Very Serious People and the deficit

I'm glad Paul Krugman liked my General Theory of Austerity paper. But he wonders whether I might be missing something, in not explaining why Very Serious People (VSPs) in the US, or mediamacro in the UK, presume that deficit reduction is always a good thing. The constant call for deficit reduction seems to transcends party politics, and furthermore should be something that the wise always promote.

I do talk about the influence of the City/Wall Street and central banks, but perhaps there is something in addition which I talked about in a recent post: deficit bias. Keynes talked about 'practical men' who tended to absorb some of the wisdom of 'academic scribblers' of 'a few years back'. The wisdom in this case was deficit bias: the tendency that many economists discussed before the financial crisis for deficits and debt to tend to rise over time, across cycles.  Perhaps VSPs and mediamacro have absorbed this particular area of academic analysis?

I think you can tell a similar story about academic scribbling of years past when it comes to the roles of monetary and fiscal policy. In the UK George Osborne argued explicitly that the economic consensus was now that monetary policy should deal with stabilising output and inflation, while fiscal policy makers should look after their own deficit. I have called this the consensus assignment. If he, or his advisors, absorbed this piece of conventional wisdom, so may VSPs and mediamacro.

So the headline academic scribbling was governments should control deficits, not the economy, and they are bad at it. Some of the theories put forward to explain deficit bias involve politicians knowingly deceiving voters by pretending tax cuts or spending designed to capture votes were 'affordable', and relying on general lack of understanding of the government finances to not be found out. That gives VSPs and the media more generally a clear role in providing a public service to help counteract the wickedness of politicians. VSPs might even think it was their public duty to constantly advocate deficit reduction to counter deficit bias.

As they say, a little knowledge can be a dangerous thing. Those of us working on the front line of monetary and fiscal interaction, or who had studied economic history or looked at the lost decade in Japan, knew the conventional assignment broke down when interest rates hit their lower bound. We knew that a liquidity trap was absolutely not the time to worry about deficits, and if you did so you would cause tremendous damage. And we were right.

So if you believe this story, the lesson for VSPs and mediamacro is you really need to talk to economists in the front line more often.

Austerity, journalists and the financial sector

The argument that current growth (since 2013 in the UK and maybe from 2014 in the Eurozone) vindicates austerity is ludicrous. Anyone who comes to the debate without existing baggage can see that developments in the UK and Eurozone have been entirely consistent with what academic critics of austerity have been saying. So rather than go over the arguments yet again, let me ask why some people continue to make or support this ludicrous argument.

In some cases asking this question does not tell you a great deal. For George Osborne, for example, you could simply say ‘he would, wouldn’t he’. Still I think there are two interesting points to note: first, here is a Chancellor who feels no inhibition in allowing sound bite to trounce economic logic, and second, he feels confident that he can get away with it, which tells you a great deal about the UK media.

Which brings me to the Financial Times (ex Martin Wolf). Now, to be pedantic, the FT tends not to say outright that current growth vindicates austerity, but instead that George Osborne is justified to claim that it does. Yet this subtlety aside, why do they pursue this line? It would be easy to lump them in with the politicians, but I think that would be both wrong, and miss some important points.

I thought about this partly because of the latest Chris Giles article on the issue (HT Alan Taylor), but also because of Paul Krugman’s comment on my earlier post that discussed the weakness of the European left on macro policy. He makes the point that Obama also showed similar weakness on austerity, and explains this in terms of the influence of what he terms ‘Very Serious People’ (VSP), “whose views on economics tend in turn to be driven largely by the financial industry.” Now at this point I usually add a caveat that there are some good economists who work for financial institutions, but generally the sector’s view on austerity is that it is necessary, and often that it is unlikely to have much impact on domestic output.

Why does the financial sector (the City, or Wall Street, or whatever the equivalent name is in other European countries) have this view? There are probably many reasons, but one that I think is very important is the 2008 recession. This recession should have been disastrous for the influence of finance: the activities of part of the financial sector brought the economy as a whole to its knees, and parts of that sector had to be bailed out with huge amounts of public money. Economists, the public and possibly some politicians began to question whether the continuing financialisation of economic activity might be detrimental rather than helpful to economic growth. No amount of expensive hospitality should have been able to repair that blow to its reputation and prestige.

Of course attempts were made to blame it all on US monetary policy, or global imbalances. The intellectual basis for these alternative stories was pretty thin, but also beyond the academic debate they did not resonate. What was really required was to change the story. The 2010 Eurozone debt crisis was therefore a godsend to finance. The focus was now on the dangers of high government debt, and the necessity of austerity to end this new crisis. Here was a story that certainly did resonate (just look at Greece), and was also an ideal distraction from the problems caused by the financial sector.

I’m not suggesting that one crisis was manufactured to distract from the other. What I am suggesting is that those working in finance understood the importance of changing the story. There was a clear party line, which fitted the dominant ideology. The state bailing out banks is terrible for neoliberalism, while a story based on the evils of excessive government spending fits the ideology perfectly. For VSPs, economic journalists or politicians it was natural to turn to the prophets of finance during the debt crisis, and so any distrust VSPs might have had of these prophets as a result of the financial crisis faded away. Although the level of economic analysis within the FT is generally high, they were perhaps also bound to follow the City/Wall Street line.

On Chris Giles’s article specifically there is much to say, and Jonathan Portes has the patience to say it once more. So let me make just one point. Chris as a good economic journalist recognises that the ‘growth vindicates austerity’ line is nonsense, so instead he tries to accuse the other side of equal mendacity. To see how silly this idea is, consider the following quote:

“It was precisely the chancellor’s fiercest critics who were themselves unable to distinguish between correlation and causation during the period of stagnation and have thereby legitimised Mr Osborne’s rhetorical victory lap. They have only themselves to blame. The lesson to learn is that the economy is complicated and everyone should be deeply sceptical of anyone drawing strong conclusions from simple links that appear momentarily true.”

Of course it is completely the other way around. If there is a simple idea here, it belongs to those who support austerity, and it is the view that monetary policy can always control the level of activity. It was austerity’s critics (beginning with Paul Krugman) who emphasised the complication of nominal interest rates hitting a lower bound. Analysis of austerity based on complex macro models almost always supports the critics view (e.g. here). Criticisms of austerity are rooted in long established theory, while the idea of expansionary austerity or the 90% critical debt level relied on simple correlations.

So Chris, there is no symmetry here between Osborne and most of his economist critics. One of the reasons I started this blog is that I found, perhaps for the first time in my adult life, finance ministers arguing positions which directly contradicted the received wisdom I was teaching undergraduate and graduate students. In an ideal world economics journalists would also recognise when this happens, and tell people about it.