What has austerity cost *me*? Half a trillion fucking dollars!

I’m me, but I’m also a fraction of a cohort. The word always makes me thinks of the Visigoths sacking Rome, but we’re more likely to be looking for jobs at Caffe Nero. The Great Recession has cost us a lot in terms of lost current GDP, but it casts a much longer shadow one which will blight people my age for the rest of our lives.

Simon Wren-Lewis points me to a Vox article which tries to quantify the cost of austerity in terms of lost GDP, 3% of GDP. Although this is couched in caveats it is close to Simon’s own calculations that austerity has led to GDP being 2% lower today. This implies an average cost per UK household of £3,500 over three years (that’s £93bn so far).

taylor fig1 19 jul

I’m less confident that austerity is the culprit here. Incompetence and ignorance at the Bank of England is far more likely to blame. Either way, the failure to get the economy working again is an ongoing tragedy of almost inconceivable awfulness. Simon concludes:

Although all governments like to give the impression that they can have a big impact on people’s prosperity, few actually do. These numbers suggest that the current UK government has managed to do so, but unfortunately by making us all poorer.

Quantifying things is good. Turning those figures into graphs is better because I’m a visual thinker. But I still think Simon does a disservice in lowballing the harm that this mini depression is doing. Sadly these harms aren’t chronic, they’re acute. They’re hitting the young and the unemployed and that needs emphasising.

I’ll outsource my take on unemployment to Chris. In utilitarian terms is George Osborne worse than the UK’s worse serial killer? Answers on a postcard.

I want to concentrate on me (young people today are so narcissistic…) because I’ve written about this before. There aren’t just current costs to a depression: they scar people. The term for this is hysteresis. This refers to the damage done to people forced to stay out, or delay entering, the labour force.

Two years ago, I wrote a response to the question “what good is macroeconomics?” Roughly $100,000 is the answer. A one percentage increase in the unemployment decreases initial wages and worsens job match. Your job sucks and you’re in the wrong one. This has effects for the rest of your life, $100,000 of effects.

Now we run the numbers for the UK.

Pessimistically, we’ll assume that the new natural rate of unemployment is 6.5%. That there has been some long standing damage done to the UK economy. Heroically, we’ll assume we’ll get unemployment down from almost 8% now by the next election. Dating austerity to mid-2010, that means that we’ll have had half of 2010 with 8% unemployment, the whole of 2011, 2012, and 2013 too, maybe 7% in 2014, and a drop to 6.5% by May 2015.

Across those five years we’ll have 4.3 million people turn 21. If a 1% elevation in unemployment imposes a lifetime cost of $100,000, for simplicity I’ll assume that unemployment at  1.5% imposes a lifetime cost of $150,000. That’s probably overly pessimistic, but it makes the maths easier.

We multiply  out the elevated unemployment rate, the adjusted lifetime cost and the 800,000 or so 21 year olds coming of age in each year and voila. Austerity is imposing £555,817,500,000 lifetime cost on the young of this country. That’s over half a trillion dollars! I had to double check the numbers but, yup, that seems about right to me across the lifetime of a whole cohort.

It represents half a trillion dollars of ideas which people never had, of coffees never made, of children never taught, of diseases not cured and houses not built. This colossal heap of lost human creativity and perspiration is the real cost of the Great Recession.


[1] A link to a part of the ONS website which is actually useful and user friendly! Surely this is a time of miracles.


Help Mervyn King or Sack Him

Mervyn King acts as though monetary policy is currently about right to hit a medium term inflation target of 2%, but insufficient to put Britons back to work. This is because his job is to provide price stability because this is meant to stabilise aggregate demand. Stabilising aggregate demand is something which was achieved very well until 2008 when it allowed it to crash and unemployment to rocket.

The mandate for price stability he has been given is not currently compatible with full employment. Merv has been told to target price stability and financial stability and although he has been relatively dovish in executing his duties, he has not been nearly forceful enough in explaining their shortcomings.

I don’t really want to call for Merv’s head because he seems to be more dovish than average for the Bank of England’s Monetary Policy Committee. I am beginning to think he is no longer capable of delivery the recovery we need. His recent comments indicate that he isn’t being clear enough why he can’t deliver the recovery people want. Today he gave evidence to the Treasury Select Committee that suggested we should be grateful for a decade of stagnation.

When this crisis began in 2007, most people did not believe we would still be here. I don’t think we’re yet half way through this. I’ve always said that and I’m still saying it. My estimate of how long it will take to recover is expanding all the time. We have to regard this as a long-term project to get back to where we were, but we’re nowhere near starting that yet. We’re in a deep crisis with enormous challenges.

In June he was one of the MPC members calling for further QE in response to the worsening situation in the Eurozone. He was entirely right to do so, even if it is the least he could have done that wasn’t nothing.

Regarding the stock of asset purchases, five members of the Committee (Charles Bean, Paul Tucker, Ben Broadbent, Spencer Dale and Martin Weale) voted in favour of the proposition [no extension of QE]. Four members of the Committee voted against the proposition. The Governor, David Miles and Adam Posen preferred to increase the size of the asset purchase programme by £50 billion to a total of £375 billion. Paul Fisher preferred to increase the size of the asset purchase programme by £25 billion to a total of £350 billion.

He has now admitted he is either unable or unwilling to do anything more. We know that there is plenty more the Bank could do because he voted for one of those things in June. We also know that there are other examples of Banks running highly accommodative policy through the exchange rate, some serious, some not so serious, which the Bank has not yet even attempted.

Mervyn King knows he isn’t going to do much about unemployment. A genuinely reflationary policy which put people back to work would threaten price stability and the Bank isn’t authorised to make that call, only the Treasury is. Since Meryvn is acting like he is happy current policy is on track but that the track includes at least five years of suffering we can help him by criticising him. He has to be enticed to explain to everyone that unemployment could be lower but that the Treasury doesn’t want it to be and that he can’t do anything on his own. Mervyn King wants more accommodative policy but is unable to deliver it with the current MPC and Bank mandate.

Rather than ignore this he should be making clear the limits of the mandate he has been given. If he is happy with doing nothing about unemployment he should be made to say so and ejected from his job, if he is unhappy he should make it clear his hands are tied unless the Treasury change his mandate. If he is unhappy with being honest about the limits of what he can delivery legally and what he can delivery technically we need a new Governor of the Bank of England.

In the US, as in the UK, criticism of central banks has predominantly been that monetary policy has been too loose. Monetary policy looks loose if you only look at interest rates but other indicators tell us monetary policy has actually been incredibly tight. Nominal GDP growth has been low all through the developed world, as has inflation. Even in the UK where inflation has been high a large portion of this has been due to tax increases not monetary looseness.

Criticism of the Fed from people like Scott Sumner and Paul Krugman have helped to shift the Overton Window, the bounds of acceptable discussion, to include the possibility that money is too tight. I don’t think it is viable to have somebody in charge of macroeconomic stabilisation who thinks it is acceptable to spend ten years recovering from a crisis. Either we help Meryvn come out of his shell or we help organise the coup of Threadneedle Street.


PS The Treasury Select Committee need to update their website more quickly. Sir Merv’s testimony is still missing. The latest story is a push piece about Merv’s upcoming appearance, but there’s no link to the testimony now it has happened. I had to crib from the Telegraph.

Probably going to regret this one…

Here’s my controversial argument of the day.

New Labour spent a lot of money on infrastructure, education and healthcare. Lots of money, I think we can all agree on that. A lot of people think a lot of this money was wasted. Some also think Labour damaged the productive part of our economy by burdening it with too much red tape and taxation.

But UK’s unemployment is currently lower than you would expect given a nasty, steep recession. Perhaps some of New Labour’s spending is having measurable effect in reducing the non-inflationary level of unemployment, even if we couldn’t work out was while they were in office what was Labour’s return on  investment.

Despite extra burdens on employers introduced by New Labour we still have a very flexible employment market. This is especially true for the young and the newly employed. The National Minimum Wage is lower for the young and those in a job for under a year have few employment rights.

If you strip out VAT and import prices (that is, if you cheat a bit but for easily rationalisable reasons) inflation has been rather low of late. Compared to the normal employment/output dynamic unemployment has also been low.

This leads me to argue that the UK may have seen some sort of positive supply shock in the late 2000s which has improved our unemployment rate today. If true this would mean that the natural rate of unemployment has decreased and the cyclical component is higher than most people realise.

EDIT 19:05 11/05/2012: Second paragraph edited. Unemployment no longer “very” low just “lower than you would expect.”

Policy Pragmatism

What concrete step caused the British Pound to appreciate rapidly on the 18th April?

The correct answer is “we’ll never know what confluence of events caused that particular movement.” Any concrete answer should be ignored. But please allow me to tentatively suggest (tentative suggestion is fine) that the price of Sterling, and hence the stance of British monetary policy, was changed by news that Adam Posen had withdrawn his support for more Quantitative Easing. This unexpected action caused sterling to hit a 19 month high against the euro.

So when Chris says to Nick Rowe “that relying upon expectations to do work is to rely upon a weak lever” I am somewhat sceptical. Adam Posen changed monetary policy by changing the future expected path of monetary policy – his actions lessened the chances of more QE and brought forward rate rises and the unwinding of the Bank’s balance sheet – and the market acted accordingly.

A similar mechanism might be all that is required for NGDP to work. A credible commitment to change the path of future policy would have immediate effects, we know this because (I tentatively suggest) we have already seen it happen.

Similarly, if Chris agrees that a higher sterling reflects tighter Bank of England policy and if Chris agrees a looser policy would help create jobs – as the sentence “I don’t doubt that more QE – the likeliest tool of an NGDP target – would create some jobs” implies – then there is something illogical in his pessimism towards adopting NGDP targeting.

I don’t think it could come from the Bank; Andrew Sentence is completely unable to offer a credible commitment to NGDP level targeting. But were the Treasury to change the Bank’s mandate then it could commit to change the path of future policy easily. Thanks (!) to  New Labour’s habit of concentrating power ever more in the executive, this change could happen at any point because the Treasury is empowered to change the Bank’s mandate at will.

I don’t think you can accuse me of Policy Utopianism, as I said in my last post many problems would remain after the adoption of NGDP level targeting. If the Doctor’s creed is “first do no harm,” the economic policy maker’s should be “first pick up the free lunches.” To ignore monetary policy, as Chris often does, is to leave all-you-can eat buffets to one side. Pragmatism requires adopting policies that put what labour, capital and land available to work. Even a “small improvement” would be a huge improvement to thousands.

How to End this Depression!

Targeting the path of Nominal Gross Domestic Product (NGDP) is probably the most “fashionable” solution proposed for dragging the developed world’s economies out of depression. This post will refer to the UK, but lots more work has been done on the US from this perspective, particularly by Scott Sumner and David BeckworthBritmouse has blogged about NGDP from a UK perspective.

Real GDP is a proxy for our incomes adjusted for inflation, how well off we are. Nominal GDP is the same but refers to our incomes in cash terms. This nominal measure deviating from trend has been what has driven the wild swings in employment and production the developed world has seen since 2007.

NGDP matters because wages and debt are sticky.

Wages: NGDP can decrease if all other prices decrease with it, the relative prices between them will not change and apart from updating some menus nothing will have really changed. But it is incredibly hard to cut wages, look at the clustering of wage changes around zero in the below graph (via Paul Krugman). This means a decrease in NGDP relative to wages will throw people out of work as employers become unwilling to employ them at the prevailing nominal wage.

Debt: We care about what real resources we can consume but all our contracts are written in nominal terms. If I owe someone £10,000 then at some point I have to hand over some bits of paper, or packages of electrons, to someone for that amount. But, if NGDP grows below trend the total nominal size of the economy will be smaller than expected when I took out the debt, but the size of my debt will not. The real cost of my debt will have increased and this will work to depress the economy because this dynamic will affect a number of people.

If NGDP sinks below trend there are then at least two mechanisms which can act to depress an economy. [1] Has it sunk below trend? Yes it has.

Is off trend NGDP growth associated with weak real GDP growth? Yes it is.

Are changes from trend NGDP correlated with changes in employment? Yes they are.

That might be a little difficult to make out for some. So I zoomed in and inverted the unemployment figures. Are they correlated? Yes, and closely.

Let me tell you a story with a different ending to the one you know. The year 2007 began with NGDP growing to trend, and employment decreasing against the backdrop of international inflationary pressures and financial distress. NGDP reversed course and began to decline during the second quarter of 2007 as did employment, crucially this was before the Lehmann Brother’s bankruptcy and the ohmygodwereallgoingtodie stage of the financial crisis. Unemployment had already increased by nearly 200,000 after NGDP began declining but before the financial crisis began in earnest.

This doesn’t exhonerate any bankers, they put the Bank and Treasury in this position after all. But it does imply different priority for actions. Occupy Threadneedle Street, my friends, not the London Stock Exchange.

Scott Sumner and Ben Bernanke

Looking at the third graph you can see NGDP decline, recovery and stagnation correlating closely with decline, (mild) recovery and stagnation in UK employment. The Bank of England controls the country’s printing presses and hence the nominal economy and responsibility for this depression lies with the Monetary Policy Committee for doing too little to avert it and with the Treasury for doing so little to force them to do more.

In the UK and US the last couple of decades have seen NGDP grow at about 5% a year, and this nominal growth has been split between price increases and economic growth. In 2008 NGDP collapsed and we saw deflation, disinflation, and recession. To date NGDP has not yet recovered to trend, in fact it remains over 10% below trend – and this is our main problem.

Increase NGDP and employment, incomes and taxes would increase, many intractable problems would vanish (though many would not). There are risks and there are methodological problems, but there huge gains for everyone if they right policy is adopted and I want to do my part to try and make sure the right policy is adopted.


[1] Data from here, I’ve used basic prices to strip out the effect of VAT jumping up and down

Microfoundations: a beautiful theory was killed by an ugly fact

Modern economics looks like macroeconomics. Not much is important when lots of people are out of employment apart from getting those people into employment. Getting macroeconomics right is therefore very important and this is why recently the Lucas Critique has been receiving extra attention.

Lucas argued in the 1970s that macroeconomics could offer little useful advice were it built on looking at specific experiences, during specific periods, under specific policy regimes exactly because such models would only be useful in those specific episodes. Macroeconomics in the 1970s, he argued, wasn’t able to teach us anything useful about the future, which is what matters.

Disciples of Lucas had a very big win in the 1970s when they predicted successfully that the long run payoff between inflation and employment would break down. That we were heading for previously unseen combination of high inflation and high unemployment. They won that fight, and I think have kinda coasted since. So, even conceding this success, I would like to put forward three critiques of the Lucas critique.

Firstly, and most obviously, it doesn’t seem very useful, it hasn’t helped anyone in the developed world recover quickly from the little depression. In fact, it seems to have actively caused inaction in some economists who have thrown up their hands when asked for policy advice and said “its all very complicated!” The sort of people who really wound up Keynes in the 1930s.

The most useful policy advice I’ve come across macroeconomically speaking is from Scott Sumner. The advice is very simple and is, essentially, for central banks to keep very sticky prices moving along a predictable trajectory. This means keeping nominal gross domestic product growing at a steady rate along a predictable level. Employment is subdued in countries which have not seen NGDP recoveries like the UK and US and employment is catastrophically low in countries which have seen NGDP plummet like Greece and Spain.

Not a lot of “deep parameters” were necessary to arrive at a useful policy. Imagine, policy changes in a way that might affect the usefulness of Scott’s advice, for example, allowing the widespread proliferation of competing currencies as favoured by the free banking crowd, would this mean Scott’s theory is not “policy invariant” and therefore useless? Possibly, possibly not, it doesn’t matter though because right now what he proposes would be useful. That is how theories should be evaluated.

Subsidiary to this, is my confusion as to what would qualify as policy invariant, “deep parameters.” All aspects of the modern economy are unnatural to an extent; the whole edifice is upheld by the state. I’m not sure what a theory which ignored everything apart from “deep parameters” would like like, but I suspect Hobbes got closest and that wasn’t very close; I remain suspicious of what this approach has to teach us about day to day macroeconomics.

Lastly, Noah and Nick‘s posts defending Lucas’s insistence on microfounding models were very, very fact light. In fact, neither cited anything that suggested the Lucas critique had been empirically verified. This led me to find out whether there was any evidence to support the Lucas critique. It turns out In 1995 “an extensive search of the literature reveals virtually no evidence demonstrating the empirical applicability of the Lucas Critique.” [pdf] A cursory search of more recent literature hasn’t thrown up anything which says “look, proof!” to me. I’d say the last four or five years reveal a similar dearth of useful policy advice.

In summary, the most major problem of microfounding macro models is that it doesn’t seem to have helped us produce anything useful for macroeconomics. Modernmacro has cost me a lot of money in forgone earnings. It has produced some nifty statistical techniques and I’m a big fan of nifty statistical techniques, but they aren’t very useful at putting my friends and I to work.

Cognitive Biases and Workfare

That last post got me thinking about cognitive biases. Being in contact with the unemployed  makes you more miserable than otherwise, but not because it actually increases your chances of unemployment – it isn’t contagious. So people’s change in behaviour or happiness must be a result of new information or old information which they were previously choosing to ignore.

While Chris (and Layard) are correct, workfare or active labour market polices can be good things, the positive effects – lower inflation and higher growth – are diffuse and the negative effects felt by both those in workfare and who meet those in workfare. So it is possible that seeing what unemployment is really like, and the exploitative practices associated with workfare is new information for some people.

Alternatively, people choose to know less about unemployment than they could and unconsciously engage various cognitive biases to effect this. To this extent cognitive biases protect most people from the negative effects of unemployment.

This means that theoretically the left should welcome workfare, for it finally destroys the recent idea, codified by Thomas Friedman, that we need to build our own economy and that we can be in control of Brand Me. Thinking an individual is responsible for their own economy and economic position is fanciful. Just as blaming the unemployed for their plight is a variant of the fundamental attribution error so too is entrepreneurial fetishism. Calculus was invented twice at the same time; someone was going to invent a pretty mp3 player eventually; somebody was going to get social networking right, some ideas are just in the air. That doesn’t mean it doesn’t make sense to handsomely reward entrepreneurs, because it means we get a more pregnant air from which they pluck ideas, but it does mean we shouldn’t attribute too much genius or control to any one person or group.

That is standard fair on the left, waking up the sheeple…

…so it should be some consolation that workfare will work to either let the employed know how horrible being jobless really is, or will breakdown whatever protective cognitive barriers they’ve erected to protect themselves from those grim truths.

Cognitive biases can lead to sloppy policy so inasmuch as they protect individuals by imposing costs on others they are good things to eliminate but it has to be remembered that they do something useful by protecting people from unpleasant truths. So finding policies that break through them will not be unambiguously good but I hope they will eventually be good.