Monday, May 18, 2015
Austerity myths revisited
Posted by David Smith at 01:00 PM
Category: Thoughts and responses

My piece on Friday, The Myth of Abandoned Austerity, has attracted quite a lot of interest. It had a simple aim - to demonstrate that fiscal consolidation, deficit reduction, continued throughout the parliament, alongside recovery.

Simon Wren-Lewis, a professor of economics at Oxford, devoted a blog post to it, here.

Jonathan Portes, director of the National Institute of Economic and Social Research, was typically condescending, tweeting that I was "confused (& confusing)". I find it best to ignore him.

Let me respond to Simon. He wonders whether I was having a go at him with my piece. To that the answer is no. I think we used to talk many years ago about the exchange rate but I have not been a close follower of his recent work.

But Simon answers the question himself: “I know this cannot be the case because I have never said that austerity was abandoned in 2012. In fact I cannot think of anyone who did.”

That means, he suggests, that I am guilty of creating a straw man. Is it a straw man, to say that some people claim the coalition abandoned austerity halfway through the last parliament? I don’t think so. I hear it a lot but let me offer one or two examples.

The Guardian for example, in its pre-election leader on the economy, on April 17, was clear:
“By 2012, with his own backbenchers in revolt, Mr Osborne abandoned austerity; from then on, aided by a steadier world economy, the UK has enjoyed moderate growth.”

This is not quite the same, of course, as economists that Simon might know saying austerity has been abandoned. So how about Paul Krugman?

As Krugman put it in his long piece, again in The Guardian, last month:
‘A return to growth after austerity has been put on hold is not at all surprising. As I pointed out recently: “If this counts as a policy success, why not try repeatedly hitting yourself in the face for a few minutes? After all, it will feel great when you stop.”

There was also this, from Krugman, in June last year:
“As Simon Wren-Lewis has pointed out repeatedly, the Cameron government essentially stopped tightening fiscal policy before the upturn.”

That prompted me to look at what Simon has been saying, for example this piece, from 2013:
“Plan A was in fact put on hold, and the recovery we have had has followed a suspension of austerity.”

In 2014, he bemoaned the fact that the Left had missed a trick by not capitalising on Osborne’s “U-turn”:
“They could say the recovery only took place once austerity was (temporarily) abandoned.”

I am not sure when the suspension or (temporary) abandonment of austerity Simon refers to is supposed to have come to an end. One thing is clear, this was no straw man.

Simon then produces a chart from the Office for Budget Responsibility’s October 2014 Forecast Evaluation Report. The report is produced by the OBR to assess the sources of the errors in its forecasts. The chart, unsurprisingly, shows that the effects of fiscal consolidation on growth diminish and then turn positive as the pace of consolidation eases. That is a matter of simple arithmetic and was always intended to be the case.

There is, it is true, slightly less consolidation in the period 2012-13 to 2014-15 than was intended in June 2010, not least because there was more in 2011-12. But the consolidation over these three years remains significant, averaging 1.1% of GDP a year according to the latest IFS estimates, and the OBR is clear that this not a significant factor in the economy's improved performance since 2013, just as it emphasies the role of external factors - the euro crisis and high commodity prices - in reducing growth in 2011 and, in particular, 2012.

As it puts it:
"Looking at our June 2010 forecast errors over time, the biggest difference between 2013 and earlier years was the lack of an external shock to knock the economy off track. In 2011, high commodity prices ate into disposable incomes and the euro area crisis damaged credit and confidence. In 2012, the euro area crisis intensified again.

"In 2013, credit conditions eased and confidence rebounded as the European Central Bank reduced tail risks in the euro area and the Bank of England’s Funding for Lending Scheme reduced bank funding costs in the UK. The effect of these changes can be seen most clearly in household spending, which picked up in absolute terms and relative to incomes. Consumer confidence rebounded, accompanied by a drop in the saving ratio. Our March 2013 forecast was produced just as confidence was turning and we underestimated the extent to which confidence and spending would subsequently pick up.

"An easing in the pace of fiscal consolidation – and the lagged effects of prior years’ consolidation – also reduced the drag on growth from fiscal policy in 2013-14. But that looks to have been of secondary importance relative to confidence and credit channels."

The latest IFS estimates bring out this point more clearly. The fiscal consolidation in 2013-14, the year of the positive growth surprise, is put at 1.5% of GDP, more than was envisaged in June 2010.

The chart below from the OBR's Forecast Evaluation Report is one I would draw attention to. It shows that, while the path is a little different to that originally envisaged in June 2010, the original consolidation target is met this year.


Labels such as Plan A and Plan B are silly. But the government has stuck pretty much to its consolidation plan. The deficit has, of course, overshot, as we have all written on many occasions. The reasons for that, as the OBR has also pointed out, are that the government chose not to introduce additional tightening in response to upward revisions in the size of the structural deficit in 2012-13, and the many other reasons it lists in the forecast evaluation document, mainly undershoots on the revenue side.

Finally, there is a lot on Simon's website about "mediamacro". I think there is an interesting public debate to be had here, perhaps even in Oxford. In the meantime I'll offer some responses, as time permits, in the coming weeks here.