Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 11 October 2017

The impact of austerity in the UK

When they do their forecast evaluation report, the OBR also look at the impact of fiscal policy on GDP. Here is the relevant chart from their report published yesterday.




There is a useful innovation compared to previous years, which comes close to an something I suggested a few months ago. The orange bar shows the impact of fiscal measures implemented in that year. The total effect of fiscal policy is this plus the impact of previous fiscal policy actions unwinding.

Suppose for example that fiscal policy reduced GDP by 1% in year 1, but its impact on the level of GDP was expected to decay by half in year 2. If no fiscal policy was enacted in year 2, then fiscal policy in year 1 would increase growth in year 2 by 0.5%. Why might the impact of fiscal policy on the level of GDP decay over time? The obvious explanation is that monetary policy ensures that it does by stabilising the level of GDP. This assumption is problematic when interest rates are stuck at their lower bound, which is why it is useful to publish the within year estimates as well as the total estimates,

You can see when this matters from 2012 onwards. We have a run of years where the total impact of austerity on growth is zero or positive, but only because of the unwinding of previous austerity. If monetary policy, or anything else, had not been able to offset earlier fiscal tightening, then instead the impact of austerity would be to reduce growth in all those years. In that (extreme) case the level of GDP in 2016/17 would be over 4% below what it would otherwise have been without any fiscal tightening from 2010/11.

As the OBR’s assessment of fiscal impact is in their publication on forecast errors, they naturally talk about whether there is any relationship between the two. This year they included this chart.



It is important to understand what we are looking at here. It is not whether there is a correlation between fiscal consolidation and GDP. As we have seen the OBR assumes there is, and indeed their calculations were the source of my estimate that the average household had by 2013 lost a total of £4,000 worth of resources as a result of austerity. The foolishness of austerity in 2010 was not that the OBR underestimated its impact, but that it left us vulnerable to negative shocks because interest rates were at their lower bound. The shock that hit in 2012 was the Euro crisis and the impact of austerity there.

What the chart above might tell us is whether the OBR have in fact underestimated the impact of austerity i.e the numbers in Chart E are too small. Each year there are hundreds of potential reasons for forecast errors, of which underestimating the impact of austerity is just one. So the best we can expect, if the OBR are underestimating the impact of fiscal policy, is a negative relationship going through zero between the two variables in Chart D but with lots of random variation on top. That is what we see in Chart D.


5 comments:

  1. London generates almost a third of UK's tax revenue, so the loss of banking jobs due to a hard Brexit would jeopardize the ability of the DWP to meet its Social Security obligations.

    Disclosure: Since 2012, I've been reporting voluntarily to the UN on the welfare crisis impacting Britain's sick and disabled.

    Montreal, Canada

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  2. The charts seem to confirm what we knew already: that Osborne did not practice what he preached. While consistently preaching austerity, in fact his fiscal policy as implemented was mixed.
    Do the OBR numbers, or other analyses, factor in the impact of the government's austerity rhetoric? Few business managers and consumers study the details of fiscal policy, relying, one presumes, on the soundbites and rhetoric in MSM reporting.
    Is it possible to differentiate the extent to which businesses and individuals made economic decisions influenced by austerity rhetoric, rather than the actual fiscal policy implemented?

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    Replies
    1. This was written in March 2913

      “Even Britain has now abandoned austerity
      And while Osborne will never publicly admit this, the big surprise of his budget is its implicit acceptance of this Keynesian view.
      Instead of trying to reduce borrowing any further or aiming for a balanced budget, as it originally promised, the British government has now accepted that deficits will keep rising in absolute terms and will still be worth 6% of GDP by the next election in 2015.”
      http://blogs.reuters.com/anatole-kaletsky/2013/03/21/even-britain-has-now-abandoned-austerity/

      Delete
  3. Also, Osborne had a little luck?

    "One economist, Alan Clarke at Scotiabank, says the compensation payments have been more successful at stimulating the U.K. economy than quantitative easing. U.K. lenders have already paid £11.5 billion ($18.7 billion) to millions of customers, and have set aside another £7.3 billion for future payments.
    But the payments are not just creating one-off windfalls: the PPI industry is also creating much-needed employment.
    As we report over on WSJ.com, claims have been coming in at such a clip that it’s created tens of thousands of new jobs to handle them.”
    {the PPI payments are being used as a down payment for new cars?}.
    http://blogs.wsj.com/moneybeat/2013/10/04/how-a-banking-scandal-is-bolstering-britains-economy/

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  4. what are the assumptions around "multipliers" that are quoted?
    are they "good" assumptions?

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