Larry Summers scribbles “Britain and the limits of austerity”. It´s a rather long and rambling defense of fiscal stimulus in the face “Secular Stagnation”:
The British economy has experienced the most rapid growth in the G7 over the last few months. It increased at an annual rate of more than 3 percent in the last quarter — even as the U.S. economy barely grew, continental Europe remained in the doldrums and Japan struggled to maintain momentum in the face of a major new valued added tax increase.
Many have seized on Britain’s strong performance as vindication of the austerity policy that Britain has followed since 2010, and evidence against the secular stagnation idea that lack of demand is a medium-term constraint on growth in the industrial world.
Interpreting the British strategy correctly is crucial because of the political stakes in Britain, the question of future British economic policy and, most important, because the British experience influences economic policy debates around the globe. Unfortunately, when properly interpreted, the British experience refutes the austerity advocates and confirms John Maynard Keynes’s warning about the dangers of indiscriminate budget cutting during an economic downturn.
Start with the British economy’s current situation. While growth has been rapid recently, this is only because of the depth of the hole that Britain dug for itself.
So let´s do that. The first chart shows a measure of “comparative austerity”. The US has been far more “austere” than the UK. But that hasn´t stopped the US performing better than the UK, as stressed by Summers and illustrated in the RGDP growth chart.
Take a look at the next chart. The reason for the better performance of the US economy, despite bigger “austerity”, is that in the US nominal spending growth (NGDP) didn´t fall when “austerity” kicked in in 2010. Despite less “austerity”, in the UK nominal spending growth fell to zero. But note, as soon as NGDP growth in the UK turns back up real output growth “roars” back!
Lesson: The central bank can (and does) offset (even if only partially because of fears of “financial instability”) fiscal “austerity” (or fiscal “profligacy”). So let´s concentrate on what can really make a difference: Monetary Policy!