Show Hide image

Making things up as you go along

The letter to the Sunday Times was political opportunism dressed up as economics.

I found time last week for a couple of rounds at the best golf course in the world, Royal Dornoch, where I am a proud member. It had been closed for a month because of the lingering snow but opened again the day we arrived. Records show that golf was first played on the links near the Dornoch Firth as early as 1616, making it the third-oldest course in the world after St Andrews and Leith.

It's like going to a Rolling Stones concert - they've been doing their stuff for so long, they just know how to put on a great show. This isn't one of those dreadful Jack Nicklaus-designed courses that ordinary mortals play once and never return. Nobody was let loose with a bulldozer here. Rolling terrain, sandy soil, no trees, spectacular views and certainly no bloody man-made lakes. Royal Dornoch is a subtle masterpiece designed by God. Ask anyone.

But the Bank of England had produced its latest Inflation Report, which contains the MPC's UK economic forecasts for both growth and inflation. So I got up at 5am Florida time to watch the press conference on the internet, having arrived back from Europe the previous night. I was particularly struck by how gloomy Mervyn King was, despite his apparently invigorating ride on a dogsled in Iqaluit, in Arctic Canada, at the G7 meeting a few days earlier, where he was photographed dressed as a penguin.

Theory out of thin air

The latest inflation numbers, published on 16 February, showed that the consumer price index rose by 3.5 per cent, driven primarily by petrol prices and the increase in VAT from 15 per cent to 17.5 per cent. This meant that the Monetary Policy Committee had to write a letter to the Chancellor, Alistair Darling, explaining why inflation is above target. The letter simply said don't worry, inflation will fall back down very quickly - and it will. And Darling, in his published response to the MPC letter, agreed that the rise was just a hiatus.

The MPC's growth forecast is extremely optimistic, and considerably more so than the one produced recently by the National Institute of Economic and Social Research (see last week's NS). If output turns out lower than the MPC forecast, it is likely inflation will be a lot lower. This would also be the case if there were to be further fiscal tightening over and above what is in the pre-Budget report. Any such tightening would depress growth, raise unemployment and increase the probability that before two years are up, the MPC will have to write another letter to the Chancellor explaining why inflation is so far below the target. Its forecast certainly makes it clear to the markets that interest rates are not going to rise any time soon.

In a letter to the Sunday Times on 14 February, 20 academic macroeconomists, including four ex-members of the MPC, suggested that the UK needed a credible medium-term fiscal consolidation to make a sustainable recovery more likely. They went on to argue: "The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery." It is very hard for anyone to disagree with those statements.

But then the 20 Tory apologists went a step too far into much more dangerous territory. They argued that, "in order to be credible, the government's goal should be to eliminate the structural current Budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year".

How do they possibly know this?

This is just the economics of making things up as you go along. They have no basis in economics for any such claim about timing, period. Further, economics has zero to say about whether, if there is tightening, it should be by £5 or £50bn. This is just political opportunism dressed up as economics.

Even though the authors of the letter suggest that there is a "compelling case" for acting swiftly, they provide no basis for such claims, compelling or otherwise. How do they know, for example, what the economic situation will be in, say, six months' or 12 months' time? What if there is evidence that the economy has gone into a double dip; would they just ignore that and proceed regardless? What if unemployment got much worse than is forecast? How do the 20 know that won't happen?

These are imprudent judgements. I tell my students that they should always be mindful, when making a policy prescription, that they should concentrate not so much on the advantages if they were right, but, most importantly, on the costs if they were wrong. The 20 economists' statement merely shows a lack of understanding of the world as it is.

Proceed with caution

Any businessman would be extremely cautious in taking advice that could drive his firm into bankruptcy, and so should any adviser advocating a policy that could badly exacerbate a recession. Interestingly, the Labour peer Lord Desai, a signatory of the Sunday Times letter, apparently agrees, arguing in an interview that "obviously during a recession you have to spend extra money, the deficit has to go up to get rid of unemployment. But once all that has passed us [my italics], we will have to tackle this because we can't go on borrowing money." "Once all that has passed us" is right, but it hasn't.

The danger of removing stimulus too soon is clear in the economics textbooks, not least because of the work of Christina Romer, chair of President Barack Obama's Council of Economic Advisers, and Ben Bernanke, chairman of the Federal Reserve. In the back of every economist's mind should be what happened in the US in 1937, when stimulus was removed too early and the economy turned back into a double-dip recession.

In a paper published on 12 February, the IMF's chief economist, Olivier Blanchard, warned that much thinking by academic macroeconomists leading up to the recession, especially its focus on having one target - inflation - and one instrument to control it - the interest rate - was misplaced. "What is clear, however, is that the behaviour of inflation is much more complex than is assumed in our simple models and that we understand the relationship between activity and inflation quite poorly." No kidding.

It was macroeconomists like this lot who got us into this mess in the first place. Why trust them now? I don't.

David Blanchflower is Bruce V Rauner Professor of Economics at Dartmouth College, New Hampshire, and the University of Stirling.

David Blanchflower is economics editor of the New Statesman and professor of economics at Dartmouth College, New Hampshire

This article first appeared in the 22 February 2010 issue of the New Statesman, IRAN