Whatever happened to deficit bias?
Deficit bias: The tendency of governments to allow deficit and public debt levels to increase. Irish Fiscal Council Glossary.
If we don’t get a fiscal stimulus (or more likely, don’t get a large enough one) the reason will be simple: politics.
The fiscal space (to use the IMF’s favourite term) is there — borrowing costs are historically low and yet the UK may choose to leave it unutilsied. The same good be said for Germany, the United States or several other advanced economies.
The advanced economy recovery from the Great Recession has relied more and more on monetary policy as a driver. Fiscal policymakers — after some useful efforts in 2008–2010 — appear to have taken a self denying ordinance on using finance ministries to boost growth through running discretionary deficits. The global picture isn’t as bad as it once was, self defeating belt tightening appears to have stopped or slowed in much of the world but the recovery is far from secure.
We have the persistent and unusual scenario of the IMF leading the call for more spending.
Te monetary reliance, the equivalent of flying a two engined plane but choosing to use only one motor has forced central bankers to be ever more inventive in their attempts to support growth. We’ve seen interest rates cut to zero, interest rates cut below zero, huge amounts of quantitative easing, all sorts of measures to support bank lending, the buying of private sector assets, interventions in the foreign exchange market and we may not be far of seeing helicopter money.
The conservatism of politicians has forced central bankers to be become radicals when it comes to economic policy. This is a strange old world we are living in and we don’t yet know what the long term consequences will be.
The driver of policy makers behavior is politics and public opinion. The consensus view of the IMF and the balance of professional economic opinion in the UK last year was that more government spending would be a good thing for growth. The public begged to differ and one of the government’s strongest lines in winnign relection was it;s focus on the need to “balance the books”, “live within our means” and aim for an overall surplus on the public accounts.
Budget surplus may often be self-harming economically but they are politically popular.
And I don’t think this is just an Anglo-Saxon phenomenon, politicians across (Northern at least) Europe take similar lines.
Which takes me back to my opening question, the title of this post: whatever happened to deficit bias? The idea, defined by the Irish Fiscal Council as, “the tendency of governments to allow deficit and public debt levels to increase”.
Certainly when I learned my macroeconomics, the text books believed this was a thing. And it makes obvious sense that the public should prefer to be taxed less or enjoy higher spending than would otherwise be the case.
And yet the public don’t — in large parts of the world — agree. Rather than a democratically driven deficit bias we seem to be infected with a democratically driven surplus bias. (Of course very few countries are actually achieving a surplus — but any politician arguing for borrowing financed infrastructure spending soon finds themselves under attack).
I was struck reading Eric Lonergan’s (excellent) response to my helicopter money post by this passage:
There is another deeper — and obvious — problem. The challenge facing fiscal stimulus is not financing, but that it doesn’t happen. Most of the developed world can’t agree how it do it politically. In the area of the world most in need of higher aggregate demand — the Eurozone — it’s illegal. Even Larry Summers has given up on infrastructure spending as a practical counter-cyclical stimulus. We really don’t want to have to wait for agreement on building airport terminals or high speed rail links to bring down unemployment. If that is our fate, depression beckons.
Now don’t get me wrong. We should have effective fiscal policy. We should be doing lots of spending on infrastructure and human capital. But so far, that appears a pipe dream. The political and institutional reality means that the only effective counter-cyclical agents are central banks. Perhaps, the new Conservative government or a reinvigorated Abe will prove otherwise — but I wouldn’t count on it.
It is interesting to ask how different monetary policy would have looked post 2008 if central banks had not been operationally independent, if a minster was directly responsible for their policies.
Public pressure for higher rates to “reward” savers was been an undercurrent of political debate for most of the past decade, ere central banks directly controlled by finance miniseries it would have been harder to ignore.
There is a real and perplexing possibility that independent central banks have been able to do more to support growth through easing than directly controlled central banks, subject to more political pressure, would have been able to achieve.
I say “perplexing” as this almost entirely reverses the academic arguments for independent central banks — that government's took poor decisions by prioritising growth over inflation control which lead to long run costs and heightened the trade off between unemployment and inflation.
Again, it’s an odd world that we live in.
Perhaps the world is odd enough that when we are designing institutions like fiscal councils (like the UK’s OBR) we need to take into account not just their role in combating deficit bias but their potential role in mitigating surplus bias too.
A body such as the Office for Budget Responsibility which checks that the Treasury’s sums add up and pronounce son whether or not the fiscal targets will be met is a helpful institution. One that also occasionally said to the Chancellor— it would help if you changed your targets or spend more now would be even more helpful.