The latest debate over UK fiscal policy is a distraction

Debate on post-crisis fiscal policy in the UK seems to have taken an odd turn, in no small part thanks to Niall Ferguson’s successful attempts to wind-up the British economics community. Ferguson’s approach to economics seems to mirror his approach to history: sample-of-one story-telling which is entertaining, controversial, and usually misleading. To his credit, he is never dull.

I am reluctant to weigh-in at this point because I am sceptical about much of what the argument is about. I don’t even trust the post-crisis GDP and inflation data, let alone attempts to “cyclically-adjust” budget deficits. I would not at all be surprised if the data for this entire period is substantially revised in the future. I would also defer to the detailed work of the OBR and others, who analyse the data without a discernible bias.[1]

My concern, however, is that we should be in little doubt about the lessons to be learnt from the post crisis global policy response.

Let’s start with austerity. The term “austerity” has lost a lot of meaning when applied to the UK (as Philip Coggan suggests). Surely, “austerity” does not simply mean one of the following: raising taxes; cutting government expenditure; a declining budget deficit; or a declining “cyclically-adjusted” budget deficit? I would define it as follows: “a large reduction in government expenditure and/or increase in taxation at a time of cyclical economic weakness”. Now, it is very clear that austerity was pursued in parts of the Eurozone after the crisis – and it is also very clear that it was self-defeating and destructive: it exacerbated the sovereign panics in Ireland, Portugal, Spain and Italy, contributing to substantially higher stocks of public sector debt and large, persistent, losses in output.

I have described fiscal policy in the UK as “pseudo-austerity”. I am not convinced that fiscal policy was macro-economically that relevant post crisis, particular relative to other forces impacting output – such as the Eurocrisis. But I do think it was a high risk policy, not least because it may have needlessly reduced output as Simon Wren-Lewis has forcefully illustrated. To this extent I strongly agree with various points made by Philip Coggan (re the relative importance of the impact of the Eurocrisis), with Simon Wren-Lewis & Chris Giles (that fiscal policy is only one factor influencing output), and with Tony Yates (who I interpret as saying that we don’t really have enough data or confidence in the various interacting forces to say that much about the effects of UK fiscal policy over this period).

All of this, is a distraction, however.

The substantive question is this: Was there a financing constraint on the UK government post-financial crisis? The evidence, I think overwhelmingly, suggests that the answer is “no”. The reason is straightforward: the Bank of England was doing QE. No one who has defended tightening fiscal policy post-crisis has explained how a government can simultaneously have financing problems and have an independent inflation-targetting central bank buying more debt than it issues. Tony? Niall? Chris?

This is extremely important because it also prevented a far more intelligent debate about the deficit, specifically over the mix of current and capital expenditure.

It is also somewhat feeble that everyone has simply accepted conventional accounting treatment of the Bank’s holdings of gilts, when at best it is debatable, at worst patently wrong. It’s not a trivial matter if it reduces net debt by 20%!

What is also very odd that the evidence for testing various fiscal hypotheses in this debate is restricted to the UK, where it is hardest to discern what was actually going on with fiscal policy. We have starker counterfactuals for all the policy permutations globally – and the messages are very clear:

  1. QE was the dominant determinant of bond market behaviour: credit risk in sovereign bonds was a uniquely Eurozone problem, pre-Draghi, pre-QE. As logic suggests, no country doing QE has faced any financing challenges regardless of its fiscal policy.
  2. Genuine austerity was a disaster: if you think UK output relative to pre-crisis trend is depressing look at Ireland, Spain, Greece, Italy and Portugal.
  3. Easing fiscal policy aggressively despite a far “worse” fiscal position than the UK had no discernible impact on market access for the government in the “QE world” (in fact the opposite – bond yields went lower). The evidence: Japan easing fiscal policy post-Fukushima.

In conclusion, a pedantic, over-personalised debate about post-crisis fiscal policy in the UK is a distraction. It fails to acknowledge important facts we should have already known, but have been forced to re-learn: responding to a financial crisis and a collapse in output with austerity risks suicide. The UK took a confused strategy of pretending. And even if UK fiscal policy was macroeconomically insignificant, cuts that mattered to individuals and segments of society were premised on a fallacy: there was no financing constraint on the UK government, and there was never a significant risk of one.

[1] For example, work from John Van Reenan at the LSE, and the Institute for Fiscal Studies. For a detailed summary from the OBR itself, this is excellent. My preference for measuring fiscal policy would be the OBR’s measures of “fiscal effort”, but I suspect there are lots of problems with it too.

About The Author

Eric Lonergan is a macro hedge fund manager, economist, and writer. His most recent book is Supercharge Me, co-authored with Corinne Sawers. He is also author of the international bestseller, Angrynomics, co-written with Mark Blyth, and published by Agenda. It was listed on the Financial Times must reads for Summer 2020. Prior to Angrynomics, he has written Money (2nd ed) published by Routledge. He has written for Foreign AffairsThe Financial Times, and The Economist. He also advises governments and policymakers. He first advocated expanding the tools of central banks to including cash transfers to households in the Financial Times in 2002. In December 2008, he advocated the policy as the most efficient way out of recession post-financial crisis, contributing to a growing debate over the need for ‘helicopter money’.

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