Why the centre-right has helped cause the drift to the far right in Western democracies

The far right now holds power in Hungary, Italy and Argentina. Trump, undoubtedly a far right figure, has a good chance of not only becoming the Republican’s presidential candidate but also beating Joe Biden. Nigel Farage was welcomed at this year’s Conservative party conference. Tim Bale notes similar trends in other European countries. The tide is not uniform, as defeat in Poland shows, but it does seem as if the far right is both gaining ground and becoming more respectable in many Western democracies.

A key question is how much this drift has been caused by or facilitated by the actions of centre-right political parties. This could involve the actions of centre-right parties encouraging support for parties further to the right, or it could involve the dominant centre-right party itself moving further right. In this post I want to draw on some of my earlier discussions to answer why this might be happening.

A prior question is what we mean by moving further right, or far right political parties. It is, as ever, helpful to distinguish between economic policies on the one hand, and social policies on the other. What most seem to focus on when worrying about the far right is the latter, and particularly a trend towards more authoritarian policies that reduce democratic freedoms and which scapegoat and harm minorities like immigrants or welfare claimants. The argument I will put forward in this post is that, for some countries like the UK at least, it is the right wing nature of economic policies pursued by centre-right parties that lead them to adopt or encourage more right wing or authoritarian social policies, which in turn encourages the far right both outside and within these parties..

The first point to make, which I explored in this post, is that it is quite possible for centrist parties to attempt to ostracise rather than encourage or adopt policies from parties less near the centre. Famously Edward Heath fired Enoch Powell after his ‘rivers of blood’ speech. On the left Starmer has excluded many left wing candidates, including the previous leader Jeremy Corbyn, from standing as MPs. In a predominantly two party system, excluding rather than embracing policies further from the centre makes perfect sense in a simple model where the two main parties try to capture the support of the median voter, and where there is little risk of many more right or left wing supporters voting elsewhere or not voting.

But what if the centre right party is committed, for ideological or other reasons, to economic policies that are quite far from the centre ground? To get elected, it needs to do two things. First, it needs to focus its campaigning away from these unpopular right wing economic policies. This is possible if the centre-right party has substantial support in the media, which it often does. Second, it needs to focus on more social issues, and try to attract socially conservative voters who may also have relatively left wing economic views. This inevitably moves it away from the centre on these social issues, unless it can successfully paint parties to the left as very liberal. I will call this the ‘culture war’ mechanism.

Focusing the policy debate on social issues, like immigration or nationalism, in itself allows political parties with more authoritarian policies the space to attract support. It also makes it more difficult for the centre right party to ostracise more extreme views. For example, if the centre right party is focusing on the dangers of immigration, it is difficult to suggest a party that believes immigration should be curtailed further is somehow beyond the pale.

This problem, of parties further to the right attracting the support of voters, members or even MPs, becomes even more acute if, while in office, the centre right party fails to implement policies that satisfy socially conservative voters. The example of the 2010 Coalition government in the UK’s immigration targets is an obvious example. As I argued here, there are strong economic reasons why a centre right party would not want to strongly curtail immigration, but if it campaigned on the basis that it will it leaves itself open to challenge from a party further to the right.

In large part, political parties that campaign to strongly and quickly reduce immigration are involved in deceit, unless they are explicit about the economic costs. I argue this here, but Nesrine Malik probably puts it better when she writes “apparently vexingly high [immigration] numbers are, to a large extent, the outcome of economic and political decisions that mean we invite immigrants to fill labour gaps that policymakers either did not anticipate, or ignored warnings about.” In the UK this also involves filling gaps that the centre right party deliberately created in the public sector by reducing the relative pay of medical, social care or teaching staff.

There is a second mechanism by which a centre right party that is committed to strongly right wing economic policies may encourage the far right. Part of having a strong right wing economic policy typically involves wanting a smaller state. In this post I looked at the strong evidence that austerity in the 2010s played an important role in increasing support for the far right. The key point I made is that this link is not just (or even mainly) because voters are reacting to being poorer, but because when cuts occur or real wages fall socially conservative voters tend to focus on ‘outsiders’ who they either feel are responsible for these bad times or who they feel do not deserve their meagre share of a shrinking pie. In this second political dynamic, the ‘austerity mechanism’, it is the right wing economic policies that directly encourage support for socially conservative policies.

With both the ‘culture war’ and ‘austerity’ mechanisms we have the adoption of right wing economic policies (e.g. neoliberalism) by the centre right leading to increasing support for far right political parties, and/or a further drift to the right (in the social/authoritarian dimension) within the centre right party itself. In both cases neoliberalism creates a drift to the far right and, because the centre right party itself moves, encourages the media to make these more far right views respectable.

To the extent that the far right (or the more right wing centre right) party is about encouraging internal divisions within society (us and them), it is likely to become populist, where its leaders represent ‘the will of the people’ (us) against the elite, their supporters and outsiders (them). This in turn can provide the platform for policy that severely curtails human rights (the rights of ‘them’ of course), and actions that bias democracy in favour of the right wing party. Such actions can range from requiring photo ID at polling booths to mounting insurrections when an election is lost.

The relative importance of these two mechanisms will obviously vary from country to country, and my focus on these two mechanisms obviously reflects the national experiences I know most about. It leads me to be able to say, in the UK and US at least, that the centre-right has played a large part in the way politics has drifted further to the right over the last decade or so. In other countries the role of the centre-right in facilitating more right wing figures taking power can be much more direct, as Tony Wood describes in Argentina here.

Both the dynamic processes I have highlighted have been pursued by centre-right parties for ideological or electoral gain, but whether those gains will be sustained or indeed reversed over time remains an open question. This is because the strategy either creates a big threat to the centre-right party from further right, or it shifts the party further right than many of its politicians wish. Both could make the centre-right party less likely to win elections in the longer term, because it opens up space for an opportunist centre-left party, particularly if that party is prepared to suppress its natural social liberalism.

Will this lead to a re-evaluation of strategy within centre-right parties? From what I know there is no sign of centre-right parties moving to the left (and therefore towards the centre) on economic or social issues as yet. I suggest here that the forces keeping them where they currently are or moving further right are too strong, and these forces in the UK include the influence of the media, the membership and those providing political donations. (Andrey Tomashevskiy finds that parties which receive a greater percentage of their income from private donors tend to adopt more extreme positions on socio-cultural issues.)

If this analysis is correct, then the global political landscape for some time to come will involve both opportunities and distinct dangers. The opportunity is that centre left parties who are prepared to appeal to the centre ground will find it easier to win elections, as centre-right voters are put off by the drift to the right of centre-right parties. The danger is that a far right party (or a previously centre-right party that has moved to the right) will come to power and curtail democratic freedoms.

Unfortunately, as I have noted before, there is no way the opportunity and danger offset each other. Even if centre-left governments became more common as a result, democracy inevitably leads to changes of power. As we are seeing in the United States, even quite obvious threats to democracy can be insufficient in dissuading enough of the electorate from voting a far right party or leader into office. If a far right party comes to power and starts distorting democracy to entrench its own position this may become very difficult to reverse.

Postscript 18/01/24

On evidence that centre-right parties adopting socially conservative, anti-immigration policies helps rather than hinders the far right, see here 

For discussion of the success of the far right in the Netherlands, which is consistent with the 'culture war' mechanism described above, see here. (HT Anand Menon)

If the next government isn’t diverting resources to investment then it will be giving up on our future

 

To prove you are not a robot, click on the cars in this picture.

You might be surprised that this blog has featured the causes and consequences of flooding over half a dozen times. However this is the first time I have been able to illustrate one of these posts with a picture taken five minutes walk from my home. In case you are wondering, there are unfortunately three cars in this picture, almost completely submerged by flood water.

Flooding and the damage it causes illustrate three themes that run through this blog. The first is the harm caused by governments trying to hit arbitrary and unnecessary financial targets by cutting back on public investment. The 2010 Coalition government cut back spending on flood defences sharply, and we see the consequences of that almost every year when we get high levels of rainfall. The second is that most of the media invariably fails to hold politicians to account for these failures, either by choice or because the broadcast media prioritises getting reporters in front of flood waters over briefing them properly.

The third theme is the ability to ignore or forget expertise. In 2007 the Pitt review concluded that climate change would create more and more of the kind of events we saw last week (essentially because a warmer temperature means that clouds can hold more water), and while the Labour government acted on Pitt's recommendations by increasing flood prevention spending substantially, the review was ignored by subsequent governments and largely forgotten by the media. As we saw with austerity, Brexit and Covid, it is very easy for governments to do things that a majority (or even almost all) experts think is foolish, and yet much of the broadcast media thinks its job is to present Westminster gossip or political debates rather than inform its viewers about the knowledge we have. The BBC’s cut in funding for Newsnight is just the latest example of how it is ignoring its mission.

In this post I want to use flooding as an example of a fourth theme that I am bound to return to time and again over the next few years, and that is the scale of extra public investment, and incentives for private investment, that are now required. My last post talked about greening the economy to get cheaper and more sustainable energy. Flooding, and how to mitigate its effects, is an example of adaptation to the climate change we have already created and are bound to create in the future however quickly we green the economy.

Unfortunately climate change is just one of a growing list of problems that require more investment. The Covid pandemic demonstrated the need for additional capacity within the existing health system to rapidly scale up its ability to test and trace new viruses. Those countries, like South Korea, that had already invested in this capacity did far better at saving lives than most other countries. Yet, as John Burn-Murdoch showed here, the NHS has been deliberately starved of investment since 2010, as has spending on preventative care. As a result, we need massive investment in health just to catch up to where we should be, let alone help us deal with any future pandemic. [1] In addition, we need to make our public buildings (especially schools) more resistant to airborne disease transmission.

More than ever, we need the popular narrative on what governments should do to move from obsessing about government debt to obsessing about public investment. We owe it to future generations to mitigate the impact of climate change, prevent worsening climate change and deal better with future pandemics. Not doing so would saddle these generations with a burden far greater than paying a bit more interest on government debt.

However it is equally foolish to pretend that investment on this scale is costless in economic and political terms. With the major economies, like the UK, working at or near to a non-inflationary maximum, additional public and private investment requires a significant shift of resources from private consumption. As Martin Sandbu noted here, democracies are not well set up for such shifts outside periods of war. Instead politicians prefer incremental changes, where losers can be compensated if necessary. But as he also writes, “what choice do we have” if we want to avoid leaving far greater problems for future generations.

While higher public spending on day to day activities in such situations requires higher taxes, higher levels of investment paid for by borrowing will require interest rates to be higher than they otherwise would have been to free up resources for that investment. [2] We can already see the battle lines of the next election reflecting this, with the Conservatives saying that Labour’s “reckless” (meaning very necessary and beneficial) additional green investment will push up mortgage rates. This line to take may not gain much immediate traction because people remember the results of Liz Truss’s little adventure as PM, but it will remain an attack against any government that dares to invest.

If a future government does prioritise public investment over reducing its debt and keeping interest rates low, the biggest threat it will face is from simplistic (“populist”) political attacks which suggest that you can cut taxes while maintaining public services, invest without borrowing and attract the labour industry needs without immigration. It is therefore imperative that all parts of society begin to see the benefits from additional investment, particularly those areas that have been neglected in the past. This, in turn brings us an additional reason why public investment in the UK has to be much higher, and that is improving transport infrastructure outside London.

The United States under Biden not only shows what can be done, but the political fragility of any attempt to invest in the future. The Inflation Reduction Act has been stunningly successful at using public money to mobilise private investment to green the economy. Partly as a result, the US economy is much stronger than most other major economies, and inflation is coming down with the soft landing theory predicted was possible but which many economists thought improbable. Yet Biden is getting little credit for all this. Instead political commentators obsess about his age, and polls suggest a close race with would-be dictator Trump.

Flooding in the UK is inevitable, but the scale of damage it inflicts is not. Climate change is inevitable, but its extent and destruction it creates is not. At some point another pandemic is bound to happen, but how much illness and death it causes is a choice society makes. To have any hope of making the right choices requires cooperation within and between societies with governments taking the lead in investing today. It requires a relatively small current sacrifice for a far greater future gain. The ability to do that is part of our humanity, but unfortunately so is tribal division, falling for charisma and believing we can return to a romanticised past.

[1] We also, of course, need to spend more day to day on health, including paying NHS staff much better, but while investment spending should come from borrowing current spending should be paid for by raising taxes. For this reason I don’t think taxes on working people in the UK should be lower.

[2] There are two reasons why interest rates will raise. The first, and most likely, is that higher demand for labour (because investment increases) will lead the central bank to raise short term interest rates to head off inflationary pressure. This in itself will raise long term interest rates, including interest rates on government debt, by at most the increase in short term rates. The second, and less likely, is that long term interest rates on government borrowing will rise just because the government is borrowing more.     

The case for increasing government debt to green the economy is greater than for increasing debt during the pandemic

 

As the chart below shows, the story of UK government debt since 1900 (as a share of GDP) is a story of crises (source).

The ratio of debt to GDP rose rapidly during WWI, stabilised thereafter and then started to fall in the second half of the 1930s, only to rise again during WWII. After WWII it fell slowly but steadily, returning to pre-WWI levels by the end of the century. It rose again during and after the Global Financial Crisis, finally rising a bit more during the pandemic.

As I explained here recently, government debt is a device that avoids sharp changes in taxes or government spending during bad times. It is therefore entirely right that during a crisis, like a world war or a financial crisis, government debt should increase substantially. To put it simply, the alternative of raising everyone’s taxes sharply would only compound the negative impact of the crisis.

For example if governments had raised taxes during the 2009 recession then the recession would have been even worse than it was. Consumers would still have increased savings and reduced borrowing during the crisis, so consumption would have fallen further than it did because taxes were higher. When governments did try to reduce their own spending and raise taxes after 2010, it caused considerable damage.

It was therefore natural for governments around the world to treat the Covid pandemic as just the kind of crisis where government debt needs to rise, to help pay for additional government spending during the pandemic. In Europe that additional spending was mainly paying large sections of the workforce to stay at home (furlough), while in the US it involved much higher unemployment benefits and other payments.

I will take the case for additional government spending during the pandemic as given. This is not yet another post from me about the wisdom of early but comprehensive lockdowns before vaccines became available. What I want to ask here is whether the reaction of most governments to keep taxes unchanged was correct? The reason that question should be asked is what happened to household savings during the pandemic. Here is the UK, and you will see a similar pattern in other countries.

In financial terms, the pandemic was not hard for most (not all) households. Instead most ended up saving much more than normal. The reason is straightforward, and goes back to something I have written a great deal about: social consumption. Most people substantially reduced their spending on activities like going out to the pub, restaurants, entertainment and travel. Sometimes this is because they were told to do so, but there are good reasons to believe this would have happened to a considerable extent anyway as people tried to avoid getting the virus from others. Social consumption amounts to about a third of total consumption, so it was inevitable that most households ended up saving a great deal during the pandemic.

There was therefore substantial scope on average for governments to pay for their additional spending during 2020 by temporarily raising taxes rather than increasing government debt. Most consumers would not have had to reduce their consumption further because they were paying higher taxes. Instead these taxes would have simply taken the place of large increases in personal savings during the pandemic.

If the pandemic was not like previous crises in that there was scope for the government to raise taxes temporarily in 2020, that does not necessarily imply that is what they should have done. For example higher taxes of whatever type will not perfectly match to reductions in social consumption, so there might be important distributional problems in raising taxes. Higher taxes might have discouraged some from working whose work was vital to keep the country going. Perhaps higher taxes would have reduced social solidarity at a time when it was most needed.

Whatever your view on this, I hope it suggests that higher government debt during a crisis is something that needs justification rather than something that should happen automatically. But strangely we do not seem to be having this conversation about the biggest global crisis facing the world today, which is climate change. So far at least the need to green the economy has not led governments to pay for that spending using deficit funding. I have talked on previous occasions about why climate change, and the need to green the economy to reduce carbon emissions, should be considered as a crisis which requires increases in government debt. Yet very recently we have seen the German courts prevent their government from increasing debt to pay for financing climate change expenditure.

The case for using deficit finance to pay for greening the economy is far stronger than paying for furlough during the pandemic. Although in theory carbon taxes fit the polluter pays model, the reality is that government spending and financial incentives have been much more effective at encouraging green energy production. As with most government investment, it is not clear why the current generation should pay for something that will mainly benefit future generations.

Why do some within Labour worry about the Conservatives weaponising their £28 billion a year pledge on green investment, and propose cutting back on those plans? Perhaps its because throughout most of the media, reducing government debt is either considered more important than preventing climate change, or the two are not connected in people’s minds. I want to propose a collective New Year resolution. If anyone claims that it is important for this or the next government to reduce their debt to GDP ratio, please someone ask why climate change isn’t the kind of crisis that should see government debt rise?

How a Labour government could be the tipping point for public discussion about immigration

 

Just over a year ago I wrote about the tipping point in public support for Brexit. The tipping point (in reality tipping points) is when trying to make Brexit work becomes an electoral liability for Labour, and they would gain votes in marginal seats if they instead talked about rejoining the EU’s customs union or single market. Despite what John Curtice has recently said, I agree with Chris Grey that the tipping point will not be before the next election, but it will only be hastened if Labour win that election.

This post asks the same question for public views on immigration. They are obviously linked, because attitudes to immigration will influence attitudes to the Single Market. At the moment both the Conservatives and Labour are saying they think net immigration numbers should come down substantially, and a majority of the public still think immigration levels should be reduced. However since around the Brexit referendum, public opinion on immigration has shifted substantially, as this chart from the Migration Observatory shows.

At first some speculated that this shift was because Brexit voters assumed that leaving the Single Market had solved their immigration numbers problem, but that idea must have been well and truly shattered by the recent figures for net immigration. To some extent more favourable views about immigration may reflect a backlash against populist rhetoric. However in the UK I think instead the major reason for this shift is a perception that immigration is no longer about more people looking for a fixed number of jobs, but instead a realisation that immigration is in large part about firms or organisations needing additional labour.

In an important sense Brexit has facilitated this change in perspective, both because of the end of free movement and because of well publicised job shortages in particular sectors. John Burn-Murdoch presents evidence along these lines in the FT (see also here), but you can also see this if people are asked about immigration to particular jobs.

For most of these occupations, more people wanted an increase than a decrease in immigration, even though they would say they wanted less immigration overall.

In this respect immigration is a bit like taxes. If people are asked whether they would like lower taxes they generally say yes, but if they are asked whether they want lower taxes and lower spending on health, education and welfare they generally say no. Equally if they are just asked about immigration you are likely to get a different response than if they are asked about immigrants to staff the NHS, for example, particularly if they are aware of NHS staff shortages. Note that, just with taxes, these are not two equally valid questions. With our current immigration regime for sure (and in practice before that) a question that links immigrants to the jobs that immigrants will do makes much more sense. The gradual reduction in opposition to immigration since Brexit noted above may be because some people are making this connection without needing to be prompted.

If this analysis is correct, will this trend towards more favourable views on immigration continue? This may depend in part on the state of the UK labour market. With a probable Labour government committed to increasing growth, it seems likely that we will see a strong labour market for at least some of Labour's first term in office. This, together with the impact of demographic change (younger people are more liberal), suggests that the trend towards a more favourable view about immigration will continue. Working in the opposite direction is that, under a Labour government, the right wing press will go back to their pre-Brexit ways with stories about ‘waves’ of immigrants who live on benefits and steal jobs, and this in turn will influence the broadcast media.

The tipping point for Brexit is when a Labour government, whose politicians are not as constrained by ideology or their members/donors/newspaper owners, find it is no longer to their electoral advantage to pretend to be ‘making Brexit work’. This happens the moment Labour would gain more votes than they would lose in key marginals by, say, joining the EU’s customs union or single market. In principle this shouldn’t just depend on what voters tell pollsters about these options, but also indirect effects like benefits to growth.

Is there a similar tipping point for immigration? As with Brexit, that tipping point would be well beyond half of the population taking a favourable view of immigration. This is because our electoral FPTP system is biased towards social conservatives, so taking a pro-immigration stance could still harm Labour in marginal seats even if only a minority of voters want less immigration.

However I’m not sure Labour have the luxury of waiting for their pollsters to tell them the tipping point on immigration has been reached. In this respect immigration is not like Brexit. With Brexit Labour can move gradually in the direction of greater cooperation with the EU from day one, and judge the viability of key steps in reversing the Brexit process. With immigration Labour will find it much more difficult to talk about numbers being too high initially, and then switch to stressing the benefits of immigration later on. In other words, with Brexit the direction of travel is the same, whereas with immigration it is not.

Labour’s discourse on immigration today, in opposition, is almost too easy. With the Conservative government simultaneously presiding over record immigration, and its MPs demanding immigration be lower, Labour’s work is being done for it. Those voters that want lower immigration will think the Conservatives have failed them, while many others will be rightly appalled at Conservative rhetoric and actions on asylum.

The situation will become very different after Labour has been in power for a year or two. The Conservative opposition (including its press) will be saying immigration is too high, and now it will be a Labour government that will be seen as responsible for immigration numbers.

Any government, Labour or Conservative, faces a strong trade-off with immigration policy. Actually restricting the ability of immigrants to fill jobs in the UK hurts the economy, which is why successive governments (of both parties) have been very reluctant to do this. Instead governments tend to resort to different sorts of gimmicks or cruelty, where Sunak’s latest measures are a prime example of the latter. However neither gimmicks or selective cruelty will have much impact on immigration numbers, and so over years those who are concerned about immigration numbers will turn on the government. A government that talks the talk on reducing immigration but fails to bring numbers down is storing up trouble for itself.

With popular attitudes to immigration becoming more divided, an alternative approach which Labour could follow may be politically wiser. Instead of seeing immigration as a numbers problem, Labour could instead focus on the role immigration plays in helping the economy. It could actively oppose the Conservative narrative, rather than presenting a slightly milder version of it. By presenting the benefits of immigration in terms of additional output and better public services, it could strengthen the growing numbers who are in favour of immigration for specific professions. It might even make pollsters stop asking questions about immigration in abstract, and instead link immigration to the jobs immigrants do. [1]

Taking this approach would mean no targets for immigration numbers, or even aspirations to reduce numbers, as the media will treat these as targets. It can involve improving pay and training to reduce the need for immigration to particular sectors, but if that influences immigration numbers at all it will take many years to do so. Labour could also talk about the contribution overseas students make to universities, and how they save taxpayers money. It could talk about the UK taking its fair share of refugees, rather than trying to pretend it can just take a selected few.

Is such a shift in rhetoric the pipe dream it may seem today? The key electoral argument for such a shift in approach from Labour is that the alternative of doing what it and Conservative governments have done in the past does not work. Pretending to be concerned about immigration, but not doing anything significant to reduce numbers because of the impact this will have on the economy, has played a key role in bringing down three administrations. Immigration was the Conservatives main weapon against New Labour before the Global Financial Crisis, it was key in bringing about Brexit and the end of the Cameron administration, and it is currently doing Sunak’s government no favours either.

With the public shift in attitudes to immigration, the next Labour government may be the point where being honest with the public about immigration and the economy could pay electoral dividends. However to work effectively that change has to begin the moment Keir Starmer walks through the doors of No.10.

Have a great Christmas, and let's hope for a new start in 2024

[1] Such an approach will not convince those who oppose immigration on principle because of xenophobia or racism, but such voters will probably go to the Conservatives or another right wing party anyway.

Lessons (so far) from the inflation bubble of 2021-3

 

Inflation went up, but now it’s coming down again. Not just in the UK, but pretty well everywhere. What macroeconomic lessons can we learn from this, and what questions still remain? Were ‘team transitory’ right after all? Were central banks too slow to raise rates, and once they started rising did they rise too fast?

The preliminary point to make is that inflation is not the cost of living. A period where inflation goes up and then comes down again means prices end up a lot higher at the end of this period than they were at the start. Those whose incomes have not matched the inflation they have experienced will be worse off, perhaps substantially so. For some who were already finding it hard to make ends meet, that is a very serious problem, which has not gone away just because inflation has fallen.

What should now be well understood is that this period of high inflation was not just about high energy and food prices. There were additional supply problems that pushed up prices, but more importantly labour markets in most of the major economies were also tight. Almost without exception, unemployment in 2022 was lower than at any time this century in the United States, Germany, France and the UK.

This meant that any increase in energy and food prices was likely to lead to some increase in wage inflation. This in turn would make the inflationary shock caused by higher food and energy prices more persistent, because firms not producing energy or food would pass on much of any increase in labour costs. To avoid this turning into a permanent increase in inflation, central banks raised interest rates in the US, UK and Euro area.

Were central banks too slow in raising interest rates? It is important to understand that central banks cannot and should not try to always keep inflation at target. When the relative price of commodities increases, it would be deeply damaging to try and reduce all other prices so that aggregate inflation did not rise. So there was always going to be an inflationary bubble in 2021-3. The issue is whether central banks could have moderated it more than they did.

It is also important to remember that in 2021 the main concern was and should have been ensuring a full recovery from the pandemic. Few anticipated the size of the inflationary shock (i.e that Russia would invade Ukraine, or that there would be so many supply side bottlenecks), and the pandemic made it difficult to read the state of the labour market. My own view, and in contrast to many others including various Lordships, is that central banks were right to delay raising rates until 2022. Once they understood that the recovery from the pandemic had been strong and that as a result the labour market was tight, they acted by raising rates pretty fast.

The fact that inflation is now falling quite rapidly strongly suggests that central banks have done enough to stop this energy and food price shock leading to permanently higher inflation. What we don’t know yet is whether they did too much, because the lag between nominal interest rate increases and falls in economic activity can be quite long. [1] However we can still make one important point.

When inflation was near its peak some economists (let’s call them the inflation pessimists) argued that a significant period of depressed economic activity would be necessary to bring inflation back down to be close to the 2% target. Only when unemployment was significantly higher than it is today, they suggested, would wage inflation start to fall back towards levels that are consistent with a 2% target.

We now know that that argument is almost certainly wrong. Wage inflation has fallen in the US and elsewhere without any large increase in unemployment. Of course unemployment may still rise because of the delayed effect of higher interest rates, but it is a bit of a stretch in the US at least to suggest that falling wage inflation in the US is a response to expectations of above trend unemployment.

What is not often discussed is that current macroeconomic theory does not suggest a period of significantly higher unemployment is necessary to reduce wage inflation. In this sense the inflation pessimists could be accused of being old fashioned. The idea that ‘if it’s not hurting it isn’t working’ comes from a traditional Phillips curve, where price and wage setters only look at past inflation when forming expectations about future inflation. The key point about a central bank trying to hit an inflation target is that price and wage setters take the actions of that central bank into account when forming expectations.

If the central bank has credibility (an overused word simply meaning here that central banks will be successful in hitting their inflation target), then this anchors future expectations about inflation at the inflation target. Wage and price setters know that inflation will come down to 2% once inflation shocks disappear or excess demand is eliminated, and so form their expectations accordingly. In this situation, there is no need for a period of excess labour or goods supply to bring inflation down. To use another much overused macroeconomic cliche, soft landings are quite possible and should be what central banks aim for.

Of course central banks can still get things wrong. They may not do enough to eliminate excess demand, in which case inflation above target will persist. They also may do too much to deflate demand leading to a period of excess supply, which could lead to inflation undershooting it's target. This second possibility is still very real in the UK and Europe, although it is looking less likely in the US.

As De Grauwe and Yi show, getting inflation down in the 2020s has been much easier than in the 1970s. This is partly because the inflationary shock was more short lived (gas prices have fallen and post-pandemic supply disruption is over, although food prices remain high) so no permanent contraction in supply was required. However it is also because we now have independent central banks with inflation targets, and a recent history where inflation has been close to target (so these central banks have credibility).

If the inflation pessimists, who thought a period of excess supply and higher unemployment was necessary to get inflation down, have been proved wrong, have ‘team transitory’ been proved right? Well that depends on what ‘team transitory’ believed and said. For the sake of exposition, let me define team transitory as saying that inflation would have come back to target without the large increase in interest rates we have actually seen.

This question is difficult to judge, because we do not know what the path of inflation would have been if central banks had not raised interest rates so much. As someone who initially argued against the size and speed of interest rate increases, it would be nice to answer yes, I was right. A great deal will depend on what happens to economic activity and inflation over the next year or so. There seem to be two possibilities, and it is may be that the major economies end up illustrating both cases.

The first possibility is that the economy achieves a soft landing: inflation comes down close to target without any economic downturn relative to trend. If this happens, it suggests increases in interest rates were required, and in that sense team transitory was wrong. [2] The second possibility is if economic activity becomes depressed and inflation undershoots its 2% target. In that case central banks will have overdone their monetary tightening, and team transitory may well have been right.

All the indications are that for the US a soft landing is more likely than not. If this transpires then both the inflation pessimists and team transitory will have been wrong, and the Fed (the US central bank) will have done very well. For both the UK and Eurozone it’s too early to say whether we get a soft landing or not. But in the US at least, at the moment it looks like the experts in the central bank are rather better at managing inflation that many outside pundits. Not a popular conclusion I know, but also perhaps not a surprising one either.

[1] Part of the reason for this is that economic activity is influenced by real interest rates (nominal rates less expected inflation). Only now, with inflation falling, are real rates becoming positive.

[2] This assumes that higher interest rates reduce aggregate demand. As I argued here, the evidence is very strong that they do.

Unofficial lockdowns, and Sunak’s deadly incompetence during the pandemic

 

It is now well established that Rishi Sunak as Chancellor played a significant role in increasing the death toll from the pandemic on at least two occasions. The first was to introduce ‘Eat Out to Help Out’ in the summer of 2020, and the second was to advise Prime Minister Johnson to ignore the medical advice from SAGE to impose a lockdown in the early Autumn and subsequently.

In both cases he will argue that, as Chancellor, his role was to protect the economy. Yet he did no such thing. As Chancellor, he failed to understand that to protect the economy you had to control the virus, which means keeping the number of people infected low. I and other economists argued this at the time, but in this post I want to set out the logic in a new way to show why there never was a health/economy trade-off.

A decade before the pandemic a group of us published an article on the economic effects of a pandemic. One of the main findings of the paper was that a severe pandemic can involve serious economic costs because consumers will avoid what we called ‘social consumption’. Social consumption involves anything that brings consumers into contact with others, so includes eating out, going to pubs or the cinema, using public transport etc. Social consumption involves a third of total consumption, so if people significantly reduce their participation in these activities the impact on the economy will be large [1].

We could call this effect an ‘unofficial lockdown’. Individuals stay at home rather than eat out or go to the cinema because they want to avoid catching the virus, not because they have been told to by the government. The key point is that if the government does nothing, individual actions attempting to avoid catching a potentially deadly virus will lead to a substantial economic slowdown. Swedish GDP fell by 7.6% in 2020Q2, even though no official lockdown was imposed.

This is why reducing the number of people infected also helps the economy recover. There is no health/economy trade-off in this kind of pandemic. If economic policy encourages people to put themselves at greater risk of getting infected, as Eat Out to Help Out (EOTHO) did, then any boost to the economy would have been limited to when the scheme operated, and thereafter there would only be economic damage as infections increased. The only situation where this might not happen is if R (the average number of people infected by one person) was sufficiently less than one and it remained below one despite EOTHO, but we know this wasn’t the case and Sunak made a point of not asking SAGE about it.

While EOTHO played some part in the second wave that grew during the Autumn of 2020, just as serious a failure was Sunak arguing against the SAGE proposal for a second lockdown in September. It is the case that an official lockdown has a bigger immediate negative impact on the economy than an unofficial lockdown. This is because, for example, in an unofficial lockdown

1. Many people will not be well informed, and will not reduce their social consumption much if at all

2. Some people will be well informed, but decide the risk to themselves is small so they will not reduce their social consumption, and discount the risk of them infecting the more vulnerable.

3. Employers may force workers to continue to travel work, even though both the work environment and travelling to it may risk infection.

Yet for the same reasons, an unofficial lockdown has less of an effect in reducing R than an official one. [2] This is what the UK experienced in the Autumn of 2020, even with the addition of some regionally based restrictions imposed by the government. With R>1, not only are more people being infected, with some dying or getting Long Covid, but the economic damage persists as individuals try to protect themselves by withdrawing from social consumption.

The UK and other countries experience of full official lockdowns is that they reduce R to less than one, so with a short lag infections start falling. This was the case for the lockdown at the end of March, the one month lockdown in November and the lockdown in January 2021. Because R<1, the number of infections fall and then the economic damage caused by individuals avoiding social consumption dissipates.

My focus on what happens to R is crucial, because there is a world of difference between R<1 and R>1. In the former the pandemic is being controlled, so that when lockdown ends the situation is manageable, and the hit to the economy from reduced social consumption will be relatively small. If R>1 the damage to the economy just keeps getting larger.

So while an official lockdown might do more damage to the economy than an unofficial one while it lasts, the official one deals with the problem, so reduces the time that Covid damages the economy. In contrast doing nothing, or taking measures that fall short of a full lockdown, allows infection numbers to increase and so allows damage to the economy to persist.

This is exactly what we saw in the Autumn of 2020. Thanks in part to pressure from Sunak, the government rejected advice from the experts to impose a full lockdown, and so infection numbers grew and consumption remained over 10% below its end-2019 level. When a sustained lockdown came in 2021Q1 consumption was only a few percentage points lower than 2020Q3 (GDP was actually higher), but that lockdown brought cases right down, and vaccines then removed the need for further lockdowns.

It is really difficult to rationalise what Sunak did during the summer and autumn of 2020. By deliberately not asking SAGE about the impact of EOTHO, he must have known this would increase infection rates. Did he really think the economy would be largely unaffected by a second wave? Unlikely, as in enacting EOTHO he was aware of people reducing social consumption because of the pandemic! Perhaps his actions were guided by perceived political advantage rather than economic or health impacts.

Gross incompetence is a strong term, but I fear it clearly applies to Sunak in these two cases. His thinking appears not to have got beyond the level of a right wing newspaper column, despite having the resources of the Treasury at his disposal. [3] His actions not only led to many people dying, but his actions also damaged the economy when he was the minister in charge of protecting it.

[1] This response modelled in our paper involves individuals trying to avoid catching the virus. It was not coordinated by governments in any way. In the paper we didn’t look at government imposed lockdowns beyond school closures.

[2] Obviously this judgement is country dependent. In countries where people and employers are better informed and more socially minded, unofficial lockdowns may come closer to replicating official lockdowns. This is why comparisons between countries that did lockdown and Sweden are potentially misleading, and why comparisons between Sweden and other Scandinavian countries are much more informative.

[3] Reporting on the Covid inquiry has naturally focused on political culpability rather than the advice politicians were being given. In this particular case it is inconceivable that the Treasury was unaware of the analysis I outline here. What happened to that analysis, and how far up the civil service hierarchy it got, are interesting questions we do not know the answer to. Until we know, we can only wonder whether senior Treasury officials' concern about higher government borrowing in lockdowns mattered more than the health of the economy.

Fiscal failures: The UK Autumn Statement and the German debt brake

 

Many people fear debt, because they worry about the consequences of not being able to pay the interest on it, or pay it back. However it is a huge mistake to let that fear override another truth, which is that debt is a brilliant device. It allowed me and millions of others to buy a house, and for many years continue to buy houses. More generally, it allows individuals to spend more money early in life, and pay for it during middle age when they are normally earning much more.

The extent to which we can transfer our own income intertemporally to smooth consumption over time has been growing over my lifetime. The opportunity to borrow when young is undoubtedly a good thing, yet despite this many on both left and right complain about the corresponding increase in debt that automatically comes from that.

Exactly the same is true for government debt. It allows governments to keep their spending on health, education and everything else stable when revenue streams fluctuate because of booms and recessions. In addition, it allows governments to cushion the impact of recessions on individuals who lose their jobs (unemployment benefit), and this ‘automatic stabiliser’ helps moderate the impact of the recession for everyone else. It allows the government to spread the cost of investment in roads and hospitals, so that those who benefit (current and future generations) help pay for it. It allows the government to respond effectively to a crisis, like the Covid pandemic.[1]

This is all possible because it is fairly costless to allow debt to fluctuate when revenue fluctuates or spending needs to temporarily rise. Imagine the harm that would follow if public service provision had to go up and down during the business cycle, with the NHS carrying out less operations in recessions, or children getting taught less.

A key corollary of the idea that debt allows smooth taxes and spending is that if debt increases substantially in a crisis it should be reduced back (if at all) very slowly. Debt to GDP can be reduced gradually over many decades (as UK debt from WWII was), or not reduced at all if there is no reason to think the level of government debt is excessive. [2] I have suggested that action to control climate change should also be regarded as a similar crisis.

Once this has become clear (as it will be to any economist), the idea of a debt target immediately becomes problematic. The whole point of debt is that it can go up and down depending on economic circumstance, so trying to fix it (or the change in it, the deficit) at some number is in danger of undoing all the good things debt can do outlined above. A target for debt is a bit like setting a target for how much fuel your central heating boiler can use, and as a result you freeze on cold days but get over hot on warm days.

So why do governments have targets for debt or deficits? The answer is that government debt can be abused by politicians for political advantage. In the early years of the Trump presidency he and the Republican Congress cut taxes for the better off, and paid for it by increasing the government’s deficit rather than raising taxes on everyone else. The political reasons why this was done are obvious, but this is an abuse of government debt, because there is no intertemporal smoothing involved.

Last week we saw our own government do much the same thing. The Chancellor cut taxes by pencilling in future public spending numbers that were pure fantasy. As these public spending numbers could never be implemented, taxes are bound to have to rise again after the election whoever wins it, to pay for more realistic public spending plans.

Why did the Chancellor do this? It’s a political win-win for him. He can claim that the Conservatives are the tax cutting party, and hope to get a bounce in the polls from voters who didn’t read the IFS, Resolution Foundation or another good analysis of what was going on. [3] He wins if that means the Conservatives stay in power. He also wins if they lose the election, because then it will be a Labour government that raises taxes and he can say I told you so.

This type of abuse of government debt by politicians is why we have debt or deficit targets. To put it starkly, if we always had governments that just acted in society’s interest, debt or deficit targets would not be necessary. It is also why saying we have to have these targets ‘because of the markets’ is quite wrong. For economies like the UK, the markets are not a kind of policeman taking action if governments abuse government debt.

Although this explains why targets for debt or deficits exist, the problem remains that trying to hit a target for debt or the deficit makes no sense in the short term, because debt is what allows the government to smooth its spending and taxes. There is a real conflict between allowing good governments to use debt wisely, and stopping governments abusing debt for political ends. [4]

There are three approaches to this conflict. The first is to ignore political abuse of government debt, and have no targets for the deficit or debt. This is kind of [5] what happens in the US, and leads to a bizarre situation where Republicans are seen as tough on the deficit but in reality are not and the Democrats have in the past reduced the deficit and suffered the associated political costs.

The second approach is to largely ignore the economic advantages of government debt and focus everything on controlling it. The clearest example of this approach is Germany, and its debt brake. (The historical background to its imposition is described by Adam Toose here. The brake is popular among the public, but not with economists.) Essentially this involves imposing a fixed path (strictly an upper bound) for nominal debt, with deviations only allowed in two circumstances..The first is a cyclical downturn, but any deviation (excess deficits) have to be corrected in the subsequent upturn (with deficits less than the target) . The second is a designated (by parliament) crisis, where any excess deficit has to be steadily paid back over a set time period (e.g. 20 years).

This debt brake has been made part of the German constitution, so the courts can overrule the government if it thinks the rules are not being obeyed. This happened very recently, where the court ruled that the government couldn’t use some of the unspent crisis money from the pandemic to spend on greening the economy. You can think of a constitutional debt brake as a natural expression of German ordoliberalism, or as just a huge mistake.

In an earlier post I described Germany’s debt brake as perhaps the worst fiscal rule ever applied by a modern government to itself. It turns government debt from a flexible instrument that allows various forms of beneficial smoothing into a rigid straightjacket that stops the government doing important things, like investing in greening the economy. Rigid targets for the total deficit or debt invariably lead to underinvestment in the public sector, and that is exactly what has happened in Germany. Lack of public investment in time leads to less private investment, and a weak economy. Germany is a textbook example of the problem I recently described here, where deficit obsession leads to economic stagnation.

The third option is to have some form of deficit target, but to make it as flexible as possible to allow the government to use its debt in a beneficial way. I have consistently argued that this is best done with a five year ahead rolling target for the government’s current deficit (excluding public investment), with no additional targets and to apply only outside recessionary periods. But I have also argued that any fiscal rule alone will always be inadequate, either because governments will always find ways to cheat or because occasionally even the best fiscal rule should be ignored. You also need a fiscal watchdog: an independent organisation that can act as a referee for aggregate fiscal policy. Osborne, when he set the remit for the OBR, ensured it would not be such a watchdog, but it would be quite easy to change its remit so it could become one.

This third, middle way can provide the benefits that government debt makes possible, but also ensure that debt is not abused by politicians for their own ends. The problem we have had in most countries that have imposed fiscal rules is that both politicians and the media have focused on the latter at the expense of the former, perhaps because they think about politics more than economics. As a result, these rules have done and are doing considerable economic harm, while any benefits remain difficult to see. [6] However, forsaking any fiscal rules would mean that the kind of fiscal deceit we saw in last weeks Autumn Statement becomes routine, rewarding irresponsible governments and penalising the more responsible.

[1] One or two economies have governments whose financial assets are greater than their debt, so they are able to finance investment and intertemporally smooth by changing their asset levels rather than their amount of debt. The political reasons why these countries are unusual will become clear.

[2] We have very little idea of what the optimal level of government debt is.

[3] As should now be clear, governments abusing debt works in political terms because voters do not regard increases in debt as future taxes. This in general is not completely irrational, because voters can always hope that someone else pays the future taxes. In the case of the Autumn Statement, however, because taxes will rise immediately after the election, then believing the Chancellor’s rhetoric or the right wing press is either being irrational or more probably reflects being ill-informed.

[4] This conflict is the basis of my paper with Jonathan Portes.

[5] Except when a Republican Congress tries to impose a debt ceiling.

[6] Advocates for rigid fiscal rules, like the German debt brake, normally count falling government debt to GDP as a benefit. This confuses means with ends. There is no solid evidence, or indeed relevant economic theory, that suggests countries with low debt to GDP derive any benefit compared to countries with higher debt to GDP.