Thursday, 15 November 2012

Faith-based economics at the Treasury Committee

I, and my colleagues Angus Armstrong and Simon Kirby, gave evidence to the Treasury Committee on Tuesday November 13th.  Should you have time and inclination, you can watch. As you would expect, we covered a range of topics: the fiscal framework and fiscal policy, multipliers, the "productivity puzzle", etc.  However, I was rather surprised by the tone of the questioning on one topic: why are long term interest rates (gilt yields) so low?  

My views on this are well known, and are set out for example hereTo summarise briefly, both theory and a variety of different types of empirical evidence suggest overwhelmingly that low long-term interest rates in the UK reflect economic weakness (domestic and global) and expectations that short-term interest rates set by the Bank of England will remain very low (again, reflecting economic weakness).  The empirical evidence, all of which I had to hand for the Committee, includes the following:
  • the fact that long-term interest rates have gone down as forecast future deficits have gone up (see the chart here); we are of course now planning to borrow even more than we thought was likely before the fiscal consolidation plan was announced; 
  •  "event studies" of how yields reacted to political or economic developments (this one comprehensively debunks the myth that gilt yields fell sharply in response to political events around the 2010 election);
  • the observed relationships between gilt yields and equity prices (they move together, suggesting bad economic news leads to lower gilt yields, as theory would predict). I explained this to the Committee (at about 11:03:30) ;
A number of questioners, however, were surprised that I did not attach any weight to the supposed "credibility" of fiscal policy, resulting from the fiscal consolidation plan put in place by the Coalition Government in June 2010.  Jesse Norman MP, for example, said (at about 10:41:45): 
 "You don't think there's anything strange about not attributing any aspects of the UK government's long-term debt yield performance to government credibility". 
Well, on the basis of the evidence described above, if the alternative is, or was, an alternative fiscal strategy that was significantly less contractionary in the short term, but still aimed at achieving long-run fiscal sustainability, then I don't (the complete absence of any serious long-run consolidation strategy would be a different matter).  So I said so (at about 10:42).  

Now it is certainly possible to argue against my views on this topic, although far fewer economists are doing so these days (no-one has really quarrelled with the IMF conclusions above, for example).  I expected to be challenged and to have to defend my reading of both the theory and evidence; that's why I was there. 

But what I found very odd was that none of the questioners on this topic seemed at all interested in why I make the arguments I do, nor were they prepared to put forward any countervailing evidence of their own. They didn't define "credibility"; they didn't specify what the "incredible" counterfactual would look like; they didn't try to explain why "credibility" should matter from a theoretical perspective; they didn't try to present any empirical evidence that "credibility" had in fact resulted in lower gilt yields. 

They simply asserted that "credibility" must have had something to do with low gilt yields, and argued that it was therefore strange that I wasn't prepared to "admit" it. Indeed, bizarrely,  Mr Norman seems to believe that I must have some, unspecified, "political" motive for not giving the credibility argument any credit; as opposed to the more simple explanation that at the moment there is simply no significant evidential support for his position. 

Essentially, this is faith-based economics.  You start by saying something that sounds plausible at the time, and seems to reflect "common sense".   That's fine, up to a point. What's not fine is to react to evidence that contradicts your theory, not by adjusting the theory but by repeating it, only louder.  Eventually you risk ending up in a position, like Mr Norman, where the evidence is neither here nor there. If someone makes a nuisance of themselves by  refusing, in the absence of evidence, to accept your theory, then he or she must have some more sinister motivation (to be fair, this was just Mr Norman: none of the other questioners remotely suggested this). 

Now, the Treasury Committee is hardly the Inquisition (and I'm no Galileo - although I can just imagine Galileo saying:  "I could handle the torture, but then the Florentine Physics Research Council threatened to cut off my funding..").  The discussion on some other issues (fiscal multipliers, "zombie companies") was much more constructive.  And I should also be clear that I have immense respect for the Committee Chairman, Andrew Tyrie, whose integrity and independence are unimpeachable, and who I believe to be doing an excellent and very difficult job overall (he has a particularly challenging task in chairing the Parliamentary Commission on Banking Standards).  But faith-based economics (over the last 10 years, not just the last two) got us into this economic mess; it won't get us out of it.  

6 comments:

  1. It's sad, because even though 'credibility' is by its nature a vague and subjective concept, we do have a simple indicator, regularly published by the Treasury, that covers the relevant kind of credibility.

    The independent forecasts of government borrowing show how credible people find the fiscal plans. And, as you and I and others have said time and again, these forecasts have got worse and worse, meaning that the government's plans are seen as less and less credible.

    And yet, as this has happened, the cost of government borrowing has come down. Therefore credibility can't be the explanation for cheaper borrowing.

    ReplyDelete
    Replies
    1. In normal economic times, when the private sector is booming, excessive government borrowing will increase credit growth and risk raising inflation. Strong growth and higher inflation means that the central bank/bond markets must raise interest rates, including the interest rate on government bonds. In this scenario, a policy of cutting deficits, if credible, will reduce the pressure on the central bank to raise rates.

      So the economic experience from 1956-2006 teaches us to follow the Osborne plan.

      But now the private sector is de-leveraging, there is a need for the government to borrow more to sustain credit growth and economic demand, lest we sink back into recession. The weakness of the economy means there is little risk of demand-pull inflation and there is absolutely no need to raise interest rates as this will only kill off weak private sector credit growth.

      Richard Koo says the leveraging and de-leveraging cycles are like Yin and Yang, requiring completely different economic thinking.

      Delete
  2. Jesse comes badly out of this. He seems to go straight into an 'ad hominem' attack on you, suggesting your considered economic views are driven by political animus against the Government. You did well to stand your ground.

    ReplyDelete
  3. Seems like an overly inflammatory title. Show me an economic forecast that doesn't use assumptions and we can start referring to the others as "faith-based".

    ReplyDelete
    Replies
    1. As long as the assumptions are clear (for example, that there is, say, no exit from the EU) I don't see an equivalence.

      Delete
  4. As many other employed people I also had several credits. It is better to have one concern than many, so I made the decision about restructuring of the credit. I used http://creditcard-consolidationloan.com/ service to effectively cover my debts and pay significantly less every month. They will help you to find preferred payment schedule and interest fee.

    ReplyDelete