A short guide to why we should not raise UK interest rates

Everyone expects the MPC to raise rates on Thursday. This would be a mistake. Discussion about interest rate changes in the press normally involve large amounts of data and charts about the state of the economy. Here I want to do the opposite: to present the minimum you need to know to understand that raising UK rates right now is the wrong thing to do.

Everyone should know that UK inflation is currently around 3% because of the Brexit depreciation. But because the impact of a deprecation on price inflation is temporary if wage inflation remains flat, the Bank said they would ignore this temporary rise. The key is to look at whether average earnings inflation is responding to higher consumer price inflation. The answer is they are not: average earnings growth has been slightly above 2% all this year, which is a little lower than the average for 2016.

But what about unemployment being at a 42 year low? Surely that means earnings growth is just waiting to kick off. The first point is that unemployment is not currently a good measure of labour market slack. A better measure is the Resolution Foundation’s underemployment index, which is still above levels before the global financial crisis. And before you say but that was a boom period, it wasn’t. UK core inflation was below 2% throughout, and earnings growth was consistent with this.

The other thing to say is that it is quite wrong to assume that we know what the level of labour market slack is that would lead to increases in earnings growth (what economists call the NAIRU). The NAIRU moves over time. As just one example of why it might move, a labour force that rents is likely to be more mobile than one that owns a house, and so the trend towards renting should reduce the NAIRU.

So looking at the labour market, there is no sign that we are close to a level where earnings inflation might pick up. And that is pretty well a precondition for inflation to exceed its target of 2% over the medium term. That is all you really need to know. If you want to know why the MPC probably will raise rates, read on.

What I suspect the Bank are worrying about is that Brexit has created what economists call a negative supply shock. In particular, both investment and productivity growth are much lower than the Bank were expecting before Brexit. They will point to various survey measures which show firms do not have any spare capacity. But this reasoning I think indicates a conceptual weakness.

Firms have two responses to lack of capacity: raising prices or investment. By choking off demand and raising rates when firms run out of capacity the Bank will discourage investment, and right now what the economy desperately needs is more investment and the productivity improvements that brings with it. The Bank shouldn’t worry about a bit of inflation that might come with higher investment, because 2% earnings growth is an anchor that will prevent inflation deviating from target for any length of time.

That should be enough, but there are two other reasons why the Bank should not raise rates. First, right now the downside risk on the demand side from Brexit surely exceeds the upside risk. Second, as the OBR chart here shows (look at orange bars), after a pause in 2017 austerity is planned to return in 2018 and 2019. Combining fiscal and monetary tightening in a boom would make sense, but we are currently in an economic downturn, with GDP per head growing this year at a third of its average pace since the recession of 2009. [1]

Finally, it is always important to consider risks. Suppose earnings growth does pick up sharply just after the MPC’s monthly meeting. The Bank always says it wants to be ‘ahead of the curve’, to avoid too rapid an increase in rates. This is the mentality that has led inflation to undershoot in the US and Eurozone since the recession, and if you take out the impact of depreciations by looking at the GDP deflator the same is true for the UK. The problem for the UK economy since the recession has not been too much inflation, but far too little demand.

[1] Specifically, average growth in 2017 is 0.1% per quarter, and averaging quarterly growth rates from 2010 Q1 to 2016 Q4 gives 0.3% per quarter          

The impact of austerity in the UK

When they do their forecast evaluation report, the OBR also look at the impact of fiscal policy on GDP. Here is the relevant chart from their report published yesterday.

There is a useful innovation compared to previous years, which comes close to an something I suggested a few months ago. The orange bar shows the impact of fiscal measures implemented in that year. The total effect of fiscal policy is this plus the impact of previous fiscal policy actions unwinding.

Suppose for example that fiscal policy reduced GDP by 1% in year 1, but its impact on the level of GDP was expected to decay by half in year 2. If no fiscal policy was enacted in year 2, then fiscal policy in year 1 would increase growth in year 2 by 0.5%. Why might the impact of fiscal policy on the level of GDP decay over time? The obvious explanation is that monetary policy ensures that it does by stabilising the level of GDP. This assumption is problematic when interest rates are stuck at their lower bound, which is why it is useful to publish the within year estimates as well as the total estimates,

You can see when this matters from 2012 onwards. We have a run of years where the total impact of austerity on growth is zero or positive, but only because of the unwinding of previous austerity. If monetary policy, or anything else, had not been able to offset earlier fiscal tightening, then instead the impact of austerity would be to reduce growth in all those years. In that (extreme) case the level of GDP in 2016/17 would be over 4% below what it would otherwise have been without any fiscal tightening from 2010/11.

As the OBR’s assessment of fiscal impact is in their publication on forecast errors, they naturally talk about whether there is any relationship between the two. This year they included this chart.

It is important to understand what we are looking at here. It is not whether there is a correlation between fiscal consolidation and GDP. As we have seen the OBR assumes there is, and indeed their calculations were the source of my estimate that the average household had by 2013 lost a total of £4,000 worth of resources as a result of austerity. The foolishness of austerity in 2010 was not that the OBR underestimated its impact, but that it left us vulnerable to negative shocks because interest rates were at their lower bound. The shock that hit in 2012 was the Euro crisis and the impact of austerity there.

What the chart above might tell us is whether the OBR have in fact underestimated the impact of austerity i.e the numbers in Chart E are too small. Each year there are hundreds of potential reasons for forecast errors, of which underestimating the impact of austerity is just one. So the best we can expect, if the OBR are underestimating the impact of fiscal policy, is a negative relationship going through zero between the two variables in Chart D but with lots of random variation on top. That is what we see in Chart D.

Why Brexit has led to falling real wages

This might seem easy. The depreciation immediately after Brexit, plus subsequent declines in the number of Euros you can buy with a £, are pushing up import prices which feed into consumer prices (with a lag) which reduce real wages. But real wages depend on nominal wages as well as prices. So why are nominal wages staying unchanged in response to this increase in prices?

Before answering that, let me ask a second question. Why hasn’t the depreciation led to a fall in the trade deficit? Below are the contributions to UK GDP from the national accounts data. Net exports are very erratic, but averaging this out they have contributed nothing to economic growth since the Brexit depreciation.

The belief that the depreciation should benefit UK exports is based partly on the idea that exporters will cut their prices in overseas currency terms, making them more competitive. Yet at the moment UK the majority of exporters seem to be responding to the depreciation not by cutting prices but by taking extra profits. If they keep their prices constant in overseas currency terms (from currency denomination data almost as many exports are priced in overseas currency as imports), sales will stay the same but profits in sterling will rise.

While this helps account for the lack of improvement in net trade, it increases the puzzle over why nominal wages are not responding to higher import prices. If exporting firms profits are rising because of the depreciation, why not pass some of that on to their workers?

One perfectly good answer is that the labour market is weak, and what has stopped real wages falling further is that firms do not like to cut nominal wages. In these circumstances there would be no reason for exporters to share their higher profits with their workforce. So the immediate impact of the depreciation has not been a decline in the terms of trade (export prices/import prices), but instead a shift in the distribution between wages and profits. But many people believe that, with unemployment falling rapidly, the labour market is not weak.

There is another reason why exporters might be increasing profits but not sales, and not passing higher profits on to higher wages, which goes back to a point I have stressed before. We need to ask why the depreciation happened in the first place. To some extent the markets were responding to lower anticipated interest rates set by the Bank of England, but there is more to it than that. Brexit, by making trade with the EU more difficult, will reduce the extent of UK-EU trade. Furthermore there are two reasons why Brexit is likely to reduce UK exports by more than UK imports.

The first is specialisation. Because countries tend to specialise in what they produce, they may not have firms that produce alternatives to many imports, making substitution more difficult. The EU produces many more varieties of goods than the UK, so they are more likely to be able to substitute their own goods to replace UK exports. The second is the importance for UK exports of services, and the key role that the Single Market has in enabling that. On both counts, to offset exports falling by more than imports after Brexit we need a real depreciation in sterling. Exporters will have to cut their prices in overseas currency terms, and a depreciation allows them to do this.

Of course Brexit has not happened yet. We still get a depreciation because otherwise holders of sterling currency would make a loss. So firms do not need to cut their prices in overseas currency yet, allowing them to make higher profits. But these higher profits will be temporary, disappearing once Brexit happens. It would therefore be foolish to raise wages now only to have to cut them later when Brexit happens (no one likes nominal wage cuts). To restate this in more technical language, when Brexit does happen the UK’s terms of trade will deteriorate as a response to export volumes falling by more than import volumes. Firms are in a sense anticipating that decline in the terms of trade by not allowing nominal wages to rise to compensate for higher import prices.

So before Brexit happens we are seeing a distributional shift between wages and profits, but once Brexit happens profits will fall back and we will all be worse off. For Leave voters who think this is all still just ‘Project Fear’, have a look at the national accounts data release that the chart above came from. It shows clearly that UK growth in the first half of this year has been slower than that in the US, Germany, France, Italy and Japan by a wide margin. What Leave campaigners called Project Fear is real and it is happening right now, but do not expect your government or some of your newspapers to tell you that. 

Economists and the Euro: for the record

Almost every time I write something about Brexit, I get at least one comment along the lines of ‘you economists got it wrong on the Euro, so why should we take any notice of you on Brexit’. This is beginning to annoy me, because in reality the opposite is true: it was because of economics and economists that we didn’t join the Euro in 2003. So the next time someone says the same to you, send them this blog post.

As far as I can see, the source of this ‘you got it wrong’ line is a poll that the Economist magazine did of academic economists on whether the UK should join the Euro in 1999. In that poll 65% said yes, and 35% said no. It was a good piece of journalism and a sensible survey, and it roughly corresponds with how I viewed academic opinions at the time. Claims by Andrea Leadsom that the Bank and IMF also recommended joining are simply wrong.

This poll has zero relevance to the Brexit issue for the following reasons:

1. Academic economists split 2 to 1 in favour of joining in 1999. In the case of Brexit, for every one economist that thought leaving was a good idea, there were 22 that said the opposite. So while a majority of economists favoured joining the Euro, the overwhelming consensus was that Brexit would involve economic costs.
   
   
2. Ask any academic about the Euro, and they will tell you that there are pros and cons, and it is largely a matter of judgement whether the pros or cons win. A key issue which I did some work on (with Rebecca Driver) was whether countercyclical fiscal policy could deal with asymmetric shocks. Our work suggested they could to a significant extent, but that made the proposed Stability and Growth Pact a concern. Others, looking at other types of risk, might come to a different conclusion.
   
   The contrast with Brexit is total. There are no major economic pros that need to be compared with the cons. Instead there are just economic costs, and the debate is about how large these will be.
   
   
3. Euro membership involved macroeconomics. Membership of the EU is mostly about trade. These are different branches of economics with little in common. Brexit involves the impact of geography on trade (gravity equations) and the impact of trade on productivity, while Euro membership involves the macroeconomic response to asymmetric shocks. It is a bit like refusing to have your hip replaced because your flu jab didn’t stop you getting flu.
   
   

The poll was in 1999. The UK did not decide to make a decision whether to join the Euro or not until 2003, and thankfully it did more than take a poll of economists on the issue. The Treasury was given plenty of time to analyse the pros and cons of entry, and it did so by undertaking a large number of studies. This is how policy advice should work in the absence of delegation: you do not ask the expert what the decision should be, but instead ask what the issues are and let the politician make the decision. I have discussed the so called 5 tests process, overseen by Dave Ramsden, in detail here. Most of the studies were done ‘in house’ by Treasury economists, but advice was sought from a large number of leading academics in the field. Peter Westaway was brought in from the Bank to write a couple, and I wrote a study on the optimal entry rate, extending and developing work I had begun back in the days before we entered the ERM.

The analysis was at the highest level, and I could detect no overt bias one way or the other. Some studies found significant benefits from joining, and others found significant costs or concerns. Although it is easy to be cynical, I have talked to some of the actors involved and it does seem as if the economics, encapsulated in these various studies, was critical in first convincing Gordon Brown and then Tony Blair that now was not the right time to join.

So the reality is that studies that summarised state of the art academic economic analysis stopped the UK joining the Euro. Without that, the decision on UK entry would have been down to politics, much like the formation of the Euro itself, and who knows how that would have gone. The economic analysis anticipated some of the problems behind the Euro crisis but not all. Economics is far from perfect, but that is no reason to ignore it when it says things you do not like to hear.

The Brexit slowdown begins (probably)

When the Bank of England after the Brexit vote forecast 0.8% GDP growth in 2017, they expected consumption growth to decline to just 1%, with only a small fall in the savings ratio. But consumption growth proved much stronger in the second half of 2016 than the Bank had expected. As this chart from the Resolution Foundation shows, pretty well all the GDP growth through 2016 was down to consumption growth, something they rightly describe as unsustainable. (If consumption is growing but the other components of GDP are not, that implies consumers are eating into their savings. That cannot go on forever)

This strong growth in consumption in 2016 led the Bank to change its forecast. By February

their forecast for 2017 involved 2% growth in consumption and GDP, and a substantial fall in the savings ratio.

What was going on here? In August, the Bank reasoned that consumers would recognise that Brexit would lead to a significant fall in future income growth, and that they would quickly start reducing their consumption as a result. When that didn’t happen the Bank appeared to adopt something close to the opposite assumption, which is that consumers would assume that Brexit would have little impact on expected income growth. As a result, in the Bank’s February forecast, the savings ratio was expected to decline further in 2018 and 2019, as I noted here. Consumers, in this new forecast, would continually be surprised that income growth was less than they had expected.

The first estimate for 2017 Q1 GDP that came out yesterday showed growth of only 0.3%, about half what the Bank had expected in February. This low growth figure appeared to be mainly down to weakness in sectors associated with consumption (although we will not get the consumption growth figure until the second GDP estimate comes out). So what is going on?

There are three possible explanations. The first, which is the least likely, is that 2017 Q1 is just a blip. The second is that many more consumers are starting to realise that Brexit will indeed mean they are worse off (I noted some polling evidence suggesting that here.), and are now adjusting their spending accordingly The third is that consumption was strong at the end of 2016 because people were buying overseas goods before prices went up as a result of the Brexit deprecation.

If you have followed me so far, you can get an idea of how difficult this kind of forecasting is, and why the huge fuss the Brexiteers made about the August to February revision to the Bank’s forecast was both completely overblown and also probably premature. All Philip Hammond could manage to say about the latest disappointing growth data was how it showed that we needed ‘strong and stable’ government! I suspect, however, that we might be hearing a little less about our strong economy in the next few weeks.

Of course growth could easily pick up in subsequent quarters, particularly if firms take advantage of the temporary ‘sweet spot’ created by the depreciation preceding us actually leaving the EU. Forecasts are almost always wrong. But even if this happens, what I do not think most journalists have realised yet is just how inappropriate it is to use GDP as a measure of economic health after a large depreciation. Because that depreciation makes overseas goods more expensive to buy, people in the UK can see a deterioration in their real income and therefore well being even if GDP growth is reasonable. As I pointed out here, that is why real earnings have fallen since 2010 even though we have had positive (although low) growth in real GDP per head, and as I pointed out here that is why Brexit will make the average UK citizen worse off even if GDP growth does not decline. If it does decline, that just makes things worse.  

Breaking the ‘strong economy’ narrative

My last post talked about the gap between the macroeconomic narrative in the UK media (‘mediamacro’) and macroeconomic facts. The gap is created or encouraged to a considerable extent by narratives employed by the political right. So how might that change, to let reality back in?

As with other things, Labour under Miliband had the right idea but did not follow it through. They talked about a ‘cost of living’ crisis, but in doing so they implicitly suggested this was some unfortunate by-product of a strong economy. The aim should be to redefine a strong economy as one that delivers solid real wage growth.

To do so makes perfect sense in current circumstances, when we have just had a policy-induced large depreciation in sterling. GDP measures the output produced in the economy, but not how much people in that economy can buy. Welfare depends on the latter, not the former.

It also makes sense if real wages have fallen because workers have priced themselves into jobs, by in effect discouraging firms to invest in labour saving machinery. Boasts that employment is at record levels make no sense in that situation, because high employment comes from lower wages rather than from additional output. [1]

I have stressed in the past (including my last post) how weak recent UK performance has been by historical standards. But a favourite trick of the government is to make international comparisons, of GDP rather than the more appropriate GDP per head. So how does our economy look if we focus, more appropriately as I argue above, on international comparisons of real wage growth?

Luckily the ILO and Geoff Tily have already done the spade work. Here is a chart for all countries, with blue denoting OECD countries.

International comparison of average real wage growth since the crisis 

Source: Geoff Tily, ILO. 

Among OECD countries the answer is striking: only Greece has seen real wages falls greater than the UK. The UK is second best among the OECD at achieving a decline in real wages! Geoff looks at data from 2008, but a quick check suggests the result holds good if we start in 2010 instead.

The data in this comparison only goes to 2015. You could, rightly, argue that 2016 was a better year for the UK, but then you would have to address what will happen to real wages this year and next. [2] You could argue that this poor performance was a consequence of the 2008 depreciation (which had lagged effects): again you would be right, but the Brexit depreciation which is not yet in these figures is just as large.

Either way this data provides strong evidence of just how terrible UK economic performance has been over the last several years. [3] What is more, unlike GDP, it is data that directly relates to the experience of ordinary people. But as Miliband found out, to quote this data is not enough. What you need to do is start proclaiming that the UK economy under a Conservative Chancellor has performed worse than any other OECD economy besides Greece. Just that, no caveats, no qualifications, no ‘cost of living’ label. Only that way will you begin to shift the narrative that we have a strong economy.

[1] If you are worried that this might help justify calls to reduce immigration, fear not. What they show is that policymakers failed to create an adequate level of aggregate demand: another consequence of austerity.

[2] If we look at the ONS series for real average earnings, normalised to 100 for 2015, it was at 101.8 in May 2010, and in February 2015 it is 100.3, a fall of 1.5%

[3] It has even been fact checked: see here.              

The Brexit depreciation and exports

I’ve read a number of people say, observing the lack of growth of UK exports, that this illustrates how depreciations have little impact on trade flows these days. This is a classic case of reasoning from a price change. I think the phrase ‘never reason from a price change’ was popularised by Scott Sumner, although I got it from Nick Rowe.

The depreciation of sterling happened because of Brexit. Some of the depreciation might have been a result of the expected cut in UK interest rates, which means it should be temporary. The rest was to compensate for the impact of Brexit on UK trade. In both cases, therefore, exporting firms in aggregate get a temporary boost to their competitiveness (or profitability of trading), which will come to an end when interest rates rise again or Brexit actually happens, perhaps imposing tariffs or other costs that reduce competitiveness.

The temporary boost to competitiveness/profitability will be good for firms that already compete in overseas markets. But I learnt many years ago when I estimated aggregate trade equations that a lot of the effect from a depreciation comes from firms trading in new markets that they had previously considered unprofitable. To do that requires some investment: in distribution and marketing, for example. A firm is unlikely to make that investment if the gain in competitiveness is temporary.

This helps explain an otherwise puzzling feature of aggregate trade following a depreciation that - unlike Brexit - leads to a permanent improvement in competitiveness. It takes many months before the full improvement in trade volumes comes through. If it was just a matter of goods getting cheaper and people buying more of them you would expect a fairly instantaneous impact, but if firms are having to invest to expand markets, the full impact will take longer to come through. [1]

In the case of Brexit the gain to competitiveness is temporary. It is a mistake to start with the depreciation, and then be disappointed by the lack of any reaction. Once you ask why there has been a depreciation, it becomes clearer why any gain to exports is likely to be modest. [2]

[1] As tariff changes are perhaps likely to be more permanent than exchange rate changes, this may also help explain the puzzle discussed here.

[2] This argument apart, one other thing you quickly learn if you monitor aggregate trade is how erratic it is. We will not know for sure what the impact of the Brexit depreciation has been until well after Brexit itself.  

The Budget and Health Care

The reasons for substantially increasing current spending on the NHS and social care are obvious. Here is some data. The first is from the OECD on UK spending on health over a long period as a share of GDP (source).

This reveals an important truth which talk of ‘protecting the NHS’ is deliberately designed to ignore: health spending increases as a share of total GDP over time. The two noticeable points beyond that are the increase in spending under Labour, and the slight decrease in spending under the Coalition government.

One area of health spending that has been particularly hit in the recent past has been spending on social care by local authorities (source).

It is in areas like this that I get so frustrated with TV journalism. I have seen countless segments or interviews on what is causing the current crisis in the NHS and health care, but I do not remember ever seeing graphs like this. Is there an unwritten understanding in the TV networks that people cannot read graphs?

The outlook for the next five years for total health spending is further falls relative to total GDP (source).

The red bars are the projected growth in GDP, and the blue bars the projected growth in health spending. Unless something is done the current crisis in social care and the NHS will get worse and worse.

This increase in spending should be permanent and financed by a permanent increase in taxes. As such a specific tax funded increase in spending would be popular, it seems sensible to do it that way. Given the current crisis in the NHS, if this is not done in the budget we either have to downgrade our assessment of the morality of our current rulers still further, or assume they really do have an ulterior motive in running the NHS into the ground.

What would be the macroeconomic effect of such a policy change? You might expect a permanent tax financed increase in spending to have no effect. Taxes would rise by an equal amount to the extra government spending, and knowing this was permanent consumers would reduce their spending by the full amount of the tax cut. So private spending falls to offset additional public spending.

There are two reasons for thinking that would not be the full story. First, consumers initially appear not to fully adjust consumption to a tax change, even when that tax change is perceived as permanent. This is quite rational if they hold precautionary savings, and wish these savings to adjust to be a constant share of post-tax income. As a result there might be a short term boost to activity from a tax financed spending increase. This could be amplified, of course, if the tax increase was delayed for a year or two. As interest rates are still at their lower bound, such a boost to activity would be welcome.

Second, spending on health care is likely to be less import intensive than the private consumption spending it replaces. This would give a permanent boost to GDP and permanently reduce the current account deficit. Now both these effects might lead to an offsetting exchange rate appreciation, but the consequent reduction in inflation and boost to real incomes that this appreciation brings would not be unwelcome given the impact of Brexit.

Three final points that I hope are obvious. First these beneficial macro effects are incidental in the sense they are not required to justify the spending increase. The case for additional spending on health care financed by higher taxes is overwhelming on its own terms. Second, this is additional to the large increase in public investment, financed by borrowing, that should be underway right now. The changes in this direction in the Autumn Statement were an order of magnitude too small. Third, the second biggest threat to the NHS right now after lack of money are staff shortages. As an important source of staff is the EU, the government seems to be doing everything it can to make things more difficult.  

Left and Right in 2016

Before the Christmas break David Blanchflower asked me a question on twitter: “why do you think we have seen the move to right-wing rather than left-wing populism?” This is my reply. I’ll just talk about the US and UK because I do not know enough about other countries. (Here is an interesting analysis of populists in Eastern Europe.) I’ll take it as read that there are currently well understood reasons for people to want to reject established politicians, and the Blanchflower question is really about why that rejection went right rather than left.

In my answer I want to distinguish between two types of people. The first are those that are not that interested in politics, and are therefore not well informed. They depend on just a few parts of the MSM for their information. The second are those that are interested in politics and are well informed, using multiple sources which are not just confined to the mainstream media (MSM). I want to argue that this distinction is crucial in helping us understand what happened in 2016.

I also want to use the term populist for policies in its most simple form, as policies that are likely to be immediately popular with the public, without the negative connotations that I discussed here. Populist policies on the left would focus on measures to curb financialisation and the power of finance (‘bashing bankers’), and measures to reduce inequality (which are popular if expressed in terms of the 1%, or CEO pay). Right wing populist policies include of course controls on immigration, combined with constant references to national identity. The need to control international trade can be invoked by left and right.

Among those who are well informed, there is no evidence that dissatisfaction with existing elites broke right rather than left. Indeed membership of political parties in the UK suggests the opposite is true. Party members in the UK are almost by definition likely to be much more interested in politics than the average citizen, and will not be dependent on one or two elements of the MSM for information. As the Labour party leadership has shifted left and adopted some of the left wing populism I’ve described, its membership has exploded. The figures are remarkable. The Labour party currently has a membership of over half a million. This is probably [1] at least three times the membership of the Conservative party. UKIP, the populist party of the right, has a membership of only 39,000, which is below the membership of the Greens.

The Sanders campaign indicates both the popularity of left wing populism among political activists in the US, but also that left wing populist policies can be as popular with voters as those from the right when they get a national platform. Sanders put greater taxes on the rich and additional Wall Street regulation at the centre of his platform, as well as opposition to trade agreements. The campaign was largely funded by individual donations, in contrast to the other campaigns. With the exposure that an extended election process gave him, Sanders’ brand of left wing rhetoric got national coverage and proved pretty popular. Sanders claimed, with some justification, that he actually polled better against Trump than Clinton, and it remains an open question whether a populist from the left might have done better against Trump than Clinton, who epitomised the establishment.

During the Sanders campaign left wing populist ideas did get wide coverage in the MSM, but this is the exception rather than the rule. After the financial crisis there was a brief period of about a year when these more left wing themes were a major media focus, but since then they appear only occasionally in the MSM. In contrast parts of the MSM in both countries has for many years produced propaganda that supports right wing populism, and the non-partisan elements of the MSM have done very little to contest this propaganda, and on many occasions simply follow it.

Let me put these points in a slightly different way. For the few of us that do attach great importance to the media in understanding recent events, it would be a major problem if on occasions where alternative ideas were given considerable coverage in the media they were ignored by voters. It would also be a major problem if those who were much less dependent on one or two MSM sources for information behaved in the same way as the average voter. But fortunately for us both the Sanders campaign and UK party membership suggest neither problem arises, but instead these pieces of evidence provide support for our ideas.

So in both the US and UK, among those who are exposed to left wing populism or who access a much broader range of information than that provided by the MSM, there is no puzzle of asymmetry. Left wing populism continues to appeal. The asymmetry at the level of the popular vote, that gave us Brexit and Trump, can be explained by asymmetry in the media. Right wing populist ideas not only get much more coverage than left wing populist ideas, but sections of the MSM actively promote these ideas. Given that this focus on the importance of the providers of information is intuitive, it is really up to those who think otherwise to provide both theory and evidence to support their view that the MSM is unimportant.

[1] I say probably because the latest data we have for Conservative party membership is 2013. However I think it is reasonable to speculate that lack of publication means numbers have been going down, not up.  

When is an economic recovery not a recovery?

This post may seem to be unusually pedantic, but please be patient

What do we mean when we say the economy is recovering from a recession? Do we mean it has started growing again, or do we mean it is returning to its pre-recession trend? Brief research suggests there is no standard definition, but Wikipedia is clear it is the latter:

“An economic recovery is the phase of the business cycle following a recession, during which an economy regains and exceeds peak employment and output levels achieved prior to downturn. A recovery period is typically characterized by abnormally high levels of growth in real gross domestic product, employment, corporate profits, and other indicators.”

The second sentence is crucial here. All economies grow on average: they have a positive trend growth rate. An economic downturn (or worse still a recession) involves the economy dipping below trend (or in a recession not growing at all). Typically whenever that has happened in the past, most economies make up for the growth they lost in the downturn, by growing more rapidly than trend once the downturn is over. This had certainly been true for the UK. We expect economies to grow over time because of technical progress, so it seems almost obvious that a recovery must involve above average growth until we return to something like an underlying trend.

Imagine a 5,000 metres race. Suppose an athlete trips and stumbles, leaving the main pack behind. If 5 minutes later I said the athlete was recovering, would you think this meant that they were getting back to their previous pace but still well behind the main group, or that they were getting back in touch with the main pack? I suspect you would think it meant the latter, and you would call a complete recovery when they were back within the main group. If you think about the main group as the underlying trend path of the economy, then a recovery in growth means getting back towards this trend path.

For this reason I would define a recovery from recession as above trend growth, and I think most macroeconomists would do the same. Here is recent quarterly growth in UK GDP per head.

The red line is the pre-crisis trend growth rate. You can see from this that only 2014 could possibly be called a recovery, and even that is a bit of a stretch. The UK is far from unique in this respect, but unlike other countries the UK economy has a pretty clear and unchanged trend growth rate since the 1950s. Until now that is. This global lack of recovery begs many important questions, which those who read economics blogs will be very familiar with: has the financial crisis had a permanent negative effect on productive potential, was the pre-crisis period really a disguised boom, are we suffering from secular stagnation, what role did austerity play?

Yet all of these important issues are sidelined in popular discussion if we misuse the term recovery, and instead describe any positive growth after a recession as a recovery. This is not a problem for economists, who tend to talk numbers, but it does matter for the public debate. I cannot help feeling that calling any positive growth after a recession a recovery also adds to a sense of disconnect people have, particularly when (as in the UK) there has really been a recovery in employment, such that productivity has been virtually flat. People ask how come there has been a recovery and yet my wages are still so much lower in real terms than they used to be?.

When the underlying trend may have slowed or shifted, then it becomes difficult to know what is or is not a recovery, but that is no reason to misuse the term. When we are talking about the past, then things should be clear. Here is the same data for 1981.

It is obvious from this data that the recovery from the 1980 recession only really began in 1983. The two previous years saw as many periods of below trend growth as above trend growth: given normal growth, the economy was effectively standing still. Unless, of course, you have a political point to prove. In 1981 the Conservative government of Margaret Thatcher raised taxes substantially in the Spring Budget, despite just seeing 5 quarters of falling output per head. They increased taxes after falling output because they wanted to reduce the budget deficit. 364 academic economists quickly wrote a letter denouncing the policy - a Brexit like majority at the time.

In 2006 Philip Booth of the Institute of Economic Affairs wrote this:

“The economic recovery that the 364 said would not happen began more or less as soon as the letter appeared.”

This sentence has been repeated time after time by right wing economists and politicians: so often that it is now repeated as fact by BBC journalists. It has become what I call a politicised truth: something that is false but is perceived to be true by journalists who talk to politicians but not academics. And the statement that the recovery began as soon as the letter appeared is simply false if you use the term recovery properly: the recovery began a year and a half later. Had fiscal policy not been tightened in the 1981 budget, the recovery might have begun earlier than the end of 1982. In that sense, the economists were vindicated by subsequent events.

In 2010, George Osborne was warned by many academic economists - almost certainly a majority at the time - that embarking on austerity so soon after the recession was folly. But, just as in 1981, he wanted to reduce the deficit. It is not difficult to imagine that as he pondered these warnings from academics, he thought to himself that Margaret Thatcher got the same advice in 1981 and everything he had read said the advice was wrong because the recovery started immediately after taxes were increased. He would have been emboldened to do the same, with what we now know were disastrous consequences. Just two years later, GDP per head had lost another 3% or more relative to trend.

This is partly a story about the dangers of propaganda that you begin to believe yourself. But it is also about the potential ambiguity of one single word: recovery.