3.1 Austerity and deficits - Debt/GDP ratio

Question 1

What is the difference between austerity and stimulus?

Answer 1

Austerity is contraction
- Cut G or raise T
- Raises budget surplus (or reduce deficit)

Stimulus is expansion
- Raise G or cut T
- Provide short term economic stimulus

Question 2

What were Osbornes reasons for why austerity was necessary?

Answer 2

1. Strucutral deficit in government spending
2. Government to debt GDP ratio was too high, unsustainable

High government debt is a significant vulnerability when emerging from recession - likely to trigger another crisis

Question 3

What was the macro environemnt after 2008?

Answer 3

• 2010, GDP growth only just recovering
• Unemployment 8% - 5.3% in 2007

Question 4

What do we look at when we justify the austerity?

Answer 4

• If there is structural deficit
• If Debt - GDP ratio is problem
• When it occurs

Size of austerity justification:
- Arguments on how big
- When debt-GDP ratio becomes problem
- Did it damage GDP or growth

Arguments tend to link with the productivity problem

Question 5

How much austerity was there?

Answer 5

• Increased at start of financial crisis
• Reductions in deficit since then
• Reductions over longer time period than expected in 2010
• Mostly decline in government expenditure - forecast to continue, but chang ein government and covid prevented that

Surplus of -0.5% between 2009 and 2010

Deficits:
2010 - 1.5%
2011 - 2.3%
2012 - 1%
13 - 1.5%

Fluctuating since

Question 6

What is a sturctural deficit

Answer 6

The difference between spending and receipts - any deficit must be financed by borrowing

They are made up of a cyclical and permanent component:

Total managed expenditure

Also could be calculated with the difference between cash terms and percent of national income

Question 7

What was the agreement with regards to austerity after the recession?

Answer 7

Agreed austerity required to remove structural deficit
- Budget deficit in part as a consequence of additional spending before the recession
- Combined with expansionary fiscal policy in 2007-8

Question 8

What was the initial expectation of the austerity?

Answer 8

• Enough to remove structural deficit by 2017
• In 2017 Office for Budget responsibility forecast a structural deficit of 1.3% of GDP in 2021-22

The plan was enough to remove the deficit, but turned out to be insufficient despite austerity lasting longer and with larger spending cuts

Question 9

What is the debt-GDP ratio?

Answer 9

1. Government debt
   - Question about sustainability of government debt usually expressed as a ratio to GDP (national income) - worry about the level of debt and the direction it is heading in

A low debt-GDP ratio can be affordable i.e. of 40-90
- Questions on how high we allow the ratio to get - if there is a point it damages the economy and if debt is heading in a sustainable/unsustain

Question 10

What is the relationship between debt and growth

Answer 10

High initial debt tends to be associated with lower growth

Reinhart and Rogoff identified 90% as the critical value

Growth on y axis, Debt-GDP ratio on x axis

Once the debt/GDP ratio exceeds 90% the average growth rate becomes -0.1%
- Although this may be coding errors

Ash and Polin found that when debt/GDP ratio exceeds 90% growth rate on average 2.2%
- Or, if you exclude outliers - countries with very high or low debt - no statistically significant relationship exists
-Message ignored by politicans

However, in practice, the relationship is causal in both directions
- High debt associated with low growth, no evidence of a preicipe

Conclude - high debt is a concern for growth buy overplayed by politicians