According to the National Institute for Economic and Social Research (Niesr), fiscal consolidation in the UK is likely to increase the UK’s debt burden. Or to put it in layman’s terms there will be ‘pain, but no gain’
They model the impact of fiscal consolidation in both ‘normal’ times (scenario 1) and in the current economic climate (scenario 2). This second scenario models the impact of fiscal cuts during the economic situation we currently have. (liquidity trap, debt burden, low confidence, low bank lending, Europe wide recession
Fiscal consolidation means government spending cuts and or tax increases. It is the attempt to reduce a budget deficit. It could also be termed deflationary fiscal policy.
Impact of Fiscal Consolidation on Debt Levels
The think tank, NIESR, states that Britain’s debt to (GDP) ratio will be 4.85 percentage points higher by 2013 because of the spending cuts and tax rises introduced by the Coalition government.
They have also modelled the impact of European wide austerity measures, and come to the similar conclusion.
Why Is Austerity Raising the Debt Burden Under Current Economic Situations?
- In the current climate, there is no effective loosening of monetary policy to help boost aggregate demand (AD). In normal circumstances, fiscal consolidation could be accompanied by lower interest rates which boost private sector demand.
- Private sector is not being crowded in. In normal circumstances (when the economy is close to full employment) a cut in government spending and or taxes, usually leads to a rise in private sector investment and spending. However, because the private sector have low confidence and are still concentrating on reducing their debt overhang, the private sectors hasn’t taken up the slack from the government.
- Large negative multiplier effect of spending cuts.
- European wide austerity. The fact most European economies are pursuing austerity and experiencing lower economic growth means that it is hard to increase exports. In normal circumstances, fiscal consolidation has often been offset by increasing external demand. But, the European wide recession is also hitting export demand.
The most tragic case is Greece. Despite repeated attempts to reduce government spending, and fiscal consolidation of 10pc of GDP, the country’s debt burden will still increase by 32.4 percentage points, to almost 190pc of GDP next year, from 165.3pc in 2011.
The author’s conclusion makes stark reading.
The direct implication is that the policies pursued by EU countries over the recent past have had perverse and damaging effects. Our simulations suggest that coordinated fiscal consolidation has not only had substantially larger negative impacts on growth than expected, but has actually had the effect of raising rather than lowering debt-GDP ratios, precisely as some critics have argued. Not only would growth have been higher if such policies had not been pursued, but debt-GDP ratios would have been lower.
1. The paper “Self Defeating Austerity” by Jonathan Portes and Dawn Holland is published in the National Institute Economic Review, no. 221, October 2012. full pdf at NIESR
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