Economists’ letter supporting Osborne says not much at all


1:22 pm - February 15th 2010

by Adam Lent    


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Yesterday a group of economists published a letter in The Sunday Times about the deficit, which the newspaper claimed was an endorsement of Tory policy on public spending.

The newspaper is not wrong. Given that Conservative policy on public spending changes close on every hour and given that this letter says just about every contradictory thing one can say on the deficit, they are indeed very closely aligned.

This paragraph, which is the crux of the letter, is the most multi-faceted (to put it politely):

The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery. However, in order to be credible, the government’s goal should be to eliminate the structural current budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year.

The bulk of this fiscal consolidation should be borne by reductions in government spending, but that process should be mindful of its impact on society’s more vulnerable groups.

What precisely is this saying?

Basically, cut incredibly hard and fast but don’t damage the economy and cut incredibly hard and fast but don’t damage healthcare, education, social care, social services, benefits, pensions, police services or anything else which helps those reliant on public services.

I think we could agree that Tim Besley (who organised the letter) has managed to find twenty economists who have accurately identified the dilemma facing government and told us nothing of any use about how to address that dillemma. It even has that marvellous economists’ get out clause “all else being equal” which basically means “as long as reality doesn’t poke its annoying head into this analysis”.

Unfortunately, the flesh is weak and I can’t resist the temptation of comparing Tim Besley’s record on the Monetary Policy Committee with that of David Blachflower (who organised an economists’ letter back in December advising against too hasty action on the deficit).

During 2008, with the juggernaut of the financial crash and recession looming, Blanchflower voted to cut interest rates every month of that year. Besley voted to maintain six times, reduce four times (three times after the crash) and raise twice. Not a single one of his MPC colleagues voted to raise once let alone twice.

With a record like that I’d lay low for a while.

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Adam is an occasional contributor, former Head of Economics TUC, Associate Fellow at IPPR and co-author of 'In The Black Labour'.
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Reader comments


You know what they say. Ask two economists and you’ll get three opinions…

2. Golden Gordon

Economists are little like statistics.
They will say want you want them to say .

3. Economist girl

I *am* an economist and what they’re saying is reasonable, if unhelpfully unspecific. It would definitely be more useful if they could point to an area and say “you can cut taxes here without any significant problems”, but if you’re looking at a group of 20 economists, especially many which don’t specialise in fiscal policy, then that’s actually a very big ask, especially in a letter to the Times of all things. If you want some real economics, you’ll need a better outlet, and I bet there’s a fair amount of analysis swimming around (I certainly hope the Civil Service has some good stuff, although I expect they won’t be sharing). Mind you, this really isn’t my area so I coudn’t put my finger on any of it.

. It even has that marvellous economists’ get out clause “all else being equal” which basically means “as long as reality doesn’t poke its annoying head into this analysis”.

Yes, as one famous economist put it: “When the facts change, I change my mind. What do you do, sir?”

You make it sound like it would be preferable to offer policy prescriptions that would not change if the situation changed

Economist girl, be quiet, you know that “economists” don’t deal with “reality”. The TUC says so. This maturity of outlook is why left-wing ideas have been predominant over the last twenty years. Oh wait.

[Besley does have a puzzling track record as an inflation hawk …. although don’t some people now say that too-low interest rates help cause the boom and bust? … but whatever you think about this MPC votes, it would be foolish to type cast him as the archetypal bad economist. He does a lot of work that left wingers ought to like – he’s big on the idea of the importance of state capacity and how well-functioning market require a well-function state, and he wrote the book on good government. He’s one of the most respected UK economists – not that that’s going to impress anybody here]

The philosopher John Austin once said: ‘There’s the bit where you say it, and there’s the bit where you take it back.’

As Adam shows, some economists have developed their own version of apparently saying something while saying nothing at all if you look at the detail….

Has anyone pointed out that 20 economists isn’t actually that many? Back in the 1980s, the left managed to find 365 economists to sign a letter criticising the Thatcher government’s policies. Presumably this letter was posted around by email to try and gather signatures. If so, 20 seems a rather low number. Perhaps a reflection on the weaknesses which Adam points out?

Of course a plan to eliminate the structural fiscal deficit must be credible to retain market confidence. However, I would suggest that unrealistic targets are more damaging to credibility than anything else. What the present government need to do is be more explicit in how they are going to reduce the structural deficit. It is this lack of detail that damages credibility. Just making statements that the government ought to eliminate the structural deficit in one parliament does nothing for credibility if no believes it is achievable.

It is interesting to see Charles Goodhart’s name on the letter. Basically they are arguing that the government should make a statement of intent to create credibility. However, ‘ Goodhart’s law ‘ named after Charles Goodhart says,

‘ Once a social or economic indicator or other surrogate measure is made a target for the purpose of conducting social or economic policy, then it will lose the information content that would qualify it to play such a role. ‘

Maybe he does not believe his own law.

I agree with the last paragraph of their letter which states.

‘ In order to restore trust in the fiscal framework, the government should also introduce more independence into the generation of fiscal forecasts and the scrutiny of the government’s performance against its stated fiscal goals. ‘

One of the main reasons why the UK has such a high structural deficit is because Treasury forecasts in recent years have been woefully inaccurately optimistic. Departmental budgets for years ahead are set from these forecasts, hence we have a structural deficit when they turned out to be wrong.

9. Economist girl

@Edward

The TUC says so, so it must be true! Economics is a frustrating discipline, there’s a lot of abstraction in the models and demonstrating causality with data is a nightmare. It’s particularly difficult if you’re trying to model a whole economy (I stick to microeconomics as far as possible – looking at the behaviour of a single market or just a few agents is more my kind of thing). This is not the fault of economists, it’s just the nature of the beast. But in spite of all this, economics does frequently come up with the goods.

@Stuart, 20 may not seem like much but they’ve got some BIG names on there (Rogoff and Sargent in particular). Let’s just say quality not quantity :oP

You make it sound like it would be preferable to offer policy prescriptions that would not change if the situation changed

But he’s not said that at all Luis.

11. Luis Enrique

Sunny,

well I must have missed what Adam meant; perhaps you can explain his meaning to me.

As far as I understand it, the qualifier “all else being equal” means that the policy advice holds only so long as the situation holds, and Adam seems to find something objectionable about that.

@1: “You know what they say. Ask two economists and you’ll get three opinions…”

Really? Try these *earlier” comments by economists then:

“The government needs to be more ambitious in its efforts to repair public finances, according to a report. However, the Institute for Fiscal Studies (IFS) warns economic recovery should not be put at ‘undue risk’.

“The IFS predicts economic growth will be 2% a year over the next five years, lower than the Treasury’s suggested 3%. It is also forecasting that weak consumer spending and a muted rebound in capital investment will hinder economic growth. . .

“In a separate report, the National Institute of Economic and Social Research (NIESR) suggests tighter spending controls will be needed if the government is to halve the budget deficit over the next four years. The NIESR also expects that economic growth will be weaker than official Treasury forecasts. NIESR predicts net borrowing will be 6.8% of GDP in 2013-14, against official forecasts of 5.5%. It also says unemployment could climb to nearly three million next year.

“NIESR said the current government spending plans would not go far enough.

“Plans for fiscal consolidation will not be sufficient to start bringing down net public debt as a share of GDP by the middle of this decade, as the Treasury expects. Instead it will carry on rising,” the report said.

“Additional retrenchment will be needed, through either extra spending cuts or further tax increases or a mixture of both.”
http://news.bbc.co.uk/1/hi/business/8494904.stm

Personally, I take the informed commentary by IFS and NIESR economists very seriously but those comments were largely ignored – as were the warnings about the fiscal black holes in GB’s budgets going back to 2000 and the warnings about the house-price-bubble going back to 2002.

The uproar caused by the letter to the Sunday Times is disproportionate in comparison with the “let’s ignor” treatment accorded to the earlier warnings by the IFS and the NIESR. What is so hugely significant about the letter to the ST is that the signatories include several names of ranking economists who are usually regarded as supporters of the Labour Party.

Btw how many opinions do we get if we ask questions of politicians or lawyers – or medics or climate scientists?

13. Economist girl

@Luis,

I think he means they should give policy recommendations on a variety of outcomes, pretty straight forward really. Although the rest of the letter implies that if the economy is going down the tube then these cuts should be postponed, it doesn’t give any detail about how much to postpone for different levels of “going down the tube”. Of course, as I said above, it’s just a letter to the Times, not really the place for in-depth quantitative analysis.

14. Luis Enrique

EG

well maybe … but I don’t see how Adam’s parsing of “all else being equal” as “as long as reality doesn’t poke its annoying head into this analysis” amounts to him criticizing them for giving a policy recommendation, qualified as being conditional on the current situation, when, as you suggest, policies for a range of scenarios would be preferable (even though that would be, as you say, quite beyond the scope of a letter to a newspaper).

15. Golden Gordon

Luis
So are you backing the Tory ideas and these economists

Wasn’t it economists that got us into this mess in the first place?

And wasn’t it economists working in banks and credit rating agencies that ok’d all that “toxic” debt?

And aen’t they all trying to climb quietly on the same train to hell, even now?

And isn’t it economists in banks that are now taking huge bonuses from our money which was used to save theirs skins, if not their reputations?

Why should anyone listen to any number of economists on any subject?

“all else being equal” means: when it all goes tits up, don’t blame me….

…..didn’t I put in my caveats…..?

It’s a sort of get out of jail free card for consultant……and economists…

18. Economist girl

@Golden Gordon

The tories and these economists aren’t necessarily singing the same tune. I don’t trust Cameron & Osborne an inch. Their party will put them under massive pressure to cut hard and fast, even if (on the improbably offchance) they don’t want to follow that plan. The vast majority of economists understand the precarious situation the economy’s in right now and would want some very positive indicators before embarking on reducing the deficit.

@Braveheart, yes to a point. There were plenty of economists with their eye on the ball, but they were ignored. In a lot of cases academic work on Finance was taken out of context, and dare I say it, some of the financial instruments that have screwed us up so royally were designed by physicists, not economists. Oh, and there aren’t that many economists working at banks, although there are some. And some of them do sterling work (Krugman often uses Goldman Sachs economists’ estimates on the US economy, and he’s certainly not a fan of Wall Street).

So, if we don’t listen to economists, to whom do we turn?

19. Luis Enrique

GG

No, and you have no basis in anything I have written to suppose that I do. I have merely 1. defended the use of “all else being equal” and 2. pointed out that Tim Besley has produced some great work.

As it happens, I don’t have a solid opinion on the timing and the right approach to deficit reduction, because I don’t think I have sufficient information. I’m certainly not backing any “Tory ideas” and as the OP points out, apart from urging some general increase in the level commitment to deficit reduction, the letter doesn’t say very much. I’d agree that we have to retain the confidence of those who invest in government debt, that we are going address the structural deficit in good order, but that’s a pretty vague statement too.

Its almost as though they don’t really have a clue.

What is the point of economists if they cannot predict anything?

No no, just because one of a series of random predictions proved right it doesn’t mean the whole edifice of modern economics is vindicated. The odds are 50-50 most of the time and economists seem to have failed more than one would have by simply tossing a coin.

The modern secular religion?

21. Economist girl

@Yurrzem!

The point is the economics predicts some things, but where there are a lot of variables it’s tricky. And “black swans” can still come out of nowhere. Economics is not about telling the future with great precision and perfect accuracy, it is about understanding fairly fundamental relationships, how things work most of the time. It’s very imprecise, because humans are such weird and complicated creatures, but it can be surprisingly effective. Economists gave the Labour government a £30 bn (approx) windfall thanks to the 3G auctions (NB these auctions are much more complicated than the art and antique market ones – designing them is no mean feat), several economists did forsee plenty of the current crisis. Economics over the last decade or so has meant that we aren’t repeating the mistakes of Japan (although there’s still a chance that the Tories can screw that one up).

@16: “Wasn’t it economists that got us into this mess in the first place?”

No it wasn’t.

This Guardian news report on 29 November 2001 was about IFS commentary on the government’s spending plans:

“Labour’s pledges to tackle poverty and drag Britain’s underfunded NHS up to European levels have opened up a £17bn black hole in the government’s finances that will have to be plugged by higher taxes, the UK’s leading financial experts said last night.

“The Institute for Fiscal Studies (IFS), an independent thinktank, said it would cost the equivalent of 6p on the basic rate of income tax for Labour to match the average European Union health spending, introduce new tax breaks for the working poor and repair the damage to the public finances caused by economic slowdown.
http://www.guardian.co.uk/politics/2001/nov/29/uk.budget2002

And this was Charles Goodhart, one of the signatories of the ST letter, back in 2002 warning of the house-price bubble:

“CHARLES GOODHART, a former member of the Bank of England’s monetary policy committee [and economics prof at the LSE], warned yesterday that the Bank is failing to take sufficient account of the house price boom in setting interest rates.

“His warning comes amid growing fears among economists that house prices, fuelled by the lowest interest rates for 38 years, are getting out of control. Yesterday, new figures showed that homeowners are borrowing record amounts against the rising value of their homes. . . ”
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2002/04/06/cngood06.xml

Similar concerns at the time about the house-price bubble came from Roger Bootle, another signatory of the ST letter, and IMF economists.

And this warning about the risk of derivative trading in 2003 was from Warren Buffett, by repute one of the richest men in the world and no stranger to financial markets:

“The rapidly growing trade in derivatives poses a ‘mega-catastrophic risk’ for the economy and most shares are still ‘too expensive’, legendary investor Warren Buffett has warned.”
http://news.bbc.co.uk/1/hi/business/2817995.stm

Of course, they and others expressing similar concerns were all ignored because silly twits kept on rubbishing economists without even considering the issues at stake. That is precisely why were are in the mess that we are. Some in politics and the financial markets have deep vested interests in rubbishing economists with bad tidings.

@20
The problem is people want an unobtainable certainty. They do not want to hear about a range of outcomes and expect economists to act as clairvoyants. As EG says there are so many variables when modeling and forecasting a modern macro economy and if variables change the outcome will change. A media myth has developed where economists did not see the GFC coming. What the media mean is none of the ones we were quoting seen it coming.

It is because of the lessons that economists learnt from the Great Depression that we are not in a GD mark 2. The absolute fundamental lesson learned from the US experience in the 1930s, was do not allow the banking system to fail. Make no mistake that without economists advising them, politicians guided by the wisdom of their populations would have plunged us into GD 2.

The world and all its travails is a world run by politicians. Give me a world run by economists and there would be no scarcity, no hunger and no poverty. Incentives for desirable outcomes would be perfectly aligned without the short-term worry about reelection. With special interests having no lobbying power pollution would be controlled through costs and incentives. An altogether better world than the current one.

My fundamental point is that this is a letter which effectively says cut now and cut very deep but only in a way that doesn’t harm the economy and doesn’t damage public services. That strikes me as useless policy advice since the very reason to avoid cutting early or deep is because it will damage the economy and/or damage public services. You might as well say raise interest rates by numerous basis points but only in a way that doesn’t make it more expensive to borrow.

It seems very likely that this was a letter designed to call for urgent and deep cuts that then had lots of caveats inserted to get big name sign-ons and thus became meaningless. The “all else being equal” clause is probably one of those caveats. It’s a phrase that says: “take this policy advice if it applies to the real world situation”, which is useless because you should be able to assume that if someone is giving you policy advice they think it is worth applying in the real world.

But what the hell, The Sunday Times spun it as twenty important economists unambiguously backing the Tory point of view (whatever that is now) and the rest of the media followed suit.

I think you are probably right, Adam. I would love to see the original draft of the letter compared to what actually was sent to the Times. It was probably rewritten on numerous occasions before some would put their name to it. In reality, they are saying government plans must be credible and who could disagree with that. It is a weird interpretation for the media to portray it as attacking the present government.

26. Luis Enrique

Adam

you may be right about the letter’s genesis, although I think in policy circles, while it might not sound very substantive, simply saying: “signal stronger commitment to deficit reduction” is regarded as meaningful. It doesn’t have to be specific, it’s just saying “turn up the heat from where it is now”.

As for the unimportant semantics of “all else being equal” I think you’ve misinterpreted those words – in economics speak, all policy recommendations are conditional on the situation – it doesn’t mean “take this advice if it applies to real world”, it means “advice is conditional on reality being as it is now” or “advice is subject to change”. Perhaps it’s the kind of thing that could go without saying. It’s like saying all things being equal, I’ll be voting Labour, acknowledging that things could change that’d change that (say, if Richard Littlejohn takes over as party leader).

Richard W, have you seen that Simpsons episode when the brainaics takeover the running of Sprinfield? That’s now I envisage a world run by economists.

@23: Absolutely relevant case made by RW that lessons learned by economists about the Great Depression in the 1930s enabled governments to avoid a catastrophic repeat – and no thanks there to Conservatives who were rubbing the very idea of fiscal boosts.

And that is not the only stellar example. Keynes warned of the potential downstream consequences of the hugely popular proposals in Britain for imposing punitive reparations on Germany at the end of WW1:
http://econ161.berkeley.edu/articles_of_the_month/ecpall.html

In short: how would Germany actually earn the convertible foreign currencies necessary to pay the reparations? Only through earning regular trade surpluses by exporting more in value than it imported – which would be hardly popular in war damaged Europe where protectionist sentiments tended to prevail. Naturally, anyone suggesting that reparations were a bad idea was absolutely daft. One outcome was the rise of the Nazis in Germany and WW2 with 40 to 50 million killed.

That colossal mistake was avoided after WW2. Instead, we had the enlightened Marshall Plan for the reconstruction of Europe.

IMO the self-styled left should be taking note of books like Roger Bootle: The Trouble With Markets – Saving Capitalism From Itself (2009) instead of trying to bin him as just another “economist”.

@24: Try comparing the argument made in the short letter to the ST with the much longer earlier commentary by the IFS and the NIESR – see BBC report with posted link @12.

That longer commentary is in line with the ST letter – and it’s very difficult to make a credible case that the IFS and the NIESR are full of incompetent economists; The keynote of the IFS commentary is that the governments needs to be more ambitious in planning to restore a sustainable fiscal position.

IMO political parties and activists really don’t like to “notice” and comment on the IFS and the NIESR because those two institutions are too independent and too widely respected beyond the political domain.

Luis, you are certainly right that some of this is about mood music and a broad message being sent by these economists. But even then I think there is an obligation to be consistent: you can’t really ask for much tougher mood music but then run scared of the likely outcomes when that mood music turns into actual policy decisions.

I really can’t understand what is so objectionable about that letter to the ST given the earlier commentary by the IFS and the NIESR, about the need for greater ambition on the part of the government in restoring a sound fiscal position, or this speech by Mervyn King, Governor of the Bank of England, in June of last year:

“The scale of the [fiscal] deficit is truly extraordinary. 12.5pc of GDP is not something that anybody would have anticipated even a year or two ago and this reflects the scale of the global downturn. But it also reflects the fact that we came into this crisis with fiscal policy itself on a path that wasn’t itself sustainable and a correction was needed.”
http://news.bbc.co.uk/1/hi/business/8117388.stm

The last sentence is especially telling: “we came into this crisis with fiscal policy itself on a path that wasn’t itself sustainable and a correction was needed.”

Seems all those dreadful economists who were commenting years ago about the fiscal black holes (structural deficits, in the jargon) in GB’s budgets even before the financial crisis were on to something. Which is probably why some feel so inclined to rubbish economists.

30. Economist girl

Maybe I’m being wildly optimistic but I think the letter is a warning to the Tories not to “slash and burn” at any expense or for ideological reasons whilst admitting that our government finances need some sorting out.

“Maybe I’m being wildly optimistic but I think the letter is a warning to the Tories not to ‘slash and burn’ at any expense or for ideological reasons”

Absolutely. Suddenly at the end of January, for reason of no transparent political pressures, Cameron felt impelled to make a public statement:

“A Conservative government would not make ‘swingeing cuts’ to public spending during its first year, party leader David Cameron has told the BBC.”
http://news.bbc.co.uk/1/hi/uk_politics/8490024.stm

Now there are good “economic” reasons which could have motivated that rush statement – namely the mounting evidence of the faltering recovery across the Eurozone bringing an increased likelihood of a double-dip recession in Europe:

“Germany’s recovery from recession faltered in the final quarter of 2009, according to preliminary figures released on Friday. The German economy failed to grow at all in the last three months of the year, with GDP unchanged compared with the previous quarter.”
http://news.bbc.co.uk/1/hi/business/8511954.stm

Like it or not, what happens in the Eurozone matters to Britain’s economy because the Eurozone is our main export market and we are relying on the depreciation of the Pound against the Euro and the US Dollar to boost our export sales.

The Conservatives do seem to be flip-flopping about public spending cuts. Whatever else, we can’t rationally blame GB for the fragile state of the Eurozone economies.

32. Golden Gordon

By the way Luis I am not scoring points I am interested on views on the matter.

“There were plenty of economists with their eye on the ball, but they were ignored.”

Yes, but there were other economists -mostly the ones on the payroll of banks, multi-nationals, governments, and right wing think tanks, although some actually believed it, – who thought there was no problem.

It’s the latter that tend to have higher profiles in the media, who appear on newsnight, get quoted in newspapers etc. They also tend to be the ones who offer opinions that many people concerned about poverty, environmental issues, and social policy etc find to be instinctively unethical. i.e they’ll defend sweatshops, say its better for global warming to destroy third world countries because we’ll make more money from arctic shipping, fail to understand that sometimes people really are treated badly by the employer and can’t always escape such a situation – indeed many don’t even understand the concept of vulnerability. They’ll also offer analysis of other social problems that is – to borrow a phrase – sociologically illiterate. (Stephen Levitt – that means you).

In fairness though I suppose this is just as much about the mainstream media as it is economics. Its easier for a churnalist to offer a soundbite from prof X that reinforces the prejuduces of the editors and owners than it is to explain a complex analysis.

34. Luis Enrique

Quote from chief economist of IMF:

It was tempting for macroeconomists and policymakers alike to take much of the credit for the steady decrease in cyclical fluctuations from the early 1980s on and to conclude that we knew how to conduct macroeconomic policy. We did not resist temptation.

Bob is right that there were warnings (and, if you wanted to look in the academic literature, plenty of reasons to suppose financial markets should not be trusted) but I reckon truth is that the economic mainstream – the consensus that actually informed policy – had dropped the ball.

35. Stuart White

Economist Girl @ 9: there are indeed some big names on the list of signatories. But there are also quite a lot of big names who are conspicuous by their absence.

@33: “It’s the latter that tend to have higher profiles in the media, who appear on newsnight, get quoted in newspapers etc.”

IMO, that’s absolute nonsense. Professional economists worth anything are very much aware of the IFS and the NIESR. Mervyn King, Governor of the Bank of England, is an economist well reputed in American academia. He, like Charles Goodhart and Roger Bootle – who expressed warnings about the house-price bubble in 2002/3 – are hardly shrinking violets.

The real problem was and is that New Labour fans don’t like any warnings or bad news. The result is that essential policy corrections are neglected.

It’s curious how quiet Ed Balls, Yvette Cooper and Ed Miliband are being through all this as they are part of GB’s inner circle and are highly educated economists. In one capacity or another, they were in positions of influence when the policy mistakes were made – eg Yvette Cooper was the minister responsible for housing from 2005 through 2008. Of course, the senior minister responsible at the time was John Prescott but he was rather pre-occupied with what is up Tracey Temple’s skirt according to many news reports.

37. Economist Girl

“Its easier for a churnalist to offer a soundbite from prof X that reinforces the prejuduces of the editors and owners than it is to explain a complex analysis.” – Planeshift

Totally. Despite what people would have you believe, economics is often very complex and subtle, and you have to be very talented (e.g. Krugman) to be able to communicate the ideas to an audience with little or no economic education, and even then it doesn’t often get through.

I also agree with Bob B (36) that when economists do voice their policy concerns they’re ignored, either because people just don’t like what they’re hearing or because what they’re saying doesn’t sit well politically.

Stuart White @ 35, you’re right. I don’t know how widely the letter was circulated, it would be very interesting to know if anyone was asked to sign and refused.

Bob, part of the problem was the mechanisms for specifically dealing with asset price inflation such as the property market did not really exist or were not central to the core objectives of the FSA and BoE. The blunt tool of raising interest rates to cool the property market was hardly likely to go down well with British industry when it raised their costs and caused unemployment. The thinking was very much that the costs of clearing up after the bursting of a bubble were less than preventing the bubble in the first place. There is no reason to suppose that Ed Balls, Yvette Cooper and Ed Milliband did not believe this as it was virtually received wisdom at the time.

The BoE in their stability reports were warning throughout the noughties of the risks to the UK banking sector of relying on the interbank market for financing. However, other than write reports they lacked the tools to do anything about it. It was the paralysis and liquidity seizure in this market that crippled the UK banking sector. Therefore, warnings are pretty meaningless if the policy tools to tackle the risks do not exist. Especially if the warnings do not resonate with the consensus and dominant thinking. It is for all those reasons that the dominant policy theme in the future will be concentrating on countercyclical capital requirements as a means to control reckless lending.

Richard: “Bob, part of the problem was the mechanisms for specifically dealing with asset price inflation such as the property market did not really exist or were not central to the core objectives of the FSA and BoE. ”

Absolutely. There’s a broad consensus (I think) that the bursting of asset-price bubbles can wreck havoc on an economy (eg the stagnation of Japan’s economy after 1992) but there is no consensus about how to identify when an asset-price bubble is inflating or what to do about curbing it.

A statement of the bleeding obvious is that a large part of the problem is that asset-price bubbles, while they are inflating, tend to be hugely popular with owners of the assets – not many house owners in Britain were complaining when house prices were rising relative to other prices until the autumn of 2007:

“American house prices rose 124% between 1997 and 2006, while the Standard & Poor’s 500 index fell by 8%; half of US growth in 2005 was house-related. In the UK, house prices increased by 97% in the same period, while the FTSE 100 fell by 10%.”
Robert Skidelsky: Keynes – The Return of the Master (Allen Lane 2009) p.5.

Of course, one sad consequence was that houses became increasingly unaffordable for those who weren’t already house owners – and most observers of the political scene would probably hope that a New Labour government would have wanted to do something about that. Unfortunately, Blair was pre-occupied with being good to GW Bush and promoting a war with Iraq.

See this recent call by Lord Turner (chairman of the FSA) for powers to deal with asset price bubbles:
http://www.ft.com/cms/s/0/d2bf7a9c-0b4c-11df-9109-00144feabdc0.html

The issue in hindsight is why was there so little debate about this before?

40. Luis Enrique

Paul Krugman says that another letter, from a bunch of economists who disagree with the first bunch of economists, will appear shortly.

It would be hilarious if former MPC member Willem Buiter’s name is on the second letter. He is married to Anne Sibert who signed the first letter. Maybe now he works for Citi will prevent him commenting.

I can hardly bear to wait for this second letter. Presumably, it will take on the IFS, the NIESR and Mervyn King of the BoE, as well as the signatories of the first letter who include several prominent Labour Party supporters, including a peer who was a shadow minister when John Smith was leader as well as being an economics prof at the LSE.

Try Marin Wolf in Wednesday’s FT on: How to walk the fiscal tightrope that lies before us:
http://www.ft.com/cms/s/0/7467f85e-1b30-11df-953f-00144feab49a.html

Wolf duffs ups the Conservative argument against the fiscal boosts but still comes down for reducing the (worryingly high) forecast ratios of public debt to GDP. Sooner or later, Britain’s fiscal stance has to be restored to a sustainable trajectory.


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  1. Liberal Conspiracy

    Economists' letter supporting Osborne says nothing much at all http://bit.ly/9Wsq7M





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