We are now starting to see the economic impact of the 'new normal' in practice, as Paul Krugman outlined the other day. Having been bullied into adopting austerity measures apparently thinking they will help their economies grow, it is beginning to dawn on many "Austerian" governments that their embrace of hair shirt economics is beginning to undermine growth.
Exhibit A is the United Kingdom. The NY Times gave an account of British towns "reeling" from the implementation of nationwide expenditure cuts of some $130 billion introduced in last June's budget. "A mass execution without appeal" is how the Times described it.
Along with this article comes a report from the Financial Times, "Economic Fears Rise as House Prices Dip", documenting how UK house prices have began to fall for the first time in over a year this past July. The article notes that this setback has come "after a year when the recovery in house prices surprised almost everyone and brought relief to Britain's stretched banks, [so] the return of a buyers' market threatens to increase jitters in a fragile economy."
Well, to us neither today's news about British municipalities reeling from the impact of the new Tory coalition government's budget cuts, nor last year's recovery in UK housing, was at all "surprising." Beset by the greatest financial crisis in the post World War II period, the last UK Labour Government did what any sensible administration ought to do when there is not enough activity in the economy to maintain employment and labor force growth: they increased public demand via increased net government spending.
For all of the wailing about Britain's "extraordinary" budget deficit, the policy response by the Brown Administration was in fact a good one. By and large, it stabilized the economy and kept unemployment down to the 7% level. In spite of the criticisms by the head of the Bank of England, the government made a very legitimate case that the rapid increase in government debt was an unavoidable consequence of the financial crisis (in itself the product of a private sector debt binge). Yes, perhaps one could very well criticize the fact that a large number of the benefits accrued towards those experiencing the least disadvantage, but this does not invalidate the notion of deploying a government's fiscal resources when confronted with a huge output gap and huge labor underutilization.
By the same token, attempts to mindlessly decrease alleged "government waste" (the new justification for the attack on the welfare state) in the context of ongoing high rates of unemployment is bound to lead to further economic weakness AND a higher public debt to GDP ratio, via a shrinking GDP. Undoubtedly, some government expenditure is highly inefficient (although, in light of the plethora of private sector induced debt bubbles, it is hardly credible to argue that all spending from the private sector is invariably more efficient than government).
But the deficit as a whole is nothing more than an accounting expression of a gap between expenditures and receipts. Complaining about this as "unsustainable" is analogous to blaming a football scoreboard, because it shows your team losing a game by 2 touchdowns, rather than focusing on the activity on the field which created the 2 touchdown gap in the first place.
In the UK (as in the USA), consumers are still trying to reduce their debt exposure and the saving ratio has been rising. So there is very little thirst for credit coming from that sector. This is, then, a problem of aggregate demand deficiency, which can only be rectified via fiscal policy. Unfortunately, for political reasons, that is impossible right now. Neither the Federal Reserve, nor the Bank of England (two of the leading practitioners of "quantitative easing" in the past 18 months) can simply wave their magic "QE" wand and improve the economy via monetary policy. Lower interest rates might lower the cost of borrowing (and help service a still large private sector debt overhang), but such a policy also steals income from savers, such as pensioners. And in regard to overall aggregate demand, private businesses have to have positive expectations that they will be able to sell the output they produce. Those expectations remain subdued which is why the commercial banks in the US are still not lending very much, whilst prevailing high debt levels render further borrowing by consumers extremely problematic
Having publicly deprecated the impact of fiscal policy and warned of the long term deleterious effects of climbing public debt, of course, the Federal Reserve and/or the Bank of England cannot now reverse course and credibly back more fiscal stimulus. To cover up the flaccid nature of their respective central banks' ineffectual monetary policy response, a number of economists present the current high levels of unemployment as "structural", implying that there is little that can be done about it. It is simply the "new normal", which in reality represents the ultimate in political failure. Our policy elites don't dare concede the futility of fiscal austerity. Hence, they resort to invoking theories like the "equilibrium unemployment rate", or "non-accelerating inflation rate of unemployment" (NAIRU, for short), the implication being that attempts to reduce labor underutilization by expansionary fiscal policy would be inflationary in the absence of "structural reforms" , such as privatization, labor market deregulation, anti-union legislation and harsh welfare measures. But these "supply side" measures in effect reflect the agenda preferences of the late 20th century, which have destroyed incomes and eviscerated the middle class. Our "new normal", then, represents a collective shrug of our policymakers' shoulders, ignoring a growing undercurrent of anger and despair.
Cross-posted from New Deal 2.0.