Fiscal policy & semi-science

What would it take for the Tories to admit that their fiscal plans are failing?

I ask because - despite today’s numbers - it looks as if Osborne’s austerity could fail even on its own terms, as his plans will not actually reduce borrowing. My table shows the point. The first column shows the PSNB forecasts in Alistair Darling’s last Budget. The middle column shows the OBR’s March forecast. And the third column shows the current consensus forecast.  You can see that whilst Osborne planned to borrow £65bn less than Darling between 2011 and 2015, weaker economic growth means that forecasters now expect that he’ll borrow much the same*.

This seems to vindicate Ed Balls’ claim that “the danger of too rapid deficit reduction is that it proves counter-productive“. Cameron is right to say that cutting the deficit is proving “harder than anyone envisaged" - if by “anyone“ he means “anyone in the Tory party.”

Why, then, don’t the Tories admit they were wrong? They do have some defences, but these are questionable, for example:

“Growth is being depressed by the euro area crisis”. However, unemployment was rising before the latest leg of that crisis. Also, the consensus expects growth to be weaker this year because of lower consumer and capital spending, not just lower exports. The consensus now forecasts a drop of 1% in consumer spending this year against the OBR’s forecast of a 0.6% rise and a fall of 0.9% in investment against an OBR forecast of 2.3% growth. These two differences take 1.5 percentage points off GDP, whilst the consensus’ lower export forecast (5.3% growth vs. 7.9%) takes only 0.75 percentage points off growth. This tells us that something has gone wrong with the domestic economy, and that the euro area isn’t entirely to blame.

“Gilt yields are low so the market has faith in our plans.” However, spreads between 10 year gilts and their US and German counterparts, at 0.24 and 0.28 percentage points respectively, are within a standard deviation of their post-2001 averages, of 0.29 and 0.53 percentage points. This means it’s hard to infer that fiscal policy has led to significantly lower yields. And even if it had, I’m not sure this is a wholly good thing. Yields can be low because markets are pessimistic about growth, not just because they are optimistic about creditworthiness.

“Things would have been even worse under Labour’s plan.” This is just unobservable. It also runs into the problem that there isn’t a massive difference between the two policies. As Fraser says, Osborne’s plan is an “only-slightly-modified version of Darling's deficit reduction plan.” But it’s hard to have it both ways - to claim both that there’s little difference between the two policies and that Osborne’s plan has made a material difference in preserving market confidence. (Of course, mutatis mutandis this is an embarrassment for Labour as well).

I suspect that arguments like these are what Popper called “immunizing strategies” - they are ways of protecting yourself from admitting you were wrong.

This is not (just) a partisan point; all politicians do something similar. Instead, my point is that policy-making is a semi-science. Like science, it conducts experiments - in the sense of doing things the result of which are unknown. Unlike science, it just doesn’t, and cannot, learn from such experiments.

* Of course, the forecasts are subject to huge error margin, but as it’s not clear which way these work, I’m not sure this is relevant for our purposes.

Comments

[Luis Enrique]

I don't know ... I have more sympathy with the idea that the EZ crisis has been a large negative shock, just in terms of general atmosphere of fear and uncertainty, plus more stress in banking system, and nobody's deficit reduction plans are immune to large negative shocks. I'm not saying they can entirely blame the EZ, but you table has 2012 onwards, maybe there it matters quite a lot.

otoh, if you discount that argument, then we are looking at quite a large implied multiplier aren't we? You say the cuts "won't actually reduce borrowing" but you show borrowing falling each year, I think you mean relative to the Darling counterfactual. So if those cuts in excess of the Darling plan have zero effect, that means for every £1 cut from spending roughly £2.50 is being cut from GDP with the result taxes fall £1, more or less.

[Luis Enrique]

sorry, it's not all necessarily on the revenue side is it, could be less off GDP, more on automatic spending (unemp bens). Anyway, on net still big multiplier.

[Rob]

How does the "consensus now" in your table square with this story: http://www.guardian.co.uk/business/2011/nov/22/osborne-on-course-deficit-reduction (I'm hoping it's safe to assume there's no pro-Osborne bias in the Guardian). It states that borrowing for this year will come in at £122bn as per the original forecast and not as per the consensus view cited in the table.

Given that the "consensus" is probably "what some analysts reckoned last Tuesday after lunch in the pub" it's probably too soon to use it as the decisive refutation of government policy, however equally daft that may be.

[chris]

@ Rob - it's too soon to say with any confidence that borrowing WILL come in at £122bn this year.
I suspect some of those tax revenues reflect the (relative) health of the economy a few months ago, and might sag if the economy flatlines over the next few months and unemployment continues to rise.

[Churm Rincewind]

Not just policy making, but all of economics is a "semi-science" in the sense that true science is validated by the possibility of control experiments by any third party. That can't be done in the fields of politics or economics.

Economics (like medicine) is a pseudo- science at best. That's why we argue about it, and that's why it can't be proved that Osborne is right or wrong. It all depends on which theory we choose to overlay on future events. In the meantime no-one argues about gravity...

[Rob]

Chris, I agree that the signs are not good, but the article I linked to (posted this morning) does say that "the City believes he is currently on course to meet his goal", which I assume takes these factors into consideration. Either way, these figures suggest that the targets have been hit so far, though there are serious doubts about the government's ability to hit future targets.

If it's "too soon" to say that the targets will be hit, it's presumably also too soon to say that they definitely won't be, given that they have been so far. I'm just quibbling with the fact that you're acting as if the targets have already been missed ("when will the Tories admit that their fiscal policy is failing"). If they fail, you'll have ample opportunity to point this out in a few months' time.

[Jorjun]

Economic restructuring has to happen, and on a large scale. It is apparent to anybody that the machinery of state grew too fast, too soon on a over-simple assumption of future earnings growth.

Of course, restructuring costs, deficit reduction has to be carried out with care, it is not achieved with reduced short-term spending.

While restructuring is taking place, the frog-eyed-one will may well carry on with his annoying horizontal hand gestures. But you would have to be an especially disingenuous lefty to reckon that the coalition is cutting too fast, or that it is implementing expenditure reduction programs too soon.

[UnlearningEcon]

'Economic restructuring has to happen, and on a large scale. It is apparent to anybody that the machinery of state grew too fast, too soon on a over-simple assumption of future earnings growth.'

Not really. This is the 'the real crisis is the growth of the public sector' narrative, designed to distract away from the massive private sector crash that got us into this mess.

'But you would have to be an especially disingenuous lefty to reckon that the coalition is cutting too fast, or that it is implementing expenditure reduction programs too soon.'

Why? They obviously are. They aren't even meeting their targets and unemployment and growth look sad.

[Cliff Tolputt]

It would be interesting to see how the forward projections for the national debt would look if adjusted for the effects of inflation and the true costs of replacing matured debt. At the moment I would think debt is being replaced at a lower coupon than borne by the now matured component(s). This too is an advantageous factor.

I do like Churm Rincewind’s view that economics is a pseudo-science and made so by the inability to test theories into respectability before they are given a practical use. A true science would brook little argument and to the benefit of everyone.

[Gareth]

The Coalition target is the REAL debt burden - PSND over nominal GDP. Yet you are judging their success on the NOMINAL borrowing figures? Bzzzt!

Darling's CPI forecast for 2010 was 2%, and 1.5% for 2011. Yes, really, *one point five percent* in 2011.

Let's have a sensible counterfactual, or at least admit that NGDP is (nearly) everything, and fiscal policy doesn't affect demand.

[Keith]

Off course no one seems to be asking why bother to reduce borrowing when interest rates are so low and likely to stay that way if total demand is low? There is no real justification for spending cuts to services or benefits on economic grounds that is right wing rubbish from the dangerous right wing people in Government. It is the "narrative" of the spin doctors to appeal to the ignorant voters and lazy journos.

Actual figures will be revised eventually so as in 1975 -6 every thing will turn out to be a mirage. It turned out that Healey was running a much more successful economy than he realised! Which as he mused later reinforced his scepticism about statistics and forecasts. On the other hand running around blathering about austerity and telling lies about a too big state that needs "restructuring" will not help growth. But I saw it all before under Thatcher so I could have told you so! She also restructured things by making millions unemployed. The rabid right are good at that.