Osborne, UK Debt and Credit Ratings

I was going to write a lengthy post on George Osborne, UK debt  and Britain’s credit rating downgrade, but fortunately Simon Wren Lewis said pretty much everything I wanted to say: What George Osborne did with his austerity programme was the equivalent of putting a sick patient on a starvation diet accompanied by cold showers. …

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Panic Driven Austerity

One of the striking feature of the Eurozone crisis was how countries with relatively low levels of government debt, rushed into severe austerity. And as a consequence of this austerity saw a drop in the rate of economic growth, and an increase in their debt to GDP ratio. One of the main reasons for the …

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Economics and Positive Thinking

If you read any number of self-improvement books, you will come across ideas such as ‘what you think, you will become’. Over, 2,500 years ago, the Buddha said: “All that we are is the result of what we have thought. The mind is everything. What we think we become.

When overused these positive thinking mantras can become a bit tiresome. But, maybe there is still some relevance to modern macroeconomics.  Not least, we have the phrase of ‘talking ourselves into a recession’. The idea that if key people in the economy keep talking about a recession, this can become a self-fulfilling prophecy. With a threat of recession, people spend less, firms invest less and this creates falling aggregate demand. Cynics may say, people wouldn’t talk about a recession unless there was some economic justification so it will be hard to attribute it all to merely negative talk. Nevertheless, it does show the potential of strong opinions having a significant bearing on the outcome.

If you wish for Austerity, you tend to Get it

The next thing that springs to mind is the recent attitude to the economy and debt. We could characterise the EU and UK’s attitude as ‘austerian’. Generally austerians take a very pessimistic view towards the economy. They are deeply worried about levels of debt and government borrowing. They fear bond markets will very soon penalise these high levels of debt. Austerians spend a lot of time telling the electorate how the economy is in a bad shape and we need to respond with strict spending cuts and tax increases. There is also a sense of morality attached to this austerity approach. ‘Debt got us into this mess, we can’t use debt to get out of it.’

The consequence of austerity measures has generally been higher unemployment and lower economic growth. In the Eurozone, austerity policies have generally failed to reduce debt to GDP ratios because of the recession. Therefore, with budget deficits failing to fall, austerians take this as evidence to cut spending more deeply. Again it is accompanied by a sense of morality. “We almost deserve a period of austerity in response to the previous lending boom of the mid 2000s.” ‘We can’t spend money, we don’t have’. Those of an Austerian nature have an instinctive dislike to the idea of printing money  – even though all evidence of the past five years is that increasing the monetary base has not caused any significant inflation. Perhaps it’s related to the idea ‘we don’t deserve to create money from nothing, but we do deserve a recession.’

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The wasted years of the UK Economy 2008-12

By any standards, 2012 has been a dismal year for the UK economy. Despite a temporary Olympic bounce, GDP remains below 2008 levels, and the Bank of England is as pessimistic as it’s ever been. Unemployment might be lower than other European economies, but with 1 million underemployed – official statistics perhaps mask the wasted resources in the economy.

A woeful recovery. Worst than the Great Depression of the 1930s.

GDP is 3.1% below where it was when the recession began 18 quarters ago in early 2008.

The Chancellor has a lot of bad news to contend with.

  • He will miss his deficit reduction plans.
  • His forecasts for economic recovery proved overly optimistic. Instead Britain has entered into the first double dip recession since the 1970s. It is quite possible, we might see first triple dip recession in 2013.

In his defence, you might point to the Eurocrisis and say it is inevitable the UK economy was harmed by the slowdown across the channel.. But, despite the recession in the Eurozone (which have problems relating to single currency), it is hard to avoid the fact that two and half years into the job, he has to take responsibility for the direction of the economy.

Essentially, Osborne started the job with great fanfare about reducing the deficit. Deficit reduction was sold as the most important objective – the implication was that without immediate cuts, the UK could end up like Greece or Italy.

But, unfortunately, the experience of the past two and half years is that fiscal consolidation during a recession tends to be counter-productive (austerity will increase deficit). Freezing public sector spending, whilst the private sector is still very fragile, has led to a large negative multiplier effect. It is hard to avoid the conclusion that the double dip recession is largely the fault of economic policy.

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Triple-dip Recession Could Lead to Lower Credit Rating

Recently, a report suggested austerity can increase debt levels. Now, there is an indication that austerity could cause a decline in credit ratings. This has certainly been the experience of many European countries – who since they introduced austerity measures – have seen a reduction in their credit rating. Austerity hawks have often sold immediate …

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Could US Make Same Mistakes as Europe?

In 2009, US and EU unemployment rates both stood at 10% – but since then EU unemployment has increased to 12% and US unemployment fallen to 7.9%. (see: US v EU unemployment)

These contrasting fortunes in unemployment are a reflection of diverging rates of economic growth. Whilst, Europe has entered a double dip recession, the US has experienced a sustained economic recovery. It is also a reflection of different economic policy – the EU has become obsessed with reducing budget deficits, the US has given more focus to promoting economic recovery.


However, in the face of concerns over levels of US government borrowing and impending debt ceilings, many in the US are pushing for a rapid fiscal consolidation.

But is US austerity necessary? and what will be the impact of austerity on a) the budget deficit and b) economic growth c) long-term structural spending and debt commitments?

Is Austerity Necessary in US?

total us debt

Total Federal Debt increased to 101% of GDP in Q2 2012. It is a sharp increase since 2008, when debt was just over 60% of GDP. But, this is to be expected in a recession as deep as past recession.

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Why Did Europe Expect Fiscal Consolidation to Work?

Readers Question. Can you explain why the Government and Economic Commentators  are talking about a multiplier (in relation to budget cuts) of between 0.5 and 1, whereas I always thought that the GDP multiplier was bigger than this.

Just to summarise a multiplier of 0.5 would mean fiscal consolidation (spending cuts) of £1bn, would lead to a drop in GDP of only £0.5bn. In other words, they hoped fiscal consolidation would be successful and only have a limited impact on reducing economic growth rates.

However, evidence from the IMF and other studies have shown the fiscal multiplier has proved much higher. In fact a multiplier of up to 2. (for every spending cut of £1bn, we have seen GDP fall £2bn. See: Fiscal multiplier and European austerity).

Essentially, this shows the limitations of using economic models which are applied during very different economic circumstances. If you look at previous attempts at fiscal consolidation undertaken during strong economic growth (e.g. Canada in 1990s), a multiplier of 0.5 would be quite reasonable.

However, there was an unwillingness to admit that the economic situation in the aftermath of a financial crisis and liquidity trap was very different.


Why might the Government and European Commentators expect  a multiplier of 0.5?

To some extent, I answered this yesterday on the post – why austerity will increase the budget deficit. But, just to recap, the may have hoped for a multiplier of 0.5 because:

1. Expansionary monetary policy. With spending cuts, usually a Central Bank can cut interest rates and loosen monetary policy so that there is a boost to demand to offset the impact of tax increases and spending cuts.

  • But, the EU and UK government should have realised that interest rates were already at record lows in 2010. Quantitative easing has done little to boost spending in the UK. In Europe, the ECB has never showed any real sign of loosening monetary policy in response to fiscal consolidation. In fact in 2011, the ECB increased interest rates over misplaced fears on inflation.

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Austerity will Increase UK’s debt burden

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 …

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