Home > Fiscal Policy, Monetary Policy > Is George Osborne Economically Literate?

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.

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  1. W. Peden
    May 24, 2013 at 13:24

    ABSOLUTELY!

    The entire “growth vs. austerity” debate has been awful. In the main, I don’t blame politicians (my ill-feeling for Ed Balls is primarily based on detailed issues of policy, because I disliked Labour when I was on the left because of Iraq and I haven’t developed any more love of them now I’ve become a classical liberal!) as they’ve always been terrible when it comes to economic policy, which is fair enough: it’s not the job of politicians to understand the finer points of theory; they have bigger things, like making actual decisions and gettign re-elected, to deal with.

    No, I blame UK macroeconomists. From 1945-1992, when they were supporting almost every single wrong decision (from the Dalton experiment to devaluation to the Barber Boom to joining the ERM) and getting it wrong on a huge range of things (e.g. Kaldor and Balogh convincing the hapless Harold Wilson to think that lowering interest rates would be good to reducing demand in the 1960s) they’ve failed on a massive scale, to the dangerous point where a very large number of people on both sides of the political divide don’t take them seriously.

    However, this is WORSE than all of those other cases. In the past, UK macroeconomists (especially at Oxbridge and particularly at Cambridge) had the excuse that they were operating with a very bad theoretical framework of Neanderthal Keynesianism, which was much worse than Neo-Keynesianism. Even a remorseless logician ends up in Bedlam when they start from false premises. Today, however, there’s no such excuse, because New Keynesianism has conquered just about everywhere and New Keynesianism is a very good macroeconomic framework.

    They’ve got the theory, but they’ve refused to use it and instead have either gone for austerianism or Paleo-Keynesianism. It’s an embarassment. Obviously, there are some exceptions, but when even Charles Goodhart is making terrible critiques of NGDP targeting, it’s clear that the profession has failed us. New Keynesianism gives us a very good answer to what to do under present circumstances in Britain: use monetary stimulus to offset fiscal austerity. We did it under very similar circumstances in the 1930s and it worked.

    As it happens, the smartest noises have come from economic historians, as far as I can tell. Nick Crafts has been brilliant in drawing analogies with the 1930s and has generally been a much better macroeconomist than the people who don that title.

    In 1981, 364 economists got it wrong. In 2013, 365 economists should get it right and push for NGDP targeting. (365, because it’s one louder than 364.)

    And I say all this as someone who HATES economist-bashing! British macroeconomists have done a great job in reforming their theories over the past 20-30 years; it’s still problem-ridden, but not significantly worse than say the US anymore. Why don’t they actually use those theories when advising people like Ed Balls and George Osborne?

    • May 24, 2013 at 15:12

      Thank you W. Peden, I very much appreciate comments like this from yourself and others. I also of course agree with everything you say – you should start a blog!

  2. asdasdasd
    May 25, 2013 at 17:22

    Balls’ position is very similar to Paul Ryan and the Republicans’ stance on monetary policy before the US elections last year.

    The rationale is the same for both. If Osborne successfully updated the inflation target to allow a more expansionary and effective monetary policy, and the economy returned to robust growth, Labour would likely loose the next election. Just as relatively competent monetary policy from the Fed probably helped Obama’s reelection.

    Therefore, Balls has to call for expansionary fiscal policy and conservative monetary policy, possibly because it is unlikely to work. Why would Balls explain to Osborne the best way to help the economy recover?

    Regardless, Ball’s description of Osborne as “economically illiterate” is correct. Osborne’s biggest responsibility as Chancellor is setting the inflation target. It has been clear for at least four years that the current inflation target is not working. Yet Osborne has done almost nothing to fix it. This strongly suggests Osborne does not understand the importance of monetary policy or the details of the inflation target. Indeed he has appeared to want to abdicate responsibility for the setting the target at all.

    In comparison Labour and Balls in particular were very proactive in setting up the target in 1997 and revising it in 2003.

    E.g. read Ed Balls’ 1997 speech on inflation targets:

    http://www.hm-treasury.gov.uk/d/Ed_Balls_macroeconomics_lecture.pdf‎

  3. James in London
    May 28, 2013 at 11:47

    Have a good break. You’ve always been a pleasure to read, and extremely insightful on the UK.

    Hopefully, we will still see you occasionally even if only as a mere “commenter” on some of the other MM sites.

    Fingers crossed on Carney.

  4. James in London
    June 10, 2013 at 14:58

    Don’t know whether you will get ths, but a short while ago I attended a group lunch with a non-staff member of the MPC. He had voted against QE but for the FLS. FLS was considered to be a non-inflationary way to help the economy.

    I guess it isn’t really monetary policy as the Bank of England isn’t buying assets and injecting fresh cash into the economy, but just acting like a bank and lending existing money it has. At the end of the day the sums are very small, at just £16bn so far, and most to a few big banks who had plentiful liquidity anyway.

    If one were to consider FLS as a sort of BoE-inspired fiscal policy, it is ironic that the majority of the MPC by voting against more QE are actually “monetarily offsetting” their own fiscal policy. Remarkable, but true to form.

  5. W. Peden
    June 13, 2013 at 01:26

    James in London,

    That confirms my suspicion that no-one can give a really good reason for why the FLS exists.

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