Time for macro-economics to get political once more
A former No10 colleague asked me recently: is there a definitive guide out there to how monetary and fiscal policy work together? What determines incomes?
What made his questions remarkable were both how fundamental they were, and yet how distant from the day job when we had worked together in Downing Street. Politicians do not do macro any more, albeit you would not know from how they boast. Chancellors demand acclaim for ‘their’ stewardship every time GDP notches up a decent run, and ‘hail’ the latest jobs figures, as if all down to their expert execution of some kind of plan. Internally, senior advisers lecture one another about the “plan for jobs”, and the need for a comms plan aimed at the some focus group that revealed a love for the word “jobs”.
Of course there is no ginormous Whitehall spreadsheet with all the jobs in it. The Chancellor does not steer the economy. For all the manifest talent amongst Government economists, the image that springs to mind is of a bunch of people sitting on top of an iceberg, staring at a map, pretending they are steering the iceberg. Insofar as the state has any say, it is outsourced to combinations of the Bank of England, Debt Management Office, Office for Budget Responsibility and the like.
This state of Macro-Impotence is still more remarkable in light of how much the macro economy matters. Macro failure led to governments being ejected in 1970, 1974, 1979, 2010 and probably 1997. To read the memoirs of Chancellors from Cripps to Lawson is to experience a constant, chaotic drama of macro economic misadventure.* Chancellors and prime ministers wrestle for the steering wheel. The connection between fiscal and monetary policy (my correspondent’s question) is constantly contested, often in the heat of a crisis. The Bank of England itself is unsure of how things work, and for most of its history has a lofty disdain for economists. For long periods you have Chancellors indifferent to monetary policy as tool — base rate stays the same for years. Then wild experiments in monetary base control or exchange rate management are launched into with little public understanding. At every budget, Chancellors tug away at a host of levers like hire purchase terms, capital controls and incomes policy, tinkering we would never dare to emulate today.
This was when the behaviour of the pound really mattered — its weakness led to the great deflationary budgets of the 1960s and 1970s and the sky-rocketing rates of 1992. Its strength wiped out British manufacturing in the early 1980s. Bad trade figures may have swung the 1970 election
We should not look to return to those days.The period 1945–1992 was for long periods a humiliating clown-show. I can see why the clumsy attempts in 2016 to criticize the Bank’s low interest rate ‘policy’ drew such condemnation; until the political class grasps the difference between the policy rate and natural, equilibriating rate, they do not deserve a bigger say. Far safer the current set up, where we only watch the pound for its instant, semi–satirical comment on the latest Government defeat.
But now I am wondering if we have abandoned the field too early. There are a number of reasons. The first: we are clearly in a very different place to where we were when we decided to stop thinking (as a political class) about macro. See this chart to understand what I mean:
The collapse of the natural interest rate across the developed world is a problem of first order importance, but because we were so long trained to think the problem was high rates and inflation, the political class is unable to think about it. Any measure that might break us out of this trap — a higher inflation target, recourse to direct monetary financing, etc — blunders into invisible third-rail taboos, and tactical thinking about who gains and loses from higher rates.
We also have a very different labour market to the one we thought we had just 10 years ago. I like to trace this through the evolving forecasts of the OBR. Back in 2011, the OBR forecast was quite vertical: employment would rise slowly, wages soon recover fast as the labour market tightens. Since then it has been flatter and flatter:
If you read those post war economic memoirs, this is the labour market all those Chancellors were dreaming about. They longed for one where you could juice up the economy and all that happened was unemployment fell. And yet today we see those weak wages as the giveaway signal of a terrible productivity crisis. We should be asking if our labour market is now far too flexible, and damaging broader macro economic goals.
Which leads to the second point: that weak productivity really turned up when aggregate demand began to fail around 12 years ago. Productivity is meant to be about slow-moving factors: skills, infrastructure, the quality of our institutions and technology. These are not meant to fall off a cliff (normally; see below). The link between the hit to our nominal GDP and weak productivity may be a macro-matter, but we have trained ourselves not even to think about that. We need to.
Finally there is Brexit and a possible simultaneous shock to demand and supply. Bank of England warnings of a 35% house price crash looked like a tactical mistake a year ago — but revealed a macro choice that politicians would want to influence: between allowing inflation to rise far beyond the target, and pursuing a really tight monetary stance to bring it down.There is even the exotic thought of a sterling crisis too. The conventional assumption is that a chaotic Brexit will lead to lower gilt rates — and the Chancellor sounds keener than his predecessors to exploit them. Hence aggregate demand might be supported. But that is not how it goes in emerging markets. What if the pound falls, confidence in the inflation peg goes with it, the prospects of Corbyn come closer, and gilt investors suddenly wonder if they are being taken for suckers? Is there some level of £/$ at which the Bank has to act and crush demand like its 1992?
In the worst scenarios there really are dilemmas to navigate and political choices to make. But it is so long since choices and dilemmas fell wholly on the politicians that David Cameron was then a special adviser**. One of the weird upsides of Trump is that it is forcing people to notice the boundaries between the political and technical/monetary sphere once more. There happen to be plenty of talented macro economists in government, mostly buried in the Treasury. It feels to me that they need to be brought to the fore again.
*I particularly recommend: Denis Healey, The TIme of My Life; Roy Jenkins, A Life at the Centre; Richard Roberts, When Britain Went Bust and Cairncross and Burke Goodbye Great Britain (both about 1976); Sam Brittan, Steering the Economy; Philip Stephens, Politics and the Pound; Nigel Lawson, The View from No11; David Kynaston’s history of the Bank of England, Till Time’s Last Stand; Duncan Needham, UK Monetary Policy from devaluation to Thatcher; and everything in Bernard Donoughue’s Downing Street Diaries. I have thus far resisted Geoffrey Howe’s memoirs but know I will crack sooner or later, and have Alec Cairncross’s Managing the British Economy in the 1960s glaring upon me from the shelf.
**You might, fairly, say “what about 2008–9?”. But unless you are really nuts there was no dilemma at all then. It was a pure aggregate demand hit, all hands to the pump, and I am personally fairly thankful the Labour team had experienced hands in place. I should also acknowledge the great “expansionary austerity” fights of 2010–12, which need another post.
