The gullible economist

I think John Cochrane has lost his marbles. Or maybe his dispute with Paul Krugman has blown his brains. Anyway, he has written one of the worst op-eds I have ever seen.  He even quotes George Osborne as an authority on (the problems with) Keynesian economics. You couldn't make it up.

Cullen fisked about half the article but gave up in disgust when he encountered this little gem:
By Keynesian logic, fraud is good; thieves have notoriously high marginal propensities to consume.
Noah, who clearly has a stronger stomach, read all of it, understood most of it, and summed it up in one word.

But not being British, both Cullen and Noah missed the sheer idiocy of this statement (emphasis mine):
With the 2013 sequester, Keynesians warned that reduced spending and the end of 99-week unemployment benefits would drive the economy back to recession. Instead, unemployment came down faster than expected, and growth returned, albeit modestly. The story is similar in the U.K.
Oh no it isn't. These are the real GDP growth paths for the US, UK, Euro area and Japan since the Lehman shock, according to ONS:

The UK and the US don't look very similar in this chart, do they? By the way, the effect of the sequester is clearly visible on the US line. What had been rather good GDP growth suddenly fell. So much for Cochrane's claim that austerity caused "modest" growth to return.

This is UK employment versus GDP over the same period:

This chart shows that UK GDP was actually recovering until Q3 2010, when it started to tail off. From mid-2011 to mid-2012 it flatlined. Similarly, hours worked and employment were both increasing until Q3 2010, when they started to tail off. Both employment and hours worked actually fell in 2011. 

Well, ok, this is employment and hours worked. What about unemployment?

Well I never. Unemployment actually rose in 2011. It didn't really start to fall until 2013.

So it seems that the UK was recovering nicely until towards the end of 2010, when it was hit by some kind of shock that clobbered both growth and employment. It did not start to recover from this second shock until 2013.

There are a number of theories as to what this shock might have been. Monetary tightening by an angry Bank of England governor determined to discipline wayward banks, oil price shocks, and the crisis in the Eurozone have all been suggested as possible causes. And so has fiscal consolidation.

The Coalition government was elected in May 2010 on an austerity mandate driven by concerns about the size of the UK's deficit in the light of the growing crisis in Greece. The majority of the Coalition's spending cuts were actually made in the first half of 2011, though they were announced long before that: but what is not often reported is that the previous Labour government had already introduced consolidation measures. Austerity actually began in the middle of 2010.

The spike in unemployment in 2011 shown on the chart above is due to public sector job cuts and the entry to the workforce of single mothers and sick/disabled people due to benefit changes. Unlike the US, the participation rate in the UK has actually risen since 2008: this is evident from the fact that although unemployment is still above its 2008 level, both employment and hours worked are now ALSO above the 2008 level. There simply are more people working.

But despite a fairly substantial increase in the workforce, the UK's GDP growth remained well below its pre-crisis trend. This is due to the UK's dismal productivity. There may be lots more people in the workforce, but they aren't producing much. The reasons for this are unclear, but low business investment seems a likely cause, coupled with the fact that many of these new entrants to the workforce have poor skills and and an inflexible lifestyle.

The fact is that GDP flattened and unemployment rose in the UK as a direct consequence of fiscal consolidation by both Labour and Coalition governments. Yes, a DIRECT consequence. In March 2013, Robert Chote, the head of the OBR, confirmed in a letter to David Cameron that OBR calculations showed Government tax rises and benefit cuts had reduced GDP:
....applying these multipliers to the consolidation measures put in place by the previous and current governments would have been sufficient to reduce GDP in 2011-12 by 1.4%. 
Nor was the OBR particularly generous with its multipliers. Chote admits that IMF research showed multipliers could be much larger after a financial crisis, which would imply that the fall in GDP from premature fiscal consolidation might be even more.

Growth finally returned at the beginning of 2013. Exactly why is unclear. It seems likely that the Bank of England's Funding for Lending scheme kickstarted growth by stimulating mortgage lending. Dis-saving by the elderly and PPI windfalls may also have played a part. And the Chancellor's 2012 Autumn Statement announced plans to increase expenditure on infrastructure and provide support for housebuyers, which was followed up in the 2013 Budget with tax threshold rises, pension increases and the Help to Buy programme for first-time buyers. The 2014 Budget continued this theme: more tax reductions, pensions reform, extension of Help to Buy (now laughably known as Help to Buy Votes), promises of infrastructure investment.

Now, correct me if I am wrong, but infrastructure investment, tax cuts, pension increases and help for homebuyers are fiscal stimulus, are they not? And of course expectations matter. Austerity starts with its announcement, and so does stimulus. Just as fiscal consolidation was a cause of the UK's poor performance in 2011-12, so fiscal stimulus seems likely to be a cause of the UK's outstanding performance in 2013-14.

So the Chancellor whom Cochrane quotes approvingly as saying that Keynesians wanting fiscal stimulus were "wrong" has actually been doing, er, fiscal stimulus - though more for political than economic reasons. It's amazing what effect the growing proximity of an election has on economic policy. 

And it's also amazing how gullible a Keynes-hating (or perhaps more accurately Krugman-hating) US economist can be. 

Related reading:

No, it's not party time yet

* There were also tax cuts in the 2012 budget, but these were offset by benefit cuts and other changes that left many people worse off. 


  1. Good piece, Frances, but I don't understand the 'poor skills and inflexible lifestyle' comment.

  2. Given the concentration of wealth any increase of GDP is extractive from the population.

    This is clearly seen in Ireland this year with a increase in the amount of diesel fumes at little else.
    Small traders continue to go to the wall as the wealth is sucked up ever people are forced to shop in discount stores that benefit from deflation dynamics.
    I have even seen the British comedy awards sponsered by lidl now which was the funniest joke of the night.


  4. What is similar about the US and the UK is that - after the initial period when recession-initiated redundancies dominated - the movements in both countries' labour market variables seem to have been driven largely by developments in the labour market - mostly policy induced - rather than determined by demand. And, consequently, with GDP and labour market developments decoupled - productivity growth has dropped out.

    So, in the US the initial poor employment record after the recession led to high productivity [see the link to my presentation at the Labour Market Statistics User Group 2013 Conference]. Whilst in the UK the continued focus of policy on increasing the labour supply and employment of the most disadvantaged in society has meant not only has employment done very well but the biggest improvements have been amongst people that started off in the worst position.

    And with the ending of the 99 week unemployment benefits at the end of 2013 the employment record in the US has improved substantially. It may be, therefore, that one of the questions to be addressed for 2014-15 is why the (supposedly just) UK productivity puzzle has been exported to both the US and also many EU countries. Whilst in the UK the already very high employment rate and the emerging effect of the ageing society will make it more difficult to boost labour supply and, therefore, employment. So, if GDP continues to grow at a healthy rate it may be that UK productivity will pick up.

  5. oh you silly socialist :)

    1. Always will be discussion between keynesian and neo-liberists. Pleas don't use word socialist ;)

  6. Labour productivity has been increasingly meaningless since the age of coal.
    We can see the function of jobs in the UK is to access purchasing power ( increasingly from its euro hinterland)
    The UK's policy should orbit around such policies as increasing electricity imports from hydrorich Norway and Iceland if they can get away with it ( pushing up costs for the Norse) much like how it is presently extracting surplus nuke energy from depression hit France , ( elec imports currently a record a7%)


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