Uber and the anti-regulations bandwagon

The news that Tfl, the regulatory body for transport in London, had banned Uber because of regulatory failures brought out the usual suspects to support or condemn the move. In addition, the company organised an online petition to reverse the decision, which half a million people have signed. Tyler Cowen declared: “The new Britain appears to be a nationalistic, job-protecting, quasi-mercantilist entity, as evidenced by the desire to preserve the work and pay of London’s traditional cabbies”, and plenty of others took a similar line.

What always strikes me on these occasions is how people can jump to conclusions without any evidence. Now it is certainly true that licensing authorities can be captured by, and therefore favour, incumbents and therefore stifle innovation. They can artificially restrict numbers to drive up prices, although Tfl do not do this. But the fact that this happens sometimes does not mean it is happening every time. Equally companies like Uber can believe that they are so big and popular that they can ignore regulations, regulations which are designed to make the market work. [1]

It is important to note on this occasion that Uber have not complained about the regulations. Instead they initially said they had complied with them. Surely the time to write articles condemning Tfl’s decision is after Tfl lose the appeal brought by Uber in the courts.

However there is public evidence in this case. We do know the that as recently as August, a Metropolitan Police Inspector wrote to TfL about his concern that the company was failing to properly investigate allegations against its drivers. Between May 2015 and May 2016 the police investigated 32 drivers for rape or sexual assault of a passenger. It appears there has been at least one case where the police allege UBER allowed a driver that had been accused of sexual assault to stay on their books, leading to another ‘more serious’ attack on a woman in his car. Here is part of the inspector’s letter:

“My concern is twofold, firstly it seems they are deciding what to report (less serious matters / less damaging to reputation over serious offences) and secondly by not reporting to police promptly they are allowing situations to develop that clearly affect the safety and security of the public.”

Uber’s boss yesterday apologised for the mistakes they had made. Whether these mistakes are serious enough to warrant revoking Uber’s license the appeals process will decide, or most likely Uber will be allowed a new license on condition that they start taking regulations seriously.

What worries me in this case is the lack of any self-awareness of those who piled in to condemn the regulator without any evidence. Ten years ago the world experienced a devastating financial crisis that was due, at least in part, to a failure of regulations and regulators to do their job that was in turn due to political pressure from those who took a similar attitude to regulations as those championing Uber. And just three months ago around 80 people lost their lives in London from a fire that almost certainly was the result of a failure to comply with regulations.

Regulation bashing has since the financial crisis become one more example of neoliberal overreach. When the two political parties that brought us neoliberalism have today brought us Brexit and a President who seems to want to start a nuclear war, it is time for neoliberals to be thinking about reform rather than just playing the same old tune. Thinking about all that and the 500,000 who signed the pro-Uber petition brought to mind a song of a well known nobel laureate called Talking WWIII Blues, the last verse of which is

Well, now time passed and now it seems

Everybody’s having them dreams

Everybody sees themselves

Walking around with no one else

Half of the people can be part right all of the time

Some of the people can be all right part of the time

But all of the people can’t be all right all of the time

I think Abraham Lincoln said that

“I’ll let you be in my dreams if I can be in yours”

I said that

[1] There is also the question of why Uber rides are cheap, and whether it is making losses simply to drive out the competition, but that is a different issue. 

Is deficit fetishism innate or contextual?

In a couple of interesting posts, Jonathan Hopkin and Ben Rosamond, political scientists from the LSE and Copenhagen respectively, talk about ‘political bullshit’. They use ‘bullshit’ as a technical term due to Princeton philosopher Harry Frankfurt. Unlike lying, bullshit tells false stories that pay no heed to the truth. Their appeal is more to common sense, or what Tyler Cowen calls common sense morality. At a primitive level it is the stuff of political sound bites, but at a slightly more detailed level it is the language of what Krugman ironically calls ‘Very Serious People’.

The implication which can then be drawn is that because bullshit does not reside in the “court of truth”, trying to combat it with facts, knowledge or expertise may have limited effectiveness. The conditions under which this might be true, and the extent to which information technology impacts on this, are fascinating issues which the authors briefly discuss. But what makes their discussion even more interesting for me is that they use what they call ‘deficit fetishism’, and in particular the stories that the UK government told before the last election, as their subject matter.

In the case of fiscal policy, deficit fetishism as bullshit involves appeals to ‘common sense’ by invoking simple analogies with households, often coupled with an element of morality - it is responsible to pay down debts. The point in calling it bullshit (in this technical sense) is that attempts to counter it by appeals to facts or knowledge (e.g. the government is not like a household, as every economist knows) may have limited effectiveness. Instead it might be better to fight bullshit with bullshit, by talking about the need to borrow to invest, or even that it is best to ‘grow your way out of debt’. (If you think the latter is nonsense, you are still in the wrong court: the court of truth rather than bullshit. As long as the phrase contains what I have sometimes called a ‘half-truth’, it has the potential to be effective bullshit.)

If for the sake of argument we accept all this, I want to ask whether deficit fetishism will always be powerful bullshit, or whether its force is a symptom of a particular time, and what is more a time that may by now have passed. This, rather than discussions of the technical merits of particular fiscal policies, may be the crucial political discussion that needs to take place right now for all those in Europe that want to put an end to needless austerity. (In the US deficit fetishism, and also austerity itself, seems to be taking a breather or having a prolonged rest: which may depend on the forthcoming elections.) Just to be clear, I’m not discussing bullshit more generally, but just the appeal of the particular example of deficit fetishism.

At first sight deficit fetishism seems to be innate, because it appeals to the basic intuition of the household and the morality of good housekeeping. However households also borrow to invest (such as in a house), and most people understand that this is what firms also do. The reason why the bullshit involving paying back borrowing may have been particularly powerful over the last five years is that this is exactly what many households have also been doing.

Although the Great Recession may have started with a financial crisis, its persistence despite low real interest rates is often put down to what many economists call a balance sheet recession: individuals and firms cutting back on borrowing (or saving more) over a number of years. That process has been particularly evident in the US and UK, with sustained increases in the aggregate savings ratio. However that process now appears to have come to an end. As individuals start to borrowing again (or at least stop running down their debt), perhaps they will become more tolerant of governments doing the same.

To this we could add an obvious external factor. In 2010 and the following two years, deficit fetishism seemed to be validated by a superficial view of external events. The difficulties that some countries were getting into because their governments had ‘borrowed too much’ was top of the news night after night. In that context, is it any wonder that most people believed the bullshit?

One final indication that the power of deficit fetishism is contextual is what economists call deficit bias. Before the Great Recession, there was a tendency in many countries for government debt as a share of GDP to rise over time for no justifiable reason. Fiscal rules and then fiscal councils were created largely to prevent this. It is difficult to square this phenomenon with the idea that deficit fetishism is always powerful.

Many political parties on the centre left in Europe (such as the UK) currently seemed resigned to deficit fetishism remaining a powerful force that can sway elections. So, if you cannot beat them, join them (and never mind what is good macroeconomics). This assumption at the very least seems debatable.

Faith based macroeconomics

When you just know something is true, like fiscal policy never matters much and NGDP targeting would have avoided the Great Recession, everything becomes about proclaiming your faith in the most effective way possible. It becomes a debating contest. The best example I know of someone like this is Scott Sumner. Here is what he had to say about something I wrote recently.

“Simon Wren-Lewis also gets the GDP growth data wrong, in a way that makes austerity look worse. He claims that RGDP growth was 2.3% in 2012 and 2.2% in 2013 (the year of austerity in the US.) But that’s annual y-o-y data, and since the austerity began on January 1st 2013, you need Q4 over Q4 data. In fact, RGDP growth in 2012, Q4 over Q4, was only 1.67%, whereas growth in the austerity year of 2013 nearly doubled to 3.13%.”

The italics are mine. When you read that someone got the data wrong, or that they claim the data is whatever, you expect to find that they made an excel error, or used old data. But Sumner is not using ‘wrong’ and ‘claim’ in their ordinary sense. He is in debating mode. What he means is that by choosing to use the (correct) annual data, I’m (accidentally, deliberately?) hiding something important. He then quotes two figures that supposedly prove his case. No analysis, no graphs – it’s a debate.

Well here is a graph of US real government consumption expenditure and gross investment, taken from FRED.

According to Sumner “austerity began on January 1st 2013”. Now look at the graph.

It gets worse. Tyler Cowan quotes from Scott’s post with approval, I guess because the guy shares the faith.

Now do you really want to follow those whose macroeconomics is so faith based that they do not even need to check the numbers? Do you want to follow someone who says (earlier in the post) “it would be useful to do a more systematic study of fiscal austerity”. What about the many studies that have already been done (e.g. here, here or here). Do they not count because they generally find that fiscal policy can matter a lot, and so fail to accord with the faith? Do you want your macroeconomics derived from faith or from careful academic analysis?  

Understanding Anti-Keynesians

Paul Krugman says Keynes is slowly winning. Tyler Cowen says no, there is lots of evidence Keynes is still losing. If this strikes you as slightly juvenile, I don’t blame you. Squabbling over the relevance of some guy who died nearly 70 years ago does make the academic discipline of macroeconomics seem rather pathetic.

Now, as you probably know, I’m not a neutral bystander in this debate. However I have always thought it important to try and understand where the other side is coming from. Leaving aside the debating points, what deep down is the core of the other side’s beliefs? But before addressing that, we need to be clear what we are arguing about. Let me single out three Keynesian propositions.

1)    Aggregate demand matters, at least in the short term and in some circumstances (see 2) maybe longer.

2)    There is such a thing as a liquidity trap, or equivalently the fact that there is a zero lower bound to nominal interest rates matters

3)    At least some forms of fiscal policy changes will impact on aggregate demand, and therefore (given 1), on output and employment. Because the liquidity trap matters, when interest rates are at their zero lower bound we should use fiscal policy as a stimulus tool, and we should not embark on fiscal austerity unless we have no other choice.

If propositions (1) and (2) strike you as self evidently correct, you might accuse me of drawing the lines in this debate in a biased way. I would of course agree that they are correct, but I would also note that there are large numbers of academic macroeconomists (don’t ask me how many) who dispute one or both of these ideas. Tyler Cowen in the post cited above talks about a ‘so-called’ liquidity trap in the context of the UK.

Many macroeconomists - particularly those involved in analysing monetary policy - did think as recently as ten years ago that there was a broad academic consensus behind both (1) and (2). I was one of them. There was talk of the new neoclassical synthesis (pdf). This idea that there was such a consensus fell apart when a number of prominent academics objected to governments using fiscal stimulus in 2009.

This suggests (3) is at the heart of the dispute. However my reason for including (1) and (2) is that if you accept these two points, point (3) follows pretty automatically. I was careful in formulating (3) not to claim that fiscal policy should become the only or main stimulus tool: exactly what role it should play alongside Quantitative Easing or other forms of ‘unconventional’ monetary policy - including those analysed by Keynesian macroeconomists - remains unclear and can be reasonably debated. As I have noted before, the two sides are not symmetrical on this point: while most Keynesians are happy for central banks to undertake various forms of unconventional monetary policy, the aversion on the other side to using fiscal policy seems more absolute.

It is here that I have a difficulty. It seems to me in a mature, ideology free science we would be discussing - when in a liquidity trap - the relative merits of alternative forms of monetary and fiscal stimulus. It would also be generally agreed that, given the uncertainties involved with all forms of unconventional monetary policy, now was not the time to undertake austerity. But that is not the discussion we are having. Why not?

An easy answer is that it is all political or ideological. Just as politicians can use fears about debt as a means of reducing the size of the state, so antagonism against fiscal stimulus comes from the same source, or an ideological aversion to state intervention. That in my view would be a sad conclusion to draw, but it may be naive to pretend otherwise. As Mark Thoma often says, the problem is with macroeconomists rather than macroeconomics.

I can think of two alternative explanations that might at least apply to some anti-Keynesians. The first comes from thinking about the importance of money to macroeconomics. Money is very important, and indeed you could reasonably argue that the existence of money is critical to point (1) above. The mistake - in my view - is to therefore feel that monetary policy has to be the right way to stabilise the economy. It makes you want to believe that (2) is not true. This seems to me to have nothing to do with ideology.

The second is historical. I suspect we would not even think of questioning the central role of Keynesian ideas for macroeconomics today if it had not been for the New Classical revolution in the 1970/80s. This revolution was successful in the sense that it did change the way academic macroeconomics was done (microfoundations and DSGE models). Most academic macroeconomists - for better or worse - are deeply committed to that change. But the revolution was opposed by many in the Keynesian consensus of that time, and so Keynesian economics became associated with the old fashioned way of doing things. This association was encouraged by many of the key revolutionaries themselves. We now know, as a result of the development of New Keynesian economics, that there is no necessary incompatibility between the microfoundations approach and Keynesian ideas. However I suspect that, at least for some, the association of fiscal policy with old-fashioned Keynesian ideas set down deep roots. It certainly seems that some notable academics were surprised that New Keynesian models actually provided strong support for the use of countercyclical fiscal policy in a liquidity trap.

I should really stop there, but having started with Tyler Cowen’s post, I really should say something about his comments on the UK. The basic facts are very simple. We had significant fiscal contraction in financial years 2010/11 and 2011/12, which then stopped or at least slowed significantly. The UK recovery was erratic from 2010 to 2012, and only reached a steady pace in 2013. That is entirely consistent with the importance of fiscal policy in a liquidity trap. (The OBR calculate that austerity reduced GDP growth by 1% in 2010/11, and by 1% in 2011/12, with little impact thereafter.) Quite why the obvious fact that other things besides fiscal policy are important in explaining growth in any year is thought to be an anti-Keynesian point I cannot see. And if the case against Keynesian ideas rests on the incorrect forecast once made by a prominent Keynesian then this is really scraping the barrel. 

Confusing levels and rates of growth

It was entirely predictable. Once growth returned to the UK economy, those with a political axe to grind, but also some who do not, and even some who should know better (uneconomical has a good detailed response), will start saying that any aggregate demand problems have gone away. The simplest argument suggesting otherwise is NIESR’s well known chart, the latest version of which is reproduced below.

Of course this does not prove that the UK still has an aggregate demand problem. Perhaps something unprecedented has happened to UK supply over the last five years. After all, consumer price inflation (CPI) is still above target. Well, as I pointed out here, CPI was above target in 2008, and 2009, and 2010 ….. so unless you want to suggest that the UK never had an aggregate demand problem, the behaviour of the CPI today is not very reliable evidence.

The main point, however, is that aggregate demand problems are about the level of GDP, not its rate of growth. In a demand induced recession, aggregate demand will fall: consumers start saving more; firms reduce the level of investment etc. As a result, resources are underutilised, the clearest indication of which is an increase in unemployment. We start a recovery when aggregate demand starts rising again at a rate that exceeds the rate of growth of underlying supply (labour force growth and technical progress). That might have just started in the UK.  GDP growth in the last quarter was 2.4% at an annual rate, which if you were pessimistic might be above trend. The chart shows the recovery started in 2010 but then stopped, but better late than never.

However that is just the start of a recovery. As the chart again shows, we should really be looking for rates of GDP growth of 4% or more if we are going to start utilising those resources which are currently being wasted (i.e. if we want to reduce unemployment). The aggregate demand problem only disappears when those resources are utilised again, and unemployment goes back to its non-inflationary rate (NAIRU). (And no, CPI inflation does not tell us that has already happened - average earnings are increasing at rates well below CPI inflation, which strongly suggests unemployment is well above the NAIRU.) As yet, falls in UK unemployment have been tiny relative to the increase that occurred during the recession.

UK Unemployment

If this all sounds too ‘Old Keynesian’, we can retell the story in New Keynesian terms. In a recession the natural real rate of interest falls below the level the actual rate can reach. Whatever shock caused the fall in the natural real interest rate (initially a need to adjust balance sheets, later compounded by fiscal austerity and a Euro recession), that shock can gradually dissipate, allowing the economy to grow. However, the aggregate demand problem only disappears when the natural real interest rate rises to equal the actual real interest rate. We should know when that happens because unemployment will fall to the NAIRU. Recessions do not just last as long ‘as it takes prices to adjust’, because we are at the zero lower bound.

The reason why this is so important is that it may be too easy to settle into a political equilibrium, where the economy is growing roughly at trend, but unemployment is not falling. It is a political equilibrium because the unemployed have very little political voice, and sections of the media encourage politicians (I’m being as polite as I can here) to label the unemployed as workshy. This may not have happened in the US since the war, but with fiscal policy being tightened as a result of Tea Party fundamentalism it could well do this time. In the UK there are some similarities with the 1980s, when unemployment stayed above 10% until near the end of that decade. Luckily no one in the UK has started arguing that current levels of unemployment are ‘structural’, but given the rhetoric about strivers vs skivers it will not be long before they do, and of course if you wait long enough to reduce unemployment you are in great danger of creating a structural problem.

So we will stop having an aggregate demand problem when unemployment falls to near pre-recession levels, and (assuming rational monetary policy) nominal interest rates start rising significantly. It would be great if that happened very quickly because of rapid growth, and while I can think of reasons why that might be unlikely, I know enough about forecasting to know it is also quite possible. However that will have no impact on the costs of austerity that have already been incurred, which is why I wrote my ‘final verdict’ on the current Chancellor six months ago.

Even earlier, over a year ago, I wrote this: “come 2015, the spin “we have done the hard work and the strategy has worked” will accord with (relatively) strong growth, while talk of output gaps and lost capacity will have less resonance. True, unemployment will still be high, but not many of the unemployed are Conservative voters, and the immunising spin about lack of willingness to work can be quite effective.” Paul Krugman described this post as ‘remarkably cynical’. I fear it will be one of my better forecasts.  

Multipliers, inflation and another response to Tyler Cowen on UK austerity

Tyler Cowen points us to a nice paper by Emmanuel Farhi and Ivan Werning on multipliers. The authors had been good enough to send me a copy earlier, so I can respond quickly. The paper contains some neat analysis, but I just want to focus on one point that Tyler mentions, which may appear counterintuitive at first, but is in fact quite a simple idea. I then want to argue against the implications for the UK that Tyler draws.

The authors focus on the ‘consumption multiplier’, which is the impact of government spending on consumption. So in a closed economy a consumption multiplier of zero is a government spending multiplier of one (there is no capital). This point is not clear from Tyler’s post.

As I have discussed before, and various papers by Eggertsson and Woodford (among others) have explored in detail, at the zero lower bound the consumption multiplier can be positive because higher output raises inflation which reduces real interest rates. The point the authors make is that the further into the future the increases in government spending are, the more powerful is this effect (as long as the zero lower bound constraint is still there). This may seem odd, but it follows simply from the properties of the New Keynesian Phillips curve.

Suppose I can increase output today or tomorrow. The New Keynesian Phillips curve basically says inflation today depends on expected inflation tomorrow and the output gap today[1]. Additional output tomorrow will raise inflation tomorrow. However it also raises inflation today because it raises expected inflation. Higher output today only raises inflation today. So for given nominal interest rates, higher output tomorrow gives me two periods of lower real interest rates, while higher output today just gives me one. A one-off addition to government spending tomorrow, because it raises output tomorrow, gives me a greater impact on real interest rates and therefore consumption than the same one-off increase in government spending today.

Does this have any new implications for the debate of UK austerity? I see things very differently from Tyler. Let’s take his initial points in turn.

1. This is where the confusion over the output and consumption multiplier comes in. Suppose we are highly uncertain about the impact fiscal or monetary policy has on inflation right now. That makes monetary policy’s impact very uncertain, but with government spending on domestic goods you get an output multiplier of one for sure.
2. Again, this is the inflation effect, where fiscal tightening reduces inflation, which at the zero lower bound raises real interest rates, leading to an appreciation. However, as Tyler notes, at the same time as 2010 austerity we also had positive inflation shocks. Furthermore, we have little idea of what caused the 2008 depreciation. So movements in the real exchange rate are not a very reliable indicator of anything.
3. I’m not quite sure what advice is being referred to here. What I would take from the timing point discussed in the paper is that you cannot ignore the impact that announcements of future austerity can have on output today. Expectations matter in macro. Those who say most of the cuts have not happened yet so they cannot explain weak UK output ignore this point. What opponents of austerity like me have been arguing for is postponing cuts until a recovery eliminates the zero lower bound constraint. Without that constraint, monetary policy can in principle completely offset the impact of any cuts on output.
4. Not guilty – indeed I have stressed how price stickiness is not the issue at the zero lower bound.
5. Again not guilty – indeed this cannot apply to anyone who uses New Keynesian theory, as the New Keynesian model is an elaboration of the RBC model.

I’ll stop there, except to make two comments. First, the conclusion that Tyler draws just does not stand up. The paper by Farhi and Werning, like much of the literature that this paper refers to, some of which I have talked about before, uses fairly standard New Keynesian models. New Keynesian models imply cuts in government spending reduce output at the zero lower bound. My discussion of this has been as transparent as I can make it. I also take great exception to the implication in (5) that I pick and choose which theory I use in order to support a particular policy position.

Second, there is a lot more that is interesting and important in the Farhi and Werning paper, particularly concerning policy in a monetary union, and I hope to talk about that in a later post.

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[1] It is not exactly the output gap in most models, but this complication is not crucial here.

In partial defense of Cyclically Adjusted Deficits

Tyler Cowen and Nick Rowe both make some good points on the use (or misuse) of cyclically adjusted budget deficits. However there is a danger in moving from ‘we have to be careful in using this concept’ to ‘we should not use this concept’. I think we can ask two questions here. First, when is it better to look at the cyclically adjusted deficit (let’s call it the CAD) than the actual deficit, and second when is it better to look at something else.

The main reason for the focus on CADs is quite simple. It is to stop people writing “because of the recession there is a black hole in the government’s accounts, so they will have to raise taxes or cut spending”.[1] Very crudely, there is the idea here that good policy involves balancing the actual budget. I would claim it is better policy to balance the CAD. The first switches the automatic stabilisers off, which makes the recession worse. Of course what people write would not matter if policymakers were wise to this, but unfortunately they are often not.

Nick Rowe says lets imagine two countries facing the same recession. The first has automatic stabilisers, but the second does not, so there the deficit does not increase as a result of the recession. However the second government undertakes discretionary action that mimics what happens in the first country that does have automatic stabilisers. So both countries are in exactly the same position, with the same actual deficit, but the second has a positive CAD whereas the first does not. Looking at the actual deficit tells us correctly they are doing the same thing, but looking at the CAD implies the second country is doing something wrong.

This means we need to be careful when the degree of automatic stabilisation might vary. I think this is well understood. It might be foolish, for example, to look at the US and Germany, and make inferences about how much fiscal policy is supporting activity based on comparing CADs. But for a given tax and benefit structure, it does nothing to invalidate the key point that it is better to balance the CAD than the actual deficit.

Now of course calculating the CAD is difficult, particularly when there is great uncertainty about the size of the output gap. But this calls for sensitivity analysis, not abandoning the attempt. It is true that uncertainty over the output gap means in theory that balancing the CAD could be worse than balancing the deficit, if we get the cyclical adjustment completely wrong, but I think that is very unlikely in practice. Here the UK is a great example. Last year the OBR revised down its estimate of potential output, and because the government's main fiscal rule targets the CAD, it tightened its future fiscal plans as a result. Now there is a great deal of debate about whether the OBR was right, but imagine what would be happening instead if the government was targeting the actual deficit. 

But while balancing the cyclically adjusted deficit is better than balancing the actual deficit, it is hardly an optimal policy. Here Nick Rowe’s example yields a deeper point. Presumably there is an optimal response to a recession, and that optimal response will certainly depend on many factors (like whether we are in a liquidity trap). The chances that this response is exactly the one that would occur using just the automatic stabilisers must be very small (particularly as the automatic stabilisers are largely independent of these factors). What we should care about is getting this optimal response right, and the mix between it happening automatically and manually (through discretionary action) is a secondary concern.

I also 100% agree with the point that budget deficits (cyclical or otherwise) may be very crude measures of the aggregate demand impact of fiscal policy. I never miss the opportunity of saying that fiscal policy is not one instrument, but many instruments with quite different effects. The example I like to use is a pre-announced increase in sales taxes. This may reduce the deficit when it is implemented, but before that it stimulates aggregate demand. In contrast, a pre-announced increase in income taxes will reduce demand before it comes into effect. However, before they are implemented the direct effect on the budget deficit of both is zero!

To sum up. When the idea that we should raise taxes or cut spending just because there is a recession is regarded as uneducated lunacy, and when fiscal councils routinely provide assessments of the aggregate demand impact of budget measures, and when people stop saying that Greece is not doing enough because it’s not meeting its actual deficit targets, then I think we can dispense with the cyclically adjusted budget deficit. I really do look forward to that day.

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[1] I think the use of the analogy with a black hole in this context is a peculiarly British habit. It makes no sense as far as I can see, and for some reason irritates me immensely. 

The UK and Austerity: some facts

There has been some recent debate about whether UK austerity is responsible for the poor performance of the UK economy (which remains poor, despite the Q3 growth numbers). The debate could be summarised thus:

Austerity Critics (e.g. Paul Krugman): “The UK has gone for strong austerity, and since it did so GDP has stagnated – told you so.”

Austerity Apologists (e.g. Tyler Cowen): “But if you ignore tax increases, and public investment, actually there has not been much austerity. The weakness of the UK economy reflects other factors.”

So, for those who are confused, here are some facts.[1]

Austerity can involve tax increases, cuts in transfers and spending cuts, so it is natural to look at the overall deficit. As I have suggested before, the best figure for the direction and impact of policy is the cyclically adjusted primary deficit. Both IMF and OECD estimates show substantial austerity.

UK Cyclically adjusted primary deficit

	2010	2011	2012	2013
IMF[2]	-6.1	-3.9	-2.8	-1.5
OECD[3]	-5.8	-4.1	-3.0	-1.9

However any deficit figure may not be a good guide to the aggregate demand impact of policy, because many tax and transfer changes will have smaller multipliers than changes in spending on goods and services. As I noted here, the IMF suggest that UK austerity over the full 2009-2013 period is relatively focused on government spending rather than taxes. However what about 2011 and 2012 in particular? The table below looks at the government spending on consumption and investment numbers that go into the national accounts.

Growth Rates in UK Government Spending on Goods and Services, and Employment

Government consumption		2011	2012	2013
	OBR March	0.3	0.5	-1.1
	OECD June	0.1	-0.7	-1.8
Government investment
	OBR March	-13.0	-5.0	-3.6
Government employment
	OBR March[4]	-4.0	-2.0	-1.9

The OBR’s forecast is quite old, but the new one will not come out until 5^th December. I’ve included the OECD’s June numbers because their 2012 figure is a clear outlier compared to other forecasts, and because many people (myself included) use these forecasts. If they are right it will make a significant difference, but for the rest of this post I’ll assume they are not, and use the OBR numbers.

Government investment makes up only about a tenth of government spending on goods and services (G for short), so putting the two together the OBR numbers suggest a fall in G of 1% in 2011, about flat in 2012 and a fall of almost 1.5% in 2013. So, the ‘contribution to growth’ of G to GDP is to reduce it by a bit more than a quarter of one percent in 2011 and 2013, with no impact in 2012. (OBR forecast (pdf), Table 3.4.)

However this ‘contribution to growth’ number in effect compares what actually happens to a counterfactual in which there was no growth in G. A better counterfactual is if G had increased by, say, 2% a year in each year, which would be a kind of neutral, average sort of figure.[6] On that basis cuts in G directly reduce total GDP by about three quarters of a percent in 2011 and 2013, and by half of a percent in 2012. If the multiplier was only one, these are still big numbers, but if it was two they become really large. It would mean that the UK economy might have grown by over 2% in 2011 rather than by less than 1%, without allowing anything for the impact of higher VAT.

So whichever way you look at it, it seems that austerity has had a major impact on UK growth. Of course other things have been important too, but I’m not sure anyone has actually claimed that austerity is the only thing holding back the UK economy.

But in one important sense this is all beside the point. Those who criticise austerity only require three things to be true:

(1) Austerity is real, rather than something imaginary. The figures above make that clear.

(2) Multipliers at the Zero Lower Bound are significant.

(3) If we had not had austerity, monetary policy would not have offset stronger growth.[5]

This is why the multiplier debate is so important. There is a lovely non-sequitur in Chris Giles FT piece on this recently, which Jonathan and Richard Portes have already commented on. Chris correctly notes that theory suggests that multipliers are larger if interest rates are stuck at zero, and then says “so theory tells us very little about the likely effect of fiscal policy on economic growth”. As I have argued many times, theory is pretty clear that multipliers on G will be greater than one in current circumstances, and could be a lot greater than one. And as Paul Krugman quite rightly keeps reminding us, it is theory that has stood up pretty well since the crisis.  

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[1] My thanks to Jonathan Portes for some discussion on this issue, but I alone am responsible for what appears here.

[2] Source: IMF Fiscal Monitor October 2012 Statistical Table 2.

[3] Source: OECD Economic Outlook June 2012.

[4] Final quarter of financial year, so 2011 figure is actually 2012Q1/2011Q1.

[5] Unfortunately we cannot be certain that (3) is true, as I have discussed before. However we cannot be certain the other way either, which is sufficient in my view to continue to criticise UK austerity. 
[6] Postscript. We are interested in why the UK economy did not grow by, at the very least, 2% pa. So the natural counterfactual is where G grew in line with GDP at 2%. It is nonsense to say that G did not contribute to zero growth because it also did not grow.