IT IS now clear that the UK economy entered the recession with a large structural budget deficit. As a result the UK’s budget deficit is now the largest in our peacetime history and among the largest in the developed world. In these circumstances a credible medium-term fiscal consolidation plan would make a sustainable recovery more likely. In the absence of a credible plan, there is a risk that a loss of confidence in the UK’s economic policy framework will contribute to higher long-term interest rates and/or currency instability, which could undermine the recovery.
Paul tackles what he calls a “UK version of 21st century Hooverism” thusly:
As you might guess, I’m very much in agreement with the second group. It’s important to be clear that the call for immediate austerity isn’t grounded in unarguable economics; in fact, the arithmetic tells you that what Britain does in the next year or two is virtually irrelevant to its long-run solvency. Instead, the call for immediate austerity is based on an appeal to “credibility”, which is very much in the eye of the beholder. So for Britain’s sake, I hope that the UK version of 21st century Hooverism doesn’t prevail.
This notion of these prominent economists that medium fiscal restraint could aid recovery via lower long-term interest rates used to be called Rubinomics during the Clinton years. But then the U.S. had higher interest rates than we do now. Currently, short-term interest rates in the U.S. are near zero while the interest rate on 20-year government bonds averaged about 4.5% last month. So how does the UK situation compare? Well, their short-term interest rates are only slightly higher while the interest rate for their 20-year government bonds averaged about 4.4% last month.