Is George Osborne Economically Literate?
I started this blog last year because I was deeply frustrated about the level of discourse on UK macro policy. The debate I saw raging in the media followed a simple template:
The UK economy clearly has excessive/deficient* aggregate demand growth. This should be blindingly obvious – just look at the CPI/real GDP* figures! Monetary policy is too expansionary/impotent*; what we need looser/tighter* fiscal policy.
* = Delete as appropriate
When I see people utter the magical words “nominal GDP” I am encouraged that we are moving on a bit, but mostly we are still stuck in the gutter. And from that gutter comes the accusation from Ed Balls in today’s Guardian that George Osborne is not “economically literate”.
Having read the New Keynesian literature on macro policy at the zero lower bound, I think this is a disgusting attack from Mr. Balls. If you accuse your opponents of being illiterate you better be damn sure your position is watertight.
Michael Woodford, Paul Krugman, Ben Bernanke, Lars Svensson, and others, spent the last decade and a half writing the literature on macro policy at the ZLB. They did not produce papers with titles like “How To Fine Tune Aggregate Demand Using Capital Spending”. They produced papers on optimal monetary and fiscal policy. Most of them actually had an emphasis on monetary policy, not fiscal policy.
If Balls was saying we need a higher inflation target (Bernanke/Krugman), or a price level target (Woodford/Svensson), or a nominal GDP level target (new, improved Woodford), and saying we should use fiscal stimulus as a tool with which to help hit those targets – I think that would be consistent with the literature. But Balls is not saying that. Instead he is on the record saying all the following:
a) UK monetary policy is “pushing on a string”; and
b) The change in the MPC remit will not produce higher inflation because the Bank will keep hitting its symmetric 2% inflation target, and
c) Oh, yes of course we need a fiscal stimulus package!
I see no indication that any of the above are different from what Balls “really believes”. Yet (a) and (b) are clearly contradictory, and the literature hardly endorses the idea of doing (b) and (c) as optimal policy. Raise or replace the inflation target and do fiscal stimulus, sure.
Would any of the New Keynesians above embrace Osborne’s fiscal policy? Surely not, though Svensson was moderately “Ricardian” in doubting the efficacy of deficit spending as stimulus, in contrast with the absolute position of today’s “fiscalists”. Osborne is at least nudging the MPC towards a Woodfordian “forward guidance” regime, and embraces Woodfordian “credit easing”. (And what about Mervyn King, is he “economically literate” in Balls’ eyes? Or Martin Weale, Spencer Dale and the rest of the hawks?)
The level of debate to which Balls and others have descended, a purely “fiscalist” position is, I believe, highly damaging. We tried a fiscal stimulus in 2008/9 and at the end we were still at the zero lower bound, reliant on inflation-targeting central bankers. In fact, we weren’t at the ZLB when the fiscal stimulus was announced, so I could say it had the opposite of the desired effect.
It is certainly laughable to imagine that £10bn of extra borrowing will lift the UK off the ZLB. £10bn is a rounding error in a £1.5tn GDP. The idea of using capital spending as an appropriate way to “fine-tune” UK demand policy is similarly absurd. Krugman ridiculed that idea when it was applied to Japan, and having seen the “success” of Japan after two decades using fiscal policy to raise debt/GDP while the BoJ successfully targets 0% inflation, it seems even more ridiculous today. Yet the policies of pre-Abe Japan are roughly those which Balls endorses… plus 2%.
In my opinion, those who claim support in (New Kenyesian) macro theory should be openly and clearly advocating for the macro policies endorsed by Woodford et al. That means raise the inflation target, set a price level or NGDP target, etc. If you want to advocate for fiscal stimulus as well, sure, fine; make that argument. If you want to say QE is a useless tool, sure, fine; make that argument.
But ignoring the CPI data (and the labour market data) and claiming that UK monetary policy is “impotent” because of the real GDP data, while simultaneously arguing we need to keep the inflation target and pretend the MPC hawks don’t exist and commit to fiscal stimulus, I find that position completely inexcusable. “Economically illiterate”, if you like. Particularly when you also celebrate a fall in the CPI rate, and I will spare the blushes of those who joined that celebration and should know better.
p.s. I am going to have to take a break from the econoblogotwittersphere to concentrate on real life. I’ll return in August to see whether Carney has brought enlightenment to the Bank with the “forward guidance” review.