Before we discuss the effects of austerity in the UK we need to check if we actually have it

The last week or so has seen a lot of debate on the effects of austerity around Europe and today I intend to look at the situation concerning the UK. The driver of this debate was something of an about-face by the International Monetary Fund in its World Economic Outlook (WEO). This highlighted what is called the fiscal multiplier which matters if you are undertaken either a stimulus programme or an austerity one as it measures what can be summed up as your “bang for your buck”.

What did the IMF say?

It had a go at sneaking the data in unawares and you may note that there is no real admittal of error here,let alone a mea culpa or apology.

Research reported in previous issues of the WEO finds that fiscal multipliers have been close to 1 in a world in which many countries adjust together; the analysis here suggests that multipliers may recently have been larger than 1 (Box 1.1).

Later we got a more explicit working of the numbers.

The main finding, based on data for 28 economies, is that the multipliers used in generating growth forecasts have been systematically too low since the start of the Great Recession, by 0.4 to 1.2,

This is quite a serious oops moment to say the least!

Informal evidence suggests that the multipliers implicitly used to generate these forecasts are about 0.5. So actual multipliers may be higher, in the range of 0.9 to 1.7.

Let me put the significance of this into plainer language.

What is a multiplier?

This is used to measure the effect of a change in public-sector spending on overall output. So if we take the original reading and consider austerity the IMF was telling people that £10 billion of austerity generates some £5 billion of output loss. This was used as an argument for austerity programmes by amongst others the IMF itself. Indeed you could say that it was the basis for the bailout programmes for Greece,Ireland and Portugal. Now it is arguing that between £9 billion and £17 billion of output would be lost which is very different.

Putting it in a nutshell we have gone from support for austerity to saying that it will be a contractionary influence. Whilst there has been a wide debate on this they seem to have missed an IMF Working Paper from June which suggested it could be as high as two.


A point I have seen ignored in the debate which has followed this is that if by its own admission the IMF was so wrong previously why should we believe it now? This is reinforced by the fact that it has veered from one extreme to another which to my mind only reinforces the view that can be summed up by the football terrace chant.

You don’t know what you are doing

Regular readers will be aware that I am a long-time critic of the IMF who feels that it has been perverted from its original role of helping with balance of trade problems to fiscal problems by politicians. Yes the same group who get into fiscal problems! If we look at the Euro area programmes it is involved in we see that countries following them have seen a better balance of trade performance. Put simply the old game has its successes the new game instead has failures so it is pressing ahead with the new game against all logic. If we consider this in the case of Portugal if it had been under an IMF trade help programme there would be light at the end of the tunnel rather than more pain.

There has been some questioning of the IMF’s data and results by Chris Giles on the Financial Times and Jonathan Portes of the NIESR. I would like to add a detail to this which is to say that there is no reason I can think of why the fiscal multiplier should be stable in these times. There are a whole range of results from country to country and from one time period to another so I do not think we learn much here. However there is one thing we can learn and it takes me back to the last election. Back on May 9th 2010 I pointed out this.

The truth is that none of the parties asking for your vote today have explained how exactly they will get a grip on the deficit and none of them have shown any clear clue as to how they will tackle public spending.

In reality we have seen cuts in capital spending rather than other parts. Put another way they have cut the bit that is easy and in so doing have cut the bit which should be towards the end of the cuts not the beginning. So it fell from just under £49 billion in 2009/10 to £26 billion in 2011/12. It is conceivable that returning to the IMF’s analysis that multipliers are higher on this type of cut.

Austerity or not?

The media is full of stories about austerity in the UK but the truth is that public-sector spending is rising and not falling. For example we see this in today’s public-sector finance numbers.

For the period April to September 2012, central government accrued current expenditure was £313.6 billion, which was £6.5 billion, or 2.1 per cent, higher than in the same period of the previous year, when central government current expenditure was £307.1 billion.

We are however being taxed harder so it would be more correct to say that austerity in the UK involves higher taxes combined with an attempt to restrict the growth of public-sector spending.

How are we doing?

There is more evidence today of the unreliability of a single month’s economic data as there have been some revisions to recent data which overall improves the numbers. However the quote below illustrates that we still have an issue.

The figures excluding the Royal Mail pension transfer show that, for the year to date, public sector net borrowing has risen by 4.2 per cent, which compares to a forecasted 1.4 per cent decline for the full year.

As you can see not only is it bad enough that we are doing worse than last year but we were supposed to be doing better!

There was always going to be a problem

If we move on from fiscal multipliers and the associated debate there was always going to be a problem as I pointed out back on May 6th 2010 just before the UK General Election.

Official forecasts for growth in the UK economy are very optimistic, what will happen if these are not achieved in reality? Just to give an example of point two our official UK forecast for growth in 2011/12 is 3%

In truth it was always very unlikely that the rose-tinted forecasts of 3% per annum economic growth were going to be achieved and that was whatever economic policy we followed. So there was trouble ahead and in many ways this trouble was probably more important than the austerity versus stimulus debate.After all if you look at the public-spending figures do we have austerity or stimulus? On the other side of the ledger we do have austerity as taxes have risen, but spending?

Is stimulus the answer?

As ever we see shades of grey here. There has been some interesting evidence on a small-scale effort in London this week. An estimated £60 million was spent building a cable car in East London across the Thames from the O2 Arena to the Excel Centre for exhibitions. However a local radio station called LBC counted the commuters in the morning peak hour and according to them there were 15 compared to a capacity of 5000! It also makes me muse the promises of an Olympics Legacy.

Lower Mortgage Rates

Tesco has marched boldly onto the scene today and cut its mortgage rates including a rather eye-catching two-year fix below 2% (1.99%). I welcome this as it represents some badly needed extra competition in our mortgage market which is currently mostly populated by zombie banks. However some nuance is required as you need a 40% deposit to qualify and there is a fee of £995 which means that in practice only relatively large mortgages with substantial equity will qualify for it. So we may also being seeing more evidence of a two-tier mortgage market where some pay less but some pay more.

This may be an indirect effect of the Bank of England’s Funding for Lending Scheme. Tesco is not one of the thirteen lenders who are currently participating but it could of course join it.

Also whilst in itself this is welcome it returns us to the deeper question of whether official policy really does mostly involve trying to reinflate the housing market/bubble.


9 thoughts on “Before we discuss the effects of austerity in the UK we need to check if we actually have it

  1. The UK economy can be divided into sectors; the government sector and the non-government sector. The latter can be subdivided into the external sector and the non-government UK sector. It is useful to consider how these sectors then interact as they are not independent. (Wynne Godley fully developed these ideas). This does not seem to be an aspect that is taken into account when analysing the effect of decisions on the UK economy. Current government policy is inevitably going to increase its expenditure as the automatic stabilisers kick in as they deprive the economy of their spending and hence the demand generated from that spending.

    The government does not seem to understand the difference between being a currency issuer (which they are) and being a currency user (which the rest of us are). This difference is, to me, the key to developing a successful policy, but it never appears anywhere. Its sad that Godley’s work, which would now be so useful, has remained within the heterodox community. After all, at one time, he even worked for the Treasury.

    • Hi John and welcome to my blog.

      Thank you for the reference to Wynne Godley! It has been quite some time since I have heard his name mentioned. I can just about remember being a schoolboy and his ideas being considered new etc.

      He correctly felt that the Maastricht Treaty was flawed but let me quote from his analysis as it is intriguing.

      “It needs to be emphasised at the start that the establishment of a single currency in the EC would indeed bring to an end the sovereignty of its component nations and their power to take independent action on major issues. As Mr Tim Congdon has argued very cogently, the power to issue its own money, to make drafts on its own central bank, is the main thing which defines national independence. If a country gives up or loses this power, it acquires the status of a local authority or colony. Local authorities and regions obviously cannot devalue. But they also lose the power to finance deficits through money creation while other methods of raising finance are subject to central regulation. Nor can they change interest rates.”

      So mostly right but the ECB is not the central bank that he expected as matters such as Emergency Liquidity Assistance have come into play.

  2. Shaun, Another excellent article. It would be interesting if you could drill down more into public spending. ie. we have seen overspend on the NHS reorganisation, we have seen money wasted on private sector outsourcing such as G4S and ATOS (40% of cases overturned on appeal incurring legal costs to the state). In light of this I’m not convinced that the overall spending figures at a macro level disprove the theory we are undergoing austerity in the UK. Also what happens if we take out the Olympic money from the figures?

    Also interesting point about the 2-tier mortgage market. Could be a big part of the reason for the price differentials we are now seeing in expensive London boroughs and elsewhere!


    • Hi Steve

      Thank you. I can add a bit more to the mortgage market issue which is to move from the fairly frequently discussed land of price to the less frequently discussed land of quantity. Mortgages are readily available for the expensive London properties but we fairly regularly hear of issues about minor criteria causing fails in ordinary/smaller mortgage applications. So it is possible that there is a quantity differential too.

      • Interesting. And this further inflates the price bubble in the expensive postcodes. And if the government finally gets around to simplifying the tax code and closing off loopholes presumably we will see an exodus of wealthy property owners out of the country?!

        Its amazing how house price falls across the country dont seem to be bigger news in the mainstream press. The artificial London bubble seems to be keeping it under the radar but you really have to wonder how long the bubble will last?!

  3. The age-old distinction between a cut and a cut in the rate of growth is at play here. Once upon a time, I used to think that such ‘errors’ were deliberate. But having seen politicians (and some BBC commentators) who can’t distinguish between an annual deficit and a debt balance, I have my doubts. Perhaps all concerned could go on a course to ensure that they are talking at least some sense? One day should be enough…

    • Hi Carys

      Perhaps they could include such matters in the PPE (Politics,Philosophy and Economics) course at Oxford and cut some of this off at source!At least then the excuses would be fewer.

      For the ordinary person it must be hard to distinguish what is going on when the areas which should help them often put up a lamentable effort.

  4. You are absolutely correct to point out the IMF new game is a complete failure. I put the IMF’s actions down to conflict of interest – nationals of a country whose currency is receiving IMF assistance need to be stood down. In short, the Euro is receiving aid. France is a country using the euro and therefore French nationals can be considered to have a conflict of interest.

    Madame Lagarde should step down immediately because

    1 : The IMF strategy is such a complete failure that a new director is needed to restore confidence in the IMF.

    2 : Potential conflicts of interest

  5. Given the state of the economy we need to thank our lucky stars that government borrowing has increased at a rate more than predicted.

    A point is made about the difference between reductions and a cut in the rate of growth. A reduction in the rate of change will, unless replaced by counterbalances elsewhere in the economy, dampen economic activity.

    Are there any supporters of stimulating austerity? Of course there are.

    There is no mystery to this: a government cannot choose its deficit. There is also no mystrey about the government’s response – it will further erode automatic stabilisers.

    Even though commentators are lamenting the lack of what they consider austerity the loss of jobs in the public sector has still been astronomically more than predicted by the so-called Office of Budget Responsibility. I hope that overshooting their borrowing forecasts and their forecasts on job losses “necessitaed” by austerity will bring it to reflect upon the efficacy of their economic models. But I will not hold my breath.

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