Home > Fiscal Policy, Monetary Policy > George Osborne, New Keynesian

George Osborne, New Keynesian

Pretend you have been appointed Chancellor of the Exchequer in May 2010, and you want to find out what what “bleeding-edge” macro research says you should do.

What do you find out?

If you’ve read New Keynesian Lars Svensson, you might be sceptical about the efficacy of deficit spending in boosting aggregate demand.  Like Svensson, you’ve watched Japan run large deficits for two decades, and seen that that the level of Japanese nominal GDP is unchanged after that all time, yet public sector debt has soared.  You don’t want to go down that route.  You might like the idea of a “Foolproof Way” to exit the ZLB, a price level target and currency devaluation, but you can see the UK CPI is already above target, and you are worried about the global politics of engaging in “currency wars”.

If you’ve read New Keynesian Ben Bernanke, you would be a strong believer in the unlimited power of the printing press in raising UK aggregate demand.

You would surely listen to New Keynesian Mervyn King, who is one of the UK’s most prestigious macroeconomists, and also happens to run your central bank.  He tells you in no uncertain terms to get the deficit down and let him get on with running  AD policy.  He tells you he tried out his printing press in 2009, and it worked very well indeed.  He’s got your back.

If you’ve read New Keynesian Paul Krugman, you’ll consider raising the inflation target to 3% or 4% as the best policy choice at the ZLB… but you get shot down by Mervyn King who thinks that’s a really bad idea, which might herald a return to the 1970s.

You’ll also believe that under New Keynesian inflation forecast-targeting, the central bank will internalize whatever fiscal policy decisions you make, and steer an appropriate course for UK aggregate demand.  Your new friend Mervyn has promised to print enough money to keep things ticking along nicely.

So maybe you get on with running fiscal policy to cut the deficit, and let the Bank take care of AD policy for a year, or two years, or three years.  Inflation stays well above target, and the jobs market, well, it could be much worse.  The printing press is duly deployed when necessary.

But bizarrely, all this time another bunch of “New Keynesian” economists are baying for your blood, admonishing you for making some kind of policy error.  They don’t seem to believe a word Ben Bernanke wrote.  They don’t believe in inflation forecast-targeting.  They tell you that monetary policy doesn’t work, and you’re an idiot for thinking it ever would.  They have nothing much to say about Japan.  And they have strange ideas about how fiscal policy can be used as a “magic money tree”, with “self-financing” deficits.  They tell you that increasing borrowing will reduce borrowing, yet reducing borrowing will increase borrowing!  They are hard to understand.

You also get advice that tells you maybe the central bank has been screwing up all along.  You find another New Keynesian, Dr. Escape Velocity – he tells you he can fix things if you let him loose with that printing press and give him room to move.  But another bunch of “New Keynesian” economists, the ones who are running the central bank, tell you in no uncertain terms that UK AD policy is working just fine.

Who do you believe?  The Bernanke/Svensson New Keynesians?  The New Crude Keynesians who think fiscal policy is all that matters at the ZLB?  The New Keynesians at the central bank who are screaming at you that everything is just fine?

You bet the farm on Dr. Escape Velocity… and throw in some interventionist fiscal policy for good measure.  Nobody’s very happy with you.

I must say I’d almost feel sorry for you after all that.  It’s a tough job at the top, isn’t it, when all you have is conflicting New Keynesian macro policy advice?

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  1. March 22, 2013 at 17:14

    Great post!

  2. James in London
    March 22, 2013 at 18:02

    He did want the job.

    Perhaps if he’d studied PPE with a good deal of emphasis on the E rather than Modern History it might have made some difference. Although I doubt it, and it might have been worse, of course. He might have been a fiscalist instead, influenced by someone whomcould have taught him, like Wren-Lewis. But then he might have joined the LibDems, and modern history would have been different.

    We shall just have to keep plugging away.

    Strange you have a “friend” in Wren-Lewis at Mainly Macro. Or are you two on the same side? I am confused, too.

    • March 22, 2013 at 18:56

      The point of this post was not really to make excuses for Osborne, I’m just using him as a foil. :)

      Wren-Lewis is stuck on the fence about MP at the ZLB. Maybe it will help, but fiscal is a sure bet. He sees the failings of IT and that’s causing the MPC to do the wrong thing; that’s very good. He prepped the TSC very well for Carney.

  3. March 22, 2013 at 18:02

    The worst thing is, his “interventionist fiscal policy” (which I agree is what it is), isn’t accepted as such by those Crude Keynesians, who say it’s just going to trigger a “debt-fuelled consumption boom” (whereas what they wanted was – how shall we say? – a temporary increase in private consumption triggered by tax cuts or spending increases financed by the sale of government bonds…). So you get no love for doing it anyway.

  4. James in London
    March 22, 2013 at 18:11

    I now see you replied to Wren-Lewis on his blog. I don’t spend enough time in the comments sections!

    I guess a key difference in Sumner vs Wren-Lewis is that the former thinks the UK has an AS problem as well as an obsession with IT. Where do you stand?

    • March 22, 2013 at 18:49

      I think the UK certainly has supply-side problems; immigration and land use regulation (“planning”) being very severe failings at the moment, but I don’t see any reason to be as pessimistic as Sumner; the CPI is highly distorted by fiscal changes, the GVA deflator has been very low.

      • James in London
        March 22, 2013 at 22:21

        There are our huge inefficient, nationalised industries, like the NHS, state schools and universities, plus all the unfunded state employee pensions. Immigration is a net benefit, and planning restrictions is just a townie vs country non-issue.

  5. March 22, 2013 at 23:29

    Yes, restriction on immigration is the problem! I’m sure we could argue (and probably mostly agree) about the supply-side for ages… without good demand policy I fear it is only going to get worse… state mortgage guarantees, etc.

  6. James in London
    March 23, 2013 at 07:29

    Good stuff. I think that “The City” is not acting as “the financial markets” needs to hear some responsibility. The markets perfectly understand monetary easing and good AD policy, as is evident by their response to good news on that front. The City, or rather Sumner’s “financial market types”, are still in thrall to IT, even if they like to sound off about AS problems too.

    A lot of those in charge were brought up in the 1970s or are so old like Goodhart they were even fighting inflation in the 1970s. A lot of them have stacks of cash and fear real terms erosion, and you hear them most complaining about the poor returns on fixed term savings bonds. They are a powerful old guard lobby group. Quite as influential as the NK economists.

    Morgan Stanley even sponsor Goodhart these days. UBS have similarly “sensible” voices. The HMT report reeks of their middle of the road “authority”, and refers extensively to Goodhart. More must be done to challenge them, and to champion the view the of the markets’ rather than these old crusties. I,should know as a few years ago I shared the views of the crusties!

  7. James in London
    March 29, 2013 at 15:01

    The more I think about HMT relying for its NGDP criticism on a privately-printed broker circular, the Morgan Stanley Charles Goodhart piece, the more bizarre I think it is. It is a desperately unaccountable way to make monetary policy.

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