The academic consensus on austerity solidifies, but policymakers go their own sweet way

With yet another study showing how damaging austerity can be, you would think that at some point some politicians would eventually get it. This tepid economic recovery has been a huge vindication of Keynesian economics, which also happens to be mainstream economics. The textbooks and state of the art macroeconomics said cutting public spending while interest rates were stuck at their lower bound was a very bad idea. And sure enough pretty well every ex post analysis of this period finds that it was. It is particularly ironic that at a time when countless articles have appeared about the ‘crisis in economics’, a massive experiment by policymakers has seen an important part of it vindicated.

There were three countries or areas that adopted austerity in spades: the US, the UK and the Eurozone. Are any of these likely to recognise the error of their austerity ways anytime soon? The conventional wisdom is that this will happen in the US, but this is to confuse actions and the reasoning behind them. Any fiscal expansion in the US would not be for Keynesian reasons. This is partly for the obvious reason that interest rates are rising, and the central bank has shown no clear sign that they would not meet any further expansion with additional increases. There remains a clear and rather urgent need for a large increase in public investment financed by borrowing, but that seems unlikely to happen. What we are sure to get is tax cuts, particularly for the rich, because that is nowadays the main goal of Republican economic policy. Among Republicans, Keynesian economics remains the work of the devil.

In the UK there is also a desperate need for public investment. In addition, the NHS is crying out for a substantial tax financed fiscal expansion, which would help get interest rates off their lower bound. But UK policy makers only have one thing on their minds at the moment. It is Brexit at any cost. We know that because they show no interest in any other options. Right now God could reveal to climbers on Ben Nevis that Brexit would cost the average UK household 20% of their income, and policy would not change. [0] While some in the government may be tempted by fiscal expansion as a way to hide those costs, the Treasury seems to be keeping an iron grip on the purse strings. Never has the UK government seemed so politically secure, and never has it been further from sensible economics.

Not all of the Eurozone’s problems are due to a failure to recognise Keynesian macro. As Martin Sandbu argues here, what has been done and continues to be done to Greece is the age old story of the creditor refusing to admit that they have made bad loans, and therefore squeezing the debtor for every last drop and not realising that doing so only makes things worse. But even here a failure to understand Keynesian economics contributes to this lack of understanding. A country that is allowed to recover from a demand led recession will be far more able to find resources to pay back debt.

However if you look very hard there are signs that things might be improving in the Eurozone. Fiscal austerity at the aggregate level seems to have come to an end. Some key actors, even in EC institutions and governments, are beginning to see how austerity policies may only encourage the rise of the populist right. But that is a long way from the key reform that is required, which is replacing the existing fiscal architecture with something more Keynesian that recognises the mistakes of the past.

If anything is going to happen at all, I doubt if it will be the abandonment of the stability pact and fiscal compact, desirable though that would be. What seems more likely is a gradual adaptation of the mess that all these rules already are. The adaptation does not even need to look like Keynesian policy. National fiscal and macroprudential policies need to focus on inflation differentials between the individual country and the Eurozone average. This focus could be embodied in a rule, which still allowed debt or the deficit to be guided by a target when inflation was at the zone average. This rule has to be symmetric in inflation differentials, prescribing fiscal expansion if a country’s inflation is lower than average.

Equally disappointing has been the complacency of independent central banks. We have had the most prolonged recovery from recession, with lasting damage to long run supply, but you might be forgiven for thinking that we were still in the Great Moderation. Central banks should be busy comparing the four main ways of avoiding another Zero Lower Bound episode: a higher inflation target, negative nominal rates, nominal GDP targets or helicopter money. They also have to stop being so discreet about fiscal policy. Keeping quiet itself makes another ZLB episode more dangerous.

Occasionally people ask why my blogs seem to be as much about politics as economics these days. I agree, there has been a change since 2015. Before that, I would have greeted a new paper on fiscal multipliers by comparing it to the existing literature, and examining its strengths and weaknesses. These days there just seems so little point. I do hope all this knowledge will one day see the light of day among policymakers, but right now I wonder if there is an equally good chance that policy makers will stop paying for knowledge they have no intention of using. [1] Sometimes writing about the finer details of estimated multipliers can seem like rearranging the deckchairs on the Titanic.

[0] Here are some man-made estimates

[1] U.S. U.K.

The academic consensus on the impact of austerity

In discussing the forthcoming UK budget, Robert Peston writes:

“And before I am savaged (as I always am) by the Krugman crew of Keynesian economists for even allowing George Osborne's argument an airing, I am not saying that the net negative impact on our national income and living standards of cutting the deficit faster is less than their alternative route of slower so-called fiscal consolidation.

I am simply pointing out that there is a debate here (though Krugman, Wren-Lewis and Portes are utterly persuaded they've won this match - and take the somewhat patronising view that voters who think differently are ignorant sheep led astray by a malign or blinkered media).”

I do not want to disappoint, and as I was about to write something on the macroeconomic consensus on austerity anyway, let me oblige - not in savaging (I leave that to my American colleague in arms!), but in justifying why I think there is such a consensus in the places that count. By consensus I do not mean that everyone agrees - of course not - but that a very large majority do, which probably counts as consensus in economics.

Unfortunately we do not have a great deal of information on what academic economists as a whole think about austerity, but we do have two important survey results which are pretty conclusive. In the US, there is the IFM Forum, which regularly asks a group of distinguished economists - including many macroeconomists - their views on key policy issues. The last poll I have seen suggests that 82% of that panel thought the 2009 Obama stimulus had reduced unemployment, while only 2% disagreed. In the UK, the CFM survey asked a similar question to a smaller group of academic economists, most of whom are macroeconomists. Only 15% agreed that the austerity policies of the coalition government have had a positive effect on aggregate economic activity, while 66% disagreed. That consensus is not universal - it would not apply in Germany for example - but I doubt if anyone would disagree when I say that US economists call the shots as far as academic macroeconomics is concerned. 

This is why economists the world over continue to teach Keynesian macro to undergraduates, and normally not as one ‘school of thought’ but rather as an initial approximation of how the economy actually works. As Amartya Sen so forcefully reminds us, the experience of the last hundred years has earned Keynesian theory this central role.

However we have another, more indirect, source of evidence. If you asked whether there was a standard model for analysing the business cycle among economists in academia and in policy making institutions, the answer would have to be the New Keynesian model. I want to include economists in central banks in particular because they have to put theories of the business cycle into practice on a regular basis. The key macromodels that central banks use to forecast and to analyse policy are Keynesian, and many are New Keynesian. Having worked a great deal with New Keynesian models myself, I also know what they imply about temporary changes in government spending in a liquidity trap (see this paper by Mike Woodford, for example). It may be possible to adapt these models to give you expansionary austerity, but no such adaptations command general or even partial support.

The models used by pretty well all central banks would therefore imply that temporary cuts in government spending were contractionary, absent any monetary policy offset. The governors of the central banks of the UK and US say this publicly. European central bank governors do not tend to say this, and instead continue to advocate austerity despite deflation. The reason why they might do this despite what their models tell them will be the subject of a later post, but I suspect it has little to do with conventional macroeconomics (but see also the point about German academic views above, and Sen’s article). If temporary cuts in government spending are contractionary in a liquidity trap, it follows that it is much better to delay this form of austerity.

I could add repeated arguments from economists at the IMF (e.g. here and most recently here), and now also the OECD (FT here, or ungated here). Of course there are some academic economists who continue to argue that the impact of austerity is expansionary or at least minor - I suspect there always will be, as long as this remains an intense political debate. They would be joined by many City economists, but they are neither unbiased nor the source of any particular expertise on this issue.

This is why, among economists with expertise, there is a clear majority view that fiscal austerity is significantly contractionary in a liquidity trap. That does not automatically mean that the 2010 policy switch was wrong, or that it had a big impact on the UK in 2010-2012: there are additional issues here which I have discussed many times. How damaging to the macroeconomy any additional austerity from Osborne will be also depends on whether we are or will be in a liquidity trap. But the fact that we might well be means that additional austerity now is a big mistake, and on this I believe the great majority of academic macroeconomists and those macroeconomists working in policy making institutions would agree.

As far as the media is concerned, I cannot believe that Robert Peston would disagree that a large section are ‘malign’, given how political this issue is. When I have talked to journalists who have some freedom to report the facts rather than what their editors want them to report, the argument I most often hear is that because this issue is political, they have to report it as a ‘debate’ come what may. I have never had the pleasure of talking to Robert Peston (he is welcome to email at any time), and I would be very interested in how he would respond to the evidence I have laid out. As for the public, the word sheep is his not mine. Would he really argue that the public are independently well informed on these matters, or unaffected by the media’s presentation of this and similar issues? Which is why I will continue to - as he might say - bang on about this, even though my audience is tiny in comparison to most journalists.

Consensus in macroeconomics

Paul Romer has continued the discussion he started, broadening it out from ‘mathiness’ to a more general discussion of how the subject is done. He describes what he regards as appropriate norms of science. The first few are I think uncontentious, but Stephen Williamson has taken exception to these two:

e) In our discussions, claims that are recognized by a clear plurality of members of the community by as being better supported by logic and evidence are the ones that are provisionally accepted as being true.

f) In judging what constitutes a “clear plurality,” we put more weight on the views of people who have more status in the community and are recognized as having more expertise on the topic.

Stephen writes:

This is absurd of course. We don't take polls to decide scientific merit. Indeed, revolutionary ideas - the ones that take the biggest steps toward Romerian truth - would be the ones that would fail, by this criterion.

I can understand that for those who typically work outside the mainstream, and indeed may be known for proposing new and challenging ideas, find this kind of talk threatening. Take it the wrong way, and it sounds like a recipe for conformity and stagnation.

I’m sure that is not what Paul intended, and I also think he is making an important point here. I suspect a natural scientist would see (e) and (f) as simple statements of how things are. In my experience natural scientists have a clear idea of what the “clear plurality” is on any particular issue, and are happy to admit it, even if they disagree with that plurality. There is nothing here that says academics cannot challenge the ideas of the “clear plurality”.

But why is it important to have an idea of what that plurality is and acknowledge it? I can think of three reasons. First, it presents an honest picture to those learning the discipline. Second, it is very important that policy makers are told which ideas are widely agreed and which are the views of a small minority. That does not stop policy makers going with the minority, but they should know what they are doing (as should voters). The public’s trust in economics might also increase as a result. Third, it helps the unity of the subject, mutual understanding and progress. It becomes clear why those who do not accept the views of the “plurality” disagree, and what they need to do to convince the plurality that they are wrong.

Convincing the majority that they are wrong is a strong motivational force for progress. In contrast, working within a small school of outsiders all of whom just know that the plurality is misguided, and as a result never bother to engage or keep up with it, is a recipe for stagnation. Before heterodox economists start hitting the keyboard, that also means that the plurality is open to unconventional ideas and do not just reject them because they are unusual or defy certain generally accepted norms.

It is for reasons like this that I have argued that it is wrong to say that macroeconomics is ‘flourishing’ simply because there are lots of different ideas/models out there. If there is no clear way of establishing which of these command general support and which are the insurgents, and what the insurgents need to do to overturn any consensus, then it is not clear how the discipline can progress.

This is all a bit abstract, so let me give an example from business cycle theory. Here there is, at present, a clear consensus theory, which is the New Keynesian model. I have been challenged on this in the past, but I would want to insist on it because I would attach a good deal of weight to those who are actually involved in business cycle stabilisation i.e. economists in central banks. (I’m not sure how important ‘status’ should be in Paul’s (f), but expertise is important, and having to put ideas into practice and responding to data all the time should count strongly.)

So when fiscal stimulus was used in 2009, those economists who opposed it should have said something like: I understand that temporary increases in government spending will raise output for given nominal rates in the dominant New Keynesian model, but I think that analysis is wrong because …. They should not have said, as some did, that fiscal stimulus was old fashioned nonsense. Whether they did this out of ignorance or contempt for the mainstream, it suggested that at least some prominent economists were not following the norms of science.