Utopianism and Scottish Independence

In case any of you thought that yesterday’s post seemed way too speculative and a bit too 'lefty' (I think it was just - admittedly rather speculative - political economy: trying to explain an empirical phenomenon involving beliefs by thinking about self interest and ideology), here is an antidote that takes another look at Scottish independence. My cue comes from the excellent George Monbiot, who I always look forward to reading. The quality of most of Monbiot’s writing is so good because it is well researched, and this sometimes leads him to conclusions that are politically uncomfortable for him.

This, as you might have guessed, is a preamble to saying that occasionally he can get things very wrong. In a recent column, Monbiot describes a No vote to Scottish independence as “an astonishing act of self-harm”. What he does is list all the things that are wrong with governance in the UK. It is a long list, and I agree with quite a bit of it. Then he says, in effect, why not vote to be free of all that?

This seems to me like utopianism at its worst. Why should we presume that an independent Scotland would be free of all the things we dislike about the UK? He talks about the UK economy being about “speculation and rent”, “beholden to a corrupt financial centre”, compared to a Scottish economy based on “enterprise and distribution”. Does this assume that much of the Scottish financial sector leaves on independence? If they do not, how long will it be before they use their influence (and the threat of leaving) at Holyrood?

I do not want to suggest that an independent Scotland would not be different from the remaining UK in some ways. But to understand what these ways might be, you need some serious analysis of why the things you do not like in the UK happen, and why they would not happen in Scotland. I would be interested to see analysis of this kind, and I hope I would be prepared to change my view about what is in Scotland’s interests as a result.

But there is an uncharacteristic lack of analysis in this article. He writes “The monetary policy committee is based in London and bows to the banks.” That really is nonsense. He is right that plenty of small countries with their own currencies thrive, and I have argued that an independent Scotland would be better off with its own currency. But that is not the policy of the Scottish government. Are they lying to attract votes, or do they want to be beholden to the interests that Monbiot derides? Either way, that does not reflect too well on Scotland’s future rulers.

Or what about newspapers? The UK “is dominated by a media owned by tax exiles, who, instructing their editors from their distant chateaux, play the patriotism card at every opportunity.” I have a lot of sympathy with that view. But in Scotland the largest selling newspaper is the Scottish Sun, owned by guess who. And no Scottish political leader would play the patriotism card, would they?!.

But surely Scotland is much more left wing than England? More, probably; but much more, unlikely. As John Curtice notes here, attitudes on inequality are not that different between the two countries. He writes “what emerges is a picture whereby the balance of opinion in Scotland is only a little more social democratic than that in England, and certainly to nothing like the extent that the relative weakness of the Conservative party north of the border might lead us to expect.” 

I think it is possible that some of those intending to vote Yes are reasoning in a similar way to Monbiot’s article. The question to ask is not could things be better in an independent Scotland. Of course they could. The relevant questions to ask is are there reasons to believe things will be better. That involves taking a realistic rather than romanticised view of its people and institutions, together with an honest assessment of the constraints an independent Scotland would face.  

Class interests

This is a small contribution to answering Paul Krugman’s question about why the wealthy want to raise interest rates, even when the economy remains depressed. (See also Steve Randy Waldman, Peter Dorman and Brad DeLong.) The preliminary point to make is that this is not just a US phenomenon. In the UK the right wing Institute for Economic Affairs set up what they call the ‘shadow MPC’, and they were voting for higher interest rates before the recovery began! The highly influential FT journalist Chris Giles, who has become a bellwether for right wing interests, has been championing the cause of an early rise in rates for many months.

I want to start with inequality, and the rising share of the 1% in the US and UK. This began in the 1980s, and is associated with deregulation of the financial sector and large cuts in top tax rates. The dominance of a neoliberal ideology, associated with Reagan and Thatcher, occurred at the same time, and there is no doubt that those who started becoming much wealthier at that time understand the connection.

Both politicians began their administrations during periods of high unemployment - higher than anything seen since the war. Both were the result of tight money: in Thatcher’s case this was a clear political choice, whereas in the US it was the result of the Volcker Fed. Whether intentional or not, this high level of unemployment greatly helped both administrations achieve their neoliberal goals, in part because it fatally weakened the power of organised labour. The period also helped the neoliberal cause because it appeared to discredit the idea that governments could intervene in the economy to achieve full employment.

Is it any wonder, therefore, that the ‘1%’ who started to become much richer in the 1980s should see tight money as an essential condition of their new found wealth? But what about the ‘interests of capital’: surely the owners of business should see that firms will be less prosperous if demand is kept too low through tight money? Here I can only quote Michal Kalecki:

“But 'discipline in the factories' and 'political stability' are more appreciated than profits by business leaders.  Their class instinct tells them that lasting full employment is unsound from their point of view, and that unemployment is an integral part of the 'normal' capitalist system.”

This was written in 1943, and the post war consensus appeared to suggest Kalecki was being too pessimistic. But that was before neoliberalism and the rise of the 1%.

Nowadays we see achieving the ‘natural unemployment rate’ as predominantly the task of monetary policy. Most economists see independent central banks as a better means of achieving this than direct political control for familiar reasons. However if you think that lasting full employment can be unsound for your class interests, then giving monetary control to conservative central bankers would also seem like a good idea.

This sets up two areas of political tension between the interests of the wealthy and, of all people, academic macroeconomists. First academic macroeconomists, and their occasional number who become central bank governors, see monetary policy as a means of achieving the natural unemployment rate and steady inflation. The wealthy see monetary policy as a means of maintaining a degree of unemployment that reduces the political threat to their wealth. Second, when monetary policy stops working in a liquidity trap, most academic macroeconomists want to use fiscal policy to take its place. To the wealthy this not only seems unnecessary, but it also calls into question their ideology about the failure of pre-neoliberal times.

As macroeconomists we know (or think we know) that it is impossible to keep unemployment above the natural rate forever, because inflation will continue to decrease, although there is now a lot of evidence which suggests it may not decrease by much. So if you wanted to critique my (and Kalecki’s) characterisation of the views of the wealthy, you might say that keeping unemployment above its natural rate is not a sustainable strategy (and therefore not rational). To which I would respond maybe, but there could be a reason why now, like the 1980s, is a particularly important time to keep unemployment high for a while.

The reason for this is that the aftermath of financial crisis is extremely threatening to the neoliberal political consensus and the position of the 1%. I remember saying shortly after the crisis that the neoliberal position that government regulation was always bad and unregulated markets always good had been blown out of the water by the crisis. This was politically naive, in part because a crisis caused by unregulated markets was morphed by the right into a crisis caused by too much government debt, or too many immigrants. But that fiction will not be sustainable once a strong recovery has reduced both government debt and unemployment. For the 1%, these are very dangerous times, and they want to be on favourable territory for the battles ahead.  

Dreams of autonomy

The latest poll results suggest a Yes vote for Scottish independence is a distinct possibility

In one sense Nigel Farage (leader of UKIP, the UK Independence Party) and Alex Salmond (leader of the SNP, the Scottish National Party) are doing the same thing. They are trying to convince voters that if only they (the UK and Scotland respectively) were free of them (Europe and the UK respectively) life would be better. The rhetoric is much the same: you will be free to make your own decisions, make your own laws, and decide your own destiny. Recent events suggest the rhetoric is working.

Here is another similarity. In both cases, the economic benefits that would flow from independence appear to be based on wishful thinking. Detailed analysis by economists not attached to any particular side come to a clear conclusion: existing arrangements are beneficial. (For example economists at the LSE for the UK and EU, and for Scotland studies by NIESR and IFS that I note here, or John McDermott on North Sea Oil here.) Let’s be blunt: independence is likely to make the newly independent poorer rather than richer.

Another similarity. At the economic level, neither side actually want complete independence. UKIP still wants all the benefits of free trade in goods with the EU – it is the free movement in people that they really object to. The SNP want to maintain a monetary union with the rest of the UK. What they do not want is to see their national health service starved of money, and their poor and disabled treated badly.

So the rhetoric is simplistic. Neither the SNP nor UKIP want complete freedom: they recognise the benefits that can come from cooperation with larger groups. So the arguments get into what is always involved in cooperative agreements: messy give and take. Will Europe allow free movement of goods without free movement of people (see Switzerland)? Will the UK allow a monetary union, and at what cost in terms of UK control over Scottish fiscal policy? But those promoting independence would rather you didn’t worry about such things, and instead focus on the rhetoric of freedom.  

Of course UKIP and the SNP are in very different places on the political spectrum. How does this influence the rhetoric of independence? Traditionally the benefits of individual freedom and autonomy have been emphasised by those on the right, and the benefits of cooperation by those on the left. England votes more to the right, Scotland more to the left. So it is quite understandable that the English right (be it UKIP or Conservative party members) should buy the benefits of going it alone. There is, after all, the phrase ‘little englander’, not ‘little britisher’. Perhaps those arguing against Scottish independence have focused too much on the safety of the status quo, and not talked enough about solidarity.

But here is the rub. Is it solidarity with the British people, or with their governing class? Although an independence vote should be about the next hundred years, there can be no doubt that a current UK government that is arguably more right wing than Margaret Thatcher has won many to the independence cause. Yet ironically Cameron and Osborne’s Conservative party have probably also encouraged UKIP’s cause by trying to chase the anti-immigration vote, and appeasing its right wing by committing to a referendum on Europe. 

Which brings me to this final thought, for those contemplating voting Yes to an independent Scotland on 18th September. Suppose you win, and as a result the remaining UK under a newly elected Conservative government without Scottish voters narrowly votes to leave the EU. Not our problem, the newly independent Scotland might say. But it would leave Scotland with a horrible choice. Do they forsake Europe to keep sterling and preferential access to their largest market, or do they become poorer still by joining the EU/Euro and trying to redirect their trade in that direction? But no worries: Scotland will be free to make that choice!

Simplistic theories of inflation

After I wrote this I saw that Frances Coppola has a post that covers some of the same ground, but the point I want to make is different.

One of the things that made monetarism so popular until governments actually tried it was its simplicity. You can express this simplicity in many ways, but most involve the idea that there is a stable demand for the real value of money (M/p), so if you can control M you must control p. Never mind that the immediate influences on inflation were much more complicated: if you knew what M was, you would know what p would be. If you controlled M you would eventually control p.

There are lots of problems with this idea. I talked about the difficulty in explaining prices by just using money in this post. The difficulty of finding the ‘right’ definition of money is not a technical problem but a feature: because money can be saved as well as buy goods (the medium of exchange is also a store of value) focusing on its role in buying goods (‘hot potatoes’) is misleading. But even if there was a stable long run demand for money for some definition, the usefulness of this becomes questionable if we cannot say what the future quantity of money will be.

This becomes blindingly obvious if money is base money and we think about Quantitative Easing. Printing base money under quantitative easing does not imply hyperinflation because the expansion in the monetary base will be reversed once the recession is over. Knowing what base money is becomes useless as a tool for saying what future prices will be. (For those more technically minded who still think there is a Pigou effect, I discussed why the Pigou effect has disappeared from modern macro here. It is based on the same point.)

The Fiscal Theory of the Price Level is potentially another simplistic theory of inflation. This works from the identity that the real value of government debt must equal the discounted value of primary surpluses (taxes less government spending). It also can be used in a naive way: treat future primary surpluses as fixed, and any increase in nominal government debt must lead to higher prices. But, as Chris Sims explains in this nice exposition at Lindau, future primary surpluses are not fixed. If debt increases, future primary surpluses can increase to pay the interest on that additional debt, and more.

There may be some that say that we cannot trust politicians to do that. To which I say which planet have you been on for the last five years? As Brad DeLong reminds us for the US, this recession has been unusual in the zeal that governments have shown in rapidly reducing primary deficits, and of course in the Eurozone this zeal - embodied in the fiscal compact - has led to a second recession. Chris Sims raised the possibility that so great has this zeal been that even though nominal debt has risen, the price level might fall to make the identity hold.

One lesson I would draw from this is that the Fiscal Theory of the Price Level, like monetarism, is not a terribly helpful way of thinking about future inflation. The idea that we can take one variable, or one equation, and distil from that the future price level is a fantasy. What is surprising is that this fantasy has been, and still remains, so attractive for some economists.

Labour's austerity problem

One of the political/economic soap operas over the last year has been the UK Labour Party’s agonising over the perception of its economic competence. The story always starts with current polling data: either Miliband’s personal ratings or Labour’s rating for economic competence. It then often seeks to find the answer to these problems in the past: either the last years of the Labour government, or the first year of opposition when Labour was preoccupied with electing a new leader.

The latest example can be found in an article today by the Guardian’s chief political correspondent, Nicholas Watt. Here Gordon Brown’s call to invest rather than cut in 2009 is blamed, and this is contrasted with an alternative that would acknowledge the need to cut, but focus on the idea that cuts would have been fairer under Labour.

I know nothing about internal Labour politics, but it seems to me that what is going on here is confusion over what the right policy should have been, rather than how to frame it. I also suspect that what really puts the electorate off is when a political party appears confused or divided about a key aspect of policy. The taboo in Labour circles over mentioning the word borrowing is a case in point, which I made fun of before Ed Miliband fell into the same trap.

So what should Labour’s line have been? As it does not have a hidden agenda to reduce the size of the state, its line should have been based on sensible macroeconomics. As my paper with Jonathan Portes suggests, the policy should have been to avoid cuts and to invest while interest rates were stuck at ‘zero’. In other words, the recovery takes priority, and the deficit should be dealt with after the recovery has been assured. Sometimes translating good macroeconomics into simple messages can be difficult, but not in this case.  

The ECB and the Bundesbank

There can be no doubt that some of the responsibility for the current Eurozone recession has to be laid at the feet of the ECB. Some of that might in turn be due to the way the ECB was set up. Specifically

1) That the ECB sets its own definition of price stability

2) This definition is asymmetric (below, but close to, 2%)

3) No dual mandate, or even acknowledgement of the importance of the output gap

4) Minimal accountability, because of a concern about political interference

It is generally thought that the ECB was created in the Bundesbank’s image. Tony Yates goes even further back in this post. Yet the irony is that the ECB abandoned the defining feature of Bundesbank policy, which could be providing significant help in current circumstances.

The defining feature of Bundesbank policy was a money supply target. Whereas the UK and US experience with money supply targeting was disastrous and short lived, the Bundesbank maintained its policy of targeting money for many years. There is little doubt that this was partly because the Bundesbank was in practice quite flexible, and the money target was often missed. Nevertheless the Bundesbank felt that maintaining that money target played an important role in conditioning expectations, and there is some evidence that it was correct in believing this.

When the ECB was created, it adopted a ‘twin pillar’ approach. The first pillar was the inflation target, and the second pillar involved looking at money. It was generally thought that the second pillar was partly a gesture to Bundesbank practice, and subsequently most analysis has focused on the inflation target.

There are very good reasons for abandoning money supply targets: they frequently send the wrong signals, and are generally unreliable in theory and practice. However a monetary aggregate should be related to nominal GDP (NGDP), and you do not need to be a market monetarist to believe there are much better reasons for following a NGDP target. What a NGDP target does for sure is make you care about real GDP, which would go a long way to correcting points (2) and (3) above. What it can also do, if you target a path for the level of NGDP, is provide a partial antidote for a liquidity trap, as I discuss here. More generally, it can utilise most effectively the power of expectations, which is why perhaps the most preeminent monetary economist of our time has endorsed them.

So do not blame the Bundesbank for the flawed architecture of the ECB. The ECB abandoned the critical aspect of Bundesbank policy, which was to target an aggregate closely related to nominal GDP. ECB policy has suffered as a result.

Eurozone delusions

I have already had a number of interesting comments on my previous post which illustrate how confused the Eurozone macroeconomic debate has become. The confusion arises because talk of fiscal policy reminds people of Greece, the bailout and all that. That is not what we are talking about here. We are talking about what happens when the Eurozone’s monetary policy stops working.

If Eurozone monetary policy was working, the Eurozone would be experiencing additional (monetary) stimulus everywhere, and average inflation would be 2%. Because Germany through 2000 to 2007 had an inflation rate below that in France and Italy, it now has to have an inflation rate above these countries. Something like 3% in Germany and 1% in countries like France and Italy for a number of years. If ECB monetary policy was working, Germany would get no choice in this, because it is part of what they signed up to when joining the Euro.

Monetary policy is not working because of the liquidity trap, so we instead have average Eurozone inflation at about 0.5%, with Germany at 1% and France/Italy at nearer zero. That implies a huge waste of Eurozone resources. That waste can be avoided, in a standard textbook manner, by at least suspending the Stability and Growth Pact (SGP), and preferably by a coordinated fiscal stimulus.

Why is this not happening? There are two explanations: ignorance or greed. Ignorance is a non-scientific belief that fiscal stimulus cannot or should not substitute for monetary policy in a liquidity trap. Greed is that Germany wants to avoid having 3% inflation, because it controls fiscal policy.

Those that say that Germany would be ‘helping out’ France and Italy by agreeing to suspend the SGP and enact a stimulus therefore have it completely wrong. If things were working normally, Germany would be getting a (monetary) stimulus, whether it liked it or not. What Germany is doing is taking advantage of the fact that monetary policy is broken, at the rest of the Eurozone’s expense. Germany gains a small advantage (lower inflation), but the Eurozone as a whole suffers a much larger cost.

Often greed fosters ignorance. It is unfortunate but not surprising that many in Germany think this is all about Greece and transfers and structural reform, because that is what they keep being told. How many of its leaders and opinion makers understand what is going on but want to disguise the fact that Germany is taking advantage of other Eurozone members I cannot say. What is far more inexplicable is that the rest of the Eurozone is allowing Germany to get away with it.