Osborne’s expansionary fiscal contraction has failed

Following last month’s budget, the government’s reputation for economic competence has taken has taken another hit, writes IPPR Chief Economist Tony Dolphin.

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By Tony Dolphin, Chief Economist at the Institute for Public Policy Research (IPPR)

Following last month’s budget, the government’s reputation for economic competence has taken another hit.

George-Osborne-corpseThe latest ComRes poll, reported in the Independent on Sunday, found 54 per cent of respondents do not trust the prime minister and the chancellor to make the right decisions on the economy. Today’s Guardian/ICM poll also shows the public have lost faith in Osborne’s ability to be “good in a crisis”.

These polls, with elections just over a week away, make tomorrow’s first release of the GDP data for the first quarter of 2012 all the more significant. Ultimately, governments are judged less on the specific details of their budgets and more on their record on growth and jobs.

If GDP contracted in the first quarter, following the 0.3 per cent decline in the final quarter of 2011, then the economy will – according to the technical definition adopted by economists – be back in recession. Whatever the causes, the government will take the blame, and its reputation for competence on economic matters will decline further.

In fact, most economists do not think GDP declined in the first quarter. There have been some bad economic numbers released in recent weeks – in particular a big fall in manufacturing output in February – but most of the monthly data for January, February and March point to moderate growth.

Economists have found that business confidence is one of the best short-term indicators of economic activity and in both manufacturing and services it was higher in the first quarter. Add in recent data showing a big jump in retail sales in March and the first fall in unemployment for ten months, and it appears the economy grew by 0.2 or 0.3 per cent.

This should not deflect from the fact the UK is experiencing its slowest ever recovery from recession. GDP is still more than 4 per cent below its peak level (in the first quarter of 2008) and on the basis of the Office for Budget Responsibility’s latest forecasts, it will not return to its pre-recession level until 2014.


See also:

Headline unemployment fall is good news, but underlying picture remains grim 18 Apr 2012

Economic update – April 2012: Coalition failures put Britain in the slow lane 17 Apr 2012

The coalition will pile on more debt than any modern government 30 Mar 2012

Is Osborne leading us to a double- or triple-dip? 30 Mar 2012

Expansionary fiscal contraction and the emperor’s clothes 13 Nov 2010


The government took office believing in the idea of an ‘expansionary fiscal contraction’: that cutting the budget deficit sharply would so boost confidence in the private sector that companies would step up their investment and recruitment programmes and the economy would grow faster than if the deficit had not been cut. Patently, this has not happened.

Companies, worried about the outlook for demand, have been understandably reluctant to invest and recruit. The economy has not grown at all in the last five quarters.

Even so, as the budget highlighted once again, there is no prospect of the chancellor deviating from the main thrust of his fiscal plan. As a result, interest has grown in the idea of ‘balanced-budget fiscal expansion’: a mix of tax and spending measures (usually involving extra infrastructure investment funded by temporary tax hikes on those with a low propensity to spend) that boost economic activity in the short term without changing the government deficit projections.

The IMF, in its World Economic Outlook published last week, urged countries ‘that are not under market pressures and where taxes are not high’ to undertake such measures. The UK would seem to fit this bill but the chancellor has given no indication that he is listening and, with the budget now gone, the chances of a further fiscal statement before the autumn statement in November are very slim.

It seems, therefore, that growth in the UK will be dependent on inflation falling and easing the squeeze on household budgets. One of the main reasons for the weakness of growth in 2011 was price inflation increasing to 5 per cent while earnings rose by little more than 2 per cent. As a result, real disposable incomes contracted by 1.2 per cent (the second largest drop in the post-war period).

The big hope for 2012 is that price inflation will fall, so that real incomes start to increase again. However, the latest figures, showing inflation of 3.5 per cent and an annual increase in regular earnings of just 1.6 per cent, are not overly encouraging.

Even in the absence of a further worsening of the eurozone crisis, the risk therefore – whatever the first quarter numbers show – is that the UK will experiences another year of moderate growth in GDP at best in 2012. If so, unemployment seems sure to remain well above 2.5 million.

In such circumstances, the prime minister and chancellor may have to get used to seeing opinion polls showing the public have little faith in their handling of the economy.


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