The Thoughtful Gavyn Davies Says That the Austerity Policies of the British Conservative Government Are the Destructive Policies of Incompetent Fools
Observers of the U.S. take note: Ryan-Romney wants to replicate the spending cuts of Cameron-Clegg-Osborne, and to reinforce austerity with an end to QE ∞.
High fiscal multipliers undermine austerity programmes: [A] 3-page article in the IMF’s latest World Economic Outlook promises to have a greater effect on global economic policy than all of the interminable meetings held at the Annual Meetings of the IMF and the World Bank in Tokyo a week ago…. IMF Chief Economist Olivier Blanchard and Daniel Leigh, presented evidence that the fiscal multiplier in the advanced economies is considerably larger than had been assumed [by Cameron-Clegg-Osborne] when fiscal austerity plans were set in train in most economies in 2010…. [A]usterity is much more damging to output in the near term than was anticipated…. [T]hey suggest that the multiplier under current circumstances might be as large as 0.9-1.7, compared to the initial assumption of 0.5…. If the multiplier is 0.5, then an initial public expenditure reduction of 1 per cent of GDP reduces… taxation or increase public transfers by about 0.2 per cent of GDP, leaving the budget deficit improving by 0.8 per cent of GDP…. If, however, the multiplier is 1.7… [t]he net overall improvement in the budget deficit would therefore be only 0.32 per cent. The economy would be in recession, and the budget deficit would hardly improve at all. Even if this were acceptable to governments, it would not be acceptable for very long to their electorates. This pessimistic arithmetic is not that far away from describing what has actually happened in some countries, like the UK….
Much therefore hinges on whether Blanchard and Leigh are right. Their methodology is certainly not watertight. Cross-sectional country studies are notoriously unreliable. As demonstrated by Chris Giles in the FT, if we exclude Greece and Germany from the 28 countries in their study, then their result largely melts away…
This is, I think, simply wrong: The result does not melt away but rather remains just as strong: the estimated slope remains the same. What does change is statistical confidence in the result. Germany and Greece carry information that Blanchard and Leigh are correct. Remove them from the sample, and the computer tells you--as it should--that it is less confident.
Davies then says some things that are right:
Having said that about this particular study, there are other, stronger, reasons for believing that fiscal multipliers are higher than many governments have been assuming…. If the central bank is assumed to hold monetary growth or inflation at a given target rate when fiscal policy is tightened, then… the multiplier will be lower. The opposite is also true. Now that interest rates are stuck at the zero lower bound, central banks cannot reduce policy rates when fiscal policy is tightened, and the multiplier is correspondingly increased. Kudos to the Keynesians for predicting this in advance, but in many ways this is a fairly standard result from dozens of econometric simulations and it should not really have come as a total surprise to policy makers….
It does not seem plausible is that the multiplier, in the current recession, is as low as governments assumed when they embarked on their austerity programmes in 2010. And that will make austerity much harder to sustain.