David Cameron has tried to frame the Brexit debate as essentially about economics. Standing with him is the overwhelming consensus of economists themselves, from academics to the International Monetary Fund (IMF). Yet their pronouncements are not having that much impact on the electorate if the polls are to be believed.
There is justification for this public scepticism. The arguments relate to what might happen to the economy at the aggregate, or macro, level. How much will GDP rise or fall, how many jobs will be lost or created, what will happen to trade, to inflation?
At the individual level, or micro level as economists call it, a great deal of progress has been made in the past 20 years or so. But at the overall, macro level, mainstream economics has if anything gone backwards. Concepts such as rational behaviour and equilibrium have been incorporated into the thinking of macro economists, at the very time that their micro colleagues are challenging them.
Olivier Blanchard, until recently chief economist at the International Monetary Fund, has real form on the perils of believing orthodox macro economics. In August 2008, for example, just three weeks before Lehman Brothers collapsed and the worst recession since the 1930s burst onto the world, he published a paper claiming that the state of macroeconomics was “good”.
The relationship between inflation and unemployment is a central building block of macroeconomics. Economists even have a special phrase for it, the so-called “Phillips curve”, named after the LSE-based academic who discovered it in the 1950s. The curve in theory says: the lower is unemployment, the higher is inflation. This is the subject of Blanchard’s latest offering in the American Economic Review.
The Phillips curve is not just of academic interest. The Monetary Policy Committee, for example, has an inflation target, and unless its members know what the curve looks like, they are not going to be able to do a very good job.
Blanchard sets out a formidable looking mathematical model. He then employs statistical techniques in conjunction with the theory, in the same way that, for example, the UK Treasury published one with their estimates of the trade costs of Brexit. Blanchard claims that “the US Phillips curve is alive”.
Up to a point, Lord Copper. For one of Blanchard’s conclusions is that “the standard error of the residual in the relation is large, especially in comparison to the low level of inflation”. Translated into English, this simply means that his model does a poor job of explaining what has been going on.
This is hardly surprising. The unemployment rate peaked in the US at just under 10 per cent in 2010. Since then it has halved to stand at just under 5 per cent. But inflation is slightly lower, at 1.1 per cent compared to the 1.6 per cent average in 2010. The story is just the same in the UK and Germany. Since the crisis, unemployment has fallen sharply and inflation has edged down. Macro models are by far the weakest part of economics.