The imaginary world of small state people

“In the end, you are either a big-state person, or a small-state person, and what big-state people hate about austerity is that its primary purpose is to shrink the size of government spending.”

So said Jeremy Warner (assistant editor of the UK’s Daily Telegraph) last year. Jeremy is a small state person, and I think many other small state people think like this. But the statement is wrong. There are a large number of people - I suspect the vast majority - who do not have any prior view about the size of the state.

In many ways the bipolar view harks back to a bygone age, where - at least in Europe - there actually was a large constituency on the left that wanted a large state as a matter of principle. In the UK that constituency lost all its influence with Margaret Thatcher and New Labour, and it has also lost its influence in the rest of Europe. However this decline in the influence of big state people on the left was matched by a rise to power on the right of those who want a small state as a matter of principle. George Osborne’s plan for the UK over the next few years is the apotheosis of this neoliberal view.

I think I’m like the majority of people in not having any fixed ideological position about whether the state should be large or small. The state is clearly good at doing some things, and bad at doing others. In between there is a large and diverse set of activities which may or may not be better achieved through state direction or control, and they really need to be looked at item by item on their merits.

My first major problem with small state people is that they are not prepared to look at these items on their merits. Instead they have a blanket ideological distaste for all things to do with government. The evidence that government is ‘always the problem’ is just not there. The idea that private sector activity is always welfare enhancing and is best left alone was blown out of the water by the financial crisis. My second major difficulty with many small state people, like George Osborne, is that they are using fear of a debt crisis (a possibility which for the UK and US is non-existent) to achieve their ends. This is political deceit on a grand scale. My third major problem follows from the second: reducing government spending during a liquidity trap recession does real harm. It wastes resources on a huge scale.

For the UK, the OBR estimates - conservatively - that austerity reduced GDP by 1% in 2010/11, and by a further 1% in 2011/12, so GDP was 2% below what it could have been in 2011/12. As there has been no offsetting fiscal stimulus in later years, and because monetary policy has been constrained by the zero lower bound, this waste of resources will not necessarily be eliminated in subsequent years. So the cumulative cost of 2010 austerity could easily exceed 5% of GDP. That is a colossal sum to waste. The estimated numbers in the Eurozone, where the austerity squeeze continues, are even worse - nearer 10% territory and counting. As I argue in this new short piece for the Economist, the fact that Osborne risks doing the same thing again from 2015 onwards is a sufficient reason not to give him the chance.

Which brings me to a final problem I have with small state people, which is their disregard for the evidence. It is true that most people are bad at acknowledging counter evidence, but those with an ideological conviction are worse than most. A common theme among small state people following Osborne’s Autumn Statement is to ask what all the fuss is about. In his rant at the BBC, Osborne says “I would have thought the BBC would have learned from the last four years that its totally hyperbolic coverage of spending cuts has not been matched by what has actually happened. I had all that when I was interviewed four years ago and has the world fallen in? No it has not.” He remembers it well, because he tried to intimidate the BBC back then as well. The claim of hyperbole is nonsense of course, as Tony Yates sets out, but I want to focus on the ‘world fallen in’ point.

Here is Janan Ganesh in the FT making the same claim in spades:

“[Osborne] has also made the spending cuts he promised without the country turning into a medieval wasteland. This is a deeper intellectual wound to the left than we currently understand; it will change the terms of debate about the proper size of the state long after Mr Osborne has gone.”

With both Osborne and Ganesh the intended meaning is that cuts have been achieved at relatively little cost. They clearly hope this idea will become received wisdom in the media. But is it true? Take the one area that Osborne has earmarked for further cuts: welfare. [1] The argument that the cuts made so far to welfare have been achieved without significant costs flies in the face of the evidence. The number of food banks in the UK has grown massively over the last five years. The Trussell Trust estimate that more than half of their clients were receiving food because of benefit delays, sanctions, and financial difficulties relating to the bedroom tax and abolition of council tax relief. As James Harrison relates in this excellent long article, the government simply denies the evidence. The Economist notes: “Welfare reform was intended to be one of the big achievements of the coalition government. But almost all of the radical ideas promised are turning out to be duds.” These are duds that create real misery. Now maybe this is all just teething problems, but the prima facie evidence is hardly that cuts have been achieved at little cost.

So how can small state people have the audacity to claim otherwise? Perhaps it reflects the power of an ideology that its protagonists want to see no evil. Perhaps it is because those hurt by austerity somehow do not count. But the claim that Osborne’s cuts have been such a success that they will cause a “deeper intellectual wound to the left than we currently understand” is simply delusional. These are fantasy ideas from those living in an imaginary world, while in reality the policies they support do serious harm.

[1] I choose welfare only as an example. It does not appear to be an isolated one. Here is an account of Chris Grayling, prisons and the Howard League, or see Alex Marsh on the UK justice system more generally. Or think of those who suffered from flooding as the government cut back money for flood prevention, while the government still pretends there were no cuts.

Government debt, financial markets and dead parrots

Following the Autumn Statement, more commentators are noting the similarity between the macroeconomic choices facing electors next year to the choice they faced in 2010. Jeremy Warner even uses the phrase ‘déjà vu’ which I used in the title to this post in August. However what he neglects to mention is the big difference between 2010 and 2015 that I highlighted in that post, which is the absence today of any financing crisis for government debt. For Warner that is understandable - for him, and I suspect a few others, it was always about reducing the size of the state. However for most people in 2010 austerity was sold because of the fear that we would ‘become like Greece’.

This idea that the financial markets are hanging on every short term movement in the government’s budget deficit persists in much of macromedia. It is a myth. It is like the parrot in Monty Python’s famous sketch: it may have lived gloriously once, but now it is well and truly dead, and has been for some time.

You do not need to understand much about financial markets to see why. The market for UK government debt does not exist in isolation, but is instead connected to markets for a whole range of other financial assets. So a small change in the supply of government debt (because of a change in the budget deficit) will have a negligible impact on the interest rate required to sell that debt. [1] The most important determinate of interest rates on UK debt, which is a long term financial asset, is expectations about current and future short term UK interest rates. That is why UK rates on 10 year government bonds are currently around 2%, but for France just 1%: the ECB is expected to keep short rates lower for longer than the Bank of England.

This arbitrage between financial assets assumes that markets believe they will get their money back. The moment the market thinks this might not happen, they will demand a ‘default premium’: a higher interest rate to compensate them for the chance of default. This default premium is our parrot - it is what seemed to swoop up and down day after day during the Eurozone crisis from 2010 to 2012. But this parrot thrived in the Eurozone during that time for a very particular reason. The climate there has now changed, which means it is not what it once was, but it chances of living outside that region were always pretty small, and are today negligible. If anyone tries to sell you one, it will be dead.

If you are thinking about buying government debt and are concerned about possible default, you need to worry about two things. First, you need to ask whether the government will choose to default. It might do so if the political costs of raising taxes or cutting spending become too large compared to the costs of no longer being able to borrow money following default. Second, you need to worry about forced default, where the government is unable to ‘roll over’ (refinance) its existing debt, because the market will no longer lend to it. The two are related, but are not identical. The second risk admits the possibility of a self-fulfilling crisis: default occurs because the market believes default will happen, even if the government actually has no intention to default and can continue to pay the interest on its debt.

This is where your own central bank is very useful. It eliminates this second type of risk, because it acts like a lender of last resort, buying any debt the government cannot refinance through the markets. This is what the ECB refused to do until its OMT programme in September 2012. Until that point, markets were worried that governments in Ireland, Portugal and Spain would not be able to refinance their debt, and so would be forced to default. With OMT the ECB changed its mind, which brought the crisis to an end. The Eurozone parrot was not completely wiped out, because the ECB still made its support conditional, and because the possibility of voluntary default by some governments still remains, but it is not the bird it once was.

The parrot probably never flew in countries like the UK, US or Japan because these countries had their own central banks. Of course many people claim to have seen it, but it seemed to disappear as quickly as it came. The idea that it could survive in the UK or US today is just silly. In 2010 deficits in the UK and US were large, and debt was rising rapidly. It might just have been conceivable (although with a lot of imagination) that the UK or US governments might have chosen to default. Today deficits are near a sustainable level, which means that debt to GDP ratios are relatively stable. If someone tells you they have seen this parrot today, or that it is just resting and will wake if this or that policy is pursued, please respond as John Cleese did:

“'E's not pinin'! 'E's passed on! This parrot is no more! He has ceased to be! 'E's expired and gone to meet 'is maker! 'E's a stiff! Bereft of life, 'e rests in peace! If you hadn't nailed 'im to the perch 'e'd be pushing up the daisies! 'Is metabolic processes are now 'istory! 'E's off the twig! 'E's kicked the bucket, 'e's shuffled off 'is mortal coil, run down the curtain and joined the bleedin' choir invisible!! THIS IS AN EX-PARROT!!”

[1] There may at the margins be some market segmentation, and it is a margin that central banks have tried to exploit through Quantitative Easing (QE). However this involved buying huge quantities of government debt to influence it, and we are still not entirely sure that they succeeded in doing so. Besides that, a few billions on the deficit this year and next is a drop in the ocean.

The OBR confirm the dangers of Osborne's gamble

A point I have repeatedly made about George Osborne’s plans for a new wave of austerity, confirmed in his Autumn Statement today, is that they risk making the same mistake as 2010. Short term interest rates will be only just above their lower bound in 2015, at best. Large cuts in government spending from 2015 on will reduce aggregate demand. So if something goes wrong (and the list of possibilities is long), monetary policy will not be able to come to the rescue.

The OBR conservatively calculate that austerity reduced growth by 1% in financial year 2010/11, and by 1% in 2011/12. As a result, the recovery in those years faltered. Are we going to be saying the same thing in 2016 or 2017?

It is a pretty obvious point, even if it appears beyond most of mediamacro. So it was good to see the OBR hinting at much the same in their forecast that accompanies the autumn statement. First, in discussing why their forecast of medium term growth is subdued, with the output gap closing very slowly, they say this (para 1.19):

“the Government’s fiscal plans imply three successive years of cash reductions in government consumption of goods and services from 2016 onwards, the first since 1948. The corresponding real cuts directly reduce GDP. The economy should be able to adjust to such changes over time, but it is unlikely to be a simple process when monetary policy is already very loose and external demand subdued.”

The words may be a little obtuse (‘unlikely to be a simple process’), but the meaning is clear. Monetary policy will not be able to offset all of the demand implications of a second wave of austerity even in the base forecast.

But the real concern involves risks, just as it did in 2010. In para 1.25 they first note that government consumption of goods and services falls to its lowest share of GDP since 1938. Then they relate that their forecast implies a sharp rise in the real share of GDP accounted for by business investment and a rising household debt to income ratio following higher house prices. They also assume that the UK will partially arrest the decline in export market share that was a feature of the pre-crisis decade. In the following paragraph they say:

“While these assumptions are mutually consistent – private spending would be expected to rise as a share of GDP when the share of household income and corporate profits derived from government pay and procurement falls – they do illustrate the challenge facing the UK economy in adjusting to the further fiscal tightening that the Government is assuming.”

Politicians are fond of talking about the challenges facing the economy, but this is one that the government itself proposes to create. It is a challenge the UK economy could do without.

Secular stagnation and computers

For macroeconomists

Secular stagnation means different things to different people, but a common motivation is the steady decline in real interest rates since the 1980s. There have been many explanations for this (some of which I discuss here), and a common feature is that while some mechanisms are quite plausible (in particular a reduction in population growth will reduce real rates in most models) individually they do not seem quite enough. It therefore appears likely that we could be looking at something with multiple causes. So here is another possible mechanism that can be added to the list, which is the fall in the price of new investment goods.

Although this link between investment goods prices and secular stagnation has been suggested before, I want to focus on a new paper by Gregory Thwaites of the LSE and Bank of England [1], which explores this effect in a complete model. His paper has some similarities to the paper by Eggertsson and Mehrotra that I talked about in this post (for example it uses a three period OLG model), but it has much more of a focus on this investment goods price effect.

One of the very striking features of recent decades has been the relatively slow growth in the price of investment goods compared to the more familiar price of consumption goods. As Karabarbounis and Neiman (2014) [2] note, this is often attributed to advances in information technology and the computer age. Thwaites extends Karabarbounis and Neiman’s data across countries and time, and shows that this decline in the price of investment goods occurs across countries, and did appear to begin around 1980.

A key issue is how much firms react to the fact that capital is becoming cheaper by substituting capital for labour. In Karabarbounis and Neiman they react with an elasticity of substitution greater than one, and they use their analysis to explain a decline in the labour share. However, as Thwaites notes, there are many studies which suggest a less than unit elasticity of substitution.

To see the implications of this, consider a very simple OLG model with log consumption and where agents only work in the first period. This implies that the proportion of income saved is constant. So if the fall in the price of investment goods leads, ceteris paribus, to a fall in the value of capital required by firms, then to equate the demand and supply for savings real interest rates will fall. (You need an OLG framework here. In the benchmark representative agent model, the real interest rate equals the rate of time preference plus the growth rate.) This is a steady state result, and the paper explores the dynamics.

That is the key idea. For me, a really interesting aspect of the paper is that it integrates housing into this analysis. If real interest rates fall, and for whatever reason the supply of housing is fixed, house prices will rise (see these two posts). This leads to an increase in gross household debt, because agents borrow from the old to buy houses. Thwaites’s model shows that this dampens the fall in real interest rates, because this is an alternative destination besides capital for retirement savings.

I recognised the mechanism, because I had been playing around with the same effect when looking at steady state changes in government debt. A permanent reduction in the ratio of government debt to GDP would in an OLG model free up savings for capital, reducing real interest rates (as we explored in this paper for example). But lower real rates also raise the demand for housing, which can be an alternative way of saving for retirement. More generally, whatever the causes of this apparent trend decline in real interest rates, the implications for the housing market - and what we think of as ‘normal’ in that market - are likely to be profound. 

[1] Thwaites, G (2014) Why are real interest rates so low? Secular stagnation and the relative price of investment goods, Centre for Macroeconomics Discussion Paper No. CFM-DP2014-28

[2] Karabarbounis, L. and B. Neiman (2014). The global decline of the labor share. The Quarterly Journal of Economics 129 (1), 61–103.

Destroying the state is no accident

In a discussion of George Osborne’s plans for the deficit, I suggested that - if we were to take them seriously - they could only be rationalised as an attempt to fundamentally reduce the size of the state. Chris Dillow, following Rick and Giles, seems to prefer the cock-up theory, whereby the destruction of the state is an accidental result of an obsession with the deficit. I’m afraid they are wrong - this is no accident.

I suspect we would not be having this discussion if we were talking about the US. Indeed, Brad DeLong, in commenting on a different post where I ask why some academics so dislike fiscal stimulus, says I’m trying so hard to be fair that I lose sight of the ball. He asks “how can you not think it is all ideology on the other side ..”. That was a discussion about academics, who you might hope were more objective and less politically strategic than politicians.

So why do I think the sharp reduction in the size of the state in the UK is no accident? The most obvious piece of evidence is how the deficit has been reduced. Osborne originally planned an 80/20 split between cuts in spending and increases in taxes. In practice, as Giles pointed out at the Resolution Foundation’s meeting, deficit reduction has almost all been about spending cuts, with almost nothing net on taxation (largely because of the LibDem inspired increases in the personal allowance). If it really is all just about the deficit, why the imbalance? As one time European Commissioner Olli Rehn put it, in complaining that (initially) France was trying to comply with Eurozone deficit rules by putting up taxes: “Budgetary discipline must come from a reduction in public spending and not from new taxes”.

The argument I use in my earlier post is that there is no sound macroeconomic case for a rapid reduction in the share of debt to GDP at a time when interest rates are still at or near their lower bound and there are risks to the recovery. So, if the macroeconomic argument for deficit reduction is unsound, there has to be another motive. Chris turns that on its head. He says: “whereas the arguments for austerity are plain daft - talk of the "nation's credit card" is sub-literate drivel - arguments for shrinking the state are at least reasonable.” Why use daft arguments rather than reasonable arguments? If they want to reduce the size of the state, why not just argue for that? Why use the deficit as a cover?

Before I answer that, let me raise another question which frequently arises. Why on earth has Ed Balls come to accept the austerity case? As Tony Yates tweeted to him today: “why are you reluctant to point out that we *need* deficit stimulus while monetary policy is limited by the zlb [etc]?” [Subsequent post here.] As Bill Keegan reminds us, this is the same Ed Balls that in 2010, while acknowledging that there should be a deficit reduction plan, said “but only once growth is fully secured and over a markedly longer period than George Osborne is currently planning …Just think if Clement Attlee’s government at the end of the second world war had decided that the first priority was to reduce the debts built up during the war – there would have been no money to fund the creation of the NHS, no money to rebuild the railways and housing destroyed in the blitz, no money to fund the expansion of the welfare state.”

The reason for this about turn is of course mediamacro, which is why I go on about it so much. When the entire media jumps on your leader because he forgot the bit of his speech where he mentions the deficit, as a politician you are bound to conclude that the battle has been lost. It is not that journalists were wrong to point out the omission - the problem was the presumption shared by nearly everyone that this was a gaff because the deficit is in reality all important. And please don’t say politicians who bow to this media pressure ‘lack courage’ - a politician’s job is to win elections.

The cock-up argument could respond that somehow the government has got trapped by its own rhetoric. It used the deficit line as an obvious stick with which to beat the opposition, but it has somehow got out of control. Except of course that Osborne did slow down/stop deficit reduction when it looked like the recovery might not come before the election. He did not feel trapped then.

Chris asks why there has been no media campaign to promote the idea of a smaller state. He writes: “I'd encourage sympathetic journalists - of which Osborne has many - to write about excessive or wasteful spending. I'd commission management consultants and civil servants to show how to improve the efficiency of each government department. And I'd find some economists to show that a smaller state tends to promote growth.” But this misses a key point I have often made about mediamacro. I do not believe (despite what some commentators on my posts imagine) that the media can persuade people of anything. In particular, they would find it very difficult to persuade people we need a smaller state.

As I showed here, seven times as many people want higher taxes and spending than want lower taxes and spending. People like their NHS, they want resources put into state education, and pensions are also popular, which is why these items tend to be protected or ring-fenced. It would be very hard to get traction arguing that we should reduce spending on these items. As Jeremy Warner, assistant editor of the Daily Telegraph, wrote: “The bottom line is that you can only really make serious inroads into the size of the state during an economic crisis. This may be pro-cyclical, but there is never any appetite for it in the good times; it can only be done in the bad.”

While people are clear about their preferences for public goods, they are not experts on macroeconomics. So when they are told that the deficit has to be reduced - painful though that will be - then they think about their own budgets and it makes sense. They remember the Eurozone crisis which involved governments not being able to sell their debt. Media myths have to come from half-truths.

Nor is it the case that the right has not helped prepare the ground for replacing the state with the private sector where it can. The neoliberal line is that the state is always slow and inefficient and the private sector is always dynamic and innovative. It is a meme that is so pervasive that it came as a shock to many when Mariana Mazzucato pointed out how much innovations like the iphone depended on state funded research. Rather than being bureaucratic and conservative, the state was often where the high risk innovation took place. Equally welfare fraud happens and it offends people a lot, but that has been shamelessly exploited in some quarters, a trend encouraged by the Chancellor himself.

The neoliberal force is strong with this government, and I see no reason to believe that does not also apply to their Chancellor and his macroeconomic policy.

Do we get the leaders our media deserves?

One of the many things I enjoyed about the Resolution Foundation meeting I talked about here was meeting for the first time people who I have long enjoyed reading, including fellow bloggers Frances Coppola and Steven Toft (Flip Chart Rick), recent blogger Giles Wilkes and Guardian journalist Polly Toynbee. On the day of the meeting Polly Toynbee wrote a nice column on the attempts by the right wing press to portray Labour as elitist and/or too intellectual and therefore ‘out of touch’ with the concerns of ordinary people. That column has a sentence that is so apt I’ll save it for the end of this post.

Readers from the US will be all too familiar with this tactic, from the Gore-Bush campaign for example. A closely related ploy is to argue that politicians who are not poor who advocate policies to help the poor are somehow hypocrites (which of course tells us a great deal about the ethics of those making that accusation). Of course attempts to use background, income or character as evidence against a politician are not unique to the right. Arguments that because Cameron and much of his circle went to Eton and therefore cannot represent ordinary people are no better.

Indeed, as this article by New Statesman editor Jason Cowley illustrates all too well, the left can easily tar their own leaders with a similar brush. Here is a quote:

“Miliband is very much an old-style Hampstead socialist. He doesn’t really understand the lower middle class or material aspiration. He doesn’t understand Essex Man or Woman. Politics for him must seem at times like an extended PPE seminar: elevated talk about political economy and the good society.”

No evidence is presented that Miliband does not “really understand the lower middle class or material aspiration”. That can only make sense if it follows from him being “an old-style Hampstead socialist”. There is no real difference between this and the articles in the right wing press about which Polly Toynbee rightly complains.

Of course left and right are not symmetrical in one important sense: power. The right control the media spotlight, and it is focused on Miliband, such that every misfortune - self inflicted (HT Tim Harford) or otherwise - becomes a reflection on Miliband’s character. So the SNP’s popularity, and the likely loss of Labour seats there, is all down to Labour's Westminster elitism, and nothing to do with a resurgence of Scottish nationalism which in turn is a reaction against the current UK government. Voter defections from Labour to UKIP are put down to an alleged Hampstead/Islington intellectual tone: never mind that we have a governing party actually falling apart over an issue crucial to the future of the country. A tweet of a house festooned with English flags is further evidence of an alleged contempt for the working class, while employing someone at the centre of government who was subsequently jailed for being part of routine phone hacking is apparently not a reflection of anything. In this situation, is it any wonder Miliband has bad personal poll ratings. [1] It has ever been thus. Neil Kinnock, an eloquent and passionate speaker with eminent working class credentials became at the hands of the media a “Welsh windbag” who did not have the gravitas of a prime minister. The only recent Labour leader not savaged by the press was Tony Blair, but only because Blair deliberately cultivated Murdoch, and had policies that were (designed to be?) not threatening to the establishment of which the press are a part, and who was famously relaxed about inequality and the growing wealth of the 1%. But I digress.

In an FT article about a week ago, Bill Emmott - former Economist editor - raised important issues about the role of the media in portraying political leaders. It has a fantastic opening paragraph:

“Look carefully at the photos from Thursday’s by-election victory of the UK Independence party in Rochester, or those of last month’s Ukip victory in Clacton. Can you see that disembodied smile? No, this is not Lewis Carroll’s Cheshire Cat; it is a Milanese mog. That feline grin represents a dangerous trend in British politics, one that goes beyond our arguments about immigration, the EU or globalisation, important though those are. It is the smile of Silvio Berlusconi.” 

According to polls, our two most popular political leaders at the moment are Boris Johnson and Nigel Farage. Emmott argues that their popularity comes from the same source as with Berlusconi: they raise a smile, and no one looks too deeply at their mistakes, flip flops or even lies. What Emmott does not explore explicitly is why they are able to get away with things that would sink other politicians. With Berlusconi the answer appeared straightforward - he owned a large part of the media. But what Emmott is suggesting is that maybe ownership is not crucial: if the media are prepared to give a leader as easy ride because they are amusing and charming, we may end up with the same result.

You might think this could not happen here - the moment that either Johnson or Farage get close to power the attitude of the media would become more critical. That seems naive - how close do they need to get? The focus of some parts of the media on background and individual character seems to me part of the same trend, and it is not going to change before the election. We already have a media environment where something like a tweet of a house gets more media coverage than the impact of welfare reforms in driving many to rely on food banks to survive, or worse. It is an environment where on the day that Scotland is devolved substantial new powers, Channel 4 news chooses to lead on what an ex-cabinet minister might have said to a policeman in the heat of the moment. Those in the parts of the media that do not have to follow a political line, but who make decisions about what is newsworthy and what is not, need to reflect on what the impact of these decisions might be.

In truth what a political leader is seen drinking, the quality of their jokes, or even their actions in responding or not to the media, tell us virtually nothing about what they will do if they gain power, and in whose interest they will act. But we are not clueless. The sentence from Polly Toynbee’s article that I wanted to leave until last was this: “By their policies we know whose sides our politicians are on – whose interests they champion.”  

[1] When those who voted Labour in 2010 were asked by YouGov whether Miliband would be up to the job of Prime Minister, 54% said yes in early October, but only 34% said so in early November. Did that one month reveal some serious flaw in his abilities as a future Prime Minister, or did his poll ratings fall because the media were incessantly talking about his poor ratings! These ratings are a convenient (because they are endogenous) device to keep the spotlight focused on him. The same YouGov poll suggests voters would be no more likely to vote Labour if Yvette Cooper or Ed Balls were leader, so the idea that Miliband is a huge impediment holding Labour back seems fanciful.

Understanding Anti-Keynesians

Paul Krugman says Keynes is slowly winning. Tyler Cowen says no, there is lots of evidence Keynes is still losing. If this strikes you as slightly juvenile, I don’t blame you. Squabbling over the relevance of some guy who died nearly 70 years ago does make the academic discipline of macroeconomics seem rather pathetic.

Now, as you probably know, I’m not a neutral bystander in this debate. However I have always thought it important to try and understand where the other side is coming from. Leaving aside the debating points, what deep down is the core of the other side’s beliefs? But before addressing that, we need to be clear what we are arguing about. Let me single out three Keynesian propositions.

1)    Aggregate demand matters, at least in the short term and in some circumstances (see 2) maybe longer.

2)    There is such a thing as a liquidity trap, or equivalently the fact that there is a zero lower bound to nominal interest rates matters

3)    At least some forms of fiscal policy changes will impact on aggregate demand, and therefore (given 1), on output and employment. Because the liquidity trap matters, when interest rates are at their zero lower bound we should use fiscal policy as a stimulus tool, and we should not embark on fiscal austerity unless we have no other choice.

If propositions (1) and (2) strike you as self evidently correct, you might accuse me of drawing the lines in this debate in a biased way. I would of course agree that they are correct, but I would also note that there are large numbers of academic macroeconomists (don’t ask me how many) who dispute one or both of these ideas. Tyler Cowen in the post cited above talks about a ‘so-called’ liquidity trap in the context of the UK.

Many macroeconomists - particularly those involved in analysing monetary policy - did think as recently as ten years ago that there was a broad academic consensus behind both (1) and (2). I was one of them. There was talk of the new neoclassical synthesis (pdf). This idea that there was such a consensus fell apart when a number of prominent academics objected to governments using fiscal stimulus in 2009.

This suggests (3) is at the heart of the dispute. However my reason for including (1) and (2) is that if you accept these two points, point (3) follows pretty automatically. I was careful in formulating (3) not to claim that fiscal policy should become the only or main stimulus tool: exactly what role it should play alongside Quantitative Easing or other forms of ‘unconventional’ monetary policy - including those analysed by Keynesian macroeconomists - remains unclear and can be reasonably debated. As I have noted before, the two sides are not symmetrical on this point: while most Keynesians are happy for central banks to undertake various forms of unconventional monetary policy, the aversion on the other side to using fiscal policy seems more absolute.

It is here that I have a difficulty. It seems to me in a mature, ideology free science we would be discussing - when in a liquidity trap - the relative merits of alternative forms of monetary and fiscal stimulus. It would also be generally agreed that, given the uncertainties involved with all forms of unconventional monetary policy, now was not the time to undertake austerity. But that is not the discussion we are having. Why not?

An easy answer is that it is all political or ideological. Just as politicians can use fears about debt as a means of reducing the size of the state, so antagonism against fiscal stimulus comes from the same source, or an ideological aversion to state intervention. That in my view would be a sad conclusion to draw, but it may be naive to pretend otherwise. As Mark Thoma often says, the problem is with macroeconomists rather than macroeconomics.

I can think of two alternative explanations that might at least apply to some anti-Keynesians. The first comes from thinking about the importance of money to macroeconomics. Money is very important, and indeed you could reasonably argue that the existence of money is critical to point (1) above. The mistake - in my view - is to therefore feel that monetary policy has to be the right way to stabilise the economy. It makes you want to believe that (2) is not true. This seems to me to have nothing to do with ideology.

The second is historical. I suspect we would not even think of questioning the central role of Keynesian ideas for macroeconomics today if it had not been for the New Classical revolution in the 1970/80s. This revolution was successful in the sense that it did change the way academic macroeconomics was done (microfoundations and DSGE models). Most academic macroeconomists - for better or worse - are deeply committed to that change. But the revolution was opposed by many in the Keynesian consensus of that time, and so Keynesian economics became associated with the old fashioned way of doing things. This association was encouraged by many of the key revolutionaries themselves. We now know, as a result of the development of New Keynesian economics, that there is no necessary incompatibility between the microfoundations approach and Keynesian ideas. However I suspect that, at least for some, the association of fiscal policy with old-fashioned Keynesian ideas set down deep roots. It certainly seems that some notable academics were surprised that New Keynesian models actually provided strong support for the use of countercyclical fiscal policy in a liquidity trap.

I should really stop there, but having started with Tyler Cowen’s post, I really should say something about his comments on the UK. The basic facts are very simple. We had significant fiscal contraction in financial years 2010/11 and 2011/12, which then stopped or at least slowed significantly. The UK recovery was erratic from 2010 to 2012, and only reached a steady pace in 2013. That is entirely consistent with the importance of fiscal policy in a liquidity trap. (The OBR calculate that austerity reduced GDP growth by 1% in 2010/11, and by 1% in 2011/12, with little impact thereafter.) Quite why the obvious fact that other things besides fiscal policy are important in explaining growth in any year is thought to be an anti-Keynesian point I cannot see. And if the case against Keynesian ideas rests on the incorrect forecast once made by a prominent Keynesian then this is really scraping the barrel.