With Jeremy Corbyn as leader of the Labour Party we will hear a great deal from his opponents that his economic policies are not “credible”. At the moment we do not have a clear idea of what these policies will be, but it is worth asking beforehand what exactly a credible economic policy is.
A natural way to define a credible economic policy is one that accords with what most economists think. If this was true, you might expect it would be difficult to win an election based on a macroeconomic policy that most economists regard as mistaken. Unfortunately, the last General Election provides a clear counter-example.
In that election George Osborne proposed eliminating the overall budget deficit within five years. That contradicted what most economists believe is a sensible fiscal policy, for at least two reasons. First, it precluded any significant increase in public investment, on things like building schools and flood defences. Every economist I know agrees that now is an excellent time to increase infrastructure investment, because labour is cheap and interest rates are low. Second, another round of austerity is very risky when interest rates are so low.
Osborne says we must reduce government borrowing quickly to prepare for the next crisis. That makes little economic or business sense. Firms that cut back on investment when borrowing is cheap and the economy is expanding generally fail. The more significant risk is that the world economy takes a turn for the worse in the next year or two because of events in China or elsewhere. If interest rates are already low because they are having to offset the impact of austerity, the Bank of England has little room to counter these global shocks. So the prudent policy while interest rates are low is to avoid austerity.
The fiscal policy platform on which the Conservatives won was not credible to most academic macroeconomists. The problem is that most people in politics and the media do not get their notion of credibility from this source.
So where does their idea of economic credibility come from? Discussion of economic policy in the media is dominated by political rather than economic journalists. They routinely provide comment after major economic policy announcements and interview politicians. They spend most of their time talking to politicians, so the Westminster bubble defines what the media sees as a credible economic policy.
Take, for example, the large increase in the minimum wage announced in the last Budget. This far exceeded the recommendations of the Low Pay Commission, the institution set up by government to advise on how high the minimum wage can go without it leading to large reductions in employment. The Commission contains academic economists who have a detailed knowledge of the research on this issue. By definition, therefore, Osborne’s announcement was not credible in these terms. However most political commentators focused on the fact that it was clever politics.
There are a number of very good economic journalists. Here we have a peculiar problem associated with macroeconomics. Most of the day-to-day macroeconomic news is about short-term market movements, and the obvious source for comment are economists working in the City. Ask an academic about why sterling moved yesterday or the latest retail sales figures, and they will probably say they have no idea because they are too busy doing “proper research”. Most of the time, therefore, academics are of little help to economic journalists.
As a result, those journalists tend to establish contacts with City economists rather than academics. The problem is that City economists are not the best source for advice on major macroeconomic policy issues, like what to do with the deficit. This does require a knowledge of “proper research”, the academics’ area of expertise. What we often get reported instead is what “the market” thinks about policy. This is code for the speculation of City economists who have little policy expertise and a set of biases that come from the financial sector (deficits are bad, low taxes are good).
City economists also have an interest in hyping up the unpredictability of the markets, and their unique role in being able to interpret the market’s fickle moods. The market is like some unpredictable god, and City economists are the high priests who can tell whether their god likes a particular policy.
Take the 2010 crisis, for example. In reality, the debt crisis was a purely eurozone affair, for clear macroeconomic reasons. There is no hint in the data that those who buy UK government debt ever thought that the UK might default. But that is not the message you here from those “close to the markets”.
As a result of all this, macroeconomic policy often has very little to do with macroeconomics as taught in universities around the world. Now you might be thinking, who cares: what do academic macroeconomists know anyway? So let’s look at the major failures of macroeconomic policy over the last 35 years. Margaret Thatcher targeting the money supply, famously opposed by 364 economists: this led to a 25 per cent fall in manufacturing production, and was abandoned after a few years. Entering the ERM at an overvalued exchange rate in 1990, despite extensive macroeconomic analysis showing this would lead to a recession: we were forced out of the ERM during a recession in 1992. And 2010 austerity, undertaken despite the warnings of many macroeconomists: we have had the slowest recovery in over a century.
Something the UK got right was not to join the euro in 2003. This decision followed perhaps the most extensive and thorough academic consultations ever undertaken by the Treasury. Academic macroeconomists are far from perfect, but the evidence suggests that you ignore their advice at your peril. So the next time someone tells you an economic policy is not credible, ask: credible with whom?
The author is professor of economic policy, Blavatnik School of Government, Oxford University