The following is an edited version of a chapter from IPPR’s forthcoming book, “Complex New World: Translating new economic thinking into public policy”.
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Tony Dolphin is the chief economist at the Institute for Public Policy Research (IPPR); the following is an edited version of a chapter from IPPR’s forthcoming book, “Complex New World: Translating new economic thinking into public policy” – see here for more
Traditional economics has not solved the problem of the boom-and-bust cycle. When Keynesian policies dominated, recessions were frequent and shallow; in the neoliberal period, they have been less frequent but deeper.
Macroeconomic policy in the post-war period, whether Keynesian or neoliberal in nature, has failed to achieve lasting economic stability because it has been based on the idea, drawn from traditional economics, that the economy can be forecast in the short-term, and that the effects of policy changes on the economy are predictable
Neither is true. Economic policymakers are unable to foresee ‘unpredictable’ events like the 2008 crisis.
The current crisis clearly points to failures in the way we conduct macroeconomic policy in the UK. The measures on which policy is set – output growth and inflation – were too narrow to foresee the crisis. In 2006 and 2007, the MPC’s models told it consumer price inflation was likely to stay close to its target rate if interest rates were nudged slightly higher, from 4.5 per cent to a peak of 5.75 per cent.
Meanwhile, policy-makers were turning a blind eye to a financial bubble that had been developing for years. The policy-making framework, busy with tinkering, was too narrowly focused.
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Despite the economic crisis of 2008, the way monetary policy is conducted has barely changed for 15 years: the government sets an inflation target, and the Monetary Policy Committee of the Bank of England adjusts its short-term interest rate – and more recently implements quantitative easing – to meet this target.
And, once the deficit is eliminated, fiscal policy will continue to be run in the way that it has been for the last 30 years: governed by arbitrary targets and largely insensitive to the economic cycle.
Yet a simple reading of history suggests greater attention should be given to asset prices – particularly those of houses – and to oil prices since all four of the major recessions experienced in the UK in that last 40 years have been preceded by large increases in the price of oil and a period of rapid gains in house prices.
While the effect policy made in the UK can have on oil prices is limited, policy makers should nonetheless be aware of the risks they can pose to the economy.
Similarly, controlling house price inflation may not always be easy, but if future surges in prices could be prevented – perhaps through the imposition of maximum loan-to-value ratios – it would probably do far more to reduce the risk of a future recession in the UK than minor adjustments to interest rates designed to keep consumer price inflation close to 2 per cent.
At the very least, house prices should be given the same weight in policy deliberations as consumer prices.
The narrow focus of policy was based on traditional economics, and its models of rational behaviour at the level of the individual. But for predicting the aggregate picture, these models have time and time again proved inadequate because they do not take account of the complexity of behaviour on a macro scale.
There is an urgent need for a better conceptual framework for the ‘macroeconomic problem’ to be developed.
History shows that narrow, rules-based approaches to macroeconomic policy do not work for long; it is time for policy makers to abandon their narrow models and develop a more complex understanding of the impact of policy interventions.
5 Responses to “It’s a complex economy, stupid”
Lord Blagger
The deficit won’t be eliminated.
The reason is fraud. Governments don’t report their debts. They just report their borrowing.
The real issue is total government debt.
So total up the debts, pensions included and its 7,000 bn, not 1,100 bn. To put that in perspective, if you pay tax, you are on the hook for 230,000 pounds, with interest.
Given that the median wage is 26,000 a year, it doesn’t take a genius to see its bust.
For last year, the increase in debts was 500 bn, on tax revenues of 570 bn. Again a school child can see that is a bust.
Inflation doesn’t work, since most of the debts, the pensions are linked to inflation. So no inflating your way out of that either.
So that leaves default. So if you are relying on the state for your pension or health care in old age, think again. They can’t pay you because they’ve run up the debts.
Even the 5.4K that is paid out is paltry compared to what you would have received if you had put the money in the FTSE. There that same median worker would have had a pension of 19K a year, instead of 5.4K. That’s the extent that that median worker has been ripped off, by the state. It’s the state that has made them poor. That’s why they won’t report the debts. That makes it clear just how much they have stolen from people.
So all your talk about macroeconomics is just waffle. It’s a simple fraud that is the real issue.
Newsbot9
Of course not, you need your shares boosting, fraudster. Of course you want to default and screw the 99% over, after all – your cash is in tax havens.
And, of course, that’s 1.2K given UK pension returns and fees. But you can’t admit that, you can’t admit your hostility to the 99% being ALLOWED to retire. Keep blaming the state for your crimes. Your fraud continues – When will you pay your share?
Newsbot9
It’d be absolutely ridiculous to do consider house prices in that way, and would cause major issues. Because, of course, of the massive housing shortage we have in this country.
That needs to be fixed first.
BenjaminGustafsson
It’s not house prices going up. It’s land prices going up… We need to tax away most economic rent for land and thereby reduce land prices on the market. A land value tax ends the boom and bust cycle. It is mathematically impossible to have a boom and bust cycle if the price on land is zero. http://vimeo.com/38500767
Nick
Or increase the supply. ie. Remove planning controls
Or alternatively, reduce the demand – immigration.