According to Chris Giles in today’s Financial Times, “..the area in which Britain still leads the international debate is fiscal policy”. This might come as a surprise to many, such as Paul Krugman. I should emphasise that Chris does make one point which I totally agree with. Gordon Brown was quick to recognise the need for fiscal stimulus in 2008, and he applauds that. So, unlike some, the argument is not that fiscal stimulus is always and everywhere wrong. Instead it is that fiscal stimulus was appropriate in the downturn, but that once a recovery began, it was necessary to switch sharply from stimulus to austerity. This argument has of course been made for other countries, including the US, as well as the UK.
Chris gives some arguments against austerity that he says range from ‘mad to bad’. The first, which he attributes to Labour politicians, is the suggestion that austerity is entirely responsible for the recent downturn in UK growth. Well, if anyone said this, they are obviously wrong (although not quite mad): there are other important deflationary forces, of course. But it is equally wrong to infer that austerity has little or nothing to do with the recent poor performance. I know of no evidence to suggest that is likely. Indeed it would be rather strange if stimulus had been effective in moderating the downturn, as Chris acknowledges it was, but that withdrawing that stimulus (and more) had no impact.
The second argument against austerity which he describes as ‘bad’ is that low borrowing rates imply that we can “go on a spending spree”. Let’s forget about the ‘spending spree’ language. What I do take exception to is the suggestion that this is a bad argument. It could be wrong, but the idea that the market price might tell you something about demand and supply is hardly bad. What Chris and others seem to have in mind here is a rather unusual demand curve. Lenders want lots of UK debt under current austerity plans, but if these plans were moderated or delayed, or if a temporary stimulus package was laid on top of them, they would suddenly panic. It is possible that they might behave this way, but I think it is unlikely for various reasons.
The source for this sudden panic idea is of course the Eurozone. However I think it is generally accepted now, among economists if not coalition politicians, that the Eurozone is different, because individual countries do not have their own central banks, and the ECB’s attitude is ambivalent. Certainly market panic does seem to be confined to the Eurozone. Indeed, with Quantitative Easing in place, the UK is in a particularly good position to respond to any market panic, as I argued here. We also have some evidence that, outside the Eurozone, the market does not panic at the first suggestion of stimulus. This does not seem to have happened in Denmark, as David Blanchflower noted, and it has not happened in the US. Also, as Olivier Blanchard of the IMF said recently, if we are concerned about market psychology we should be worried about growth as well as debt.
It is far from clear why the current government’s rapid move to austerity is just sufficient to avoid market panic, but anything more moderate (like the previous government’s plans) would send them into a tizzy. The reduction in UK interest rates on debt that we have seen is part of a worldwide trend, and not an indication that the UK leads the world in finding the appropriate policy stance. Meanwhile, the UK recovery has stalled in a major way, and the scale of unutilised labour resources is large and growing. The view exemplified by Chris’s article that we should wait and see what happens, and hope that Quantitative Easing might yet do the trick, is much too complacent. It was wrong two years ago, and it is even more wrong today.