My take on RES Lecture: pursuing flexibility by way of inflexibility

I attended Chancellor Osborne’s RES lecture today where he outlined the three key goals he would take into the next parliament:

1. Enhanced financial stability, moving towards greater detachment of the real economy from asset price cycles;
2. Reduced debt-to-GDP;
3. Enhanced productivity.

These actually sound like quite laudable goals, motherhood and apple pie even (were they not time-based). I was persuaded that moving prudential supervision to the Bank, as well as establishing and empowering a FPC may have been helpful in moving towards goal number one (if less persuaded that HTB2 serves this end). Goal number three also sounds great – sign me up (and the factoid that London’s central line runs to a greater distance than that between Leeds and Manchester was terrific). But number goal two. Well, it sort of depends how it is done.

The Chancellor outlined a desire for lower debt not on a Rogoff & Reinhart high debt = low growth basis (although a nod was given in that direction). Also, although reducing the prospect of debt service costs rising are mentioned, the project does not rest on this aspect of debt reduction. Importantly for me, lower debt is advocated as a laudable end because it increases policy flexibility to respond to unanticipated future shocks that would otherwise rock the economy: debt levels could safely be raised without threatening the transversality condition. In other words, he wants dry powder. I like the sound of dry powder. That sounds like a good thing to want to have in the back of your mind if you are responsible for a large part of UK macroeconomic policy. (I suspend at this time doubt as to whether even much higher levels of debt on the part of a monetary sovereign would provoke a currency crisis, but see ad infinitum that this argument has merit.)

But the Chancellor has gone further than the aspiration for dry powder. He has committed to eliminate the budget deficit and achieve a budget surplus by the end of the next parliament. Furthermore, once he’s got there he plans there to be a new arrangement whereby a fiscal surplus must be delivered every year if the OBR green flags a few key (as yet unspecified) heuristic variables that signify ‘normality’. This is a commitment to tighten policy, seemingly come what may. It is the commitment to policy inflexibility in order to achieve policy flexibility. It is like the Bank of England committing to a five year path of rate hikes so that they can offer a credible response to economic shocks at the end of said period. It may be that such a policy tightening is absolutely warranted by unfolding economic conditions. But as Simon Wren-Lewis, Tony Yates, Frances Coppola and Chris Dillow have all blogged in recent days, committing to this tightening while monetary policy is at the Zero Lower Bound (ZLB) has the potential to deny a monetary response to a future shock. In summary, committing to fiscal tightening (policy inflexibility) to deliver fiscal policy flexibility at a time during which there is no monetary policy flexibility heightens the (I hope low) risk that the UK falls into a slump and policy rates are stuck at the ZLB.

Anyway, I got to open the questions which was a highlight of my day. I resisted the urge to look a complete idiot by inquiring as to the Chancellor’s understanding as to the nature of money for a monetary sovereign, purpose of taxation and debt issuance (which is a conversation I would love to have in private but the odds of which happening are exceptionally long). Instead, I asked whether the pursuit of lower debt levels and more dry powder while the Bank was still at the ZLB heightened the risk that the Bank would be trapped at the ZLB, and that as a consequence his first main goal would be undermined? I was thinking of Claudio Borio’s work here and here, as well as a bunch of Stein. Of course, my question was insufficiently well worded to elicit an answer going to the heart of the matter. Instead it was explained in quite a charming and kind-hearted way that the Bank was independent.


2 thoughts on “My take on RES Lecture: pursuing flexibility by way of inflexibility

  1. I wouldn’t be so self-critical about your question not eliciting an answer, politicians are professionals, trained to avoid answering the god-damned question.


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