The Economist’s misguided lecture to macroeconomists

In a bizarre leader article The Economist praises microeconomists for their use of data to better predict people’s behaviour and recommend macroeconomists do the same:

Macroeconomists are puritans, creating theoretical models before testing them against data. The new breed [of microeconomists] ignore the whiteboard, chucking numbers together and letting computers spot the patterns. And macroeconomists should get out more. The success of micro is its magpie approach, stealing ideas from psychology to artificial intelligence. If macroeconomists mimic some of this they might get some cool back. They might even make better predictions.

I’m tempted to label this as obvious baiting but the misunderstanding is deeper than that. Read more

Fiscal rules, growth and the ZLB

Yesterday I wrote that the consequence of a fiscal rule with a short horizon has been austerity, which delayed the UK’s economic recovery. Of course, that analysis misses a very important element of the recent recession, which is that the UK’s monetary policy was at the ZLB. That greatly increased the effect of fiscal policy on GDP in a way that wouldn’t happen in normal times. It’s also why Portes and Wren-Lewis recommend that any fiscal rule be suspended during periods where monetary policy is at the ZLB. So why am I really worried about a growth cost that is only realised in very unusual circumstances?

If the ideas about secular stagnation turn out to hold water then we may be hitting the ZLB far more often in the coming decades. Even if that doesn’t eventuate, real interest rates have been trending down for a long time, which has led some people to recommend a higher inflation target to avoid the ZLB in future. The upshot is that, unless there are changes to the standard monetary policy regime–flexible targeting of 2 per cent inflation–high fiscal multipliers and fiscal activism may become a regular occurrence. If it does then the government’s fiscal rule had better work during those times, too.

Why fiscal rules matter: growth

Last week I discussed the importance of good fiscal rules for sustainability, but the recent mess in the UK has demonstrated how poor rules can inhibit growth. When the Government took office in 2010 it faced a startlingly high deficit. It promised to eliminate that within five years, which happens to be the length of a Parliament in the UK. That’s probably not a coincidence. As Portes and Wren-Lewis point out in their paper, Governments like operational targets that they can achieve within their term of office. If you face a big hole in your budget then promising to fix it within the decade is no good if you might only be in power for half that time.

That has important consequences for the way surpluses and deficits are dealt with. It means that governments tend not to save surpluses beyond their term because they reap little benefit from it. They also attempt to close deficits within the term, which can be too rapid when the deficit is large. The recent recession in the UK is a textbook example of the latter problem. Read more

Re-opening the NGDP targeting argument

Did you follow the NGDP targeting debate with interest but bemoan the lack of theoretical arguments? Then you’ll love the latest iteration of the debate, in which ex-Bank of England macroeconomist, Tony Yates, takes on Oxford’s Simon Wren-Lewis.

Tony’s initial swings at NGDP targeting focus on the sub-optimality of weighting inflation and output equally:

I don’t see that following a levels target of any variety, NGDP or otherwise, is an alternative to raising the long run average inflation rate, however implemented.  There’s no choice but to bite the bullet and figure out a different trade-off, between the costs of long run higher inflation, and the costs of higher volatility imposed by missing stimulus at the zero bound.

Simon is more positive about NGDP targets and garners another reply from Tony. The whole exchange is well worth reading for anyone with an interest in monetary policy.

Should the OBR cost Opposition proposals?

Today has seen a debate over whether the Office for Budget Responsibility should cost Opposition policies. Sajid Javid appeared on the BBC to defend the Government’s decision not to allow it. He avoided criticising the idea but pushed the Government’s line that now is not the right time to extend the OBR’s mandate. On the other side of the debate, Simon Wren-Lewis criticises the Government for delaying.

am a big fan of extending the OBR’s responsibilities but there are solid reasons for the Government to demur. Read more