Tuesday, May 5, 2015


Peter Spence has a long and rambling discussion of the debate in the UK over macroeconomic policy, which includes this from George Osborne:
George Osborne, the Chancellor, has also spoken in defence of the central bank’s aggressive response to the financial crisis. He has argued that a combination of “tight fiscal policy and loose monetary policy is the right macroeconomic mix” to help rebalance the economy.
The “right macroeconomic mix” depends on what the question was. Suppose you were an economist working for Reagan’s Council of Economic Advisers in early 1983 when a toxic mix of expansionary fiscal policy offset by incredibly tight monetary policies had sent interest rates soaring and the currency through an incredible real appreciation. Back then the Volcker FED was begging policy to change the macroeconomic mix. Wouldn’t you advise the President to take up the offer? But the UK has been in a very different situation as Paul Krugman explains:
The interesting line, however, is Yates’s note that Britain had relatively high inflation in 2010-2011, which might have meant that the economy faced supply-side rather than demand-side problems, so contractionary policy might have been appropriate. My question is this: even if you accepted that argument, wasn’t that an argument for monetary rather than fiscal contraction? And if the BoE didn’t consider the evidence of overheating sufficient to justify pulling back on its quantitative easing, which had already tripled the size of its balance sheet, why should the Treasury have decided to tighten on its own? After all, the basic logic of the situation is that you should wait until monetary tightening — until the central bank is starting to move off the zero lower bound — before fiscal consolidation. That way you can trade off fiscal tightening for a slower pace of monetary tightening, and avoid deepening the slump. But in 2010-2011 the British central bank wasn’t ready to tighten in any case, so fiscal policy should have waited.
But it gets worse when you consider what Peter Spence was writing about:
After a full parliament of near zero interest rates and quantitative easing, some are beginning to wonder whether the nation’s savers have been forgotten. The Bank of England has taken the brunt of the protests, accused of forgetting the interests of the thrifty at best, and at worst of stealing from them by generating inflation.
It may be true that low real interest rates have led to lower portfolio income for certain savers but this is not the doing of the Bank of England as it was the stupid decision to pursue fiscal austerity that kept UK economic growth low, which induced the Bank of England to do the right thing – lower interest rates. Had the Cameron government not engaged in this fiscal austerity, the UK economy would be closer to full employment which would likely mean higher real interest rate might be a reasonable monetary policy.


reason said...

"George Osborne, the Chancellor, has also spoken in defence of the central bank’s aggressive response to the financial crisis. He has argued that a combination of “tight fiscal policy and loose monetary policy is the right macroeconomic mix” to help rebalance the economy."

I've come increasingly to the conclusion that this is 100% wrong. Just look at the implications from the point of view of the typical pension fund. The supply of safe government bonds is going down (tight fiscal policy), but the amount of private debt is going up (loose monetary policy - I'm assuming here that monetary policy will work mainly through the credit channel and less through relative currency prices). The amount of private debt going up will be a combination of investment funding and personal credit, but the net effect must be to push asset prices up and yields down.

Now my question - doesn't higher levels of private indebtedness, high asset prices and less safe (government guaranteed) assets imply less financial stability? Doesn't that also mean that relatively small disturbances can push a proportion of the more leveraged population into negative net financial positions (i.e. insolvency)?

Now the big question - why is this a good thing?

john c. halasz said...

Just to add to "reason"'s point, any wealth effect consumption stimulus from ZIRP and QE induced financial asset inflation is likely to be counterbalanced and even swamped by the contrary need of retirement savers and insurance companies to increase their purchases of over-priced assets to assure sufficient future income flows to meet future contingent liabilities. And, of course, the flattening of yield curves and risk premia, due to the induced shortage of "safe" assets, will result in distorted investment allocations, under-compensated returns-to-risk, and, of course, guaranteed capital accounting losses, once interest rates were to re-normalize.

reason said...

thanks for the support. Now the second big question: Why aren't any mainstream economists (apart from indirectly and incoherently Brad Delong) pushing this line. Why is the (originally IMF pushed I think) line that a tight fiscal, loose monetary policy mix regarded as the way to go? I can only think it depends critically on what I mentioned as an aside assumption that MONETARY policy works MAINLY through the credit channel and less through relative currency prices, is not accepted. I can understand why the IMF dealing with LDCs may have thought this a reasonable assumption, but it is harder to understand why it is taken over without question by those responsible for large developed economies.

reason said...

pgl - I really would like to see what you think of think of this. You have a bigger megaphone than I do.

ProGrowthLiberal said...

Reason - I finally got around to this. I know Simon Wren Lewis and Paul Krugman have been addressing your query. And they have also been very critical of the IMF.