Dartmouth Business Journal (DBJ): As a leading economist in the field, where did your interest in economics originate?
David Blanchflower (DB): I actually started doing economics when I was at school. I discovered it was something I liked and could do. In England, you specialize pretty early, so I did an economics degree in high school, university, and then I taught in a school and realized that I was interested in unemployment—youth unemployment. I went back, did a masters, [got a] PhD degree, and became a labor economist. Not least because I was interested in some of the big events that I saw particularly in the 80’s around the world…big growth in youth unemployment, which I hoped had gone away but now it has come back again. My interest was in trying to solve unemployment and trying to think about the real world and do practical things in the real world.
DBJ: What exactly about unemployment interested you? Was it because it’s a general problem or was there some other motivational factor?
DB: It’s a really hard problem, it turns out. Many people have tried to work on it, people have just been awarded Nobel prizes for studying it, but we still don’t understand it. Why are certain people unemployed? Why won’t unemployment go away? What’s the impact of unemployment and the social and economic losses concerned with it? One of the things I’m especially interested in is how unemployment is scarring. [We have evidence] that unemployment spells in the 80’s and 90’s, when people were 20, continue to hurt them 30 years later. We can show that when you have particularly long spells of unemployment when you’re young, and you don’t make the transition from school to work, your wages later in life are lower, your health is worse, and the likelihood that you’ll be unemployed again is higher. So the loss to you and society is big. The other interesting thing is that if you enter the working world during a recession, your lifetime earnings are lower. I think we should be doing things about that because it’s not peoples’ fault.
On unemployment, the other thing I’ve done a lot of work on is happiness. Spells of unemployment everywhere make people really unhappy, by a lot. People have asked, is unemployment voluntary or involuntary, and it turns out it doesn’t matter…unemployment makes people unbelievably unhappy by a lot.
DBJ: Can you talk about your research or work like the economics of happiness and your book The Wage Curve?
DB: Work on the wage curve is about understanding some facts in the data. I’m a data person. I’m interested in trying to find statistical, empirical regularities–patterns–in the data because that’s what a science should do. After doing lots of research across countries and time, we found that there was a strong pattern in the data that said wages and unemployment were negatively correlated and that was called the wage curve, and it says stuff about what’s going on now.
DBJ: So you wrote The Wage Curve a few years ago and now it has significant relevance. Can you elaborate?
DB: Roughly, what the wage curve says is that if unemployment doubles, say from 4% to 8%, real wages will fall by about 10%. If you look at the US since the start of the recession, roughly unemployment has doubled and real wages have fallen by about 8.5%, so we were pretty darn close. An economist would say a wage equation is the same everywhere.
It turns out when you look at happiness, the happiness equation is also the same everywhere. But what’s really interesting to an economist is that happiness has not risen in the US since 1975. In developed countries it has. But happiness levels today in the US are approximately the same as they were in 1975. Now that’s intriguing to researchers. So relative things matter. Basically if I get a BMW and you don’t, that makes me happy. But if I get a BMW and you do too, my happiness doesn’t rise because you got one too. So we’re interested in relative things. National happiness has not risen even though income has risen.
DBJ: How do you define happiness? How is economics applied to happiness?
DB: I will answer this in a number of ways. If you think about what a macro policymaker does–and I was a policymaker–the three things that you care about are inflation, unemployment, and growth. But you can’t eat those. They aren’t things we actually care about in the sense that they’re intermediate goods. And ultimately what we actually care about is well-being, some measure of utility. If unemployment’s low then we’re doing okay, if inflation’s low we can buy cheap stuff and our standard of living is higher, and if we grow, we’re doing better. People worry about how you measure happiness. And a first order answer is that it doesn’t really matter. You ask people. How happy are you on a scale from one to ten. It turns out that’s quite good. It’s very correlated with life events. Unemployed people say they’re unhappy. That happens all the time. If I ask how happy you are, I can validate it by asking your friends how happy are you. I can ask your mother, your spouse. That’s one thing you can do. It turns out happy people smile more, called the Duchenne smile. There are physical things you can look at like the brain.
DBJ: Can you describe your experience with the Monetary Policy Committee and the Bank of England? What you did there in the beginning and then towards the point when you predicted the financial crisis?
DB: I went there first in mid-2006. I hadn’t applied for the job and I wasn’t a monetary economist. It was an appointment by the Chancellor of the Exchequer or the prime minister of Britain. There was quite a lot of controversy about the fact that I wasn’t going to give up my job at Dartmouth; I said I’d take leave and commute.
When I first went over there, there was a lot of disagreement about how to think of the world, and I essentially thought that a lot of the stuff that was happening in the US was going to subsequently happen in the UK. But they believed in decoupling, which was that America was irrelevant. And I said, “Oh no, that’s such hogwash.” I always had it in my head that when the US sneezes, the rest of the world catches a cold.
And that was what happened. As the US started to go into recession, the data started to weaken. Eventually, the housing market collapsed, the labor market collapsed. The US went into a recession in early ‘07, with output starting to fall in ‘08. And then the UK and Europe followed almost exactly the same path perhaps six to nine months later. People in the UK didn’t notice it, but I did. And I kept saying, “Something horrible is going to come out of the financial markets,” and that was exactly what happened. By August 2008, I started voting for cuts in rates. The one big one, which I am now remembered for, is called the Blanchflower cut. I basically said we have to cut by at least 150 basis points, which was the biggest cut ever. Then we cut by 100 and then another 100. We had rates down, and we turned to quantitative easing.
The Bank of England did the right thing, but I think it was the Fed, Ben Bernanke, and monetary policy that saved the world. I think Gordon Brown saved the world as well because he coordinated a fiscal stimulus across the G20 of a trillion. You can’t forget Alistair Darling of the UK either. He rescued RBS and Lloyd’s. People are often unaware that the failure of RBS would have been much, much greater than Lehman’s because in terms of assets, RBS is one of the largest banks in the world.
I asked Alistair in a TV interview, “How close to Armageddon did the world economy come?” He said 3 hours. If they hadn’t saved RBS in the morning, it would have failed in the afternoon. I tried to understand the implications of that, but the thoughts were too awful. I think stock markets and cash machines would have closed around the world. I think we would have seen the stock market falling by 50%. Banks everywhere in the world would be closing. And Ben Bernanke thinks unemployment would have gone up to 25%. It literally would have been “Financial Armageddon.”
That’s what we avoided. People have underestimated the scale of the shock, but when you talk to central bankers around the world–like me, Mervyn King, and Ben Bernanke–we saw and all think we came very, very close to the most enormous collapse. If we hadn’t acted in the way we did…
DBJ: A few questions about the European sovereign debt crisis. What was the main cause?
DB: I think the main cause was that countries especially were able to borrow money at very low rates. They didn’t put their fiscal house in order, and they were accepted as a member of the EU for political reasons. That lowered the cost of borrowing in boom times, but always the worry was what was going to happen in the bad times. The UK under Gordon Brown went through a long period of deciding whether it should join, but basically for these reasons decided not to.
The problem is that you have your own central bank and your own currency and you depreciate that currency. Look at Ireland and Spain, where housing markets collapsed. Now they have to rescue their banks because the banks have gotten themselves in all sorts of trouble. But they’re on their own.
But what people don’t understand is that this is about the German banks. Essentially Greece and Ireland have a really strong card to play, which is that if they default they bring the banks down with them because German banks are linked to Ireland, Greece, Portugal, everywhere else. And I think the ECB has shown itself to be singularly playing what I call the economics of the Maginot Line, which is worrying about inflation, which was a mindset formed in the 1970s. This is a sovereign debt crisis. They can’t get around to rescuing these countries quickly enough. They’re not prepared to pay them money and so they keep saying how it’s going to stop here. Well it didn’t stop at Greece. It didn’t stop with Ireland. Hasn’t stopped in Portugal. Everyone said it’s going to stop with Spain. Spain covered the auction much less than people thought, raised rates, and I think what has happened now is the conversation of a few weeks ago about whether Spain was going to be safe…I think the conversation has now moved on from there because of their complete incompetence. And now we’ve moved onto Italy, which is also completely incompetent.
The ECB made a terrible mistake in July 2008, raising rates when they had gone into recession. They just raised rates again, which actually makes the cost of borrowing in Portugal, Ireland, Greece, and Spain a big problem. It has now brought Spain fully into the sector, as 70% of homeowners in Spain are on variable rate mortgages with the expectation of more rate rises to come. That will basically raise defaults, lower viability of most of the banks, and push Spain into default. It was an idiotic decision in July 2008, and they’ve just done it again. The problem in Europe is not inflation. Inflation is 2.7%.
DBJ: What would you suggest to improve the solution?
DB: I think a classic move is to have a European bond. If they issue a European-wide bond it would lower the cost of borrowing for the peripheral countries. It wouldn’t be ideal for Germany and France but it would help out all of the countries in serious need of help. Instead of Ireland or Greece issuing a bond at 13%, the Euro area as a whole issues it. That’s the first way of fixing things. Solves a great deal of the problems. And then the gainers are going to have to do something to help the losers. If they don’t, the sensible strategy on the part of the losers is to say, well we’re going to default. For the Irish and the Greeks…their best strategy is to default. Whether that means a 100% default or a 70% haircut for the bondholders, the governments, or whoever.
The European countries have made it clear that they will only act when there’s a crisis. The role of a monetary policymaker or central banker is to reduce crises, yet all they’ve done is create crises. So create another crisis to get this problem solved. Irish debt is being downgraded to junk. They tell Ireland she better not default because then she won’t have access to the capital markets. That’s no threat. All they have to do is go to [German Chancellor] Merkel and say, “unless you rescue us, you’re going to have to rescue your banks.”
DBJ: In your career thus far, what do you think was the most meaningful, significant, or interesting thing?
DB: The most significant thing I did was being on the MPC. I guess my big moment was my 150 basis point cut. But that wasn’t a great prize because the economy was tanking. Now, I often get called the person who called the recession, which is quite a good position to be in. It has had a big impact on my career.
But it was a very lonely place to be. I’ve said it was the most awful time ever. People were briefing against me. People said I was a crazy person. At the bank, everybody treated me like the guy who hadn’t washed. The newspapers wrote all sorts of awful things, the worst of which was I was an idiot without a village. You have to learn to look through that. In the end, it’s very easy to fold. But I didn’t. I held my ground. [I had faith in my ability to] read the data really well, a strength I didn’t realize I had.
DBJ: What are you doing now?
DB: We’re working on [the relationship between] biology and happiness–pulse rates, blood pressures…how physical things are impacted by happiness. I’m doing lots of work on youth unemployment and trying to get governments to help the young and unemployed. Actually, because I argued it, the government put a tax on bankers’ bonuses of about 1.5 billion and took that money to fund measures to help the young. So I’m proud of that. Also, I’m a central bank watcher. I wonder what macro policymakers should be doing now. I worry about making big macro mistakes again.