Daily commentary: On Austerity and Britain’s double dip

Last January I called the contrast between the US and the UK "the best real-time economic experiment we can have on what does and doesn’t happen as a result of government spending." My point was that the two economies have had similar trajectories and have similar economic models. Watching how Britain using austerity compares with the US using more stimulus would be instructive.

I have said this many times. But a cut in the public sector when the private sector is indebted and needs to net save will produce a similar cut in the private sector. There’s nothing wrong with that to the degree debts are too high, but this fact needs to be recognised. The fact is austerity does not promote growth. It’s one thing to say you are uncomfortable about high levels of government deficit spending and recommend fiscal consolidation despite negative near-term impacts. But, you can’t invoke the confidence fairy and tell us that fiscal consolidation will lead to near-term growth. In the mind of UK Chancellor Osborne, fiscal consolidation would lead to immediate prosperity. This has turned out to be false.

The thing to watch for when using austerity is debt deflation and depression. You can have government and households both cutting back and I believe that could be healthy in many circumstances. I am not against austerity per se. However, if austerity causes a debt deflation that imperils a weak banking system, you have to be careful about unintended consequences and deadweight economic loss. And at a minimum, you have to recognise that austerity leads to recession.

That’s it. Here are the links.