Monday, November 1, 2010

Global Economic Austerity

Last week's news about UK GDP was quite promising - quarterly growth of 0.8% is just what we needed given looming spending cuts and prospects of house price falls.

In economics it is tempting to make simple comparisons - this happened in Country A. So if we do the same, we will get same result.

The impact of spending cuts is going to vary enormously depending on local factors.

For example, In the 1990s, Canada successfully cut spending and reduced the deficit without causing fall in growth. This is often held up as model of austerity packages. But, Canada was helped by:
  • Sharp fall in interest rates
  • Booming US economy,
  • High demand for commodities
When you have all these kind of factors in your favour, the economy is more resilient to impact of spending cuts. In this kind of situation, reducing deficit whilst maintaining growth can actually improve situation.

Compare the situation of Canada to Ireland, Greece or Portugal, and you couldn't get a bigger difference.

The Euro members face - no independence over Monetary Policy. The ECB still worries about the inflation. There is no monetary stimulus to offset the fiscal austerity. There are also signs that the 'political union' of the EU is becoming more insular and less willing to aid countries suffering macro difficulties. The EU have never given a priority to reducing unemployment, and this is now getting worse.

There is also no independent exchange rate depreciation. Spain and Greece have become uncompetitive. To regain competitiveness there is a reliance on deflation - reducing prices. Unfortunately deflation in a period of debt is the last thing the economy needs.

Where Does UK Fit?

The UK situation is finely balanced.

The UK is belatedly benefiting from the 20-25% depreciation in the value of the Pound. We are also benefiting from the most substantial (as a % of GDP) programme of quantitative easing amongst OECD countries. The Bank of England also avoids the inflation fixation of the ECB. They are ready to pursue more quantitative easing if necessary.

This makes me hopeful that the UK may avoid the awful cycle of austerity, falling GDP, falling tax revenues and the need for more austerity that is currently in vogue in Eurozone.

But, though growth of 0.8% is promising, it should be remembered
  • Forward looking indicators like consumer confidence are more pessimistic.
  • Growth of 0.8% fails to make much of a dent in the spare capacity and high unemployment of the UK.
  • Spending cuts and job losses are going to be substantial in new year.
  • The Housing market looks fragile. Given importance of housing wealth, a fall in house prices would have a significant impact on reducing spending and consumer confidence.
Whatever Nick Clegg says, the government will not have any flexibility in delaying spending cuts should the economy falter.

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1 comment:

Austerity Bill said...

Austerity measures are now a hot topic globally. Although it does cause large unrest in every country that it affects, can we argue against it? Aren't the measures aiming to improve the economy in the long run?