Nobel-prizewinner Paul Krugman on the austerity lie the British people are being sold

This Snookered Isle
Britain's Terrible, No-Good Economic Discourse

The 2016 election is still 19 mind-numbing, soul-killing months away. There is, however, another important election in just six weeks, as Britain goes to the polls. And many of the same issues are on the table.

Unfortunately, economic discourse in Britain is dominated by a misleading fixation on budget deficits. Worse, this bogus narrative has infected supposedly objective reporting; media organizations routinely present as fact propositions that are contentious if not just plain wrong.

Needless to say, Britain isn’t the only place where things like this happen. A few years ago, at the height of our own deficit fetishism, the American news media showed some of the same vices. Allegedly factual articles would declare that debt fears were driving up interest rates with zero evidence to support such claims. Reporters would drop all pretense of neutrality and cheer on proposals for entitlement cuts.

In the United States, however, we seem to have gotten past that. Britain hasn’t.

The narrative I’m talking about goes like this: In the years before the financial crisis, the British government borrowed irresponsibly, so that the country was living far beyond its means. As a result, by 2010 Britain was at imminent risk of a Greek-style crisis; austerity policies, slashing spending in particular, were essential. And this turn to austerity is vindicated by Britain’s low borrowing costs, coupled with the fact that the economy, after several rough years, is now growing quite quickly.

Simon Wren-Lewis of Oxford University has dubbed this narrative “mediamacro.” As his coinage suggests, this is what you hear all the time on TV and read in British newspapers, presented not as the view of one side of the political debate but as simple fact.

Yet none of it is true.

Was the Labour government that ruled Britain before the crisis profligate? Nobody thought so at the time. In 2007, government debt as a percentage of G.D.P. was close to its lowest level in a century (and well below the level in the United States), while the budget deficit was quite small. The only way to make those numbers look bad is to claim that the British economy in 2007 was operating far above capacity, inflating tax receipts. But if that had been true, Britain should have been experiencing high inflation, which it wasn’t.

Still, wasn’t Britain at risk of a Greek-style crisis, in which investors could lose confidence in its bonds and send interest rates soaring? There’s no reason to think so. Unlike Greece, Britain has retained its own currency and borrows in that currency — and no country fitting this description has experienced that kind of crisis. Consider the case of Japan, which has far bigger debt and deficits than Britain ever did yet can currently borrow long-term at an interest rate of just 0.32 percent.

Which brings me to claims that austerity has been vindicated. Yes, British interest rates have stayed low. So have almost everyone else’s. For example, French borrowing costs are at their lowest level in history. Even debt-crisis countries like Italy and Spain can borrow at lower rates than Britain pays.

What about growth? When the current British government came to power in 2010, it imposed harsh austerity — and the British economy, which had been recovering from the 2008 slump, soon began slumping again. In response, Prime Minister David Cameron’s government backed off, putting plans for further austerity on hold (but without admitting that it was doing any such thing). And growth resumed.

If this counts as a policy success, why not try repeatedly hitting yourself in the face for a few minutes? After all, it will feel great when you stop.

Given all this, you might wonder how mediamacro gained such a hold on British discourse. Don’t blame economists. As Mr. Wren-Lewis points out, very few British academics (as opposed to economists employed by the financial industry) accept the proposition that austerity has been vindicated. This media orthodoxy has become entrenched despite, not because of, what serious economists had to say.

Still, you can say the same of Bowles-Simpsonism in the United States, and we know how that doctrine temporarily came to hold so much sway. It was all about posturing, about influential people believing that pontificating about the need to make sacrifices — or, actually, for other people to make sacrifices — is how you sound wise and serious. Hence the preference for a narrative prioritizing tough talk about deficits, not hard thinking about job creation.

As I said, in the United States we have mainly gotten past that, for a variety of reasons — among them, I suspect, the rise of analytical journalism, in places like The Times’s The Upshot. But Britain hasn’t; an election that should be about real problems will, all too likely, be dominated by mediamacro fantasies.

Paul Krugman

http://mobile.nytimes.com/2015/03/23/opinion/paul-krugman-britains-terrible-no-good-economic-discourse.html?referrer=

Wasn't quite sure whether to put that in US or UK lol

The man talks total sense.

Since the financial crisis of 2008, there has been a robust, and at times heated, debate among economists over the proper role of activist fiscal policy—not just in a slump, but in an economy like ours, that’s been in recovery for years. No one has been more active in that debate than Nobel economist and New York Times columnist Paul Krugman.
“How many people, I wonder,” [url=http://krugman.blogs.nytimes.com/2015/01/06/the-record-of-austerity/?module=BlogPost-Title&version=Blog main&contentcollection=Opinion&action=Click&pgtype=Blogs®ion=Body&_r=1]Krugman recently asked[/url], “even among economists who have eagerly taken sides in the austerity debate, have a sense of what the overall picture looks like since the great turn to austerity in 2010?”
Thus the man who has most eagerly taken the anti-“austerity” side of the debate sets us up for the Big Picture—the bracing, visual proof that he was right all along about the need for much more government spending. And here it is.
Paul Krugman’s Figure

Looking at 33 advanced countries over four years, from 2010 to 2013, Krugman plots the change in real gross domestic product (GDP) against real government purchases. They clearly move together. “Does this picture,” he then asks triumphantly and rhetorically, “make you think that Keynesian economics is nonsense?”

What you’re supposed to say is “no.” Governments clearly must spend more when growth is poor to get the economy back on track. And lest we think that this conclusion might be unscientific, Krugman tells us that the t-statistic—a measure of how likely his finding is real rather than dumb luck—is 7.7. A t-statistic of 1.96 means that it’s only 5% likely that the relationship between changes in growth and government purchases is spurious; Krugman’s t-statistic is a whopping four times higher so there is virtually no chance that he is wrong.
Right?
Wrong.
Though he could easily have done so, Krugman decided not to look at whether monetary policy mattered. What is remarkable about this is that eminently respectable economists had been pointing out this failure for years. “Why do Keynesians,” Scott Sumner asked on his blog, “show cross-sectional graphs of fiscal austerity and growth, mixing in countries that have their own independent monetary policy with those that do not?” Why indeed. Sumner’s point is that countries that have independent monetary policy can, in principle, offset fiscal drag with more accommodative monetary policy.
So is he right? Can they? Let’s see.
Below, on the right, I re-do Krugman’s figure for advanced countries with independent monetary policies. This is important, since crisis-hit Eurozone countries can’t use monetary policy.

Lo and behold, Krugman’s spending-growth relationship collapses entirely (the line actually slopes, insignificantly, in the opposite direction). This is just as Sumner would have expected. So much for Krugman’s t-statistic.
Krugman, the objective, model-driven economist behind the blog named “The Conscience of a Liberal,” has been [url=http://krugman.blogs.nytimes.com/2015/02/27/the-closed-minds-problem/?module=BlogPost-Title&version=Blog main&contentcollection=Opinion&action=Click&pgtype=Blogs®ion=Body]relentless in his criticism of political bias and closed-mindedness[/url] among economists on the right since the crisis—rightly, in many cases. It is hard to be honest and to claim to have learned nothing new, since the crisis, about how economic policy works—or doesn’t work. I certainly underestimated how powerful monetary policy could be at the zero interest rate bound—but this could hardly be denied after the experience of 2013, in which a massive Fed asset purchase program (which followed on the backs of programs in commercial paper, etc.) offset a massive fiscal crunch.
“Sorry, guys,” Krugman wrote in April that year, “but as a practical matter the Fed—while it should be doing more—can’t make up for contractionary fiscal policy in the face of a depressed economy.” But it did.
Sorry, Paul, but your chicken-soup theory of monetary policy—it probably won’t help, but it couldn’t hurt—is not only frivolous, but wrong. Would you like to see the t-statistic?


http://www.forbes.com/sites/realspin/2015/03/12/the-austerity-wars-debunking-paul-krugman/

Krugman Gets the Big Picture Right

In about 1980, there was a big change in the way academic economists did macroeconomics. The old method was to write down a system of equations representing macroeconomic quantities (gross domestic product, investment, etc.). The new way was to write down an optimization problem, representing the decision-making of one or more agents in the economy. This approach is called DSGE (short for Dynamic Stochastic General Equilibrium). The old approach is sometimes called IS-LM which refers to the name of two curves in a graph in a classic model; they are also referred to as Old Keynesian models.

Since 2009, there has been a big debate in the economics blogosphere about whether academic econ took a wrong turn when it switched tactics. The main advocate of this view is Paul Krugman, who is a force of nature unto himself. According to Krugman, IS-LM models do a good job of explaining the essential qualitative features of what we’ve seen since the 2009 financial crisis. Krugman’s most prominent opponent in this debate is University of Chicago professor John Cochrane. In a recent post, Cochrane calls for advocates of the IS-LM approach to back up their claims with quantitative data and publish it in reputable peer-reviewed journals:

The right way to address this is with models -- written down, objective models, not pundit prognostications -- and data. What accounts, quantitatively, for our experience?…Models confront data in the pages of the [American Economic Review], the [Journal of Political Economy], the [Quarterly Journal of Economics], and Econometrica. If old-time Keynesianism really does account for the data, write it down and let's see.

It’s a legitimate challenge. But in fact, the challenge has already been met! In 1992, macroeconomist Jordi Gali, then of Columbia University, published a paper called “How Well Does the IS-LM Model Fit Postwar U.S. Data?” in the Quarterly Journal of Economics (QJE).

In that paper, Gali compares an IS-LM type model with a more modern type of statistical model called a structural vector autoregression, or VAR (this is the type of model that Christopher Sims won the 2011 Nobel Prize for inventing). Gali uses the VAR to pick out “shocks,” or surprise events, that happened to the U.S. economy in the past. He then analyzes how the old-school IS-LM model predicts that the economy will respond to those shocks, and finds that the predictions are pretty accurate.

In other words, even as far back as 1992, it was clear that IS-LM type Old Keynesian models fit the data pretty well.

So why haven’t academics kept using IS-LM models? Why haven’t they even followed up on the 1992 Gali paper? One reason is because of the Lucas critique.

The Lucas critique -- named after University of Chicago economist Robert Lucas -- says that even if a model fits the data, you can’t use it to make policy recommendations. Suppose you look in the past and see that every time the government increases spending, growth goes up. Doesn’t that mean that fiscal stimulus works? Not necessarily -- maybe it only works when people aren’t expecting it! Maybe if you raise spending on purpose in order to try to boost GDP, the correlation will suddenly break down.

I’m not saying that this is actually true of fiscal stimulus. But in general, it could be true of any policy action. This implies that if you really, really want to be sure that your policy will have the intended effect, you need to use a model that is totally structural -- a model that won’t suddenly change when you try to use it, because it’s based on things that don’t change when policy changes, such as consumer tastes or technology. Modern DSGE models are generally assumed to be structural (though some have their doubts). Old-style IS-LM models are obviously not structural, and that’s why they were abandoned, not because they failed to fit the data.

So Krugman is probably right that IS-LM models explain the past as well as anything else we’ve got. Cochrane is right to demand that IS-LM be tested against the data, but so far those tests have turned out favorably. On the other hand, if you think the Lucas critique is a big deal -- as most academic macroeconomists do, rightly or wrongly -- then just fitting the facts isn’t enough. You need to explain why those facts will hold up even if the government changes its policies. IS-LM, in its traditional form, doesn’t come with any such explanation. And unless and until it does, academia is unlikely to embrace it.

As a final note, the Federal Reserve Board still does use something quite a bit like an IS-LM model. For the Fed, at least, the Lucas critique isn't the only game in town.

http://www.bloombergview.com/articles/2014-12-12/krugman-gets-the-big-picture-right

Think maybe this should be in US Ben if you feel like moving it.