Stefan Stern swings and whiffs

DIY economics
The (genuine) economist John Kay has a term for all this: DIY economics. These are the things that we sort of think we know even if they have no basis in theory, or indeed practice. Like a dodgy shelf, DIY economics will come crashing down at your feet sooner or later.

OK, so, on his list of things which are DIY economics (what I refer to as folk economics) are the following:

Expansionary fiscal contraction
This is the theory, popularised by Ken Rogoff and Carmen Reinhart, which holds that public debt levels of over 90% of GDP will lead to slower growth, and that therefore significant cuts to public spending – aka austerity – are needed before growth can resume. George Osborne built a political programme and reputation on it.

Embarrassingly, the distinguished academics had to concede later on that there had been an error in their spreadsheet calculations, and that the theory was not quite as robust as had been asserted. Voters are now taking a similar, but less nuanced, view on the benefits of austerity. So on second thoughts, wannabe chancellors might not want to trumpet this one too loudly.

No. It’s the idea that you can indeed have fiscal contraction but if you offset it with an even bigger dose of monetary expansion then you will get growth. It did actually work in 1932 as well, whatever we might think about it having done so more recently. That is, properly stated, it’s an entirely fine idea although whether it works in all and every circumstance is another matter.

Zero lower bound

Years of ultra-low interest rates produce this phenomenon, whereby the central bank (the Bank of England in our case) can no longer stimulate the economy as rates are at rock bottom. The recent tweak up to 0.5% is the first move away from the floor that had been established. But the fact that rates will probably remain low for many months to come is a sign of economic weakness, not strength.

No. Zero lower bound insists that monetary policy is ineffective if you cannot reduce interest rates again, as they are zero. QE has rather proven that that is wrong. Still entirely possible that fiscal policy would have worked better etc but the insistence that monetary cannot is proven to be wrong.

Laffer curve

This is a remarkable piece of economic wishful thinking, drawn up on a restaurant napkin, which states that cutting taxes for the rich will always and inevitably lead to economic growth, wealth trickling down and the reduction of government deficits. Ronald Reagan tried it in the 1980s. The deficit soared.

No, it’s simply the (true) observation that at times lower tax rates can increase revenue collection.

Forward guidance
This was the idea touted by Bank of England governor Mark Carney, that by indicating where interest rates and the economy were generally heading, more influence could be exercised without the need for market interventions. But markets and economic data have defied the guidance. We don’t hear much about this any more.

Expectations – if the BoE says interest rates are going to rise then market ones rise immediately. This works.

Stefan Stern is the co-author of Myths of Management, and a visiting professor at Cass Business School

Oh, he works with the Senior Lecturer…..

7 thoughts on “Stefan Stern swings and whiffs”

  1. This is a remarkable piece of economic wishful thinking, drawn up on a restaurant napkin, which states that cutting taxes for the rich will always and inevitably lead to economic growth, wealth trickling down and the reduction of government deficits. Ronald Reagan tried it in the 1980s. The deficit soared.

    The more the Left lies about a particular thing the more true that thing is, and so needs to be discredited. That smear of the Laffer curve is ridiculous. Funny how if you ask normal, sane people if they would work less if their tax rate was 60%, 70%, 80%, 90% you get an answer which is opposite to the one believed by Leftist ‘intellectuals’?

  2. I queried the Laffer Curve example on Twitter, and to his credit Stefan replied:

    “Sure, absolutely right, was a rush job and I was focusing on the claims made for the benefits of tax cuts for the rich. But fair point. I did warn you it was DIY economics..!”

  3. Am entirely mystified by this article, since “expansionary fiscal contraction”, “Laffer curve”, “zero lower bound”, “forward guidance” are all things that have been analysed / discussed / actually put into practice in some cases, by proper fully-fledged economists rather than popular misconceptions dreamt up by DIY-folk-economists. Stuff that appears in textbooks doesn’t strike me as “DIY economics” though I could understand that popular misunderstandings of it might count (e.g. Laffer curve being misunderstood to mean “all tax cuts increase revenue” which Timmy regularly points out is a misinterpretation of it).

    And the Rogoff and Reinhart thing is just way off base – even Wikipedia seems to have a reasonable article on what “expansionary fiscal contraction” actually is and evidence for/against since the concept was academically formalised in the early 90s based on data from governments trying to enact such a thing in the 80s.

    Was any research – even a quick google? – or indeed any academic expertise expended in the creation of this piece? Was it written on the back of a napkin?

  4. Earnings between £100k -£124k are taxed at a marginal rate of 60%. That’s why doctors who take early retirement (due to another Osborne idiocy) work part time.

  5. Earnings between £100k -£124k are taxed at a marginal rate of 60%.

    And above that rate, the allowance for tax relief on pension contribs is also cut back – quite possible that your average Guardian commentator is not to meet this news with wailing and gnashing of teeth at the injustice of it, but you would be hard pressed to maintain that there is no alteration of behaviour at these sorts of pay scales.

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