Even Britain has now abandoned austerity

By Anatole Kaletsky
March 21, 2013

The Age of Austerity is over. This is not a prediction, but a simple statement of fact. No serious policymaker anywhere in the world is trying to reduce deficits or debt any longer, and all major central banks are happy to finance more government borrowing with printed money. After Japan’s election of Prime Minister Shinzo Abe and the undeclared budgetary ceasefire in Washington that followed President Obama’s victory last year, there were just two significant hold-outs against this trend: Britain and the euro-zone. Now, the fiscal “Austerians” and “sado-monetarists” in both these economies have surrendered, albeit for very different reasons.

Much attention has been focused this week on the chaos in Cyprus. Coming after the Italian election and subsequent easing of Italy’s fiscal conditions, the overriding necessity to keep Cyprus within the euro — and its military bases and gas supplies outside Russian control — will almost surely mean another retreat by Germany and the European Central Bank from their excessive austerity demands. But an even more remarkable shift has occurred in Britain. The Cameron government, which embraced fiscal austerity as its main raison d’etre, was suddenly converted to the joys of debt and borrowing in this week’s budget.

Of course, the rhetoric of British Chancellor George Osborne’s budget speech gave no hint of his Damascene conversion. On the contrary, it ridiculed “people who seem to think that the way to borrow less is to borrow more.” But Osborne’s trademark sneers could not disguise the meaning of the policies and numbers he presented.

Long after the U.S., Japanese, Chinese, Canadian, Australian and most European governments, Britain has finally been forced to accept Keynes’s “paradox of thrift”:  A government that tries to reduce its borrowing during a recession generally weakens the economy so much that it ends up increasing its total debt. Conversely, a government that expands deficits during periods of weak economic activity, or finds ways to encourage private borrowing and discourage private saving, usually ends up lightening the national debt burden.

Osborne’s budget numbers presented a textbook example of Keynes’s paradox. In last year’s budget, Osborne predicted that government debt would peak at 76% of GDP in fiscal year 2014/15; but this week, despite (or because of) another year of Draconian tax increases and spending cuts, he has projected the government’s debt burden to keep rising for a further two years, to 86% in 2016/17. Contrast this with the U.S. budgetary experience, where the debt ratio has already stabilized near Osborne’s original 76% target, despite (or because of)  the Republicans’ refusal to raise taxes and the Democrats’ refusal to cut spending on anything like the British scale.

This contrast suggests that the main reason for Britain’s inability to stabilize its debt burden has not been any lack of fiscal effort but, on the contrary, the impact of excessive austerity on economic growth. And while Osborne will never publicly admit this, the big surprise of his budget is its implicit acceptance of this Keynesian view.

Instead of trying to reduce borrowing any further or aiming for a balanced budget, as it originally promised, the British government has now accepted that deficits will keep rising in absolute terms and will still be worth 6% of GDP by the next election in 2015. That would leave Britain with by far the highest deficit ratio among the major economies after five years of unprecedented austerity. Meanwhile the U.S., with comparatively little fiscal effort, is projected to reduce its deficit to just 2.4% by 2015.

Now for the good news. The British government’s decision to accept huge deficits for the foreseeable future instead of trying vainly to reduce them was strong evidence of a long-awaited policy U-turn from over-zealous fiscal tightening to U.S.-style economic stimulus. But Osborne’s speech contained two even clearer signs of a surprisingly radical “Plan B” to start undoing the deflationary effects of the government’s original economic policies in time for the 2015 election.

The first shift away from austerity was predictable, but turned out to be more radical than generally expected: The Bank of England’s mandate was changed, from targeting 2% inflation at all times, to stabilizing inflation at around this level over the “medium term,” while recognizing “the trade-offs between inflation and output variability” and noting that “monetary activism has a vital role to play in the Government’s economic strategy … [and] commitment to fiscal consolidation.” In other words, Britain has effectively imported the U.S. Federal Reserve’s “dual mandate” of managing both inflation and unemployment, with the kicker that the BoE must print money to ensure that government deficits are financed at rock-bottom interest rates.

A bigger surprise than this demand for more “activist” monetary policy was the radical new destination proposed for the money to be printed by the BoE. Britain has decided to create a new bubble in house prices and mortgage borrowing.

While Osborne repeated his mantra that “you can’t cure a crisis caused by debt with more debt,” he will now do exactly this by creating a British equivalent of government-guaranteed Fannie Mae mortgages to offer what the U.S. would describe as “sub-prime loans.” The government whose excessive prudence has discouraged banks from offering mortgages worth more than 75% of a home’s value, will now guarantee borrowers who have a 5% deposit the additional 20% loans they need to qualify. In doing this, the Treasury will expose itself to any falls in house prices beyond 5% — and this exposure will not be included in national debt statistics.

In short, Britain will imitate the off-balance sheet financing of Fannie Mae that helped to trigger the 2008 crisis, and will use this mechanism to create £130 billion of “high loan-to-value mortgages over three years,” which will be much more leveraged than Fannie Mae’s “conforming” loans. (The U.S. equivalent of this sum, in relation to GDP, would be roughly $1.5 trillion.) This new policy can be criticized on several grounds — for example financial imprudence, or inflating house prices or unfairly subsidizing borrowers — but excessive austerity is not among them.

PHOTO: Britain’s Chancellor of the Exchequer, George Osborne, holds up his budget case for the cameras as he stands outside number 11 Downing Street, before delivering his budget to the House of Commons, in central London March 20, 2013. REUTERS/Stefan Wermuth

8 comments

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

The author must be happy.

Posted by keebo | Report as abusive

The author may be happy about that, but he must also have abandoned ‘optimism’ by now, in view of the latest data coming from Europe…

Posted by reality-again | Report as abusive

Interesting how most Brits believe they’re suffering through a five-year depression as do many other Europeans.

Then, there’s our own Nobel Laureate, Paul Krugman, who has authored a book “How to Get Out of This Depression”. For some reason, he seems to be referring to the United States! We should just ignore the 48 million people barely surviving on Food Stamps, and the millions of now unemployed people who no longer receive unemployment benefits and are not even counted among the officially unemployed. Guess they’re just lazy-butt losers who haven’t been hit with the Tinkle-Down/Supply-Side Economics from the One Percenter “job creators”.

Posted by ptiffany | Report as abusive

Keynes is never right..

But government has to spend because of “security” and “social order” reason NOT economic reason. I am quite certain that if the economy is measured by utility, then the economy is not growing at all with debt.

But then: Do you want debt or do you want the pitch forks of the unfortunates.

Remember that even if you draft them and send them to wars to get rid of them. They have already bred and they will breed more. There will be their kids and of course the kids of their kids to pick up the pitch forks again. There is a very steady and growing supply of that.

So let’s just do whatever it takes, don’t think ahead, screw the consequences, the future is always bleak anyway.

Posted by trevorh | Report as abusive

The funding of governments by private banks is the biggest scam in history. At any point that the public wakes up and realizes it, those governments will suddenly criminalize that debt, along with the banks that loaned it and start over with a clean slate. For now though, they’re satisfied buying up all the gold (real money) with fiat paper (printed from thin air) backed by the governments (cartels) ability to collect taxes (steal) from the production (labor) of a given population.

If we don’t pay our debts, we lose everything. Governments lose nothing when they don’t pay theirs. Ours is real, theirs is fake.

Posted by LysanderTucker | Report as abusive

Tovarische Kaletskii is correct but for the wrong reasons. As so many do, he keeps playing the Keynesian shell game to explain why consuming what we haven’t produced is harmless. Nevertheless, austerity cannot possibly save us. But the reason is that we, the inhabitants of the self-styled “first world countries” are hopelessly addicted to the idea of getting something for nothing. We must have our social engineering even at the cost of cannibalizing our children. The future will damn us. We know this instinctively. But we do not care.

Posted by Fougasse | Report as abusive

i may be somewhat naive. but from information i have gleaned, nothing exists money wise. all of the worlds economies are based on debt. this is a system that has functioned for over a hundred years. why not change it? why not set everything to zero worldwide, so no debt exists. start from a clean slate as it were. surely if every person is indebted to their credit cards, financial institutions in debt to each other, governments and economies etc etc, nothing exists. or is the point to hold poorer areas at ransom? enlighten me please.

Posted by interrogator | Report as abusive

Sorry but this is Keynsian nonsense. Borrowing huge amounts of money to stimulate the economy is a great idea – as long as you are not already mired in debt. This is basic monetary nous. If this Keynsian idea of borrowing while in massive debt were the miracle cure the left calim it is, the world’s ecomonies wouldn’t be in such a state. The fact is that borrowing while in massive debt is a GAMBLE. You may get lucky, and it may work in your favour like the author of this article claims. Most of the time though it will only result in an even bigger debt, and will certainly just addict the population further into the idea that the sole purpose of a government is to provide a higher and higher standard of living while requiring less and less work in return. You can fuel this kind of socialist monetary expansion for a while – but it always guaranteed to fail after a whort period. Look at the political history of Britain since the second world war and it goes like this: Nice Labour come to power, do lots of nice things, but screw up the economy. Nasty Tories come to power, do lots of nasty things but – fix the economy. Nice Labout get voted it, and the cycle repeats endlessly. So society has a choice between the nice guys who are incompetent in basic housekeeping (due to their left-wing upbringing which brainwashes them into believing whole-heartedly in Keynsiansim as a kind of infallible science) and the nasty Tories, who do understand the basic schoolground rules of economics. So to a major degree, it is the FAULT of the Labour party that the Conservatives get in periodically – because as the economy gets slowly destroyed by excessive debt and borrowing – the electorate comes to its senses and votes in the Conservatives so they can step back from recklessness of a high-tax high-borrowing economic policy, (which is akin to gambling and lying to the elctorate) in order to make the cuts necessary to stabilize the economy, while the left moan and whinge that the cuts are the problem, not the cure. The point is that austerity WILL WORK IN THE END and is a much better, more permanent solution than gambling with money that you do not have. If the author of this article thinks the Tories have given up austerity – and he has a point because the cuts are not anything like as severe as they could be – we can be absolutely sure of one thing – Labour would have borrowed us into submission by now.

Posted by cactusnick | Report as abusive