The Observer, Saturday 13 October 2012 21.08 BST
George Osborne’s drastic deficit-cutting programme will have sucked £76bn more out of the economy than he expected by 2015, according to estimates from the International Monetary Fund of the price of austerity.
Christine Lagarde, the IMF’s managing director, last week caused consternation among governments that have embarked on controversial spending cuts by arguing that the impact on economic growth may be greater than previously thought.
The independent Office for Budget Responsibility implicitly used a “fiscal multiplier” of 0.5 to estimate the impact of the coalition’s tax rises and spending cuts on the economy. That meant each pound of cuts was expected to reduce economic output by 50p. However, after examining the records of many countries that have embraced austerity since the financial crisis, the IMF reckons the true multiplier is 0.9-1.7.
Calculations made for the Observer by the TUC reveal that if the real multiplier is 1.3 – the middle of the IMF’s range – the OBR has underestimated the impact of the cuts by a cumulative £76bn, more than 8% of GDP, over five years. Instead of shaving less than 1% off economic growth during this financial year, austerity has depressed it by more than 2%, helping to explain why the economy has plunged into a double-dip recession.
Labour seized on the IMF’s intervention as a vindication of shadow chancellor Ed Balls’s argument that the cuts programme is self-defeating. “The IMF’s analysis should be a wake-up call for David Cameron and George Osborne,” said the shadow chief secretary to the treasury, Rachel Reeves. “It’s time the prime minister and the chancellor listened to the evidence, accepted their plan isn’t working and changed course.”
TUC general secretary Brendan Barber said: “The chancellor has repeatedly used the IMF as cover for his austerity strategy, despite warnings that deep spending cuts in the midst of a global turndown would make a bad situation worse. Now that the IMF has admitted spending cuts could hit the economy at least twice as hard as it previously thought, the government has all the evidence it needs to change course.”
Neal Lawson, director of left-wing pressure group Compass, said, “the cuts were never going to work, but these calculations show the effect is bigger than anyone judged. The economy isn’t suffering from government borrowing but a severe lack of demand that only the government can fix.”
Osborne told reporters in Tokyo that the IMF does not allow for the boost provided to growth by the Bank of England’s £375bn of quantitative easing. “The point I would make about their study of the fiscal multipliers is that they explicitly say they were not taking into account offsetting monetary policy action. In the UK, I would argue we have a tough and credible fiscal policy to allow for loose and accommodative monetary policy and I think that is the right combination.”
But many economists believe the dent in growth caused by austerity policies may be larger than first thought, because the financial crisis has left banks starving firms and households of credit; and with many countries cutting back simultaneously, it is harder to fill the gap created by cuts with demand for exports.
Former monetary policy committee member Danny Blanchflower said: “In a way, the surprise is that it’s taken everybody so long to work it out: Keynes knew it in the 1930s. This is the ‘long, dragging conditions of semi-slump’, and the multipliers are likely to be larger when you’ve got banks that aren’t lending and you’re coming out of the longest recession in 100 years.”
Adair Turner, chairman of the Financial Services Authority, said that the Treasury should have pumped even more into Britain’s banks during the credit crisis to leave them in a stronger state. “The recovery from recession has been far slower than most commentators and all official forecasts anticipated in 2009,” he said. “That reflects our failure to understand just how powerful are the deflationary effects created by deleveraging in the aftermath of financial crises.”
The OBR, set by Osborne to give an independent assessment of the economy, will publish a report on Tuesday explaining why it has consistently overestimated economic growth, and is expected to touch on the issue of whether the cuts are taking a greater-than-predicted toll. At its last forecast, in March, it predicted 0.8% growth this year; the IMF now expects the final figure to be -0.4%.
• This article was amended on Sunday 14 October to add the word “implicitly” to clarify how the Office for Budget Responsibility used a “fiscal multiplier” to estimate the impact of the coalition’s tax rises and spending cuts.