The fifth in our series of seminars with economic experts took place on 11 March with a discussion on fiscal austerity with Jonathan Portes, director of the National Institute of Economic and Social Research (NIESR). Below is a brief overview of our discussion, with short audio clips. Before taking over at NIESR, Jonathan was chief economist at the Cabinet Office, where he advised the cabinet secretary and Number 10 on economic and financial issues. His expertise covers a wide range of economic policy issues, including labour markets, skills, migration, poverty and international economic and financial issues. Most recently he has been a very active player in the debates around migration and austerity.
What austerity means
I began by asking what we meant by austerity and how much of it we have actually had in the UK. Jonathan explained that although there is not a precise definition, he saw austerity as a process of accelerated deficit reduction after the increases experienced around the time of the financial crisis. This has resulted in a significant fall in both the actual deficit, which was always likely to improve as the economy recovered, and the underlying (or structural) deficit. [4.52 mins]
As regards the measures that can be taken to implement austerity, Jonathan felt that some actions could be more beneficial, or less damaging, than others. Revenue measures, such as increasing broad based taxes (such as VAT), or taxes on land or property might be preferred. It may also make sense to cut some areas of wasteful government expenditures, but reductions in public investment can prove costly in the longer term. [2.33 mins]
The experience of austerity over the last parliament could be split into two parts. In the first two years there was substantial austerity, which was large by both historical and international standards. Since then, there has been much less austerity and the pace of fiscal consolidation has slowed. [2.19 mins]
What were the risks of not pursuing austerity?
We discussed what the financial market risks would have been of not pursuing the policy of austerity in 2010. At the time there were significant fears that a failure to implement credible austerity might endanger the UK’s credit ratings and, more importantly, might lead to a loss of confidence in financial markets which could raise the cost of finance.
Jonathan rejected this argument and suggested that the risks for the UK – which was borrowing in its own currency – were always very low. He also felt that the experience of the past few years, with the UK still borrowing significant amounts while the cost of finance remained low, supported this view. [7.11 mins]
When asked if it was vital to listen to what financial market participants were saying, Jonathan argued that it was not what people said which was important, but rather the signals interpreted through market price movements that mattered. [4.15 mins]
In response to questions from the audience, Jonathan said that, in his view, there had never been much danger that higher public deficits would have crowded-out private investment spending, given that interest rates have remained so low. [5.32 mins]
He also did not see that there was a problem of quantitative easing creating a ‘false market’ for government debt, although he did see challenges ahead in returning monetary policy to normal. [3.40 mins]
The contribution of fiscal policy to the financial crisis
We then moved on to talk about whether fiscal policy had been too loose in the run-up to the crisis. Jonathan felt that this may well have been the case, although probably not to a substantial extent. He felt that the bigger problem was the failure to recognise the problems in the financial sector and the related over optimism in the tax revenues from this source. [4.23 mins]
Jonathan did not see the crisis as necessarily symptomatic of over consumption, but there was clearly a case for well targeted investment, particularly in transport and housing. [5.13 mins]
He felt that economic tools such as cost-benefit analysis are useful in this regard, but may be insufficient when dealing with large transport projects with significant externalities. [2.07 mins]
How would the economy have fared without austerity?
Finally, we discussed how the economy might have developed without austerity. Jonathan thought there would have been considerable uncertainty, but felt that the balance of risks favoured taking a cautious approach, in the sense that the risks of moderately overheating the economy, leading to inflation, were more manageable than the risks of deflation. A big area of uncertainty related to the supply side of the economy and the linked issue of the fall in unemployment and weakness of productivity.
If this was symptomatic of lower potential output, or even a ‘secular stagnation’, then clearly a fiscal stimulus would not be the right policy response. However, Jonathan was more optimistic, preferring the more standard analysis that the fall in output in the crisis was due to a sharp fall in aggregate demand. [7.30 mins]