Thursday, 24 April 2014

When economics students rebel

I read the Manchester Post-Crash Economics Society’s (PCES) critique of economics education in the UK with a bewildering mixture of emotions. (Claire Jones has a short FT summary here.) It is eloquently and intelligently written, but I believe in some respects fundamentally misguided. It is indicative of a failure of mainstream economics education, but not (as it thinks) a failure of mainstream economics. Yet even after all these years, it is a position I can empathise with.

At its heart the critique is an appeal for plurality in economics. Rather than pretend that there is one right way to do economics (what the critique calls neoclassical), the critique says we should recognise that there are many alternative perspectives which have significant worth (and which therefore undergraduates should have significant exposure to). These alternative perspectives have become marginalised within economics over the last few decades, and the critique suggests that the financial crisis is evidence that this process should be reversed. This is not an unusual complaint, and I hear it frequently from those working in other social sciences.

Let me first say what I agree with here. Students should certainly be shown something of heterodox (non-mainstream) thought. I’d like to think that if we taught economics to undergraduates as a more problem solving discipline, with less emphasis on its axiomatic/deductive structure, that would become easier. We should certainly get more economic history in there, and again that would be easier with a problem solving approach.

What I disagree with strongly is that the current dominance of mainstream economics should be reversed, and that we should go back to ‘schools of thought’ economics. There are three reasons for this.

●     Of course mainstream theory can be conservative. It has been used by some to support a particular ideology. I complain a lot about both. But the most important reason mainstream economics has become dominant is not because of these things, but because it has proved far more useful than all of its heterodox alternatives put together. I agree with Roger Farmer here: economics is a science. Its response to data and events may be slow compared to the normal sciences, for obvious reasons, but it is progressive. I cannot see any fundamental barriers to its continuing development.

●     This is because mainstream economics can be remarkably flexible. One of the sad things about the way economics is often taught is that students do not see much of the interesting stuff that is going on in both micro and macro, and instead just learn what the discipline looked like 50 years ago.

Let me give one example. Students get taught that under perfect competition the wage is equal to the marginal product of labour. If that was all there was to say, then you might indeed believe that economics was just a means of excusing current levels of executive pay or arguing against the minimum wage. But instead it is just the start of what economics has to say. Read Alan Manning, who argues that because firms generally set wages and changing jobs is costly, monopsony is the more relevant default model. Read the Piketty et al paper I referenced here which talks about rent seeking by executives, and how cutting top rates of tax encouraged this rent seeking. These are powerful and effective critiques of marginal productivity theory.

●     At first reading, heterodox writers can seem like a breath of fresh air, because they are more holistic and often less formalist. But while many complain, with some justice, that mainstream economics can be resistant of radical ideas, I have personally found at least as much intolerance on the other side. Some heterodox economists appear to reject almost everything that is mainstream, which is frankly just silly. 

I think there may be a particular problem for students who are exercised by what they see as economic injustices around them. Economics in its studied neutrality can appear indifferent to that. It is natural for those who take an anti-establishment, left wing view to react to this perceived indifference by asking for revolution rather than evolution, by looking for a new paradigm. Perhaps those on the right, who may be happier with the status quo, find it easier to work within the mainstream, and use it to their own advantage. Yet any discipline where a utilitarian view is routine, and where diminishing marginal utility is standard, can hardly be described as inherently biased towards the status quo.

I think it is true that economics as a discipline has tried too hard to emphasise that it is an objective, politically neutral discipline, thereby underplaying value judgements when it makes them. Worse still, sometimes heavily value laden ideas like the importance of Pareto optimality are portrayed as being value neutral, which is clearly nonsense (see above). Yet the idea that it should be possible to build a science of human behaviour which is independent of ideology or politics is a noble ideal, and one which has been partly achieved. We may need (and are getting) more political economy, in the sense of recognising that economics works alongside and interacts with social and political forces, but I do not think we need more partisan economics. 

Let me get personal. Over the last few years, I have been in charge of a macroeconomics course at Oxford. For better or worse, if past evidence is anything to go by, one or two of those taking this course will end up helping run the economy. There is so much important mainstream theory that needs to be covered in that course, because it is theory that is essential to trying to understand what is currently going on in the world. At its core is Keynesian theory, which has proved its worth since the recession. (Interest rates didn’t rise because of all that government debt, inflation didn’t take off because of all the money that has been created, and austerity did delay the recovery.) It would be a great step backwards if I had to stop teaching part of that, and instead teach Austrian or Marxian views about the macroeconomy, or still worse spend time worrying about what Keynes really meant. I would much rather a future Chancellor, Prime Minister, or advisor to either, remembered from their undergraduate degree that mainstream theory said austerity was contractionary, rather than ‘well it all depends on whether you are a Keynesian or an Austrian’.

None of this implies that there are not large gaps in the discipline, large elements that will not stand the test of time, and that there is much still to be done. But I agree with Diane Coyle (about economics, if not DSGE) that “the Naked Emperor needs to be reclothed rather than dethroned”. New ideas could perhaps come from heterodox thought, although I suspect that they are more likely to come from other social science disciplines. But they will be developed within the mainstream, leading to the evolution of mainstream thought. If students want to change the world, I think they are much more likely to do this by working within mainstream economics than heterodox thought.

Tuesday, 22 April 2014

Targeting wage inflation

I was pleased to see that David Blanchflower and Adam Posen have advocated using wage inflation as an intermediate target in their analysis of labour market slack in the US. Specifically they say

“Our results also point towards using wage inflation as an additional intermediate target for monetary policy by the FOMC, paralleling on the real activity side the de facto inflation targets on the price stability side.”

I have periodically argued for wage inflation targets in the case of the UK, but both their and my arguments are universal.

My own argument for targeting wage inflation has been a combination of theory and practicality. As I have often pointed out, there are good theoretical arguments for targeting alternative measures of inflation besides consumer prices. The way macroeconomists usually measure the cost of inflation nowadays is to score the distortion to relative prices created by the combination of general inflation and the fact that different prices are set at different times. The ‘ideal’ price index to target would be one that gave a higher weight to prices that changed infrequently, and a low weight to those that were changed often. Wages are just another price in this context, and they are changed infrequently.

The practical argument is that if we had been targeting wage inflation over the last few years, monetary policy would have worried less about the temporary inflation induced by shocks such as commodity price increases or sales taxes. Here is a chart of recent and expected wage inflation (compensation per employee) from the OECD. 

In normal times we would expect 2% price inflation to be associated with something like 4% wage inflation because of productivity growth. Wage inflation has not come close to that number in recent years in the UK, US or the Eurozone. It is difficult to see how the ECB could have raised interest rates in 2011 - as they did - if they had had wage inflation as an intermediate target.

The argument put forward by Blanchflower and Posen is rather different, because they associate wage inflation with the real side of the dual mandate in the US. To quote:

“wage inflation should be considered as the primary target of FOMC policy with respect to the employment stabilization side of the Fed’s dual mandate, at least for now. Unlike unemployment, the rate of wage inflation requires less judgment and is subject to less distortion by such factors as inactivity. At least four of the labor markets measures that Yellen cites as worth monitoring- unemployment, under-employment of part-timers, long-term unemployment, and participation rate- reveal their non-structural component by their influence on wage growth. And that is what the Fed should be trying to stabilize along with prices.”

To paraphrase, unemployment (or anything similar) can become distorted as a measure of labour market slack, but wage inflation is a good indicator of the true state of the labour market.

I would add one final point. The spectre that seems to haunt central bankers is the inflation of the 1970s. That has to be avoided at all costs. Yet the 1970s was associated with what was called a wage-price spiral: both price inflation and wage inflation rising rapidly, and a feeling that this was a contest between workers and firms that neither could win, but where society was a loser. If we want to avoid a wage-price spiral happening again, it is only logical that we look at wages as well as prices.

The Banks and Austerity: a simple story of the last ten years

There are probably a number of reasons why bank leverage (the amount of lending banks do in proportion to their capital) increased rapidly in the 00s: reduced regulation, underestimation of systemic risk as a result of the Great Moderation, a search for yield when interest rates were low, simple greed. Bank profits rose, and so did the incomes of those working for them. However the consequence of excessive leverage was inevitable: a major global financial crisis. Banks had to be bailed out using public funds.

This produced a large negative demand shock which monetary policy was not able to counteract, because nominal interest rates fell to zero. In the US and UK governments undertook substantial fiscal stimulus to dampen the recession, but this, the recession and bank bailouts raised levels of public debt. As Reinhart and Rogoff show, credit booms and bust generally lead to public debt crises.

In recent research Alan Taylor and co-authors go further. They show that recessions are deeper and more prolonged if they are accompanied by a financial crisis, they are deeper and longer still if that financial crisis is preceded by a credit boom, and finally “the path of recovery is worse still when a credit-fueled crisis coincides with elevated public debt levels”.

Yet we need to be careful to avoid seeing some kind of inevitability here. For a start, following this recession there was no public debt crisis outside of the Eurozone. There was widespread concern about debt, which led to fiscal contraction, but no crisis. Prompt action that avoided a crisis, some would say. But we should be suspicious here. As Paul Krugman notes, this concern about debt was largely down to “the influence of the Very Serious People, whose views on economics tend in turn to be driven largely by the financial industry”. This financial industry got some of its economics seriously wrong, as Krugman notes here. I’ve also suggested that there may be self interest at play: finance needed to change the story from bank regulation. Even more cynically big banks needed lower debt levels to make their next bailout credible, so it could carry on enjoying high wages via an implicit subsidy. So, outside the Eurozone, was concern about debt real, imagined or manufactured?

In the Eurozone there was a debt crisis. Everyone agrees the Greek government had overspent. But this crisis could have been resolved fairly quickly, if the Greek government had immediately defaulted on its debt, and the ECB had offered unlimited support for other solvent governments. However Greek default would have led to large losses for European banks, and possibly created a second financial crisis. As a result, default was initially resisted in Greece (to allow banks time to minimise the damage) and avoided elsewhere, and instead draconian austerity policies were imposed in the Eurozone periphery.

In a very direct sense, banks created austerity in the Eurozone. If that sounds like an outlandish conspiracy theory to you, here is Philippe Legrain, former advisor to the European Commission President:

“The primary cause of the crisis was the reckless lending of German and French banks (both directly and through local banks) to Spanish and Irish homeowners, Portuguese consumers and the Greek government. But by insisting that Greek, Irish, Portuguese and Spanish taxpayers pay in full for those banks’ mistakes, Chancellor Angela Merkel’s government and its handmaidens in Brussels have systematically privileged the interests of German and French banks over those of euro zone citizens.”

Furthermore we know the political influence of the banks is huge: here I talk about the US and UK, but it seems unlikely that this does not also apply to the Eurozone. So in the Eurozone we had a second recession, which was the direct result of austerity. Eventually the ECB agreed to (in principle) provide unlimited support to solvent Eurozone governments, but not before austerity had been hardwired in the form of a new fiscal compact. Changes in bank regulation have fallen far short of what is required to avoid another crisis, as banks warned that increasing regulation would restrict their ability to lend, and therefore prolong the recession. The earnings of bank employees quickly recovered and resumed their rapid rise (see here, or here).

Rather than seeing the financial crisis and austerity as two essentially separate stories, the needs and influence of the banks connect the two. Now there are many things missing from this story that I am sure are important, such as opportunism from those who wanted a smaller state. However one rather neat feature of this account is that it requires very few ‘exogenous shocks’. Indeed you could even argue that something like Greece was bound to happen somewhere, and so even this was endogenous to the story. As Mark Blyth writes, “what starts with the banks ends with the banks”.

Monday, 21 April 2014

House prices and secular stagnation

This post starts off talking about the UK, but then goes global

We are all used to seeing graphs of house price to income ratios. Here is Nationwide’s first time buyer house price to earnings ratio for the UK and London.

UK First time buyer house prices relative to earnings: source Nationwide

Housing is becoming more and more unaffordable for first time buyers. Yet prices are currently booming (at least in London), and demand is so high estate agents are apparently now holding mass viewings to cope. In the UK the media now routinely call this a bubble, and the term ‘super bubble’ is now being used. London may be a bit unusual (see this extraordinary research), but it can also be a leading indicator for UK prices in general.

Bubbles are where prices move further and further away from their fundamental value, simply because everyone expects prices to continue to rise. One of the earliest and most famous bubbles involved tulip bulbs in the Netherlands in 1637. Yet that bubble lasted less than a year. The dot-com bubble lasted two or three years. If you think there should be some underlying constant value for the house price to income ratio, then this UK housing bubble has been going on for much longer than that. Instead of being pricked by the 2009 recession, it merely seems to have paused for breath. 

Yet does it make sense to compare house prices (the price of an asset) to average earnings or incomes? A more natural ratio would be the ratio of rents (the price of consuming housing) to earnings, and this has been relatively stable over this period. Or to put the same point another way, the ratio of house prices to rents has shown a similar pattern to the ratio of house prices to incomes shown above. (The Economist has a nice resource which shows this, and covers all the major countries besides the UK.)

If we think of housing as an asset, then the total return to this asset if you held it forever is the weighted sum of all future rents, where you value rents today more than rents in the future. Economists call this the discounted sum of rents. (If you are a homeowner, it is the rent that you are avoiding paying.) So why would house prices go up, if rents were roughly constant and were expected to remain so? The answer is that prices would go up if the rate at which you discounted the future fell. The relevant discount rate here is the real interest rate on alternative assets. That interest rate has indeed fallen over much the same time period as house prices have increased, as Chapter 3 of the IMF’s World Economic Outlook for March 2014 documents.

Think of it this way. You believe that the return you get from owning a house (the rent you get or save paying) will be roughly constant in real terms. However the return you get on other assets, measured by the real interest rate, is falling. So housing becomes more attractive as an asset. So more people buy houses, and arbitrage will mean its price will rise until the rate of return on housing assets adjusts down towards the lower rate of return on other assets. As Steve Nickell pointed out in 2004, if the expected risk free real interest rate permanently fell from, say, 4% to 2%, this could raise real house prices by 67%.

It is the expected return on other assets that matters here. The fact that actual real interest rates have fallen in the past would not matter much if they were expected to recover quickly. A key idea behind today’s discussion of secular stagnation is that real interest rates might stay pretty low for a long period of time. That in turn implies that house prices will be much higher relative to incomes than they were when real interest rates were higher.

So what appears to be a bubble may instead be a symptom of secular stagnation. We can make the same point by looking at another measure of affordability, again provided by Nationwide.

UK First time buyer mortgage payments as a percentage of mean disposable income: source Nationwide

First time buyers are able to afford elevated house prices, because interest rates on mortgages are so low. Of course raising the deposit is a problem, but the government’s Help to Buy scheme has come to the rescue by effectively restoring the 95% mortgage that disappeared in the recession.

Secular stagnation is a global idea, so if this story is right then we should see similar patterns abroad. Using the Economist as a guide, I think we can split countries into three groups. The first group is the UK, France (which looks very much like the UK!), Belgium, Italy, Sweden, Canada, Australia and New Zealand. There the house price to income ratio rose sharply in the 2000s, and has stayed high. The second group is the US, Denmark, Ireland, Netherlands and Spain, which also show large increases in the 2000s, but where post-recession declines have been so large as to actually wipe out (or come close to wiping out) these gains. For these countries it could be a bubble, or it could be an underlying rise temporarily offset by the impact of the recession. The third group is Germany and Switzerland (and maybe Austria), where the ratio has been falling over time, but has picked up over the last five years. There is one outlier, Japan, where the ratio has been falling since 1990. In a nutshell, the data is not clearly consistent with the secular stagnation story but does not clearly reject it either (ever thus!)

Does this mean we should stop calling what is happening in the UK a bubble? The first point is that secular stagnation is just an idea, and it may prove wrong, and if it does house prices may come tumbling down. Second, even if it is not wrong, it is still possible to have a bubble on top of the increase implied by lower interest rates. Indeed one of the concerns about the lower real interest rates associated with secular stagnation is that, by raising asset prices not just in housing but elsewhere, it may encourage bubbles to develop on top. So all we can say with certainty, for the UK at least, is that the Financial Policy Committee will have their work cut out when they next meet in June.   

Saturday, 19 April 2014

Misunderstanding macroeconomic models

The first half of this post is meant for non-economists, but it ends with a couple of points on OLG modelling

I recently wrote a post on the Eggertsson and Mehrotra paper on secular stagnation, because I thought the paper was interesting. A much more critical post from Unlearning Economics (UE) has just appeared in Pieria. UE says it “helps to illustrate the troubles faced by contemporary macroeconomics”. One of UE’s complaints seems to reflect a misunderstanding, often shared by non-economists, about what much academic macromodelling is designed to do.

UE objects to the fact that the model assumes that the amount the young can borrow (the degree of leverage) is exogenous, which means that there is no attempt to explain where this constraint on the borrowing of the young comes from. UE also complains that the model contains no banks, and no investment in physical capital. In other words, the model is much too simple. It is a natural enough idea: to explain what might be currently going on, you need a more complex model that includes everything that could be important.

There is certainly a place for this kind of more elaborate model. Christiano, Eichenbaum and Trabandt in this paper want to argue that a model based on New Keynesian theory can track what has happened over the last ten years. Their model has 40 equations. If I was trying to do a similar exercise, I would want to augment the standard New Keynesian framework with at least the following: nominal wage stickiness as well as price stickiness, a financial sector that endogenised both the cost and rationing of credit, a model of consumption which allowed for credit constraints and precautionary saving, a housing market, a model of the labour market that combined matching with rationing (as here), and something that allowed recessions to have long lasting (hysteretic) impacts on labour supply and technical progress. However large models like this will involve many macroeconomic ‘mechanisms’, and it will generally be unclear which mechanisms are important at driving particular results or explaining particular facts. We do not want to treat the elaborate model as a black box, but instead we want to understand its properties.

To understand complex models, we need much simpler models. (I once - in this paper - called the process of relating complex models to simpler models ‘theoretical deconstruction’.) In fact it is often sensible to start with the simpler model. For example, a particular issue with secular stagnation is to show how the natural real interest rate can be negative for decades rather than years (i.e. beyond the Keynesian short term)? What mechanism can do this? As I explained in my post, neither a standard representative agent model nor a standard two period overlapping generations model (OLG model, where the two generations are those earning and those retired) will give you that result. What Eggertsson and Mehrotra show is that a very simple three period OLG model (which adds a young generation that borrows) where borrowing by the young is constrained (they would like to borrow more but cannot) can provide just that mechanism.

That is a key point of the paper. The paper is not designed to explain where borrowing constraints come from: there is now a big literature on that. Thankfully the authors do not feel compelled to microfound these constraints. Instead the paper simply offers and explores a mechanism whereby an increase in these borrowing constraints could move the natural interest rate into negative territory, and for it to stay there. Having established that result, it is for subsequent work (which the authors intend to do) to see if that mechanism survives complicating the model, by for example adding investment.

Suppose the endeavour is successful, and a more complex but realistic model is able to provide an account of secular stagnation that includes other important mechanisms and which is based on a realistic set of parameter values. That would be a success, but those not familiar with all the work would ask: why does this model allow real interest rates to be negative when the standard models we know do not. The reply would be that the three period OLG structure was critical, and to see why have a look at the original, simple model.

Now you might say the authors should wait until they have built the more realistic model before creating what could turn out to be a research path that might fail to achieve its goal. That would be quite wrong, because the more debate there is within the academic community when ideas are at their early stages the better. I want to give an example of this, but here I will go into territory that will probably only interest macroeconomists.

It might be the case, for example, that the authors intuition that their results will survive introducing other assets like physical capital can be shown to be wrong very quickly. Indeed, Nick Rowe has already made such a claim, arguing that the presence of land as an asset ensures a positive real interest rate. If Nick was right this could be enough to kill the research programme, without any more time being wasted. Whether he is right is another matter: this paper by Rhee may be relevant in that respect.

Here I just want to add a final thought. Within an OLG framework, it may not be necessary to establish the existence of a steady state with negative real interest rates. The typical period in an OLG model lasts two or more decades. So if the dynamics of such a model involved some overshooting, it might be possible to generate prolonged periods (in years) of negative interest rates even if the steady state real interest rate was positive. To be honest I’m not sure what might give rise to overshooting of this kind, but that may just reflect my inadequate imagination.  

Thursday, 17 April 2014

Abusing economic analysis: UK Treasury edition

For US readers, this is about the misuse of dynamic scoring in analysing tax changes

Ask most people if they think a particular tax - like fuel duty - should be reduced, and they will say yes. If you ask people do you think income taxes should be raised to pay for a cut in fuel duty, you will get a rather different response. So just asking people if they would like one particular tax to be cut without saying how it will be paid for is pretty meaningless. Unless of course your aim is to provide ‘evidence’ that taxes are too high, and you are not too worried about the nature of that evidence.

There is a slightly more sophisticated version of this trick, and the UK Treasury have just played it. Each individual tax potentially distorts the pattern of economic activity. If that pattern without any taxes is near some ideal, then we can call taxes ‘distortionary’. If we taxed apples and used this money to subsidise the production of pears, people would eat too many pears and not enough apples. However there is one tax that is not distortionary, because it does not influence incentives and therefore this pattern of economic activity. It is a poll tax - a tax levied on each individual independent of their income, wealth or what they spend their money on. Economists call this a lump sum tax. So cutting any distortionary tax, and paying for this by raising a poll tax, is bound to produce beneficial results in terms of reducing distortions.

There is only one problem with paying for a particular tax cut by raising a lump sum tax - in the UK we do not have a poll tax. We did very briefly - it was not very popular, because people care about fairness as well as the distortionary impact of taxes. For this reason, you should not expect to find a government department like the Treasury modelling the benefits of cutting fuel duty by assuming it was paid for by raising a poll tax. Unfortunately, that is exactly what has been done in a Treasury/HMRC report released this week

George Osborne is not planning to reintroduce a poll tax - veneration of a past Conservative Prime Minister would not go that far. I think the argument the Treasury would use to justify what they have done is simplicity. If you pay for a cut in fuel duty by, say, raising income taxes, you have to model the impact of two taxes on economic behaviour rather than just one. I don’t think that is a very good excuse, but even if we think it has some validity it has a direct implication: an individual study of this kind is meaningless on its own. It can only be used in conjunction with other studies that look at the impact of raising other taxes. Will Treasury officials therefore stop their masters using the numbers from this exercise to justify cuts in fuel duty? No prizes for guessing the answer. (They might if they could but they don’t have that degree of influence.)

So what could have been the beginning of an intelligent discussion of the costs and benefits of particular taxes (as in the Mirrlees review, for example) has been turned into a simple propaganda exercise.

Unfortunately it gets worse. Fuel duty is particularly ‘distortionary’ because its rate is high (see Chart 2.1 of the Treasury paper). There might be a good reason for that. The tax could be high because it is trying to offset damage that is not prevented by the market: road congestion, pollution and of course climate change. In terms of the language of economics it is (at least in part) a Pigouvian tax designed to offset externalities. In that case the tax is not distortionary at all: a world without fuel tax would not be ideal, and imposing a fuel tax gets us nearer that ideal. As Chart 3.1 from the paper indicates, these beneficial impacts of fuel duty are not modelled by the Treasury’s CGE model. (This is why, as John McDermott notes, this kind of partial dynamic modelling tends to be attractive to right wing outfits. Is it significant that the paper does not actually include the words ‘climate change’, and just uses the vaguer term environmental damage?)

So what the Treasury have done is modelled all the benefits of cutting the tax, but ignored all the costs. If this was but one stage in a process that would subsequently look at the cost of these externalities, and would realistically model how these tax cuts were paid for, fine. As a stand alone exercise, I’m afraid the Treasury study is worthless.

As Chris Giles notes in an excellent report, this is really part of a political exercise to build the case for tax cuts. It has two unfortunate side effects. First, it just encourages the suspicion among many that anything coming out of the UK Treasury at the moment is worthless propaganda. Second, it encourages those on the left who think that mainstream economics is inherently biased. But if you saw an opinion poll that asked people if they thought a particular tax was too high, without also asking what tax they would increase to balance the books, you would not say that this shows opinion polls are inherently biased. Instead you would just conclude that the person commissioning the poll had a political agenda. You might also ask whether the polling company should have accepted the commission.

Tuesday, 15 April 2014

Inequality, inheritance tax and the UK election battleground

In an earlier post I sketched out what I thought would be the essential macroeconomic battleground for the forthcoming (2015) general election.

●    The Conservatives would lead on austerity and growth. In May 2012 I suggested the line: “Austerity laid the foundation for our current growth, so we need to stick with it to ensure growth continues”, and the Chancellor has certainly followed my advice! Having linked austerity and growth, the Conservatives will go on to claim that only they can be trusted to deliver more austerity, and therefore continued growth.

●    Labour, on the other hand, will lead on how living standards have stagnated over the last five years, which current growth is unlikely to change before the election. Having offered the Chancellor some spin in May 2012, in that post I thought it was only fair to offer something to the opposition, which was this chart.

This is all nonsense of course. Osborne’s claim is Orwellian: austerity was not necessary for achieving growth, but actually delayed it. In Labour’s case we have no idea what lies behind the productivity collapse which is the main factor behind the chart above, so ascribing it all to government policy is a bit heroic. Having said that, the more the Chancellor tries to claim credit for employment growth, the more he opens the government up to the idea that they are responsible for the decline in living standards.

For those who are tired of this focus on traditional macroeconomics, there may be some better news. One additional element in the battleground to come might be the issue of inequality, but only if Labour chooses to fight on this ground. The reason is that the Conservatives have signalled that they will reprise their ambition to raise the exemption threshold for inheritance tax from £325,000 up to £1m.

President Obama has said that inequality is the “defining challenge of our time”. Thomas Piketty's “Capital in the Twenty-first Century” emphasises the importance that concentrated wealth is likely to play in increasing this inequality if it is allowed to be transmitted across generations. Inheritance taxes are clearly central to all that. So the Conservative proposal to raise the inheritance tax threshold is in effect saying that they do not regard increasing inequality as a problem.

Will Labour respond by raising the issue of inequality? They have been reluctant to do this in the past, which seems paradoxical. One of the reasons for this paradox that I speculated on here was a view that to be elected Labour has to have some backing from the business sector. This position was recently outlined by Alan Milburn (former Labour cabinet minister) in this FT article. “Labour cannot afford a rerun of the 2010 election campaign, when not a single major corporation was prepared to endorse it. Overcoming that …. will need Labour to embrace a more avowedly pro-business agenda and match it with a more overtly pro-business tone.” He goes on: “Being a “One Nation” party means governing in the interests of all sections of society, better and worse-off alike. Reintroducing a 50p higher income tax rate does not match that objective.” There we have Labour’s dilemma in a nutshell. Taking action to reduce inequality is seen as anti-business, and it is argued that Labour cannot win without some business sector support.

So I read with interest a piece by Ed Balls in the Guardian today. There he majors on the cost of living, but there is just a hint of something more: “the ongoing cost of living crisis is deeper and broader than one or two sets of figures. It's about whether most people on middle and lower incomes see their real earnings grow in line with the growth in the economy.” But inequality is not mentioned once, and fairness is only mentioned in the context of “balancing the books”.

This is hardly raising inequality as a “defining challenge of our time”. Does this reflect a genuine difference between the left on either side of the pond, or simply that Obama is in power and Ed Balls is not? If it is the latter, is Labour right to fear that going strong on inequality would lose them the election? Let me end with some encouragement from an unlikely source. A recent Financial Times leader argued that
“ratcheting up the IHT threshold to £1m cannot be justified at present. Making this promise is good pre-election Conservative politics. Implementing it in these austere times would be socially unjust.”
They make a number of important points. Even if thresholds remain unchanged, and despite high house prices, the OBR estimate that just 10% of estates will be liable to pay any tax at all. Implementing the £1 million threshold would cost the Treasury more than £3bn, which in times of austerity is money that could be better used elsewhere. And finally they say that redistribution is vital if inequality is not to be exacerbated. When the FT starts worrying about inequality, perhaps this is after all a battle that Labour can win.