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.