When the facts change…
Adam Posen’s interview in today’s FT (behind the pay wall) makes for very interesting reading.
His calls for the Bank to be more inventive in its monetary policy are always worth reading (he made an excellent speech on this theme at the TUC earlier this year) but what struck me was his point on austerity:
For him, the main reason that growth has been so feeble has been that austerity has had a larger impact than the BoE or government thought possible.
Posen is very careful not to argue for fiscal loosening (he clearly sees directly commenting on fiscal policy as beyond his remit) but this insight is very useful nonetheless.
To an extent this is nothing new, Posen has previously stressed the impact of austerity in explaining weak UK growth.
Fiscal policy, however, played an important role as well. Cumulatively, the UK government tightened fiscal policy by 3% more than the US government did – taking local governments and automatic stabilizers into account – and this had a material impact on consumption. This was particularly the case because a large chunk of the fiscal consolidation in 2010 and in 2011 took the form of a VAT increase, which has a high multiplier for households.
I, and many others, thought that austerity would likely have a large impact on the economy at the time it was implemented.
The Bank and the Government disagreed, they decided the impact of a VAT hike and spending cuts was less than the critics feared and the economy was strong enough to handle them. Even if they were wrong on this, they assumed the Bank of England would be able to offset any slowdown.
I think what has happened to the UK economy over the past two years is pretty clear evidence that both the Bank and the Government got this wrong. The economy has stagnated and monetary policy has proved incapable of driving a recovery.*
Mr Osborne’s plans make sense only so long as the OBR’s own growth forecasts are correct… It is to be hoped that if circumstances require it, he will show flexibility and use temporary fiscal measures to counter a slump
The OBR’s growth forecasts haven’t proved to be right at all, far from it. But the Government is sticking to fiscal plans premised on the idea that they are. This is the triumph of faith over evidence.
*I am well aware of the argument that we face a supply side rather than a demand crisis. I disagree.
We of course need longer-term reforms to the UK (see for example Frances’ recent piece in the Observer, but in the short run what we have is a problem of effective demand).