Just goes to show how much damage a crippling deficit can do to a country.

If our credit rating had been downgraded, and it nearly was, we’d be growing even more slowly than we currently are.

Unsurprisingly enough though, if you look at the chart of budget deficits, the rankings look pretty much the same.

What Duncan *always* seems to ignore in his anti-Osbourne missives is that the Uk budget deficit is out of control and if it stays that way we won’t be able to borrow more at such reasonable levels. He also ignores the results of increasing debt levels – lower growth as more spending has to be diverted into interest payments and taxes have to be higher.

It *isn’t* OK to keep spending the way Labour did, and financing it by ever more debt. Fortunately most of the country is starting to see it that way.

Just goes to show how much damage a crippling deficit can do to a country.

Growth was in fact higher before Osborne really got going – we’ve slowed down since. So the deficit is not correlated to growth here, it’s Osborne’s policies to cut spending massively and reduce investment at the wrong time.

Tyler @2,

There is a correlation between aggressive front-loaded attempts to cut deficits and faltering growth.

Not between deficits and growth as such – look at the US.

You also don’t explain why growth was flat in the past 6 months, but strong in the previous 6 months.

“It *isn’t* OK to keep spending the way Labour did, and financing it by ever more debt. Fortunately most of the country is starting to see it that way.”

On the contrary, it’s exactly what we needed. Private debt caused the crisis, and the best way to allow the private sector to deleverage is for the public sector to pick up the slack. This is an accounting reality, which is why the Coalition are relying on a further increase in private debt for AD to remain at acceptable levels.

@1: “If our credit rating had been downgraded, and it nearly was, we’d be growing even more slowly than we currently are.”

You write this as though credit ratings provide some kind of objective assessment of economies, rather than being part of the whole political mechanism that drives economies towards measures which, as Duncan indicates (and the WEO Chap 3 report he often refers to prove beyond reasonable doubt), are harmful to those real economies.

Pretty well all the evidence points towards Duncan being right on ‘expansionary fiscal contraction’; this is more valid than your argument which is based on an assumption that because Credit Rating Agenies are Credit Rating Agencies, the fact that they hold to the tenets of a disproven model of recovery principally as the means to restore their own badly tarnished reputations is irrelevant, and that they should be seen as very conveniently right anyway.

“If our credit rating had been downgraded, and it nearly was, we’d be growing even more slowly than we currently are

As everyone knows by now (except ‘Anon’), the credit ratings agencies played an enormous role in creating the conditions that led to the financial crisis.

Their willingness to slap Triple A ratings on all manner of Wall Street-engineered mortgage rot was enormously lucrative for the raters but a disaster for the global economy.

Jog on.

@3 Sunny and @4 Duncan

Deficits and total debt ARE MOST CERTAINLY correlated to growth. Even your mate Krugman did one, but the most famous paper is the Rogoff one.

“You also don’t explain why growth was flat in the past 6 months, but strong in the previous 6 months.”

The cuts have barely started yet, given most started in this financial year i.e. a month ago. The terrible weather was most certainly a factor in the poor growth, but the cuts aren’t going to be a massive factor – yet you are trying to pin the blame for worse than expected growth on them. In reality I doubt you have any empirical eveidence for that argument.

In the same manner I can easily (and with some evidence) argue that too much debt, both government and household, is acting to drag down growth. Commodity prices are also clearly a factor. The point is though, that there are lots of linking factors, not wholly understood. By anyone.

What you are doing though is picking one thing that the government have done that you don’t like, making the assumption that ALL of the unexpectedly poor GDP is caused by that, then trying to use it as a politcal stick.

In truth though, you have no direct evidence, just an opinion, and there is just as much evidence for other factors and even many cases where cutting back the public sector has been good for an economy’s growth.

As I hope you should know (being an ex BoE economist) GDP prediction is not a simple effort, and is more dark art than anything else.

Front loaded??

Remind me of the difference between Osborne’s plans and Darling’s.

Shrinking our way to growth is the tory plan. Unless you are a banker.

They don’t give a shit if it sends the economy into another recession because they are alright jack. High employment is good for keeping the workers in line. And anyway, a recession gives their backers opportunities to buy stuff cheap.

Disaster capitalism. Look over there ………A Royal wedding……. while we carry on transferring wealth to our rich friends.

Remind me of the difference between Osborne’s plans and Darling’s.

Over 40billion pounds

Hey, cjcjc, some of us are unpartisan enough to know Darling was rubbish too. Tory pink or tory blue are just as bad.

The point of the OP is that the medicine doesn’t seem to be working, whoever is administering it.

Those basket cases in Europe, with their high taxes and all that, seem to be doing better!

Growth is slow because the economy is still gummed up with businesses and industries that have been kept artificially afloat by the bail-out. A Keynesian stimulus might increase economic growth in the short term but would only make the inevitable correction more unpleasant. What we needed was a nasty but short crash to cleanse the system.

Tyler,

The VAT increase and £6bn worth of cuts may be far from what’s to come but they are not the same as nothing, so will have played some part in reducing growth. Furthermore, a part of the reason for the economic decline is due to to the fact that confidence has declined dramatically after austerity announcements – exhibit A: http://bit.ly/jQgIz5

You say personal debt is dragging down the economy, and I agree- that’s why we need the govt. to pick up the slack, as it is able to borrow on favourable terms (that were favourable before Osborne’s budget). We could also use some large scale debt write offs.

If you advocate a smaller state, fine, but now is not the time for cuts. A more sensible position would be to support investment followed by larger cuts – Tim Harford has a good article on this: http://bit.ly/jlamfS

I cannot find a single respectable economist – left or right – who has supported current austerity drives. This government are either ridiculously opportunistic and cruel, or grossly incompetent. I honestly don’t know which one it is.

Hasn’t Germany done well despite adopting austerity policies? I’m a bit shakey on the German situation so any info would be appreciated.

@15: “Hasn’t Germany done well despite adopting austerity policies? I’m a bit shakey on the German situation so any info would be appreciated.”

I found this illuminating on the German economy:

“The banking system in the UK seems paralysed by the excesses of the past few years – which is not what you see in France and Germany,” says the Deutsche Bank economist. “In Germany, especially, banks are not problem-free but people and businesses have not had to correct for any kind of over-borrowing.” [13 May 2011]
http://www.ft.com/cms/s/0/a7a6be7e-7d83-11e0-b418-00144feabdc0.html#axzz1MHfH8RrM

@15

Germany and France are doing well because they:

- Have decent BoPs
- Have low personal debt levels

In particular, Germany’s excellent BoP means that austerity is not much of a problem.

40bn over five years.

What was the difference in year one?

Fiscal spending was cut, real GDP growth falls. Post hoc ergo propter hoc!

The real GDP numbers are low in the UK in large part because the GDP deflator is so high. The GDP deflator is much higher than forecast; in the last Darling budget it was predicted to be 1.5% for 2011, now 3%. Nominal spending is rising at the top end of the forecast.

Ceteris paribus, if the deflator was per the 2010-11 outturn, and everything else tracked the Darling plans and forecast, we would without doubt have seen similarly weak real GDP growth in 10Q4/11Q1.

So, is your thesis that Osborne’s “austerity” has caused a higher than expected deflator, or that nominal spending would have in fact exceeded Darling’s March 2010 forecast, absent Osborne’s changes to fiscal policy?

It is not unreasonable to argue that the VAT rise contributed to a higher deflator in 11Q1 at least; hard to see this applying in 2010. Ex-snow, hard to see whether the VAT rise brought forward any spending to 10Q4.

It is also hard to make a coherent argument that the in-year 2010/11 spending cuts have damaged in-year spending to a very significant degree, because they were so small.

So do you make the argument that current spending was lower because the Spending Review changed expectations of future fiscal policy? It is not entirely incoherent; more public sector employees expecting future lay-offs; private sector suppliers seeing a lower flow from the public purse.

But then you must also consider the counterfactual: would expectations have changed for the worse, post a Spending Review in Autumn 2010 with a Labour Chancellor, even if the overall fiscal plans did not? It seems reasonable to say they would. Darling promised cuts “worse than Thatcher” but did not decide where they would fall; a proportion of the public sector was living on borrowed time, even under Labour’s plans.

Looking forward to people trying to insist that the coming year(s) of stagnation are due to things other than austerity, and we are just idiots committing correlation/causation and post hoc ergo propter hoc fallacies.

@14 Cahal

Personal debt is holding the economy back, but rapidly increasing government debt is doing more damage.

Too much government debt leads to higher taxes, lower public spending after debt servicing and higher interest rates. It also leads to a loss of confidence which makes it less likely that people will invest in a country.

That’s before you take into account the crowding out effect, as corporates find it harder to issue debt as the market gets swamped in government paper. It might be cheaper for the government to borrow, but that doesn’t help a corporate raise money…..unless of course you are saying that the government should run everything?

@Cahal

It is not unreasonable to expect that that with high government debt, a high fiscal deficit, high unemployment, and relatively high inflation, we will see low real GDP growth for the next year or years. Are there any countries in the world in a position similar to the UK, which have all four of those problems, and are seeing high real GDP growth?

The question is what effect fiscal policy is having on the variables. I am genuinely neutral on this. I am not sure. But we need analysis which is more convincing than “correlation, therefore causation”. The economy is a complex beast. Preliminary GDP numbers are not always greatly accurate at this stage in the cycle, so drawing strong conclusions from them is perhaps not wise.

I am confused about why inflation is so high despite such high unemployment. This is not a good sign, and it is a strong indicator that we are not in a Keynesian “liquidity trap”, which is often cited as motivation for higher deficit spending.

*Apologies for essay

Tyler,

‘Personal debt is holding the economy back, but rapidly increasing government debt is doing more damage.

Too much government debt leads to higher taxes, lower public spending after debt servicing and higher interest rates. It also leads to a loss of confidence which makes it less likely that people will invest in a country.’

If a business owner takes out a bank loan to invest in his enterprise, has he burdened himself with debt? Not really, because the results of the investment made him more able to pay. Similar principles apply with government investment. As for confidence, well:

http://bit.ly/jQgIz5

Seems businesses are more concerned with demand than government debt.

‘That’s before you take into account the crowding out effect, as corporates find it harder to issue debt as the market gets swamped in government paper. It might be cheaper for the government to borrow, but that doesn’t help a corporate raise money…..unless of course you are saying that the government should run everything?’

Crowding out only occurs 100% at full employment. At the moment, investors are swarming towards safe financial assets as a result of the crisis (and also as a result of the EZ crisis). This is evident from the fact that US & UK borrowing rates are historically low (and UK ones were low before Osborne’s budget btw). Without government bonds, they will simply hold their assets in cash, hence large corporate surpluses and the general lack of business investment we are seeing. Government bonds are also vital for pension funds.

Where did I say government should run everything? The last time (afaik) a government fully repaid its debt was the US in 1871, which engineered a pretty awful depression. Bear in mind also that large cuts are not necessarily the right way to reduce a deficit – economies don’t work like household budgets. No respectable economist has endorsed the budget cuts at this stage in the business cycle, regardless of how big they think the state should be.

Gareth,

‘It is not unreasonable to expect that that with high government debt, a high fiscal deficit, high unemployment, and relatively high inflation, we will see low real GDP growth for the next year or years. Are there any countries in the world in a position similar to the UK, which have all four of those problems, and are seeing high real GDP growth?’

I think you have the causal link wrong. High inflation a result of three things: VAT rise, BoE’s inability to tighten due to fiscal consolidation, and most prominently international shocks.

High debt and fiscal deficit, well, unless you believe Ricardian equivalence (which Ricardo himself didn’t believe), I don’t see how you can think that is the cause of low growth. If so, why was the economy growing when the debt was similarly high for the first 3 quarters of 2010?

Again, high unemployment a result of a faltering economy, not a reason for it.

‘The question is what effect fiscal policy is having on the variables. I am genuinely neutral on this. I am not sure. But we need analysis which is more convincing than “correlation, therefore causation”. The economy is a complex beast. Preliminary GDP numbers are not always greatly accurate at this stage in the cycle, so drawing strong conclusions from them is perhaps not wise.’

Well the graph I linked to above shows business confidence declining after austerity announcements, yes that might seem like post hoc ergo propter hoc but I find it hard to come up with another explanation.

I also find it hard to believe that the preliminary cuts, however small they were, and a consumption tax rise (generally associated with the highest DWL) did not effect some of the bad numbers we’ve seen. Yes, there was snow, but then there wasn’t exactly a resurgence of growth afterwards as you might expect. The GDP numbers may not be 100% accurate but I doubt they have a large enough margin of error to mean the economy grew at an acceptable rate in Q1.

‘I am confused about why inflation is so high despite such high unemployment. This is not a good sign, and it is a strong indicator that we are not in a Keynesian “liquidity trap”, which is often cited as motivation for higher deficit spending.’

The reasons for inflation aren’t due to the money supply, they are mostly supply side factors. Mervyn King was mocked for saying that if you take out VAT, oil & energy the pressure is more deflationary, but he has a point.

The liquidity trap isn’t a black or white affair, but I do think we’re in a situation where the BoE will find it pretty hard to influence short term interest rates with conventional monetary policy (evident from high retail interest rates despite 0.5% base), which I see as a case for short term fiscal expansion.

Honestly, with some of the attitudes those on the right are taking atm, they’d be shouting down Milton Friedman as a spendthrift inflationist. Expansionary fiscal policy in a downturn has been endorsed by almost every conservative economist from Hume to Say to Bastiat.

I have no idea how people think this austerity will engineer growth or even reduce the deficit when it goes against the entire history of economic thinking and indeed what every current respected economist says. My only conclusion is ideology or arrogance.

@Cahal, thanks for the detailed response! It is very information and much of what you say makes a lot of sense.

I particularly like “shouting down Milton Friedman as a spendthrift inflationist”

I do not understand the argument for the liquidity trap in the UK. The liquidity trap is broadly the situation where monetary policy cannot cause inflation. This does not seem to match the status quo. A large part of the price level changes we have seen have been imported due to the change in the value of Sterling – an effect of monetary policy. So if monetary policy /can/ cause inflation, then we are not in a liquidity trap, QED. Is this wrong? (I am not an expert

The Bank have been surprised by this, and have made the point many times: they expected domestic producers to be boosted by making imports more expensive: Mervyn King’s “rebalancing” drive. But the capacity was not there, so instead domestic prices simply adjusted upwards with the price of imports. I think this ties in with your argument about the supply side.

Is a supply side problem itself a good reason for fiscal expansion? I’m not sure I follow that.

“High inflation a result of three things: VAT rise, BoE’s inability to tighten due to fiscal consolidation, and most prominently international shocks.”

Do you think the 10Q4 GDP growth figure was lower because of the VAT change coming in 11Q1? This is subtle but it is important.

I am confused by the monetary tightening argument. Monetary policy affects demand, not merely inflation, right?

If you say:

a) Osborne’s fiscal policy has lowered demand
b) the Bank would be tightening monetary policy, absent (a)

Then this is surely an argument that the Bank is working to simply *directly offset* fiscal policy. i.e. if Osborne was not lowering demand through fiscal policy, Mervyn King would be doing it! And this is not dissimilar to what King/Osborne have both been saying (fiscal contraction “allows” looser monetary policy).

So I still do not have a good counterfactual:

1) real GDP growth would have been hurt by a higher deflator due to the international commodity price shocks, even absent Osborne
2) demand has been lowered by Osborne’s fiscal changes, but would have been lowered by monetary tightening absent those changes
3) VAT effect kicked in 11Q1, where growth was bad but not 10Q4 bad
4) the “real” problem is supply side, which is not an effect of tight fiscal policy

One side-track: as a Labour supporter I really don’t want to be a position where we want to argue that higher taxes (including VAT) are bad for growth. This is handing the victory to the Tories – it saddens me greatly to see Balls follow this strategy I would rather our country move towards a more Nordic model, and high VAT is part of that, e.g. 25% VAT in Norway/Sweden.

*I’m sure I’ve repeated myself a couple of times in this ramble, sorry

Peoples definitions of liquidity traps vary. I’ve always thought it was when the central bank cannot influence demand rather than inflation. So, as you say, loose monetary policy is importing inflation but that is (mainly) a result of a devalued pound making current imports more expensive, rather than boosting exports significantly. So almost all of the inflation is cost push rather than demand pull – without the VAT rise I expect that inflation would be below 3%, and I also anticipate it will go down a bit now because oil and commodities have tanked.

Again, the liquidity trap isn’t either ‘on or off’ – but in the situation we’re in – demand for cash/safe assets is high – it is pretty difficult for standard central bank operations to influence demand, though not impossible. I guess I’m just trying to say that fiscal policy is a hell of a lot more effective at stimulating demand. In the long term this would be offset, but in the short term monetary policy cannot influence whilst fiscal policy can.

‘Is a supply side problem itself a good reason for fiscal expansion? I’m not sure I follow that.’

A case of bad wording – I meant cost push rather than the supply side.

‘Do you think the 10Q4 GDP growth figure was lower because of the VAT change coming in 11Q1? This is subtle but it is important.’

Yes, if only slightly.

‘So I still do not have a good counterfactual:

1) real GDP growth would have been hurt by a higher deflator due to the international commodity price shocks, even absent Osborne
2) demand has been lowered by Osborne’s fiscal changes, but would have been lowered by monetary tightening absent those changes
3) VAT effect kicked in 11Q1, where growth was bad but not 10Q4 bad
4) the “real” problem is supply side, which is not an effect of tight fiscal policy’

1) Yes, not all of the stagnation is Osborne’s fault. But even so, he is dogmatically sticking to his guns despite the faltering economy. I just don’t think that’s sensible.

2) Partially. Think about it his way: there is not enough AD in the economy. The bank has some ability to increase it, but now that we’re practically at the zero bound this is limited. Fiscal policy can boost it far more effectively, and yes, some of it would be offset in the medium term by tightening monetary policy, but it would still give the economy that initial boost that monetary policy is unable to provide.

3) I think the VAT increase has been steadily incorporated from the end of 2010 and still ha snot been fully passed on.

4) I disagree. I think there is not enough AD – 500,000 jobs but 2.5million unemployed.

‘One side-track: as a Labour supporter I really don’t want to be a position where we want to argue that higher taxes (including VAT) are bad for growth. This is handing the victory to the Tories – it saddens me greatly to see Balls follow this strategy I would rather our country move towards a more Nordic model, and high VAT is part of that, e.g. 25% VAT in Norway/Sweden.’

I’d actually support lower income tax but a Land Value Tax and Carbon Tax – both of these are ‘good’ taxes in the the former actually encourages economic activity and cannot be passed on, and obviously the latter reduces pollution.

@Cahal – thanks so much! I find this debate really interesting.

“Yes, not all of the stagnation is Osborne’s fault. But even so, he is dogmatically sticking to his guns despite the faltering economy”

This is a kind of different spin to the headline of this post

I just went back to check the numbers on this. I try to use Darling’s 2010 budget as a baseline. If you measure Total Managed Expenditure / Nominal GDP, the figures (projected) for 2011-12 have changed over the last three budgets as follows:

Darling Mar’10: 46.9%
Osborne Jun’10: 45.5%
Osborne Mar’11: 46.0%

so in effect surely he *is* allowing fiscal policy to loosen with the lower-than-expected GDP growth. Otherwise you would have expected spending/GDP to stay in line with previous forecasts.

I just wish Labour’s argument was so much stronger. If you take out the VAT rise, the spending cuts required to meet Darling’s plan for the deficit would be similar to Osborne’s. We don’t have a coherent story, and I worry we will be punished by the electorate for this for a long time.

No problem! Good to have a discussion without people getting angry.

‘This is a kind of different spin to the headline of this post ’

Yeah I generally don’t agree with libcon tbh..

‘I just went back to check the numbers on this. I try to use Darling’s 2010 budget as a baseline. If you measure Total Managed Expenditure / Nominal GDP, the figures (projected) for 2011-12 have changed over the last three budgets as follows:

Darling Mar’10: 46.9%
Osborne Jun’10: 45.5%
Osborne Mar’11: 46.0%

so in effect surely he *is* allowing fiscal policy to loosen with the lower-than-expected GDP growth. Otherwise you would have expected spending/GDP to stay in line with previous forecasts.

Govt. spending grows naturally as a % of GDP because of Baumol’s cost disease, so even though spending is increasing this doesn’t really show a loosening of fiscal policy. The apparent increase is mostly due to low private sector growth, which some stimulus would help by ‘crowding in’. Is that nominal expenditure as well as GDP? Where did you get it from – just I’d like to look at it myself?

The best way to look at how fiscal policy is changing is ‘government contribution to GDP’ but I don’t think that figure is available for the UK, only the US

‘I just wish Labour’s argument was so much stronger. If you take out the VAT rise, the spending cuts required to meet Darling’s plan for the deficit would be similar to Osborne’s. We don’t have a coherent story, and I worry we will be punished by the electorate for this for a long time. ‘

I’m not Labour aligned, but it just seems that Labour would have been more flexible if the economy had faltered. The Coalition’s biggest issue is how they’ve tied their own hands politically.

27. Cahal

“The Coalition’s biggest issue is how they’ve tied their own hands politically.”

I think this is a major issue with their deficit fetish. They appeared to be so adamant that the primary budget must be balanced before the end of this parliament that they were leaving no flexibility if the economy performed worse than expected. Considering that they need growth to close the deficit are they really saying if growth disappoints they will cut even deeper no matter what is happening with unemployment and the global economy? That is a particularly dumb position for any government to take five years in advance.

Although, it is thought that there is an implicit pact between the chancellor and the Bank for a loose monetary position to be maintained while the government pursues a tight fiscal policy, there is no guarantee that the Bank will maintain this beyond the next six months. There is a naivety at the heart of this government that manifests itself in believing their own talking points. As talking points have encountered realpolitik we get u-turn after u-turn. If they are to be judged in whether they eliminated the deficit before the next election, it is possible even now to forecast that the policy will fail. Kenneth Rogoth reckons they will do well to achieve half their deficit reduction plans and that seems about right. Unfortunately, it will have come at the cost of much unnecessary hardship to suit ideology.

@Cahal I had to extract them from the PDF files of each Budget. Yes, nominal TME over Nominal GDP – the Darling budget only gives a range of Nominal GDP predicted for 2011-12 so I used the midpoint.

The ONS measure of GDP by expenditure has “General Government Final Consumption Expenditure” – this is what you mean by government contribution to GDP, is that right? 10Q4 saw a positive contribution to growth from that series; p16 of http://www.statistics.gov.uk/pdfdir/qna0311.pdf

I see your point (and which Richard makes too) about inflexibility, yet… continued U-turns are not an indicator of inflexibility! If external shocks are causing the poor economic performance in the very short term, it is hard to see the government could do much about that. The snow had melted by the time the GDP figures came out!

My worry for the Labour party is that we seem to be tying ourselves to the mast of “Osborne causes economic doom”. This might play well currently, but if the economy does recover it will look very bad. In any case, there are only so many times you can play the “Something Must Be Done” card before people will wonder whether the “something” you did last time is not actually helping much.