Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday, 21 October 2016

Neoliberalism and austerity

I like to treat neoliberalism not as some kind of coherent political philosophy, but more as a set of interconnected ideas that have become commonplace in much of our discourse. That the private sector entrepreneur is the wealth creator, and the state typically just gets in their way. That what is good for business is good for the economy, even when it increases monopoly power or involves rent seeking. Interference in business or the market, by governments or unions, is always bad. And so on. As long as these ideas describe the dominant ideology, no one needs to call themselves neoliberal.

I do not think austerity could have happened on the scale that it did without this dominance of this neoliberal ethos. Mark Blyth has described austerity as the biggest bait and switch in history. It took two forms. In one the financial crisis, caused by an under regulated financial sector lending too much, led to bank bailouts that increased public sector debt. This leads to an outcry about public debt, rather than the financial sector. In the other the financial crisis causes a deep recession which - as it always does - creates a large budget deficit. Spending like drunken sailors goes the cry, we must have austerity now.

In both cases the nature of what was going on was pretty obvious to anyone who bothered to find out the facts. That so few did so, which meant that the media largely went with the austerity narrative, can be partly explained by a neoliberal ethos. Having spent years seeing the big banks lauded as wealth creating titans, it was difficult for many to comprehend that their basic business model was fundamentally flawed and required a huge implicit state subsidy. On the other hand they found it much easier to imagine that past minor indiscretions by governments were the cause of a full blown debt crisis.

You might point out that austerity was popular, but then so was bashing bankers. We got austerity in spades, while bankers at worst got lightly tapped. You could say that the Eurozone crisis was pivotal, but this would be to ignore two key facts. The first is that austerity plans were already well laid on the political right in both the UK and US before that crisis. The second is that the Eurozone crisis went beyond Greece because the ECB failed to act as every central bank should: as a sovereign lender of last resort. It changed its mind two years later, but I do not think it is overly cynical to say that this delay was partly strategic. Furthermore the Greek crisis was made far worse than it should have been because politicians used bailouts to Greece as a cover to support their own fragile banks. Another form of bait and switch.

While in this sense austerity might have been a useful distraction from the problems with neoliberalism made clear by the financial crisis, I think a more important political motive was that it appeared to enable the more rapid accomplishment of a key neoliberal goal: shrinking the state. It is no coincidence that austerity typically involved cuts in spending rather than higher taxes: the imagined imperative to cut the deficit was used as a cover to cut government spending. I call it deficit deceit. In that sense too austerity goes naturally with neoliberalism.

All this suggests that neoliberalism made 2010 austerity more likely to happen, but I do not think you can go further and suggest that austerity was somehow bound to happen because it was necessary to the ‘neoliberal project’. For a start, as I said at the beginning, I do not see neoliberalism in those functionalist terms. But more fundamentally, I can imagine governments of the right not going down the austerity path because they understood the damage it would do. Austerity is partly a problem created by ideology, but it also reflects incompetent governments that failed to listen to good economic advice.

An interesting question is whether the same applies to right wing governments in the UK and US that used immigration/race as a tactic for winning power. We now know for sure, with both Brexit and Trump, how destructive and dangerous that tactic can be. As even the neoliberal fantasists who voted Leave are finding out, Brexit is a major setback for neoliberalism. Not only is it directly bad for business, it involves (for both trade and migration) a large increase in bureaucratic interference in market processes. To the extent she wants to take us back to the 1950s, Theresa May’s brand of conservatism may be very different from Margaret Thatcher’s neoliberal philosophy.

Wednesday, 19 October 2016

News, entertainment and Trump

There seem to be two types of media outlets in both the UK and US. There are those who push a clear right wing political agenda to those who would rather read about celebrities or sport: the Daily Mail or Sun in the UK and Fox News in the US. As President Obama said, if I watched Fox News even I wouldn’t vote for me. And then there is the non-partisan media. What values drive their coverage of political events?

I was thinking about this after reading a comprehensive account by Thomas Patterson of the media’s role in the rise of Donald Trump, based on research by the Harvard Kennedy School’s Shorenstein Center. The basic story is that the media gave Trump far more coverage than other candidates in the crucial pre-primary period. Furthermore, contrary to popular myth, this was not just the cable news channels, but also papers like the New York Times and Washington Post. The rise of Donald Trump owes a great deal to this bias in media coverage.

The other remarkable thing about this excess coverage, even among the established newspapers, is that it was favourable. The term ‘favourable’ needs decoding in this context. What seems to happen involves a two stage process. First, Trump simply gets attention by saying outrageous things. Once his poll ratings start to rise as a result of this publicity, he is talked about in a positive way because he is gaining popularity.

Journalists in the non-partisan media bend over backwards not to express personal views on policy or character. What they do instead is treat political contests as a horse race. It is all about who is up or down, who is rising and falling. On top of that views are expressed on why some candidates are doing better than others. Those who are winning generally require explanations in terms of positive virtues: hence the favourable treatment of Trump. Few journalists dare say that Trump is gaining popularity because a large section of the population is racist!

In other words, Trump played on conventional, non-partisan news values and won big time. He was great entertainment at first, and after that got him noticed he became the news because the additional news coverage helped increase his poll ratings. That news was favourable because his poll numbers were rising. In case you think this could only happen for someone on the right, according to this research the second part of the dynamic was even more true for Bernie Sanders. The candidate who really suffered was Clinton.

That the media should play such a large role in allowing someone like Donald Trump to get so close to the White House should be a big concern for those working in the media. The free press is supposed to help safeguard democracy from quasi-fascists, not make it easier for them to come to power! I wonder if part of the problem is that the non-partisan media is also mixing politics and entertainment. As talking about policy is not entertaining for most, particularly if it has to be done in a ‘balanced’ way, it is more attractive to the non-partisan media to treat politics like sport. I cannot help feeling that if in a real horse race it was shown that the commentary on the race had an influence on the outcome, something would be done to change that very quickly indeed.

Monday, 17 October 2016

Structural Reforms and Greece

Should the Troika - the Eurogroup, ECB and IMF - be concerned about how bread is sold in Greece? You would think they had more important things to worry about, like getting Greece out of the huge recession caused by their own policies. But no, you would be wrong. The Troika decided that standards specifying the weights that loaves could be sold at were a restrictive regulation, and demanded change.

This is one of the examples Joe Stiglitz quotes in his new book on the Euro, which I review in the New Statesman here. Now you might agree that at the very least this represents a misdirection of the Troika’s energies, and more generally that it involves unwanted interference in national sovereignty. But in Joe Stiglitz you have one of the best economists in the world, so he also tells you that there is a long-standing economics literature on how regulations like these can increase competition because they facilitate comparison shopping.

Stiglitz is very critical of many other ‘structural reforms’ that were imposed on Greece by the Troika. The only structural reforms that it might have made sense for the Troika to suggest were measures that would have moved resources into exports, thereby helping an external demand led recovery (see Ireland or Spain). As I note, even here Troika meddling may have had undesirable consequences.

As I said in a recent post, a little knowledge can be a dangerous thing. But of the three parts of the Troika, the IMF ought to have the knowledge to do better. (The ECB has apparently just created a task force to consider economic reforms.) Over 1,500 economists work at the Fund. Whether that knowledge gets to the right people at the right time is another matter. But I suspect the main problem at the fund is politics rather than economics. I have written about this recently, in the context of an Independent Evaluation Office report on the IMF’s Troika role. Here is a more substantive piece by Edwin Truman at the Peterson Institute in a similar spirit.

Greece is currently trapped in a debtor's prison created by the Troika. The Troika insist that debts have to be repaid. The IMF knows the prisoner does not have the ability to do this, but does not have the political will to demand that as a result the prisoner should be released. Debt repayment requires yet more austerity, which kills the chance of the recovery, so even with austerity debts are not repaid. Some debt forgiveness is probably in the interests of everyone, including the creditors, because after a recovery Greece will be in a much better position to pay any remaining debts. But it is politically unattractive for the creditors, so it does not happen.

This is a disaster for Greece, but a bad omen for Brexit. Those who advocated Leave say it is in the Eurozone's interests to agree favorable trading terms with the UK. To do otherwise would be to sacrifice economic interests to make a political point. The obvious irony of course is that this is exactly what Brexit was: sacrificing economic interests to make a political point. But Brexiteers want to believe, in their topsy turvy way, that European leaders would not be as reckless as they are. Greece is an example of how Europe's political leaders can also discard economic logic if it is in their own political interest to do so. 

Friday, 14 October 2016

Brexit and Sterling

Is the Brexit induced decline in Sterling a blessing in disguise? So argues Ashoka Mody, and to a lesser extent Paul Krugman. Their basic argument is that Brexit will hit the City, and it is the City that has created an unbalanced economy and an overvalued currency. Reducing the size of the financial sector is a necessary condition to rebalancing the economy, and Brexit can achieve this.

Ashoka Mody’s disdain for the City is absolutely clear. He writes: “The banking-property complex has been a parasite on the British economy, creating pathologies of financial vulnerability and exchange rate overvaluation.” We can see the overvaluation in the large UK current account deficit. Paul Krugman is less pejorative. The City is just an important UK exporter that Brexit will cut down to size, so we will need to make other UK exporters more competitive to fill the gap.

Neither author disagrees that, because the depreciation of Sterling will raise import prices (in economic speak it will lead to a deterioration in the terms of trade), people in the UK will be poorer. But there is also a difference in mechanisms between the two authors, which has implications for how you view this effect. For Mody the City has caused Sterling to be temporarily overvalued as a result of a “finance-property bubble”. As this is a temporary effect (bubble), sterling was bound to fall at some point anyway. As a result, Brexit has only brought forward the day that UK citizens became poorer.

Krugman on the other hand does not argue that sterling was overvalued in this sense: the City is just an important export industry that will particularly suffer from Brexit. As a result, Brexit does make the average citizen poorer permanently. But he notes that, to the extent that this depreciation also results in a redistribution from the City to more dispersed manufacturing, it might benefit some of the parts of the UK that heavily voted for Brexit.

There is nothing wrong with the logic of both arguments, as you would expect given the authors. The key question is whether they are empirically appropriate in this case. I have argued, prior to Brexit, that Sterling was overvalued, and it also seems that the IMF agrees as well. The key issue is why it was overvalued. If the reason for the overvaluation was something Brexit has ‘cured’, then Brexit has indeed ended that overvaluation. If Brexit has not taken away the reason for overvaluation, then the correction to that overvaluation has still to come.

Paul Krugman’s logic is closer to the one I have also used in arguing that the Brexit depreciation is a result of Brexit making it more difficult for UK industry to export. The twist Paul applies is a distributional one: rather than Brexit making it more difficult to export across the board, it hits one particular industry, allowing other industries to grow. Once again the key issue is whether Brexit does have this distributional effect, hitting the City harder than UK manufacturing.

Suppose there is something in what both authors suggest. I would make a very basic point. If we wanted to cut the City down to size, we didn’t have to achieve this using Brexit. We could instead have imposed much stronger regulations on the UK financial sector (basically higher capital requirements), and watch some of the industry leave in disgust. That way we would have avoided all the additional costs that Brexit will impose (recently restated by the Treasury, but only now considered ‘news’ by the Times), and with the additional benefit of having a financial sector that was not too big to fail. My fear is that after Brexit the opposite will happen: policymakers will go even easier on City regulation in an effort to make up for the damage Brexit will do. So I’m still finding it hard to see any silver lining in the Brexit decision.

Thursday, 13 October 2016

Did the Bank of England cause Brexit?

Suppose that by the mid-2000s, immigration from the EU (and the potential for additional immigration) had led to an important shift in the UK labour market. The possibility of bringing labour from overseas meant that old relationships between the tightness of labour market and wage increases no longer held.

You might think that was bad for workers, but that is not so. It would mean what economists call the natural rate of unemployment (or NAIRU) has fallen. Unemployment can be lower without leading to wage increases that threaten the inflation target, because workers fear that the employer can resort to finding much cheaper overseas labour. It reduces the power of workers in the labour market, but also leads to overall benefits. (This is just an example of the standard result that reducing monopoly power is socially beneficial.)

But it is only good news if the Bank of England recognises the change. If they do not, we get stagnant wage growth and unemployment higher than it need be. The obvious response is that the Bank will know there has been a change because wages will start falling faster than they would expect based on previous relationships. However that effect may be masked by the well documented employee and employer reluctance to actually cut nominal wages. Add in the shock of the financial crisis, and this change in the way the labour market works might well be missed.

Here is the big leap. Suppose the above had happened, and the Bank of England did not miss the change. Monetary policy would have been much more expansionary, bringing unemployment well below the 5% mark. Nominal wage growth would have been stronger, and a buoyant labour market would have generated a feel good factor among workers. With more vacancies and less unemployment, concerns about immigration would have begun to fade. The Brexit vote would still have been close, but would have gone the other way.

You may say how could monetary policy be more expansionary given how close we are to the Zero Lower Bound? If that was the case the Bank should have said they were out of ammunition, and placed responsibility with the government and austerity. But for the last two years at least, the Bank could have cut interest rates and has not. You could blame the relentless expectation in the media and financial sector that rates would increase, but the Bank should be able to rise above that.

Of course the Brexit blame game is easy to play when the vote was so tight. The most speculative aspect of this chain of thought is the initial premise about a shift in the NAIRU created by immigration potential. While the possibility makes sense, whether the data backs it up is much less clear. Yet there is some evidence of a structural shift in the UK labour market in the mid-2000s, as Paul Gregg and Steve Machin report.    

Tuesday, 11 October 2016

Ricardian Equivalence, benchmark models, and academics response to the financial crisis

Mainly for economists

In his further thoughts on DSGE models (or perhaps his response to those who took up his first thoughts), Olivier Blanchard says the following:
“For conditional forecasting, i.e. to look for example at the effects of changes in policy, more structural models are needed, but they must fit the data closely and do not need to be religious about micro foundations.”

He suggests that there is wide agreement about the above. I certainly agree, but I’m not sure most academic macroeconomists do. I think they might say that policy analysis done by academics should involve microfounded models. Microfounded models are, by definition, religious about microfoundations and do not fit the data closely. Academics are taught in grad school that all other models are flawed because of the Lucas critique, an argument which assumes that your microfounded model is correctly specified.

It is not only academics who think policy has to be done using microfounded models. The core model used by the Bank of England is a microfounded DSGE model. So even in this policy making institution, their core model does not conform to Blanchard’s prescription. (Yes, I know they have lots of other models, but still. The Fed is closer to Blanchard than the Bank.)

Let me be more specific. The core macromodel that many academics would write down involves two key behavioural relationships: a Phillips curve and an IS curve. The IS curve is purely forward looking: consumption depends on expected future consumption. It is derived from an infinitely lived representative consumer, which means Ricardian Equivalence holds in this model. As a result, in this benchmark model Ricardian Equivalence also holds. [1]

Ricardian Equivalence means that a bond financed tax cut (which will be followed by tax increases) has no impact on consumption or output. One stylised empirical fact that has been confirmed by study after study is that consumers do spend quite a large proportion of any tax cut. That they should do so is not some deep mystery, but may be traced back to the assumption that the intertemporal consumer is never credit constrained. In that particular sense academics’ core model does not fit Blanchard’s prescription that it should ‘“fit the data closely”.

Does this core model influence the way some academics think about policy? I have written how mainstream macroeconomics neglected before the financial crisis the importance that shifting credit conditions had on consumption, and speculated that this neglect owed something to the insistence on microfoundations. That links the methodology macroeconomists use, or more accurately their belief that other methodologies are unworthy, to policy failures (or at least inadequacy) associated with that crisis and its aftermath.

I wonder if the benchmark model also contributed to a resistance among many (not a majority, but a significant minority) to using fiscal stimulus when interest rates hit their lower bound. In the benchmark model increases in public spending still raise output, but some economists do worry about wasteful expenditures. For these economists tax cuts, particularly if aimed at those who are non-Ricardian, should be an attractive alternative means of stimulus, but if your benchmark model says they will have no effect, I wonder whether this (consciously or unconsciously) biases you against such measures.

In my view, the benchmark models that academic macroeconomists carry round in their head should be exactly the kind Blanchard describes: aggregate equations which are consistent with the data, and which may or may not be consistent with current microfoundations. They are the ‘useful models’ that Blanchard talked about in his graduate textbook with Stan Fischer, although then they were confined to chapter 10! These core models should be under constant challenge from both partial equilibrium analysis, estimation in all its forms and analysis using microfoundations. But when push comes to shove, policy analysis should be done with models that are the best we have at meeting all those challenges, and not models with consistent microfoundations.

[1] Recognising this point, some might add some ‘rule of thumb’ consumers into the model. This is fine, as long as you do not continue to think the model is microfounded. If these rule of thumb consumers spend all their income because of credit constraints, what happens when these constraints are expected to last for more than the next period? Does the model correctly predict what would happen to consumption if the proportion of rule of thumb consumers changes? It does not.  

Saturday, 8 October 2016

Very Serious People and the deficit

I'm glad Paul Krugman liked my General Theory of Austerity paper. But he wonders whether I might be missing something, in not explaining why Very Serious People (VSPs) in the US, or mediamacro in the UK, presume that deficit reduction is always a good thing. The constant call for deficit reduction seems to transcends party politics, and furthermore should be something that the wise always promote.

I do talk about the influence of the City/Wall Street and central banks, but perhaps there is something in addition which I talked about in a recent post: deficit bias. 
Keynes talked about 'practical men' who tended to absorb some of the wisdom of 'academic scribblers' of 'a few years back'. The wisdom in this case was deficit bias: the tendency that many economists discussed before the financial crisis for deficits and debt to tend to rise over time, across cycles.  Perhaps VSPs and mediamacro have absorbed this particular area of academic analysis?

I think you can tell a similar story about academic scribbling of years past when it comes to the roles of monetary and fiscal policy. In the UK George Osborne argued explicitly that the economic consensus was now that monetary policy should deal with stabilising output and inflation, while fiscal policy makers should look after their own deficit. I have called this the consensus assignment. If he, or his advisors, absorbed this piece of conventional wisdom, so may VSPs and mediamacro.

So the headline academic scribbling was governments should control deficits, not the economy, and they are bad at it. Some of the theories put forward to explain deficit bias involve politicians knowingly deceiving voters by pretending tax cuts or spending designed to capture votes were 'affordable', and relying on general lack of understanding of the government finances to not be found out. That gives VSPs and the media more generally a clear role in providing a public service to help counteract the wickedness of politicians. VSPs might even think it was their public duty to constantly advocate deficit reduction to counter deficit bias.

As they say, a little knowledge can be a dangerous thing. Those of us working on the front line of monetary and fiscal interaction, or who had studied economic history or looked at the lost decade in Japan, knew the conventional assignment broke down when interest rates hit their lower bound. We knew that a liquidity trap was absolutely not the time to worry about deficits, and if you did so you would cause tremendous damage. And we were right.

So if you believe this story, the lesson for VSPs and mediamacro is you really need to talk to economists in the front line more often.