Tuesday, 21 April 2015

Greece: of parents and children, economists and politicians

Not part of the mediamacro myths series, but in a way related.

Chris Giles has a recent FT article where he describes how non-Greek policymakers (lets still call them the Troika) see themselves like parents trying to deal with the “antics” of the problem child, Syriza in Greece. He splits these parents into different types: those that want to act as if the child is grown up (though they believe they are not), those who want to be disciplinarians etc. As a description of how the Troika view themselves, and present themselves to the public, the analogy rings true. It certainly accords with the constant stream of articles in the press predicting an impending crisis because the Greeks ‘refuse to be reasonable’.

In FT Alphaville Peter Doyle writes about a recent meeting at the Brookings Institution in Washington, the highly respected US social science research/policy think tank. In that meeting Wolfgang Schäuble and Yanis Varoufakis, finance ministers of Germany and Greece, gave back-to-back presentations. He describes how “Schäuble was avuncular, self-effacing, and Germanic, and was tolerated rather than warmly embraced by his hosts.” In contrast “when Varoufakis spoke, eyes burning with anger, his hosts were animatedly engaged.” The audience actively sympathised with the position of Greece, and asked “how it felt to be right but penniless”. He writes “There was no doubt where the hosts’ sympathies lay between their two guests.”

I am not surprised at all by this account. The arguments that many of us have made about how far Greece has moved and what agonies it has endured in order to satisfy the unrealistic wishes of their creditors are I think widely shared among our colleagues. We know that if Greece was not part of the Euro, but just another of a long line of countries that have borrowed too much and had to partially default, its remaining creditors would be in a weak position now that Greece has achieved primary surpluses (taxes>government spending). The reason why the Troika is not so weak is that they have additional threats that come from being the issuer of the Greek currency.

It is important to understand what the current negotiations are about. Running a primary surplus means that Greece no longer needs additional borrowing - it just needs to be able to roll over its existing debts. Part of the argument is about how large a primary surplus Greece should run. Common sense would say that further austerity should be avoided so that the economy can fully recover, when it will have much greater resources to be able to pay back loans. Instead the creditors want more austerity to achieve large primary surpluses. Of course the former course of action is better for Greece: which would be better for the creditors is unclear! The negotiations are also about imposing additional structural reforms. Greece has already undertaken many, and is prepared to go further, but the Troika wants yet more.

As Andrew Watt points out, from the perspective of the Eurozone and IMF, this is all extremely small beer. [1] You would think the key players on that side had more important things to do with their time. The material advantages to be gained by the Troika playing tough are minimal from their perspective, but the threats hanging over the Greek economy are damaging - not just to investment, but also to the very primary surpluses that the Troika needs. So why do the Troika insist on continuing with brinkmanship? Can it be that this is really about ensuring that an elected government that challenges the dominant Eurozone political and economic ideology must be forced to fail?

In a recent post that I (jokingly) entitled ‘Should economists rule?’ I suggested that much of the debate about the delegation of economic policy to economic experts was really an issue about political transparency rather than diminished democracy. Elected politicians normally always have ultimate control. Sometimes ‘delegation’ amounts to little more than making the advice they receive transparent: contracting out the fiscal forecast to the OBR would be an example. [2] All that democracy loses in this case is the ability of politicians to conceal or manipulate the advice they receive, and to fool the public as a result. Greece may be (unfortunately) a good example of how far politicians are prepared to go in misleading their own electorates to cover-up their mistakes and achieve their own political ends.
[1] The IMF mainly consists of hundreds of economists, but it is run by politicians, and on issues like this the politicians tend to take control.

[2] With central bank independence they do lose control, but normally with the power to take back control in some way. Furthermore, if the undemocratic central bank persistently made bad decisions, taking back control would be popular. An exception is the ECB, which may help explain why many of its words and actions are seriously problematic.

Mediamacro myth 1: 2010 Britain faced a financial crisis

The idea that the Coalition rescued Britain from a crisis is routinely put forward as fact by both the Conservatives and Nick Clegg. Every time the media let such statements pass (as they invariably do), the language seems to get more florid: Clegg’s latest is that the coalition was born in the “midst of an economic firestorm”. [1]

The facts say this is pure nonsense. The economy had begun to recover from the recession, and this recovery might have continued if it had not been hit on the head by domestic and Eurozone austerity. As Larry Elliott makes clear (see also here), there was no sign of any market panic, either in the markets for Sterling or government debt. 

But the government’s budget deficit was very large, and debt as a proportion of GDP was therefore growing. If, through a separate myth, you have created the idea that the major (perhaps only) goal of aggregate fiscal policy is to reduce deficits, this seems like a serious problem. But the deficit was rising because of the recession. It always does rise in a recession and fall in a boom, as the chart below shows. It was particularly high in 2010 because this recession was particularly deep.

Any economist would cringe at the idea that policy should try and eliminate deficits and surpluses created by the economic cycle, because that would mean destabilising the economy. This is sufficiently well known (cyclical deficits and surplus are called ‘the automatic stabiliser’) that it could undermine the idea that the high deficit was an immediate problem. This is one reason why it is important to push another mediamacro myth - the idea of Labour profligacy, which we debunk tomorrow. [2]

So where is the half-truth that gives the ‘firestorm’ myth some credence? It is of course the Eurozone crisis, and the idea that the UK could suffer a similar fate to the Eurozone periphery. But academic macroeconomists understand that the situation of a country with its own central bank, like the UK, is quite different from a country without, because the central bank can (and in the UK will) act as a lender of last resort, so the government will never ‘run out of money’. That simple fact is sufficient to prevent any crisis happening for an economy like the UK. Greece was profligate, and had to default, but the crisis in the rest of the Eurozone ended the moment the European Central Bank agreed to act as a lender of last resort in 2012.

Why is it so important to keep up the pretence that in 2010 the UK economy was ‘on the brink’ of a financial crisis? Because only then can the pain of the subsequent few years be excused. The truth is that the failure to recover until 2013 was not the inevitable cost of rescuing the economy from crisis, but an avoidable choice by the Coalition government. The delayed recovery, and the damage that did to living standards, was at least in part a direct consequence of attempts to reduce the deficit far too early, and there was no impending crisis that forced the government's hand. [3]

Previous posts in this series

[1] There is something about Clegg that wants me to see him in the best possible light. So I imagine that, when confronted just after the 2010 election by briefings from the Treasury and the Bank about the dire economic situation, he really believed what he was reading. He did not realise that, from the Treasury at least, it is standard practice to say this to any incoming government. (One of the interesting untold stories of austerity is the extent to which it was encouraged by senior Treasury civil servants.) But I suspect my imagine of 'Clegg the naive' is, well, imaginary.

[2] If the financial crisis had permanently lowered UK GDP, or the tax potential of GDP, then that would also imply the need to reduce government spending at some point. But, as most economists agree, you do that when monetary policy can offset the impact of these cuts on demand. You do not choose to undertake austerity when short term interest rates cannot fall any further.

[3] The clear majority of macroeconomists agree that austerity when short term interest rates cannot fall any further will reduce output. The OBR calculate that austerity cut growth in financial years 2010-11 and 2011-12 by 1%, but there are good reasons for thinking this may be an underestimate. 

Monday, 20 April 2015

UK mediamacro myths: an introduction

I’ve written an article for the New Statesman entitled “Covering up the austerity mistake”. The first half is about the nature of the mistake, which readers of this blog will be familiar with. The second half is how this mistake was effectively ignored by most of the media. Given the size of the mistake - lost resources worth on average at least £4000 for each UK household - calling this a media cover-up is hardly an exaggeration.

Let’s be absolutely clear: this £4000 figure is not just the opinion of one economist. It is based on analysis by the OBR, which the media is happy to treat as authoritative on most occasions. The OBR say austerity reduced GDP growth by 1% in both financial years 2010-11 and 2011-12. With no significant growth in 2012, that means a total output cost of at least 5% of GDP, which is about £1,500 per person or £4,000 per household. The only serious challenges I have seen of this analysis are that the numbers are too small. My own estimate of the total cost of austerity would be considerably higher, but I tend to use the OBR based figure because the OBR rightly has authority.

This cover-up is only part of the story. What I call ‘mediamacro’ continues to portray the economy as the Coalition’s strong card, yet all the data suggests this has been the worst recovery on record, with an unprecedented failure of living standards to rise. The combination of supposed competence and terrible outturns can only be sustained through a series of interlinked macroeconomic myths. Mediamacro - and particularly the political commentators who either perpetuate or fail to challenge these myths - have created an alternative reality, where a return to average growth rates during what should be a recovery period is treated as a triumph, and where stagnant productivity is either ignored or celebrated (by praising rapid employment growth).

That the governing parties want to cover-up such a big mistake and create this alternative reality is understandable. They enjoy the privilege of having at least half of the print media available to create and promulgate the myths that allow the cover-up. But myths cannot be created out of thin air. To get the majority of the remaining media to perpetuate these stories requires that they have some link to reality - what I call a half-truth, but which is really a much smaller fraction of a truth.

As a result we have the bizarre situation that this last five years has been terrible for the average person’s living standards, but nevertheless a majority think the government is relatively competent at managing the economy. This paradox can only be explained by the widespread belief in a set of interlinked myths supported by the media. It should be the task of the non-partisan media to expose myths rather than sustain them, and failure to fulfil that task diminishes our democracy.

As this is so central to the election, I want in each of the next 8 days to discuss a particular macro myth: how it springs from a half-truth and interlinks with other myths, but why it is clearly not supported by the facts. (Apologies to non-UK readers whose interest may be less direct, but I hope you understand that occasionally I really should be parochial. Normal service will be resumed shortly after 7th May.) Each post will be short, with one diagram at most, and easily accessible to non-economists. It is really important that the facts they contain get across to as many as possible.

Sunday, 19 April 2015

From seats to governments: UK general election arithmetic

This is written for UK readers, who will know who all the parties are. However you do not need to know the details to get the main points.

How do you translate seats into governments? So many parties, so many variables. Here is a suggestion, based on the idea that the number of seats that the big two are likely to get is much more uncertain than for the other parties. Then split those other parties into three groups: the ‘left bloc’ (mainly SNP, but also Plaid, Greens, Galloway and SDLP), the LibDems, and a ‘right bloc’ (NI Unionists plus UKIP). If Sinn Fein win 5 seats which they do not take up, there are 645 seats to play for, and a total of 323 seats gets you a majority.

Assume the left block gets 58 (50 SNP, 3 Plaid, 3 SDLP, 1 Green, 1 Galloway), the LibDems get 24, and the right block get 13 (e.g. 3 UKIP). That is a total of 95, leaving 550 to divide between Labour and the Conservatives. We can now split the result into a two dimensional set of possibilities depending on how the Labour/Conservative battle goes:

1) Con 323+ (Lab 227-) seats - Simple Conservative government

2) Con between 310 and 322 seats (Lab 240-228) - Coalition continues.

If you add the right bloc to 310 you get 323. In this case the Conservatives could shun the LibDems, but I suspect they will prefer to continue to work with the LibDems than having to rely on the right bloc, and the LibDems would find the attractions of continuing in government too strong to say no.

3) Con between 286 and 309 seats (Lab 264-241) - LibDems decide.

In this situation the LibDems have indicated they would ‘talk to the Conservatives first’, but in principle they could go either way: see below.

4) Lab between 265 and 298 (Con 285-252) - Labour SNP understanding.

265 plus the left bloc of 58 gets to 323. Would the LibDems get a look in? There is a possibility near the Lab 265 mark, where Labour might want to avoid the chance of one of the smaller left block parties causing difficulties. But it is not clear why Labour would want a coalition with the LibDems in this case, rather than something similar to their SNP understanding.

5) Labour between 299 and 322 (Con 251-228) - Labour choice

Labour would still have the option of an SNP arrangement, but it could alternatively form a coalition, or make an arrangement, with the LibDems. Some suspect Labour would find the politics of not being dependent on the SNP attractive, but they would probably want a new LibDem leader in exchange.

6) Lab 323+ seats - Simple Labour government.

At the moment the polls and models are suggesting we are in Labour-SNP territory, but only just, and things could easily slip into the ‘LibDems decide’ zone, with other outcomes still quite possible. If the LibDems do have to decide between Cameron and Miliband, things get very interesting.

There seems little doubt that Clegg and some other senior LibDems would favour continuing with the current coalition: the fact that Clegg has indicated he will talk to the largest party first indicates that, because in itself talking to the largest party makes little sense when the left block is so much larger than the right block. However most of his party members would more naturally favour the opposite arrangement. Furthermore, LibDem policies are generally closer to Labour than the Conservatives.

There are plenty of superficial sound bites that will be brought into play by the LibDem leadership to favour choosing the Conservatives: besides largest party talk, there is also the line of not wanting to be associated with a party that wants to break up the union (also largely nonsense). But what LibDem members really need to think about is the survival of their party if they continue with the current coalition when they have perfectly feasible alternatives. Imagine, for example, if the referendum went against continuing EU membership. Even if it did not, imagine the next two years when uncertainty about EU membership held back investment, and growth faltered under renewed austerity. Imagine the NHS finally collapsing from lack of funding. The Conservative party would recover from all those things, but the LibDems would always be seen as the party that chose to let this happen. I’m afraid I do not know enough about LibDem internal decision making to know how far the party would in practice be able to overrule its leadership in the days after the election. (If you do, please comment or email.) If they cannot, or chose not to, this zone merges with ‘coalition continues’.

Of course the number of seats obtained by the LibDems, and other minor parties, are uncertain, although less so than the Con/Lab split. However realistic changes to these numbers just move the location of these various zones, rather than change the zones themselves. The zone margins are also probably not precise: for example it is conceivable that one of the major two would prefer a LibDem coalition to having a majority of only 1. 

One final point about the role of the SNP. If the SNP seat count was much smaller (which seems very unlikely to happen), we would have a symmetrical position. In essence it is a three party model, with the LibDem position being ‘forced’ on the boundaries because the largest party has the option of instead going with the minor parties. A large SNP block creates an additional zone, where Labour can only govern with SNP support. Now suppose you are indifferent between the policies of Labour and the SNP, but are inclined to vote SNP because you think that would give Scotland more influence. Is there a downside? There would seem to be two.

The first concern would be that some English voters might not vote Labour because they did not want Scotland to have this additional influence. You could see Conservative claims of Labour-SNP chaos as code for this. The second is that it may deprive Labour of being the largest party. However that does not matter in any constitutional sense here, because the way I have set up the problem each minor party (in terms of seats) will only form a coalition with one of the major two. (The DUP might be an exception to this rule.) It only matters to the extent that being the largest party in terms of seats might influence the LibDems choice! Interesting times.

Saturday, 18 April 2015

Should economists rule?

Tim Harford in the FT talks to seven random mainstream economists about their radical ideas for economic policy. (Podcast, not pay walled, here.) Nick Stern wants green cities (with much greater economic autonomy), Jonathan Haskel wants more spent on research (because the returns are very high), Gemma Tetlow wants to merge income tax with national insurance, Diane Coyle wants to reduce boardroom pay, John van Reenen wants new institutions to promote infrastructure, Kate Barker wants changes to how housing is taxed, including capital gains on main residences, and Simon Wren-Lewis wants ‘democratic helicopter money’.

You can find more details about democratic helicopter money here. The democratic bit is that the central bank gives the created money to the government on condition that it is used for a stimulus package, but the form of the stimulus package would be the government’s choosing. I was impressed that Tim managed to turn a very pleasant chat over coffee (while taking few notes) into a coherent account of my argument. The only point I might have added is that my suggestion of turning helicopter money democratic is in part to avoid some of the political difficulties he alluded to.

The common strand in many of these suggestions, which Tim draws out, is a desire to replace direct political control by something more technocratic. Now you could say that this is simply a power grab by economists. However if you think about the examples here, they represent important and widely recognised policy mistakes which tend to be universal and persistent: failure to deal with climate change, failure to invest enough in R&D, unnecessary complications in the tax system, runaway boardroom pay, failure to invest in infrastructure even when borrowing is ultra cheap, a broken housing sector and procyclical fiscal policy. It is not as if the status quo is doing just fine.

I would add just two observations. First, the argument is often not about ‘losing democratic control’, but instead about advice being open and transparent. The alternative to some advisory body, whose deliberations should be publicly available and subject to scrutiny, is often secret advice from the civil service, or worse still from policy entrepreneurs. Second, what is thought political infeasible today may relatively quickly become commonly accepted.

I was quite surprised that Tim thought democratic helicopter money was particularly radical and politically infeasible. But then I remembered fiscal councils. My first published piece advocating (advisory) fiscal councils was in 1996, and for more than a decade this was considered the impractical idea of a few ‘out of touch’ economists, who were obviously anti-democratic. Then, little more than a decade later, the idea very quickly became acceptable. Nowadays, it seems like fiscal councils are everywhere. So the one part of Tim’s piece that I would not take too seriously are his scores for political feasibility and radicalism. Today’s supposedly radical idea can quite quickly become received wisdom.

Friday, 17 April 2015

Osborne's failure

I've mentioned before the coalition economics website, where the academic economists who analysed the Labour government's economic record for the Oxford Review do the same for the Coalition. My analysis of the Coalition's record on fiscal policy is now up.

It starts by noting three similarities between how Brown and Osborne started their time in office. First, they both made important and progressive institutional changes: Brown established the Monetary Policy Committee and Osborne set up the Office for Budget Responsibility. Second, they both established fiscal rules that improved on past practice. Third, they both started with significant fiscal contractions.

So why will history judge Osborne so much more harshly than Brown? Why did Osborne's policy cost each UK household on average at least £4,000, while Brown's (inherited) contraction had no similar cost in terms of lost resources?

The answer, of course, is that the macro contexts were very different. Brown's fiscal contraction happened when the economy was relatively strong, and interest rates were above 6%. Osborne's austerity happened when the economy was just starting a recovery from a deep recession, and interest rates were at their then Zero Lower Bound (ZLB) of 0.5%. Mainstream macroeconomic theory says that these different contexts make all the difference: when interest rates are at the ZLB, monetary policy cannot counteract the negative impact of fiscal austerity on output.

Why did Osborne ignore this basic piece of macroeconomics? Was his policy based on an alternative macro theory? A remarkable speech he gave at the RSA in April 2009 suggests not. In that speech he said that his macro framework was based on New Keynesian theory, because that theory implied monetary policy should look after macro stabilisation and fiscal policy should focus on debt control. Yet New Keynesian theory also says that monetary policy becomes ineffective at the ZLB, and cutting government spending in that situation reduces output. Incredibly the speech makes no mention of the ZLB problem, even though UK interest rates had just hit 0.5%!  

Could it be that Osborne, or his economic advisers, had simply not done their homework properly? One simple piece of evidence suggests not: his proposals for more austerity after 2015 risks making exactly the same mistake again, with interest rates still at or near their ZLB. A much more plausible explanation for his actions were that the macroeconomic risks were understood, but were put to one side for political and ideological reasons. First the possibility of hitting Labour with a populist concern about the deficit was too great a temptation to resist for a Chancellor for whom political tactics are everything. Second, austerity was a means of implementing an unpopular policy of reducing the size of the state by the back door.

Now you may cynically say that in a contest between economics and politics/ideology, politicians will always choose the latter. However much that is true or false, when that choice costs each household at least £4,000, it would be very strange if that politician survived the judgement of the electorate.  

Wednesday, 15 April 2015


Mainly for economists

Francesco Saraceno reminds us about the days in which very important people believed in the confidence fairy (aka expansionary fiscal austerity), which are not so very far away. He also points to some recent ECB research which shows that confidence - as measured by surveys - clearly falls following fiscal austerity. The confidence fairy, rather than waving her wand to make everything alright again, may be making austerity worse. 

However, looking at the research in detail revealed some results I found at first surprising. In particular, revenue cuts have a bigger effect on consumer confidence than spending cuts. In terms of GDP impacts, theory - and most but not all empirical evidence - suggests that temporary spending cuts will have a larger impact on overall activity than temporary tax increases, if there is no monetary offset and incentive effects are not very large. Do these empirical results contradiction this?

To answer that you need to ask two further questions. First, what does consumer confidence actually measure? Second, and perhaps more interesting, what information do fiscal announcements actually reveal.

The answer to the first question seems to be a mixture of things, some of which relate to the individual household’s income, and some related to the general economic situation. To the extent that the consumer is thinking about the former, then it would make sense that a tax increase might have a larger impact on confidence than a spending cut. This would tell you very little about the economic impact of the two types of measure.

The obvious answer to the second question is that the information conveyed by an announcement of a spending cut or tax increase is just itself. If we stick to taxes, then if the announcement had not been made, the consumer would have just assumed lower taxes (for a time, or forever?). But this is naive from an intertemporal perspective, and clearly non-Ricardian. In the logic of Ricardian Equivalence, a tax increase today must imply cuts in taxes tomorrow for a given path of spending.

There are three alternative, more ‘rational’, ways of thinking about the announcement of a tax increase. Suppose the current government budget deficit is not sustainable. Taxes either need to rise today, or tomorrow after more borrowing. The announcement then tells us about the timing of the tax increase. If Ricardian Equivalence held it would have no impact on lifetime discounted income, but if for many possible reasons it did not hold, then a tax increase today could depress consumer confidence. However, to the extent that confidence depended on the general economic situation, you would expect ‘bringing forward’ expenditure cuts to have a much greater impact than bringing forward tax increases (with the caveats noted above), because of consumption smoothing. In that case spending cuts should reduce confidence more than tax increases.

A second possibility is that a tax increase could signal something about the future economic situation. Perhaps the consumer had thought the deficit was sustainable because they were optimistic about future growth, but the tax increase told them to be less optimistic. Reduced optimism could lead to reduced confidence. To the extent that the fiscal action conveys information about future pre-tax incomes, the tax increase conveys the same information as a spending cut.

A final possibility, which is generally ignored when discussing the plausibility of Ricardian Equivalence, is that the announcement of a tax increase tells consumers about the composition of any consolidation. Suppose again that the deficit is unsustainable. Either taxes have to rise or spending fall, but the consumer does not know which of these will happen. If spending is then cut, this tells the consumer that taxes will not rise, which in terms of the consumer’s own income would represent a plus. So in that case a spending cut could increase consumer confidence.

Trying to evaluate the impact of past fiscal actions is complicated, in large part because it is difficult to know what the counterfactual was, or what people thought the counterfactual was. Were changes thought to temporary or permanent? (Governments hardly ever say, and even if they did would they be trusted?) To what extent do people internalise the government’s budget constraint? If they do, are fiscal changes telling us about the timing of taxes or spending, or their mix, or something else? It seems to me that these difficulties arise whether we are trying to assess the impact of fiscal changes on confidence, or on activity itself.