Some Keynes personal history you might not have read yet

This post following exchanges on Twitter this morning.  It’s a link to a piece written by Ariadne Birnberg.

It’s family-unit self-promotion, since Ari is my wife.  But relevant to the general theme of this blog, as it recounts the story of her grandmother, Naomi Bentwich, who typed up ‘The Economic Consequences of the Peace’ for Keynes.

Brief sketch:  While working for him she became convinced he was in love with her.  Was dispensed with after confronting him with this.  And, seemingly, lived on with this delusion, divining messages in his journalism, and driven to write her own autobiography about her and Keynes after being interviewed by Roy Harrod, who was writing his own Keynes biography.

Here’s the article:  Most Beautiful Maynard.
[Link corrected from earlier draft].

 

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More tax collection now in Greece isn’t so great!

I just had an email conversation with Greek macroeconomist Evi Pappa who is a Professor at EUI in Florence. 

She made a point about tax collection that I had, for some reason, not grasped, even though it’s blindingly obvious.

Right now, in the throes of an aggregate demand death spiral, cranking up tax collection on the mass of the population is not going to help.  Because it’s an increase in taxes!  [That’s the mental leap I made today!]  And will depress aggregate demand still further.  And, since they are in a single currency, there will be no compensating monetary policy loosening for them.

In the longer term, tax evasion is obviously vital to sort out.  But if that task has to be begun right now, the best thing would be to cut tax rates so that increased tax collection did not mean higher tax revenues.   In fact, in the short-term, cutting tax rates might actually help spread the custom of collecting and paying taxes more widely.  If think of tax evasion as a costly activity, then we might expect that, without changing the costs of tax evasion, cutting tax rates would lower the returns to tax evasion, and, hence increase taxes paid.  [h/t Pontus Rendahl at Cambridge for pointing this second rather basic point out to me].

Of course, a lot of Syriza’s rhetorical focus on this has been about extracting more revenues from the rich and super-rich.  Extracting that money would not depress demand much, because those individuals tend to have very low propensities to consume out of marginal income.  But if that can’t be done without the collateral damage imposed by much wider tax collection on the weight of lower and middle-income individuals, then better to postpone until the trajectory of the economy is more certain.

But try telling this to Greek’s creditors.

And we can make similar arguments about G.  That’s government spending.  The pensions and civil servant salaries that are the focus of so much outrage are the Greeks digging Keynesian holes and filling them.  And whatever the rights and wrongs of those payments six months ago, they are more needed now than before.

There’s an irony in the fact that the way the argument has played out between Syriza and the Eurogroup, which has led to renewed recession in Greece, and flight from Greek banks, has actually taken what is optimal from a politics-free perspective further away from what is politically feasible.

If there were no issues about sovereignty, moral hazard, tit for tat, credibility, etc, the best thing now would be for a much more generous package in the short-term, to counter the recession, relative to the situation last Summer.  However, Syriza’s own tactics, the ‘do what I say or I will blow my own brains out’ strategy, and Eurogroup’s probable increased scepticism about the Greek’s capacity to stick to conditions that would go along with any deal, mean that what they are prepared to offer is probably not more generous than before, and perhaps harsher.

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Conserving Keynes

Paul Krugman swats aside my naive plea for a New Keynesian consensus on fiscal policy, suggesting that conservatives have always been opposed to Keynes.  But I stand by it.  I think our Conservatives [UK, big C] were tethered by those views.  Else why be so gentle, 2010-2015 and now?  Not all of them, for sure.  There’s audible commentary complaining that the job was only half-done.  The job being deficit reduction.

And if we go back further in history, say to the post-war period, there was essentially a consensus about Keynesian demand-management.  In my view this was never really ditched, either, in the 1970s and 1980s.  It’s just that we came to understand the inflation process better, how to do monetary policy and fiscal policy together.  There are some notable contradictions to this view, of course, like the March 1981 Geoffrey Howe budget that prompted the 364 economists letter.  But, later on in that period of Tory hegemony, there were Keynesian flavours.  Nigel Lawson, despite believing that low-taxes/small state was good for long-run growth, also knew that cutting taxes was stimulative in the short run, and would help them get elected.

Actually, I think I’ll stop there.  After all – applying one of the lessons of the initial exchange here to myself – I’m not a historian and should stick to economics.

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Austerian empirical macro wars

Niall Ferguson’s FT Op-Ed has sparked more rounds of artillery fire in the empirical macro wars over what can and cannot be read into the effects of austerity in the UK.  I come at this debate from the relatively more ‘Austerian’ position [compared to Krugman, Portes and Wren-Lewis], having been supportive of the initial 2010-2011 phase of Coalition fiscal policy.  But I don’t see anything to approve of in Ferguson’s attempt to declare victory for George Osborne.

I’m not sure what one can prove by looking at one short episode so informally as this.  A few points. [Many repeated from my ‘Luck of the Austerians’ post].

First, taking the totality of empirical macro and macro theory on the impact of fiscal shocks, the weight of evidence is greatly in favour of what Ferguson and others are calling ‘Keynesian’.  Which is that an experimental yank of the fiscal tiller to tighten it will contract the economy, temporarily.  How much is uncertain.  That this obtains for all levels of initial debt is dubious.  But I’m pretty sure that the UK is/was in the region where fiscal tightness could not have been expansionary.

Observing that the UK eventually started growing again after a few years of shrinking deficits doesn’t tilt this weight of evidence.  Indeed, as others have pointed out, what we saw is entirely consistent with the consensus view that fiscal shocks are temporarily contractionary.  (If I were lecturing my MSc macro lot, I would also tick them off for making no proper attempt to identify fiscal shocks – what was alluded to by the ‘experimental yank at the fiscal tiller’ phrase above.  But that is for another post.)

Some were undoubtedly predicting that the economy would enter a death-spiral of ever greater deficits following austerity.  We haven’t seen such a death-spiral.  But that this hasn’t happened doesn’t disprove that that was a consideration worth weighing in the menu of policy options.  [In fact, I’m sure it did weigh on policymakers minds, else the medicine would have been doled out in harsher doses].

Monetary policy was, if you were a sceptic about new-fangled quantitative easing (as I was), already maxed out in March 2009.  It was perfectly reasonable to worry about losing control of the economy.  We had watched this very thing happen in Japan already.

And, let us not forget, this is not over.  Interest rates are trapped at the zero bound six years later.  David Miles, soon to depart the MPC, will almost certainly depart never having voted for or implemented a rate rise.   Although growth has recovered, most concede now that the UK will never retrace anywhere close to the roughly 15% gap between output per head now and where it might have been had it continued growing at its long run trend extrapolated through pre-crisis output.  My central view is that fiscal policy won’t be judged to be responsible for that calamity, but there are plausible hysteresis arguments that it is/was that can’t be dismissed with rhetoric alone.

So, even the death-spiral argument, outlandish as it might seem to economic conservatives, is alive and kicking.

Niall replied on Twitter that finding ourselves at the zero bound is a consequence of the financial crisis, and happened regardless of fiscal stimulus.  True enough.  But that doesn’t rebut the argument that the stimulus [the initial tolerance of increasing deficits] was necessary, nor that rates have remained more firmly and persistently pinned to the zero bound in the UK than they would have had fiscal policy been looser subsequently.

Niall’s piece reads to me more like an instinctive, political defence of those he sees as his own team.  If that’s the case, it’s disappointing that the debate has become a left-right thing.  I don’t see why it should.  A pretty hard-nosed and dispassionate reading of the modern consensus macro model [for all its flaws] and how to do time series econometrics gets you to a position where Niall’s arguments fall apart.  And my sense is that the Osborne-Treasury view is much closer, in private, to the view I have articulated here, than Niall’s.   They know fiscal retrenchment is contractionary.  That’s why it was gradual, and is still planned to be.  Because the pain had to be smoothed if this and the subsequent elections were not to be lost.

NF settles on the catchphrase that the Labour Party’s defeat can be blamed on Keynes.  But actually the Coalition’s strategy was undoubtedly constrained by Keynesianism, and this served them well.

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A small bit of macro, post-election-post-mortem

So, UK voters opted for redoubled deficit reduction while we are still trapped at the zero bound, followed by a spurt of spending towards the end of the next Parliament.

I would have voted for the opposite, [although no-one was offering that to me].  Ie a splurge now, followed by a protracted period of deficit reduction and subsequent surpluses, when monetary policy could safely accommodate them.  It was depressing to watch the whole of the campaign go by without this basic idea getting much of an airing.

If the natural rate shock that the UK is facing proves to be shallow and temporary from here on, then this won’t be ideal, but it might not be disastrous either.  Or, regardless, if as the over-confident Bank of England say, their unconventional tools are strong and fast-acting enough to compensate, it won’t matter what the Conservatives decide to do.

Of course, since the 2010 Plan A was abandoned mid-course, despite it being explained (and described after its abandonment) as a ‘deficit-reduction-come-what-may’ plan, sensible observers would factor in a fair chance that 2015 Plan A will also be abandoned if it does not go well.  If it this comes to pass, we might hope that this time the demand-boost that would normally accompany abandonment would not be foregone by trying to pretend that the harsh medicine was continuing, as happened last time under the discipline of political priorities. (The priority being to make sure that the Coalition did not appear to have lost the argument).

Although we have single-party government again, this is only a superficial difference.  The Conservatives are a tense and fragile coalition.  And I would guess that there was every bit as much chance of wavering rebels tilting fiscal policy in the direction of easing, especially in those UKIP constituencies that are going to be hardest hit by cuts to spending and transfers.

 

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More on John Taylor vs Bernanke

John Taylor has published Wall St Journal Piece rounding on Bernanke’s blog.  Some new points and some points repeated follow….

JT claims that the Taylor Rule emerged from ‘two decades of research on optimal policy’.  I think it’s important that John does not allow this to be read by WSJ readers, who might not have encountered any of the actual research, as ‘after two decades, we figured out that the Taylor Rule was optimal policy’.  Because that would not be right.

As I wrote in my last John Taylor piece, Taylor Rules do a pretty good job, in a narrow range of DSGE models, but they fall short of optimal policy even there.  Moreover, it’s worth re-emphasising just how much the financial crisis ought to shake our faith in this pre-crisis research, which almost exclusively ignored banking and finance.  We have no idea, really, in model terms, how Taylor Rules do in a financial crisis.  There’s an inkling that models that progress is made by augmenting TRs with a term in spreads, a modification that can take the presciption a long way from the original.  But given our lack of confidence in the tools we have so far to articulate crises [most of them don’t and can’t articulate crises], this is only an inkling.

Even if we leave aside the banking and finance problem, there were some interesting connundrums that JT’s one sentence research summary leaves out.  For example, if you take a modern macro model and work out what is the optimal Taylor Rule – tune the coefficients so that they maximise social welfare, properly defined in model terms, you will get very large coefficients on the term in inflation.  Perhaps an order of magnitude greater than JT’s.  This same result is manifest in ‘pure’ optimal policies, where we don’t try to calculate the best Taylor Rule, but we calculate the best interest rate scheme in general.  In such a model, interest rates are ludicrously volatile.  This lead to the common practice of including terms in interest rate volatility in the criterion function that we used to judge policy.  Doing that dials down interest rate volatility.  Or, in the exercise where we try to find the best Taylor Rule, it dials down the inflation coefficient to something reasonable.  This pointed to a huge disconnect between what the models were suggesting should happen, and what central banks were actually doing to tame inflation [and what John Taylor was saying they should do].  JT points out that most agree that the response to inflation should be greater than one for one.  But should it be less than 20?  Without an entirely arbitary term penalising interest rate volatility, it’s possible to get that answer.

JT recommends in his WSJ article that rather than flipping to quantitative easing, central banks adopt a ‘fixed money growth rule’.  WSJ readers might well like the sound of that.  Because it has a ring of ‘sound money’ about it.

But those working in monetary policy research would be perplexed to hear such a rule recommended.  What does it even mean, anyhow?  If we were in a situation where there was a pure liquidity trap, with interest rates not only at but expected to be zero indefinitely, we know [from the same models JT invokes to support his other cases] that money growth at whatever level has no effect on anything.  Flipping to a fixed or variable rate money growth rule does nothing at all.  Suppose, differently, we are in a situation of a temporary liquidity trap, where interest rates are expected to be positive again after a period of time.  Presumably, JT, the master of interest rate rules, would like policy to resume adherence to the rule when later possible.  In which case, the amount of money growth induced while at the zero bound is irrelevant.  It only becomes relevant if the central bank, when conditions allow rates to lift off the zero bound, is expected to accommodate the extra money in terms of rates being lower than the TR prescription by the mount required by the nature of money demand.  So money growth does something only if we make a credible commitment to ditch the Taylor Rule later.  JT isn’t advocating that.  What is he advocating?  I am mystified.

JT also makes reference to the idea that the zero bound is not a problem for the Taylor Rule.   He has stated this a few times.  He refers to a 2000 paper by Reifschneider and Williams which offers ‘a rules-based approach to deal with the problem’.  This reference is perplexing.  The zero bound cannot be overcome by anything suggested in that paper.  It’s a constraint, and policy has to live with it as best it can.  If the natural rate falls to 7 or 8 percentage points below zero [a common guess in central bank circles in the heat of the crisis] some pre-crisis tinkers to the Taylor rule cannot ‘deal with’ this problem.  Moreover, it deserves repeating that undue adherence to the Taylor Rule has been shown  to open up the possibility of entering self-fulfilling traps at the zero bound.  This could be just a theoretical curioso.  But, to the extent that it is – to the extent that the model in which it occurs fails us – we should also regard the research advocating Taylor rules as a curioso too.

Let me return, finally, to the matter of the coefficient on the Taylor Rule, which JT says we can agree should be greater than 1.  This really captures the sense in which for JT monetary policy design is done and dusted.  Well, I don’t think things are like that any more.  As I wrote before, John Cochrane explains that the equilibrium selection that is going on in rational expectations studies of alternative Taylor Rules may be a load of nonsense.  What is JT’s position on that?  Williamson, Wright and others think that the model of money in the background (of the model JT has in mind when he invokes the >1 coefficient result) is a load of nonsense.   And then there’s the issue of how sticky prices are modelled.  And heterogeneity….

Really, we are nowhere near agreeing that anything like the Taylor Rule is optimal policy.  The crisis, and wave after wave of powerful critiques from other strands of mainstream macro, but outside the policy rule research agenda have revealed that these old received wisdoms are much less useful than we thought.

 

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Macpherson’s constitutional reforms continue

A quick one to note this Civil Service blog by Nick Macpherson, a review of a William Keegan book, and mentioned in a Tweet recently by Danny Blanchflower.

Danny picked it up to point out that this blog excuses Labour from causing the financial crisis.  This is actually not a particularly controversial thing to say in open economic discourse.  But it has become politically controversial as both the Conservatives and the Lib-Dems [wrongly, and hamfistedly] try to lay responsibility for the crisis at Labour’s door in their campaign to badge themselves as reliable fixers.

And this makes the blog an extraordinary thing.  Another instance of a senior civil servant sticking a neck out and taking ownership of a piece of advice or intellectual contribution.

It’s in the same vein, though less dramatic, as Nick Macpherson’s letter covering the Treasury analysis of currency options in the event of Scotland opting for independence, which revealed that he advised parties to the decision not to allow an independent Scotland to continue to participate in a currency union.

On that occasion, it was asserted that Nick’s intervention was justified because the break-up of the Union was an existential threat.  And somehow different therefore from all previous policy issues, on which it was proper for Macpherson to advise in private.  I found this logic to be a non-sequitur, simply on the grounds that there was no previously established and openly declared policy on personal interventions like this.  One can argue that the currency question bore on an existential threat to the Union.  But why did it follow that the civil service could be commanded, or take it upon itself to appoint one of its members to speak out?  And also presumably not to act on the behest of other parties representing groups of taxpayers, like the SNP?

On this occasion, there is no existential threat.  But Nick anyway speaks out.  I happen to agree with all that he says.  But is it right to speak out like this?  Where will it all end?  My instincts are that we should have more of it, since the UK is a small country and there is a shortage of credible and sensible reflections on economic affairs.  But if this is not done in an orderly and constituted way there are risks.  The next Government might look at Nick’s blog and think:  ‘if this is going to go on we must make sure the next Perm Sec is ONE OF US’, and we move inexorably to a politicised civil service along the lines of the US.

 

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