Tuesday, June 22, 2010

Spinning the economy out of control

I was stunned to see George Osborne announcing in interviews that the alternative forecasts from the new Office of Budget Responsibility demonstrated a failure by the last government. Is he really so economically illiterate that he cannot tell the difference between two different forecasts and actual data? Possibly, he is. And judging from a halting performance by Danny Alexander on the PM programme, the Chief Secretary is no better and isn't even taking advice from David Laws on the matter. Little Danny's main argument rested on the fact that the Labour growth forecast was higher than all but one other independent prediction - which is interesting, but hardly conclusive.

You see, despite all the spin from the Osborne/Alexander team, things actually aren't as bad as they are suggesting. There's certainly no evidence to support claims that things are substantially worse than expected now that they have got their sticky little fingers all over the Treasury books. Even arch-Conservative Fraser Nelson has had to admit that the figures are better than expected
Unemployment, inflation, the deficit – everything is better than not only the Treasury forecast but better than the market had been preparing for. (And Citibank, which compiled the graph, thinks things will get better still – because the economy will keep surprising in the upside).... Manufacturing, house prices, gilt yields – on almost every metric you can think of, things are not as bad as had been feared

The BBC's correspondent, Stephanie Flanders reported this interesting snippet from the launch that her colleague
Paul Mason was able to get Sir Alan [Budd] to confirm that [the] 2015 figure means that the OBR does think that Labour's policies would have eliminated a
large part of the structural deficit by the end of the next Parliament. The OBR expects it to go from 8.8% of GDP in 2009-10 to 2.8% in 2014-15.

So - by the test laid down by Osborne - Darling's policies would have worked. There was no need to impose extra cuts for the sake of machismo and no need to be more brutal than Labour would have been in raising tax and cutting spending. That hasn't stopped the Tories rolling Norman Lamont around the media studios - a man rated as one of the worst chancellors we've ever had and who lost the right to have his comments taken seriously almost two decades ago.

In the other, sane corner, we have the Nobel economics laureate, Paul Krugman with a simple prescription.
Spend now, while the economy remains depressed; save later, once it has recovered. How hard is that to understand?
His comments apply to the US, but he specifically adds that they have international resonance.
Right now, we have a severely depressed economy — and that depressed economy is inflicting long-run damage. Every year that goes by with extremely high unemployment increases the chance that many of the long-term unemployed will never come back to the work force, and become a permanent underclass. Every year that there are five times as many people seeking work as there are job openings means that hundreds of thousands of Americans graduating from school are denied the chance to get started on their working lives. And with each passing month we drift closer to a Japanese-style deflationary trap. Penny-pinching at a time like this isn’t just cruel; it endangers the nation’s future. And it doesn’t even do much to reduce our future debt burden, because stinting on spending now threatens the economic recovery, and with it the hope for rising revenues

He even debunks some of the comparisons being bandied around as justification for slashing cuts now.
Canada 1994-1998: Fiscal contraction took place as a strong recovery was already underway, as exports were booming, and as the Bank of Canada was cutting interest rates. As Stephen Gordon explains, all of this means that the experience offers few lessons for policy when the whole world is depressed and interest rates are already as low as they can go.
Denmark 1982-86: Yes, private spending rose — mainly thanks to a
10-percentage-point drop in long-term interest rates, hard to manage when rates in
major economies are currently 2-3 percent.
Finland 1992-2000: Yes, you can have sharp fiscal contraction with an expanding economy if you also see a
swing toward current account surplus of more than 12 percent of GDP. So if everyone in the world can move into massive trade surplus, we’ll all be fine.
Ireland, 1987-89:
Been there, done that. Let’s all devalue! Also, an interest rate
story something like Denmark’s.
Sweden, 1992-2000: Again, a large swing toward trade surplus.
So every one of these stories says that you can have fiscal contraction without depressing the economy IF the depressing effects are offset by huge moves into trade surplus and/or sharp declines in interest rates. Since the world as a whole can’t move into surplus, and since major economies already have very low interest rates, none of this is relevant to our current situation.

Paul Krugman is scared.

Osborne has an opportunity today to reshape the public sector in a way that no other Conservative chancellor has ever been given. The narrative is that the economy is in crisis and that the fix is to cut public spending - even though there are strong arguments against that policy. What Osborne can do is to make ideological cuts primarily designed to reduce the size of the state, with cutting costs a secondary effect. But he only has this one chance. The honeymoon period is already ending and the positive political capital is being expended. If he doesn't wield the Thatcherite axe now, he may never get the chance again, so Paul Krugman isn't the only one to be scared out there. If Osborne gets this wrong, then we could see the UK plunged back into a recession far darker than the one that Labour guided us through.

Good reasons to be scared.


Fergus said...

Ah - "Nobel laureate Paul Krugman". Having a Nobel Prize in Economics does not make you uniquely right. I am sure that Nobel Laureate, Milton Friedman, would have disagreed profoundly with Paul Krugman's analysis. Such is Economics as a science.

PoliticalHack said...

It is true that if you put four economists into a room, you will get at least five different opinions. Paul Krugman has one advantage over Friedman, though - being alive is known to enhance economic judgement.

Fergus said...

"...being alive is known to enhance economic judgement."

Crass, but unsurprising.

Anyway, aren't you all Keynesians now? He's been dead since 1946.

Question (Masters students and above only) - would Keynes be a Keynesian?

Answer - nowhere near as obvious as you probably think.