Was the Government’s macroeconomic policy right after all?
With the UK’s return to growth, many will now no doubt argue that the government’s macroeconomic policy has turned out to be a success.
So, are they right? Does the recent pick-up in UK growth prove that the Government were right all along? Have the critics of tight fiscal policy been confounded?
The short answer is very straight forward, “no”.
Simon Wren-Lewis blogged on this yesterday. His answer focuses on levels of output rather than rates of growth and is very persuasive. He concludes:
Even earlier, over a year ago, I wrote this: “come 2015, the spin “we have done the hard work and the strategy has worked” will accord with (relatively) strong growth, while talk of output gaps and lost capacity will have less resonance. True, unemployment will still be high, but not many of the unemployed are Conservative voters, and the immunising spin about lack of willingness to work can be quite effective.” Paul Krugman described this post as ‘remarkably cynical’. I fear it will be one of my better forecasts.
Although I also think there is another, just as powerful answer – the way the economy is developing bears very little resemblance to what the government was aiming for. (And all this leaves to one side for the monent the unprecendented squeeze in living standards).
Back in June 2010 the Government’s strategy was clear – rapid deficit reduction would be accompanied by consistent growth and a rebalancing of the economy towards investment and net trade. Two thirds of all growth would come from rising exports and business investment, deficit reduction would been steady and GDP would continue to rise.
What has happened instead is almost three years of stagnation followed by a consumer-led recovery. Consumer spending is rising faster than consumer income with a falling household savings ratio making up the difference.
In effect we are seeing a very different kind of recovery to the one the government intended and almost three years later than they expected.
Now of course the government will try to make political capital out of this – but they are on very weak ground. As I’ve argued before:
Those arguing for a stimulus at the Budget are not saying that without a stimulus we will face perpetual contraction, what they are saying is that a stimulus now would lead to a quicker recovery, lower unemployment and better economic outcomes than would otherwise be the case.
The worry now is that growth expectations are so weak, and the public so accustomed to bad economic news that any growth will be hailed as a sign of success. The fact that some people are seeking comfort in the experience of the early 1980s is a reason for concern.
Meanwhile, there is every chance that the OBR will react to this pick-up in growth by revising up their estimate of the output gap and down their estimate of the structural deficit. Once again the government will probably claim that this is a sign of their success (‘deficit reduction is picking up pace and back on track, etc’). Again they have no grounds for doing this – if the output gap was actually larger all along then this was an argument for looser fiscal policy not a vindication of tight policy.
But then again I shouldn’t be too surprised by any of this, this after all the Government that reacted to loosing the triple A rating by basically arguing – ‘the fact that we have lost the AAA means that we must stick to our plan to retain the AAA rating’.