Fiscal council developments

As longstanding followers of this blog will know, I have a particular interest in what are called either ‘fiscal councils’ or ‘independent fiscal institutions’. As I have been and will be preoccupied with other issues for a while, I thought I would try and squeeze in one post on recent developments both in the UK and abroad.

In the UK we had Dave Ramsden’s Treasury review (pdf) of the OBR. The most positive aspect of the review is the recommendation for more resources. I guess the headline news was that the OBR would not be asked to cost opposition policies before elections, as the Dutch fiscal council has done for some time, and as the Australian PBO now does. I would have liked a different decision, but my disappointment is mitigated by three factors:

• the report does recommend the “OBR should ensure greater availability of tools and data to allow third parties to cost alternative policy options”.
  
• in the UK we have the IFS, which does do this and currently (and rightly) has a quasi-official status
  
• the level of the fiscal debate in the UK media is currently so poor that I’m not sure how much such a development would improve things.

This last point raises something of a paradox. People like me hoped that fiscal councils like the OBR would improve the public debate. This paradox reflects in part the particular nature of the OBR, which would not be allowed to say - for example - that the fiscal charter is economically illiterate (i.e. no economist agrees with it). Fiscal councils in some other countries can do that, and indeed were set up to do that. This is a gap the IFS cannot fill. I guess the OBR will not be allowed to comment on the economics of different fiscal rules until the UK gets a more sensible rule. I think it is quite likely that if the OBR was able to say such things, we would not have had this particular fiscal charter and we would all be better off as a result.

With the rapid growth in the number of fiscal councils around the world, the case for some kind of international network has become much stronger. It is therefore good news is that one is about to be established for those in the EU. There are at least two important roles such a network can have, apart from the obvious one of spreading best practice.

First, it can help establish and maintain independence for individual fiscal councils, which may be put under various kinds of pressure by their national governments. Sometimes this pressure is just verbal, and often indicates that the council is doing its job. I have just come back from Ireland, where the Irish fiscal council criticised a pre-election giveaway by the government. Its chairman John McHale also suggested that it might break the Commission’s fiscal rules. The government then revealed that it had obtained agreement from Brussels, but had not told the fiscal council. It managed to spin this as an error made by the council, which journalists dutifully parrotted. Substantive criticism was thereby deflected. That kind of thing from governments is only to be expected. It becomes more serious when governments react to criticism in financial or even existential terms, as has happened in Canada and Hungary. In those cases, the council needs all the defence it can get.       

Second, a network can act as an important pressure group on the Commission. The Commission itself has recently established an Advisory Fiscal Board, which if nothing else can increase the dialogue between the fiscal councils and the Commission. I talked about the dual system of fiscal monitoring within Europe here, and how I hope we will see a gradual reduction in central control and more discretion given to national governments monitored by strong national fiscal councils. If Daniel Gros is right and German hegemony is coming to an end, then maybe it might just happen - one day.     

 

Avoiding Fiscal Fudge

There has been some recent disquiet in the UK about politicians before the election failing to offer voters a clear account of how they would achieve their fiscal plans. The Financial Times has taken the lead, but others have concurred. A point I have stressed is that each party’s aggregate fiscal plans are quite different, even though Labour in particular seems to want to hide this fact. But the complaint I want to focus on in this post is about something different - it is about failing to make it clear how plans will be achieved in terms of detailed policy changes.

While I think journalists and bloggers are right to complain, I think it is even more productive to suggest what can be done about it. Politicians do what they think is most likely to get them votes. In a time of austerity, they have calculated that any bonus they might get by being transparent will be more than offset by votes they will lose from coming clean on specific cuts or tax increases. This is hardly a unique UK phenomenon - the phrase ‘magic asterisk’ comes from the US, and Paul Ryan managed to fool quite a few ‘serious people’ by deploying it before the last US election. If the factors that enter this calculation do not change, neither will the behaviour of politicians.

In 1996 I wrote a paper with the title of this post. It was the first time I proposed setting up an independent fiscal institution, or fiscal council, like the OBR. One of the few examples of such a body at the time came from the Netherlands. Those who complain about lack of transparency on fiscal matters before elections should really examine what happens today in that country. There the Dutch equivalent to the OBR offers to cost the fiscal plans of any opposition party before an election. They take up this offer, because failing to do so would be seen as a clear sign that plans were not credible. The detail that the Bureau for Economic Policy Analysis (CPB) go into is extraordinary, as I noted at the beginning of this post: here (pdf) is an example.

So in the Netherlands we have a situation where the fiscal plans of each party before an election are transparent, detailed and independently costed. There is no fiscal fudge. To use a bit of economics jargon, it is a political economy equilibrium which each individual party finds it too costly to depart from. In most other countries we have an alternative equilibrium that involves plenty of fiscal fudge, from which it would be too costly for any individual party to try and break. Is there something peculiar about the Netherlands that means their set-up could not work elsewhere? I have heard excuses along those lines, but none which I find convincing.

So how might we get from where we are now to something like the Dutch example? Well it so happens that in the UK we have a unique opportunity if Labour forms the next government. Ed Balls recently asked the OBR to cost their post election plans, but this would involve an extension of the OBR’s current mandate, and George Osborne did not want that to happen. Of course political advantage was behind both the request and the refusal. However, given the request, if Labour forms all or part of the next government, it will be very difficult for them to reject extending the OBR’s remit in this way. Those who complain about lack of fiscal transparency should help make sure this happens. Of course the details of how the OBR might do this need to be worked out, and it may not be appropriate to do it exactly as they do in the Netherlands. But the UK also has another piece of good fortune on this front: the previous director of the Dutch fiscal council, Coen Teulings, is currently a member of the economics department at Cambridge, so is easily on hand to give advice. We should not miss this opportunity to end fiscal fudge.  

Does the Dutch central bank employ any macroeconomists?

Did you think that the policy of fighting recession by increasing austerity was now intellectually bankrupt? No one seems to have told the Dutch central bank. (Hence the deliberately provocative title of this post.) The latest forecast by the Bank says

• The economy will shrink by 0.8% this year, followed by growth of 0.5% next, “accelerating” to 1.1% in 2015
• The unemployment rate will rise sharply, reaching a peak point at 7.2% of the labour force midway through 2014.
• The budget deficit will increase from 3.5% this year to 3.9% next.

What should the government do about this? The central bank says “"The forecast course of the factual and structural deficit in 2014 does not meet the recommendations given in May by the European Commission to correct the excessive budget deficit in the Netherlands. Extra consolidation measures are therefore necessary."

Unfortunately the central bank is being entirely predictable in continuing to urge austerity as the economy weakens. In earlier posts (here and here), I noted how the central bank’s advice was rather different from the Dutch CPB (Bureau for Economic Policy Analysis), which clearly does employ macroeconomists. What is just so depressing is that the central bank seems oblivious to the increasingly overwhelming evidence that austerity during a recession is the complete opposite of what you should be doing in a country without its own monetary policy. Unlike some other Eurozone countries, there is no market pressure forcing policymakers’ hands in the Netherlands.

If you think this is excessively rude, please read my own checklist on the subject. I am not disdainful of those in 2010 who thought austerity was necessary because either a debt crisis was around the corner, or economic recovery had been assured, and have subsequently done what Keynes suggested should be done when the evidence becomes clearer. I think they were wrong back then, and said so, but it was an understandable mistake, and even the best economists make mistakes. But I’m afraid to continue in 2013 to advocate a course of action which anyone can see is doing immense harm to so many people is just inexcusable. If you understand this, and are a macroeconomist working for this or another European central bank with similar views, then you have my sympathy. If you work for one of these banks and think I’m being too harsh, please tell me why in comments. But more importantly, let’s hope that Dutch politicians treat this advice, along with the recommendations of the Commission, with the contempt it deserves.

Why politicians ignore economists on austerity

I have written before about fiscal policy in the Netherlands. I have done so in part because that country has a strong macroeconomic tradition, and I regard their long standing fiscal council (CPB) as a model of how to try and get good economic analysis and evidence into the policy debate. It is therefore an indication that something is very wrong when the political consensus there follows the austerity line.

The key target for policy in the Netherlands appears to be the 3% budget deficit number that was at the centre of the old Stability and Growth Pact. The latest CPB forecasts are for deficits of 3.3% of GDP in 2013, and 3.4% in 2014. The main reason is that the economy is in recession: GDP is expected to fall by 0.5% this year (following a fall of 0.9% in 2012), and grow by only 1% in 2014. The governing coalition includes the Labour Party, and its leader Diederik Samsom says it would be unwise to sharply cut government spending in a recession. What he means by this is that they will not try and hit the 3% figure this year, but instead do so next year!. After announcing austerity measures of over 2.5% of GDP in the autumn, the coalition has recently prepared a list of additional cuts totalling  0.7% of GDP. These include tax increases, a pay freeze for public sector workers and extra charges on industry.

So we have a discretionary procyclical fiscal policy, in an economy without its own monetary policy to offset its impact. The one ray of hope is that the trade unions, who have previously been prepared to discuss the details of austerity, no longer wish to do so. The FT reports  the largest labour federation as describing the cuts as “stupid and ill-advised”. The Labour Party is urging the unions to take part in discussions about the cuts, so they can - as one report puts it - “seize the opportunities offered by new measures to stimulate the economy”. This sounds a bit like asking a Christmas Turkey to talks about the recipe for the stuffing. The unemployment rate, which was 4.4% in 2011, is expected to rise to 6.5% in 2014.

So why are politicians, in the Netherlands and elsewhere, pursuing a policy that most economists regard as an elementary error? This was a question raised by Coen Teulings, who is the director of the CPB, the Dutch fiscal council. He was commenting on an IMF sponsored conference in Sweden, at which most economists argued against short run austerity when the economy was weak, and instead advocated dealing with budgetary problems through long term structural reform. The politicians in the audience, led by the Swedish finance minister Anders Borg, disagreed. He summarises their view as follows: “Politicians lack the ability to commit today to austerity measures to be implemented tomorrow. Hence, the only option is to take action straightaway.” (Borg was a driving force behind setting up Sweden’s own fiscal council, but his subsequent interaction with it has been more difficult, as Lars Calmfors and I describe here.)

Tuelings does not take this argument seriously, for good reasons. Instead he provides three suggestions as to why politicians are ignoring the economists. The first is a memory of the 1970s, when Keynesian policies were pursued because many failed to see the structural impact of the oil crisis. Politicians do not want to make the same mistake again. The second is that economists neglected countercyclical fiscal policy for too long, and therefore have failed to provide politicians with a clear guide to what policy should be, like perhaps an equivalent to the Taylor rule for monetary policy. Third, while both structural reform and short term austerity have political costs, politicians can sell the latter more easily, and success can be demonstrated more quickly.

The last argument can be partly seen as the austerity counterpart to the common pool explanation for deficit bias: structural reform can hit particular groups hard, while generalised austerity spreads pain more widely (or perhaps hits particular groups who have a small political voice). There may be something in the second argument, but there is a chicken and egg issue here. As someone who has written papers evaluating fiscal rules for a number of years, I have not noted much interest from European policymakers.

I suspect, however, that most of the interest in Taylor rules for monetary policy comes from central banks rather than politicians. I think this is a key problem with fiscal stabilisation policy: the lack of an institution that fosters research of this kind, that consolidates knowledge and pools wisdom. In my dreams I imagine a linked set of national fiscal councils that could play that role. What is unfortunately very clear is that central banks (or at least those running them) cannot do for fiscal policy what they have done for monetary policy: just look at the detailed and well formulated analysis of austerity in this recent speech (section 3.1) by the president of the Bundesbank. Returning to the Netherlands, it is no secret that the CPB is not part of the austerity consensus, while the Dutch central bank certainly is.