4.1 Effect of Austerity

Question 1

What are the limits of the Deficit/GDP / Debt/GDP curves (%GDP)? Where is it unsustainable

Answer 1

SGP limits:
Deficit/GDP: 3%
Debt to GDP: 60%

Unhealthy:
Deficit/GDP: 6%
Debt/GDP: 120%

Critical:
Deficit/GDP: >6%
Debt/GDP: > 120%

Unsustainable:
Deficit/GDP: >3%
Debt/GDP: >120%

Question 2

Where do some countries land on the graph?

Answer 2

Greece at 15.6% and 130%

Germany at 3.1% and 75%

UK at 11.5% and 68%

Question 3

What was the forecast of net debt and how does it differ?

Answer 3

2010 forecast significantly lower than 2019 forecast for net debt
- appears in 2010 had too much austerity - as time progressed not had quite enough (even though amount increased and lengthened)
- Reoccuring problem of economic growth being much weaker than expected

Question 4

What are the two types of fiscal policy?

Answer 4

Pro cyclical - governments raise spending in booms and forced to retrench in downturns, exacerbating upswings and downswings

Counter cyclical - fiscal stimulus to moderate the downturn, fiscal contraction during boom periods, to prevent overheating

Question 5

Which type did Keynes agree with this? Was he right?

Answer 5

Keynes favoured counter cyclical - boom, not the slump, is the right time for austerity
- Most economists agree

Structural deficit and debt/GDP ratio necessitated austerity when appeared recession was over (Arguably 2010)
- Why did GDP growth perform so badly post recession - was this austerity?

Question 6

What was the effect on GDP

Answer 6

Graphed on week 4 page 1, basically average growth rate plateud and started to grow after 2017 however at a much lower rate

Question 7

What did the effect of austeity depend on

Answer 7

Need to know how large the changes in fiscal policy were, and how large multiplier is

Multiplier: ratio of change in national income to change in fiscal policy

If multiplier is 1, a £1bn cut will cause GDP to fall by £1bn

Investment and incomes drive fiscal policy

Question 8

How big is the multiplier? What is the effect in the long run

Answer 8

OBR use spending multiplier of 0.6

Public investment multiplier of 1

Income tax multiplier of 0.3

Recently IMF argued in recessions could be in range of 0.9 - 1.7% - short run multipliers

Long run:
- Multiplier is 0
- It deays over time, eventually becoems zero
- Means austerity may shift growth from one year to the next but need up back where we would have done

Effect graphed on week 4 page 1:

Basically dip in growth short run, then fast growth, then growth rate decays back to normal level

Question 9

What effect did austerity have on the UK?

Answer 9

Austerity reduced GDP below the estimated level where it would have been no austerity occured

Even with IMF multiplier effect of austerity on GDP is relatively small - big difference between austerity and the actual performance. The big problem for the UK economy was not austerity, but productivity

Actual GDP level was much lower than expected

Question 10

Summarise stuff

Answer 10

Austerity larger than necessary over short time period,
- Growth low, more austerity and longer

Austerity lowered growth in SR, effect suggested larger than what OBR estimates

Permanent effect on GDP growth/level do not come from standard macro models

For it to be true, multiplier must have bigger effect than estimated, and effects have to be permanent

The extent to which GDP is below trend unlikely to be explained by austerity - problem with long run and not short run growth:
- Austerity coincides with negative shock to underlying rate of technical progress (supply side shock)
- Causes and consequences of that supply side shock become next big economical questions