The Dysfunctional Debate over Debt, Deficit and Macro Economic Policy

by Stephen Fisher and Zach Ward-Perkins

This blog post counts as work in progress for a more thorough analysis of the issues of political debate and public understanding of macroeconomics. Comments very welcome.

There is a big choice at this election: between austere and austere-er; between cuts and £30bn or so more cuts. Even the so-called anti-austerity SNP turns out, according to the Institute for Fiscal Studies (IFS), to be offering similar spending plans to Labour, just over a longer and slower timescale. Why so?

The premise for the political debate over public finances seems to be that there is an urgent need for deficit reduction because UK government debt is too high. But according to the vast majority of academic macroeconomists, this premise is false. Many believe that some reduction in the deficit would be a good idea while the economy is growing, but with negative real interest rates there is no urgency. With interest rates near their lower bound, rapid deficit reduction risks considerable harm to growth.

Moreover, the Nobel-prize-winning economist Paul Krugman went further last week and advocated spending and deficit increases. Krugman was particularly critical of Labour, claiming that it has been “amazingly willing to accept claims that budget deficits are the biggest economic issue facing the nation, and has made hardly any effort to challenge the extremely dubious proposition that fiscal policy under Blair and Brown was deeply irresponsible”. Overall he deemed deficit-fixation “a peculiar British disease”, and drew comparison to economic discussions in the US, where the deficit is no longer a major issue. Moreover, many more macroeconomics than Krugman, including the prominent blogger Simon Wren-Lewis, have convincingly argued that not only is continued harsh austerity unnecessary, but that austerity has hurt the economy since 2010.

How did we get into this situation where continued austerity is seen as the only politically viable option even in the face of such strong intellectual arguments against it? Simon Wren-Lewis has a superb series of blog posts and an excellent article in the New Statesman that deals both with the macroeconomics, and discusses some of the politics and media coverage. It is worth summarising his argument.

Essentially his description of economic policy over the past five years is that the government chose to pursue austerity policies that economists warned would do harm and did not have to undertaken. The cuts predictably reduced economic output so the government eased off in 2012 and as a result growth returned in 2013. Despite the lasting economic damage, Wren-Lewis argues that the government have managed to present their record as a success story by, firstly, equating government and household budgets and so justifying belt-tightening and living within one’s means. Secondly, blaming the deficit on Labour when borrowing was not profligate in 2007 and only escalated as a result of the financial crisis. Thirdly, by pretending that there was no policy change with the easing in 2012 and finally, claiming that the 2013 recovery vindicated the austerity policy, when it was actually prompted by the relaxation of austerity measures.

Wren-Lewis then, rightly, notes that much of the media seems to have taken the goal of deficit reduction as more important than that of increasing public welfare and standards of living. So he asks, “how did the coalition government manage to transform the media debate on macroeconomic policy so comprehensively?”

He suggests the answer is a mixture of an influential partisan press, an easily intimidated BBC, too much reliance on City economists with biased views on macroeconomic policy, and, by implication, a lack of attention to the views of mainstream academic economists.

There is indeed a puzzle to solve here about why so much of the media have accepted the idea that deficit reduction was urgent in 2010 and still think it is now. But not all of the media deserve to be tarred with the same brush and it is not right to presume that this is all the coalition government’s doingd

While the Tory press have naturally been happy to accept the government’s narrative and arguments about macroeconomic policy, the same cannot be said for many other papers. The Guardian has been consistently in favour of fiscal expansion, Martin Wolf and others at the FT too. Even the economic liberal Economist magazine in their endorsement of the Conservatives last week noted that, “Mr Miliband also promises deficit reduction, and at a pace that makes more macroeconomic sense than the Tories’ plan.” Nonetheless there is still a sense in which arguments in favour of slower deficit reduction have been overwhelmed in public debate by those in favour of austerity, or just by the degree of attention to the problem of government debt as opposed to social welfare, income growth or productivity.

It is always difficult to identify what drives media coverage and public debate. Certainly the government have been the chief beneficiaries of much of the macroeconomic narrative in the media. Doubtless they have been influential, but it is probably not simply a case of the government persuading the media of the rightness of its views. The role of other political parties is also relevant. So too are the relationships of distrust between the media and politicians.

Ironically, it is perhaps because politicians and the media are wary of each other that it came to be relatively easy for the coalition government to push their views, and, moreover, a look at the history shows that it is the actions of the Labour Party are also important in the narrowing of the debate. In the run up to the 2010 election Brown initially wanted to frame the choice as one between Tory cuts and investment under Labour. The media smelt a rat and were determined to force the then Labour government to admit that there would have to be some cuts in public expenditure after the election if Labour were re-elected. Labour conceded the point. Alistair Darling accepted that there would have to be dramatic cuts. The Tory spending plans going into the election were for more cuts than Labour would enact. Rather than querying whether the plans would have a negative effect on growth, the predominant media mind set at the time was to presume that both main parties were trying to pull the wool over the public’s eyes regarding the scale of the deficit reductions. Vince Cable, referring to the deficit as the “elephant in the room”, and making this the main theme of the Lib Dem manifesto launch event, enhanced this media mind set.

The macroeconomists’ argument that severe cuts at the same time as low interest rates would be counter-productive, by reducing, or eliminating, growth, were aired by some commentators, such as the FT’s Martin Wolf. But the arguments were not pervasive. BBC and ITN analysis in 2010 arguably suggested that the goal of deficit reduction was paramount and drew misleading comparisons with Ireland and Greece. The constraints of Eurozone membership were critical to understanding the problems of Greece and Ireland and did not apply to Britain. As a result of the pre-2010 election debate, the public went into the election expecting that there would be cuts, and accepting the need for them, but not at all clear about the scale of them.

All this, together with riots in Greece and emergency Eurozone meetings at the time of the post-election government formation negotiations, made it easier for those on the right of the Liberal Democrats to argue for joining the Tories and for the new coalition to argue for immediate substantial cuts. A key plank of Liberal Democrat justification for joining the Tories in a full coalition was the importance of creating a stable government, and it is clear from David Laws’ account of the process that the Lib Dems were keen to see major cuts as a strong signal to the markets. Andrew Adonis argues, in his book on the 5 Days in May, that the Lib Dem leadership, Laws and Clegg particularly, went with the Tories instead of Labour primarily for ideological reasons, and that their warnings about market threat were just a cover.

The story that the coalition parties needed to provide a united front has remained a bedrock of both parties’ political messages. It is striking that in the Leaders Question Time programme on 30th April 2015 both Cameron and Clegg still appealed to a comparison with Greece in 2010 as a justification for their coalition and the austerity that followed. One of them compared the absolute sizes of the British and Greek deficits at the time, ignoring the enormous difference in the size of the economies that sustain them.

Through a mixture of the actions of all three major parties, a narrative began to form on the economy that was highly beneficial to the Conservatives. In the face of very little economic knowledge amongst the general public, the key thing to consider is not the efficacy of a policy but how well it fits into a common-sense narrative of what should work. As the economists Shiller and Akerlof have noted, the natural human tendency to understand the world through simplified stories of cause and effect, rather than necessarily more accurate but more complex explanations, is crucial to general theorising about the economy. In the face of the Conservatives’ dramatic failure to meet their 2010 targets and their successful attempts to deflect attention away from this, it is increasingly obvious that the ability to create a story of the economy that can be adapted to ever-emerging new facts is a crucial part of governance.

However, these narratives are usually challenged, and, in light of this, Labour’s failure to mount a strong attack on the coalition austerity plans seems peculiar. Tim Bale’s book Five Year Mission, on the Labour party since the 2010 election, explains how the long Labour leadership election gave the Conservatives time and space to argue that the huge government debt was the result of Labour profligacy in the good times before the financial crisis, and that they had “maxed out the nation’s credit card.” He also suggests that Ed Miliband’s decision not to appoint Ed Balls to the shadow chancellorship was in part because of concerns that Balls’ critique of the government’s austerity programme was leading to him being painted as a ‘deficit denier.’ After Alan Johnson resigned from the job, Balls was only given it after agreeing that Labour would continue to advocate Alistair Darling’s severe deficit-reduction plan. Moreover, even if it were based on spurious economic reasoning, Labour feared that the economy would eventually recover, and when it did having been totally against austerity would be viewed as foolish in the public’s eyes.

Bale goes on to argue that even as early as 2011, “like it or not, people were convinced that, even if the bankers had played a big part in the crisis, Labour was to blame too – and that the only way out of it now was for the country to tighten its belt, grit its teeth, and get through the pain. If they could have been persuaded to think otherwise, the moment was long gone.” It could be said that Miliband’s Labour decided to take a page out of New Labour’s formidable guide to public relations, even if ironically it meant trying to move on from New Labour as much as possible. For Philip Gould, a doyen in this respect, has famously argued that once you’ve lost an argument with the public it is always better to concede and move on than to challenge, even if you still think you’re factually correct.

It is reasonable to be sympathetic with Labour’s predicament here. As the anthropologist David Graeber has noted, debt holds a particularly powerful place within human thought. Debt is surrounded with strong moral connotations of obligation and responsibility, and so when Labour try and explain the debt it is simply seen as evidence of their irresponsibility. Labour was therefore pinned into a corner. Debt seems toxic to the public, and ideas of a credit card being maxed out are easier to comprehend than traditional Keynesian arguments that a bit more debt now can lead to more beneficial outcomes in the future.

There is therefore a political risk for Labour if it tries to break away from the whole of this story, as the public has become so deeply convinced by this narrative. Labour’s position therefore seems to be an instance of a generic problem whereby opposition parties can face strong political incentives not to oppose the government strongly enough, even when they think there is something wrong with a policy. Famously Labour also faced the difficulty of trying to argue against the details of legislation for the Child Support Agency without being painted as in favour of errant fathers.

However, the absence of an anti-austerity argument becomes more confusing after the paper by Reinhart and Rogoff was found to have data errors that undermined the conclusion that that high government debt reduces economic growth. After this there was little or no serious academic evidence supporting the idea that deficit reduction was necessary in the UK to increase economic growth, and much saying the opposite. Nonetheless, in his latest budget speech the Chancellor again stressed that higher debt “harms potential growth.” So far as we know this claim is without foundation in the academic macroeconomic literature and it was left unchallenged by both Labour leaders and the media.

The success of the pro-austerity narrative is now so commonplace that, in many ways, justification of swift deficit reduction has become separated from many of the key points that were raised in 2010. Back then the argument made by many, including explicitly Osborne, was that if we didn’t cut now, interest rates would soar and bankruptcy would soon follow. Such apocalyptic predictions are now totally absent from political discourse, and are untenable due to historically low interest rates around the world. Yet, even though debt to GDP has stabilised, there seems now to be as much if not more concern about debt reduction in the media and public opinion than before the 2010 election. All of this suggests a success for the Conservatives’ strategy. Whilst David Cameron recently shifted the focus to the debt that would be left to our children, many articles simply write about it as if its importance was self-evident, without ever explaining why. The Labour Party manifesto starts with a bold promise to reduce the deficit every year, but there is not a single line of substantive analysis on why deficit reduction is important.

Opinion polls show that the public do not like the austerity measures but believes they are necessary, thereby effectively accepting the dominant media narrative, against the views of the macro-economists. Therefore, clearly it is not the case that Labour can simply throw off the shackles of the Conservatives’ economic policies and arguments, as Krugman would have them do, for too many people believe them to be true. The polls also show that the public think the government has managed the economy well even though the Office for Budget Responsibility (OBR) shows us that the austerity measures have made households an average of £4000 worse off.

Maybe this discrepancy is partly because the public care about other economic outcomes too, but a lack of public knowledge and understanding about macroeconomic policy are also likely to be part of the explanation. Certainly a well-informed and healthy debate about macro-economic policy is important for democracy to work as it should.

12 thoughts on “The Dysfunctional Debate over Debt, Deficit and Macro Economic Policy”

  1. Strange that in the whole of this article there is not one mention of the national debt of £1.5 trillion and the annual interest due thereon.

    1. This number is meaningless without considering the size of the economy sustaining it. If you do this, you will see that the current level of debt is not historically significant (debt to GDP ratio).

    2. After all that Quantitive Easing the Bank of England holds 25% of it. Yes, we owe it to ourselves.

      The national debt sounds scary but really reflects the desire for net financial assets in the economy. There is not actually any need for it to be issued as debt (as evidenced by the BoE holding 25% of government debt and yet we have record low inflation).

      Did you know that loans do not come from deposits but that deposits come from loans? Read this Bank of England paper:

      Click to access qb14q1prereleasemoneycreation.pdf

  2. A selective left-wing review of the macroeconomics of debts and deficits presented as if it were mainstream. The authors are correct that the deficit and debt are not a problem. They are wrong that austerity can be replaced with stimulus and that ensuing growth will take care of the budget.
    For a counter view, consult the literature on generational accounting begun in the 1990s with the work of Auerbach and Kotlikoff and continued more recently by Gokhale.
    The real fiscal problem, identified by generational accounting, is that the present value of the stream of spending commitments arising from current legislation is unsustainable. As Herb Stein famously said, “the unsustainable must surely end”. We face a fiscal time bomb.
    Britain is not alone if facing this problem but the clock is ticking and the longer the dreamworld of left-wing macroeconomics persists, the bigger will be the bang.

    1. Still, there is no good argument for cutting government spending at the present time. Given the disproportionate level of suffering that will result for those at the lower end of the income distribution, this makes me very angry. The Conservatives have needlessly set an agenda of class politics that will probably end very badly and damage many of our great institutions. If they were really concerned about the deficit they would raise taxes since there is no evidence of a correlation between GDP and the tax rate, whereas every pound cut in spending results in almost two pounds of lost government revenue. They are more concerned with short term benefits for millionaires and gifting the Royal Mail to their best mates. Such a waste.

  3. Its a good article with many valid points. However the tone suggests that no economists are advocating deficit reduction or the ones that are are in someway ‘bias’. So where did the idea of deficit reduction come from….did the Tories just make it up for a laugh or are they working under guidance….I don’t buy that the Tories are fundamentally evil and want the economy to fail nor that they are ignorant of the counter arguments, in fact the reverse they want the economy to do well..who does not?

    What this does highlight is the spineless nature of both labour and Tories to deal honestly with the public for fear of their opponents using there honesty against them. Basically irresponsible politics.

    1. Anyone who supports the repeatedly discredited strategy of austerity must be economically illiterate or evil. Austerity does not help with the deficit. It just shrinks the state. Who benefits from this? Wealthy capitalists. Who suffers? People who depend on public services such as the disabled. It’s like trying to equate the pleasure of the predator catching the prey with the pain of the prey being eaten alive. Weighing a slightly more healthy balance sheet against human lives. At least the cuts would have been less deep and slower with Labour, although they should have rejected them altogether (although they were working with an electorate that had been constantly lied to).

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  5. I take issue with “a lack of attention to the views of mainstream academic economists.”

    Why presume mainstream orthodox economists are the ‘go to’ people for macroeconomics? This cohort completely failed to predict the GFC, and then subsequently failed to give credit to their heterodox, i.e. non-mainstream, brethren (who did).

    Moreover the mainstream, such as Wren-Lewis and Krugman, still believe ‘the deficit’ is a thing that needs ‘fixed’ (when times are good). Hence, ironically, mainstream ‘macro’ is it still ultimately tied to the very ‘household’ paradigm it purports is wrong. This acceptance of the narrative of the need to ‘tackle the deficit’ (albit ‘eventually’) means they have lost the argument right then and there. Conversely when heterodox economists claim government finances are not like a household’s, they really do mean it – to the extent that the two are not only as unalike as can possibly be, but also that they are (the two) complementary components of the economy.

    Heterodox economists include people such as Steve Keen, Ann Pettifor and Bill Mitchell. All are characterised by using ‘stock/flow’ consistent models. That is they take a disciplined accountancy approach to what are known as government ‘monetary operations’ e.g. QE.

    I personally started out wondering why the government borrows money at all. In my reading over the past several years since the GFC, I have found Modern Monetary Theory (MMT), espoused by Bill Mitchell and others, to be by far the most convincing. If you are unfamiliar (and you might be because MMT is mainly US and Aussie-based), I would urge you to watch this video…

    PS I have referenced this video in particular as it is from a British economist based in Australia (the talk is of the Aussie budget deficit but the principle equally applies to the UK). There is a huge literature and many other videos of a similar nature are available also.

    PPS In case you are wondering how credible MMT is, might I mention two pieces of evidence. Firstly Jamie Galbraith (son of JK and a noted economist in his own right) supports it. Secondly the US Senate Budget Committee recently appointed as Chief Economist one Stephanie Kelton who is also a leading MMTer.

  6. I think most people know that a little debt used sensibly (for a car to get you to work or for a mortgage) is a good thing and that in bad times Government borrowing to spend to kick start things is sensible. What people also have come to realise is that Governments have got addicted to debt and we now have crazy levels of liabilities which will take decades to clear, this is simply bad economics and unsustainable.

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