Spain, and how the Eurozone has to get real about countercyclical policy

Matthew Klein has a good account of how Spain’s macroeconomic fortunes are improving, but only from a very bad place. I’m not that knowledgeable about the Spanish economy, so I cannot add any detail. However I do want to pick up on one point, which he and others (including Martin Wolf - see below) have made, which I think is wrong and misleading.

Before I do that, I just want to make a general point about the current recovery. At its heart it is export led, which is exactly what you would expect. Just as this post which compares Greece to Ireland shows, the Eurozone does have a natural correction mechanism when a country becomes hopelessly uncompetitive as a result of a temporary domestic boom (whatever its cause). The mechanism is a recession and what economists call ‘internal devaluation’: falling wages and prices. The problem with this correction mechanism is that, on its own, it is slow and painful, particularly when Eurozone inflation is so low.

So the key question is what could Spain have done to avoid having such a painful period of correction. The cause of the problem was the excess private sector borrowing of the pre-crisis period, and the associated capital inflows. This was part of an unsustainable property boom that led to a large current account deficit and rising inflation. (I liked the point that Matthew Klein made about how export orientated firms have recently increased their borrowing. Extra borrowing is not bad if the investment is sound.) What could Spain have done to cool things down? As Matthew Klein points out, Spain already had some sensible macroprudential monetary policies, and it seems likely that more of the same would not have been enough.

Which brings us of course to fiscal policy, and it is here that so many commentators go wrong. They say, correctly, that Spain’s problem was never a profligate government. They say, correctly, that the actual budget was in surplus from 2005-2007. Of course the relevant number is the underlying (cyclical adjusted) balance, and the IMF now thinks that shows a persistent although small deficit. But as Martin Wolf points out, again correctly, the IMF in 2008 thought very differently. As I have said many times in the case of the UK, ex post numbers for pre-crisis cyclically adjusted deficits can be very dodgy because of the depth and persistence of this recession.

The mistake everyone here makes is to judge the appropriate fiscal policy by the size of the deficit. That is like saying that a bigger fiscal stimulus in the US in 2009 was impossible because the deficit was already very large. For an individual country in a currency union the deficit is not the appropriate metric to judge short term fiscal policy. Unless there are very good reasons for believing the economy is too competitive, the appropriate metric is national inflation relative to the Eurozone average. From 2001 to 2007 the GDP deflator (the price of domestically produced goods) for the Eurozone as a whole increased at an average rate of just over 2%. In Spain it increased at an average rate of nearly 4%. 2% excess inflation over 7 years implies a 15% loss in competitiveness. So forget the actual budget deficit or any cyclically corrected version, fiscal policy was just not tight enough.

I have been told so many times that for Spain to have a tighter fiscal policy before the crisis was ‘politically impossible’. If that really is true, then Spain has little to complain about when it comes to the subsequent recession. If you cannot do any better, you have to leave the natural correction mechanism to do its slow and painful work. But I suspect what is ‘politically impossible’ is in part a reflection of the Eurozone’s flawed Stability and Growth pact itself, which focused entirely on deficits.

It seems more than likely that the existing monetary but not fiscal/political union is here to stay for some time. Many in Europe’s political elite plan to move quickly to greater union (see Andrew Watt here), but there are serious obstacles in their path. The current system can be made to work better, and strong countercyclical fiscal policy is an obvious part of that. Combining this with medium term deficit reduction is technically trivial. Just how many years and recessions does it take before what is obvious textbook macroeconomics can become politically acceptable?

A way forward for the centre left on deficits

When it comes to fiscal policy the politics of the right at the moment [1] could be reasonably described as deficit fetishism. The policy of the centre left in Europe could also with some justification be described as growing appeasement towards deficit fetishism. Given its success for the right in Europe, it seems unlikely that this side of the political spectrum will change its policy any time soon. [2] Things appear a little more malleable on the centre left. In the UK, in particular, we will shortly have new leaders of both Labour and the Liberal Democrats. In addition, the Scottish Nationalists have adopted the rhetoric of anti-austerity, even though their fiscal numbers were not far from the other opposition parties during the elections.

Attempts to get the centre left to avoid deficit fetishism need to fight on two separate fronts. First, politicians and/or their advisers need to be taught some macroeconomics. Academics too often assume that politicians either know more than they actually do, or have behind them a network of researchers some of whom do know some macroeconomics, or who have access to macro expertise. (I used to believe that.) The reality seems to be very different: through lack of resources or lack of interest, the knowledge of left of centre politicians and their advisers often does not extend beyond mediamacro.

The second front involves the politics of persuasion: how can politicians successfully persuade voters that deficit fetishism, far from representing responsible government, in fact represents a simplistic approach that can do (and has done) serious harm? I think for academics this is a far more difficult task for two reasons. First our skills are not those of an advertising agency, and we are trained to follow the scientific method rather than act as a lawyer arguing their case (although, if you believe Paul Romer, the scientific method is not universally adopted among macroeconomists). Second, the experience of the last five years on the centre left is that deficit fetishism helps win elections.

It my last post I tried to argue why the success of deficit fetishism was peculiar to a particular time: the period after the recession when households were also cutting back on their borrowing, and where the Eurozone crisis appeared to validate the case for austerity. In other times households try to borrow to invest in a house, and firms try to borrow to invest in good projects. As a result, once the debt to GDP ratio has begun to fall, and yet interest rates remain low, the power of alternative narratives like ‘it makes sense to borrow to invest in the future when borrowing is cheap’ will increase.

Yet responding to deficit fetishism by implying the deficit does not matter, or that we can print money instead, or even that we can grow our way out of the problem, is unlikely to convince many. [3] It just seems too easy, and contradicts people’s personal experience. The trick is to appear responsible on the deficit, but at the same time suggesting that responsibility is not equivalent to fetishism, and other things matter too. I think this provides a powerful motivation at this time for a policy that is designed to obtain balance on the current balance (taxes less non-investment spending) rather than eliminating the total deficit. This is far from ideal from a macroeconomic point of view, as I discuss here, but as a political strategy in the current context it has considerable appeal. In the UK it allows you to attack the ‘excessive and obsessive austerity’ of Osborne, who is ‘failing to invest in the future’, while following a policy that it is difficult to label irresponsible. [4]

Of course this policy was close to that adopted by Labour, the Liberal Democrats and the SNP at the last election, so many will just say it has already failed. I think this is nonsense for three reasons. First, the policy I’m advocating is a combination of targeting a zero current balance, and at the same time arguing aggressively against excessive austerity. Labour deliberately avoided being dubbed anti-austerity during the election. (The Liberal Democrats were handicapped by arguing for austerity for the previous 5 years as part of the coalition.) The only party to adopt an anti-austerity line was the SNP, and it did them no harm at all. Second, the reason Labour wanted to avoid pushing the policy at the election was that they felt they had tried this a few years before and failed, but as I argued in the previous post deficit fetishism only shrives in a particular context, and that context is passing. Third, what sank Labour on fiscal policy was that people swallowed the Conservative line that it was Labour’s profligacy that caused the need for austerity, essentially because this line went unchallenged for five years.

This last point is worth expanding on. Too many in the Labour party think that because many people now believe this idea, the best thing to do is pretend it is true and apologise for past minor misdemeanours (knowing full well it will be interpreted by everyone else as validating the Conservative line). This is almost guaranteed to lose them the next election. It will just confirm that the last Labour government was fiscally profligate, and the Conservatives will quote Labour’s apology for all it is worth. To believe that this will not matter by 2020 is foolish - it is the same mistake that was made in the run up to 2015. It is no accident that political commentators on the right are arguing that this is what Labour has to do. So the first task for Labour after the leadership election is to start to contest this view. They should follow the advice that Alastair Campbell is said to have given after 2010, and set-up an ‘expert commission’ to examine the validity of the Conservatives claim, and then follow through on the inevitable findings. [5]

I can understand why it may seem easier right now to avoid all this, adopt deficit fetishism and ‘move on’. But to do this accepts the framing of economic competency as being equivalent to deficit fetishism, and therefore forfeits a key political battleground to the right. In addition, once you accept severe deficit reduction targets, it becomes much more difficult to argue against the measures designed to achieve them, as on every occasion you have to specify where else the money would come from. (In the UK, that partly accounts for the disaster we saw on the welfare bill. In Europe it leads to the travesty of what was recently done to Greece, where Greece was only allowed to stay in the Eurozone at the cost of adopting harmful additional austerity.) As we have seen in the UK and elsewhere in Europe, there is a large amount of popular support for an anti-austerity line, and if the centre left vacates that ground the vacuum will be filled by others. Arguing against deficit fetishism (or in more populist terms ‘obsessive austerity’) while pursuing fiscal responsibility through a balanced current budget can become a winning strategy for the centre-left in Europe over the next few years.

[1] It is easy to forget that there is nothing that makes this the inevitable policy of the right. George W. Bush took the reduction in the US deficit under Clinton as a cue to cut taxes and raise the deficit.

[2] This sentence is just for those who like to ask why I tend to write more posts giving advice to the centre-left rather than to the right on this issue.

[3] I have argued for ‘QE for the people’, but always as a more effective tool for the Bank of England to stabilise the economy and not as a more general way for governments to finance investment. (Even if this becomes ‘democratic’ along the lines suggested here, the initiative must always come from the Bank.) As for growing your way out of debt, this is much closer to the policies that I and many others have argued for, but it may unfortunately be the case that at the low point of a recession this line is not strong enough to counter deficit fetishism.

[4] It was also the main fiscal mandate of the last coalition government, of course. This could be supplemented by targets for the ratio of government investment as a share of GDP. As long as these are not excessive, an additional debt or deficit target seems unnecessary.

[5] The question should not be ‘did Labour spend too much before the recession’, because that is not the line that did the damage. The question should be more like ‘did the Labour government’s pre-2008 fiscal policy or the global financial crisis cause the 2009 recession and the subsequent rise in the UK deficit?’  

Should central bankers stick to talking about monetary policy?

Few disagree that the recent remarks on corporate governance and investment made by Andy Haldane (Chief Economist at the Bank of England) are interesting, and that if they start a debate on short-termism that would be a good thing. As Will Hutton notes, Hillary Clinton has been saying similar things in the US. The problem Tony Yates has (and which Duncan Weldon, the interviewer, alluded to in his follow-up question) is that this is not obviously part of the monetary policy remit.

Haldane gave an answer to that, which Tony correctly points out is somewhat strained. Perhaps I could illustrate the same issue by going down a better route that Haldane could have used. He could say that the causes of low UK productivity growth are clearly under his remit, and one factor in this that few dispute is low investment. If he was then asked by an interviewer what might be the fundamental cause of this low investment, Tony would argue that his reply should be that he couldn’t really comment, because some of those reasons might be too political.

I have in the past said very similar things to Tony when talking about the ECB, and their frequent advice to policymakers on fiscal rectitude and structural reforms. My main complaint is that the advice is wrong, and I puzzle over “how the ECB can continue to encourage governments to take fiscal or other actions that their own models tell them will reduce output and inflation at a time when the ECB is failing so miserably to control both.” But I have also said that in situations where fiscal actions have no impact on the ability of monetary policy to do its job (which is not the case at the moment), comments on fiscal policy are “crossing a line which it is very dangerous to cross”.

However I am beginning to have second thoughts about my own and Tony’s views on this. First, it all seems a bit British in tone. Tony worked at the Bank, and I have been involved with both the Bank and Treasury on and off, so we are both steeped in a British culture of secrecy. I do not think either of us are suggesting that senior Bank officials should never give advice to politicians, so what are the virtues of keeping this private? In trying to analyse how policy was made in 2010, it is useful to have a pretty good idea of what advice the Bank’s governor gave politicians because of what he said in public, rather than having to guess. (Of course private advice to politicians is never truly private, but this hardly helps, because with secrecy it allows politicians to hint that advice of a particular kind was given when it might not have been.)

The issues of MPC external member selection that Tony worries about are real enough, but perhaps that illustrates problems with the selection process. My guess is that the Treasury would be inhibited about choosing an MPC member who had previously been strongly critical of the government on other issues anyway. As I said my main complaint about the ECB is the nature and context of the advice they give, and at least by making it public we know about this problem.

It is often said that central bankers need to keep quiet about policy matters that are not within their remit as part of an implicit quid pro quo with politicians, so that politicians will refrain from making public their views about monetary policy. Putting aside the fact that the ECB never got this memo, I wonder whether this is just a fiction so that politicians can inhibit central bankers from saying things politicians might find awkward (like fiscal austerity is making our life difficult). In a country like the UK with a well established independent central bank, it is not that clear what the central bank is getting out of this quid pro quo. And if it stops someone with the wide ranging vision of Haldane from raising issues just because they could be deemed political, you have to wonder whether this mutual public inhibition serves the social good.

Why are some central banks so coy about the impact of fiscal policy?

The Bank of England’s inflation report is a mine of information about what has and might happen to the UK economy. There are fifty pages on the prospects for demand, supply and inflation. Yet when it comes to fiscal policy, the latest report contains just one paragraph:

“The MPC’s projections are conditioned on the tax and spending plans outlined in the March 2015 Budget, which incorporates continued fiscal consolidation. The Institute for Fiscal Studies estimates that a little over half of the Government’s planned fiscal consolidation, relative to the March 2008 Budget, had taken place by the end of the 2014/15 fiscal year. The remaining consolidation is expected to be achieved primarily through reductions in government consumption.”

The report does not even say the obvious, which is that fiscal policy will therefore act as a significant drag on growth over the next few years. How much of a drag? The OBR estimate that past fiscal consolidation has reduced GDP by around 2%. We could therefore infer from this paragraph that future consolidation will tend to reduce future GDP by a similar amount. But this assumes that the Bank agrees with the OBR’s assessment about the past, and the Bank says nothing on this.

There is a lot more that could be said. If fiscal consolidation comes in the form of cuts to welfare rather than government spending on goods and services, will this make a difference to the demand impact? If, given the promises made during the election campaign, some of this deficit reduction does not take place, how much earlier would we expect interest rates to rise? These are at least as important as the other issues considered at length in the report.

So why the silence on the impact of fiscal policy? I guess it is deemed politically sensitive to talk about such things. But silence is not a neutral position in the current political context. Silence suggests that the demand impact of fiscal policy is somehow unimportant, or perhaps particularly uncertain: both of which the Bank knows are untrue. This is not about monetary policy makers trying to avoid treading on the toes of fiscal policy makers. It is about monetary policy makers supporting a political position which chooses to be economical with the truth about the impact of fiscal policy. The Bank being coy is the Bank colluding with those who are being economical with the truth.   

Mediamacro myth 2: Labour profligacy

As I noted in my previous post, the very big government budget deficit in 2010 was largely the result of the recession. That fact is difficult to square with the myth that the coalition government rescued the economy from an impending financial crisis, so it is important to push another explanation for the large deficit: that it reflected the profligacy of the previous government.

Economic journalists know full well this is a myth. Yet it is a myth repeated on countless occasions by the coalition parties, and by journalists working for the partisan press. On one occasion one of these journalists tried to rubbish a post where I wrote it was a myth, and I hope learnt to regret the experience.

Just inspecting the chart in my last post shows this myth is nonsense. But the political commentators that are central to mediamacro seldom look at economic data. What they do remember of the pre-recession budgets of Gordon Brown was some criticism that he was not being as prudent as he might be. That memory is both correct (both the IFS and NIESR made that criticism) and the criticism is valid, as I set out in my study of this period. (To read the study free before the election, go here.) This is the half-truth that sustains the myth.

But mild imprudence is not profligacy. We can see that by looking at another chart, for the debt to GDP ratio. Profligacy would imply a rapidly rising ratio, but this ratio before the recession (37% in 2008) was below the level Labour inherited (42% in 1997), and below its fiscal rule figure of 40%. No profligacy there.

So the Labour profligacy argument on its own would fall apart, if it was not itself buttressed by another myth: the argument that the government should have been running large surpluses in 2007, because we were in the midst of a major boom. That myth is important and widespread enough to deserve a post of its own tomorrow.

One final point. There was no impending financial crisis in 2010, but there was a very real financial collapse in 2008. Even though Labour was not profligate, if it had been more prudent wouldn't that have given it more ammunition to fight the recession caused by the financial collapse? To the extent that Labour's countercyclical fiscal policy in 2009 was moderated by a worry about debt (which I suspect it was), this is a half-truth. But as Vicky Pryce, Andy Ross and Peter Unwin state in their book 'Its the Economy Stupid: Economics for Voters' (which I happily recommend, and which in its initial chapters covers much of the ground of this series):

"The elimination of the UK's structural deficit [under Labour before the recession] would not have been even a sticking plaster in the face of the haemorrhaging of the finance sector's jugular"

I would also add that the Conservatives not only argued for even less financial regulation before the financial collapse, but opposed Labour's measures to moderate the recession in 2009.

Previous posts in this series

(0) UK mediamacro myths: an introduction

(1) 2010 Britain faced a financial crisis

Confidence

Mainly for economists

Francesco Saraceno reminds us about the days in which very important people believed in the confidence fairy (aka expansionary fiscal austerity), which are not so very far away. He also points to some recent ECB research which shows that confidence - as measured by surveys - clearly falls following fiscal austerity. The confidence fairy, rather than waving her wand to make everything alright again, may be making austerity worse. 

However, looking at the research in detail revealed some results I found at first surprising. In particular, revenue cuts have a bigger effect on consumer confidence than spending cuts. In terms of GDP impacts, theory - and most but not all empirical evidence - suggests that temporary spending cuts will have a larger impact on overall activity than temporary tax increases, if there is no monetary offset and incentive effects are not very large. Do these empirical results contradiction this?

To answer that you need to ask two further questions. First, what does consumer confidence actually measure? Second, and perhaps more interesting, what information do fiscal announcements actually reveal.

The answer to the first question seems to be a mixture of things, some of which relate to the individual household’s income, and some related to the general economic situation. To the extent that the consumer is thinking about the former, then it would make sense that a tax increase might have a larger impact on confidence than a spending cut. This would tell you very little about the economic impact of the two types of measure.

The obvious answer to the second question is that the information conveyed by an announcement of a spending cut or tax increase is just itself. If we stick to taxes, then if the announcement had not been made, the consumer would have just assumed lower taxes (for a time, or forever?). But this is naive from an intertemporal perspective, and clearly non-Ricardian. In the logic of Ricardian Equivalence, a tax increase today must imply cuts in taxes tomorrow for a given path of spending.

There are three alternative, more ‘rational’, ways of thinking about the announcement of a tax increase. Suppose the current government budget deficit is not sustainable. Taxes either need to rise today, or tomorrow after more borrowing. The announcement then tells us about the timing of the tax increase. If Ricardian Equivalence held it would have no impact on lifetime discounted income, but if for many possible reasons it did not hold, then a tax increase today could depress consumer confidence. However, to the extent that confidence depended on the general economic situation, you would expect ‘bringing forward’ expenditure cuts to have a much greater impact than bringing forward tax increases (with the caveats noted above), because of consumption smoothing. In that case spending cuts should reduce confidence more than tax increases.

A second possibility is that a tax increase could signal something about the future economic situation. Perhaps the consumer had thought the deficit was sustainable because they were optimistic about future growth, but the tax increase told them to be less optimistic. Reduced optimism could lead to reduced confidence. To the extent that the fiscal action conveys information about future pre-tax incomes, the tax increase conveys the same information as a spending cut.

A final possibility, which is generally ignored when discussing the plausibility of Ricardian Equivalence, is that the announcement of a tax increase tells consumers about the composition of any consolidation. Suppose again that the deficit is unsustainable. Either taxes have to rise or spending fall, but the consumer does not know which of these will happen. If spending is then cut, this tells the consumer that taxes will not rise, which in terms of the consumer’s own income would represent a plus. So in that case a spending cut could increase consumer confidence.

Trying to evaluate the impact of past fiscal actions is complicated, in large part because it is difficult to know what the counterfactual was, or what people thought the counterfactual was. Were changes thought to temporary or permanent? (Governments hardly ever say, and even if they did would they be trusted?) To what extent do people internalise the government’s budget constraint? If they do, are fiscal changes telling us about the timing of taxes or spending, or their mix, or something else? It seems to me that these difficulties arise whether we are trying to assess the impact of fiscal changes on confidence, or on activity itself. 

Saying the obvious

Give any student who has just done a year of economics some national accounts data for the US, UK and Eurozone, and ask them why the recovery from the Great Recession has been so slow, and they will almost certainly tell you it is because of fiscal austerity. And they would be right, as I set out in this recent VoxEU piece. There I present some back of the envelope calculations, but they are confirmed by model simulations: not just those I quoted in the text, but also others that I did not have space to mention.

When writing that piece, I kept having doubts. Not about the analysis, but just that this was all so obvious. It uses basic models (DSGE or more eclectic) that we teach undergraduates and postgraduates. It is supported by the clear majority of empirical evidence. I felt like I was telling people the macroeconomic equivalent of a rise in the demand for apples will mean an increase in their price.

The reason I put those doubts aside are also familiar. The fact that at least half the world’s politicians and mediamacro continue to ignore the obvious. The fact that too many economists continue to look for other reasons to explain this malaise (or pretend there is no malaise), because somehow they think acknowledging that fiscal policy can influence demand is old fashioned, or left wing, or something. These facts and that I was in good company.

While there are too many academic economists who want to deny that fiscal policy is largely responsible for the weak recovery from the Great Recession, I also suspect there is a majority that know it is true. This is why I wrote a post about the lessons to draw for the future. Although we teach students all about time inconsistency and say at the same time what advantages independent central banks can have, I suspect we also know that the case for independent central banks is broader than issues to do with commitment.

Economics is always in danger of being corrupted by politics and ideology, and macroeconomics seems particularly vulnerable in this respect. (I have still not entirely convinced myself if and why macroeconomics is special in this respect. Sometimes things that are actually micro, like financial regulation or labour supply responses to tax changes, seem just to get labelled macro when they become controversial or have macro consequences!) Some say that this corruption is inevitable and that we should embrace it, rather than attempt to avoid it through delegation to institutions like independent central banks. I disagree: demand management is basically a technical issue with political implications. If we did not have independent central banks today, I suspect we would be seeing the US congress voting to raise interest rates. And of course there would be a few economists with their models saying it was a good idea, even though the vast majority thought otherwise.

The reaction to my earlier post, both from comments and elsewhere, was that this weak recovery caused by fiscal austerity was not just bad luck caused by a misreading of the Eurozone crisis, but the result of a more fundamental political economy problem. We therefore need to rethink how stabilisation policy is done at the Zero Lower Bound (ZLB). Of course we also need to think about whether we should try and minimise these ZLB episodes, by either raising the inflation target, or by reformulating how monetary policy is done, or some other means. However the risk of large negative demand shocks will remain, so it would be prudent to complete the delegation of macroeconomic stabilisation policy that was begun by making the operation of interest rate policy independent of political control. Doing that would also be a good opportunity to revisit the arrangements that can ensure independence is compatible with accountability and some degree of democratic oversight.   

That £170 billion bombshell

Paul Johnson of the IFS has written that under Labour “national debt [could be] around £170 billion higher (in today’s terms) by the end of the 2020s than would be achieved through a balanced budget.” That was all that certain newspapers needed to start talking about a borrowing bombshell under Labour.

£170 billion is a meaningless number, and the end of the 2020s is a meaningless date. First, we should put everything as shares of GDP. £170 billion is about 10% of GDP, and debt is currently around 80% of GDP. However it would be completely wrong to infer that under Labour debt to GDP would be 90% of GDP by 2030. If they achieved current balance by financial year 2017/18, then my excel spreadsheet says that with nominal GDP growth of 4% a year, by 2030 debt to GDP would be around 65% of GDP. (A few points below 65% if investment remained at 1.5% of GDP, a few points above it became 2% of GDP.) If the Conservatives balanced the overall deficit each year debt to GDP would be about 47% of GDP by 2030.

So a £170 billion bombshell actually means debt to GDP would have been reduced from 80% of GDP to around 65% of GDP. So the correct headline should have been “debt to GDP cut by a fifth in 2030 under Labour’s plans”. That is debt, which is much more difficult to reduce than the deficit. To say this is a ‘different interpretation’ is too polite – newspaper reports got it completely wrong. Who should you blame for this: Paul Johnson, innumerate journalists, biased newspapers? I’ll leave that to you.

There remains a real question of how quickly debt to GDP should be reduced. In terms of the analysis I did here and here, Labour’s plans - if it did achieve current balance by 2017/18 - are tougher than the path I described as ‘fast’ debt reduction, although not nearly as tough as Osborne’s plans. (This analysis was done before the Autumn Statement, but to pretend that the analysis needs to be revised on that account gives these numbers spurious precision.) However my ‘fast’ path did not keep to current balance after 2020, but had some further deficit reduction over the next five years. (As a result, debt to GDP was below 60% by 2030 under this fast path.) I have not seen Labour commit to sticking to current balance until the end of the 2020s. So in that sense as well the £170 billion number is meaningless.

What you should conclude from this is simple. First, as Paul Johnson and many others have pointed out, both Labour and Conservatives are aiming for tight fiscal policies (tighter than I and others think sensible given the macroeconomic situation), but the Conservatives’ plans involve substantially more cuts than Labour. Both involve reducing debt to GDP quite rapidly, so there is no question that both plans would not trouble the markets. So the only reason for going for Osborne’s plan, now apparently involving budget surpluses, is if you expect another financial crisis in the 2030s, and want debt to GDP to be something like it was before the last one. [1] Or, as a headline writer might put it (but somehow I doubt many would): “budget surpluses and austerity so we can afford to bail out the banks again soon”.

   

[1] For those who are really into fiscal rules, there is a technical question about whether it is better to have a target for the overall deficit or the current balance. As George Osborne has moved from the latter to the former, it may be best to read his detailed analysis of the issue. Cannot find anything? Well maybe, as I note here, he is simply following the discussion in Portes and Wren-Lewis (2014), which argues for deficit targets but a separate target for the public investment to GDP ratio.

When central bank losses matter

This is a post about why the taboo against helicopter money or money financed fiscal stimulus is irrational once we have Quantitative Easing, but might nevertheless be in the interest of some groups.

Many macroeconomists have argued that we shouldn’t think about central banks in the same way as private banks. A central bank can never be insolvent, at least as long as people use the currency it issues. It can cover losses by creating more money. All that matters, from a macroeconomic point of view, is whether it has the ability to do its job, which is to control inflation. 

I do not want to talk about controlling inflation here. Instead I want to talk about these losses, and in particular who gains when these losses are made. Macroeconomists tend to focus on the controlling inflation point, so let me avoid that by imagining a really simple world. There is a constant price level target, and base money velocity (nominal GDP/money) is constant in the long run, so base money must return to some constant value in the long run to meet the target. In the short run velocity is not constant and we can have recessions due to demand deficiency in the usual way.

Think about Quantitative Easing (QE). [4] The central bank creates money to buy government debt in the market at a time when that debt is expensive, because it only does QE when interest rates are low. [1] Suppose it just so happened that all this government debt that the central bank buys comes from pension funds. These funds sell their debt, take the money and keep it as money. After some time, the economy recovers, interest rates rise and the price of this government debt falls. The central bank no longer needs the debt, and it wants to reduce the money stock to get to the price level target, so it sells the debt back to the market, or more specifically to the same pension funds it bought it from. As the price of these assets has fallen, the central bank makes a loss. The pension funds gets back the debt they originally sold, but they have some money left. They have gained.

Good for them you might say - why should I care? Well the central bank is concerned that it has not got all its money back (it made a loss), and to control inflation it needs to take more money out of the system. It asks the government to recapitalise it, which the government does by raising taxes. What has in effect happened is that money has passed from the taxpayer to the pension fund.

My purpose in pointing this out is not to make some distributional point. Instead it is to note that QE in this case involves the central bank giving money away to pension funds. So why is this considered kosher, but the central bank giving the same amount of money (its loss on QE) directly to the public is considered deeply problematic? [2] Why would it be thought completely wrong for the central bank to voluntarily give the same amount of money to the government so that they could help stimulate the economy by some fiscal means (a money financed fiscal stimulus)? [3]

If you think that my assumption about price level targets and constant long run velocity was somehow critical here, imagine the case where to meet its inflation target the money newly created in the long run (the loss on QE) did not need to be taken out of the system. The pension funds gain but no one seems to lose. But if the expansion of money had been via a helicopter, then every citizen would gain instead. So why is acceptable to create new money and give it to pension funds (through losses on QE), but not create money to give to ordinary people or the government? The former is called monetary policy and is OK for a central bank to do, but the latter is called fiscal policy and this the central bank cannot do.

Why does this matter, apart from the distributional point? Because as a means of stimulating the economy in the short run the effectiveness of QE is highly uncertain compared to the effectiveness of direct transfers to citizens or public works. We seem to be stuck with an ineffective form of stimulus, because something more effective is taboo, or goes by a different name. To repeat it in a simple but more provocative way: a central bank giving money to people or governments is out of the question, but a central bank giving money to parts of the financial sector is just fine. That is a very convenient taboo for some.  

[1] Suppose this is government debt issued many years ago, when interest rates were 5%. So debt with a nominal value of £100 pays 5% interest. If interest rates are now 2.5%, then this debt is more valuable than its nominal value - indeed someone would pay you something near £200 for it if it had a long maturity. However if interest rates go back to 5%, the value of the debt would fall back to £100.

[2] Assume Ricardian Equivalence does not hold, so giving money away now is expansionary even though that money has to eventually come back when the central bank is recapitalised.

[3] If the money financed fiscal stimulus was in the form of additional but temporary government spending, and when the central bank was recapitalised the Treasury paid for this by temporarily reducing government spending, we get what I call a ‘pure’ money financed spending stimulus. I know of no theory which says that would not be expansionary. 

[4] If you want to be topical, you could think about creating money to buy foreign currency instead.

Mediamacro and responsibility

The Chancellor gives a huge pre-election bribe to the moderately wealthy over 65s, and describes the fact that everyone who can is trying to get hold of the bribe (and completely overwhelming the NS&I as a result) as a great success. [1] Chris Dillow describes this as corruption. To their credit, right wing think tanks have also condemned it for what it is. But the Chancellor says this is all part of his economic plan.

I suspect the penny is beginning to drop in mediamacro. This was supposed to be a government where deficit reduction was the overriding priority. It was of such importance that it was worth the risk (which materialised) of delaying the recovery until 2013 to achieve. Hard, sometimes painful choices had to be made to achieve the goal of reducing the deficit. A Chancellor who was prepared to do unpopular things for the greater good. The essence of responsibility.

Unless you were a top rate tax payer, of course. Or, following the Prime Minister’s conference speech last year, a moderately well off taxpayer. And now if you are moderately well off and over 65. Penny dropped? But this last example also tells mediamacro a difficult truth. Its modus operandi is that it can rely on the opposition to expose such things, but Labour appears to have been silent on this. Obviously, because these kind of bribes work because those that receive it are thankful and the much larger number who pay for it are not so fussed. [2] So it needs to seek out those who will call a spade a spade. It has a responsibility to do so. This time it could use right wing think tanks. Next time it may have to resort to economists who write blogs.

Chris Giles, economics editor of the FT, wrote an interesting opinion piece a few days ago. It appears at first sight to be an attack on Labour’s record in opposition. But it ends with “the intriguing thing about Mr Miliband’s Labour party is that its broad economic prospectus for the 2015 general election is perfectly sensible.” In contrast “the Tories’ plans appear ideological and border on calamitous for many public services.” If you want more detail on this, see my debate with Oliver Kamm in Prospect magazine. So his article is a form of puzzle: how did responsible Tories and reckless Labour change places?

One possibility, of course, is that there never was a puzzle. Chris lists many alleged failings by Labour, but a lot look superficial and presentational to me. Furthermore (and I know Chris will not want to admit this) when Ed Balls said Osborne was cutting too far too fast, he was right. In particular, public investment (school repairs, flood prevention) was cut immediately when there was no need to do so to meet the coalition's fiscal rules. Those who think it had to be done to appease the market should reflect on the fact that Britain lost its AAA rating because of weak growth, and pretty well everyone thinks that public investment has the largest GDP multiplier.

It is the media’s responsibility, which Chris for his part has grudgingly fulfilled, to point out - one way or another - who has the more responsible macroeconomic plan post 2015. The opposition will not make that case, because it has become terrified of being labelled spendthrift. Yet it is hard to find a macroeconomist who does not think Labour has the better macro policy from 2015, whatever their views about 2010 austerity. A responsible media needs to get this point across, just as it needs to point out pre-election bribes.

[1] Once upon a time NS&I was just a way that the government could sell its debt to ordinary people at slightly below market rates because it was safer than banks. However after the financial crisis, when it became clear how risky banks were, the government seems to have contracted the range of products that NS&I sell, I guess because of lobbying by these same banks. Once you could buy indexed linked assets from NS&I - no longer. Now it has become a vehicle for giving bribes to selected groups of savers.

[2] This is the ‘common pool problem’, one of the reasons economists give to explain deficit bias, which is of course being irresponsible about the deficit. 

Faith based macroeconomics

When you just know something is true, like fiscal policy never matters much and NGDP targeting would have avoided the Great Recession, everything becomes about proclaiming your faith in the most effective way possible. It becomes a debating contest. The best example I know of someone like this is Scott Sumner. Here is what he had to say about something I wrote recently.

“Simon Wren-Lewis also gets the GDP growth data wrong, in a way that makes austerity look worse. He claims that RGDP growth was 2.3% in 2012 and 2.2% in 2013 (the year of austerity in the US.) But that’s annual y-o-y data, and since the austerity began on January 1st 2013, you need Q4 over Q4 data. In fact, RGDP growth in 2012, Q4 over Q4, was only 1.67%, whereas growth in the austerity year of 2013 nearly doubled to 3.13%.”

The italics are mine. When you read that someone got the data wrong, or that they claim the data is whatever, you expect to find that they made an excel error, or used old data. But Sumner is not using ‘wrong’ and ‘claim’ in their ordinary sense. He is in debating mode. What he means is that by choosing to use the (correct) annual data, I’m (accidentally, deliberately?) hiding something important. He then quotes two figures that supposedly prove his case. No analysis, no graphs – it’s a debate.

Well here is a graph of US real government consumption expenditure and gross investment, taken from FRED.

According to Sumner “austerity began on January 1st 2013”. Now look at the graph.

It gets worse. Tyler Cowan quotes from Scott’s post with approval, I guess because the guy shares the faith.

Now do you really want to follow those whose macroeconomics is so faith based that they do not even need to check the numbers? Do you want to follow someone who says (earlier in the post) “it would be useful to do a more systematic study of fiscal austerity”. What about the many studies that have already been done (e.g. here, here or here). Do they not count because they generally find that fiscal policy can matter a lot, and so fail to accord with the faith? Do you want your macroeconomics derived from faith or from careful academic analysis?  

Who is lying about UK budget plans? The OBR test.

Over the next five months you will be told by the Conservatives that Labour’s spending plans will ‘cost billions’, are unaffordable, will put the recovery at risk - I could go on and on. Is there any truth in all this? Well you can read what I and others have written, but that involves looking at lots of numbers which, even if you are an economist or economic journalist, takes time. So here is a very simple reason why you can ignore all these Conservative claims.

Some months ago Ed Balls asked the Chancellor if the OBR, which does all the government’s number crunching, could also look at Labour’s fiscal plans. Now the OBR is independent, and interrogates what the government tells it to make sure it is not being deceived. So they would do the same to Labour’s fiscal plans, if instructed to do so. If Labour’s fiscal plans really are irresponsible, or do not add up, here was an excellent opportunity to expose that using an independent authority.

George Osborne refused Ed Ball’s request. Now Osborne will say that there were various technical issues, and that such a move might damage the OBR’s impartiality, but remember that Osborne is the most political of Chancellors. If he saw a clear way to damage Labour’s economic credibility, do you think he would let such concerns bother him for a second? (The OBR’s equivalent in the Netherlands does this kind of exercise, and the Dutch political debate is much better as a result.) So there really is only one conclusion to draw. Allowing the OBR to cost Labour’s plans would have done Labour more good than harm.

So it really is that easy. Do by all means look at all the numbers (which come to the same conclusion), but if you want a simpler reason to ignore Conservative claims about Labour’s future plans, this is it. The OBR test is clear, compelling and correct. (And any fair minded journalist who reports these Conservative claims should at least note the OBR request and refusal.)

What about the other way around: is what Labour say about Conservative plans just fear mongering? In this case we do have OBR numbers, and they said about existing plans (which exclude Cameron’s conference tax give-away but also any additions to the coalition’s welfare cuts):

“Consistent historical data for RDEL [Departmental Spending] are not available over a long period, but the closest equivalent in the National Accounts implies that by 2019-20 day-to-day spending on public services would be at its lowest level since 2002-03 in real terms (based on whole economy inflation), since 2001-02 in real terms per capita and since the late-1930s as a share of GDP.”

To see what those numbers might mean in practice, let Rick start you off.

Update

At their press conference today where the Conservatives ‘costed’ Labour’s plans, Osborne was twice asked about the OBR refusal. According to the Guardian the first time he did not answer. The second time he said

“The OBR brought in an external reviewer last year. The review concluded that it was not right to let the OBR audit opposition spending plans now. But this can be looked at in the next parliament.”

Balls proposal was first made, and rejected, in October 2013. Kevin Page’s review was not published until nearly a year later, so will not have been the basis of Osborne’s rejection. [1] Osborne’s reply is interesting – he is not rejecting the idea in principle, but just for now. Now it is true that the OBR is relatively young, and would need more resources to do this, but they are reportedly up for the task if asked. So my key point still stands. If the Chancellor really thought that OBR analysis would damage Labour, would he let caution and some small extra costs get in his way?

[1] Here is what Kevin Page’s review actually said:

“Given that the organisational underpinnings of the OBR are in their institutional infancy and are interdependent with a host of government departments and agencies, it is recommended that caution be exercised in considering the expansion of the OBR’s mandate (e.g. costing certification of opposition manifestos). The OBR may not have the organisational capacity to expand its remit without further drawing on the resources of other government departments. In addition, the particularly narrow legal framework of the OBR and its interdependencies with the executive branch may risk creating perceptions of conflicts-of-interest.”

Monetary Impotence in context

Mainly for macroeconomists

There are a significant group of people who think that monetary policy must be the right answer even in a liquidity trap because of the centrality of money in macroeconomics, and because of ‘basic’ ideas like money neutrality. Call them market monetarists if you like. They dislike fiscal stimulus because - in their view - it just has to be second best, or a fudge, compared to monetary policy. Their view is not ideological, but essentially based on macro theory. Now it may not be very relevant to the real world, but for many holding the theoretical high ground is important, because it colours their view of the real world.

That is the group that Paul Krugman has been arguing with recently, and why the point he made in his post yesterday is so critical. It is set in an idealised two period world where Ricardian Equivalence holds, but that is entirely appropriate for the task in hand. If people believe something because of (in their view) basic theory, and you think they are wrong in terms of basic theory, then that is the level on which to argue.

The argument is that in a liquidity trap, when prices are sticky, temporarily expanding the money supply - even if it involves helicopter money (i.e. money financed tax cuts) - will not do anything to get you out of the trap. Another, and more modern, way of saying the money supply increase is temporary is saying that the inflation target is unchanged, so the long run price level is unchanged. (Long run money neutrality does hold in this world.) I will not go through Paul’s argument in detail - I have gone through the same logic before. The basic point is that the temporary increase in money is saved, not spent, because agents know it is temporary. Short run money neutrality does not hold, and not because prices are sticky, but because of Ricardian Equivalence.

It is exactly the same reason why the Pigou effect is no longer discussed. Ricardian Equivalence killed the Pigou effect as a fundamental theoretical idea. If the inflation target is unchanged, when prices fall today the future price level must fall pari passu, reducing the future nominal stock of money. There is no wealth effect. As I noted here, even allowing money to be special in not being redeemable does not get the Pigou effect back, because with irredeemable money any wealth effect comes from the long run stock of money.

Money is not a hot potato in this world. The potato has gone cold because of the liquidity trap, and the money is happily saved to pay the future tax increases that will be required to keep the long run money stock (and price level) constant. 

While in this largely frictionless world money is impotent, additional government spending is a foolproof way of expanding demand. So is raising the long run price level, which means at some point raising the inflation target.

All I really wanted to do in this post was make an observation. The theoretical point that Paul makes depends crucially on thinking in an intertemporal manner, which gives you Ricardian Equivalence. Just as price rigidity kills short run monetary neutrality, so does Ricardian Equivalence in an inflation targeting liquidity trap world. So here is modern microfounded macroeconomic theory providing support to increasing government spending rather than monetary policy in a liquidity trap. Modern theory is not inherently anti-Keynesian. .  

Can we have our instrument back?

This is a rather long post about how one of the instruments of macroeconomic policy has been taken away, and replaced by a fetish about government deficits. It is not technical.

The latest Bank of England forecast has inflation returning to the 2% target by the end of 2017, which is in three years time. That is an unusually long time to be away from target. So what is the MPC proposing to do about this long lapse from target? Absolutely nothing. Tony Yates goes through all the detail, but remains mildly shocked. Much the same thing is happening in the US. In both countries the main discussion point is not what to do about this prolonged target undershoot, but instead when interest rates will rise. Two members of the MPC are voting to raise rates now! [1]

Cue endless discussion about whether the Bank or Fed think Quantitative Easing does not work anymore, or has become too dangerous to use, or whether the target is really asymmetric - 1% is not as bad as 3%. [2] All this is watched by a huge elephant in the room. We have a tried and tested alternative means of getting output and inflation up besides monetary policy, and that is called fiscal policy. We teach students of economics all about it - at length. But in public it has become like the family’s guilty secret that no one wants to talk about.

Once upon a time (in the 1950s, 60s and 70s) governments in the US, UK and elsewhere routinely used both monetary and fiscal policy to manage the economy. Governments did not stop using fiscal policy for this end because it did not work. Instead they found, and economists generally agreed, that when exchange rates were not fixed monetary policy was a rather more practical (and probably more efficient) instrument to use. They certainly did not stop using it because it caused the rise in inflation in the 1970s. That rise in inflation was the result of oil price shocks, combined with in many countries real wage resistance by powerful trade unions, and policy misjudgements involving both monetary and fiscal policy.

When, in the previous paragraph, I wrote ‘economists generally agreed’, I am talking about what could be described as the academic mainstream. However there were also two important minority groups. One, and the less influential, argued that the mainstream was wrong, and fiscal policy was better than monetary policy at stabilising demand. The other, often among those labelled monetarist, not only took the opposite view, but had a deep dislike of using fiscal policy. For example, many believed its use would be abused by politicians to increase the size of the state (and almost all in this group wanted a smaller state). For some there was the ultimate fear that politicians would run amok with their spending, which would force central banks to print money, leading to hyperinflation - we can call this fear of fiscal dominance. However, as I noted above, the rise in global inflation in the 1970s was not an example of fiscal dominance. I shall use the label ultra-monetarist for this second group: ultra, because it is not clear Friedman himself would be among this group.

These minorities aside, the mainstream consensus was that monetary policy was the instrument of choice for managing demand and inflation, but that fiscal policy was always there as a backstop. So, when Japan suffered a major financial crisis and entered a liquidity trap (interest rates fell to their Zero Lower Bound (ZLB)), the government used expansionary fiscal policy as a means of moderating the recession’s impact. At the time the results seemed disappointing, but following the experience of the Great Recession Japan’s performance in the 1990s does not look so bad.

The key event that would eventually change things was the creation of the Euro. For countries within the Eurozone, monetary policy was set at the union level, so to control demand within each country fiscal policy was the only instrument left. Unfortunately the influence of ultra-monetarists within Germany had always been very strong, and for various reasons the architecture of the Eurozone was heavily influenced by Germany. This architecture essentially ignored the potential use of the fiscal instrument. Instead the influence of monetarism led to what can best be described as deficit fetishism - an insistence that budget deficits should be constrained whatever the circumstances.

Within the Eurozone individual governments no longer had their own central banks who could in extremis print money. The worry among the ultra-monetarists who helped design the Eurozone architecture was that some rogue union members would force fiscal dominance on the union as a whole, so they put together fiscal rules that limited the size of budget deficits. This was both unnecessary, and a mistake. It was unnecessary because the Eurozone set up a completely independent central bank, and made fiscal dominance of that Bank illegal. It was a mistake because it completely ignored the issue of demand stabilisation for countries within the Eurozone - in practice it either took away the fiscal instrument (in a recession) or discouraged its use (in a boom [3]).

While the design of the Eurozone reflected the obsessions of ultra-monetarists within Germany, in the rest of the world the academic mainstream prevailed. So when the financial crisis hit, and interest rates fell to the ZLB across the globe, governments in the UK and US again used fiscal stimulus as a backup instrument to moderate the recession. The IMF, normally advocates of fiscal rectitude, concurred. The policy worked. But two groups were not happy. The ultra-monetarists of course, but also many politicians on the right, whose main aim was to see a smaller state, and who saw deficit reduction as a means to achieve that goal. Both groups began to warn of the dangers of rising government debt, which was rising mainly because of the recession, but also because of fiscal stimulus where that had been enacted.

What happened next was that the Eurozone struck back, although not in a calculated way. It turned out that it did contain just the kind of rogue state the architects had worried about: Greece. The fiscal rules failed to prevent excessive Greek government borrowing. Did this lead to fiscal dominance and hyperinflation in the Eurozone? - of course not, for reasons I have already given. But it did lead governments in the Eurozone to make a fatal mistake. What should have happened, and always does happen to governments that borrow too much in a currency they cannot print, is that Greece should have immediately defaulted on its debt. But instead Greece was initially encouraged to borrow from other Eurozone governments, perhaps because some countries worried that default might lead to contagion (the market would turn on other countries), but perhaps also because default would have hit commercial banks in the larger Eurozone countries who owned this Greek debt.

Eventually contagion happened anyway, and Greece was forced into partial default, although not until it had taken the poison of loans from other Eurozone countries which were conditional on crippling austerity. Equally important was the impact that Greece had on the use of fiscal policy in the rest of the world. Those ultra-monetarists and right wing politicians that had been warning of a government debt crisis used the example of the Eurozone to say that this proved them right. Many (but not all) economists in the mainstream began to believe it was time to reverse the fiscal stimulus, as did the IMF. 

From that point on, the idea that you could - and when monetary policy became ineffective should - use fiscal policy to stimulate the economy became lost. Even in 2009 it had been a difficult policy to sell publicly: why should government be increasing debt at a time that consumers and firms had to reduce their own debt? For those who had not done an undergraduate economics course (which included most political journalists), politicians of the right who said that governments should act like prudent housewives appeared to be talking sense. Greece and the subsequent Eurozone crisis just seemed to confirm this view. Deficit fetishism became pervasive.

Of course this about turn was just what both ultra-monetarists and politicians on the right wanted. The focus on government debt had an additional advantage in certain influential quarters. What had started out as a crisis caused by inadequate regulation of the financial sector began to appear as a crisis of the government’s making, which if you worked in the financial sector which had just benefited from a massive public subsidy was a bit of a relief. You could be really cynical, and say that austerity made room for another big financial bailout when the next financial crisis hit. 

But those with a more objective perspective watched the years after 2010 unfold with growing concern. There were no government debt crises in the major economies outside the Eurozone - instead interest rates on government debt fell to record lows. The market appeared desperate to lend governments money. The debt crisis was confined to the Eurozone. However austerity within the Eurozone, undertaken across the board and not just in the crisis economies, did nothing to end the crisis. The crisis only ended when the ECB offered to back the debt of the crisis countries. The offer alone was enough to halt the crisis, and interest rates on periphery country debt started to fall substantially. But austerity’s damage had been done, creating a second Eurozone recession. The fiscal policy instrument works, even when you use it in the wrong direction! Austerity delayed the UK’s recovery, and while growth was solid in the US, austerity there too meant that the ground lost as a result of the recession was not regained.

So those with a more objective perspective, including many in the IMF, began to realise the fiscal policy reversal in 2010 had been a big mistake. The world had been unduly influenced by the rather special circumstances of the Eurozone. Furthermore within the Eurozone the crisis that austerity had meant to solve had actually been solved by the actions of the ECB. It began to look as if austerity - in perhaps a milder form - had only been required in a few periphery Eurozone countries.

All this should have meant another policy switch, at least to end fiscal austerity and perhaps to return to fiscal stimulus. But deficit fetishism had taken hold. This was partly because it suited powerful political interests, but it was also because it had become the pervasive view within the media, a media that liked a simple story that ‘made sense’ to ordinary people. Politicians who appeared to deviate from the new ‘mediamacro consensus’ of deficit fetishism suffered as a consequence.

So as 2014 ends, we have at best an incomplete recovery and inflation below targets, yet central banks are either not doing enough, or have given up doing anything at all. A huge amount of ink is spilt about this. But if central banks really do believe there is nothing much they can do, with a very few exceptions they fail to say the obvious, which is that it is time to use that other instrument, or at least to stop using it in the wrong direction. Perhaps they think to say this would be ‘too political’. The media in the UK and US continue to obsess about government deficits, even though it is now clear to almost everyone with any expertise that there is no chance of a government funding crisis, so the obsession is completely misplaced. Within the Eurozone deficit fetishism has achieved the status of law!

There are some who say we cannot use the fiscal instrument to help the recovery, and get inflation on target, because debt will become a problem in 30 years time. It is as if a runner, who normally gets their fuel from eating carbohydrates but has run out of energy in mid-race, is denied a food with sugar (HT Peter Dorman) because a high sugar diet is bad for you in the long term. Others in the Eurozone say we must stick to the rules, because rules must be kept. But rules that create recessions with no compensating benefits are bad rules, and should be changed. Rule makers can make mistakes, and should learn from these mistakes. [4] It is perfectly possible to design rules that both ensure long term fiscal discipline, but which do not throw away the fiscal instrument when it is needed.

So every time someone writes something about what monetary policy could or should do to get inflation back to target, they should say at the outset that this goal could be achieved - in a more assured way - by a more expansionary fiscal policy. Political journalists who presume that more borrowing must be bad should get a severe telling off from their economist colleagues. For one thing that should now be clear is that rising debt since the recession has done no harm, but austerity policies that tried to tackle rising debt have done considerable damage. The 2010 Eurozone crisis was a false alarm. Macroeconomics needs to get its fiscal instrument back, and deficit fetishism has to end, but this is being prevented by an alliance between the political right, the ultra-monetarists, and I’m afraid the media itself.

[1] In the UK there is a certain irony here. When inflation was above target in 2010-13, most of the MPC was brave enough to avoid raising rates. Although they forecast that inflation would come back to 2% within two years, this forecast was met with considerable skepticism. Three members of the MPC in 2011 voted to follow their ECB colleagues and raise rates. Perhaps as a result, the Treasury wrote a paper in 2013 which said that on occasions like that (when inflation was above target in a recession) the MPC could be a little more relaxed about the speed at which inflation returned to target. The irony is that this latitude is being used (abused?) now, when inflation is below target and we are still recovering from a recession.

[2] Maybe in the US the target is asymmetrical - but shouldn’t be - but in the UK it is symmetric by law.

[3] In a boom, when fiscal policy should have been contractionary, budget deficits were low as a result of the boom, so the rules suggested no action was required.

[4] Equally those that lent money when they should not have lent money have to accept that they made a mistake.