As the Global Financial Crisis (GFC) and consequent recession were in progress, the Labour government looked at how fiscal stimulus could be used to moderate its impact. This would increase the budget deficit that was already rising as a result of the recession, but they knew that cutting interest rates alone would be insufficient to deal with this crisis, and that you do not worry about the deficit in a recession. That is Econ 101, i.e. basic macroeconomics, and it is 100% correct.
Here Osborne and his advisors saw a political opportunity. Before the recession, fiscal policy had been all about meeting the government’s fiscal rules about debt and deficits, because monetary policy looked after smoothing the business cycle. There had been much discussion about the extent to which Gordon Brown had been fiddling these rules. Osborne could therefore make political capital over the rising deficit, particularly if he could suggest the deficit represented fiscal profligacy rather than the result of the recession.
But what about Econ 101? The advice he was given (I suspect) was reflected in a speech he gave in 2009. This gave a short account of the history of macroeconomic thought, and described how the New Keynesian model underpinned his macroeconomic policy. It said that in today’s world the consensus is that monetary policy not fiscal policy dealt with moderating booms and recessions. Yet it failed to mention that this idea no longer worked when nominal interest rates hit their lower bond. And that unconventional monetary policy was powerless in the New Keynesian model. The speech was given a month after interest rates hit their lower bound.
The speech also said nothing about expansionary austerity, or the need to appease the markets. That would all come later. This also suggests that Osborne's focus on the deficit was a simple but devastating macroeconomic error, a result of just not doing your homework. It was an incredible error to make, as the fact that interest rates had hit their lower bound was all over the financial press. If the media had been in touch with academic economics they would have pounced on this black hole in the speech. (Maybe this is complete coincidence, but his main economic advisor had previously worked at the IFS, where as I have said elsewhere they do not do macro. )
As an economic choice his policy was crucially out of date, but as a political choice it was almost brilliant. The line he pushed on the deficit came to dominate the media narrative, which I was later to describe as media macro. It did not win the 2010 election outright, but it went on to win the 2015 election. I say almost brilliant, because it has proved the undoing of his successor. The economic damage done by cutting government spending at the one and only time monetary policy could not offset its impact was immense. I think it is no exaggeration to call it the most damaging UK macroeconomic policy mistake in my lifetime as an economist.
It was damaging in part because politics drove two additional features of his policy after he became chancellor in 2010. First, the austerity policy would have had less economic impact if most measures had been delayed until later into the 5 year term of the coalition government. But that would have meant deep cuts before the next election, and Osborne could see that would do political damage. Second, although the fiscal rule did not require it, public investment was cut back sharply in the first few years, because investment is often easiest to cut. As I say in that 2015 post, those cuts in public investment alone could have reduced GDP by 3%.
By 2010 you need to introduce other actors who played a part in these mistakes. The Treasury did what the Treasury unfortunately often does, and put public spending control above the macroeconomic health of the country. The Governor of the Bank of England pretended that losing his main instrument didn’t matter, even though I’m told the MPC had almost no idea what impact unconventional monetary policy would have. If either institution had acted better perhaps the damage done by the austerity policy could have been moderated, but we will never know.
But the main damage was done when the Conservatives were still in opposition. Did the policy of opposing fiscal stimulus start off as a policy to reduce the size of the state under cover of deficit reduction: what I call deficit deceit? Or was it just something to beat Labour with: the first in what proved to be a long line of bad economic judgements simply designed to wrongfoot his opponents. Without the actors involved telling us, I think it is impossible for us to tell. However there are two things I think we can clearly say.
First, if it started as ignorance rather than deceit, it turned into the latter as Osborne prepared to repeat the policy all over again before the 2015 election, while at the same time cutting taxes. Second, if it started as ignorance it is far too kind to call it a mistake. It is similar to someone who has never learnt to drive taking a car onto the highway and causing mayhem. It reflects a cavalier attitude to economic expertise that has, I have argued, its roots back in the early days of Thatcherism.
 This advice served him well in other respects, such as establishing the form of his fiscal rule (which would help limit the impact of austerity after 2011) and creating the OBR.