Cummings and goings

In recent months I have tried to steer away from politics and focus on economics. But as a line from the fictionalised memoir The Tattooist of Auschwitz recently reminded me, anyone “who lectures on taxation and interest rates can’t help but get involved in the politics of his country.” So it was that two years after Boris Johnson was elected as leader of the Conservative Party I watched this week’s BBC interview with Dominic Cummings, architect of the Brexit campaign and until December Johnson’s chief of staff, which lifted the lid on life in Downing Street (a short summary for non-UK based viewers can be found here on YouTube). It was many things – compulsive viewing; exculpatory; self-justifying; incoherent and despite Cummings’ denials, clearly motivated by revenge. But most of all it shone a light into the tawdry workings of British politics in recent years and acts as a reminder of how far standards of governance have fallen.

The context of the interview was also interesting. The BBC, and particularly its political editor Laura Kuenssberg, has come in for significant criticism in recent years that it has given the government an easy ride over its many policy failings. In this case Kuenssberg asked some very direct questions, although as many people pointed out, she has not given the same grilling to anyone still in government (though largely because they refuse to submit to such scrutiny). For all that, the interview was highly illuminating and raises questions for anyone with an interest in good governance.

The lies that they told

I will start with Cummings’s observations on Brexit, having pointed out for the last five years that he headed a campaign that wilfully lied to the electorate. He admitted that “on questions such as whether Brexit is a good idea, no-one on earth knows.” This from a man who led a campaign to persuade the electorate that it was! He went further to suggest that “it is perfectly reasonable to suggest that Brexit was a mistake.” As an insight into Cummings’ character, this speaks volumes. His efforts to try and appear thoughtful and rational contradict some of the policies he has long espoused and confirm David Cameron’s judgement that he is a “career psychopath.”

Cummings also denied lying about the costs of membership (the infamous £350 million per week claim), arguing that it was designed to set a trap for his political opponents and dismissed claims that it misled people into voting for Brexit. He further dismissed claims that he used Turkey’s willingness to join the EU to persuade the electorate that the UK was about to be swamped with huge numbers of immigrants. But in the immortal words of Mandy Rice-Davies almost 60 years ago “he would, wouldn’t he.” Cummings did implicitly admit that he did not present the information in its true context (aka he lied) but he justified doing so in order to get people to talk about the issues.

This is both disingenuous and dangerous – dangerous because it has set a precedent for people in public life to make all sort of false claims “in order to generate debate.” But if such lies are not called out, such statements tend to become accepted as truth by those prepared to propagate the falsehoods. Until recently I always thought that George Orwell’s 1984 was a satirical novel warning us of the consequences of totalitarianism (“Ignorance Is Strength”). I now realise that it has become an instruction manual for zealots intent on pursuing their particular interests.

How not to run a government

Given the character of the man, it says a lot about Boris Johnson’s style of leadership that Cummings was appointed the prime minister’s chief of staff. Cummings has little time for Johnson’s ability to lead (although this is undoubtedly coloured by his December sacking) but he clearly thought that Johnson was the only politician capable of “getting Brexit done.” Another insight into Cummings’ character was his response when asked why he took on the role. He told Kuenssberg that he did so only under certain conditions and seemed genuinely baffled when she asked whether he was motivated by any sense of public duty. There was very much a sense that Cummings used the role to pursue his own agenda rather than that of the country. Under the UK’s constitutional arrangements this is highly dangerous. Outside election periods, it is very difficult to call the prime minister to account and they have near-total carte blanche to do whatever they think necessary in order to pursue a particular policy. Giving someone like Cummings the protection of the prime minister’s office is like giving sticks of dynamite and a box of matches to a toddler.

The whole interview exposed the lack of strategy from the current government and the underhand tactics that it used to achieve the one goal that it had – that of getting Brexit done. Outside of this policy, the government seems to be largely rudderless and Cummings gave more insight into its dreadful handling of the pandemic with his central claim being that the prime minister put “his own political interests ahead of people’s lives.” Whilst Cummings' motivation can be called into question, he at least served a purpose by directing the spotlight towards the vacuum at the heart of government.

A deep-seated problem

All this matters because, as I have pointed out numerous times, well-run economies tend to deliver the best outcomes for their citizens. Whilst economics tries to be value neutral, it is hard to accept that the values demonstrated by the British government’s actions in recent years represent a good platform to deliver the best economic outcomes. An excellent post by Professor Geoff Mulgan highlighted that the government is representative of a narrow clique whose interests do not necessarily coincide with those of the wider electorate. Two of his main points bear repeating. The first is that this group does not really understand economics and thus does not grasp the implications of many of their policy slogans. A second point is that this clique “doesn’t really do ideas. It’s much better at commentary and critique than prescription.” 

A second critique was offered by the journalist, broadcaster and clergyman Giles Fraser, who notes that previous Conservative governments were at least guided by some form of moral compass. Even the pro-market Thatcher government, which was widely criticised for its apparent indifference to the social hardship caused by some of its policies, was deeply rooted in a moral view of the world (see, for example, this 1978 article by Margaret Thatcher in the Daily Telegraph). I will come back to the subject of economics and morality another time, but suffice to say a government that continues to make missteps which, (to reuse my all-time favourite political quote from fictional spin doctor Malcolm Tucker) are “the result of a political class, which has given up on morality and simply pursues popularity at all costs”, suggests we are sliding down a very slippery slope.

Last word

Although I do not like a lot of what Cummings stands for, I do understand his position. He sees an ossified political system which is ripe for reform and is prepared to do anything in his power to effect change. But hitching his campaigning zeal to the personal ambition of a Boris Johnson has resulted in a hollowing out of Britain’s political culture. More worrying still is that the vast majority of the electorate do not seem to care. Like him or loathe him, however, I urge people to watch the Cummings interview and make their own minds up as to whether the social, political and economic course upon which Britain is embarking is one that they are comfortable with.

QE inside out

Twitter can often be something of an intellectual cesspool in which people continue to shout across the cultural divide without ever hearing the views of the other side. It can, however, be a source of great enlightenment and I was very taken by a post (here) by Alfonso Peccatiello explaining why QE can never be inflationary. Having thought about it, there are many elements of this Twitter thread which are wrong. Nonetheless, it served a very useful purpose in forcing me to assess the nature of money and for that it is to be commended.

Inside versus outside money

At issue is the nature of “inside” versus “outside” money. Peccatiello argues that “inside money never reaches the real economy. Outside money does” and to the extent that he characterises QE as inside money, it cannot therefore impact on inflation. I suspect there is some confusion about definitions here and in order to get a better handle on this, we need to understand the concepts under discussion. The notion of inside versus outside money was introduced into economics by the seminal work of John Gurley and Edward Shaw, Money in a Theory of Finance, published in 1960. It was a very innovative work for its time and looked at the interaction between the real economy and monetary growth. As they put it, “real or “goods” aspects of development have been the center of attention in economic literature to the comparative neglect of financial aspects.”

Gurley and Shaw (G&S) define inside money as originating from within the private sector. Since one private agent’s liability is simultaneously another agent’s asset, inside money is in zero net supply within the private sector. Thus, funds held in bank accounts would be classed as inside money because they are an asset of private firms or households but a liability of private sector banks. Conversely, outside money derives from outside the private sector and is either fiat (unbacked) or backed by some asset that is not in zero net supply within the private sector. An increase in the stock of currency by the central bank would be classified as outside money, because although it is an asset of the private sector it is a liability of the public central bank.

The vexed question of money neutrality

Since outside and inside money represent different types of liquidity, they have differing effects on the wider economy. One implication of this is that the money stock is not homogenous – money is not just money as it is comprised of these two differing types. This calls into question the notion that money is neutral (i.e. it does not impact on real quantities in the long run and serves only to impact on prices). In light of the debate regarding the impact of liquidity creation by central banks and the recent surge in inflation, this may help us to shed some light on the monetary transmission process and the role of QE within it.

Without boring the reader with the details of the process, G&S demonstrate that in their general equilibrium framework inside money is neutral but outside money is not (the interested reader is referred here). How do we categorise QE?  In the sense that the central bank creates reserves to buy assets from the private sector (in this case, the non-bank private sector) but uses them to buy government bonds, they are merely swapping one type of outside money for another (cash for bonds). Consequently, the inside-outside composition of private sector assets remains unchanged. I thus agree with Peccatiello that QE can be categorised as inside money. If we accept the proposition of money neutrality, this implies that QE is unlikely to have any long-term impact on real activity. But this does not mean that it has no impact on prices. Indeed, classical monetary theory argues that if it does anything, QE will impact on price inflation.

Moreover, monetary neutrality relies on the absence of frictions but, as the work of Karl Brunner and Allan Meltzer has demonstrated, such frictions do exist and thereby allow monetary policy to have an impact on the real economy – perhaps only for a limited period of time. QE may not have had the impact on the economy that central banks hoped but there is in theory scope for it to boost activity. Analysis conducted by the BoE in 2011 suggested that the initial round of asset purchases boosted UK GDP by 1.5% to 2% compared to what would have happened in its absence.

Should central banks continue with asset purchases?

If we therefore accept that asset purchases do impact on inflation and prices, does it make sense for central banks to continue the programme, particularly in view of the surge in US inflation to 5.4% last month – the fastest rate since 2008? The short answer would appear to be no. Whilst it is true that the prices of used cars contributed a third of the monthly rise in the CPI in June, which is likely to be a temporary phenomenon, there is evidence that prices are rising rapidly across the board. Accordingly the Fed is widely expected to taper its asset purchases before too long with suggestions that the Fed will broach the subject at next month’s Jackson Hole symposium. Investors will recall the 2013 experience when the prospect of a slowdown in Fed asset purchases prompted the infamous taper tantrum which resulted in a spike in bond yields. However, with financial asset prices at red hot levels, taking some air out of the market may actually not be such a bad thing.

Last word

Whilst there is general agreement that QE has been the primary driver of asset prices in recent years, there remains much debate about its impact on the wider economy. Whilst I have never been persuaded of some of the claims made for it by policymakers, I have never accepted that it has zero impact. Even if the effects are small, such has been the magnitude of asset purchases that even small spillovers will show up in GDP and inflation data. This 2016 paper by Martin Weale and Tomasz Wieladek offers evidence that in contrast to the claim made by Peccatiello, “US (UK) QE had a similar (much larger) effect on inflation and (than) GDP.” If asset purchases have helped the economy to avoid a slow post-pandemic recovery, they have done their job. But having done their job, it may now be time to think about scaling back.

Open season

The announcement that the UK government intends to scrap almost all Covid-related restrictions in England on 19 July has led to significant concerns that it is yet again taking a risk with the pandemic that is not justified by the evidence. Covid cases are rising rapidly with latest figures showing a rise of 49% on a week ago (+383% over the last four weeks). Boris Johnson admitted in his speech to the nation that numbers could double to 50,000 per day by the time “Freedom Day” arrives. New health secretary Sajid Javid suggested in a radio interview that they could even rise to 100,000 per day. For the record, the previous record high was 68,053 on 8 January. For those who recall Boris Johnson’s promise that “data not dates” would determine the government’s policy actions, the latest announcement has raised more than a few eyebrows.

Is this a just policy?

There is no support for this strategy from the medical profession with the BMA calling for the continued use of face masks, arguing that even if the vaccination strategy has lowered mortality risks, the risk of infection has not disappeared which could have significant health impacts due to complications resulting from long Covid. However, the move appears to be a political response to the vocal and ill-informed anti-mask movement which somehow sees masks as an infringement on personal liberty. Indeed, this TV interview with a backbench Conservative MP spoke volumes when she called the wearing of masks on public transport “an infringement of civil liberties.” Ironically this concern for civil liberties was invoked on the day that parliament debated a policing bill which even many Conservative MPs find draconian. More seriously, as members of the medical profession pointed out, the wearing of masks gives people freedom to do things more safely that they may not otherwise be able to – such as travelling on public transport or visiting a restaurant.

One of the issues thrown up by this debate is the trade-off between personal and social responsibility. Anti-maskers argue that they should be allowed to exercise their own judgement as to when to wear them. Pro-maskers argue that since masks generate a positive externality by protecting others as much (if not more so) than the wearer, their use generates a wider social benefit. Welfare economics has attempted to build on the idea of Rawlsian justice as a way of assessing social choices, in which we have to balance the greatest possible amount of liberty being given to each member of society subject to the constraint that liberty of any one member does not adversely affect any other member.

To the extent that a person not wearing a mask impinges on the rights of those who wish to take precautions against Covid, the economist (not to mention the Rawlsian philosopher) would argue that simply doing away with masks flies in the face of social justice. After all, a public space belongs to everyone – not simply the group that makes the most noise. For the record, after Israel last month eliminated the requirement to wear a mask, 10 days later it was forced to backtrack.

Is there a herd immunity argument in favour of opening up now?

The proportion required to be vaccinated in order to achieve herd immunity differs according to the disease – for measles it is 95%, for polio 80%. Previous estimates suggest that such immunity for Covid would require between 60% and 70% of the population to be vaccinated (some estimates put the proportion even higher). For the UK alone, we are in the window, with around two-thirds of the adult population now having received two doses of the vaccine (though that figure drops to around 50% once we allow for children, who are not scheduled to receive the vaccine). But on a global basis we are nowhere near this. According to the respected website Our World in Data, only 24.4% of the world’s population has received one dose of the vaccine. So long as country borders remain open – even if only partially – the risk of cross-border transmission remains high.

A recent article in Nature suggested that herd immunity to Covid is now unlikely to be achieved and the epidemiology community is “moving away from the idea that we’ll hit the herd-immunity threshold and then the pandemic will go away for good.” As new variants emerge – much like the delta variant – and immunity begins to wane, the likelihood is that Covid will become an endemic disease in much the same way as flu. In this sense, at least, the UK government’s argument that we will have to live with Covid is consistent with scientific thinking. However, this is not an argument for ending all restrictions.

On the plus side, although cases are rising sharply, hospital admission and mortality rates have not. This provides strong support for the government’s argument that the vaccine programme has helped break the mortality link. Whether or not this remains the case cannot easily be predicted. The UK population is only partially vaccinated and virologists fear that ending restrictions in such an environment will create a breeding ground for new Covid variants. Even if the worst case does not arise, the medical evidence is clear: Avoid unnecessary exposure to Covid.

A recipe for economic chaos

It is perfectly understandable that parts of the hospitality industry want to get back to business as usual. But the wider economic costs of opening up are potentially significant. The government plans to scrap the working from home guidance and it will be up to employers to find an agreement with staff as to how the transition back to the workplace will be managed. However, the self-isolation rules requiring people to quarantine for 10 days in the event they come into contact with Covid will only be lifted on 16 August. On the basis that two people are forced to isolate for every recorded case, 100,000 cases per day as per Sajid Javid’s suggestion, would result in 1.4 million people having to self-isolate in the second half of July and first half of August.

Even if the number of cases is “only” 50,000 per day, it still implies that 2% of those in employment will be affected which will have significant implications for businesses. It is likely that many employers will continue to allow their employees to work from home but there are many jobs where this is simply impossible (e.g. retail). There will thus be some very heated conversations between employers and employees about the appropriate time to return to work.

Last word

In some respects the government’s insistence on setting a date to end restrictions is reminiscent of the approach to the Brexit deadline: Announce the date; implement the policy and deal with the fallout later. But given the government’s past approach to Covid which has seen it criticised for being too slow in applying lockdowns and closing borders, not to mention the policy towards old-age care homes, it is reasonable that people are concerned about the consequences of opening up at a time of rising Covid cases. The government knows that it cannot afford to get this policy wrong. Many people’s lives literally depend on it.

Telling it like it is

Andy Haldane, the Bank of England’s outgoing chief economist, is an eclectic thinker on matters of economic policy and his valedictory speech on his last day in the role was a tour de force of the issues facing central banks today. In recent months, Haldane has warned that inflationary pressures are building and in each of the last two MPC meetings he has voted to reduce the BoE’s asset purchase limit from the planned £895 billion to £845 billion (though I sometimes wonder whether an impending departure allows policymakers to throw off the shackles and vote against the consensus). Whilst this is not a huge change in the grand scheme of things it is a signal of intent and in his speech Haldane explained the reasoning behind his thinking.

In Haldane’s view the current conjuncture is rather different to that which prevailed in the wake of the GFC when the recovery was a rather slow and protracted affair. This supported the slow withdrawal of the post-2008 stimulus but with the economy apparently set to grow very strongly in 2021 “this time that policy script feels stretched.” The danger is that large and rapid balance sheet expansions (chart) but limited and slow withdrawals “puts a ratchet into central bank balance sheets” which raises concerns of fiscal dominance – the extent to which monetary policy becomes subservient to the needs of the fiscal authorities to manage deficits and debt rather than the primary goal of fighting inflation. Economists agree that large volumes of asset purchases do increase the risk of fiscal dominance but are less in agreement that recent actions will lead to such an outcome. There have been suggestions, particularly in Germany, that the ECB’s policies in recent years have been designed to support the heavily-indebted euro zone economies although we will only know if fiscal dominance has taken root if the ECB fails to act in the face of any inflation pressure. But as Haldane put it, “this is the most dangerous moment inflation-targeting has so far faced.”

He also pointed out that “a dependency culture around cheap money has emerged over the past decade.” I have a lot of sympathy with this view and argued strongly that central banks should have been quicker off the mark from 2013 onwards to withdraw some of the monetary stimulus put in place after the GFC. This is not to say that policy should have turned restrictive but it perhaps should have been less expansionary. After all, as I have consistently pointed out, the economy in 2012/13 may not have been in great shape but it was in far better condition than in 2008/09. The actions of central banks in the five years after the GFC were akin to performing life-saving surgery on a patient long after they had left the operating theatre and were resting on the ward.

As with all procedures there are side effects and one of those associated with lax monetary policy is extremely high asset values, both financial (equities) and real (housing). If investors do not expect central banks to take some air out of the balloon, they will continue inflating prices. This is more than just a financial market problem – there are social implications as well. For example, many young people who were leaving school in 2008 will now be thinking of starting families but find themselves priced out of the housing market. Moreover, rising asset values are fine for those sitting on a portfolio of stocks but serves to enhance the wealth disparity versus those who do not. And as I have been pointing out for some time, low interest rates penalise savers – particularly those nearing retirement. Expansionary monetary policy is undoubtedly the right policy in the right conditions but I am with Andy Haldane in hoping that central banks do not wait too long before cutting back on some of the support they are currently providing.

Haldane’s speech stood in contrast to the BoE Governor’s annual Mansion House Speech, given a day later, which was a rather more conservative take on the state of the economy. That said Andrew Bailey did highlight the upside risks to inflation, and I agree with him that they are likely “to be a temporary feature of the bounce-back.” Bailey’s speech carried the usual warning from policymakers that the central bank is prepared to tighten monetary policy if required to stave off an inflation threat but that this does not form part of the current baseline. Whilst inflation has not proven to be a problem in the wake of the GFC, so that this threat has never been put to the test, there may come a point where the BoE may have to follow up on its threat to take away the punchbowl.

There are some former BoE policymakers (notably Danny Blanchflower) who are completely opposed to the idea of raising interest rates any time soon, and who give no credence to the Haldane view of the world. But this is to assume that the conditions prevailing today are similar to those more than a decade ago. But this is not the case: As Bailey pointed out in his speech the degree of economic scarring following the recent output collapse has been far smaller than expected. Moreover, governments are adopting a much more active fiscal policy approach today, in contrast to a decade ago when monetary policy had to do all the heavy lifting.

A final argument as to why the zero (or negative) interest rate policy should have a limited shelf life is derived from the Japanese experience where more than 20 years of expansionary policy have done little to get the economy back on the path which the government desires. There is a general belief that monetary policy is neutral in the long-run i.e. it may impact on nominal quantities but does little to influence real growth rates or productivity. This has been borne out by the Japanese experience which demonstrates that monetary policy does nothing to impact on the supply side of the economy. This is hardly surprising: Monetary policy cannot boost the capital stock or improve education and training standards, implying that other policy prescriptions are required. The UK’s dire productivity performance over the past decade makes it clear just how much these alternatives are sorely needed.

As Andy Haldane goes off to face new challenges as Chief Executive of the Royal Society of Arts he will leave a gap at the BoE which will not easily be filled. He has not met with universal acclaim from within the economics profession but I have always found his willingness to cross-pollinate economic ideas with those from other disciplines has resulted in some illuminating insights. He will leave big shoes to fill.