Although this discussion is about the UK, the macroeconomic issues
involved apply equally elsewhere.
Most of the media discussion of Labour’s new fiscal rule presented
before the budget focused on the commitment to balance the current
budget. The media did this because ‘the hook’’ was the
similarity between this aspect of the rule and the rules proposed by
Brown or Balls. As I noted
at the time, no one in the media seemed to want to compare this goal
to the Chancellor’s overall surplus objective, which remains rather
extraordinary.
In some ways this element is the least interesting part of the rule.
Two other key parts are that current balance is a rolling five year
target, and the knockout if interest rates hit their zero lower bound
(ZLB). Both are more difficult to explain quickly in a mediamacro
world where the deficit is considered all important, although at
least with the rolling 5 year target a quick response is that the
coalition government adopted exactly that form of target. If they had
adopted the less flexible target of current balance by 2015, the
economy would have been even more screwed by austerity than it
actually was.
The really new feature of the rule is the knock out. (This was
described as a ‘loophole’ by one political reporter: mediamacro
again.) The rule is deliberately suspended to allow for fiscal
stimulus when interest rates hit their ZLB. How much stimulus?
Whatever it takes to get interest rates to rise above the ZLB. In
Portes
and
Wren-Lewis
we suggest the Bank of England are the obvious people to advise on
this (the size of stimulus, not its form in terms of spending
increases or tax cuts). The focus of fiscal policy switches from
deficit control to stabilising demand, but only because monetary
policy can no longer do that job effectively.
If such a rule had been in operation during the Great Recession, we
would have seen a continuation of the fiscal stimulus we saw in 2009
into later years. That would have meant, for sure, that government
debt would have risen by more than it did, but it would also have
meant, for sure, that output would have recovered more quickly. What
would have happened to the debt to GDP ratio we cannot know for sure,
but the important point is that this does not matter.
It is this last point which is the most difficult to convince people
about in the mediamacro world. In this (imaginary) world, we have to
worry about the deficit because if we do not there might be a
financial panic, with interest rates on government debt rising and
perhaps even an inability to sell that debt. The best response to
this concern is it would not matter even if it happened, because the
Bank of England would buy the debt and keep interest rates on that
debt down. Of course the market panic scenario will not happen
anyway, because there is zero chance that the government will
default, but trying to convince people that the financial markets
will behave rationally after the global crisis is hard.
Many non-economists think creating money to cover the deficit sounds
outlandish, until you point out it is already happening with QE. The
potential size of the QE programme is unlimited. The whole point of
QE is to keep long term interest rates, like the interest rate on
government debt, low. QE happens when short interest rates are at
their ZLB. That it why, when rates are at the ZLB, fiscal policy can
focus on stimulating the economy. [1]
There are some who think that any kind of fiscal rule represents
appeasement of the austerity position. As I discussed in my post
on MMT, I do not think that is very good economics, particularly for
a party (like Labour) that is committed to maintaining an independent
central bank that uses monetary policy to stabilise demand. In that
regime, when you are not at the ZLB, deficit bias is a potential
problem. I think intergenerational fairness is important, and we
shouldn’t ignore it just because the argument is misused to support
austerity. I am reminded of this every time I look at Norway, and
recall how Mrs. Thatcher effectively used oil revenues to cut taxes
rather than build up a sovereign wealth fund. There is a certain
irony that George Osborne’s current policy of going for surplus,
while totally wrong for today, would have been the right policy in
the late 80s and 1990s.
Ellie Mae O'Hagan recalls
how many on the left (in my recollection all shades of the left)
argued that when austerity started to bite there would be a popular
revolt against the policy. That did not happen, in part because of
mediamacro, but also because there was not a clear alternative to
unite behind. Labour tried to have it both ways, expressing worries
about what austerity was doing but also agreeing that the deficit was
a current concern. In Labour’s new fiscal rule we have a policy
that sets out clearly how we should deal with any new crisis, and
also how we should have dealt with the last one. It is a policy the
left should unite behind, because overcoming mediamacro’s obsession
with deficits will not be easy.
[1] You can only do this if the government controls the currency its
debt is issued in. When that does not happen, as many developing
countries have found to their cost, you do have to worry about the
bond markets. That was exactly the problem that led to the Eurozone
crisis, until the ECB came up with OMT.
A more elaborate
argument for countries that do borrow in their own currencies is that
a market panic over government debt would be accompanied by a run on
the currency. Paul Krugman tackles
this, but following discussions with the FTs Martin Sandbu I do plan
to discuss this issue further at some point.
