Front-Loaded Austerity in the UK
The major risk of immediate “front-loaded” fiscal austerity in the UK is that the painful cuts in spending, subsidies and public employment and increases in taxes will have a recessionary effect on an anemically recovering economy. By contrast, a credible early commitment to gradual fiscal consolidation to be phased in a more back-loaded manner would have reduced the risk of a double-dip recession while maintaining the authorities’ commitment to credible fiscal consolidation. The risk of the UK’s fiscal strategy is (as pointed out by Martin Wolf of the FT) analogous to that of climbing a mountain without a rope; i.e. not having a Plan B in the event of the Plan A of front-loaded fiscal austerity leading to a double-dip recession.
The only Plan B in the mind of Prime Minister David Cameron is that the Bank of England (BoE)—i.e. its governor, Mervyn King—will opt for QE2 in the event that the fiscal austerity proves recessionary. But QE2 by the BoE may not be sufficient to compensate for the recessionary risk of a front-loaded fiscal adjustment. A less risky fiscal path would have implied a more back-loaded fiscal adjustment that could have been credibly locked in by legislation now, with the path of spending cuts and tax increases to be implemented gradually over time.
Editor’s Note: This post is exerpted from a much longer analysis available exclusively to RGE Clients: “Front Loaded Stimulus, Back-Loaded Austerity: The Optimal Fiscal Austerity Path and the Risks of Other Routes”
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