Watch for the endgame

I just returned from the UK where I gave several talks and interviews.  The main purpose of my trip was to give the Adam Smith Lecture at the Adam Smith Institute.  I was very impressed with the people there, especially Ben Southwood and Sam Bowman.  Here is a link with a video of the lecture.  I also spoke at the Cambridge Union, and to some bankers and Treasury people.  I did a BBC radio interview, and an interview on BBC’s “Newsnight” TV show, which should be broadcast soon.

Almost from the beginning, I’ve been more popular in the UK than the US.  That’s probably because the US has a sharper left/right split.  Over here my views are too right wing for the left (which is rapidly moving ever further leftward), whereas the right sees me as a redistributive Keynesian inflationist.

I noticed that in the UK all the talk is of raising interest rates later this year, as their economy is growing fast and the employment population ratio is nearing the previous all time peaks of 1971 and 2006 (what a contrast with the US!)  You may recall that a few years ago I said that the exit from policies can be very revealing.  It can help us to understand the effects of policy (as when tapering had a market reaction in the US) and also the underlying dynamics of the monetary fiscal interaction.

First a bit of background information.  Since 2008, the UK has run extremely large budget deficits, bigger than the US as a share of GDP. Everyone agrees these are too large, and need to be reduced. But Keynesians have argued that austerity should be very gradual, to avoid derailing the recovery. That’s a fair argument (although I have doubts due to monetary offset), but the implication is that if the recovery ever becomes so strong that you need to raise rates, then clearly the first place to tighten is fiscal policy, and policymakers should only raise rates when the budget deficit has returned to the optimal level based on the classical principles of public finance.  Britain is obviously far from that point.

A few years back I was very skeptical of the notion that fiscal stimulus in the US was being done because of a lack of effectiveness of monetary stimulus.  I predicted that when the time came for tightening Keynesians would prefer monetary tightening to fiscal austerity, even though their own model says that fiscal austerity should be done first, as it reduces the (still too high) budget deficit.

In my admittedly unscientific survey of the UK press it seems to me that there is more enthusiasm for monetary tightening than accelerated fiscal austerity, just as I expected.  Here is an editorial in The Independent, which doesn’t even mention of the option of fiscal tightening.  (And here’s the Times.)

Just to be clear, I am not criticizing the BoE, which has done a good job under Mark Carney. NGDP is rising at a brisk rate.  Given the refusal of fiscal policymakers to speed up the austerity process, the BoE may need to raise rates in 6 months to a year.  That’s monetary offset, and it is quite appropriate.  The real problem in Britain is government spending, which is still too high.  (Or if you are a left-winger, the real problem is that taxes are too low.)

PS.  Obviously I’m pleased that there is a single-minded focus on the BoE as the institution that should and does steer the nominal economy.  It’s a pity that single-minded focus wasn’t there in 2008 and 2009.

HT:  Travis, W. Peden



41 Responses to “Watch for the endgame”

  1. Gravatar of Daniel Daniel
    24. June 2014 at 06:06

    This is off-topic, but since this blog is dedicated to monetary policy, I think it would help to include biological facts

  2. Gravatar of Matthew McOsker Matthew McOsker
    24. June 2014 at 06:14

    If you raise rates reducing NGDP, the wont deficits get larger as a % of GDP?

  3. Gravatar of TallDave TallDave
    24. June 2014 at 06:41

    PS. Obviously I’m pleased that there is a single-minded focus on the BoE as the institution that should and does steer the nominal economy.

    Almost no one seems to understand this in the United States. The left thinks the federal government should just spend more, and regulate more, and redistribute more. The right is pretty sure all our economic problems can be solved with sound money, more efficient (i.e. less public) spending, less onerous regulation, and incentive effects (redistribute less).

    Almost everyone still seems to be confused about what nominal rates mean. The conventional description of Fed policy is still “ultra-loose.”

  4. Gravatar of W. Peden W. Peden
    24. June 2014 at 06:53

    I haven’t caught someone in the act of saying “More fiscal tightening would be bad, but we need to raise interest rates” yet. I expect that I shall soon, and that their response will use the dreaded phrase “macroprudential considerations” i.e. using a whisk to cut a steak.

  5. Gravatar of Philo Philo
    24. June 2014 at 07:34

    You write: “Keynesians have argued that austerity should be very gradual, to avoid derailing the recovery. That’s a fair argument (although I have doubts due to monetary offset) . . . .” Isn’t this soft-pedaling your position? Isn’t your view that in a fiat-money regime fiscal policy is relevant to “the business cycle” *only if the monetary authority is incompetent*. Or is “a fair argument” just a soft way of saying “a bad argument”?

    Even with non-fiat money–suppose, for example, that some weight of gold were the unit of account–fiscal policy would be relevant only as it affects velocity: the government could spend what it borrows *from people who would otherwise simply have hoarded gold*.

  6. Gravatar of Luis Pedro Coelho Luis Pedro Coelho
    24. June 2014 at 07:44

    You know this fish joke?

    Two young fish are swimming along and encounter an older fish who asks “Hi kids, how’s the water?”. The brasher of the young fish replies “just great, you know?” and they swim away. When out of earshot of the older fish, the brash fish asks the other one “what the f*ck is water?” and they continue swimming along.

    Here’s the EU monetary politics versions:

    Two young economists are discussing the economy when they encounter the older fish who asks “Hi kids, how’s the stance of monetary policy?”. The brasher, a Keynesian, replies “just great, Milton, very accommodating, you know?” When Milton has moved far enough away, the brash one asks the other one “what the f*ck is the ‘stance’ of monetary policy?” and they continue arguing fiscal policy.

  7. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    24. June 2014 at 07:58

    You’ll know you’re well known in the UK when Jeremy Clarkson asks you to take a lap around the track in ‘a reasonably priced car’.

  8. Gravatar of Morgan Warstler Morgan Warstler
    24. June 2014 at 09:48

    9 Things Only People Who Went To Sleepaway Camp Will Understand–344

  9. Gravatar of Benny Lava Benny Lava
    24. June 2014 at 12:47

    The UK sounds like market monetarist paradise. But what about the EU? With new changes can we assume faster growth and lower unemployment for 2014 in the EU? And what is Sweden’s central bank doing now that they have deflation and rising unemployment?

  10. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    24. June 2014 at 12:59

    I thought the Tim Congdon question at the very end was good. Maybe Scott could do a blog post expanding on his response to it.

  11. Gravatar of Rajat Rajat
    24. June 2014 at 13:42

    “it seems to me that there is more enthusiasm for monetary tightening than accelerated fiscal austerity”

    Don’t you know it’s because the U.K. Has a house price bubble caused by recklessly low interest rates?! Monetary policy affects asset prices and prices generally whereas fiscal policy affects real variables… That’s how most people – including most market economists and media commentators – think.

  12. Gravatar of Adam Adam
    24. June 2014 at 13:45

    I’m curious about where you’re seeing the American left move “ever further lefward.” What did you have in mind?

    As for which lever to pull when its time to tighten, shouldn’t the significant austerity that’s already happened over the last three years be relevant?

  13. Gravatar of Major-Freedom Major-Freedom
    24. June 2014 at 16:28


    Your first question:

  14. Gravatar of Ben Ben
    24. June 2014 at 16:45

    Fake house price boom. Dodgy unemployment figures skewed by zero hour contract “jobs” and benefit rules on self employed. Same as 2008. Same lazy economists looking at high level figures.

  15. Gravatar of Major-Freedom Major-Freedom
    24. June 2014 at 16:50

    “…whereas the right sees me as a redistributive Keynesian inflationist.”

    I just ask why the support for initiations of violence. Left wing and right wing politics are the same in this respect.

  16. Gravatar of Scott Freelander Scott Freelander
    24. June 2014 at 18:05


    The Adam Smith presentation was the best I’ve seen from you. I would even all it masterful.

  17. Gravatar of Benjamin Cole Benjamin Cole
    24. June 2014 at 19:00


    As a Market Monetarist, I place less emphasis on fiscal deficits. I would prefer aggressive QE.

    But, if fiscal deficits are “financed” by QE, are they “too large”?

    That is, if USA runs a $1 trillion federal deficit, but the central bank buys $1 trillion in US Treasuries, then there is no increase in the national debt, or burdens on taxpayers.

    In the above case, what makes the deficit “too large.”

    What if the federal government cuts taxes by $1 trillion, and does $1 trillion in QE? If the deficit “too large”?

  18. Gravatar of J.V. Dubois J.V. Dubois
    25. June 2014 at 01:14

    I enjoyed the video and I also have to say that this is a good post as well. And there is one part that was very interesting for me. What caught my attention in your video is your observation that people in general think that CB is responsible for inflation and that fiscal policy is responsible for real growth.

    This is obviously nonsense and you did a pretty good job of explaining it. However if this is really what public and even some pundits and journalist think – then it is easy to explain why there is so little call for fiscal tightening.

  19. Gravatar of Britmouse Britmouse
    25. June 2014 at 01:41

    Keynesians still think we should try to close an output gap which is possibly very large, and that the “doctrine of immaculate growth” is still maybe true, so we can possibly have non-inflationary positive AD shocks.

    Meanwhile the BoE thinks strong RGDP growth coupled with anything “bad” which goes up (house prices, household debt, the CPI, …) is a sign of “financial instability” or a “bubble” which will lead to another 2008-style recession, because that is what they think happened last time.

    It seems more likely to me that the BoE will raise rates for quite arbitrary reasons, rather than strong NGDP growth. Preferences for fiscal over monetary AD stabilisation will no doubt continue after rates go up, and the excuse will be the need to avoid hitting the ZLB again and/or that low rates cause bubbles and/or something else.

  20. Gravatar of Britmouse Britmouse
    25. June 2014 at 01:41

    Oh, but good post and a nice presentation 🙂

  21. Gravatar of W. Peden W. Peden
    25. June 2014 at 03:16


    “Preferences for fiscal over monetary AD stabilisation will no doubt continue after rates go up”

    But only, I suspect, in one direction. People aren’t proposing bigger spending cuts or tax rises in order to cool down the housing market.

    In other words, we’re in danger of getting into a situation where there is fiscal stimulus to boost AD and interest rate rises to reduce AD. That’s quite a recipe for crowding out of the private sector.

  22. Gravatar of Joseph Joseph
    25. June 2014 at 03:49

    Just to play devil’s advocate, couldn’t one make a case that it might be appropriate for the BOE to move first in terms of tightening, if only a little bit simply because monetary policy is more nimble than fiscal policy and it’s easier to reverse course if things go wrong, like most central banks did in the August, September, October period in 2008. Fiscal policy on the other hand is set in increments at a minimum of year, and effectively much longer than that.

    This is all predicated on the assumption that monetary offset is not 100%, which I think is a reasonable assumption for the time being, if only because the monetary authorities do not react as reasonably as they should when interest rates are extremely low.

  23. Gravatar of W. Peden W. Peden
    25. June 2014 at 03:59


    I would go further and say that it is better to use monetary policy for AD management full-stop. Fiscal policy should focus entirely on more long-term issues like debt management, the level of savings, tax fairness etc.

    However, if it makes sense to raise interest rates later this year, then can be no Keynesian economic (as opposed to political) reason for the Chancellor not increasing austerity in the Autumn Spending Review in November.

  24. Gravatar of Britmouse Britmouse
    25. June 2014 at 04:18

    W. Peden, that’s the funny thing. Many Keynesians do tend to call for “more austerity” in the form of cutting “Help to Buy”, but then also “less austerity” in the form of, say, large government spending on building “social housing”, because they believe the former is merely inflationary, but the latter will create jobs. That is why I call them supply-side fiscalists.

  25. Gravatar of W. Peden W. Peden
    25. June 2014 at 04:57

    There’s a position close to that one which is reasonable, which is that cutting Help to Buy is a good idea because it’s trying to solve a lack of housing by increasing the demand for existing housing, whereas building social housing (as opposed to “anti-social” housing, which has creaky floorboards that make lots of noise in the middle of the night and disturb the neighbourhood) at least addresses a supply problem by increasing supply.

    However, I think you’re right to say that a lot of Keynesians, especially in the UK where just thinking about housing tends to lower our IQs by 20 points, have that supply-side fiscalist view.

  26. Gravatar of Student Student
    25. June 2014 at 06:54

    Very convincing stuff… and then the commerce department releases 2014Q1 GDP numbers showing a 2.9% drop, yikes! Thats the first decline since 2011Q1 and the largest since 2009. Thats only one data point but the case may not be closed just yet.

  27. Gravatar of SG SG
    25. June 2014 at 06:57

    Additional GDP revisions are confirming the prescience of Mark Sadowski’s Q1 forecasting…

  28. Gravatar of ssumner ssumner
    25. June 2014 at 07:54

    Daniel, I didn’t quite understand that link.

    Matthew, Yes.

    W. Peden, Good point.

    Philo, I meant that it is a fair point if you don’t believe in monetary offset. But in that case you should favor tighter fiscal, not tighter money.

    Adam, Do they still favor abolishing the minimum wage? Do they still favor 28% top tax rates? How about abolishing capital income taxes and going with a progressive consumption tax?

    Rajat and Britmouse, Either interpretation is scary.

    Everything, Thanks for the comments on the talk.

  29. Gravatar of Daniel Daniel
    25. June 2014 at 08:24

    It means that the “fiat” part of fiat money is difficult to accept for humans, on a deep emotional level.

    Hence the right-wingers/austro-sadists/goldnuts/etc foaming at the mouth against non-existent inflation.

  30. Gravatar of Daniel Daniel
    25. June 2014 at 08:52

    Actually, it explains Keynesian blindness, too – since their arguments rely on a supposed impossibility of devaluing the currency.

    It’s hard to say what framework the ECB follows in its decision making, but the same gut feeling (that the scarcity of money cannot be overcome) guides them, too.

    At the end of the day, the fact that the supply for the medium of exchange/account should be elastic is something most humans have a tough time accepting.

    And, like you repeatedly said, central banks follow the macroeconomic consensus of the day.

    If that isn’t a recipe for perpetual failure, I don’t know what is.

  31. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    25. June 2014 at 09:44

    Am I the only one who finds the reasoning of Cecchetti and Schoenholtz weird, in this post;

    ‘…overshooting a 2% inflation target (or a 2.1% inflation target) to get back to the 1990-2007 price path would be relatively straightforward. It could be achieved by running inflation at 3% temporarily for three years and then returning to the 2.1% path.

    ‘The bottom panel shows that getting back to the pre-crisis nominal GDP path is a completely different story. To return to the previous trend within three years, policymakers would need to aim at nominal GDP growth in excess of 10 percent annually. That’s a pace of growth that we haven’t seen since 1984, when the recent era of low inflation began.’

    It seems to me that their two graphs show that inflation targeting was a big mistake. It produced a huge drop in NGDP. Which seems the opposite of their conclusion.

  32. Gravatar of W. Peden W. Peden
    25. June 2014 at 10:35

    Patrick Sullivan,

    It’s yet another case of people rating inflation expectations very highly, while literally not even considering income expectations.

  33. Gravatar of TravisV TravisV
    25. June 2014 at 11:29

    Kevin Erdmann wrote a fascinating post here:

    I’m still trying to get my arms around it……

  34. Gravatar of Ralph Musgrave Ralph Musgrave
    25. June 2014 at 17:40


    Are you still a market monetarist and if so what does MM now consist of? Reason I ask is this.

    You say “Since 2008, the UK has run extremely large budget deficits, bigger than the US as a share of GDP. Everyone agrees these are too large, and need to be reduced. But Keynesians have argued that austerity should be very gradual, to avoid derailing the recovery. That’s a fair argument…”.

    Now that’s a big change from your previous pronouncements to the effect that fiscal stimulus is a waste of time, Keynsianism is all nonsense, MMT is nonsense, etc etc.

  35. Gravatar of dtoh dtoh
    26. June 2014 at 02:34

    Patrick R. Sullivan,
    I would describe their reasoning as bizarre. Basically, we didn’t target, therefore NGDP is way below where it should be, now it’s a long way to get back to target. Therefore targeting won’t work.

  36. Gravatar of ryan ryan
    26. June 2014 at 07:24

    “The real problem in Britain is government spending, which is still too high.” That is not the UK’s real problem. The real problem is the external balance, which is deteriorating. By relying on the BoE to tighten monetary policy (today’s pre-emptive macroprudential measures aside) this is going to exacerbate the external imbalance issue given the relative trajectories of interest rates with the UK’s main competitors will put GBP under upward pressure. If you, or any of your readers, are interested I have written an article on this issue on my own website

  37. Gravatar of ssumner ssumner
    27. June 2014 at 06:24

    Ralph, Saying something is a fair argument doesn’t mean I agree with the argument. I still think fiscal stimulus is a waste of money for monetary offset reasons. You would have noticed that if you had not stopped reading right at the end of the passage you quoted.

    Thanks Patrick, I’ll do a post on that.

  38. Gravatar of TravisV TravisV
    29. June 2014 at 08:04

    Prof. Sumner,

    Frances Coppola disagrees with you about the UK here:

    “But sadly that’s where the agreement ends. Quite apart from the fact that not everyone agrees that the UK’s fiscal deficit is too large, I think it is very evident that loose monetary policy cannot offset fiscal austerity. Admittedly, the combination of tight monetary policy with fiscal austerity – as in the Eurozone – is far worse, but most economists agree that the UK’s fiscal austerity in 2010-12 did derail its recovery despite the Bank of England’s monetary offset. The reason for this is likely to be the regressive nature of QE and fiscal austerity, both of which disproportionately affect poorer people – who are also those with the highest marginal propensity to consume. Supporting asset prices for the rich does not have the same effect on AD as increasing benefits and cutting taxes for the poor.”

  39. Gravatar of Frances Coppola Frances Coppola
    29. June 2014 at 08:46

    That’s a bit misleading, Travis. I actually agreed with Scott that deficit reduction should precede interest rate rises. I don’t think measures to reduce the deficit faster are appropriate at the moment in the UK, but that is because I think the economy is far more fragile than people realise. I explained why in the post.

    Regarding monetary offset: my view differs from Scott’s in that I think monetary policy works best when fiscal policy is complementary rather than antagonistic. But as there is a real shortage of counterfactual evidence, we may simply have to agree to differ.

  40. Gravatar of Frances Coppola Frances Coppola
    29. June 2014 at 10:35


    I completely agree about the external deficit. In my view it’s a much bigger problem than the fiscal deficit, but no-one is really talking about it let alone addressing it. The problem is that half of the UK’s exports go to the Eurozone, which is running a structural current account surplus because of tight fiscal policy and weak capital spending. If this continues, either the UK will have to find alternative export markets or accept that its current account deficit – and associated fiscal deficit – must continue. Chris Dillow ably discusses this here:

  41. Gravatar of am am
    1. July 2014 at 23:30

    Do you have a take on this. It would seem worthwhile that an analysis on the UK economy versus Eurozone economy and versus US economy is required and would be valuable. Is it another bubble or something better. The point is these other major western economic zones seem to be struggling and why?

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