Evan Soltas
Feb 22, 2012

Policies Across the Pond

Might the US learn something from the UK?

Note: I'm switching over to image Google Docs graphs--i.e. not interactive--because there appears to be something wrong with the embedding feature for the interactive ones.

I decided today to look into the policy mix in Britain. My only prior knowledge came from the well-publicized effort of Prime Minister David Cameron to push through an austerity plan in 2010--and the Left's scorn for such ideas:

The coalition Government believes that the bulk of the reduction must come from lower spending rather than higher taxes...The country has overspent; it has not been under-taxed...My measures today mean that 77 per cent of the total consolidation will be achieved through spending reductions and 23 per cent through tax increases. I believe this gets the balance right.
That's from Chancellor George Osborne's speech to Parliament. I couldn't find tax revenue data in FRED on the UK, so the change in real expenditures probably understates the austerity a bit in terms of net public saving. But the point is there, in the second graph: the Cameron austerity really hasn't happened. In fact, the US federal government has become much more "severe" in its hair shirt, with a year-over-year fall in real expenditures of approximately 3 percent. So if anything, the stance of fiscal policy in the UK is more expansionary than American fiscal policy. (The output gaps are nearly identical, so the comparison compares deficits appropriately.)

Meanwhile, Mervyn King's Bank of England has been substantially more accommodative than Ben Bernanke at the Fed. After pushing rates to near-zero, as Bernanke did, King did the next textbook step to circumvent the zero lower bound constraint: raise the level of expected inflation. This pushes down the real interest rate further into the negative territory, which should boost investment and output in the short run. This is classic stabilization policy in monetary theory. It's only new to the people who think that central banks should only maintain price stability, which amounts to a total abdication of any responsibility to dampen cyclical swings.

It should be no surprise, given the favorable position of fiscal and monetary policy in Britain, why output has held up relatively well, despite the ongoing concern over sovereign debt in the Eurozone. (I understand Krugman's "worse-than club" criticism, but it must be acknowledged that there isn't much to blame in terms of policy.)