Wednesday 27 February 2013

The disaster of axiomatic macroeconomic thinking

This is something I published recently on the European Tribune

On Friday (22nd February), Moody's downgraded the UK's credit rating by a notch. That is actually a non-event. Rating agencies clearly play to an ideological agenda (for instance, they consistently give a higher rating to a private company than to a state for a similar level of risk), and it's hard to see in what circumstances the UK, a country with its own central bank emitting fiat money, could default.
What makes it somewhat more interesting is that UK's chancellor, George Osborne, reacted that way :

"Tonight we have a stark reminder of the debt problems facing our country - and the clearest possible warning to anyone who thinks we can run away from dealing with those problems," he said. "Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it.
"We will go on delivering the plan that has cut the deficit by a quarter, and given us record low interest rates and record numbers of jobs."
"As the rating agency says, Britain faces huge challenges at home from the debts built up over many, many years, and it is made no easier by the very weak economic situation in Europe.
"Crucially for families and businesses, they say that 'the UK's creditworthiness remains extremely high' thanks in part to a 'strong track record of fiscal consolidation' and our 'political will'.
"They also make it absolutely clear that they could downgrade the UK's credit rating further in the event of 'reduced political commitment to fiscal consolidation'.
"We are not going to run away from our problems, we are going to overcome them."

Now, this got some reactions. Paul Krugman, Mark Thoma, Simon Wren-Lewis(and many others I'm sure) quickly wrote about this, and made very good, and damning, points. What I would like to focus on is the fact that this could even be said, the assumptions (spoken or unspoken) that Osborne's statement carried with it. Incredibly, they are by many not seen as assumptions, or points of contention, or even hard-acquired knowledge. Rather, they are there as undisputable facts of life that everyone knows. I will list the ones that come to me, but will surely miss some that you may want to add.

To make the point clearer, I should probably add something that not Osborne but Moody's said -the main (official at least. The main reasons may be ideology and wanting to trot out the brand name) reasons behind the downgrade.

"The main driver underpinning Moody's decision to downgrade the UK's government bond rating to AA1 is the increasing clarity that, despite considerable structural economic strengths, the UK's economic growth will remain sluggish over the next few years due to the anticipated slow growth of the global economy and the drag on the UK economy from the ongoing domestic public and private sector deleveraging process," the agency said.
"The country's current economic recovery has already proven to be significantly slower - and believes that it will likely remain so - compared with the recovery observed after previous recessions, such as those of the 1970s, early 1980s and early 1990s."

To that, Osborne claims that this is just the signal that more austerity is needed in order to meet a harder than expected fiscal target. Implied here are :

Assumption 1 The state of the economy is entirely exogenous to the Government

OK, actually I believe that Osborne would be prepared to say that the Government can make it worse by pursuing left-wing targets, but that's one way traffic, nothing can be done to make it better, and no right-wing target could make it worse. This is an extraordinary claim, and I would really want a stronger adjective.
The Government is the biggest employer in the country by some ridiculous distance. Surely Osborne would reckon that a private company could do some good -else why even try to attract such companies, as many policies directly propose to do. Why then would an entity well over ten times bigger than the biggest local private entity not be able to? Unless, of course, it choses to.
However, even if the Government was not a huge employer (and who knows, at the rate that teachers and NHS doctors, it may end up being the case), it would still be a mind-boggling claim. The Government, unlike any private agent (again,officially at least) has executive power, and is backed by a parliement that has legislative power. It is in a unique position to have an impact on the economy.
And after almost three years in power, that saw the move from an appreciable recovery, possibly the most impressive one in the OECD, transformed into an intermittence of recession and marasm, it is now hard to attribute the recent worsening to Labour policies. Yet, in the face of a worse than forecast economy, Osborne sees that as the call for more austerity :

Assumption 2 The main target of the Government should always be to balance the books
Here I don't intend to debate Modern Monetary Theory -not that it is an uninteresting topic, merely that it would be an unnecessary distraction. You don't even need the MMT framework to see how odd that assumption is.
Actually, I believe that even in Schwabian housewife economics, it should be seen as absurd. Forget the macro effects for a moment (not for too long, though) -would you say that the main target of parents should always be to balance the books ? That when one of them becomes unemployed, they should strive not to add a penny in debt, should that mean having one of their kids starve and the others drop out of school to save some cash?
And as we know, the Government is not a household. Much of its spending comes back as revenue from increased economic activity -indeed, in times like these of persistent depression, probably MORE comes back than was spent, in particular thanks to the avoidance of long-term loss of potential.
We expect -we need many things from a Government. This, in turn, will require some spending. It will also require some taxation. Those two should, in the very long run, probably not average a neat balance, but not something hugely different either. Still, spending and taxation are at most a means to goals, and even then, the primary drivers for fixing them certainly are not a year over year balancing act.
Yet here we are, served with notice that despite considerable structural economic strengths (yes, I wondered, too. Maybe the reference point is not too challenging. Anyway, it's their statement) the country is going nowhere fast, Osborne's reaction is instantly "we'll need more efforts to balance the books".
I'm sure you noticed my dropping the « year on year » well...

Assumption 3 : The only term is the short term
OK, I'm not naïve. Correction, I am easily naïve, but I also pay sufficient attention to often be cynical.
I realise that our society will be short-term biased. In the private sector, many managers change roles every very few years, but even that is geological term compared to how their bonuses are calculated. In politics, it seems that it's now pure PR in a horse-racing reporting of a non-stop electoral campaign.
I realise that Osborne is a professional politician (if the editing policy allows me to use such rude words), hoping to trip Cameron and become alpha Gorilla sometime in the future. However, he is also the Chancellor of a country going through the biggest economic crisis in seventy years (eighty if you don't count the war). Roosevelt was also a politician, after all.
Even if you want to aim at balancing the books, it is blatantly insane to add "within the legislature ". There is no reason why the legislature calendar should be synchronised to the economic one. On the other hand, since some infrastructure works will have to be done over the next 20 years, a good book-balancer would make use of the lowest rates -and costs- ever to get better quality for less money. However ...

Assumption 4 : there is no such thing as a business cycle
Yes, I know, that's odd for people who often sprout out conclusions straight from Real Business Cycle theory. Yet, when you keep bragging about having reduced the deficit by a quarter (and got a record number of jobs -I'd like to see the source for that one, but of course if you start counting the minute after everyone got laid off in a panic, for half of them to ber e-hired as the panic subsides, it's not exactly a stellar achievement), while taking as your starting point 2009/10, with a hugely inflated deficit due to the program of bank bailouts, you are either immensely disingenuous, or you have to believe that any movement in the balance is permanent.
Apart from that one point, over the legislature, the debt had been brought to a point where servicing the interest was at the lowest point in 110 years. Not that it should matter all that much when the UK has its own central bank, but in any case it's hard from that fact to derive the conclusion that, in Osborne's words, "As the rating agency says, Britain faces huge challenges at home from the debts built up over many, many years"
He also adds that: "they say that 'the UK's creditworthiness remains extremely high' thanks in part to a 'strong track record of fiscal consolidation' and our 'political will'. [...] They also make it absolutely clear that they could downgrade the UK's credit rating further in the event of 'reduced political commitment to fiscal consolidation'."
Absent from Moody's statement (yet implied by Osborne's reaction) was the word "immediate". The UK debt went from over 260% of GDP in 1820 to under 30% in 1913, then from 180% in 1946 to around 25% in the early 1990s. That's the aforementioned track record -note how it did not happen in a single legislature. As for the political will, well, that's just that, unlike in the States, none of the main parties has shown to be intent on threatening to default to score petty political points. All it needed for the UK was to say that they would pay and, with their own central bank, nobody could prevent them from doing so. And nobody was asking for immediate payment either.

Assumption 5: Interest rates are low only because of AusterityTM
At this stage, I wish I had saved the link to Krugman's post with the evolution of the borrowing rates of the UK, USA and Japan in parallel.
The clear message was that what mattered was having your own central bank. Actually, the UK's rates were (and are) the highest of the three, which goes against Osborne's implied claim -although one should be careful of the reason for that. Long term rates are simply projections of short-term ones and it may be that investors felt that the Band of England would be more likely to be pressurised into raising rates than the others.
Still, claiming that the rates are a gift from AusterityTM is a laughable proposition -but a very, very frequently heard one among, for instance, readers of the Telegraph or the Economist.
All those assumptions, that are trotted out as undisputable -pretty much axiomatic- are blatantly wrong. Yet Osborne can say that and not be instantly laughed off the stage.

I understand, as Krugman bluntly explains, that Osborne cannot say otherwise without losing his claim to be qualified to do anything. Actually, even if Austerity was the right course of action, I am not entirely clear as to why Osborne, who does not seem to understand anything about economics and finance, would be qualified either, but I digress.
However, it is an abominable course of action. This person, who lectures his entire country and beyond about responsibility and taking personal hits for a greater cause, is sending millions into destitution, poverty and even death for the sake of a gamble to maybe boost his personal neurotic ambitions.
Might may be de facto right. But over and above, used that way, might is wrong.

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