The Macroeconomic Funding Gap

The experience of the past two weeks for the UK economy has demonstrated how much macroeconomics matters. We had a botched fiscal event that combined a wilful ignorance of the need for policy to be accountable and transparent with the error of stoking demand in an environment where it needs to be smothered. This policy mistake not only pushed up borrowing costs for the government but also raised the spectre of defaults on mortgages, as it seemed that policy interest rates would have to rise rapidly to offset the unwarranted policy stimulus.

Had the government sought macroeconomic advice – and, indeed, been sufficiently confident to learn from the research evidence – I am convinced that much of the volatility would have been avoided. Indeed, when we at the National Institute of Economic and Social Research ran the Chancellor’s proposed policy interventions through a standard macroeconomic model on the morning of 23 September, we found that this planned pre-election boom would have two consequences: significantly higher interest rates and a more volatile economic cycle. It is precisely to avoid such outcomes that macroeconomists argue for simple transparent rules that reduce short-term, politically motivated meddling.

But the UK will be able to see out this economic squall. The bigger problem is that the country is grappling with a host of issues that, to my perhaps jaundiced eyes, are macroeconomic in nature. These include stagnant real wages, trade compression, low investment, declining relative productivity, escalating inflation, a tight labour market, burgeoning public and household debt, and a swollen central bank balance sheet.

Yet the public body charged with funding science, UK Research and Innovation, has no dedicated programme of supporting research in macroeconomics. Nor does it fund a centre devoted to questions of macroeconomic policymaking and the normative study of policy (“What can we do better?”).

I have been going round policy circles this summer asking why. One argument put to me is that the basic problems in macroeconomic analysis have been assigned. For example, monetary policy looks after nominal demand and fiscal policy focuses on questions of distribution. New ideas are only needed in a crisis, but new research is unlikely to be able to contribute in a timely manner.

This argument does not convince because many believe that the UK’s succession of crises are actually the result of errors in macroeconomic analysis and design – and even more so in policy practice. In the absence of a research base, too much emphasis is placed by policymakers on circles of close friends, whose ideas are not always subject to academic or public scrutiny.

A second response to my question is to suggest there are no significant issues specific to the UK, so we can act like jackdaws and borrow from other country’s research agendas, with a particular focus on North America. This argument looks sensible at first glance as the building blocks of modern macroeconomics, emphasising decision rules in the context of optimisation problems, emerged from the US. There is also a vibrant community of American macro bloggers who many of our domestic policymakers follow ardently.

However, as a small, de-industrialised economy, the UK is very different from the US, and it abounds with specific issues. Brexit is perhaps the most germane, but there are a host of others. What is the optimal structure of UK public debt? How should financial regulation be separated from monetary policy, if at all, when finance is such a large part of the UK economy? What is the relationship between government tax and spending policies and subsequent economic growth when the capital stock is low? How sticky are domestic prices? What is the overall global demand for holding sterling assets? This list shouts about a divergence between what policymakers want and what they need.

The most damning response to my question is that most of the major expertise is abroad anyway. Naturally, I bristle. The UK does regularly face the loss of top scholars to overseas positions, but we still have a very strong set of macroeconomists at home. Without sufficient funding, however, we can neither influence research agendas nor encourage dissemination to the policy arena. We need to nurture the talent pool, yet UKRI has repeatedly declined to extend its funding to the London School of Economics’ Centre for Macroeconomics, the UK’s leading centre of excellence.

But a deeper talent pool will not help the UK unless the Treasury and the rest of Whitehall reaches out more systematically and openly into it. It is just too hard for many outsiders or newcomers to the UK system to get involved. The moving parts of the machinery have long been directed far too tightly by ministers and advisers in order to gain media traction, rather than to address complex and difficult economic issues with expert advice.

There was a clumsy attempt in policy circles to blame the macroeconomics profession for the policy failures that led to the global financial crisis. But that suggestion that looks even more ridiculous now than it did in 2009. What we have found time and again is that when a crisis hits, the UK’s room for manoeuvre is limited by poor policy decisions made in the past. The quality of those decisions can only be improved by creating a bedrock of macroeconomic research talent.

This article first appeared in Times Higher Education Supplement on 10 October 2022 and is reproduced here with their kind permission.