Timing of Austerity Measures

Readers Comment on UK National Debt – What we are doing now is not dissimilar to Roy Jenkins’ cuts in the late 60′s he brought us out of an £800m deficit into a £387m surplus, toughen up and let the economy settle.

There are several examples of where governments have been able to transform public finances through well-timed spending cuts and tax increases. However, just because something worked in the 1960s or 1980s, it doesn’t mean it is the best solution for the UK economy in the present climate.

In the 1960s, we didn’t have:

  • Unemployment of over 2.5 million
  • A liquidity trap where interest rates of 0.5% failed to encourage lending.
  • A global economic downturn
  • An asset bust with falling house prices.
  • A balance sheet recession with banks desperate to improve their balance sheets.

Since the announcement of spending cuts in 2010, the economic recovery has faltered, unemployment has continued to rise and we now face a double dip recession. This double-dip recession will lead to lower tax receipts and higher spending on benefits – making it much more difficult to reduce the deficit. This is what people mean by ‘self-defeating austerity’. You get caught in a cycle of spending cuts leading to lower growth. This lower growth leads to lower tax receipts and therefore need for more spending cuts.

The problem is people like to think that if you create economic pain you must be doing something good. But, wage cuts, job losses in the public sector and higher unemployment doesn’t help anyone. We certainly won’t solve an underlying budget deficit by depressing the economy.

The government claim spending cuts were necessary by comparing ourselves to Greece and Ireland. But, outside the Euro, we have much greater flexibility, the bond market isn’t subject to the fears of liquidity shortages you get from being in the single currency. Bond yields on UK debt have fallen since the recession because the private sector want to save – they don’t have the confidence to invest in the private sector in the current climate. Whilst the private sector want to save, whilst we are in a liquidity trap, the focus should be on economic recovery – not misplaced spending cuts which push us into another recession.

In the long term, the UK does need to tackle an underlying structural deficit. This will involve unpopular decision like raising retirement age, limiting health care and education spending. But, this budget adjustment needs to be focused on long term measures which don’t create a negative economic spiral in the short-term. Otherwise the austerity is self-defeating.

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3 thoughts on “Timing of Austerity Measures

  1. I don’t agree with the last paragraph above. It says “In the long term, the UK does need to tackle an underlying structural deficit. . . . But, this budget adjustment needs to be focused on long term measures which don’t create a negative economic spiral in the short-term.”

    A structural deficit can be defined as a deficit which is not intended to have any stimulatory effect. That is on contrast to a deficit that arises from the classic Keynsian “borrow and spend” policy: which you could call a “stimulus deficit”.

    Under a structural deficit, borrowing is simply a REPLACEMENT for tax. That is the deflationary effect of tax is replaced by the deflationary effect of borrowing. Thus any country can wipe out its structural deficit any time it chooses simply by raising taxes and cutting borrowing. The cut in borrowing is essentially a form of QE: that is money is left in lenders pockets. And they will tend to do something with that money. The stimulatory effect of that cancels out the deflationary effect of the extra tax.

    It’s actually a LITTLE more complicated than that, but basically that’s it.

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