The adoption of austerity post the financial crisis in 2010 by the UK government is heavily debated. This essay evaluates the arguments for and against this fiscal contraction deliberating on the applied and possible fiscal policy measures and the limitations of monetary policy after the fiscal stimulus provided in 2008.
When the housing bubble
burst and Lehman Brothers collapsed in 2008, the subprime mortgage crisis
magnified into a global financial crisis. Governments had to rush in and save
banks. If not, the fall of public confidence in the banking system would have
made the problem far more severe. Large fiscal stimulus packages were rolled
out to cushion the blow. But for how long would a government be willing to take
further debt for expansionary fiscal policy? They could have continued to
increase public expenditure to compensate for the fall in private expenditure
in accordance with the Keynesian theory. Or increase savings, let the wage rate
drop and have the demand rise due to a price advantage in the long run (Hayek,
2006). By 2010, United Kingdom’s national debt reached 75.6% of its GDP (Eurostat).
Had bond yields increased due to falling market confidence, the fiscal
situation would have been worse off. It would imply that the risk associated
with government bonds is higher and have negative implications about the
government’s credibility, all raising the cost of public debt in the future. Thus,
in the 2010 elections, the campaigns of both the Conservative and Labour
parties suggested reducing the fiscal deficit. No one spoke in favour of
further stimulus and austerity was adopted.
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The UK government feared
a Greek-style meltdown. A country having borrowings in its own currency and a
friendly central bank may not have to fear public debt as much. It could always
keep a control on interest rates or postpone repayment by issuing new bonds. However,
then governor of the Bank of England, Mervyn King, appeared to favour
austerity. It remains uncertain if he would have sanctioned further
quantitative easing. Typically, central banks reduce interest rates to
stimulate the economy in such conditions. Lower interest rates promote
consumption which would have decreased due to lower fiscal expenditure. The
drop in interest rates from 5.5% in 2008 to 0.5% generated £350 billion to
inject into the economy (Giles, 2018). But with interest rates at an all-time
low of 0.5% since 2009, there wasn’t much that could be done on the monetary
policy front (Bank of England). The drop in interest rates from 5.5% in 2008 to
0.5% generated £350 billion to inject into the economy. the Value Added Tax
(VAT) was raised to 20% and public expenditure was cut to bring down the deficit
(Finch, 2010:1). The combination of additional revenue and a lower deficit
would cut down the need for further debt and help service the existing.
Austere spending decisions lowered the welfare expenditure. The employment level decreased because of lower government expenditure. As a result, demand plunged and so did the gross domestic product. High uncertainty had lowered the public confidence. The GDP growth rate was insufficient to counter the shrinking in the economy caused by austerity. International Monetary Fund (2012) warned that the country might face permanent damage to its productive capacity if the same policies were continued. The government’s tax revenues took a hit owing to lower output. This resulted in a higher debt to GDP ratio as the budgetary deficit grew. As real wages of public sector workers and local council budgets fell, homelessness and reliance on food banks rose. Social care for the elderly was negatively impacted and help from Red Cross was called in to shoulder the increased pressure on the NHS (Gillett, 2017). Mark Blyth (2013) noted that there was disparity in the impact of austerity across different levels of society. He pointed out that the consequences were felt more severely by the larger share of public service users who didn’t have enough wealth to counter the cut in welfare spending.
In theory, falling
deficit would result in lower taxes in the future. This should increase
consumer confidence in the economy. However, critiques of austerity blame the
government for the plummeting consumption levels. They believe the government
should have continued with quantitative easing when the private spending shrank.
Wage rates fall with falling public expenditure. This gives the economy a cost
advantage as compared to its competitors in the global markets. To benefit from
this, it is necessary that foreign demand for the domestically produces goods
increases. But many Eurozone were implementing austerity themselves and thus,
there was no substantial increase in foreign demand for British goods.
Moreover, countries like China had induced a fiscal stimulus in their economies
despite not having been impacted as greatly by the crisis. Hence, there was already
enough supply in the market for any country to benefit from rising demand. There was perhaps not once cause to the
declining consumer spending in the UK. While UK’s own fiscal policy changed in
2010, the economic environment globally was also impacted by several countries
introducing policy changes. The commodity prices changed and the Federal
Reserve was keeping global rates low, all of which had some impact on the UK
economy (Buttonwood, 2015). In spite of the falling consumption, there was a
need to reduce government expenditure to reduce the deficit. Further fiscal
stimulus, after what was introduced during the financial crisis, would have led
to a sharp increase in government debt. Such a high debt level would make
fiscal policy unsustainable and repayment challenging (Emmerson, Keynes and Tetlow,
2013).
In terms of real total
spending, the cut wasn’t as much from 2010 to 2015. Britain’s general total
disbursements as a percentage of national income were the third highest amongst
the G6 nations between 2007 to 2009 and remained so in 2013 (OECD, 2014).
Annualised average real increase in spending on social security and health rose
and real spending on working age and pensioner benefits grew between 2010 and
2013 (Keynes and Tetlow, 2014: 16-17).
The economy’s recovery
in 2013-2014 sparked another debate. Had austerity worked or was it the result
of policy alteration in 2012? Klein (2015) asserted the growth was a result of a
reversal from austerity. Smith (2015) refuted, stating that the government was
still austere in spending decisions with the fiscal tightening being larger
than 3% of GDP. Krugman (2015), however, maintained that abandoning further
fiscal cuts after two years of austerity led to the economic growth.
Whether the economy
would have been in a better position without austerity will remain unknown.
What can be concluded though is that austerity was not an economic necessity then.
But with UK’s ageing population, welfare expenditure will only increase in the
future. Such a welfare cap will become necessary for better policy decisions as
the pressure on NHS and public services escalates. Continued quantitative
easing in 2010 would have made public finances more unsustainable and fiscal
austerity in future more drastic. Spending cuts or higher taxes, no matter
when, will always be met with heavy criticism. Hence, a developed country with
ageing population could aim at increasing sources of income, reducing income
inequalities and reducing the dependence on welfare expenditure.
Bibliography
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Buttonwood
(2015) What is austerity?. The
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(Accessed 15 April 2018)
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J. (2010) Budget 2010: VAT rise to 20%
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(Accessed 15 April 2018)
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S. & Tetlow, G. (2014) Survey of
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