I’ve put a chart here showing real economic growth in the US since 1901. An alternative title for this graph would be “The vindication of macroeconomic management”. Many people tend to be quite dismissive of macroeconomists, thinking them little better than astrologers and little use for much beyond stimulating discussion. This graph tells you one very important reason why that’s wrong.
I want you to see in this graph three distinct phases. In the first, before the use of macroeconomic management (which really began after the Second World War), we see a certain degree of volatility in economic growth. A few of the extreme movements visible here can be related directly to the First and Second World Wars; most cannot. After macroeconomic demand management was introduced (built upon the ideas of Keynes), volatility in US growth fell dramatically (i.e. contrary to much ill-informed discussion on the right, Keynesianism and the so-called “Neo-Classical Synthesis” was a great success). Following various 1960s critiques of Keynesian methods there was a switch away from Keynesian methods to monetary rules in the 1970s (as can be seen, these worked no better for the US in growth volatility terms) and then to modern monetary techniques during the 1980s (particularly under Volcker and Greenspan). The introduction of these modern monetary techniques was associated with a reduction in volatility almost as dramatic as the reduction in the Keynesian period (so, though Keynesian techniques were successful, we eventually worked out how to do even better).
Now, it is quite plausible that the next year or two will see quite low growth — even recession — in the US. That would mean a point or two on this line that went below the x-axis. Problems could just conceivably be even worse than this. But don’t rely on it for political purposes — don’t just assume that the economy is going to be so bad that current governments will be automatically ejected, and especially don’t assume that the US is going to be mired in recession for a long time. Perhaps the extraordinary nature of current events (especially if UK house prices continue to fall significantly, adding securitized UK housing debt to the sub-prime debt problem — perhaps taking down a number of European institutions) — perhaps the one-in-a-generation nature of these events will defeat even the skill of modern central bankers. But I doubt it.
I have appeared in all kinds of media over the past couple of years criticizing the Bank of England, mainly for not raising interest rates. But my disagreements with the MPC have lain at the level of a quarter point here, a half point there. The debate between those that agreed with me and those that agreed with the MPC was an important one — there might have been 0.2 per cent of GDP at stake, perhaps £20bn or more. But though certainly worth debating, these discussions are dwarfed by the changes visible in my figure, in which tens of percentage points of GDP over a few years might be at stake. I may not think that the MPC has been doing things perfectly, and the cost of errors might be more than I have suggested, but I don’t think the MPC or the Fed or the ECB have got things all that wrong, and I have every confidence that policy will be used aggressively and (near enough) appropriately. With felicitous use of monetary policy we may yet walk the tightrope between rising inflation and recession, and the slowdown in growth may not seem so very out of keeping with the fluctuations in my chart above.
I certainly think there will be a slowdown, and that it will probably be materially more significant than that predicted in the Budget. I also think that recent events should make us look again at the use of inflation targeting in its current form and that the fiscal rules need radical surgery. However, for the reasons I have set out above (and elsewhere), I think we are much more likely to have a slowdown that will seem painful by the standards of the past fifteen years, but be much less dramatic than much overwrought press commentary. I would urge David Cameron and his team to be careful about making apocalyptic predictions. Quite apart from the risk of looking like a Jeremiah or appearing to revel in the grief of others, there is the risk of looking like a fool and for Brown and Darling to appear vindicated in two years’ time. We certainly don’t want that!
