It is the mark of science and perhaps rational thought to operate with a falsifiable understanding of how the world works. So it is fair to ask economists… what could happen that would cause you to… acknowledge that the model you had been using was flawed? As a vigorous advocate of fiscal expansion… I have for the past several years suggested that if the British economy – with its major attempts at fiscal consolidation – were to enjoy a rapid recovery, it would force me to substantially revise my views….
Unfortunately for the British economy, nothing in the past several years compels me revise my views….
The cumulative output loss from this British downturn in its first five years exceeds even that experienced during the 1930s… a decade or more of Japan-style stagnation [is] emerging as a real risk.
An effective policy approach to Britain’s economic problems must start with the recognition that the principle factor holding back the British economy over both the short and medium term is the lack of demand…. [A] car might have many infirmities, but if its electrical system did not work the car would not go. If that was fixed, the car would run, even with other problems. So it is today. Moreover, to a greatly under-appreciated extent in the policy debate, short-run increases in demand and output would have medium to long-term benefits…. A stronger economy means more capital investment and fewer cuts to corporate research and development. It means fewer people lose their connection to good jobs and become addicted to living without work. It means that more young people get first jobs and it means more businesses choose leaders oriented to expansion rather than cost-cutting. The most important structural programme for raising Britain’s potential output in the future is raising its output today.
The objection to this… is profoundly flawed….[T]he behaviour of financial markets suggests that economic weakness rather than profligacy is the main source of concern… the costs of buying credit insurance on the UK to rise when overall interest rates fall… it is evolving optimism and pessimism about the future, not changing views about fiscal policy driving markets… the primary determinant of fiscal health in both the US and UK over the medium term will be the rate of growth… austerity policies that slowed growth could even backfire in the narrow sense of raising debt-to-GDP ratios and turning debt unsustainability into a self-fulfilling prophecy.
Britain must change the pace of fiscal consolidation to stand a chance of avoiding a lost decade… hen demand is needed for growth and the private sector is hanging back, the first priority must be for the public sector to stop exacerbating the contraction.