Progressives are often their own worst enemies. Recently they’ve complained that the Cameron’s program of fiscal austerity (which is rather mild so far) has caused the British recovery to stall. They point to flat RGDP in the past two quarters. But this observation doesn’t support the Keynesian model; indeed it actually buttresses the real business cycle model of people like Casey Mulligan and Lee Ohanian.
The debate over fiscal austerity involves two separate issues; does austerity reduce AD, and does slower growth in AD reduce real GDP. In order to see whether fiscal austerity is reducing AD, you need to look at NGDP growth, not RGDP growth. And the data shows that the British are spending more, it’s just that the growth is showing up in the form of higher prices, not higher output. Just as the RBC-types would predict.
In fairness to the other side, the first quarter numbers were distorted by higher VAT rates. If wages are sticky, higher VAT rates look like an adverse supply shock in the simple AS/AD model. But even so, the Bank of England did provide enough monetary accommodation for 9% (annualized) spending growth. And this leads to the bigger problem with the Keynesian argument; in a world of inflation targeting, fiscal stimulus/austerity has no impact on NGDP. The BOE is currently under enormous pressure to stop inflation from rising any higher. The BOE governors are not particularly hawkish, and some are said to focus on nominal income trends. But due to political constraints they can only do so much. A recent article in The Economist points out that right now the BOE essentially offsets any fiscal actions:
He did not mention that a run of bad inflation figures (up to 4.4% in February) has made a fiscal U-turn trickier. Anxiety about the impact this year’s fiscal tightening will have on the economy is one factor that has so far deterred the Bank of England from raising interest rates. Three of the nine-strong monetary-policy committee voted for an increase this month. Any easing in the fiscal squeeze could easily tip the balance towards a rise.
So then what’s holding back British growth, if not the fiscal austerity? Very simple, it’s the 4.4% inflation. If you are a real business cycle proponent you’d say that shows stimulus doesn’t work. If you are a Keynesian, you’d say the inflation reflects special factors like oil and VAT, and that more AD would boost growth. I’m sort of half way in between for the UK, (and 70-30 demand-side for the US.) But even if you take a 100% Keynesian position, it doesn’t help the case for fiscal stimulus. The 4.4% inflation has led the BOE to essentially say; “this much NGDP growth and no more.” They are at the limit of what they will allow, for both NGDP and inflation. Just as in the US, the central bank steers the nominal economy. And nothing Cameron does to fiscal policy will change that fact.
I should add that things in the UK may not be quite as bleak as the RGDP numbers suggest. The employment figures have been much more positive:
ONE of the few bright spots in the general gloom around the British economy has been the jobs figures. Today’s data seem like more of the same, at least at first glance. Unemployment fell by 88,000 in the three months to April, the biggest quarterly drop for more than a decade. The jobless rate slipped to 7.7%, which seems almost tolerable given the rates in other debt-ridden, housing-bust economies such as Spain (20.7%), Ireland (14.7%) and America (9.1%). And enough private-sector jobs (105,000) were created in the first quarter to more than make up for government layoffs (24,000).
But they also note that recent unemployment claims data suggests a slowdown in employment growth, so I’d expect the numbers to weaken in future months.
This post was partly a reaction to a Matt Yglesias post, which blamed the UK slowdown on fiscal austerity. Yglesias made an important error in his argument:
The key policy failure, however, is this fantastical belief in the power of exports:
. . .
Trade just isn’t important enough to a medium sized rich country for this to work. In 2010, exports were only about 5 percent of the UK’s GDP.
The World Bank claims UK exports are actually about 28% of GDP.