Economics that don’t add up
March 20, 2011Posted by on
Advances of computer technology enable a modern society to model just about anything, something that politicians set great store by. Particularly for its use in macroeconomics modelling, where such modelling can serve as either a Judas goat or a scapegoat. However, the adage of GIGO (garbage-in/garbage-out) still applies , and my experience leads me to the belief that the use of any model validation is functionally dependant more on the desired outputs than on the use of any valid data input. This, in turn, is totally dependant on the modelling process itself. Achieving the desired output is simply a matter of manipulating the input data and, if necessary, the modelling process. For a politician this is already too much detail. What the politician wants is a favourable political result, which is ‘the desired output’ and the ability to offset the blame should things go wrong.
‘Spending to invest’ was the mantra most central to fiscal policy under the previous UK New Labour administration. In some thirteen years of such a spending policy there is no evidence that New Labour ever, or at least occasionally, calibrated their macroeconomics modelling against reality. While thirteen years provided ample opportunity to confirm any macroeconomics model against reality, there’s no sign that New Labour’s ‘perceived reality’ changed in those thirteen years. Given this entrenched perceived reality, questioning the macroeconomic model used would be pointless. However, there’s no sign that this perceived reality has changed now that New Labour are the opposition party. Any self-criticism by New Labour, or criticism of their fiscal policy by the present coalition Government, isn’t about the macroeconomic modelling. Rather, any such debate simply dissolves into maelström of blame, where the poor goat transmutes into a sacrificial lamb of some dubious origin. The tentative approach of the UK coalition administration to the scale of the budget deficit and national debt fails to bring much comfort. There’s no sign that they challenge the macroeconomic modelling for government spending, but simply the scale of that spending.
Sorry, but the fiscal multiplier doesn’t multiply claims the Adam Smith Institute (ASI). The ASI give a link to this paper (via Scott Sumner), where the paper’s researchers claim that their study provides new evidence of important fiscal-monetary interactions as a crucial determinant of the effects of fiscal policy on GDP, leading them to conclude that ‘Country Characteristics Determine the Effects of Fiscal Stimulus‘. As the ASI point out, for those of a Keynesian persuasion, the results aren’t pretty. The central conceit, that government borrowing to spend boosts the economy by more than the amount of the spending (the multiplier) just isn’t true. Just isn’t true for the UK, that is. The fiscal multiplier just doesn’t multiply.
- The impact of government fiscal stimulus depends on key country characteristics, including the level of development, the exchange rate regime, openness to trade, and public indebtedness.
- Higher development (like the UK) makes for a higher multiplier – openness to trade for a lower – for the UK these two might roughly balance each other out
- Indebtedness also matters: when the outstanding debt of the central government exceeds 60 percent of GDP, the fiscal multiplier is not statistically different from zero on impact and it is negative in the long run.
As the ASI contend, with UK debt at end Jan 2011 at 57.6% of GDP, at current borrowing rates the UK has about 3 months before the effects of deficit spending turn negative. But that’s not the end of it:
- Exchange rate flexibility is critical: economies operating under predetermined exchange rate regimes have long-run multipliers greater than one in some specifications, while economies with flexible exchange rate regimes have multipliers that are essentially zero.
- The pound is extremely flexible: so none of the fiscal stimulus we’ve already had has had any effect either.
If this paper is correct then that’s it for Keynesianism in the UK, into the dustbin of history with it. For if the fiscal multiplier just don’t multiply, there’s no point to it all at all.
It would seem that every politician, or at least every member of the Cabinet , should have an albatross hung around their neck in the form of the following adage:-
Why are we doing, what we are doing and how do we proceed from here?
Why? The debt we’re in?