Yesterday the IMF released one of its regular reviews (“Article IV consultations”) on the UK economy. Both government and opposition seized on it to reinforce their narratives. But for observers trying to make sense of these claims by reading what the IMF’s summary actually says (here) there is a problem: it’s written in economics jargon and not English. For example, in the passage central to the controversy passage:
Under these circumstances, gains from delaying fiscal consolidation could be larger as multipliers are estimated to move inversely with growth and the effectiveness of monetary policy. To preserve credibility, reconsidering the path of consolidation should be in the context of a multi-year plan focused on further reducing the UK’s large structural fiscal deficit when the economy is stronger and taking into account risks to sovereign borrowing costs. Fiscal easing measures in such a scenario should focus on temporary tax cuts and greater infrastructure spending, as these may be more credibly temporary than increases in current spending.
What they are trying to say here is that attempting to lift the economy using a fiscal stimulus, i.e. reduced taxes and/or increased public spending, works best if growth is already low and if loose monetary policy isn’t working – which will be the case if the economy does not improve soon. But any stimulus has to be carefully designed to ensure that the government’s deficit reduction plans retain credibility. They suggest two types of policy that might achieve that: temporary tax cuts or greater infrastructure spending. In other words, not a slower pace or reversal of public expenditure cuts.
More on this later: first it helps to get a wider perspective of what the IMF is trying to say.
Their starting point is that the UK economy is currently unsustainable because of the massive government deficit (i.e. that public spending is way ahead of taxes). That means that the public sector is too large and has to be cut back to rebalance the economy. This is completely consistent with the Coalition government’s analysis, and it is where the Labour opposition is most uncomfortable. Labour draws a lot of political support from public sector workers and beneficiaries of government expenditure. They would rather not admit publicly either that the level of such expenditure before the crisis was unsustainable, or that it needs to be cut back now at anything like its current pace. But it is difficult to dispute the numbers, so they keep mum or change the subject.
But the IMF also says that there is considerable spare capacity in the economy – in other words that the private sector could expand easily if only consumer and investment demand was stronger. This fits better with the Labour narrative. Government supporters often suggest that the UK economy’s unbalanced nature was more than just an excessive public sector, which leaves little practical spare capacity, and so it is not so easy to grow through boosting demand: the extra demand might simply go into inflation or imports, for example. They point to the decline in manufacturing and the size of the “socially useless” investment banking sector before the crisis.
This leads to another point made by the IMF, which is that persistent low growth will cause longer term damage to the economy, as the spare private sector capacity whittles away. And unemployed people tend to lose their skills and value the longer they are out of work. There is a nightmare that stalks the minds of economists which they name “hysteresis” (borrowing the word from materials science) whereby people who are put out of work never get back into it, and high unemployment persists long into a recovery. Europe in the 1980s and 1990s is held up to be a prime example of this, compared to the US in the same period. The word makes its appearance in the summary.
But they do point out that UK unemployment is remarkably low compared to previous recessions, or what is going on in other economies, including the US. They put put this down to “labour market performance”, though others suggest that this has more to do with the fact that home construction played a much smaller part in the economic boom than elsewhere, and a lot of the vanished GDP was in sectors, like finance, which weren’t big employers.
The IMF report goes on quite a bit about monetary policy, not criticising the Bank of England’s performance so far, but suggesting that it could be further loosened. This might be through even lower interest rates or through “quantitative easing” – the buying of bonds by the Bank – especially if the latter was more in private sector bonds, rather then the gilts which the Bank has so far been buying.
The continued fragility of the UK banking sector causes the IMF some worry, as does the possibility of further trouble from the Euro zone. The former could provoke the government into more bailouts, which would put government finances under strain. The latter would exacerbate this problem as well as making growth more difficult. They welcome the government’s attempts to reform banking to expose government finances less to risk.
So where does that leave us? the Government can take comfort from what amounts to a strong endorsement of its policies. But by leaving open the idea of a fiscal stimulus, especially through a temporary tax cut, it gives Labour ammunition. Labour’s shadow chancellor Ed Balls can quite reasonably suggest that things are bad enough now for such a policy, without having to wait.
But, while wading through the dense economic jargon, I am left with an overwhelming impression of the blindness of macroeconomists, hiding behind their aggregated statistics and theoretical models. They don’t look far enough behind the figures. This is starkest in their faith in monetary policy. The theoretical models of money have entirely broken down in the wake of the financial crisis – but economists have placed so much weight on them that mostly they still cannot admit that they are so much garbage. The monetary authorities are left with a number of policy levers, interest rates and so on, whose effects are not properly understood. Whether looser policy will lead to any significant stimulus in demand that will lead to job creation is in fact very doubtful.
And talk of multipliers and other economic mumbo-jumbo gets in the way of trying to see if a particular form of fiscal stimulus might do more harm that good. An example of the kind of thinking that is needed comes in an article by US economist Raghuram Rajan in today’s FT: Sensible Keynesians see no easy way out. The problem with stimulus is that you have to balance the benefits now against the costs later. If the stimulus addresses the problem of unemployment, especially the long term sort, then the trade off is likely to be worth it. If it doesn’t then it won’t. Would a temporary tax cut, such as in VAT, achieve this? Personally I think the effects are likely to be marginal, and that most of the stimulus would disappear in higher prices, higher pay and increased imports. A more cogent case can be made for infrastructure spending if the infrastructure is genuinely useful to the future economy. That’s a harder test than theoretical economists allow – it is difficult to see much benefit from Japan’s massive infrastucture spending in the 1990s, for example. And the spending may not help provide jobs where they are most needed. In the UK there seems a good case for more house building: but by and large we do not need more houses where most of the unemployed people are living.
In last week’s Bagehot column in the Economist, the writer describes how people are hoping to wake up from the austerity nightmare so that they can get back to real life before the crisis. But the nightmare is reality and the pre-crisis existence is the dream.