Mediamacro myths. The third way.

Simon Wren Lewis has a string of posts explaining what he describes as several ‘myths’ of ‘mediamacro’, and contrasting that with how he sees the true narrative of the financial crisis and the different governments’ conduct during it.

I want to recap on a few points where I depart from his narrative, compelling and persuasive though it is in large part.

I do think in broad terms the initial drive to austerity was warranted.  [Though this is enough to embrace either the path the Coalition chose, or the one that Labour were proposing at the 2010 election].

And on two grounds.

At that time, there was a real sense that our own banking system could have been engulfed by a second financial crisis, and that this would have stretched our sovereign’s ability to pay.  Simon has pointed out, persuasively, that spreads on UK debt were not blowing up at the time, and so this casts doubt on those worries.  That said, there’s lots about measured market views about things that is puzzling, all the time.  For instance, I find it perplexing [though I haven’t to my knowledge been joined in this view] that markets believed the ‘do whatever it takes’ promise behind the ECB’s OMTs [Outright Monetary Transactions]. Which to my mind seem nothing more than a successful bluff.  It’s also worth pointing out that just as there can be bad self-fulfilling prophecies in sovereign markets, there can also be good ones.  Just perhaps this explains the apparent success of the ECB and the UK case too.   I’d also note that markets don’t know everything.  There’s a lot that the BoE/PRA know/knew about the state of bank finances and exposures that markets don’t/didn’t.

I also don’t buy that having your own currency frees you from sovereign debt problems.  Though it’s true that the issuer of an independent currency can always print it to meet any financing obligations, it can’t do that AND hit other macroeconomic, particularly inflation objectives.  And it’s perfectly possible to conceive of a situation where default is a better option than a hyperinflation needed to plug a large hole in government finances.  If it comes via expected inflation, you need a lot of seigniorage to finance goverment, and can wreak catastrophe on the un-indexed [read poor] and on future credibility.

These worries did not come to pass, but I found them persuasive at the time, and the fact that these risks did not materialise doesn’t negate that they were part of the distribution of plausible events.  We should remember too that it’s not as though monetary or fiscal policy was drastically tilted to cater for these worries, and rightly so, in my view, since, even for me, they were tail events.

A second reason why the initial push to austerity seemed ok to me was that inflation was well above target.  At that point, therefore, it seemed plausible to view very weak levels of activity as in large part a problem of the financial crisis having throttled the supply side.  Something which it was worth fighting against with fiscal and monetary policy, but which high inflation indicated that as much was being done on both fronts as was warranted.

Someone arguing from Simon’s perspective might counter at this point and ask:  isn’t the fact that inflation has been protractedly below target vindication of the Krugman-Wren-Lewis position?  That’s certainly arguable.  It’s conceivable that the supply-side factors pushing up on inflation in the early phase of the crisis should have been seen as temporary things masking the overriding weakness in demand, and something monetary and fiscal policy needed to look through.  However, even accepting that, there was the offsetting concern of being prepared for the Eurozone related implosion of the remainder of UK banks, already referred to.  And, regardless, one can put the weakness of inflation down to a failure of fiscal policy to switch modes quickly or far enough once it became clear that our own sovereign-banking nexus was going to be ok.  Indeed, even such relaxation as was allowed by Osborne was accompanied by disastrous expectations management in the form of an attempt to deny that there had been any change of plan.

The rest of Simon’s narrative I buy, pretty much.  And right now wish that parties postpone deficit reduction until the recovery has got to the point where interest rates could be lifted clear off the zero bound, and have enough room therefore to compensate for any fiscal contraction.  [And regret that the BoE as repeatedly implied that it has the tools to do whatever it takes to meet the inflation target under current envisaged future fiscal policies].

Once accommodation with monetary policy was possible, I’d be in favour of switching to a fairly hawkish fiscal policy, to facilitate paying down the debt so that in the not too distant future we could run it up by another 40 percentage points again to alleviate the burden of the next major economic crisis that comes along.

I am also not sure about the inference that ‘mediamacro’ is conspiratorial in any sense.  Note that Simon does not claim this.(1)  But in case anyone extrapolates to take mediamacro as that, I’m not willing to go so far.  I’ve met a few of the protagonists, and they seem to be very clever and opinionated and fiercely independent.  They probably also know that their personal brands would implode if they were sniffed out as peddling something that they did not themselves believe.

I’d finish with a classic bit of academic fuzziness too.  Even though there are lots of holes in the Coalition narrative SWL and PK identify – and I concur with them on a lot – we have to be mindful of the fact that ‘macromacro’ [the antidote to medicamacro] itself is a rag-bag of work in progress.

If I knew the New-Keynesian plus financial frictions model of money, macro and unemployment to be true, I could trash to pieces most of what the Coalition say.  However, this body of knowledge begs lots of questions itself.  We could turn this very uncertainty back on the Coalition, of course.  At many steps they were saying ‘this is how it is, and this is what we should do about it’.  And the reply would have been.  ‘Well, actually, things are a lot more nuanced than that, and the weight of evidence points in this direction.’  But in doing this, we have to concede that there is no cast-iron account of the causes of and conduct during the crisis with which we can beat the Lib-Dem-Tory policymakers.  In previous posts on the New Keynesian model Simon actually points out some of its flaws.  He doesn’t buy its strictures that such high weight be placed on deviations of nominal things from target [which under some circumstances would have meant worrying a lot about the initial large deviation of inflation from target in the crisis].  And sees [rightly] many of its foundations in micro as dubious.

For me, the logical corrollary of that scepticism is that our distribution over possible explanations of and prescriptions for what we saw has to be somewhat diffuse, and no complete rhetorical victory is possible.  There probably is something in mediamacro.  I don’t believe in it myself.  [More precisely I put a low weight on it being true].  But we can’t discount it entirely.

(1) In the first version of this post I wrote that I could not remember whether Simon had or had not claimed a conspiracy of mediamacro.  Simon put me right and pointed out that he had not.  Apologies, Simon!

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8 Responses to Mediamacro myths. The third way.

  1. Walrus says:

    I think one of the biggest problems of the coalition and media macro is them equating public debt to private debt. The main reason for the current austerity is that government and media have convinced the electorate that if we don’t save (now that the economy has barely started moving again) , we won’t be able to pay back later when it crashes again. This negative thinking not only slows down recovery but leads people to believing that the austerity is required otherwise another crisis like this will occur. We need to boost consumer confidence,move away from zlb and most importantly tackle the recession’s cause. Making the public pay for failures of banks is the worst aspect of media macro.

  2. “Though it’s true that the issuer of an independent currency can always print it to meet any financing obligations, it can’t do that AND hit other macroeconomic, particularly inflation objectives.”

    If inflation is below target or the central bank wants to increase the inflation target in an independent issuer state it can. Also if tindependent it can incorporate policy tools which stimulate more effectviely while stimuling financialization and instability less if it wishes.

  3. Fred Fnord says:

    “They probably also know that their personal brands would implode if they were sniffed out as peddling something that they did not themselves believe.”

    What is that line about people having trouble understanding things that they are well-compensated not to understand? And of course the selection is earlier: people who say things that politicians and other public figures want to hear tend to rise in the ranks. Being repeatedly wrong is certainly no impediment.

    “If I knew the New-Keynesian plus financial frictions model of money, macro and unemployment to be true, I could trash to pieces most of what the Coalition say.”

    This is entirely the wrong way to think about things, though! It’s not ‘right’ or ‘wrong’. It’s a model. Models reflect reality more or less accurately, but they are by nature never ‘right’.

    Would you say that a meteorological model with a 72% accuracy is right or wrong? What if a new one came along that was 74% accurate? What if the former was closer to modeling reality (took more inputs and used them in a realistic way to run its calculations)? Which one is ‘right’?

    The plain fact is, a model is good insofar as it is predictive. Saying it is not ‘right’ is floating out between ‘irrelevant’ and ‘meaningless’, but closer to the latter.

    • Tony Yates says:

      You take me too literally. I think about models the same way you do. [As ought to be clear from my earlier posts. And you can see this here as I reveal my own diffuse distribution over possible models]. I think it’s fine to shortcut this and use ‘right’ sometimes, but I can see why you jumped me for it.

      On rising in the ranks. What you describe is certainly conceivable. But it doesn’t match my personal experience of the journalists I have met.

  4. Roy Lonergan says:


    On “in broad terms the initial drive to austerity was warranted”, you haven’t said for how long you think that justification held. As long as it took the government to change? And I assume that that justification doesn’t hold now?

    Also, on paying down debt, do you mean reduce the nominal balance or just reduce it as a percentage of GDP?

    Finally, if you consolidate the government and BoE’s balance sheets (I’m an accountant so I just can’t help it) then hasn’t QE reduced the debt already in nominal terms? (I guess what I haven’t been able to understand is why QE needs to be reversed?).


  5. richard reinhofer says:

    The sovereign’s ability to pay? Are you worried about running out of paper or ink?

  6. Stephen Bloch says:

    “inflation … can wreak catastrophe on the un-indexed [read poor]”

    Are “the un-indexed” really predominantly poor? It seems to me that poor and middle-class people get most of their income from wages, which are usually inflation-sensitive, while rich people get most of theirs from investments — interest, dividends, capital gains — which are less likely to be inflation-adjusted. (I don’t know whether pensions in the UK are inflation-adjusted.)

    Furthermore, inflation is basically good for debtors and bad for creditors; poor people are much more likely to be in the former category, right?

    All of which would explain why there’s been such a loud demand from rich and powerful people to Fight Inflation Now, even when there was no sign of it.

  7. Aziz says:

    1. I think the big problem with the drive to austerity is that came out of a totally false narrative about the so-called confidence fairy. Cameron claimed that budget-cutting would create confidence and that this would be expansionary, a position I believe that has no actual support in economics, where everyone knows that austerity is contractionary in the first order, and that while there may be some second order “confidence” effects, it would be pretty hard to offset the first order contraction, let alone exceed it.

    2. Inflation was above target, but I thought inflation was a concern for monetary policy makers? I mean, I think the framework is pretty clear. Controlling inflation is the BoE’s job (post the effects of whatever fiscal policy the Treasury enacts).

    3. In terms of the sovereign risk factor, I think we would have been well-instructed to look at Japan and the Great Depression era-U.S., where the bias was toward monetary deflation and very low rates in the wake of a financial crisis. Maybe being a monetary sovereign doesn’t entirely free you from sovereign risk, but it certainly does free you from (and I quote David Cameron) “becoming Greece” which has been on the wrong end of a one size fits all monetary policy that hasn’t fitted the Greek economy.

    4. I’d say the bias to austerity is worsening the risk of falling into a Japan-style deflationary trap.

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