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Ed Balls Embraces “Monetary Activism”

July 22, 2013 8 comments

Ed Balls, October 2011:

“With our economy stagnated since last autumn David Cameron and George Osborne are now betting on a bail out from the Bank of England.

“The Government’s reckless policy of cutting spending and raising taxes too far and too fast is demonstrably not working. But rather than change course the Government has spent the last week urging the Bank of England to step in and essentially print more money. The Bank of England has been left with no choice but to step in and try to offset the contractionary effects of George Osborne’s Budget plans

“This is the Bank of England’s contribution to a Plan B. But while another round of quantitative easing may help, I fear it will do little to create the jobs and growth we desperately need if we are to get the deficit down. When monetary policy is already so loose – with interest rates at record lows – and with confidence depressed this is, as Keynes said, like pushing on a string.”

Ed Balls, July 2013:

Very different policies have resulted in different outcomes for the British and American economies. In the US, the combination of monetary activism and President Obama’s fiscal growth plan has helped ward off global threats, strengthened the recovery, and seen a continued fall in the deficit.

“Fiscal growth plan” is an excellent phrase, there’s so much nuance packed in there, and it avoids all the negativity in phrases like “cutting the deficit” or “fiscal austerity”.  Just take the word “fiscal” and add “growth plan” – who will notice?

Year US
Structural
Balance
2010 -8.5
2011 -7.7
2012 -6.4
2013 -4.6

Source: IMF WEO (April 2013)

All we need to do is to cut the deficit and print money – sorry – “a fiscal growth plan and monetary activism” – Ed Balls’ new “One Nation Labour” macro policy?

[Edited: added links]

Is George Osborne Economically Literate?

May 24, 2013 6 comments

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.

UK Macro Policy, A Short Story

May 16, 2013 2 comments

A short story for Jonathan Portes and Prateek Buch.  Is the use of deficit-funded capital spending a sensible way to fine-tune UK demand policy?  Opinions welcome.  (What would Krugman say?)

George Osborne writes to the Bank of England:

Dear Bank of England, please target 2% inflation!  Thanks!

The Bank of England meets and prepares its reply:

Dear George.  Here’s the path we’ve set out for the nominal economy.  You’re going to get above-target inflation and poor real GDP growth over the next two years, with the CPI rate hitting 2% after that.  Is that OK?

George replies:

Dear Bankers, thanks!  That’s really great.  I actually want a bit more inflation and faster nominal GDP growth.  But instead of telling you to provide a bit more inflation and/or NGDP, I am going to do a £30bn capital spending package over two years.  I have told my voters this will raise NGDP!  So take it as a subtle hint.

Bank of England to George Osborne:

Erm, really?  Do you want us to target 2% inflation or not?  We could just target higher NGDP growth, but we’ll probably get even higher inflation too.  Shall we do that?

George Osborne to Bank of England:

WOAH.  STOP RIGHT THERE.  What are you thinking?  Please target 2% inflation.  Gosh darnit guys, aren’t I making this clear?  Can you imagine what Ed Balls would say if I asked for more inflation?  I’d be crucified!   2%, 2%, 2%.  Got it?

One month passes.  Stuff happens… let’s say for the sake of argument that one of our major trading partners tips into recession.   The Bank meets to set monetary policy again.

Bank of England to George Osborne:

Well George, we’re going to target 2% inflation like you said.  Here’s the path we’ve set out for the nominal economy.   Exports are looking a lot worse than last month, but government spending is up!  So you’re getting an above-target CPI rate and poor real GDP growth over the next two years.  We’ll hit the 2% after two years – is that OK?

p.s. By the way George, the national debt is looking pretty ugly.  You might want to think about getting the deficit down.

George Osborne Correctly Rejects Fiscal Stimulus

May 15, 2013 4 comments

George Osborne explained the Sumner Critique to the CBI tonight:

What’s more, without allowing inflation to climb even further above target, a fiscal stimulus three years ago would simply have been offset by less supportive monetary policy, with no net impact on demand.

With the independent MPC judging that the risks to inflation and output are evenly balanced, the same is true today.

So, just as the argument for fiscal stimulus three years ago was mistaken, so is the suggestion for a discretionary fiscal loosening now. Because we have sensibly allowed the automatic stabilisers to operate, our deficit is only just falling in nominal terms.

This is an improved version of the wording Osborne used last time.  Pedantically correct wording, noting the forward-looking nature of monetary policy.

Paul Krugman, Deficit Hawk

April 25, 2013 1 comment

Forgive me for some cheap sniping at the great Professor, but I couldn’t resist.  Via Travis Allison here is Paul Krugman writing in 2000 about Japan:

Japan has the dubious distinction of being the first major nation since the 1930’s to experience a ”liquidity trap,” in which even cutting the interest rate all the way to zero doesn’t induce enough business investment to restore full employment. The result is an economy that has been depressed since the early 90’s, and that in 1998 seemed to be on the verge of a catastrophic deflationary spiral.

The government’s answer has been to prop up demand with deficit spending; over the past few years Japan has been frantically building bridges to nowhere and roads it doesn’t need. In the short run this policy works: in the first half of 1999, powered by a burst of public works spending, the Japanese economy grew fairly rapidly. But deficit spending on such a scale cannot go on much longer.

What is Paul Krugman’s 2000 policy recommendation for Japan?  The BoJ should set an inflation target and then do QE.

Here is Paul Krugman in a 2012 interview with Martin Wolf:

“The question is, what did [Ben Bernanke] do as we started to look more and more like Japan? At that point the logic says you have to find a way to get some traction. Fiscal policy might be great. But if you’re not getting it you should be doing something on the Fed side and I think that logic becomes stronger and stronger as the years go by. And it’s sad to see that the Fed has largely washed its hands of responsibility for getting us out of the slump.”

To complete the picture here is Paul Krugman writing in 2010 about how new UK Chancellor George Osborne should give up on the deficit-funded capital spending splurge, and should instead set an inflation target and print lots of money:

Oh, no, sorry, I couldn’t find that quote.

George Osborne, New Keynesian

March 22, 2013 12 comments

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?

How Tight Money and Fiscal Stimulus Failed in 2008

March 7, 2013 Leave a comment

Scott Sumner, Marcus Nunes and Simon Wren-Lewis have all commented on Charlie Bean’s speech on NGDP targeting.  With such illustrious company I doubt I can add anything of substance to the debate, but I wanted to pick up on what Marcus said since I think it helps better frame the debate that’s going on in the UK regarding the use of fiscal and/or monetary “stimulus”.

Thinking about monetary policy in terms of the central bank “doing things” is often unhelpful.  In late 2008 the Bank of England was “doing lots of stuff”.  They were very busy adjusting interest rates downwards; most people think of the Bank’s actions as aggressive“.  Cutting Bank Rate from 5% to 0% in six months is “monetary stimulus” par excellence – right?

The November 2008 MPC minutes are instructive.  Here is what the MPC discussed:

33.  The projections in the Inflation Report implied that a very significant reduction in Bank Rate –possibly in excess of 200 basis points – might be required in order to meet the inflation target in the medium term. However, a number of arguments were discussed for not moving Bank Rate by the full extent implied by those projections.

This says that the Bank’s internal models say they needed to cut Bank Rate by more than 2% to keep inflation on target at the forecast horizon.  They instead decided to cut by 1.5%, and give four reasons why they didn’t do more:

34.  First, the projections had used the normal convention that they were based on the Government’s most recent published tax and spending plans. The Government had already announced its intention to bring forward some planned spending commitments. Moreover, the changing composition of output would lead to a fall in effective tax rates from those assumed in the projections. Consequently, it would make sense for the Committee to reassess the required scale of monetary easing after the Chancellor’s Pre-Budget Report.

This is a demonstration of the “Sumner Critique”.  The Bank is offsetting fiscal stimulus by cutting interest rates less than they otherwise would have done if no fiscal stimulus had been planned.

The second reason for not cutting the rate the full 2% is that they don’t have a clue what is going on in the banking sector.  That seems like a good argument to do more not less, but then I’m not the one who bangs on about uncertainty all the time.

The last two arguments are what can only be described as a catastrophic policy error; my emphasis throughout:

36.  Third, a key concern was the degree of surprise to financial markets. Too large a surprise could pose upside risks to the inflation target if the resulting depreciation of sterling was excessive. There was a risk that such a move might be misinterpreted as a change in the Committee’s reaction function, which would damage the credibility of the inflation target. That suggested leaving some of the required monetary loosening until after the Committee had had an opportunity to explain its change of view on the outlook for inflation in the November Inflation Report, and to assess the market reaction to both the Report and the decision.

37.  Fourth, some members thought there was an argument for leaving some of the required policy loosening to the months ahead to support confidence as the economy weakened.

I know I tend towards the melodramatic, but I honestly believe that people reading those sentences today should be shocked and disgusted.

The MPC are deliberately cutting Bank Rate less than is necessary to keep forecast inflation on target because they are worried about the “credibility of the inflation target”.  Does that make any sense to you?  It should not.  It is the kind of nonsense which should get policy-makers removed from office with immediate effect.

And they are refusing to cut the rate so that they can later on “support confidence” as the economy weakens?  “Why, yes, Captain, I have just turned the ship in the direction of the iceberg.  This will allow me to later on swerve away from the iceberg so I can demonstrate my excellent navigation skills… if all goes to plan, ha ha!”

Now go and read the quote Marcus provides from Charlie Bean again; or this one:

But there is a danger of expecting too much from monetary policy. The Great Recession of 2008-9 was unlike earlier policy-induced downturns aimed at reining back excessive inflationary pressures.

It is true that there is a danger of expecting “too much”.  Monetary policy can’t solve supply side problems.  There is a perfectly reasonable argument that the demand shock which started in 2008 Q2 was not anticipated by the MPC.

But if you read the minutes above, how can you possibly agree that “reining back inflationary pressures” had no place in the MPC’s reaction to the crisis?  Or that, from the implication in the quote Marcus gives, the MPC did “as much as they could”?  Or that giving monetary policy makers total discretion over the policy stance is a really good idea?

Here is what happened to the three year market inflation expectations in 2008:

UK Market Inflation Expectations in 2008

UK Market Inflation Expectations in 2008.  Source: Bank of England

Since index-linked gilts are based on the RPI not CPI, you should take off 0.5% to 1% to get the expected CPI.  By the start of December markets were expecting the Bank to provide three years of deflation.

Alistair Darling was talking about the UK being in a quasi-Depression in August that year, yet did nothing about Bank Rate being at 5%.  He proposed a fiscal stimulus package in the Pre-Budget Report of November 2008; from the PBR:

Discretionary action of £16 billion will deliver a fiscal stimulus package of around 1 per cent of GDP in total in 2009-10, in addition to the support provided by measures in 2008-09.

Annual nominal GDP fell by 3% in 2009, rather than the “0.5 to 1%” rise expected in the PBR forecasts.  Fiscal policy was the wrong focus in 2008, and it’s the wrong focus in 2013.  Regime change, please, Mr. Osborne.