Austerity and Economic Hyperbole

Chris Dillow thinks that talk of policies leading to disaster is overdone, which is surely true. However he also says “I don't think the claim that austerity has depressed economic activity is a counter-example here.” I disagree.

Consider the UK first. The OBR thinks that GDP growth was 1% lower in both FY 2010/11 and FY 2011/12 as a result of austerity. There are good reasons for believing that is a conservative estimate, but let’s use those numbers for now. They also think the impact of austerity in later years was small (remember Plan A was abandoned in 2012): others would argue that the effects of earlier measures might be more long lived, but again let’s ignore that possibility. In normal times if you reduce growth by 1% the level of GDP will quite quickly recover to the path it would have followed before the shock. However that usually happens because of monetary policy, and we are not in normal times when interest rates are at their Zero Lower Bound. So the impact of these two growth shocks on the level of GDP might be quite persistent. We know that GDP only started growing again in a consistent way in 2013, so it would be reasonable to assume that austerity caused the level of GDP be 2% lower in both 2011 and 2012. If we stop there (which is another very conservative assumption), that is a cumulative loss of GDP of 5% (1%+2%+2%).

Now if 5% of GDP does not seem a lot to you, it may be because it is easy to get punch drunk with figures about economic growth. Or maybe everything seems small besides the impact of the Great Recession, although in 2009 UK GDP fell by a bit less than 5%. But 5% of resources that have been completely wasted (because the unemployed disliked their forced leisure time, and firms’ capacity was idle) is a bit less than £100 billion, which is about £1500 for every man, woman and child in the country. If £1500 does not seem much to you, that probably says something about how well off you are.

If I think about the two other major UK macroeconomic disasters in the last 45 years, Thatcher’s monetarism and ERM membership, it is much harder to suggest that sums of this magnitude were wasted. Monetarism did bring inflation down quickly. This could almost certainly have been achieved in a more cost efficient manner, but it seems unlikely that the efficiency gain would have been as high as 5% of GDP. In other words, a recession may well have been required to bring inflation down. In addition during the ERM crisis large sums were lost defending an overvalued exchange rate, but in terms of the direct losses made by the Bank of England, at least someone else got that money, and maybe some of it is being returned right now! On neither of these occasions is it clear that anything like 5% of GDP was wasted. More generally, I would find it hard to think of another Chancellor (or any other minister for that matter) who clearly wasted a similar amount.

Numbers for the Eurozone are worse still. If model simulations are to be believed, we are talking about cumulated losses of around 10% of GDP and counting. I noted the continuing large output gaps in the Eurozone here. (I'm not aware of any model simulations that look at US growth without austerity, but I am sure they must exist.)

Finally remember that these output losses are completely unnecessary. Nothing of any importance has been gained as a consequence. So as far as austerity is concerned, I think strong language hyperbole is justified.