A guest post by Mark Sadowski
Krugman discusses some of the mistakes he has made through the years and concludes by discussing his failure to predict the recent relatively strong growth of the U.K. economy in the face of contractionary fiscal policy.
“Finally, Britain is growing much faster right now than I expected. Fundamental model flaw? I don’t think so. As Simon Wren-Lewis has pointed out repeatedly, the Cameron government essentially stopped tightening fiscal policy before the upturn, which means in effect that the “x” in my equation didn’t do what I thought it would. On top of that, there was a drop in private savings, which is one of those things that happens now and then. The point is that the deviation of British growth from what a standard Keynesian model would have predicted, while real, wasn’t out of line with the normal range of variation-due-to-stuff-happening; nothing there that warranted a major revision of framework.”
The UK’s Office of Budgetary Responsibility (OBR) estimates of the impacts of fiscal austerity on the level of real GDP (RGDP) can be found in Chart 2.26 on Page 54.
If you read the surrounding text you’ll note the graph depicts the varying effects of each type of fiscal policy change, including both spending and revenue, on level RGDP by fiscal year. (Fiscal years in the UK run from April 1, through March 31.) The estimates in this chart are comprehensive and fully account for the lagged effects.
The chart shows that fiscal policy is estimated to have the following effects on level RGDP in percent by fiscal year.
Since these are level effects we need to convert them to changes.
Now let’s turn to the actual nominal GDP (NGDP) and RGDP growth and inflation as measured by the GDP implicit price deflator:
Estimates for 2014Q1 are not reflected in the above graph. Here are the resulting growth rates by fiscal year.
FY NGDP RGDP Deflator
2010-11 4.6 2.0 2.6
2011-12 3.1 0.8 2.3
2012-13 1.4 0.3 1.1
2013-14 4.0 2.3 1.7
Note that when the OBR estimates that fiscal consolidation was most deleterious to economic growth, AD (NGDP) growth was actually at its fastest, and as fiscal consolidation was progressively decreased in each of the two subsequent fiscal years, both NGDP and RGDP growth nevertheless decreased. Note also that in the just completed fiscal year RGDP growth was faster than in any of the three previous fiscal years, but since NGDP growth was not as fast as it was in FY 2010-11 this is due more to the fact that inflation has slowed than it is to faster AD growth.
In other words, the timing of the economic effects of fiscal consolidation does not at all match the actual pattern of AD growth, suggesting that rather than the U.K. economy being in a liquidity trap, monetary policy has been fully offsetting fiscal consolidation. Moreover, the recent superlative RGDP growth is more due to a subsiding of negative aggregate supply (AS) shocks than it is to outstanding AD growth.
It seems to me, rather than simply shrugging and saying “stuff happens”, maybe it’s time that “stuff” (monetary policy and AS shocks) be incorporated into the fiscalist model.