Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 8 December 2016

The reporting of market ups and downs is not really a joke

It began as part of my undergraduate lectures. After teaching students about the key role of expectations in influencing exchange rate movements, I joked they too could now become one of those City economists who comment on market movements. X goes up and the market falls - you explain the fundamentals. X goes up and the market rises, appearing to contradict the fundamentals - you say the markets were expecting a bigger rise in X. There is no data to contradict you, so no one will question your wisdom.

Companies pay market researchers tons of money to find out why people do or do not buy their products, so the idea that an individual can know why the market moves within hours of it moving is just nonsense. Yet day after day we see City economists telling us just this. They hardly ever express any doubt or uncertainty. They know if they did the media would regard that as boring, and choose someone else next time.

In writing posts I talked about why the media used City economists for this kind of commentary, because academics would be hopeless at it. In my lecture I said an academic, if asked by the media to comment about why sterling fell by 1% yesterday, would give one of two replies. Either ‘oh, did it, I hadn’t noticed - too busy marking’ or ‘who knows, there could be lots of reasons, we have no evidence on this at all’. But as I said it during the lecture I realised that it some way this was not really a story about how hopeless academics are in talking about daily market changes, but a story about how the media treats knowledge. After all, the second response is the truthful one. Even the first conveys some truth: unless you are speculating on the markets why does one day’s modest market movement matter?

The media use City economists because they are used to telling stories. Stories that will impress clients with lots of money to invest. As I’m sure Chris Dillow has written, people are swayed by confidence, even if that confidence is completely unfounded. Put a climate scientist, who being a scientist knows about all their doubts and uncertainties and is honest about them, in a debate with a media savvy climate change denier, and you will see that many will find the climate denier more convincing.

So the fact that the media gets City economists to tell their stories day in and day out tells us something interesting about the media. They seem quite happy to allow people to tell stories as fact, because it appears that they are asking an expert who ‘knows’. Now I’m sure the response would be by both the media and the City economist that of course everyone really understands that these are stories and not knowledge, and they are worth repeating because they are plausible stories. They could be true, but everyone really knows they are just conjectures based on little solid evidence.

But does everyone really know this? I’m sure the City economist knows this. I’m less sure about the audience, and even sometimes about the person interviewing the economist. This is a game of pretend that has been going on for so long that what is pretend has become real. Wouldn’t it be a good idea to insist on these City economists prefacing everything they say by ‘Of course we do not know, but my hunch is that …’ Isn’t it better to properly inform viewers of what is going on here, even if it does become a little repetitive? Or is informing the viewer not what this is about? And does this constant repetition of false certainty not have something to do with how City economists can be regarded by some policymakers as high priests to the fickle god of the market. 

It was interesting that some of the reaction I got to Saturday’s post was ‘why don’t forecasters tell people about these uncertainties’. Why are they not more modest? But the better ones are, and any academic who knows about macro forecasting will tell you how uncertain unconditional forecasting is. The fact that this knowledge is not reflected in how the media (or politicians) talk about them has everything to do with the media (and politicians). It suits most of the media (not all) to exaggerate the certainty, and then to express shock/horror when forecasts are wrong. And in a way it is a perfect example about the dangers of treating the media as just a harmless purveyor of news: you end up blaming the forecasters for something which is not their doing.

Tuesday, 6 December 2016

The OBR and the impact of Brexit

In doing my homework for an appearance at the Treasury Select Committee this morning, I noticed one point which is of some relevance to the debate about whether the OBR is being too pessimistic about the impact of Brexit. Two major ways in which Brexit will have an influence on the public finances is through lower immigration from the EU and lower productivity. The two are linked, because the OBR correctly assumes that lower immigration of skilled labour will in itself reduce productivity. (Productivity also falls in the OBR’s analysis because of reduced investment.)

The OBR also assumes that Brexit will reduce the trade intensity of the UK: less exports and imports. This is pretty obvious to anyone who has looked at international trade: transport costs may not be as high as they once were, but gravity equations tell us that geographical distance is still a key factor in influencing whether trade takes place, which means that reduced trade with the EU will not be matched by new trade outside the EU.

The Treasury analysis of Brexit assumed that this lower trade intensity would also reduce productivity. The OBR do not include this effect, calling it too uncertain. This is a slightly surprising judgement. To see this, look at this piece by Maurice Obstfeld, chief economist at the IMF. Here is a quote:
“Empirical research supports Ricardo’s fundamental insight that trade fosters productivity [by increasing efficiency through comparative advantage]. But the productivity and growth benefits of trade go far beyond Ricardo’s insight. With trade, competition from abroad forces domestic producers to raise their game. Trade also offers a wider variety of intermediate production inputs firms can use to produce at lower cost. Finally, exporters can learn better techniques through their engagement in foreign markets, and are forced to compete for customers by raising efficiency and upgrading product quality (for example, Dabla-Norris and Duval, 2016).”

Now few things are ever certain in economics, but none of these transmission mechanisms from greater trade to higher productivity are particularly fanciful: they all make common sense (at least as seen by an economist). They are all one directional, which means assuming an effect of zero is an extreme point in every case. In this sense, the OBR is being rather optimistic about the impact of Brexit on the UK economy.

Saturday, 3 December 2016

Hitting back

Not a post about a certain byelection, but a reaction to reading this:
“A more serious incident was the forecast by the Office for Budget Responsibility in the UK, which said last week that Brexit would have severe economic consequences. Coming only a few months after the economics profession discredited itself with a doomy forecast about the consequences of Brexit, this is an astonishing reminder of the inadequacy of economic forecasting models.

The truth about the impact of Brexit is that it is uncertain, beyond the ability of any human being to forecast and almost entirely dependent on how the process will be managed. “Don’t know” is the technically correct answer. Before the referendum, Project Fear was merely a monumental tactical miscalculation. Today it is stupidity. One of the debates was whether people should be listening to experts. We have moved beyond that. Because of a tendency to exaggerate, macroeconomists are no longer considered experts on the macroeconomy.”

Shrug your shoulders and move on? If it had appeared in the partisan press that would be a sensible reaction, but this was written by a widely respected journalist in the UK’s internationally renown financial newspaper. Furthermore - lest my motives be misunderstood - written by someone whose knowledge on the Eurozone is beyond dispute and whose views I often agree with. Well on this occasion this particular member of a discredited profession who is no longer apparently considered an expert on macroeconomics is not prepared to take this kind of stuff anymore, whoever it may come from.

It is difficult to know where to start with such apparent and complete ignorance. Nonsense expressed as platitudes. You can only make sense of “beyond the ability of any human to forecast” if you either think we know nothing about the impact of trade restrictions, which is false, or that forecasts are non-probabilistic. No journalist has any excuse nowadays for misunderstanding the probabilistic nature of forecasts (Bank of England fan charts), and any academic economist who knows anything about forecasting will tell you that unconditional macro forecasts are only slightly better than intelligent guesswork. They exist because it is worth being slightly better than guesswork when the stakes are so high.

You can also only make sense of these two paragraph if the writer is unaware or is just choosing to ignore the difference between conditional and unconditional forecasts. These are long words for a very simple concept. You would not dream of asking your doctor to forecast the number of times you would catch a cold over the next year (an unconditional forecast), but if you gave them all your relevant data they could probably make a better guess than your own. Their forecast would be probabilistic, but if you took the mean as ‘the forecast’ then in any particular year your doctor would generally be wrong. It would be absurd for you to then say that, having ‘discredited the profession with this inaccuracy’ you were now going to ignore their advice about how to avoid catching colds (advice based on conditional forecasts). But this is the logic of these two paragraphs.

As for a tendency to exaggerate, the simplest response involves a black kettle. But on this particular occasion I think there is a more honest response. In the Brexit campaign I felt the temptation to exaggerate (I don’t think I ever succumbed), because the media was failing to get the message from economists across. Our collective knowledge about the impact of trade restrictions was treated as just one more opinion, or described as Project Fear. When you are effectively being ignored you tend to shout louder.

But this is all defensive. Trying to explain yet again some basic economic ideas, and to be honest about what you can or cannot do and any failings you have. I’m just tired of doing this stuff over and over again, so it is time not just to defend. There are many good journalists out there, who when they write about macroeconomics do try to check with academics that what they are writing makes sense. (It was one of those journalists who drew my attention to the article I quote above.) It simply lets them down when others think they can write this sort of stuff without any of the kind of basic fact checking that journalists are supposed to do. It brings the profession of journalism into disrepute.

And they can only get away with it because academic economists only get a media voice by the grace and favour of journalists. If anyone should be doing some serious introspection after the Brexit result it should be journalists and the media. Warning of the dangers of trade restrictions was not a ‘tactical mistake’. What was a mistake was for journalists to allow those warnings, that knowledge, to be characterised as Project Fear, all in the name of ‘balance’ or cheap copy. But this was not a temporary lapse in an otherwise good record, but just another example of a growing tendency for the media to allow politicians to define economic facts and truths, a record I described in my lecture.

To have the nerve to blame economists for the Brexit result, to suggest that using their knowledge was a ‘tactical mistake’, to imply that the OBR should pretend they know nothing about Brexit, all that is itself amazing malevolent chutzpah. But it goes beyond audacity to criticise a profession and subject matter you appear not to understand when it is this lack of understanding that has contributed so much to the damage over the last few years.

Thursday, 1 December 2016

Some concrete proposals for economists and the media

You can now listen to my SPERI/New Statesman prize lecture in full here, or even watch it all here. The talk looks at recent UK history, involving austerity and Brexit, to argue that there are serious problems in how the broadcast media treats economics. [1] The two main problems I talk about are exclusion and balance. Exclusion, where academic economists are simply ignored because they are not part of the Westminster bubble, can lead journalists to assume statements made by politicians are true even though an economist knows they are false or at least highly questionable. I give a number of examples in the talk, including after the 2013/14 floods where Cameron said there had been no cuts in flood prevention when there clearly had been cuts. Balance is where a view that represents a consensus among academic economists is treated as just another opinion, to be balanced by the opposite view. This simply devalues knowledge. The costs of Brexit is a clear example.

Solutions to these problems must start with academic economists themselves. It is asking too much to expect journalists to know whether a view put forward by an economist represents a consensus among academics or an idiosyncratic view. An obvious way to remedy this is through regular, topical polls of as many academic economists as possible. (I prefer this approach to sampling selected academic ‘leaders’ for reasons I may discuss in a later post.) The example I have in mind was the poll of Royal Economic Society members undertaken by the Guardian during the Brexit campaign. What these establish is whether a consensus exists or not on key issues. They are much better at doing this than letters to newspapers.

The reason why this is far better than getting more academics on programmes like Newsnight (not that I have any problem with that) is that it can then prevent the problem of balance. I use in the talk the example of climate change to show how the broadcast media could treat a consensus view among economists (90% or more agreement) as knowledge, not as simply an opinion to be balanced against another. Getting the broadcasters to do that will not be easy, but academics first need to remove the objection that journalists cannot know what economic knowledge is. Our target audience should not be Newsnight but the 6pm or 10pm news programmes, which may be the only non-partisan news that readers of the right wing press ever see. We need political correspondents to routinely say what the economic consensus is, and use it to interrogate politicians when they deviate from it.

Economists could learn a great deal from the physical and medical sciences on how to use collective pressure to ensure media policy is changed. Climate change is the obvious example where the media began to treat knowledge as just contested opinion (because that is the media’s preferred format), but it was changed as a result of pressure from the scientific community, working through existing institutions that represent scientists. This can be effective not just with the big ticket issues like Brexit, but also where an individual piece of research is misrepresented in the media.

Only once this pressure is brought to bear on the media will we see the media begin to improve its own capability in the area of economics. As I note at the end of my talk, the BBC trust recently commissioned a report on the use of statistics, and most of its recommendations could equally well be applied to economics. To achieve that requires pressure and help from economists as a collective.

The broadcast media should be a defense against populism, not the means by which populism takes hold. If you treat knowledge as just an opinion, of course people will vote for whatever sounds good to their ears. Let’s cut government spending: we should all tighten our belts. Let’s keep immigrants out so there will be more jobs for natives and better access to the NHS. As I explained in my lecture, this was not just a problem involving the EU referendum: because the broadcast media accepted the Conservative narrative on austerity by excluding the views of the majority of academic macroeconomists they helped them win an election. [2]

The referendum story is far from over: key decisions on issues like the Single Market have still to be made. We cannot expect people to make sensible decisions about these issues if expertise on these issues (not just economic, but legal, constitutional etc) is kept locked away in specialist programmes they will never see, or ignored altogether. We must stop allowing politicians to dictate what is knowledge and what is just an opinion.

[1] The lecture and this post are about the UK. Although the general points I make about expertise are universal, my specific recommendations only apply to a broadcast media that is not under government control and is regulated to prevent partisan broadcasting. Although my knowledge of the US is far less, it seems to me the problems there are deeper still, particularly now we have a POTUS and Congress who show no respect for truth.

[2] Someone asked me recently what had gone wrong with the media, but as I say in my talk this problem has been there for decades (see this post on Jay/Birt in the 1970s). What has happened is that, because of underlying social and economic trends, and simply because politicians have learnt how to play the media, media rules that kind of worked when politicians played by the rules and respected truth fall apart when they do not.

Tuesday, 29 November 2016

A little English coup

In August 1991, hardline elements in the army and KGB staged a coup against Mikhail Gorbachev, shortly after Gorbachev had agreed to reorganise the USSR as a new confederation. To many this seemed like an end to the reforms that Gorbachev had brought, as the coup leaders appeared to have the support of the whole military. Yeltsin was defiant in Moscow, but those who remembered the Prague Spring probably thought the tanks would win out. Then the coup’s nominal leader, Gennady Yanayev, gave a press conference in which he looked nervous with his hands shaking, and it became clear that the coup leaders were meeting serious resistance. It collapsed shortly afterward.

I remembered this when watching the proponents of hard Brexit shout down any concern about what the government might agree following the EU referendum, and attack anyone who pointed out the difficulties that leaving the single market might bring. They too have carried out a sort of coup against parliamentary democracy, and maybe declaring judges enemies of the people is the equivalent of Yanayev’s shaking hand. They cannot quite believe what they have done, and fear it may all collapse when people realise what is going on. Our Prime Minister has had to draw on her faith in God to enable her to continue leading this coup.

If you think coup is too strong a word, think about what has happened. An advisory referendum decided by a very narrow majority to leave the EU. That is all this slim majority of the electorate decided. They did not vote to leave the single market (SM), partly because most leaders of the Leave campaign told us (correctly) that leaving the EU was quite compatible with staying in the SM. They did not vote to end freedom of movement. Leaving the EU is not one policy, but a whole range of possible policies with quite different effects, and the electorate have said nothing about their preferences among these possibilities. In short, the referendum was about the EU and not the SM, and whatever they say now we know that you can be in the SM without being part of the EU.

Yet a new government, with no mandate from the voters, has decided that only it should be allowed to interpret what leaving the EU should amount to, and the electorate through their representatives in parliament should have no say in the matter. The people, having indicated a change in direction, are to be allowed no say whatsoever in where exactly they are to be led. The differences between these alternative paths out of the EU are immense, and this choice on how exactly to leave the EU will have a huge impact on every citizen. Yet the people and their representatives are not even to be allowed to know what options the government are aiming for. (The OBR was even denied knowledge of how the government intending fulfilling its guarantees to Nissan.) The pretext for this coup, involving keeping their negotiating hand secret, is as thin as the Soviet coup’s claims that Gorbachev was unwell.

Any attempt at parliamentary control over what might happen is described as trying to stop Brexit. Why not seek to stay in the SM? Just asking that question means to the coup leaders that you are trying to stop Brexit (of course it does not). Why not see what might be on offer before starting the clock on being thrown out with nothing? That is just a delaying tactic, they say. Why not have a second referendum on the final deal? Finding out what the electorate thinks once that the exit deal is clear would be against the will of the people, they chime without irony. When you are told that consulting the people or their representatives is against the will of the people, you know there has been a kind of coup.

But I fear that in this case the coup leaders’ nervousness is unwarranted. Three judges have thrown MPs a lifeline, a chance to stop this coup, and MPs look like throwing it right back. Those Conservative MPs who know what damage this will do have decided they can do nothing to stop the Conservative party being taken over by fanatics. The Labour party appears pathetic: its leadership wanting exit from the SM for their own reasons (talking shamelessly about ‘access’ in the hope of muddying the water) and the PLP is more concerned about losing votes than improving their electorate’s welfare (it is the story of austerity all over again). They had a chance of coming together to lead the opposition to this coup and they have blown it. Instead of Boris Yeltsin, we have Tom Watson, who joins in the mantra that opposing triggering Article 50 is going against the will of the people.

And instead of courageous citizens of Moscow we have Labour party members saying it is best to bide time and work within for change. This timidity is obnoxious to see: they should instead be demanding their MPs take back control. It is their prosperity that will be diminished by this coup, their right to work in the EU taken away. It seems to me that approving Article 50 is the last chance for representative democracy to have its say. Once that vote is in the bag, the government can do what it likes and nothing can be certain to stop them. (A vote on any final deal is no choice, because the consequences of saying no will be far worse.)

So MPs are acting like turkeys voting for Christmas. They know that in all likelihood voting to trigger Article 50 will throw away their chance to stop the government ending our membership of the SM, thereby reducing their constituents access to public services and the chance to keep young people’s right to work in the EU. They will be handing all the levers of power to a government that seems to be run by a minority of fanatics. Is this what a once proud country has allowed itself to become? Is this what a parliament that once stood up to kings has been reduced to?

Monday, 28 November 2016

The Autumn Statement and buckets of water

David Willetts, who I have generally found to be pretty sensible, praises Hammond’s Autumn Statement in the FT as casting off Osborne and Treasury orthodoxy. This is the same Autumn Statement that I described as a return of austerity: wasting resources by cutting spending when interest rates are at their lower bound. I think these two different views of the same event can be explained by an analogy.

Imagine four different reactions after a fire breaks out.

  1. The house is fitted with a sprinkler system which puts the fire out pretty quickly

  2. There is no sprinkler system, but the house owners find every drop of water they can, using buckets and hoses, to put it out

  3. The owners get one bucket, but only ever fill it half up because water is not free

  4. The owners do nothing: the fire will soon burn it itself out, they say, and water needs to be conserved.

In case it is not obvious, the fire is a negative output gap - wasting resources - and water is the deficit or debt. David Willetts is praising Hammond for moving from (4) to (3). Instead what he and the Treasury should be doing is (2), and then installing (1), which if you haven’t guessed is analogous to a fiscal rule with a zero lower bound knockout.

I know the Conservatives will not do (1) until this generation of politicians have passed, because it would be an implicit admission that 2010 austerity was a mistake. I also know that Labour is committed to such a fiscal rule.

Hammond may get lucky, and economic growth could be much stronger than forecast such that the MPC soon stops QE and raises rates. In my analogy, the fire might not spread. But policy should always take account of reasonable risks, and the probability at the moment is that we will stay at the lower bound for some time. The official output gap may be small compared to 2010 (although I worry it might in reality be a lot larger), but if you discovered a fire in your house what would you do?

Saturday, 26 November 2016

Whatever happened to the government debt doom spiral

A number of people, including the occasional economic journalist, are puzzled about why government debt at 90% of GDP seemed to cause our new Chancellor and the markets so little concern when his predecessor saw it as a portent of impending doom. I always argued that this aspect of austerity had a sell by date, so let me try to explain what is going on.

The 90% figure comes from a piece of empirical work which has been thoroughly examined, and found to be highly problematic. (Others have used rather more emphatic language.) Part of the problem is a lack of basic thinking. Why should the markets worry about buying government debt, beyond the normal assessment of relative returns. The answer is that they worry about not getting their money back because the government defaults.

If a government cannot create the currency that it borrows in, then the risk of default is very real. Typically a large amount of debt will periodically be rolled over (new debt sold to replace debt that is due to be paid back). If that debt cannot be rolled over, then the government will probably be forced to default. Knowing that, potential lenders will worry that other potential lenders will not lend, allowing self fulfilling beliefs to cause default even if the public finances are pretty sound.

The situation is completely different for governments that can create the currency that the debt they sell is denominated in. They will never be forced to default, because they can always pay back debt due with created money. That in turn means that lenders do not need to worry about forced defaults, or what other lenders may think, so this kind of self fulfilling default will not happen.

Of course a government can still choose to default. It may do so if the political costs of raising taxes or cutting spending is greater than the cost of defaulting. But for advanced economies there is an easier option if the burden of the public finances gets too much, which is to start monetising debt. That is what Japan may end up doing, and what others may also do if QE turns out to be permanent. But this is a very different type of concern than the threat of default. And it does not, in the current environment, lead to the emergence of large default premiums and market panics.

How can I be so sure? Because with QE we have had actual money creation, and it has not worried the markets at all. It seems hard to tell a story where markets panic today about the possibility of monetisation in the future, but are quite sanguine about actual monetisation today.

So for economies that issue debt in currency they can create, there is no obvious upper limit anywhere near to current debt/GDP ratios when economies are depressed and inflation is low. Japan shows us that, and we must stop treating Japan as some special case that has no lessons for the rest of us. (How often did we hear of their lost decade in the 1990s that it couldn’t happen anywhere else.)

It was good that the IFS suggested Hammond has a look at Labour’s fiscal rule. As I explained in this post, Hammond’s new ‘rule’ is pretty worthless. But one key part of Labour’s rule that keeps being ignored but is crucial in today's environment is the knockout if interest rates hit their zero lower bound. It is for the reasons described above that this knockout is there and is perfectly safe: when interest rate policy fails you can completely and safely forget the deficit and debt and use fiscal policy to ensure the recovery. It is the basic macro lesson of the last 6 years that is fairly well understood among academic economists but still remains to be learnt by most people who talk about these things. Whether senior economists in the UK Treasury need to learn it or just keep quiet about it for other reasons I do not know.