not a world that Paul Krugman (or myself) could live in. The scientific method is too deep in our bones to make this possible. We are not about the write posts which have the subtitle “a response to justified criticism’.

How does any of this relate to my granddaughter? The reason is that I think the premise for Paul’s talk is not real. There is no puzzle about what people like him should do now. We do what we have always done: ask what is happening and why. We put forward plans for what should happen once these dark times are over, plans that come from good explanations of the what and the why. When Paul talks about Appeasement and Emulation, he is really talking about what opposition politicians and their advisers should not do.

What people who analyse the evidence and ideas lose when Trump becomes President is any sense that we are participating in a conversation, a public discourse, that includes people who have power. Even those politicians who are in opposition cannot really listen because they will have their hands full limiting damage. Or in the UK case, they are too busy fighting each other.

2016 has not seen a sudden transition to this world, but more the blocking out of the remaining lights that pierced this post-truth darkness. We have effectively had a Republican Congress at constant war with a Democrat White House since 2011, and that Republican Congress increasingly under the control of the Tea Party and Fox News. The UK and Eurozone have been dominated by completely unnecessary austerity since 2010. As I used to say about austerity around 2012 or 2013, we had won the intellectual debate but the world went on as if we had lost.

I was thinking along these lines after talking to the Treasury Select Committee on Tuesday. I wrote a post just before I went, on why the OBR was perhaps being too optimistic about Brexit. Yet when I offered to explain the reasons for this to the Committee, no one seemed to want to hear. Politicians want to make the most of Brexit, when in reality all they can do is limit the damage. Politicians want to recognise people’s anxieties about immigration, when really they have to tell people that they are wrong: not about their grievances, but their belief that this has much to do with immigration.

We can, and should, continue to rage against the dying of the light. What is difficult, in this time of crazy, is being able to put that rage aside, and engage in a form of quietism, a retreat from the here and now of political discourse. Not a retreat into any kind of acceptance of where we now are, but instead into asking what and why, and from the answers to those questions to planning for the time when facts get back into fashion. But more than that. Using the answers to the what and why to prevent us lapsing back into our current post-truth world.

[1] Of course politics has always been driven by ideology as well as evidence, but there is a critical difference between wanting to find evidence to back your ideology, and not caring about evidence at all. We seem to have moved from the former to the latter in recent years. This is related to Frankfurt’s concept of political bullshit.

[2] I say ‘original’ here deliberately of course. Whatever his motives, Owen Smith did see why it was important to champion the anti-Brexit cause.

Tyrie and the IMF on austerity

Suppose you were given advice about the UK economy every year, and these were the outturns for growth. What, in retrospect, would you complain about? I think most people would complain that you should have been advised more robustly that growth would be weak in 2011, and non-existent in 2012. But Andrew Tyrie, chair of the Treasury Select Committee, seems unconcerned about that. He complains that when the IMF did become increasingly worried (as in April 2012 for example), it should have kept quiet. 

GDP Growth rates: source OECD Economic Outlook 2014:1

This is of course just another example of the establishment’s attempt to deny the evidence about austerity. It is particularly rich because the Treasury was also becoming increasingly worried that growth would not return before the election, which is why it eased off on austerity and brought in Help to Buy. Anyone who tells you they just knew the UK savings ratio would fall sharply in 2013 and so there was no need to worry is either lying or a fool.

There are two other absurdities in Mr Tyrie’s article worth noting. The first is that he says the IMF should have been more robust in its advice to the Eurozone. Apart from the fact that it was pretty robust, just exactly what does he expect the IMF to have said that might have prevented the second Eurozone recession? It should (and did) say less austerity, which is understandable given the central role austerity played in that second recession. That is the same austerity that in 2010-12 Mr. Tyrie thinks was sensible policy in the UK.

The second is this line. “Most ill-considered of all was the IMF’s specific policy recommendation to bring forward capital investment. Big infrastructure projects are hard enough to agree on, design and manage as it is.” Would that be infrastructure projects like flood protection for example, which were already on the drawing board but which were postponed?

Of course this article is really just a shot across the IMF’s bows. In your forthcoming report lay of the criticism about things like Help to Buy because there is an election on the way. But what Mr. Tyrie should really write about is this. On austerity the IMF were too sanguine in 2010/11, but they (and particular Olivier Blanchard) have looked at the evidence and changed their minds. That is something the UK establishment, Mr. Tyrie included, have completely failed to do.

What is the attraction of helicopter money?

The reviews of the first episode of Mark Carney and the Treasury Select Committee seem generally favourable. Of course those wanting to see inflation targeting killed off right from the start were disappointed (as they were bound to be - you cannot kill an established star that quickly), but its demise has not been ruled out. From my point of view one of the real positives from the show was the evident desire of the new Governor to have a debate about the monetary policy framework, a debate which as I noted before has been largely missing in the UK. Martin Wolf, as ever, eloquently explains (£) the reasons why we need this debate, and I’m glad to see his suggestion that we might look at earnings growth as well as CPI inflation. To put the point strongly, one reason why monetary policy is currently so passive around the world is an unjustified obsession with just one particular measure of inflation.

Martin Wolf also says we need to talk about helicopter money, and the FT leader took a similar line the previous day. Here I admit I am conflicted. The macroeconomist in me wants to complain: as I have said in the past, helicopter money is either a plea for fiscal expansion - which is good, but why not call it that - or a policy for above target future inflation, which may also be good but why not call it that too? However perhaps I am being politically naive - maybe it is the only way we can get governments at the moment to undertake fiscal expansion.

Let me first summarise the macroeconomics as I see it. Suppose the government cuts taxes using new money created by the central bank (often called base money). This helicopter money seems formally equivalent to debt financed tax cuts, with the central bank buying the government debt through Quantitative Easing (QE), and then destroying the debt so it can never be sold. If so, helicopter money differs from tax cuts plus QE only in so far as the money creation with QE is temporary (the debt owned by the central bank is not destroyed), while with a helicopter drop it is permanent. With temporary money creation (QE) it is possible to claim that future inflation will not be allowed to exceed the target, because the central bank is free to reverse QE as much as it needs to. Standard macro would suggest that a permanent increase in base money will raise the price level eventually, so it may no longer be possible to prevent inflation exceeding its target at some point.

Is this standard macro right? I think many get confused by discussion flipping from prices to quantities or vice versa. They may think that the central bank can always raise interest rates to keep inflation in check. But just as in a free market the apple producer cannot flood the market with apples and keep the price of apples high, the central bank cannot flood the economy with money and keep interest rates high. It cannot independently control base money and short term interest rates.[1]

That is the macroeconomics as I see it. What about the naive part. First there is a standard point. A central bank could promise to raise inflation in the future, but will it keep that promise? There is a time inconsistency problem here, which I have talked about before. Perhaps we need some device to force the central bank to make good on raising future inflation, and printing money now might be just that device. In that sense, helicopter money may be a more effective means of increasing future inflation than raising the inflation target. However, if that is the argument, it is better to be honest and call for helicopter money as a means of raising future inflation. The FT leader I mentioned appeared to suggest the opposite.[2]

Second, perhaps this is all about fiscal policy after all. Governments have convinced themselves that we need austerity because government debt needs to come down, and helicopter money allows them to relax austerity without compromising on debt. Stop trying to convince governments they can be much more relaxed about debt in a recession, and let them use money creation as a way of getting fiscal stimulus. As long as there is not too much helicopter money, the increase in future inflation will probably be manageable and will help the recovery, so why quibble. But lets keep quiet about the future inflation bit - we do not want to put them off.

Which brings me back to Dr. Carney. Just imagine that the Chancellor told him over the next few months that he had decided to embark on a limited programme of helicopter money. The aim was to stimulate the economy, and the fact that the money was being used for tax cuts before an election was just one of those coincidences. As the Chancellor knew that Dr. Carney was in favour of additional stimulus, he was sure that he would be happy to go along with this. What would Dr. Carney say? Well we already know from episode one:

“with respect to so-called helicopter money, which was referred to there, I will be absolutely clear, I cannot envisage a circumstance where I would support that as a strategy”

Do I think these are the words of a seasoned central banker who is afraid to break a taboo? I suspect instead they are the words of a good macroeconomist who wants to call a spade a spade. If the Chancellor announced bond financed tax cuts, we know Dr. Carney would not object. If he announced a higher inflation target - well that is also a decision for the Chancellor and not the Governor. But announcing a policy that could severely compromise the future Governor’s ability to do what he is mandated to do, while pretending it does not - I think he has every right to object to that.[3]

[1] Perhaps the hope is that tax cuts financed by printing money will increase demand - because the government has not issued any debt which will require future tax increases to pay back or service (Ricardian Equivalence will not apply) - yet the central bank can still sell what assets it has to mop up the money created by the tax cut. But as this leaves the private sector holding the same amount of government debt as they would if the tax cut was debt financed, it is difficult to see how this trick could work.

[2] As I explained here, if helicopter money was expected to raise prices, consumers would need to save all the tax cut to preserve the real value of their money balances. However savings would still fall because higher prices at the zero lower bound would reduce real interest rates. So the policy is more expansionary because future inflation increases. Here is a closely related post.

[3] I cannot help noting, however, that to the extent that austerity involves price increases of some form, you could legitimately argue that the Chancellor is already making life rather difficult for the MPC. Here is a chart from a recent speech by MPC member Ian McCafferty [HT uneconomical]. The FT suggests the government’s increase in university tuition fees may add 0.3% to inflation both this year, and in the following two years.

Carney and the Treasury Select Committee: Episode One Preview

The new Governor of the Bank of England, Mark Carney, will appear before the Treasury Select Committee for the first time tomorrow. The Committee asked for evidence that could help them with their questioning, and I obliged with the short note reproduced below, which also provides a useful summary of my current views on UK monetary policy which have otherwise been scattered around various posts. However the new Governor’s first appearance might also be an appropriate point to say something about central bank communication in the era of the Zero Lower Bound (ZLB).

Consider the following alternative things Dr Carney might say:

1) At the ZLB there is really nothing more we can do. We have tried QE, which may have helped at the margins, but decreasing returns have clearly set in, and basically monetary policy is now a spent force.

2) The ZLB means we have to do things differently, but we are still able to achieve the goals set for us using a variety of unconventional policies. The instruments have changed, and everything is more uncertain, but otherwise its business as usual.

I’m sure the first statement will never be made, but I think there is a clear danger that something like the second message will be the one conveyed. I know there are some who think, perhaps with the right choice of target, that the second statement is true, but I do not think it is. The following would I believe be the right thing to say:

3) At the ZLB there are still actions that the monetary authorities can take to try and stimulate demand. However there may be limits to this ability, which means that monetary policy can no longer ensure that the output gap falls to zero and that we hit our inflation target. This needs to be understood when other policy decisions are taken.

It is the right thing to say not only because it is nearer the truth, but also because it is the best way to protect central bank independence in the long run.

I was also going to say something on helicopter money, prompted by the following from a leader in the FT today:

“Demand stimulus by helicopter money need not be more inflationary than other types. It could be less so, since by definition it does not come with a built-in expectation of future reversal through tax rises (unlike public borrowing) or monetary tightening (unlike quantitative easing).”

However I realise it requires a whole post to cover all the reasons why this makes no sense, so here is my piece for the select committee, in which no helicopters appear.

1. Monetary policy has two objectives: to stabilise inflation at an acceptable level, and to try to eliminate any output gaps. As a result, academic work on monetary policy has two ultimate goals for monetary policy: to minimise excess inflation and to minimise the output gap. Views about the relative importance of these two objectives vary, and our knowledge here is very partial, but both objectives matter.

2. The current UK monetary policy regime places one of these objectives - targeting inflation - above the output stabilisation objective. This is in contrast to the regime in the United States, which has a ‘dual mandate’, which essentially corresponds to the two objectives outlined above. So why have in the past most macroeconomists, including myself, been relatively content with focusing on inflation as the primary policy objective?

3.  The most important reason was that these inflation targets were interpreted in a flexible manner. (The regime is often called flexible inflation targeting.) Specifically the Bank of England has interpreted this flexibility as trying to hit the inflation target in two years time. The general view was that over this kind of time frame, hitting the inflation target would be consistent with closing the output gap. So although minimising the output gap was not a primary policy objective, that objective would be fulfilled under flexible inflation targeting. The theory behind this view is that inflation is ultimately determined by a Phillips curve, which implies inflation will only be stable in the long run if the output gap is zero.

4. Recent UK experience has unfortunately shown that view to be seriously incomplete. Inflation has been persistently above target, yet output is well below its sustainable level.[1] The MPC has currently set policy to achieve the inflation target in two years time, but it does not expect the output gap to come near to being closed in two years time. So the inflation objective is overriding the output gap objective.

5. There are probably two reasons why we now have a conflict between hitting the inflation target and closing the output gap. The first could be called bad luck. The UK economy has been hit by a series of positive inflation shocks: a large depreciation with lagged effects, increasing commodity prices, and increases in certain government charges and taxes. The second is more fundamental and also more a matter of conjecture. When inflation is low, high unemployment appears to have a smaller downward influence than when inflation is higher. One obvious reason for this is that workers are particularly resistant to nominal wage cuts.

6. Whatever the causes, there is now a clear conflict between what a sensible UK monetary policy would be doing and what is actually happening. Monetary policy is not providing enough stimulus to the UK economy, because it is focusing on the inflation target, and not the output gap. Inflation targeting in the UK is not working, and something needs to change.

7. Some commentators suggest that a change in personalities may be sufficient to deal with this problem. I think this is quite wrong. It is clear to me that the MPC takes the Bank’s interpretation of inflation targeting very seriously. It was put very well by Adam Posen in his recent (22nd Jan 2013) evidence to this Committee: “anyone who was on the [MPC] basically took the equivalent, in my opinion, of an oath of office. They were serving on the committee under the terms of the given inflation target.” Posen was generally a ‘dove’, not because he wanted inflation above the target, but because he thought inflation would come down more quickly than others.

8. For this reason, I do not think the MPC would be able to do what the US Fed is currently doing with monetary policy. The Fed has said that they are willing to see inflation go (a little) above their 2% target in order to get unemployment down. I believe the MPC would regard that as violating their remit. It would be useful if the Committee could see if the new Governor takes a different view.

9. If I am right, some change (or official reinterpretation) in the UK monetary regime has to take place. There appear to be three types of change that could be explored: moving to a dual mandate, looking at other measures of inflation, or getting rid of the inflation target completely.

10. Perhaps the most straightforward change would be to make monetary policy in the UK more like policy in the US, by adding an output gap or unemployment objective alongside the inflation target. It would not be necessary, and given current uncertainties it would not be desirable, to specify a particular number for unemployment or output. Instead the MPC could be charged with ensuring output was at a level consistent with long run inflation stability, or some similar phrase. The risk that this change would lead us back to the 1970s is zero. What this change would enable the MPC to do is allow inflation to be above target in 2 years time if they expected the output gap to persist.

11. Another possibility would be to stay with an inflation target, but to broaden the range of inflation measures that were looked at. There is no reason from economic theory why consumer price inflation is the ‘right’ inflation measure to target, and other measures (like output prices, or wage inflation) may be at least as relevant. Unfortunately the series of positive inflation shocks the UK has recently experienced have their maximum impact on consumer prices. Monetary policy in the UK would now be very different if the inflation target was for earnings growth - and there is no reason in terms of the macroeconomics why it should not be.

12. Both these suggestions have one apparent disadvantage: we lose the simplicity and clarity of a single target. By specifying more than one target, and not specifying the trade-off the MPC should use when the targets conflict, we are leaving more to the discretion of the MPC. However, such a regime would still give less discretion to the MPC than monetary policymakers in the US or Eurozone currently have. The targets would still be set by the Chancellor.

13. The third alternative is to replace a single inflation target by a single target for something else. Targets for nominal GDP have been widely canvassed. It is absolutely vital that here a clear distinction is made between targets for nominal GDP growth, and targets for the level or path of nominal GDP. It is the latter that many economists have recently suggested might offer some clear advantages over inflation targets, and which were discussed in a recent speech by the new Governor.

14. As some eminent macroeconomists, like Michael Woodford, have been arguing for the advantages of such ‘history dependent’ targets for some time (well before the recession), a debate on their merits is overdue. Although this issue is widely discussed in the US, we have very little discussion in the UK. This may be because the natural host for such a discussion would be the Bank, but the Bank has felt that it would be inappropriate for it to question its own remit. I hope the new Governor does not take that view, and it would be useful for the Committee to ask him about this. If the Bank, under its new Governor, still felt it inappropriate for it to lead a discussion on the merits or otherwise of NGDP targets, then the Committee itself should think about undertaking this role.

15. While I would welcome an extensive discussion of this type, it would be unfortunate if that debate put on hold any change in UK monetary policy. As I have argued above, policy is providing insufficient stimulus to the UK economy now, because of the form of the current monetary policy regime. Changes could and should be made to that regime now, without in any way prejudicing the results of a more extensive debate on NGDP targets. That is why I think it is important to address the possibility of moving to a dual mandate, or looking at alternative inflation measures.  

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[1] Macroeconomists use almost as many names for this sustainable level as there are estimates for its magnitude (natural rate, NAIRU, natural level, output potential...), but unless anyone wants to suggest that none of those currently unemployed are capable of working, there can be no doubt that UK output is currently below this level.