Why George Osborne’s fiscal policy has helped to deliver weak growth
Why is the UK flirting with a double dip recession, while the US economy seems to be picking up speed? Adam Posen (right), an external member of the Bank of England’s interest-rate setting and money-printing Monetary Policy Committee, gave his own answer to this question in a speech to the National Institute of Economic and Social Research this week.
Posen points out that the major difference between the two recoveries has been consumer spending.
It has certainly held up better in the US as this chart from Posen shows:
And this chart shows that consumption has been an important factor in the US recovery:
Private consumption, the orange chunk, has clearly driven the US economy, while it has been weak here in Britain.
So why did Americans spend more that Brits? The Office for Budget Responsibility has argued that consumption disappointed here because of higher than expected inflation.
Posen agrees with this and accepts high global energy prices, given rocket boosters by the pound’s depreciation, as one of the explanations of why Brits didn’t consume like Americans:
“The fact that British real incomes were hit harder than American households’ incomes by energy price increases could be ascribed in large part to the past depreciation of Sterling, which also hit real incomes directly.”
Yet he also thinks UK fiscal policy should take some of the blame:
“Cumulatively, the UK government tightened fiscal policy by 3 per cent more than the US government did – taking local governments and automatic stabilizers into account – and this had a material impact on consumption. This was particularly the case because a large chunk of the fiscal consolidation in 2010 and in 2011 took the form of a VAT increase, which has a high multiplier for households*.”
Adam Posen does not seek to pass judgement on the Government’s fiscal policy. As he puts it:
“I do not offer a normative evaluation of the merits of the current or prior government’s fiscal policies. It is elected officials, and not technocrats like central bankers, who should make the political decisions about tradeoffs between long- and short-term concerns, as well as about the risks to credibility.”
“I do need to be as objective as possible about the past impact of fiscal policies in order to make my forecasts and to set monetary policy. It is in that pursuit that I offer these assessments.”
And that assessment speaks very clearly. If Posen is right, one of the reasons our economic recovery has been weaker than in the US is that the Chancellor slammed on the fiscal brakes too soon.
*Incidentally, Posen estimates that the fiscal multiplier of a VAT move is around 1, meaning that raising or lowering the tax raises or lowers GDP by a similar amount. The OBR believes (see page 95) that the multiplier is only 0.35, so raising or cutting VAT by 1 will have a much lesser impact on output.
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