Comments on the British Budget and Relevance to Fiscal Discussions in America

March 20, 2013

The British Budget avoided surprises.  It was already well-advertised by the team of Prime Minister David Cameron and his financial sidekick George Osborne that there is to be no backing down from a strategy of austerity in the face of excessive fiscal deficit spending and rising debt, never mind that weak growth (and in turn fiscal revenues) has been the cause.  Invoking the T.I.N.A argument (there is no alternative) of the legendary former Prime Minister Thatcher, Cameron and Osborne have pitched their budget strategy as the only sensible response, claiming that alternative approaches to stimulate growth and then reduce the deficit as laden with risk to British financial markets.

Thus far, the British fiscal way has failed to cut the deficit or to provide sufficient economic growth, which is a necessary condition to get that task done.  In today’s presentation of the 2013 budget, estimates of public sector net borrowing were revised upward by a collective sum of almost GBP 60 billion for the years through Fiscal 2017-8, and debt keeps cresting, reaching 85.6% of GDP in that final year of the forecast horizon.  Spending continues to get slashed, but taxes too have been reduced from the baseline for a range that includes beer, oil, corporate income, and personal income. 

British growth continues to be abysmal.  Real GDP grew just 0.03% per annum over the eleven quarters since the Conservatives returned to power in the second quarter of 2010.  The budget projects growth of 0.6% this year and 1.8% in 2014.  These are revisions from 1.2% and 2.0% predicted just four months ago.

The most novel element of today’s budget message was also telegraphed in advance, namely new instructions for the Bank of England to consider growth as well as price stability when setting monetary policy.  Cameron and Osborne would like the Monetary Policy Committee to behave more like the Federal Reserve, which has a dual mandate and which under Bernanke has introduced data driven guidelines for the future path of its interest rates.

This is an ironic step, indeed.  Fiscal policy is being run as rigidly as possible.  There is no thought that the original strategy may have been flawed.  Right or wrong, austerity is the only choice, and it will be followed until the goals are met or voters kick the government out, whichever comes first.  But in mandating the Bank of England to follow a more discretionary approach to monetary policy, the central bank is being set up to do what the politicians rule out for themselves, that is to learn from mistakes. 

Meantime, Britain’s weak growth is blamed on everything but the austere budget.  Euroland’s debt problems have harmed global markets, and the common currency’s weak demand has hit British exports.  Steps to integrate the euro area further along banking, fiscal, and regulatory lines threaten to put Britain at a disadvantage. and plans are in the works for an eventual voter referendum after the next election on whether the U.S. should maybe leave the EU altogether. 

The validity of the view that weak growth stems from several factors other than fiscal policy can be examined by comparing the British and U.S. economic performances since the Conservatives came to power in the U.K..  In both countries, the political Left and Right are divided sharply over fiscal policy.  The difference is that the view that it’s better to temper the degree of austerity has been followed in America.  Even there, however, fiscal policy has been reined in a lot more than a majority of economists would prefer, and not surprisingly, U.S. GDP growth of 1.8% per annum since the second quarter of 2010 has been anemic by comparison with 1950-2000 norms.  That said, growth of 1.8% is far more decent than zero. 

The United States has outperformed the Cameronesque U.K. in other vital respects.

  • U.S. consumer price inflation has averaged 2.7%, about a quarter less than Britain’s annualized pace of 3.4%.  Elevated prices for energy and other commodities have been a problem in both countries.
  • As a percentage of GDP, the U.S. fiscal deficit has been falling about a percentage point per year.
  • The U.S. current account has also been better behaved than Britain’s.
  • U.S. unemployment has receded to 7.7% from a peak of 10.0%.
  • U.S. ten-year Treasury yields have fallen 186 basis points from 3.80% on May 6, 2010 when Cameron was elected to 1.94% presently.  The 10-year British gilt, in comparison, has fallen by a smaller 152 bps from 3.40% to 1.88% in spite of draconian fiscal restraint that was proposed initially as the way to promote low long-term interest rates.
  • The Dow Jones Industrial Average has climbed 37.9%, 71% faster than the 22.1% rise of the British Ftse.
  • The Fed and Bank of England have both been practitioners of quantitative easing.  But mirroring the show of British fiscal self-flagellation, monetary policy in Britain is now on hold, while QE by the Fed has continued. 

Sterling by coincidence is trading now very close to its dollar level when Cameron’s Tories beat Gordon Brown and the Labour Party in May 2006.  Known as cable, the pound against the dollar has risen a mere 1.2% on balance from its level back then.

When I first went to work at the New York Fed in 1974, British Budget Day was arguably the biggest annual event for an international economist.  Until Labor came to power in 1997, monetary policy changes were decided by Britain’s government, not the central bank.  Back in 1974, moreover, there was no autumn spending statement in Britain.  All elements of fiscal, monetary, and economic regulatory policy were packed into the single event of the annual budget delivered in the early spring.  Numerous pages of coverage were allotted to the budget in the following day’s budget.  The inclusion of a shift in the Bank of England’s remit in this year’s budget seems to be a throw-back to the good old days when the U.K. eschewed an independent monetary policy.  Hopefully, Britain will avoid some of the other dark events experienced in the 1960s and 1970s.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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