UK Macroeconomic Policy Mistakes of the Past

Given that title, I’m not sure I need to write a post, since no one will read this post which is really a comment on Simon Wren-Lewis’s post “Left, Right and Macroeconomic Competence.” I thought this title was less openly twitty than “Commenting on Wren-Lewis,” but I will go on to comment on Brad DeLong commenting on another post by Wren-Lewis.

Mainlymacro has been even more a must read than usual and, it seems, has been very stimulating. the post on Macroeconomic Competence is excellent.

Wren-Lewis starts by saying it is unfair to the right to act as if US Republican presidents are representative. Then he looks at the UK and three alleged policy mistakes. One choice seems odd to me.

three major macroeconomic policy errors over this period, all of which occurred when the Conservatives were in power. However that alone proves nothing: Labour was in power for fewer years and might have been lucky. [1]

The period starts with Margaret Thatcher and the brief experiment with monetarism. Here you could use the inflation/unemployment contrast – the policy succeeded in getting inflation down very rapidly, but at high costs in terms of unemployment, which persisted because of hysteresis effects.


The 1990 recession can also be linked to left/right influences. The rise in inflation that preceded the recession (and to some extent made it necessary) was partly down to Nigel Lawson’s tax cuts. I have been told by one insider that the key wish at the time was to cut the top rate of tax, but it was felt that to do this alone would be politically damaging, so tax cuts were made across the board. That was not the only reason for the late 80s boom – there was also the decline in the aggregate savings ratio that in my view had a great deal to do with financial deregulation – but it was a factor.

I am especially relatively ignorant about the UK, but I had a different story for the late 80s inflationary boom and subsequent recession. My story is that the 1987 stock market crash made the lady who wasn’t for turning, turn. I think that Thatcher feared a second great depression and demanded expansionary monetary policy by the non yet independent Bank of England. In any case, there was sharply expansionary fiscal (and I think monetary) policy and an inflationary boom, followed by a recession.

According to the conventions of both academic macro and policy makers, this was a bad mistake (they mistake they always fear). It is also the time when the Western border of schlerotic old Europe moved from the Atlantic to the English Channel. In 1985, the UK was the number one example of hysteresis, Eurosclerosis and all that. In the 90s it was the number two example of relatively healthy “Anglo-Saxon” economies (I typed the scare quotes, because I, like most anglophones, am not Anglo-Saxon).

I think the UK policy errors of the late 80s showed that “hysteresis” is Greek for “tight monetary policy” — that the extremely persistent unemployment problem was tractable, if one were willing to accept temporarily slightly higher inflation.

I’d tend to guess that the error was inducing an un-necessary inflation fighting recession in 1990, not inducing an inflationary boom in the late 80s.

Attempting to reduce my exteme ignorance, I went to FRED and slapped together this graph. I use the 3 month gilt rate as a safe short term interest rate, because it was easy to find. The 3 month nominal rate minus lagged CPI inflation is my index of monetary policy (the deviation from a super simple sub-Taylor rule). The registered unemployment rate follows with a lag of about one year (longer than the standard pre-hysteresis 6 months but not very long).


My reading of the graph is “keep the safe short term real interest rate below 5% (5%!) and you’ll be OK”.

Well that was long. I still haven’t mentioned Brad’s comment on the other post by Wren-Lewis. The other post, Understanding Anti-keynesians is also excellent. One point which is worth stressing is (bold mine)

I suspect we would not even think of questioning the central role of Keynesian ideas for macroeconomics today if it had not been for the New Classical revolution in the 1970/80s. This revolution was successful in the sense that it did change the way academic macroeconomics was done (microfoundations and DSGE models). Most academic macroeconomists – for better or worse – are deeply committed to that change. But the revolution was opposed by many in the Keynesian consensus of that time, and so Keynesian economics became associated with the old fashioned way of doing things. This association was encouraged by many of the key revolutionaries themselves. We now know, as a result of the development of New Keynesian economics, that there is no necessary incompatibility between the microfoundations approach and Keynesian ideas. However I suspect that, at least for some, the association of fiscal policy with old-fashioned Keynesian ideas set down deep roots. It certainly seems that some notable academics were surprised that New Keynesian models actually provided strong support for the use of countercyclical fiscal policy in a liquidity trap.

Wren-Lewis is kind enough not to name the notable academics who were clueless about what the actual math actually said. I might add that the confusion is understandable, since New Keynesian models are reverse engineered to get old Keynesian policy implications out of DSGE models. To be less rude, one might say they are engineered to reconcile DSGE models with the stylized facts, that is with reality. But one might risk rudeness by noting that it is impossible to tell what New Keynesians are up to, since, by the standards of macroeconomic research, reality and old Keynesian models are indistinguishable.

I wanted to comment on Brad’s comment. This is related to Wren-Lewis and civility vs rude people. Brad’s post A Question for Simon Wren-Lewis: How Can You Not Think That It Is All Ideology on the Other Side? begins

“Simon Wren-Lewis bends over so far backwards to be fair that, I think, he loses sight of the ball:”

and as a counter argument quotes Douglas Holtz-Eakan with as the only further comment “And how can you not think it is all ideology on the other side of the hill.”

I cut the Douglas Holtz-Eakin quote down. it is from
Structural Reforms to Reduce Debt and Restore Growth:

Even if one believed that countercyclical fiscal policy (‘stimulus’) could be executed precisely and had multiplier effects, it is time to learn by experience that this strategy is not working. [] have all failed to generate growth. The policy regime of macroeconomic fiscal (and monetary) fine-tuning backfired in the 1960s and 1970s, leaving behind high inflation and chronically elevated unemployment, and it is working no better in the 21st century…

I wish to feed the troll and respond to these claims

1) “precisely” is setting up a straw man. Precisely zero Keynesians argue that stimulus can be executed precisely. The assumption that if something can’t be done precisely right it should not be done at all is indefensible and Holtz-Eakin doesn’t argue it.

2) “multiplier effects” is ambiguous. Does it mean a multiplier greater than zero (that which is needed to justify stimulus in a liquidity trap) or greater than one ? Anti-Keynesians (I am thinking of Lucas, Fama and Cochrane) assert that the multiplier must be exactly zero, so fiscal stimulus is bad policy. Then another set of anti Keynesians (including Cochrane) argue that the data don’t prove that the multiplier is greater than one, so the data show that Keynesians are wrong. The fancy mathematical point that 1>0 escapes them.

3) “fine-tuning backfired in the 1960s and 1970s, leaving behind high inflation and chronically elevated unemployment,”

unemployment was not chronically elevated in the US in the 60s (certainly) or the 70s. This was a period of extremely rapid growth of employment with v shaped inflation fighting recessions which caused temporarily, not chronically, elevated unemployment. The chronically elevated unemployment occured in the 80s and (in Europe) early 90s. This followed a shift in policy (and in academic macroeconomics). Prominent rational expectations revolutionaries (Lucas, Sargent — really prominent) said that their theories implied that inflation could be defeated without causing unemployment (certainly not chronically high unemployment). The chronically high unemployment followed the abandonment of Keynesian economics.

Holtz-Eakin could just have well have written “Adam Smith’s proposals were disasterous as the publication of TheWealth of Nations was followed by chronically hing unemployemnt (after an interval of roughly 2004 years).

Holtz-Eakin is, quite literally, playing heads I win, tails you lose. “followed by” is as strategically vague as “precisely” is strategically narrow. He holds his arguments to the standard of getting the time right give or take a decade or two.

Commenting on Brad who was commenting on Holtz-Eakin to comment on Wren-Lewis, Howard wrote “Ideology is much too generous a description for partisanship.”

heh indeed.