The ECB as a Lender of Last Resort to Governments

John McHale rightly points out that in my earlier post on the European Commission’s justification for austerity, I said little about the Lender of Last Resort to governments (LOLR) issue. What I did say is that OMT should have been established much earlier, and that this might have allowed Ireland and Portugal to continue to sell government debt to the markets at tolerable interest rates, which in turn might have allowed them to implement budget consolidation at a less damaging pace. (Whether they would have taken that opportunity is another matter.)

However this begs an obvious question, which is how OMT conditionality should operate. One possibility is that the ECB imposes as least as harsh conditions as the current Troika. Alternatively the ECB passes responsibility for imposing conditions to the Troika, and the Troika continues to do what it has already done. It would be wrong to say nothing would be gained as a result. If OMT works and the governments continue to borrow from the market, then we avoid some of the toxic intergovernmental lending that is in danger of tearing the Eurozone apart. However we will still have excessive fiscal deflation.

Do we need any conditionality at all? Unfortunately we do. To offer OMT unconditionally would take us back to the pre-2007 situation, where default was not thought possible. It revitalises the arguments that gave rise to the disastrous Stability and Growth Pact and the more recent Fiscal Compact. As Charles Wyplosz and others have emphasised, it is very difficult to run any kind of system where component parts have autonomy to borrow without having the discipline of default, unless you resort to a degree of central control that is not feasible for the Eurozone.

Conditionality should not come naturally to any independent central bank. There is no significant example of a country delegating fiscal decision making to an unelected body, and even if it did so there are reasons not to use a central bank for that task. But before addressing this dilemma, we should establish what the nature of conditionality should be.

The remit of the central bank should be short run macroeconomic stabilisation and long run price stability. OMT can be justified under this remit, as I argued here, because if a country finds itself in a bad market equilibrium, this will have a negative impact on the monetary transmission mechanism and short run macroeconomic stability. Conditionality can also be justified under this remit, because a complete failure of fiscal control in one country in a union when default is not allowed will compromise monetary policy for the union as a whole. (One of my own papers with Campbell Leith looks at this in a two country case. [1]) By complete lack of fiscal control, I essentially mean that a government is insolvent at a level of interest rates consistent with normal monetary policy. [2]

In other words, all the ECB needs to worry about is whether fiscal policy is sustainable in the long run. It should have no concern about which of the many possible sustainable fiscal paths a government chooses - that is up to the national government. There is a analogy with the well established rules for central bank support of private banks. If the bank is solvent but suffering from liquidity problems, support should be unequivocal and unlimited. If the bank is insolvent, no support should be forthcoming. [3]

The problem with this analogy is that solvency for a government involves a political as well as a technical judgement. Suppose a government submits fiscal projections that are sustainable. This could involve government debt initially rising but stabilising at some high level. If it then starts falling again so much the better. There could be two things wrong with this projection. The first is technical: for example growth assumptions may be too optimistic or tax receipts given growth are too optimistic. The second is political: the plan may involve cuts in spending, or increases in taxes, that are unlikely to be realised because the political costs are too high.

No central bank should like to be in a position where it has to make these political judgements. It would like to offload the problem on someone else. The obvious someone else is the market, but that will not work because all the market tells you is that there exists a bad equilibrium, and not whether a good equilibrium exists. To use Keynes’s famous analogy, the market is judging who the market thinks is beautiful, and not who is actually beautiful. The ratings agencies seem ‘market like’, but are in effect just a bunch of people with a (perhaps informed) opinion, and a not very good track record.

Who else could the ECB delegate conditionality to? Delegating to EU heads of state would be a bad idea, for reasons that I hope are obvious. [4] Delegating to the Commission seems too close to that. A better possibility would be the IMF. The IMF certainly knows all about this issue: see this research for example. However all of these agencies have a recent track record that does not inspire confidence. An acid test is how any arrangement would have worked in the case of Greece. What should have happened, as soon as the true extent of Greece’s fiscal problems had become clear, is that whatever body the ECB had delegated its conditionality assessment to should have concluded that default was more likely than not, and therefore OMT should not have been provided.[5]  

I have an alternative suggestion, which regular readers will not find surprising. A number of Eurozone countries now have fiscal councils, whose very job is to assess the sustainability of fiscal policy. They are the obvious people to ask. Putting such an important question to the relevant national fiscal council may be politically unwise - could that council survive a decision that led to default? It would be better, for this and other reasons, for fiscal councils to act as a group in advising the ECB on the sustainability of national fiscal plans. That way expertise could be pooled, and experience shared.

Let me be quite clear what I am suggesting here. As soon as a country specific default premium began to emerge on a Eurozone member’s government debt, the ECB would ask the collective of Eurozone fiscal councils whether they thought current fiscal plans would result in a sustainable level of debt. If they did, the ECB would announce that OMT would apply to that country i.e. it would buy whatever quantity of that debt that could not be sold to the market. That decision could be reviewed annually until the default premium faded away. If the fiscal councils collective did not think current fiscal plans were realistic and sustainable, OMT would not be forthcoming. In these circumstances, there would be no bailing out by the Eurozone or IMF, and default would almost certainly follow.

The Commission plays no part in this. However, I think the Commission still has a very important role to play. The ECB, as part of the role it should have in preventing deficient aggregate demand in the Eurozone as a whole, should publicly state that because of the zero lower bound they cannot use monetary policy to fulfill this function. They should ask the Commission to coordinate fiscal actions to provide additional support to demand. In doing this, the Commission would clearly not ask that much of countries on OMT, so most of the ‘burden’ would fall on others, like Germany or the Netherlands.

Which brings me back to my previous post, and why I think what I said there was quite compatible with LOLR issues. Now some commented on that earlier post that it was not politically feasible, by which they mean Germany would not countenance it. I am sure that is right, although what has disappointed me (and others - see Kevin O’Rourke) is that the election of Hollande did not emboldened countries like France and Italy to provide any kind of counterweight to German views.

One of the advantages of being an academic is that your advice does not have to be bound by what is politically feasible. It is important that someone sets out what is best as they see it, and others can then modify it to satisfy political constraints. However the problem in this case is not so much that fiscal stimulus rather than austerity, and the ECB acting as a LOLR, are not in the German national interest. I think you could make a case that they are in fact in Germany’s long term national interest, because a well functioning Eurozone is in their interests. The problem seems more that policy makers throughout Europe have two economic blindspots. [6] Those blindspots are the fallacy of austerity at the Zero Lower Bound, and the necessity of a LOLR. What I will not do is give advice which accepts that those blindspots cannot be removed.

 

[1] See also Canzoneri, M. B., R. E. Cumby and B. T. Diba (2001), “Fiscal Discipline and Exchange Rate Systems”, Economic Journal, No. 474, pp 667-690.

[2] Using Eric Leeper’s terminology, it means the fiscal authority is active: for a discussion of the active/passive idea and its application to the ECB and OMT see here.

[3] One problem with the Bagehot dictum is contagion: if an insolvent bank is allowed to fail, this may create a liquidity (or even solvency) crisis for others. These contagion arguments have much less weight when it comes to countries in the Eurozone, once OMT has been established and the conditionality involved is clear and non-political.

[4] See, for example, Cyprus. Colm McCarthy describes it well here (HT Kevin O’Rourke)

[5] This may be a little unfair on the IMF, who almost certainly came under intense political pressure from the Eurozone to provide funds before the inevitability of default was conceded. I do not know whether this assistance, which allowed default to be delayed, was provided against the better judgement of some of those in the Fund.

[6] See a shrill Kevin O’Rourke here.

On the economic achievements and failures of Margaret Thatcher

I was not going to write anything on Mrs T, but then I just happened to read yesterday a journal article that says something important about her legacy today. I also decided to write something to challenge some of the myths and taboos created by the political right and left. The right in the UK tends to mythologise Margaret Thatcher, in a similar way I think the right in the US does with Ronald Reagan. So its worth pointing out two major macroeconomic errors that were made while she was Prime Minister. The left is less inclined to hero worship its own Prime Ministers (generally it does the opposite), but it has its own taboos when it comes to macroeconomic history.

What was the journal article? It is a paper [1] that looks at the causal impact of fathers' job loss on their children's educational attainment and later economic outcomes. The place and time is the UK recession of the early 1980s. The study concludes: “Children with fathers who were identified as being displaced did significantly worse in terms of their GCSE attainment than those with non-displaced fathers.” Not a very surprising result, but further evidence of the long term damage done by high and prolonged unemployment (what macroeconomists call hysteresis effects).

The UK recession at the beginning of the 1980s was the worst since the second world war. UK unemployment increased dramatically, from below 6% to nearly 12%, and stayed high until the end of the decade. The chart below boxes the Thatcher years. (Unemployment would have been higher still if the government had not encouraged the unemployed to register as disabled, as John Van Reenen relates and even George Osborne admits.)

UK Unemployment

Did the government led by Margaret Thatcher intend for this to happen? Almost certainly not. Their plan involved replacing traditional macroeconomic policy by monetarism, which meant gradually declining targets for the growth of a particular monetary aggregate. As Chris Dillow points out, they expected this would lead to a steady decline in inflation, with a minor and temporary dislocation in terms of output.

Many thought that a foolish thing to believe at the time, but in macroeconomic terms Mrs Thatcher’s administration were revolutionaries who despised conventional wisdom. When presented with Treasury forecasts telling them with unusual accuracy what would happen, they rubbished the Treasury advice. As unemployment rose rapidly, and many in her party urged her to change course, she gave her famous ‘this lady’s not for turning’ speech that is so eulogised by some Conservatives today.

The attempt to hit their monetary targets failed dismally: 81/80 target money growth 7-11%, actual 19.1%, 82/81 target growth 6-10%, actual 13.7%. After that monetary targets were effectively abandoned. One of the biggest experiments in UK macroeconomic policy turned out to be a disastrous failure. As GDP fell by over 2% in 1980, and remained flat in 1981, and manufacturing output fell by 15% in two years, it is not surprising that inflation fell rapidly, although too many on the left believed it would not.

Yet, as I have noted before, this period is regarded by many as Mrs. Thatcher triumphing over doubters, including most academic economists. This myth may be partly responsible for the current government's obstinacy about austerity. So how can it be regarded as a triumph? Output did recover - well of course it did, but as the chart shows unemployment stayed persistently high, with the long run costs that I noted above. Inflation came down rapidly, but far more rapidly than was intended.

Was this unintended cold turkey cure in any sense optimal? I think that is highly unlikely for many reasons. One is that the traded sector bore the main cost of the recession. The period coincided with North Sea oil coming on stream, which in itself would have led to an appreciation in sterling and a movement of resources away from the traded sector. In these circumstances, embarking on a policy that produced a further appreciation in classic Dornbush overshooting style led to the very uneven recession. Now the Dornbusch analysis was fairly new, so perhaps the government can be forgiven for not anticipating that this would happen, but by 1980 it was all pretty clear what was going on, and that was the point at which the lady refused to turn.

But the key point remains that this skewed, cold turkey policy to reduce inflation was never part of the plan. The plan itself was a complete failure, and if you think the outcome was optimal (which I do not) then that is down to luck rather than judgement.  

The second failure involved North Sea oil. I have compared how the UK and Norway responded to additional government revenue from North Sea oil before. The Norwegian government created a sovereign wealth fund, so that the gains from North Sea oil could be enjoyed by future generations. The UK government thought the people should make that choice, and so cut taxes. The people, for one reason or another, do not appear to have invested that money to replicate what a sovereign wealth fund would do. So Mrs Thatcher made the wrong choice, and whether it was for ideological reasons or more base electoral considerations is secondary. It was a major mistake that current and future generations will pay for.

Those are two major failures, but what about the successes? The Thatcher era saw the implementation of supply side reforms that ended and then reversed the relative decline of UK productivity. As Paul Krugman has pointed out, the lags here need to be long, but I think we have good reason to believe that they are. As Nick Crafts outlines here, and John Van Reenen here, this improvement came about partly through increased goods market competition, but of course it also reflected a reduction in union power that was one of the major aims of government policy. The taboo on the left is not to admit (at least publicly) that UK trade unions had grown too powerful in the 1970s, and that any benefits this had were outweighed by inefficiency and often severe dislocation.

The battles of the 1980s, and the path Mrs Thatcher took,  were not inevitable, and it is possible that the UK could have moved to something like the German model where unions retain a strong presence. However the path followed by the UK is at least partly the responsibility of the left as well as the right: some of the proposals later introduced by Mrs Thatcher were first tabled by the 1969 Labour government and Barbara Castle, and were defeated by the Trade Union Congress and the later Labour Prime Minister Jim Callaghan.

This post is not meant to be comprehensive: I have said nothing about the rise in poverty under Mrs Thatcher (briefly mentioned here), inequality more generally and the role that taxation had in increasing that (of which the poll tax was just one example), selling off state assets or under investing in what was left. (Van Reenen gives more detail on some of these.) A second major UK macroeconomic disaster also occurred right at the end of her premiership. The UK entered into the European Exchange Rate Mechanism at an overvalued exchange rate, which led to another major recession. That story, and my own very small part in it, will have to wait for another time.

   

[1] Gregg, P., Macmillan, L. and Nasim, B. (2012), The Impact of Fathers' Job Loss during the Recession of the 1980s on their Children's Educational Attainment and Labour Market Outcomes. Fiscal Studies, 33: 237–264

Myths and Realities of the 1970s

I have been pondering why inflation targeting is so popular, as opposed to the more natural idea of a dual mandate. I say more natural for two reasons. First, because the dual mandate corresponds to the two roles of monetary policy: short run demand management and determining medium/long term inflation. Second, because it maps naturally to the objectives that macroeconomists typically assume or derive when modelling monetary policy: minimising both excess inflation and the output gap.

I think a big reason for the popularity of inflation targeting is the 1970s. A common story for why inflation was allowed to rise so high for so long in that decade is that monetary policy was targeting the output gap, and policy makers got their estimate of the natural rate very wrong. (A classic reference is Orphanides (2002). [1]) A dual mandate, it is suggested, encouraged that mistake, and could lead to the same mistake being made again. So central banks given independence since the 1970s tend to have low inflation or price stability as their primary goal, rather than a dual mandate.

There is an obvious rejoinder to that argument. The US Fed maintains its dual mandate, yet it shows no signs of acquiescing to the kind of increases in inflation we saw in the 1970s. Its latest forward guidance says it will tolerate inflation up to 2.5% (as long as unemployment stays high) before it considers raising interest rates. That is hardly going back to the 1970s. There are people who think that QE will, any moment now, open the inflation floodgates, but I want to keep to serious macro in this post.  

So current experience shows there is no reason why a dual mandate should inevitably lead to rising inflation. I think there were three important contributory factors to what happened in the 1970s that are just not present today. First, our knowledge of inflation output trade-offs, although hardly complete now, was much weaker back then. Second, the Fed and other monetary policy makers did not have clear inflation targets that they were publicly committed to. Third, there appeared to be an alternative instrument for dealing with inflation: direct controls on prices and wages. [Postscript: see comment from Robert Waldmann and my reply below.] The 1970s really was a different world in terms of the understanding of macroeconomic policy.

I’m reminded of all this by a fascinating chapter (released today) in the forthcoming IMF World Economic Outlook. The main focus of the chapter is on how the Phillips curve has shifted over time. There are two clear findings. The first is that the sensitivity of inflation to the output gap is much lower now than in the 1970s. Second, the importance of expectations about future inflation (compared to past inflation) is much greater. An obvious way of interpreting both results is that inflation expectations are now much more firmly anchored.

However the chapter also contains an interesting comparison between the behaviour of 1970s inflation and monetary policy in the United States and Germany. We all know that the US had to wait until Volcker in 1979 before inflation control was restored. However the Bundesbank did this much earlier: inflation was brought down to below 3% in 1978. While it could hardly be immune from the impact of the oil price shocks and high inflation elsewhere, its record in keeping inflation anchored looks much better than other countries. Here is the relevant chart from the chapter.

Now there is a popular story about this as well, which is that the Bundesbank was practicing monetary targeting during this period. But, as the WEO chapter points out, this is also a bit of a myth. Studies suggest [2] that in practice the Bundesbank was not a rigid money supply targeter in the way both the US and UK attempted to be in the early 1980s, but instead adopted a more flexible approach which can be characterised by some form of Taylor rule. Furthermore the output gap played an important role in that rule, and the Bundesbank also got its estimates of the output gap wrong.

To quote from the WEO chapter:

“the Bundesbank’s success was not linked to meticulously meeting the monetary targets, which it actually missed throughout the 1970s, or to focusing on inflation with no regard for output developments. Rather the Bundesbank’s success was a reflection of the robust framework it developed, which allowed it to keep longer-term inflation expectations anchored while flexibly responding to shorter-term output shocks.”

I think you can argue that what monetary targets did was proxy a dual mandate. Inflation would not be allowed to rise unchecked for too long, but equally movements in output would be offset by interest rate changes, in the classic IS-LM manner.

So I think the lesson of the 1970s is that it is important to have publicly stated inflation targets, but not that the short term output stabilisation role should be subordinate to hitting those targets. In the future there will surely be a similar IMF WEO chapter looking back at the divergent behaviour of US and Eurozone output in the 2010s (see Ryan Avent here). I’m sure one of its arguments will be that the US did so much better in part because monetary policy had a dual mandate, while the ECB acted as if all that mattered was inflation.

 

[1] Orphanides, Athanasios, 2002, “Monetary-Policy Rules and the Great Inflation,” American Economic Review, Vol. 92, No. 2, pp. 115–20.

[2] The WEO chapter notes Clarida, R.H. and Gertler, M. (1997) “How the Bundesbank Conducts Monetary Policy” in Reducing Inflation: Motivation and Strategy eds Romer and Romer, Chicago University Press, pp 363-412 and Gerberding, C., Seitz, F. and Worms, A. (2005) “How the Bundesbank Really Conducted Monetary Policy” North American Journal of Economics and Finance, 16, 277-92. The second study reconstructs the real time data set that would have actually been available to policy makers, and finds as a result that it is the change rather than the level of the output gap that was important in their Taylor rule, and that a term in excess money growth is also significant. This slightly earlier paper by Clausen and Meier does something similar, but with results closer to a traditional Taylor rule.

Nasty politics in hard times

This is a post about morality rather than economics, and as a result I am rather unsure about whether I should be writing it at all. Yet it is something that I have kept thinking about over the last few days, even though I would rather put it out of my mind. So perhaps this is blogging as therapy.

When jobs are scarce, people become understandably more exercised about the idea that some people are getting an income from the state without trying to find a job, just as they imagine that immigrants are ‘stealing‘ what jobs there are. Such views are encouraged by the tabloid press, as I noted here - the tabloids are our equivalent of Fox News.

 
There has recently been a particularly egregious example of this in the UK. For those UK readers I just have to say the Philpott case and the Daily Mail, and they can skip the rest of the paragraph. For those outside of the UK, a criminal case recently came to an end where someone called Mick Philpott and two others were jailed for killing their six children by burning down their house. It was not murder: the individuals intended to rescue their children and frame someone else as part of a custody battle, but the ‘plan’ did not work out. A tragic case, and as the architect of the plan, Philpott received a very heavy sentence for manslaughter. Philpott had 17 children by five different women, and received large amounts of money in benefit payments. Which allowed the Daily Mail newspaper to print the headline “Vile Product Of Welfare UK”. Not to be outdone, the Sun said “Let's hope this is the last time the state unwittingly subsidises the manslaughter of children.”

This all takes place at the same time as the government’s welfare reforms are starting to be implemented. I am far from an expert in this area, so I have not talked about these reforms in this blog, although I did recently note how they are expected to reverse recent declines in child poverty. That aside, whether these reforms make sense or not is beside the point here. What is important is that one of the government’s stated aims is to make the system more efficient, because in times of austerity money needs to be saved.

It is clear that the problem of the welfare state allowing, let alone encouraging, certain people to remain unemployed and have large families is not the main issue in trying to make the welfare system more efficient. To quote the Economist: “Though most of them seem to end up in newspapers, in 2011 there were just 130 families in the country with ten children claiming at least one out-of-work benefit. Only 8% of benefit claimants have three or more children. What evidence there is suggests that on average, unemployed people have similar numbers of children to employed people.”

What we do know is that the vast majority of welfare payments go to people who are trying to find a job but cannot because jobs are scarce, or who are disabled, or who do have a job which is very poorly paid. These are people that most citizens in the UK would never want to exchange places with, and they deserve our sympathy and support. So what do you do if you are a public figure who knows these facts, and a national newspaper like the Daily Mail not only distorts the truth with its headlines, but by implication paints all those receiving welfare in such horrible colours?

I would suggest any decent person would try to bring the debate back to reality. At the very least you might say the following: "The Philpott case is an individual tragedy. Children have died in that case. I think that is where we should let that case lie. I would not want to connect that to the much wider need to reform our welfare system." That is what Danny Alexander, the (LibDem) Chief Secretary to the Treasury said. But this is what his boss, the Chancellor George Osborne, said. "Philpott is responsible for these absolutely horrendous crimes and these are crimes that have shocked the nation. The courts are responsible for sentencing him, but I think there is a question for government and for society about the welfare state – and the taxpayers who pay for the welfare state – subsidising lifestyles like that, and I think that debate needs to be had."

So he sees no problem with the Daily Mail’s headline. Regular readers will know that I think George Osborne has been a hopeless Chancellor, and in addition that he has subordinated his economic task to the urge to make political capital. Yet even I was surprised by this attempt to use the tragic deaths of six children in a bizarre and unique case to try and score political points. 

People can make up their own minds about the morality of this. Or you might take a cynical view, that all politicians will take any opportunity they can to make populist points, and that there is no morality left in politics. In which case the last thing any politician should do is say this “... do you exploit tragedy, like the Philpott tragedy? The right place for Mr Philpott is behind bars, but do you exploit the deaths of six children to try and make a political point about the welfare system, and at the same time say to people that this is somehow a common truth about people on benefits?" Perhaps there is just a little morality left in politics, whichever side you are on.

What does the ECB think it is doing?

Or rather, why isn’t it doing something? Consumer price inflation is currently 1.7%. The OECD expects 1.6% as a whole for 2013, and 1.2% for 2014. The ECB sees downside risks due to the impact from lower activity, which it acknowledges is falling but which it hopes will recover soon. The OECD expects GDP to be flat this year, and increase by 1.3% next - is that what is meant by a recovery? On activity the ECB sees downside risks, but does not mention any upside risks. On the prices side they see upside risks from administered prices, VAT and oil, but for all three it is questionable whether it should react to these type of shocks at all.

In fact, if you look at other measures of inflation, the inactivity is even more puzzling. Annual increases in the GDP deflator have been at or below 1.2% since 2009, and the OECD expect a rise of only 1% in 2014. Wage increases (compensation per employee) have been below 2% since 2009, and are expected by the OECD to be around 1.5% this year and next. (Wages should normally increase by more than price inflation because of underlying productivity growth.)

With this in mind I read Draghi’s statement today, where he announced no change in the 0.75% interest rate, looking for some justification for why nothing was being done despite falling activity and below target inflation. After listing all the reasons that would normally suggest cutting interest rates, there was this: “Against this overall background our monetary policy stance will remain accommodative for as long as needed.”

I’m sorry, but this does not compute. The Eurozone is suffering from a large negative demand shock due to many things: partly austerity, but also the kind of balance sheet adjustment that we have seen elsewhere. (See, for example,  Reza Moghadam of the IMF here.)  In macroeconomic terms, we have a large leftward shift in the IS curve. What monetary policy is meant to do in these circumstances is to cut real interest rates to restore demand. In macroeconomics speak, to move down the IS curve until demand is restored. Moving a bit along the IS curve, and saying ‘look, we are helping’, is not good enough. Policy needs to respond to the size of the shock. Now monetary policy is difficult when signals and forecasts conflict. But when everything is pointing in the same direction, it is really easy.

The other interpretation of what the ECB is doing is that they do understand basic macroeconomics, but consumer price inflation of 1.7% prompts no action (because its close to 2%), and they expect (in contrast to the OECD) inflation to stay at this level. But is this plausible? One word that does not feature in Draghi’s statement is unemployment. The OECD expects unemployment to rise to 12% this year and next, which is 2% higher than in any year from 2000 to 2010. So how does this square with consumer price inflation stabilising at just below 2%? The answer is it does not. The ECB staff forecasts for consumer price inflation for 2014 are “between 0.6% and 2.0%” - exactly in line with the OECD.

So something is very wrong here. Even if you assume that the ECB are focused on hitting consumer price inflation alone, and care nothing for activity, unemployment or other inflation measures, they are doing nothing about future inflation falling well below 2%. So however you write the job description, they are not doing their job. What happens in this situation? Does anyone have ultimate control over the ECB? Or was the possibility that the ECB would not do their job properly never imagined?

Dealing with Increasing UK Poverty

I ended a recent post with the following: “Surely it should now be clear that this is a government with at least as strong an anti-state, anti-poor ideology as Mrs Thatcher, but with rather less honesty about what it is doing.” For someone who tries to avoid hyperbole, this is pretty strong stuff. So where is the evidence for this claim?

The anti-state side should be familiar to regular readers. Once you realise that the austerity policy has no sound basis in terms of macroeconomics, and the markets are saying ‘please supply more UK government debt’, then you look for other motives. A desire to shrink the size of the state seems to account for both the composition of the austerity programme, and the refusal to undertake a balanced budget stimulus. I have obviously focused on this macro issue, but the anti-state focus of policy is also pretty clear in the NHS reforms, and in the push (I could use a stronger term) to create academy schools.

What about the anti-poor part? This is not my field, so the evidence I present below may not be the most up to date or complete. However I think its worth setting out the evidence as I see it, because it does not get the publicity it deserves. Here I focus on the standard measure of poverty, which is the number of people with income below 60% of the median for that year.

First from a historical perspective, lets go to the latest annual study by the New Policy Institute.

Different UK groups in poverty (after housing costs)

	1981	1991	2000/01	2010/11
Children	20%	31%	31%	27%
Working‑age adults with children	16%	25%	25%	24%
Working‑age adults without children	7%	15%	16%	20%
Pensioners	22%	35%	25%	17%

Source: Hannah Aldridge, Peter Kenway, Tom MacInnes and Anushree Parekh, Monitoring Poverty and Social Exclusion 2012, New Policy Institute.

Poverty increased across the board in the decade of Mrs. Thatcher, although of course correlation does not establish causation. What is really noticeable since then has been the decline in pensioner poverty, which can be seen as a success story for government action. 

Poverty among other groups has been relatively static. Given that the 1997 Labour government made reducing child poverty a major priority, the relatively small reduction there is disappointing, but it was not for want of trying. Researchers at the IFS estimate that had financial support merely risen with inflation, child poverty would have risen by over one-quarter to around 4.3 million by 2010. [1]

So what of the future? The following table comes from another IFS study that tries to estimate likely levels of poverty out to 2020. It is out of date in that it takes no account of cuts in welfare provision announced by George Osborne in November last year, of which more below.

Estimates of future proportions in UK poverty

	2009 (data)	2015	2020
Children	19.5	22.2	24.4
Working‑age adults with children	17.1	18.5	20.0
Working‑age adults without children	15.0	15.9	17.5

Source: Brewer, Browne and Joyce (2011) Child and working-age poverty from 2010 to 2020, IFS.

So poverty is going back up. [2] This is a direct result of policy. The study estimates that “the impact of changes to personal tax and benefit policy announced by this coalition government is to increase relative child poverty by 200,000 in both 2015-16 and 2020-21, and to increase relative poverty for working-age adults by 200,000 in 2015-16 and 400,000 in 2020-21.” “The main culprit is the change in uprating benefits from the RPI to the CPI.”

Yet this is out of date. In the pre-budget report in November the Chancellor announced that uprating would be further reduced to 1% for three years. So the likely increase in poverty is even greater than these figures suggest.

As the government is creating this increase in poverty, how are they going to deal with the problem? The answer seems to be by stigmatising the poor. The Chancellor famously said “Where is the fairness, we ask, for the shift-worker, leaving home in the dark hours of the early morning, who looks up at the closed blinds of their next-door neighbour sleeping off a life on benefits.” Unfortunately this line appears to resonate with a growing hardening of public attitudes towards welfare provision. This in turn reflects a persistent tendency of particular tabloid newspapers to run stories about benefit scroungers. [3]

For example, Randeep Ramesh writes “Stories referring to large families had more than doubled in frequency since 2003, accounting for some 7.4% of articles. The facts are that families with more than five children account for 1% of out-of-work benefit claims. Very large households with ten or more children are a staple of tabloid shock stories: there are, according to DWP, 180 such claimant households in Britain.” As Ian Mulheirn points out here, using Department of Work and Pensions research, the percentage of those claiming unemployment benefit whose previous work record suggests they are trapped in a dependency culture is pretty small. So the facts do not support the rhetoric, which of course politicians know, so the rhetoric is part of the strategy. (There is also an unwillingness within government to try and model the impact of reforms, as Alex Marsh notes.)

Thus the solution of how to ‘deal with’ poverty is to return to Victorian attitudes (HT Mark Thoma, who also has this nice historical account from the US.) There is even the suggestion that UK ministers might change the statistics to reflect the idea that poverty is a result of character rather than circumstance. Dependency is always an issue with welfare, but as Brad DeLong writes here (and James Kwak here), it does not warrant hysterical overreaction.

When the charity Save the Children recently launched its first campaign to help UK families in poverty, the reaction from conservative MPs and the right wing press was predictably to blame the messenger. Perhaps they think the rapid growth of food banks in the UK of the last few years is also politically motivated?

[1] My reading of this was that in the case of child poverty (and unlike pensioner poverty), fiscal measures were fighting against the effects of greater wage inequality.

[2] These poverty measures are sometimes criticised because they are relative, and disguise the fact that everyone’s living standards are going up. I think this criticism is misplaced, but it is worth noting that it does not apply to the recent past and near future, where real incomes in the UK have tended to fall.

[3] I’m often surprised at how social scientists are reluctant to give newspaper reporting the importance it deserves in shaping certain social attitudes. We are often told about the ‘puzzle’ that people’s perception that crime is increasing is at odds with the fact that it is falling, yet given how crime is reported, I see no puzzle at all.