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Light at the end of the tunnel – or an oncoming train?

Economists are famous for disagreeing – as, of course, are politicians. And there is a lot of disagreement around at the moment. George Osborne is determined to cut Britain’s large public-sector deficit, and cut it quickly. This, argues the Coalition government and many economists, is necessary to maintain the UK’s AAA sovereign credit rating. This, in turn, will allow interest rates to be kept down and the international confidence will encourage investment. In short, the cut in aggregate demand by government would be more than compensated by a rise in aggregate demand elsewhere in the economy, and especially from investment and exports. By contrast, not cutting the deficit rapidly would undermine confidence. This would make it more expensive to borrow and would discourage inward investment.

Not so, say the opposition and many other economists. A contractionary fiscal policy will achieve just that – an economic contraction. In other words, there is a real danger of a double-dip recession. Far from encouraging investment, it will do just the opposite. Consumers, fearing falling incomes and rising unemployment, will cut back on spending. Businesses, fearing a fall in sales, will cut back on investment. Economic pessimism, and hence caution, will feed on themselves.

So who are right? The first two blogs by Stephanie Flanders, the BBC’s Economics Editor, look at the arguments on both sides. The third attempts to sum up. The other articles continue the debate. For example, the link to The Economist contains several contributions from commentators on either side of the debate. See also the earlier posting on this site, The ‘paradox of cuts’.

Articles
The case for Mr Osborne’s austerity BBC News Blogs, Stephanomics, Stephanie Flanders (7/9/10)
The case against Mr Osborne’s austerity BBC News Blogs, Stephanomics, Stephanie Flanders (8/9/10)
Austerity plans: Where do you stand? BBC News Blogs, Stephanomics, Stephanie Flanders (10/9/10)
Are current deficit reduction plans likely to boost growth? The Economist debates, various invited guests
Debt and growth revisited Vox, Carmen M. Reinhart and Kenneth Rogoff (11/8/10)
Leading article: Mr Osborne should prepare a Plan B Independent (13/9/10)
Shock fall in UK retail sales adds to fears of double-dip recession Guardian, Larry Elliott (16/9/10)
Chancellor accused of £100bn economic growth gamble by Compass Guardian, Larry Elliott (18/9/10)
Double-dip recession: bulls and bears diverge over future economic prospects Guardian, Phillip Inman (16/9/10)
Speech by Mervyn King to TUC Congress TUC (15/9/10)
Barber, Blanchflower and the fake debate on double dip The Spectator, Ed Howker (14/9/10)

Confidence data
Consumer confidence Nationwide
ICAEW / Grant Thornton UK Business Confidence Monitor (BCM) ICAEW
Business and Consumer Surveys Economic and Financial Affairs, European Commission

Questions

  1. Summarise the arguments for the Coalition government’s programme of rapidly reducing the public-sector deficit.
  2. Summarise the arguments against the Coalition government’s programme of rapidly reducing the public-sector deficit.
  3. What factors are likely to determine whether there will be a double-dip recession as a result of the austerity programme?
  4. Why is it very hard to predict the effects of the austerity programme?
  5. How effective is an expansionary monetary policy likely to be in the context of a tightening fiscal policy?
  6. How important are other countries’ macroeconomic policies in determining the success of George Osborne’s policies?
  7. How similar to or different from other recessions has the recent one been? What are the policy implications of these similarities/differences?
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