Faith-based economics at the Treasury Committee
I, and my colleagues Angus Armstrong and Simon Kirby, gave evidence to the Treasury Committee on Tuesday November 13th. Should you have time and inclination, you can watch. As you would expect, we covered a range of topics: the fiscal framework and fiscal policy, multipliers, the "productivity puzzle", etc. However, I was rather surprised by the tone of the questioning on one topic: why are long term interest rates (gilt yields) so low?
My views on this are well known, and are set out for example here. To summarise briefly, both theory and a variety of different types of empirical evidence suggest overwhelmingly that low long-term interest rates in the UK reflect economic weakness (domestic and global) and expectations that short-term interest rates set by the Bank of England will remain very low (again, reflecting economic weakness). The empirical evidence, all of which I had to hand for the Committee, includes the following:
- the fact that long-term interest rates have gone down as forecast future deficits have gone up (see the chart here); we are of course now planning to borrow even more than we thought was likely before the fiscal consolidation plan was announced;
- "event studies" of how yields reacted to political or economic developments (this one comprehensively debunks the myth that gilt yields fell sharply in response to political events around the 2010 election);
- the observed relationships between gilt yields and equity prices (they move together, suggesting bad economic news leads to lower gilt yields, as theory would predict). I explained this to the Committee (at about 11:03:30) ;
- and cross-country comparisons; as the IMF has pointed out: "fiscal indicators such as deficit and debt levels appear to be weakly related to government bond yields for advanced economies with monetary independence."
A number of questioners, however, were surprised that I did not attach any weight to the supposed "credibility" of fiscal policy, resulting from the fiscal consolidation plan put in place by the Coalition Government in June 2010. Jesse Norman MP, for example, said (at about 10:41:45):
"You don't think there's anything strange about not attributing any aspects of the UK government's long-term debt yield performance to government credibility".
Well, on the basis of the evidence described above, if the alternative is, or was, an alternative fiscal strategy that was significantly less contractionary in the short term, but still aimed at achieving long-run fiscal sustainability, then I don't (the complete absence of any serious long-run consolidation strategy would be a different matter). So I said so (at about 10:42).
Now it is certainly possible to argue against my views on this topic, although far fewer economists are doing so these days (no-one has really quarrelled with the IMF conclusions above, for example). I expected to be challenged and to have to defend my reading of both the theory and evidence; that's why I was there.
But what I found very odd was that none of the questioners on this topic seemed at all interested in why I make the arguments I do, nor were they prepared to put forward any countervailing evidence of their own. They didn't define "credibility"; they didn't specify what the "incredible" counterfactual would look like; they didn't try to explain why "credibility" should matter from a theoretical perspective; they didn't try to present any empirical evidence that "credibility" had in fact resulted in lower gilt yields.
They simply asserted that "credibility" must have had something to do with low gilt yields, and argued that it was therefore strange that I wasn't prepared to "admit" it. Indeed, bizarrely, Mr Norman seems to believe that I must have some, unspecified, "political" motive for not giving the credibility argument any credit; as opposed to the more simple explanation that at the moment there is simply no significant evidential support for his position.
Essentially, this is faith-based economics. You start by saying something that sounds plausible at the time, and seems to reflect "common sense". That's fine, up to a point. What's not fine is to react to evidence that contradicts your theory, not by adjusting the theory but by repeating it, only louder. Eventually you risk ending up in a position, like Mr Norman, where the evidence is neither here nor there. If someone makes a nuisance of themselves by refusing, in the absence of evidence, to accept your theory, then he or she must have some more sinister motivation (to be fair, this was just Mr Norman: none of the other questioners remotely suggested this).
Now, the Treasury Committee is hardly the Inquisition (and I'm no Galileo - although I can just imagine Galileo saying: "I could handle the torture, but then the Florentine Physics Research Council threatened to cut off my funding.."). The discussion on some other issues (fiscal multipliers, "zombie companies") was much more constructive. And I should also be clear that I have immense respect for the Committee Chairman, Andrew Tyrie, whose integrity and independence are unimpeachable, and who I believe to be doing an excellent and very difficult job overall (he has a particularly challenging task in chairing the Parliamentary Commission on Banking Standards). But faith-based economics (over the last 10 years, not just the last two) got us into this economic mess; it won't get us out of it.