UK Finance Minister George Osborne’s Washington ‘I told you so’ speech has prompted a thorough going over of the issue of what the recovery in the UK does or does not prove regarding the Coalition’s ‘austerity’ fiscal policy, by Chris Giles, Jonathan Portes, and Simon Wren-Lewis.
I want to add one point to this. One of the challenges for what Osborne calls the ‘fiscalist’ position [the position that it was tight fiscal policy that aggravated the recession, and that it was its gradual loosening that caused the recession to wane] is that they purportedly need to show that the pace of consolidation slackened, causing the subsequent pick up in growth.
Jonathan Portes’ patient review of the facts showed that indeed the pace of consolidation, measured by the speed at which the cyclically-adjusted, structural deficit falls, did indeed drop off, a bit. So, if this were a correct challenge, Portes shows that it was met.
However, seen through the lens of a modern macro model, Osborne’s challenge to the ‘fiscalist’ position may be false. We might guess that what happened in May 2010 was a switch between two fiscal rules, towards one that entailed a less generous use of deficits to counter recessions, and a lower average debt to GDP ratio. When people in the economy realised that this switch was going to happen, and what it entailed [a process that probably began some time before the election, as it was clear that Labour were not going to hold on to power, but was not complete until well after it, when the fog cleared on Treasury plans], they cut back their own spending, say, anticipating higher taxes and lower disposable income. However, as the rule was followed through, no further belt-tightening by the private-sector was needed. Although taxes and spending were doing what they needed to do to bring about the lower [relative to Labour plans] final debt to GDP ratio, private sector spending did not need to adjust further on account of these plans being followed through.
Actually, in the language of these rules, one might argue that fiscal policy loosened relative to the first post-2010-election plans, as the time over which the deficit was to be closed was lengthened. [A rules-based echo of the ‘ever smaller fiscal shocks’ hypothesis that Osborne puts in the mouth of the ‘fiscalists’]. This actually works in favour of what Osborne called the ‘fiscalist’ position. On account of this loosening (relaxation of the pace of structural deficit elimination) one might expect some stimulus to private spending: belts did not need to be as tight as consumers and firms had chosen to fasten them. So consumers could treat themselves.
The key point here is that changes in the structural deficit may be anticipated to some extent, since they are pre-announced and part of an overall design [=’rule’] so these changes don’t measure fiscal impulses or shocks whose effect we then go looking for in private sector spending.
The argument above has been drastically simplified [believe it or not] to make a point.
For instance, you might wonder at the notion that we should assume that the private sector understands government plans. [Osborne has repeatedly tried to confuse and disempower his audience, not least in this latest speech, with his claims for austerity’s supposed stimulus, or by denying that there was any change in plans]. Perhaps it took time to sink in, so each change in the structural deficit was felt like a new disruption to their own private plans. If this were the case, then the Osborne challenge is less incorrect. [But recall that Jonathan Portes answered it.]
Or, by contrast, perhaps we should think of the private sector as rational and sceptical; never in the first place believing that Osborne would have the stomach to see such plans through to the extent announced. In this case, the logic I sketched is still right, and the Osborne challenge is false. So long as the private sector’s guess at the final path for fiscal outcomes [strictly speaking fiscal intentions] doesn’t change, no further readjustments in private spending plans would be needed.
The other big simplification is that there were lots of other things going on at the time. Confidence in the UK [and around the world] was rescued by apprehending that the US fiscal stimulus was working, and that, bit by bit, the Eurozone authorities were getting to grips with their sovereign debt crisis, and that steps by the UK authorities to shore up the financial sector had worked and would hold. It is possible [indeed surely most likely] that this is the dominant reason why growth recovered in the UK. Even if the Osborne challenge to fiscalists were sound [that you can measure the extent of fiscal shocks by the profile of the structural deficit] their impact could easily be swamped by changes in demand induced by the private sector response to these global events. This final appeal to the notion of the counterfactual might seem repetitive, but it seems appropriately repetitive, since George Osborne has so frequently try to abuse it.