Economy

mainly macro: Mediamacro melodrama

 

The UK macroeconomy
was one of the big stories of the previous two weeks, so you might think this blog
post should have covered it earlier. However my guess at the time was that
media coverage was a bit like a nervous flyer who, when the plane
hits a bit of normal turbulence, decides it’s is going to crash
and everyone will die. As I’m not a journalist, it seemed better to
wait a week to see if I was right.

I’m glad I did.
This is what got the media so excited about, and what happened next

From around the 6th
January interest rates on UK 10 year government debt rose over a week from around
4.6% to around 4.9%. But then interest rates fell back as quickly as they had increased to around 4.65%.

Was this a UK or
global blip? To answer that we need to look at US rates.

We see something
very similar, but of slightly smaller amplitude. This tells us that
what we saw in the first half of January was mainly a movement in
global long term interest rates, with a little bit of UK specific
icing on top that largely disappeared once the latest UK inflation
data came out.

I’ll come to why
this might have happened in a minute. But why did virtually the entire the UK media get this all so wrong? The main lesson here is
that data is volatile, and you can have a lot of egg on your face if
you treat every short term movement up or down as permanent, or worse still the beginning of a
trend. It’s a lesson that all economists know but journalists are
increasingly paid to forget. But that is not the only reason
journalists got over excited a week or two ago.

Another is the Truss
fiscal event. Conservative politicians, and those journalists aligned
to them, are desperate for Labour to suffer something comparable to
what happened to the Conservatives under the leadership of Liz Truss.
So they are tempted to shout fire whenever they see a puff of smoke,
even when that smoke looks like it’s mainly coming from a long way away! That then led other journalists to feel they had to cover the
same story, and political journalists put a UK political spin on it
because that is what they do.

When journalists
cover anything to do with fiscal policy, we know from long experience
that the language and reasoning they use can be very different from
the macroeconomics taught in universities. I call it mediamacro. It
involves for example treating the government as if it’s a household, treating
deficits
as a sign of political irresponsibility
, and personifying
financial markets as a kind of vengeful god
. As is often the
case, it is much better to read good academic economists, like
Jonathan Portes here
, than the stuff most journalists
write.

The end result of
the media’s uninformed overreaction and distorted coverage was that many people were seriously misled, and
the media almost manufactured a crisis out of nothing. In case you
have forgotten, just a week ago newspapers
were speculating
that Reeves was about to be sacked
and who might replace her, all because of largely global movements in
interest rates over which she had no influence. I used the word
melodrama in the title of this post, but I could have equally used
madness.

What caused the
upward blip in global longer term interest rates? To be honest, who knows and who
cares? When I was much younger I was approached about
moving to a much better paid job working in the City, and I said no
because I thought worrying about such things would soon bore me to
tears. I found real macroeconomics much more interesting, and still do.
If, unlike me, you are interested in short term bond market fluctuations, here
is the Toby Nangle
looking at what evidence we do
have, and here
is Paul Krugman speculating
that it might be all about
Trump. It must certainly be true that as a result of Trump becoming
POTUS, the degree of macro policy uncertainty has shifted sharply upwards and
this will mean longer term interest rate movements are likely to
become more erratic.

What about the
exchange rate? Sterling did depreciate in January, and that hasn’t
been reversed, but the
scale of movement is small
and therefore not at all
unusual, so once again there is nothing of interest here unless you
speculate on currency movements.

This whole episode
did raise two other issues that are worth discussing.

Fiscal
vulnerability

Because Reeves like
previous Chancellors has pledged to follow the golden rule, which is that day
to day (current) spending should over the medium term be paid for out of taxes. As a result, anything that looks like it will increase spending over the medium
term will lead to speculation of what other items of spending will be
cut to compensate, or whether taxes will have to rise. Higher long
term interest rates mean higher spending servicing the government’s
debt.

The most important
point here is to again ignore a lot of what you read or hear in the
media. First, the fiscal rule that Reeves is committed to looks at
the expected balance between spending and taxes in a few years time, so there
is absolutely no need to cut spending in the short term. 
Second, there are
all kinds of macroeconomic developments that could have an impact on
the government’s current deficit in a few years time, so this kind
of thing will happen constantly. As a result, and as this episode
clearly illustrates, it is generally better to wait and see rather
than react immediately. Third, there is no reason why higher spending
in one area has to be met with lower spending elsewhere. It can also
be met with higher taxes. That the media tended to talk about
spending cuts rather than higher taxes has no macroeconomic
justification.

So Reeves was
absolutely right to ignore all the media hysteria. However it has to
be said that Reeves did earlier make two mistakes that contributed to
the way the media covered this aspect of the story. First, the fiscal rule that balances current
spending with taxes used to apply to forecasts five years ahead, for
good reasons. In the Budget she changed this so it will eventually
apply to just three years ahead, which was
simply a bad
decision. Second after the budget Reeves
made the mistake of appearing to rule out significant increases in
taxes in the future.

Many react to talk
about spending cuts by blaming this particular fiscal rule, but that in my view
is a mistake. As long as the golden rule looks far enough ahead, any
short term volatility caused by fluctuations in spending or taxes is likely to be reflected in volatile economic reporting rather than erratic economic policy, and it is a mistake to conflate the two. I
put the case
for the golden rule as a fiscal rule
here.

Short term
economic growth

The second lesson is
about data on economic growth, which was also mentioned frequently in
reporting. However monthly or quarterly growth figures are also
erratic, so the lesson about not being misled by short term
fluctuations in the bond market also applies to growth figures. The
Conservatives are currently boasting that they left office with
economic growth the highest in the G7, but because that is based on a
particular quarterly growth rate it is a meaningless claim.

Equally any impact
policy may have in increasing underlying growth normally involves
considerable lags. It is very unlikely that anything the new Labour
government has done will have had any impact on the growth numbers
currently being reported (i.e. end 2024). If policy has anything to
do with recent growth numbers, it is the policy of the last government.

To take just one
example, you will read a lot about how employers dislike the NIC hike
imposed in the budget. Below is the OBR’s assessment of the impact
of this on GDP, alongside the impact of the modest increase in
public investment also announced then.

They estimate that
higher employers’ NICs will reduce the level of GDP by 0.1% in
financial year 2026/7. Less than half of that will occur in the
forthcoming financial year. These estimates are relatively uncertain,
but anything much larger or quicker is pretty unlikely. While it is easy for a journalist to link the October budget to recent growth data, that does not mean that in reality there is any causal link at all. 

What this chart also
shows is that fiscal policy can boost demand and therefore growth in
the short run, as long as this impact is not offset by a more
restrictive monetary policy. We are on more solid ground in quantifying these effects.
The last budget was expansionary, and should boost GDP growth in
2025/6 by around 0.5%. To the extent that Labour are ‘kick-starting
growth’ this is it, but don’t expect to start seeing it in the
data until at least six months time.

Although monthly or
even quarterly changes in economic growth are not very interesting,
growth in the longer term and the impact the Labour government might have on it are worth discussing. These questions, rather than mediamacro melodrama, are subjects I hope to return to fairly soon.


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