Thursday, 1 October 2015

Nonsense on data revisions

Following publication of revised GDP figures today, Robert Peston writes:

"a particular school of Keynesian economists may choose to re-examine their contention that only a fool or a liar would say there is a legitimate debate about whether George Osborne's policies were good or bad for the recovery."

Sorry Robert, but this is just nonsense: complete and utter nonsense. This "particular school" has never based their assessment on observing what is still the weakest UK recovery since anyone can remember and looking for something to blame. They based it on what macro theory and the great majority of empirical studies tell us would be the impact of the fiscal austerity that happened. At the conservative end of such assessments is the OBR, who calculate austerity reduced GDP growth by 1% in each of the financial years 2011 and 2012. Estimates of this kind are completely independent of data revisions for one period in one country. We might doubt such estimates if they implied that without austerity we would have had implausibly rapid growth, but for this recovery they do not. 

The other point completely missing from Peston's account is that the UK's growth performance even with these revisions is still terrible. As I have often pointed out, high inward migration in recent years means you really have to look at GDP per head to make comparative statements about this recovery. As the ONS point out, this new data still shows that only in this year has GDP per head exceeded its pre-recession peak. Assuming recent data revisions have not changed this, average growth in GDP per head between 1955 and 2008 was about 2.25%. Any recovery from such a deep recession should have seen growth rates well in excess of this. Instead the revised data give us 1.1% growth in 2011, 0.5% in 2012, 1.5% in 2013. Only by 2014 had we got near the long term average growth rate. This is still an absolutely terrible performance for a recovery.

That is not some "particular school" talking. That is just basic stuff that any good economic journalist should point out: see Ben Chu for example. I suspect it would also be what Robert Peston would point out if this was not all so political and the government were not breathing down the BBC's neck. The mediamacro problem is still very much with us.

Sunday, 27 September 2015

On giving advice

I was happy to agree to be on an advisory panel for Shadow Chancellor John McDonnell MP. There are only two reasons why I would say no to any major political party who asked me to give them their advice. The first is if this restricted what I would otherwise write on this blog or elsewhere. No such request has been made, although if you are hoping that I will reveal in posts accounts of what happens at panel meetings you will also be disappointed.

The second reason why I might have said no is if I thought the advisory panel was for presentation only, and all advice would be ignored. I have no reason for believing that in this case, and some grounds for thinking the opposite, which I discuss today in the Independent. In particular their position on fiscal policy is similar to the one I suggested here, although getting the message clear probably requires some work. 

One rather sad comment on the formation of this group is that those joining it will be forever tainted by associating themselves with a "hard left dinasours". Or to put it another way, its members should have said no to the Labour party leadership because they now have pariah status. As I pointed out in the Independent article, the current leadership will have to come to some kind of accommodation with the rest of the parliamentary party, and so Labour policies are unlikely to be the kind of far-left platform that many in the media seem happy to imagine. As Labour are the main opposition to the current government, and I think their macro policies are pretty awful, it would have been bizzare indeed if I had said no to this invitation.

Robert Peston has a short blog post on this new panel. He asks a very good question, which is why previous party leaderships have not done anything similar. I would quibble about one phrase in his post though, and that is this group is designed "to establish an economic ideology outside the mainstream". As I have often said, my own macro is pretty mainstream. What has happened since 2010 is that macro policy has departed from that mainstream.      

Friday, 25 September 2015

The path from deficit concern to deficit deceit

I have always written that the arguments in 2010 for focusing fiscal policy on reducing debt were understandable. They were wrong, but you could understand why reasonable people might make those arguments. In particular at the time the problem of the recession appeared to be over, recovery was under way, and the Bank of England seemed confident in the power of unconventional monetary policy. It seemed reasonable to move attention to the deficit.

So when 20 economists and policy makers wrote in February 2010 apparently supporting George Osborne’s deficit reduction plans, I was not surprised. The majority of macroeconomists, like me, disagreed, and we were right, but I could understand where they were coming from. One of those signing that letter was Lord Turnbull, head of the Civil Service and Cabinet Secretary between 2002 and 2005. By August 2012 around half of those that signed the letter had the good sense and honesty to backtrack on what they had written. The Chancellor may also have (wisely) revised his original plan to end the current deficit within 5 years, but his zeal to bring down debt rapidly by cutting government spending had not disappeared. When he was re-elected in May, it was for a programme of renewed austerity.

But the story does not end there. A few days ago Lord Turnbull had the opportunity to question the Chancellor on his drive for further austerity. This is a part of what he said.
“I think what you are doing actually, is, the real argument is you want a smaller state and there are good arguments for that and some people don’t agree but you don’t tell people you are doing that. What you tell people is this story about the impoverishment of debt which is a smokescreen. The urgency of reducing debt, the extent, I just can’t see the justification for it.”

A former head of the civil service, who had initially supported Osborne on the deficit, was now accusing him of deliberate deceit. Big news you might have thought. And quite a turnaround in just 5 years.

Yet it is not surprising. Osborne’s fiscal plans really have no basis in economics. That leaves two alternatives. Either Osborne is just stupid and cannot take advice, or he has other motives. George Osborne is clearly not stupid, which leaves only the second possibility. It is therefore entirely logical that Lord Turnbull should come to agree with what some of us were saying some time ago.

What a strange world we are now in. The government goes for rapid deficit reduction as a smokescreen for reducing the size of the state. No less than a former cabinet secretary accuses the Chancellor of this deceit. Yet when a Labour leadership contender adopts an anti-austerity policy he is told it is extreme and committing electoral suicide. Is it any wonder that a quarter of a million Labour party members voted for change.

Sunday, 20 September 2015

What do macroeconomists know anyway?

In an article in the Independent today I argue that what goes for a ‘credible’ economic policy among politicians and the media is often very different from what an academic economist might describe as credible. Which invites the obvious response: who cares, what do academic economists know anyway? So I look at what I regard as the three major macroeconomic policy disasters in the UK over the last 35 years, and one success.

The success was the decision not to join the Euro in 2003. It is pretty clear that this was the right decision, and it was made after what may have been the most extensive academic consultation ever undertaken by the Treasury, coupled with substantial macro analysis. (I talk more about this here.) The Prime Minister Tony Blair was initially in favour of joining, but the analysis helped persuade him otherwise.

The first failure was Mrs. Thatcher’s monetarism, which was famously opposed by 364 economists. Those on the right have tried to spin this as a failure by the economists, but the actual policy framework of money supply targets was a complete disaster and was quickly abandoned, never to be tried again. (Here is a discussion, and here is an account from one of the two movers behind the letter.)

Current austerity we all know about: if not, read this.

The third disaster was the UK’s entry into the European Exchange Rate Mechanism (ERM) in 1990 at an overvalued exchange rate, and the subsequent recession and forced exit in 1992. My argument that this went against macroeconomic analysis needs some justification. At the time I was in charge of macroeconomic research at the National Institute (NIESR) in London, and I undertook with colleagues what was easily the most extensive analysis of the consequence of entry into the ERM at different exchange rates. This was subsequently published in 1991, but all the material was first presented before we entered the ERM.

We concluded that the UK’s actual entry rate was 10-15% above the equilibrium rate. The implication was unavoidable: either we would be forced out, or trying to stay would lead to a recession as part of an ‘internal devaluation’. I remember Sam Brittan, one of the main writers at the FT at the time, saying that he thought we had won the intellectual argument, but that his instinct was still that we should enter at a high rate.

After entry into the ERM the UK entered a recession, and we were then forced out just two years later. Our analysis was vindicated. It is true that the whole system eventually collapsed as a consequence of the tight monetary policy that followed German unification, but it is no accident that the UK was the first to go (Black Wednesday). On leaving the ERM sterling depreciated by 10%, and the UK recovered quickly from recession.

There is no doubt that had the Treasury taken our advice and entered at a lower rate, less jobs would have been needlessly lost. I have often wondered if I could have done things differently to make a more persuasive case. But honestly I doubt it: the almost macho appeal of entering at a ‘strong’ rate was too great, together with the idea that the market knew best. As I say in The Independent, macroeconomists are far from perfect, but the UK evidence suggests that you ignore their advice at your peril.

Haldane on alternatives to QE, and what he missed out

Andrew Haldane, Chief Economist at the Bank of England, gave a typically well researched and thoughtful talk recently. The main subject matter was the problem of the Zero Lower Bound (ZLB): why we may hit it much more often than we would like, and why QE is not a great instrument for dealing with it. To quote:
“QE’s effectiveness as a monetary instrument seems likely to be highly state-contingent, and hence uncertain, at least relative to interest rates. This uncertainty is not just the result of the more limited evidence base on QE than on interest rates. Rather, it is an intrinsic feature of the transmission mechanism of QE.”

In the past I have emphasised the point about lack of evidence simply because it is obvious. But as Haldane’s discussion shows, the problems are more basic than that. Some people argue that we can always get the result we want with enough QE. Yet if the central bank and the public never know how effective any amount of QE will be, then lags make it a poor instrument. It is refreshing to see a senior member of the Bank finally acknowledge its limitations.

Haldane considers two alternative ways of dealing with, or avoiding, the ZLB: a higher inflation target and getting rid of cash so that negative interest rates of whatever size become possible. The first is obviously welfare reducing, but as Eric Lonergan argues the second is likely to be as well. (See also Tony Yates.) But what is really strange about Haldane’s analysis is what is missing from his discussion.

One omission is a discussion of the possibility that targeting something other than inflation might help. The other omission is any discussion of helicopter money. There are some basic contradictions in the Bank of England’s views on helicopter money, but because central bankers tend to talk to each other I suspect they remain concealed. One argument is that helicopter money will somehow reduce confidence in the currency, but then the Bank seems happy to research getting rid of cash and imposing negative rates on money as if this is all about technicalities. [Postscript - meant to link to John Cochrane's discussion, and here is a reply by Miles Kimball.] I should have referenced  Another argument is that helicopter money will threaten the Bank’s independence because it will have to rely on government to (if necessary) recapitalise it, when at the same time the Bank has already obtained an underwriting guarantee for losses on QE. Also strange is the argument that independence will be threatened once the Bank does a 'helicopter drop' because governments will want the money for themselves, as if politicians had not noticed the amount of money being created under QE. After all Jeremy Corbyn's proposal was a response to the reality of QE, not the possibility of helicopter money.

The really ironic argument is that helicopter money is too like fiscal policy, and that there should be democratic control over fiscal policy. This is what central bankers mean when they talk about blurring the lines between monetary and fiscal policy. The argument is ironic because I am sure that if you actually asked most people which they would prefer - being charged to hold money, 4% average inflation, or occasionally getting a cheque from the Bank - the answer would be emphatic. So we rule out helicopter money because its undemocratic, but we rule out a discussion of helicopter money because ordinary people might like the idea.

There is also an element of hypocrisy. It is sometimes argued that helicopter money is unnecessary because it has a very similar impact to conventional fiscal policy. This is true, but it deliberately ignores the fact that governments around the world have gone for fiscal contraction because of worries about the immediate prospects for debt. It is not as if the possibility of helicopter money restricts the abilities of governments in any way. If governments undertake fiscal stimulus in a recession such that helicopter money is no longer necessary, it will not happen.

So it is good that some people at the Bank are thinking about alternatives to QE, which is a lousy instrument with unfortunate, and potentially permanent, distributional consequences. It is a shame that the Bank is not even acknowledging that there is a straightforward and cost free solution to this problem. My last two posts have involved defending central bank independence, but with independence comes a responsibility not to exclude discussion of particular policy options simply because they break some kind of taboo.      

Thursday, 17 September 2015

Central Bank Independence and MMT

This is a follow up to my last post on Corbyn and central bank independence (CBI). No apologies for returning to this topic: not often do you get to talk about policies that are in the process of being formulated. One of the influences that is said to be important for John McDonnell (the new shadow Chancellor) and his advisors is Modern Monetary Theory (MMT).

A comment I sometimes get on my posts is that my arguments are similar to those put forward by followers of MMT. I have not read much MMT literature, but in what I have read I have normally not found anything I take great exception to. On some issues, like the way monetary policy continues to be presented in textbooks, they definitely have good reason to complain about the mainstream. However their account of the way monetary and fiscal policy work seems quite a close match to what many mainstream economists think, which I guess is why my arguments can be similar to theirs.

One area of apparent difference, however, is CBI. You will sometimes hear MMT people talk about CBI being a ‘sham’, whereas mainstream macro attaches great importance to CBI. So which is right? Part of the problem here is that CBI in the UK (where the government decides the goal the Bank has to achieve) is rather different from that in the US (where the Fed has much more discretion over the choice of targets) and the Eurozone (where the ECB is largely unaccountable and has huge power). I’m just going to talk about the UK set up. (For a MMT perspective on the US, see here.)

CBI in the UK, established by Gordon Brown and Ed Balls in 1997, is no sham. The Monetary Policy Committee (MPC) decides when and by how much to change interest rates, and government has no influence on the MPC. How do I know this? From observation and from a huge number of conversations with MPC members. Since 2009 the MPC has decided when and by how much to do QE. Any Treasury authorisation to do QE was a formalisation that essentially followed Bank wishes, but it never specified when and how much QE should happen. So a fair description of the UK set up is that the government defines the goals and instruments of policy, and the MPC decides how to use those instruments to best meet those goals.

I would agree with the comment that this set up leaves the government taking big strategic decisions, like what the target should be. But CBI as defined in the UK still has two major advantages over the pre-1997 alternative

  1. party political motives for changing interest rates are ruled out. I know such motives influenced at least the timing of rate changes before 1997. (How do I know - same answer as before.)

  2. it forces governments to be explicit about their goals, and the relative priorities among these. I personally believe this has an important role in conditioning (but not determining) expectations, which is very useful. (Yes you can call me a New Keynesian for this reason.)

You could add time inconsistency and credibility issues in there as well if you like. (Giving this to secondary importance perhaps makes me less of a New Keynesian.)

Are there any negatives to set against this? One argument you often hear is that CBI is anti-democratic, but I really think this is just nonsense in the UK context. Government delegates technical decisions all the time, and as long as there is strong accountability (which in the UK there is), the right people are on the MPC and they are truly independent (from government or the financial sector) this works well. When governments only face elections every 5 years and elections are won or lost over a whole range of issues, quite why a Chancellor deciding when to change rates following secret advice is more democratic is unclear. It also improves democracy because, as Chris points out, the Chancellor is not held to account for the technical mistakes of his advisors.

A more important argument against CBI is that it makes money financed fiscal expansion much more difficult. A government that is obsessed by the size of its deficit might not undertake a bond financed fiscal expansion when a fiscal expansion is needed. It might have undertaken a money financed fiscal expansion, but CBI prevents it doing this because the central bank controls money creation. However this problem can be easily avoided by (a) taking a more sensible view of government deficits and debt, as MMT would also advocate, or (b) allowing helicopter money.

It is (a) that makes the debate over Corbyn’s QE particularly ironic. A National Investment Bank can be set up perfectly well based on borrowing from the market, and you can ensure it gets the funds it needs by a government guarantee. The only reason you would avoid trying to do that is because the NIB debt would count as part of the government’s deficit, and you were worried about the size of the deficit. The last people who should be worried in this way are followers of MMT.

Scott Fullwiler has an elaborate discussion of why Corbyn’s QE does not interfere with CBI, but concludes: “As such, government guaranteed debt of the NIB would be effectively the same thing as plain vanilla deficits, which as shown above is not different in a macroeconomically significant way from Overt Monetary Financing of Government via People's QE.” Which begs the question, why not go with plain vanilla deficits to fund the NIB. If it is because you are worried about the political costs of higher deficits, that will be as nothing compared to the political costs of instructing the Bank to finance a NIB.

So where does this apparent antagonism for CBI come from? Perhaps it comes from a tendency of some from the mainstream to make too much of CBI. To imply that the more independent a central bank is the better, regardless of who determines goals, whether there is accountability and who makes the decisions. Proof that independence is not all that matters is provided by the ECB. But we should not let the bad drive out the good. If Labour abandons the innovations made by Brown and Balls, I think it will be a classic example of the triumph of ideology over both good economics and self interest. 

Monday, 14 September 2015

Labour and Central Bank Independence

Sometimes Paul Krugman can be very annoying. On a number of occasions I have written a draft of a post, and while in the process of admiring editing it, have found that PK has just written something rather better. So I bin my post on why Corbyn’s resounding victory is partly the product of Labour’s failure to oppose austerity rhetoric: read this instead.

In any case it may be more useful to look forward to what Labour’s macroeconomic policy might become under Corbyn and the shadow Chancellor John McDonnell. There has been some suggestion, encouraged by what I insist on calling Corbyn’s QE, that Labour are contemplating getting rid of an independent Bank of England. I think in macroeconomic terms this would be a bad idea, and in political terms a terrible idea. It is best to say this sooner rather than later, before commitments are made.

In essence all the Bank of England normally does is decide how to change interest rates to hit a target decided by government. Whether it is an inflation target or some other target(s) is for the government to decide. There are plenty of macroeconomists who would favour a higher inflation target, or targeting a different measure, so there is a great deal of scope for change here. But once that target has been chosen, why are politicians better at trying to hit it than a bunch of technocrats some of whom have spent their lives studying this one task?

It is vital to appreciate how different the UK set up is from the Eurozone. Many years ago I was very suspicious of central bank independence (CBI), because I thought it might lead to just the kind of deflationary bias that we see today in the Eurozone. Partly because of decisions made by Ed Balls and Gordon Brown, the Monetary Policy Committee (MPC) in the UK is quite different. The target is symmetrical, and the MPC has independent members and is very transparent and accountable. So what is there not to like which the government cannot already change?

I fear the situation has become confused because of austerity at the Zero Lower Bound. What CBI prevents either the government or the central bank doing is a money financed fiscal stimulus: a fiscal stimulus paid for by creating money rather than issuing government debt. The central bank can create money, and has done, but cannot force the government to spend more or cut taxes. The government cannot force the central bank to permanently create money to finance these things.

But this is only a problem if you have a government committed to deficit fetishism. It would be ironic indeed that a Labour party now pledged to fight austerity decided it needed to print money because they were reluctant to borrow more. It would be the ultimate triumph of austerity, and also just daft.

It would also be a gift horse to those currently implementing austerity. It would allow them to say that the only alternative to austerity was printing money which would lead to inflation. They have already begun to say it. It is spin that can be fatally undercut as long as CBI is preserved. But if that independence is ended, then you will create an army of mainstream academic economists who will say that high inflation is now more likely.

There will be some of those who advise Corbyn and McDonnell who might be tempted to say what have mainstream economists ever done for us. But if Paul Krugman is right, and I think he is, one of the reasons that Corbyn got elected is that Labour party members could see that the government was pursuing a policy that went against mainstream, as well as some heterodox, economics. Corbyn and McDonnell will have enough enemies in the media and the City as it is. It seems just stupid to create enemies elsewhere by foolishly ending the Bank’s independence.