What lessons can be learned from the economic recoveries now being observed in the UK and US? Is George Osborne right when he claims that the critics of austerity have now been vanquished?
First, some perspective. Along with just about every other major (and minor) economy, the US experienced a deep recession in the immediate aftermath of the financial crash. Thanks partly to fiscal and monetary stimulus, the recession, although deep, didn’t last that long. But, for a number of reasons, the recovery was weak, at least compared to previous cycles. A reasonable forecasting rule of thumb used to be that the harder the economic fall, the bigger the subsequent rebound. In the most recent cycle, this has not been the case. What should have been a vigorous bounce back has been prevented by ongoing deleveraging, everybody trying to pay back debt all at once. Feeble though it might have been, the US economy, once it began to grow again, has continued to do so. Most recently, there are some signs that growth may actually be accelerating.
The path of the UK economy paints a similar story but, until recently at least, one that shows a deeper recession and somewhat slower recovery. Unlike the US, the government tightened rather than relaxed fiscal policy, at least in the early stages of the crisis. This, I think, accounts for a large part of the difference in overall economic performance. Both countries moved to fix their respective banking systems. The US can claim to have achieved thus; the UK is still a work in progress but much has been achieved - more than many commentators thought likely.
Both countries indulged in aggressive and ultimately unconventional monetary stimulus. It is surprising that little has been made of the probability that the government debt purchased by the two central banks is unlikely to be repaid, at least on any reasonable time horizon. The debt interest that the UK government pays to the Bank of England simply flows back, ultimately, to the Treasury. Viewed in this way, one consequence of ‘quantitative easing’ is a significant reduction in the effective stock of debt of the two respective governments, something that we can only look at with envy. Critics of all of this fret about inflation but this has yet to rear its head in any material way.
In this simple narrative, similarities in policies resulted in similar macroeconomic outcomes. Where there were different outcomes, policy differences can be similarly identified.
Europe, as is painfully familiar, pursued an alternative policy mix. Aggressive fiscal austerity in many countries was accompanied by reluctant and relatively feeble monetary stimulus. One consequence of which, which has not attracted enough comment or analysis, is that the euro has been too strong. Japan lost two decades (not just one) pursuing a policy mix that led, until very recently, to an over-valued currency. Another difference between the US and the UK on the one hand and the euro area and Japan on the other is the speed which banking systems have been cleaned up.
In the UK, there is a vigorous debate over the nature of the recovery. Is it well balanced or is it a good old fashioned British housing boom? The evidence is mixed but tends to support the idea that an increased flow of cheap credit has combined with the global attractions of London property to produce something we have seen too many times before. It is too early to draw any firm conclusions but for the current mini-boom to be sustainable it has to broaden out into exports and (non residential) investment spending. But things are going so well that David Cameron is mentioning possible large income tax cuts.
The budget deal in the US, while far from perfect, is another policy step in the right direction. One fascinating and new feature of the US policy debate has been the calls from surprising quarters for quantitative easing to be supplemented - or perhaps replaced - with massive infrastructure stimulus. The thinking here is based in part on need: the US needs a lot of money to be spent on crumbling roads and bridges. This money will have to found sooner or later; it may as well be now while the government can borrow at rock bottom rates. Rather than the Federal Reserve giving money to banks that then do nothing with it, an infrastructure boom could have some real and positive economic consequences.
Meanwhile, Europe obsesses about who will pay for any future bank bailout while failing to deal with the consequences of the last banking bust.
