George Osborne and fellow Conservatives are attempting – seemingly with success – to run the argument that the fact that the economy is now growing quickly proves that their austerity policy was the right one. The message gets pumped out by the Tory Party, and everyone that wishes them well. For example, I subscribe to tweets from an old Bank of England colleague Tim Montgomerie, now Times columnist and influential thinker on the right, and this is one of his staple retweets. Although the silliness has been countered already by others, it seems appropriate to fight repetitive twaddle with repetition. And while I’m at it, it’s worth recapping on the multiple mistakes made since the Coalition took over.
Modern macro theory suggests that economies will eventually return to growth unless governments kept contracting fiscal policy. The Coalition’s plan involved a slow reduction in fiscal drag. This reduction in drag has contributed to the return to growth. That growth proves nothing about what the ideal path of fiscal policy was beforehand. It does disprove any claim that austerity would lead with certainty to a vicious cycle of ever higher deficits and ever greater recession. But no-one ever made such a claim. Some of Ed Balls’ interventions alluded to there being a risk of such a vicious cycle. This was understandable, because arguably that’s what the Euro peripheral countries are going through. But that this was a risk then is not disproved by it not materializing later. Even my six year old boy understands that just because he threw a double six in a game of Snakes and Ladders doesn’t disprove that there was a risk he could have got a double one. By taking this tactic, Osborne presumes and then exploits the public’s lack of understanding about risk and uncertainty. It’s highly undignified for an incumbent Government that they choose to debase current economic debate with their rhetoric on the recovery, though rather standard practice in UK and seemingly US politics [the Scottish Independence question, and the debt-ceiling fights being two cases in point].
Contrary to what the Government has been saying, the overwhelming evidence is that fiscal contractions reduce growth, at least temporarily. This is true in the workhorse model of monetary and fiscal policy (The sticky price New Keynesian model). And it’s true in various empirical studies, where care is taken to identify autonomous shocks to fiscal policy. The effect is presumed to be more marked when interest rates are at their zero bound, so long as you think that unconventional monetary policy instruments either cannot, will not, or should not be loosened to compensate for the conjectured fiscal tightening. The overdue return to growth of the UK economy is entirely consistent with this evidence.
The Coalition went wrong at the outset. They started out by declaring their Plan A and stating that they would commit to it come what may. This was silly and incredible. Obviously there were some circumstances that would prompt a shift to a plan B. It’s just that the Coalition would not tell us. It was macho bluster, aimed at sharpening the political difference between themselves and an irresponsible Labour (according to their caricature, anyway) and at the markets, who they feared might run from UK government banks and bonds. And so circumstances proved: as the Institute for Fiscal Studies have pointed out, and Simon Wren Lewis has highlighted in his blog, the Coalition did switch to a plan B, and then some, in fact adjusting its deficit targets at least twice.
This fake certainty was a second blow to the cause of promoting good understanding of risk and uncertainty in economics and policymaking. It plays to a view amongst some policymakers and the media that any sign that you don’t know precisely what the right thing to do is indicates weakness or incompetence. The reality was that there was a genuine debate about the fiscal risks at that time, and about the consequences for the economy of the austerity plan. Contrast the bluster surrounding the bogus ‘Plan A’ no turning back stuff with the much more rational, if occasionally maddening, continual hedging by the Bank of England.
The Coalition hoped to paint itsef as the new party of fiscal responsibility (eg by setting up the new Office for Budget Responsibility). But instead history seems to be repeating itself. Initially irrationally straitjacketed fiscal policy when there is no need to worry about the polls with a view to saving money for a pre-election splurge. And in the process cementing the reputation of the UK for fiscal obsfucation.
Personally, I took seriously the worries that markets may have dubbed us a Greece or an Ireland in May 2010. It was possible that the combination of political uncertainty and the uncertainty about the fiscal strain caused by a possible need for a second capital injection into UK banks could have provoked a run on UK bonds. Others seemed not to worry about this, on the grounds that we had our own currency. My position was that being able to print our currency at will to plug a fiscal hole caused by our failing banks did not constitute an insurance that we or markets would feel solves the problem, or provides a sufficiently comfortable route out. Money printing in those circumstances would be default through more gradual means and lead to great economic costs itself. However, once the risk of such a meltdown abated, much looser fiscal policy could have been contemplated, and indeed such a contingent loosening could have been promised at the outset by government. This might have lifted confidence without frightening financial markets. As it turned out, inflation ended up high and stable. And I judged that to be a sign that loosening beyond the Plan B/C Osborne chose was not necessary. (It would have boosted output, but probably just at the expense of higher inflation, and arguably inflation was high enough above target). However, it would have been better to build the Plan B/C that was followed into the original, contingent on markets deciding that the Coalition was stable, and that either no further bail-out was needed or we could afford it anyway. So, although I don’t think there was that much wrong about the initial and eventual paths for the deficit, I think these fiscal choices were executed in a highly damaging and dishonest way, one that will cast a shadow over future fiscal policies. (What is the point of ‘austerity’ if you don’t buy credibility with it?)
These weren’t the only mistakes made on fiscal policy. One impropriety we should not forget was the act of soliciting of comments on the soundness of the Coalition’s fiscal plans from the Governor of the Bank of England, then Meryvn King. This was highly risky and ill-advised. I think it was a shame that the Governor agreed to cooperate. The risk was that it politicises the office of Governor, corroding the apparent independence of monetary and other policies. The risk was aggravated in this instance by it being widely assumed that Lord King had acted in an advisory capacity for the Conservatives before his time at the Bank. (If I recollect correctly, this is hinted at in Nigel Lawson’s biography). In my view, Bank of England Governors should not comment on policy choices not directly within their own remit, to avoid the risk of being seen as a political appointee, and their bosses, the Chancellor, should not solicit such comments. If the appointment looks political, then this may create an incentive for the next aspirant Governor to say things that sound supportive of Government policy, and the corrosion accelerates. At a time when the Bank was taking on more powers on the financial stability side, it seems especially unwise to try to include Bank officials in the debate about optimal fiscal policy. (Why? Well, it could incite widespread discontent with an over-mighty Bank of England, and a movement to clip the wings of the Bank. This wouldn’t itself be a bad thing, but if that led to markets thinking that the independence of monetary policy would be compromised as a result, then inflation expectations could rise, and the output cost of hitting the inflation target would be temporarily higher).
Comments by the Governor that seem permissible to me would be comments that explain how (eg) fiscal policy bears on the best choices for the central bank instruments, and the likely performance of monetary policy. An example of a permissible comment might have been the following: ‘Frankly, there is a lot of controversy about the ideal fiscal policy at the moment [I’m taking you back to May 2010 right now], and this is anyway a political choice. However, tight fiscal policy is going to mean, other things equal, that monetary policy would ideally like to be looser. We have unconventional instruments to try to execute that, but their effectiveness is uncertain [this bit obviously far-fetched, as the BoE engaged in its own QE certainty nonsense at this point], so we can’t be sure of being able to generate the looseness needed to compensate for fiscal austerity, and this creates a risk that inflation and possibly real activity would be below target. That itself doesn’t mean that austerity is the wrong choice, just that there are likely consequences for the ability of the MPC to meet its target at the zero bound to interest rates. Ultimately this is the Government’s mandate at all times, so it’s perfectly natural that it makes these choices. However, I’m explaining the consequences to you so that you don’t inadvertently judge the MPC to have fallen down in its duties when in fact fiscal policy was changing what was possible or likely.’
So, supposing the recovery is now secure, we can’t declare ‘mission accomplished’ on fiscal policy. The Coalition fortunately chose to ditch it’s own unbelievable fiscal straitjacket, fearful of the economic consequences of not following a Plan B. Sadly, they chose to promise falsely that they would not deviate, and then tried to pretend that they hadn’t afterward, perhaps correctly calcluating that they would get away with it. Having indulged in the usual crass ‘certainty politics’, they concluded by trying to fatally undermine our grasp in the notion of the counter-factual, by pointing to the recovery as evidence that they were right all along. If instead of fiscal probity the mission was to spread economic illiteracy for political gain, then I think we can say that it was ‘mission accomplished’.