Is a flexible labour market a problem for central bankers?

Recessions and milder economic downturns are typically a result of insufficient aggregate demand for goods. The only way to end them is to stimulate demand in some way. That may happen naturally, but it may also happen because monetary policymakers reduce interest rates. How do we know we have deficient aggregate demand? Because unemployment increases, as a lower demand for goods leads to layoffs and less new hires.

A question that is sometimes posed in macroeconomics is whether workers in a recession could ‘price themselves into jobs’ by cutting wages. In past recessions workers have been reluctant to do this. But suppose we had a more prolonged recession, because fiscal austerity had dampened the recovery, and over this more prolonged period wages had become less rigid. Then falling real wages could price workers into jobs, and reduce unemployment. [1]

This is not because falling real wages cure the problem of deficient aggregate. If anything lower real wages might reduce aggregate demand by more. But it is still possible that workers could price themselves into jobs, because firms might switch to more labour intensive production techniques, or fail to invest in new labour saving techniques. We would see output still depressed, but unemployment fall, employment rise and stagnant labour productivity. Much as we have done in the UK over the last few years.

It is important to understand that in these circumstances the problem of deficient demand is still there. Resources are still being wasted on a huge scale. Quite simply, we could all be much better off if demand could be stimulated. How would central bankers know whether this was the case or not?

Central bankers might say that they would still know there was inadequate demand because surveys would tell them that firms had excess capacity. That would undoubtedly be true in the immediate aftermath of the recession, but as time went on capital would depreciate and investment would remain low because firms were using more labour intensive techniques. The surveys would become as poor an indicator of deficient aggregate demand as the unemployment data.

What about all those measures of the output gap? Unfortunately they are either based on unemployment, surveys, or data smoothing devices. The last of these, because they smooth actual output data, simply say it is about time output has fully recovered. Or to put it another way, trend based measures effectively rule out the possibility of a prolonged period of deficient demand. [2] So collectively these output gap measures provide no additional information about demand deficiency.

The ultimate arbiter of whether there is demand deficiency is inflation. If demand is deficient, inflation will be below target. It is below target in most countries right now, including the US, Eurozone and Japan. (In the UK inflation is above target because of the Brexit depreciation, but wage inflation shows no sign of increasing.) So in these circumstances central bankers should realise that demand was deficient, and continue to do all they can to stimulate it.

But there is a danger that central bankers would look at unemployment, and look at the surveys of excess capacity, and look at estimates of the output gap, and conclude that we no longer have inadequate aggregate demand. In the US interest rates are rising, and there are those on the MPC that think the same should happen here. If demand deficiency is still a problem, this would be a huge and very costly mistake, the kind of mistake monetary policymakers should never ever make. [3] There is a fool proof way of avoiding that mistake, which is to keep stimulating demand until inflation rises above target.

One argument against this wait and see policy is that policymakers need to be ‘ahead of the curve’, to avoid abrupt increases in interest rates if inflation did start rising. Arguments like this treat the Great Recession as just a larger version of the recessions we have seen since WWII. But in these earlier recessions we did not have interest rates hitting their lower bound, and we did not have fiscal austerity just a year or two after the recession started. What we could be seeing instead is something more like the Great Depression, but with a more flexible labour market.

[1] Real wages could also be more flexible because the Great Recession allowed employers to increase job insecurity, which might both increase wage flexibility and reduce the NAIRU. Implicit in this account is that lower nominal wages did not get automatically passed on as lower prices. If they had, real wages would not fall. Why this failed to happen is interesting, but takes us beyond the scope of this post.

[2] They also often imply that the years immediately before the Great Recession were a large boom period, despite all the evidence that they were no such thing outside the Eurozone periphery

[3] J.W. Mason has recently argued that such a mistake is being made in the US in a detailed report.

Misrepresenting academic economists

Brad DeLong entered the debate between myself and Unlearning Economics with a post entitled “The Need for a Reformation of Authority and Hierarchy Among Economists in the Public Sphere”. He writes

“Simon needs to face that fact squarely, rather than to dodge it. The fact is that the "mainstream economists, and most mainstream economists" who were heard in the public sphere were not against austerity, but rather split, with, if anything, louder and larger voices on the pro-austerity side.”

The dodge, and I think it is a pretty good dodge, is that politicians and a good part of the media choose the economists they publicise. If you accept that austerity came from what I call deficit deceit - an attempt to reduce the size of the state using the false pretext of deficit reduction - then obviously politicians and their supporters in the media would choose those economists whose views were useful in promulgating that deceit. As the UK discovered during the Brexit debate, even a tiny proportion of economists (8!) can appear much larger if the media gives them much more attention than they deserve.

But the argument remains a dodge in the following respect. How were people outside economics, including much of the non-partisan media, meant to know that particular academic economists were unrepresentative of the majority? Indeed how can even economists be sure of this? I’ve argued that the majority of academic macroeconomists were always against austerity, particularly once the reason for the Eurozone crisis had been resolved by Paul De Grauwe, but the evidence I use to back this up is piecemeal and indirect (see here, pages 3 to 4).

Part of the problem is a certain disregard for consensus among economists. If you ask most scientists how a particular theory is regarded within their discipline, you will generally get a honest and fairly accurate answer. In contrast economists are less likely to preface a presentation of their work in the media with phrases like ‘untested idea’ or ‘minority view’. In macro it also reflects periods in the past, which still resonate today, when there was deep division and antagonism between different groups. This extends to not being sure what is taught at masters level in the top schools: it turned out, when André Moreira and I did the research, that there was more consensus in one key respect (Chicago excluded) than some had imagined.

Part of Brad’s post it seems to me is simply a lament that Reinhart and Rogoff are not even better economists than they already are. But there is also a very basic information problem: how does any economist, let alone someone who is not an economist, know what the consensus among economists is? How do we know that the people we meet at the conferences we go to are representative or not?

To help fill that gap we have in the US the IGM Economic Experts Panel survey, and in the UK/Europe the CFM survey. (The IGM survey has recently started a European version.) The US IGM survey has asked a question about the Obama stimulus package on more than one occasion, and the latest result is here. It is one key part of the evidence for my claim that most academics were and are against austerity.

However all these surveys share a common feature which I find problematic, and which also reflects on Brad’s concern. They are selective, and deliberately designed to only include the academic elite. IGM writes that panel members are all senior faculty at the most elite research universities in the United States. So they tell us not what academic economists think, but what a chosen sample of ‘elite’ economists think. Now if those samples are well chosen, as I think they mostly are for these surveys, that may not matter too much, but how representative they are can always be questioned. It also gives the impression that it is only this elite that are worth listening to when it comes to policy issues, something I think is simply wrong as well as being elitist.

As part of the build up to the Brexit vote, the Observer newspaper commissioned Ipsos MORI to email all members of the Royal Economic Society. 91% of those who responded thought Brexit would have a negative impact on UK GDP in the longer term. As most UK academic economists are RES members, it was therefore possible to say that there was a clear consensus among academic economists that Brexit was harmful. To be able to say this about all economists, rather than just a select few, in my view strengthens the power of the survey. (Some defend elitist surveys because the elite is ‘influential’, but if they influence their fellow economists that will show up in a larger sample.)

I think the experience with austerity and Brexit suggests it is time for national economics associations (like the RES or AEA) to start representing the opinions of economists by conducting such polls of their members under their own initiative. With email addresses the technology makes it easy to do. It is time these organisations started telling both us and the world about what the consensus (if any) is on key policy issues. It would be an important step towards ending the misrepresentation of economists and economics.

Should economics be democratised?

In the continuing fallout from the Brexit vote comes a call to democratise economics. I tend to think about these issues by drawing an analogy between economics and medicine. The reason I like this analogy is that both are stochastic sciences: people are unpredictable in terms of their behaviour and biology, at least in terms of the current state of knowledge. There remains a great deal that is mysterious. Both can use theory to a considerable degree, but both also rely on statistical analysis and experiments/trials. I am happy to acknowledge that medicine is ‘better’ in some sense than economics (although I do not really know, or know how that could be ascertained), but I would argue that any difference is of degree rather than kind.

One other similarity that is worth mentioning because it always comes up: both are hopeless at forecasting. Your doctor will not tell you how long you have to live, and can often only give you a rough idea even if you have a fatal disease. Economists get involved in macroeconomic forecasting not because users think it is accurate, but because it is marginally better than guesswork. But while doctors cannot tell you how long you will live, they can tell you that smoking will be very likely to shorten your life. Equally an inability to do good macro forecasts does nothing to refute the claim that if we make trade with our neighbours more difficult we will do less of it and this will reduce people’s welfare and incomes.

The two subjects are also similar in that key decisions are often delegated to expert committees: in the UK the MPC and NICE, for example. But when it comes to other policy decisions, the two subjects differ. Occasionally government or policymakers clash with medical experts on medical matters, but that is rare. In contrast politicians quite routinely ignore economic expertise, or choose minority views over the consensus. The difference is not hard to explain of course: political interests and economic decisions are often intertwined. This can in turn influence the discipline itself. But if you accept my analogy, this is not good for society. Those who voted for Brexit were told it would produce positive results for them in the long term, and will almost certainly be disappointed.

Is the solution to this to democratise economics? I cannot think of anyone, or at least no economist, who would object to the public knowing more economics. Some might go further, and suggest that knowledge of economics among policy makers is dangerously deficient. I would also agree that sometimes economists can learn from interactions with policymakers or even the public. But when it comes to medicine people generally do not want to know about medical science. What they want to know is what medical opinion is on key issues, and they want policymakers to make decisions that embody that knowledge.

I think the same is true of economics. Most people do not want to know the theoretical basis for why fiscal consolidation when interest rates are at their lower bound is bad for the economy, let alone the arguments that a few make against that consensus opinion. (If you read this blog, you may be an exception to this generalisation.) Instead they want to know what the consensus opinion is and how strong that consensus is. If the economics conflicts with their intuition, they might want to check that economists are answering the same question as they are. This the broadcast media generally fails to do, and the tabloids only do if it suits their political line. There are reasons for this in the way the media works, which I have discussed many times, but it would be negligent for economists to imagine it was not their problem as well.

For example in medicine I suspect you could rely on medics to be able to tell you what the consensus opinion on issues was. Unfortunately that would be less true in economics. But that is partly economists own collective fault, because the number working on subject areas can be quite large and not as well connected as they might be. To take just one example, there seemed to be a widespread perception among macroeconomists that many of the top schools taught little Keynesian economics at graduate level. It turns out according to survey data I and Andre Moriera collected that most schools do teach quite a bit of Keynesian economics.

Which leads to my punchline. Economists need to act more as a collective. We need to regularly survey economists (all economists, not just selected groups) about what they think on key policy issues, recording at the same time whether this is their area of expertise. We need spokespeople to explain any consensus in the media. When policymakers, City economists or think tanks depart from this consensus, these spokespeople need to be aggressive as a discipline in pointing this out, and not leave this to individual academics. Much as the medical profession does when rogue claims become popular. We do not so much need to democratise economics, but to organise it.

Public investment: has George started listening to economists?

I have in the past wondered just how large the majority among academic economists would be for additional public investment right now. The economic case for investing when the cost of borrowing is so cheap (particularly when the government can issue 30 year fixed interest debt) is overwhelming. I had guessed the majority would be pretty large just by personal observation. Economists who are not known for their anti-austerity views, like Ken Rogoff, tend to support additional public investment.

Thanks to a piece by Mark Thoma I now have some evidence. His article is actually about ideological bias in economics, and is well worth reading on that account, but it uses results from the ChicagoBooth survey of leading US economists. I have used this survey’s results on the impact of fiscal policy before, but they have asked a similar question about public investment. It is

“Because the US has underspent on new projects, maintenance, or both, the federal government has an opportunity to increase average incomes by spending more on roads, railways, bridges and airports.”

Not one of the nearly 50 economists surveyed disagreed with this statement. What was interesting was that the economists were under no illusions that the political process in the US would be such that some bad projects would be undertaken as a result (see the follow-up question). Despite this, they still thought increasing investment would raise incomes.

The case for additional public investment is as strong in the UK (and Germany) [1] as it is in the US. Yet since 2010 it appeared the government thought otherwise. Public net investment, which was 3.2% of GDP in financial year 2009/10, has fallen to an expected 1.5% of GDP in 2015/6. We are about to have a spending review where non-exempted departments have been asked to look at cuts of at least 25%. One of those departments is the department of transport, which is responsible for almost a quarter of public investment.

However since the election George Osborne seems to have had a change of heart. First he has implemented Labour’s proposal of a national infrastructure commission, which was in turn one of the ideas of the LSE’s growth commission. If it works it should reduce the number of political white elephants that US economists worry about. Second, he has talked about spending £100bn on these projects before 2020. That is a huge sum: the total for annual gross public investment is currently around £70 billion.

So how do you square £100bn extra public investment with the government’s goal of achieving surplus by 2019/20? Is the £100bn a smoke and mirrors number? We will find out when the Autumn Statement is published. Ignore any numbers quoted by the Chancellor. Instead have a look at the OBR’s figures for net public investment as a percentage of GDP (you can find a time series in their databank here). In the June budget public investment was expected over the next 5 years to stay at or below the 1.5% of GDP figure. If the numbers in the Autumn Statement forecast are significantly above that, we will know that the Chancellor really has started listening to economists.

[1] Postscript. An IMF study on German infrastructure investment is here.

The academic consensus on the impact of austerity

In discussing the forthcoming UK budget, Robert Peston writes:

“And before I am savaged (as I always am) by the Krugman crew of Keynesian economists for even allowing George Osborne's argument an airing, I am not saying that the net negative impact on our national income and living standards of cutting the deficit faster is less than their alternative route of slower so-called fiscal consolidation.

I am simply pointing out that there is a debate here (though Krugman, Wren-Lewis and Portes are utterly persuaded they've won this match - and take the somewhat patronising view that voters who think differently are ignorant sheep led astray by a malign or blinkered media).”

I do not want to disappoint, and as I was about to write something on the macroeconomic consensus on austerity anyway, let me oblige - not in savaging (I leave that to my American colleague in arms!), but in justifying why I think there is such a consensus in the places that count. By consensus I do not mean that everyone agrees - of course not - but that a very large majority do, which probably counts as consensus in economics.

Unfortunately we do not have a great deal of information on what academic economists as a whole think about austerity, but we do have two important survey results which are pretty conclusive. In the US, there is the IFM Forum, which regularly asks a group of distinguished economists - including many macroeconomists - their views on key policy issues. The last poll I have seen suggests that 82% of that panel thought the 2009 Obama stimulus had reduced unemployment, while only 2% disagreed. In the UK, the CFM survey asked a similar question to a smaller group of academic economists, most of whom are macroeconomists. Only 15% agreed that the austerity policies of the coalition government have had a positive effect on aggregate economic activity, while 66% disagreed. That consensus is not universal - it would not apply in Germany for example - but I doubt if anyone would disagree when I say that US economists call the shots as far as academic macroeconomics is concerned. 

This is why economists the world over continue to teach Keynesian macro to undergraduates, and normally not as one ‘school of thought’ but rather as an initial approximation of how the economy actually works. As Amartya Sen so forcefully reminds us, the experience of the last hundred years has earned Keynesian theory this central role.

However we have another, more indirect, source of evidence. If you asked whether there was a standard model for analysing the business cycle among economists in academia and in policy making institutions, the answer would have to be the New Keynesian model. I want to include economists in central banks in particular because they have to put theories of the business cycle into practice on a regular basis. The key macromodels that central banks use to forecast and to analyse policy are Keynesian, and many are New Keynesian. Having worked a great deal with New Keynesian models myself, I also know what they imply about temporary changes in government spending in a liquidity trap (see this paper by Mike Woodford, for example). It may be possible to adapt these models to give you expansionary austerity, but no such adaptations command general or even partial support.

The models used by pretty well all central banks would therefore imply that temporary cuts in government spending were contractionary, absent any monetary policy offset. The governors of the central banks of the UK and US say this publicly. European central bank governors do not tend to say this, and instead continue to advocate austerity despite deflation. The reason why they might do this despite what their models tell them will be the subject of a later post, but I suspect it has little to do with conventional macroeconomics (but see also the point about German academic views above, and Sen’s article). If temporary cuts in government spending are contractionary in a liquidity trap, it follows that it is much better to delay this form of austerity.

I could add repeated arguments from economists at the IMF (e.g. here and most recently here), and now also the OECD (FT here, or ungated here). Of course there are some academic economists who continue to argue that the impact of austerity is expansionary or at least minor - I suspect there always will be, as long as this remains an intense political debate. They would be joined by many City economists, but they are neither unbiased nor the source of any particular expertise on this issue.

This is why, among economists with expertise, there is a clear majority view that fiscal austerity is significantly contractionary in a liquidity trap. That does not automatically mean that the 2010 policy switch was wrong, or that it had a big impact on the UK in 2010-2012: there are additional issues here which I have discussed many times. How damaging to the macroeconomy any additional austerity from Osborne will be also depends on whether we are or will be in a liquidity trap. But the fact that we might well be means that additional austerity now is a big mistake, and on this I believe the great majority of academic macroeconomists and those macroeconomists working in policy making institutions would agree.

As far as the media is concerned, I cannot believe that Robert Peston would disagree that a large section are ‘malign’, given how political this issue is. When I have talked to journalists who have some freedom to report the facts rather than what their editors want them to report, the argument I most often hear is that because this issue is political, they have to report it as a ‘debate’ come what may. I have never had the pleasure of talking to Robert Peston (he is welcome to email at any time), and I would be very interested in how he would respond to the evidence I have laid out. As for the public, the word sheep is his not mine. Would he really argue that the public are independently well informed on these matters, or unaffected by the media’s presentation of this and similar issues? Which is why I will continue to - as he might say - bang on about this, even though my audience is tiny in comparison to most journalists.

Economists vs. Business Leaders?

Today illustrated very clearly why the monthly CFM survey of mainly academic, mostly macro UK economists was such a good idea. (And something that I should have included in this discussion.) I have often written that I thought austerity was only supported by a small minority of UK macroeconomists, but my evidence for this has been much thinner than I would like. Today CFM published their latest survey which asked: “Do you agree that the austerity policies of the coalition government have had a positive effect on aggregate economic activity (employment and GDP) in the UK?”

The response was clear: 15% agreed, 18% neither agreed nor disagreed, and 66% disagreed. As CFM reported: “Ignoring those who sat on the fence, 19% agree and 81% disagree with the proposition. This ratio is unaffected by confidence weighting.”

That was welcome confirmation of my prior, but what was much more important is that the survey came out on the same day as the Daily Telegraph published a letter from 100 business leaders saying exactly the opposite. To quote: “We believe this Conservative-led Government has been good for business and has pursued policies which have supported investment and job creation.” Now of course a letter (organised by whom?) is not a survey, and it is hardly news that Labour has policies that are unpopular with business leaders. Yet the letter was nevertheless the lead item on BBC news today.

However in at least some of the reports I heard that led on the letter ‘news’, the CFM survey was also mentioned. I myself participated in Radio 4’s World at One (about 11 minutes in) as a direct result of the survey. Robert Peston went as far as to ask: “Who to trust - business leaders or economists?” I liked the way he introduced his post:

“Neither business leaders nor economists have a monopoly of wisdom on what's good for Britain or are free from political bias. But it is perhaps therefore all the more important to remember that those paid to think about how best an economy should be run don't necessarily agree with those paid to run companies.”

He might have also added that, probably without exception, we are paid a lot less than business leaders, so the danger that our opinions might be influenced by Labour policies like reintroducing the 50p income tax rate or introducing a mansion tax is perhaps also smaller!

Zero UK Inflation

Today it was announced that UK consumer price inflation hit zero in February. The ONS estimate that we have to go back to the 1960s for the last time this happened. More importantly, core inflation fell back 0.2% to 1.2%, after 0.1% increases in the previous two months. As Geoff Tily points out, if you take out the 0.2% contribution from the decision to raise student fees (which are hardly an indicator of excess demand), then the Governor could be writing a letter to the Chancellor based on core inflation, and not just the actual inflation rate.

The Chancellor is in election mode and so does not care: in fact he says zero inflation is good news, and he just hopes no one asks him why he chose to reaffirm a symmetrical 2% target. For the Bank of England it means the key question is now should they cut rates? As I noted here, optimal control exercises on the Bank’s model and forecast say they should, and I discussed here why there is an additional strong prudential case for doing so.

The point I want to make now is about survey evidence on capacity utilisation. I had a number of memorable meetings with various economists and officials at the Treasury, Bank and elsewhere when the Great Recession was at its height, but the one that left me most puzzled was with one of the more academic economists at the Bank of England. It was at about the time that core inflation started rising to above 2%, despite unemployment being very high and very little signs of a recovery. At much the same time survey measures of capacity utilisation were suggesting a strong recovery, completely at variance with the actual output data. The gist of our discussion was: what the hell is going on!? It was particularly puzzling for me, because I had many years before done a lot of work with survey data of this kind, and back then it seemed pretty reliable.

The problem with the 2010 period was that it was exceptional, and so in that sense it was not that surprising to see surprising things going on. My own pet theory at the time was that the financial crisis had made firms much more risk averse, which made them less likely to cut prices in an attempt to gain market share. Move on to today, and things are perhaps a bit less exceptional. What today’s figures emphasise is that the inflation ‘puzzle’ of 2010/11 has gone away. Levels of inflation are now much more consistent with substantial spare capacity in the economy. However the bizarre behaviour of the survey data has not disappeared.

Here is a nice chart from the ONS, comparing various different measures of spare capacity.

  

What it shows is that labour market indicators suggest an amount of spare capacity well outside the ‘normal’ range from the pre-recession years. In contrast, both hours worked and survey based indicators (the first six measures) suggest the output gap is quite small, and in one case actually positive. As this OBR paper shows, survey measures of capacity utilisation were suggesting a positive output gap as early as 2012.

Faced with this combination of spare capacity in the labour market and firms reporting its absence, a macroeconomist would suggest it could be a consequence of high real wages, encouraging substitution from labour to capital. Firms were fully utilising their capital – hence no spare capacity – but had hired less labour as a result. However a notable characteristic of this recession in the UK has been the high degree of labour market flexibility, with large falls in real wages. One of the more persuasive theories for the UK productivity puzzle, which I outlined here, is that we have seen factor substitution going in the other direction.

Back in 2010, I was reluctant to suggest the survey data were simply wrong, partly because of their past reliability but mainly because inflation was telling a similar story. On the day that inflation hits zero, I think the argument that these survey measures are not measuring what we used to think they measured has become much stronger. But that still leaves an unanswered question - why have they gone wrong, when they worked well in the past? 

On city economists and the FT survey

Tony Yates believes the claim that the 2013 UK recovery vindicates austerity is “twaddle”. It is a politically motivated claim that makes no sense in terms of basic macroeconomics. Yet today we have the results of the FT’s survey of economists, which among other things asked “Has George Osborne’s “plan A” been vindicated by the recovery?”. Chris Giles and Claire Jones report that “A thin majority of 42 to 38 said the chancellor was “vindicated””. (All the FT’s questions and my replies are below.) Confused?

The first point to make is that of the economists surveyed, many gave equivocal replies. For example many pointed out, quite rightly, that Plan A had been put on hold in 2012. So there is a lot of interpretation involved to get that 42/38 split. Second, only little more than a dozen of the economists surveyed were academics: there were far more city economists, plus others from organisations ranging from the Institute of Economic Affairs to the TUC.

So what if we just looked at the replies from academics. Here I counted just two clear Yes responses, from Patrick Minford and Mike Wickens. There were ten clear Nos, and only a few equivocating.

For the much larger number of city economists surveyed, I actually thought the split was more even: as many No as Yes replies, and a large number of neither. Yet that still means that at least a dozen city economists gave a clear Yes.

So this sample clearly suggests a divide in the views of city versus academic economists. Where does this divide come from? Here are some possible answers, with some brief remarks. Sensitive city economists should look away now.

(1) Academics live in ivory towers, whereas city economists work with real data in real time.

(2) City economists are obsessed with short term forecasting, and so find it difficult to take a more considered, analytical view. They may also be more subject to outcome bias.

Remark: I’m biased, but here is a quote from one response: “Certainly, the hysteria among unreconstructed Keynesians about the consequences of “plan A” have been shown to be ridiculous.” And here is the data:

(3) A few city economists may be hired more for their ability to talk rather than for their knowledge of macroeconomics.

Remark: Please note the ‘A few’ in this sentence. Here is another quote: “The return of growth in 2013 … [is] an invalidation of the new [sic] Keynesian assertion that growth could not return during fiscal consolidation.” which would fail in any exam anywhere. A kinder way of making the same point would be that some city economists learnt their trade when RBC models were taken more seriously.

(4) City economists are influenced by the ideology that pervades the city. That ideology says that the financial sector is invariably a force for good, and government generally a force for bad. Advocating austerity fits with that ideology, and also has the advantage of distracting attention away from what caused the recession in the first place, and the massive bail out that the city received.

(5) One idea behind austerity, which is that the markets are poised to punish excessive debt, suits those who ‘are close to the market’ and can therefore interpret its moods.

Here are the FT questions and my replies.

1. Economy To what extent will the UK maintain its recent pace of economic growth in 2014? Will households start to feel better off?

Do not have a clue, and if they are honest neither does anyone else. Consumption, and the associated demand for credit, is the key, and we have very little evidence on this. Whether households 'feel' better off will depend on whether they are better off, which mainly depends on Q5.

2. Sustainability Is the recovery set fair, or will this upswing end in tears? Why?

If by tears you mean hitting supply constraints and inflation rising as a result, I would be surprised if this happens in 2014. My instinct is that there is scope for a substantial recovery.

3. Monetary Policy Will the Bank of England change its forward guidance in the coming year? Should it?

The MPC will change its forward guidance if there is a useful message it wants to get across. If at 7% unemployment there are still no signs of overheating in the labour market, they could well lower this threshold to 6.5% or less.

4. Fiscal policy Has George Osborne’s “plan A” been vindicated by the recovery in 2013 and should the planned pace of deficit reduction continue unaltered?

The economy was always going to recover at some point, so how can a recovery that occurred 4 years after the recession vindicate Plan A? And then there is the fact that the data appears to show Plan A was put on hold in 2012. This is basic economics and data guys - why are you even asking the question? Perhaps you have made the mistake of reading your own newspaper's leaders! 

The second part of the question should therefore be: should policy revert to Plan A now that the recovery has begun? The answer is no, because another dose of austerity will slow the recovery for sure (ask the OBR, the IMF, and pretty well any academic macroeconomist.) As long as interest rates are at the zero lower bound, and there is no problem selling debt, austerity is a major mistake. In 2010 they had Greece as an excuse - what is the excuse now?

5. Labour market and productivity By the end of next year, what are we most likely to be saying about the productivity puzzle?

I hope we will have some more clues about the puzzle, which is really THE issue at the moment. If the suspicions of many in the Bank and elsewhere are correct that this has a lot to do with bank lending to SMEs, we should be asking how we avoid SMEs being so dependent on a few large UK banks in the future.

6. Housing. To what extent does the housing market need to be restrained? If so, what policies might work?

Yes. There are plenty of instruments (but interest rates are not one of them), but a very simple thing both the Bank and the government could do is say that - as the government intends to substantially increase the supply of housing and the MPC will raise interest rates at some point - a large decline in house prices is quite likely over the next decade.

7. Scotland How would a yes vote for independence affect the Scottish economy and the rest of the UK in 2014?

On fiscal matters the negotiating position of an independent Scotland is weak, and as a result arrangements if they keep Sterling will be tough. I would not be surprised if we ended up with a new Scottish currency if Scotland votes for independence. I suspect the SNP know this, but want to avoid admitting it before the vote.