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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19 Responses to Austerian empirical macro wars

  1. Joe Hazell says:

    Tony, when you talk about ‘identifying fiscal shocks’ and ‘how to do time series econometrics’, what exactly do you mean? Forgive me if I’m misreading, but my reading of the UK is that time series econometrics *as applied to the UK* has very little to say because we couldn’t possibly have enough data to seriously attempt to identify anything properly.

    Not that I disagree with you, it just seems to me that NK ZLB macro, and maybe time series empirics from elsewhere, are the reason why your analysis holds.

    • Tony Yates says:

      It’s a long story. Essentially you are looking for a change in fiscal policy that isn’t itself responding to the business cycle. Because if the change you study is, even in part, then you will conflate the effect of the change in policy with the thing that was causing the business cycle movement itself. There’s never enough data to do anything properly, but I’d say that the UK gives as good a chance as anywhere to carry out the usual tests, and there are quite a few papers doing just that. Sorry I don’t have time to give you a proper answer.

      • Joe Hazell says:

        Thanks! To be a little clearer, I understand the econometrics of identifying fiscal shocks, in general. I meant, more specifically, that I don’t see how you can do it in the UK with such little data. The papers I’ve seen that identify fiscal shocks with VARs convincingly (Hall, Ramey), seem to use about half a century IIRC.

      • Tony Yates says:

        I see, sorry. So, in the UK we can use post war data too. And we can get an answer to the question: on average, what is the effect of a fiscal shock? And then we have to rely on that in trying to figure out the effects of very recent fiscal policy changes. I’m not suggesting you can estimate and identify a VAR based on 2010-2015 data only.

      • Joe Hazell says:

        Right! Thanks again. So I suppose my question is the following. Suppose I estimate a VAR on UK postwar data of government spending, interest rates and output, and identify it in some appropriate way (the details of which are not relevant to my question).

        Would you/time series modellers consider the impulse response from a government spending shock (correctly identified) to be a reasonable measure of the impact of government spending on the economy?

        My guess is that it would be insufficient because the IRF will embed an endogenous response of monetary policy to government spending shocks (i.e. monetary policy offset) that doesn’t happen at the ZLB, i.e. the IRF will tend to understate the impact of fiscal shocks at the ZLB.

        Since this is the nub of the issue, theoretically speaking, it doesn’t seem to me that VARs will have very much to say.

      • Tony Yates says:

        That’s a good point. But the ‘old’ IRFs will give you a lower bound on the impact. And one can use Monte Carlo evidence to estimate how much the zero bound constraint magnifies. For example, generate data from a DSGE model. Estimate on that data a VAR. Identify the effects of a fiscal shock. Now repeat but with the zero bound constraint binding to different degrees. Actually that’s an idea for a paper.

      • Joe Hazell says:

        Cheers! An interesting thought …

  2. RogerFox says:

    The fly in the ointment is right here –

    “… 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.”

    It wasn’t fiscal policy that took rates to zero – it was monetary policy – QE. Rates went to zero because CBs made them go there, and QE was the instrument by which it was accomplished. Absent QE, CBs don’t have even the theoretical ability to move rates lower.

    Policy-makers continue to assert that ultra-low rates promote growth; though there is a complete lack of empirical evidence to support that opinion. They were and are determined to do as much QE as it takes to keep rates at 0% – fiscal policy wouldn’t have changed anything for us any more than it has for Japan.

    • Tony Yates says:

      Monetary policy had to take rates to the zero bound [which wasn’t achieved by QE, that happened afterwards; and they can set rates at 0 without any QE at all by the way] because, without it, the recession would have been even deeper. The same body of knowledge that refutes NF’s stuff about fiscal policy also testifies to this point. The more tight is fiscal policy, the more monetary stimulus is needed, typically. So I think you have it completely wrong.

      • RogerFox says:

        If they could make rates go to zero without QE, why do QE?

      • Tony Yates says:

        Remember rates reached 0.5 [their choice for the floor] without doing any QE. QE started afterwards. Same for the US. Same also for the ECB. QE is intended to provide more stimulus when there is no more room for further interest rate cuts. How and whether it works is a matter of controversy, but I’ve blogged about this too.

  3. Jeffrey Foster says:

    In any case it’s heartening to see that even those sympathetic to conservative views still find Ferguson’s recent writing on the subject to be politically-driven diatribes whose arguments “fall apart” as the author here puts it, when examined dispassionately. Ferguson himself focuses a lot of time and energy in his pieces on claiming that only those on the extreme left could think such a thing about his writing, claiming that not only are his own views not politically-motivated, but that the views of anyone who disagrees with him must be.

    • Tony Yates says:

      I think my position is just seeing it through the lens of pretty standard NK macro, and apolitical. Reasonable people taking the same approach can disagree. Hence divergence between SWL, Portes, and myself, for example.

      • Jeffrey Foster says:

        Right I understand that but this approach is not what Niall Ferguson is doing, by your own estimation, rather he’s engaging in “an instinctive, political defence of those he sees as his own team” as you accurately put it.

        Don’t misunderstand, I’m not saying that you’re coming at it driven by political motivations. Sort of the opposite. I’m saying that Ferguson’s arguments on macroeconomics can be seen as baseless even by someone not motivated by politics in saying so, contra what Ferguson claims.

      • Tony Yates says:

        I see. I misunderstood, sorry.

  4. Barry says:

    Tony Yates: “If that’s the case, it’s disappointing that the debate has become a left-right thing. ”

    Become? It always was.

  5. How does zero contracts jobs, tax cuts for people that don’t need them, cuts affecting poor and middle class help the UK econ? With a new round of cuts coming in July by Osborn that will only hurt the ones that have taken the biggest hits during this long recovery?

    • Tony Yates says:

      Not quite sure why you are asking me that question. Very briefly, I’d say we need a gently falling government debt/GDP ratio, so that come a crisis, we can run big deficits to help those who lose out most in a recession (mainly the unemployed) and help stabilise the economy over all, especially as now seems apparent, there can be times when monetary policy runs out of room to help. So debt financed government policy has to be set in this framework. Aside from that, there’s the question of redistribution [transfers from rich to poor that don’t require debt]. I haven’t talked about that at all here. The spending and tax cuts you talk about aren’t desirable right now, in my view, because we are not out of the woods yet on the recession [we are still at the zero bound to rates]. But sooner or later they will be, and though painful, the alternative, which is depriving the next generation of the capacity to run up debt in a crisis, is worse, and unjust.

  6. Tom Brown says:

    Tony, I’m curious what you think about this from Scott Sumner:

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