Were nowhere near knowing what quantitative easing does

We're nowhere near knowing what quantitative easing does

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Jonathan Portes, Director of NIESR, talks to Pieria about the response to the crisis and where we go from here.

Q: Are you surprised that the financial crisis has not prompted wider debates within the economics profession?

A: I’m not sure that’s true. It takes a while for these things to filter through. There’s certainly no consensus in academia, policymaking circles or among commentators over how the financial crisis arose, what the responses should be and what the consequences are for economics.

I’m not a historian of economic thought but I would assume that if you went back to 1929 the situation was very similar. We think of the Keynesian consensus as being a post-war phenomenon so you’re talking of over a decade of intellect ferment. What will economics look like in 10 years after the dust has settled? I don’t know. But I think certainly macroeconomic modelling, forecasting and analysis is very much up in the air in a way that it wasn’t 10 years ago.

Whether it will stay up in the air or come down where it started I don’t know.

Q: Do you view the “Great Moderation” as a period where debates surrounding macroeconomics impact on policy were effectively silenced?

A: I think that’s true. The Great Moderation was effectively a period – from a policymaking point of view – where people thought macroeconomics was dead. The received wisdom was that macroeconomics was over as a policymaking problem and hence academic macroeconomics wandered off into areas that had almost nothing to do with policy.

Q: Do you think that sense of complacency has been shaken?

A: It’s clear that we are in a position where we really have much less consensus on the impact of policy tools. You have quite wide divergences in forecasts.

I think if you looked at the policy debates seven or eight years ago at the Monetary Policy Committee basically people were arguing about whether you should pay attention to this labour market indicator or that business confidence indicator. The basic view was that if the economy looked too hot you put interest rates up and if it looked to cold you put them down.

Now, however, there are quite fundamental debates going on for example about what do we think the consequences of deleveraging will be on demand, what channels that could work through and what policies can be undertaken to counter it. Within these you have big differences of opinion with some people arguing that QE is completely ineffective and that monetary policy is impotent, while other people believe that monetary policy just hasn’t been tried hard enough.

These are serious and fundamental debates about how the economy works and what the relationship is between finance, money and the real economy.

Q: What do you make of criticisms over the policy responses of the Bank of England?

A: There is a lot going on in central banks at the moment. It’s amazing how quickly you get this new convention wisdom – people are already talking about quantitative easing as if it was old hand and you read articles by serious commentators talking about “standard quantitative easing”.

Well quantitative easing is not standard. I was in the Cabinet Office when we were first talking about it and this was really radical stuff. No-one was saying that this was anything remotely normal and it’s certainly not standard in the sense that neither our macro model nor any other conventional macro model has any particularly rigorous of a) calibrating the impact of quantitative easing and b) measuring the impact or advising on policy relating to its withdrawal.

We are nowhere near knowing what quantitative easing does let alone some of the other things around expectations management or NGDP targeting that are being discussed.

Q: Do you think that at this point there is growing evidence that monetary policy can struggle to offset the impact of deficit reduction policies?

A: I think that’s the case. There’s two ways of looking at it:

One is to say that with interest rates at the zero lower bound monetary policy is ineffective. In Simon Wren-Lewis’ model that is the case but other people’s models still suggest there are other things that central banks can do to stimulate demand.

Another way of looking at it is from a more practical viewpoint. Where I differ policymaking-wise from people like Adam Posen, who would say that we should be doing more QE and eventually it will work, is that I think that if you are so uncertain about the impacts of asset purchases then just as a practical matter it is pretty difficult to make policy. Under those conditions I would be worried about overshooting.

Due to this I tend to regard fiscal policy as the conservative side of macroeconomic policy management because we do sort of know how to calibrate it. This is why I find the Financial Times editorial line completely bizarre as for a some time now they have argued that we should take the “helicopter money” idea seriously while supporting the government’s fiscal plans on the grounds of credibility.

It seems to me the idea that you risk the government’s credibility by borrowing an extra couple of percent of GDP for investment but there would be no risk to credibility by doing something which nobody in modern times in an advanced developed country has ever tried and that is generally considered to be last ditch strategy is an odd conclusion.

Q: What could the UK government do to aid the economy through the downturn without worsening the long-term outlook for public finances?

A: In the short term I think they should increase spending both through funding investment projects and through some tax cuts.

The medium- to long-term problem for public finances is predominantly one of healthcare and pensions. To my mind, I actually believe that thinking of those as a fiscal problem is probably the wrong way to start.

We are getting older and richer, which means that we will be spending a lot more on healthcare in 20 years time and that’s what we should be doing. There is no model you can write down of preferences under which that would not be the right thing to do.

That has to be paid for and ultimately it has to be paid out of our pockets. And then there’s a choice over whether that funding comes from taxation, private insurance, some sort of social insurance or direct out-of-pocket payments. You have to come up with a system that is both politically acceptable and that has as much equity and efficiency you can achieve.

It seems to me that the solution whereby we privatise the whole system and make everyone pay for it except for the poor is not particularly politically sensible, efficient or equitable. It seems equally unlikely, however, that a 1948-style centrally controlled National Health Service spending 15% of GDP is going to be either politically feasible or very efficient.

By definition you are going to end up with some mixed system of private/public insurance with some sort of quasi-market for services.


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