The Green Budget analysisjust released by the IFS contains a lot of material. (For a very reasonable summary, see this from the FT.) One point that a number of papers have picked up is, to quote the Independent, that the UK “Coalition’s fiscal plans for the next Parliament imply the largest dose of austerity anywhere in the developed world”. Actually the analysis appears to come from the IMF’s World Economic Outlook forecast. Here is a chart of the IMF's estimated and forecast structural budget deficits for a number of countries as a proportion of potential GDP.
The extent of additional consolidation planned for the UK beyond 2015 is clear. It is important to note that structural balance (zero on this chart) is not in any sense a neutral position. It means that debt to GDP will be falling as long as GDP is growing. That is what Germany is currently doing, and France is aiming for, while both the US and Japan are only going for a roughly stable debt to GDP ratio.
As I have emphasised many times, the critical issue is not whether it is desirable to gradually reduce net government debt as a percentage of GDP (I think it is), but when you try to do this. Theory and evidence clearly tell you not to try during a liquidity trap, when interest rates are stuck at their Zero Lower Bound. This will waste a great deal of resources, and cause unnecessary hardship. In my recent VoxEU piece, I argued that real GDP in 2014 could have been up to 4% higher in the US, UK and Eurozone if government consumption and investment had followed a fairly neutral trajectory, rather than being cut back substantially.
That result did not come from assuming some outrageous multiplier, but largely reflects the extent of austerity already undertaken. Compared to that neutral path, government consumption and investment were between 10% and 15% lower by 2014 in those countries or country blocs.
One explanation for the extent of austerity is that it represents political opportunism by those who seek a smaller state. Now I know that some do not like to entertain such thoughts: they think to suggest such things indicates a lack of political balance. However as I discussed here, there seem to be compelling reasons to at least explore that possibility. If we do, then the size of these cuts in spending are important, because they clearly show that - for the moment at least - opportunism has been remarkably successful in its own terms. By this measure the size of the state has been substantially reduced by making deficit reduction the number one macroeconomic priority.
This is in turn important because it influences the lessons to draw from this experience. To a macroeconomist, losing up to 4% of GDP a year is a huge cost. Such a cost might be excusable if it had been required to get inflation down from some high level, but instead it has lead to inflation well below target. The obvious question to ask therefore is how to avoid such costs happening again. If the basic cause has been political opportunism, and that opportunism has been successful in its objectives, then it seems highly likely that it might happen again the next time we have a major global recession. If that is the case then macroeconomists need to rethink how policy is made after major recessions. In the meantime, if political opportunism is what is driving policy, we will see in countries like the UK how far that opportunism can be pushed.
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