Tag: ConDem

Downgrade our AAA rating? Moody’s has become part of the problem

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It was ideological politicians and fearmongering ratings agencies that launched this damaging austerity experiment

Duncan Weldon, guardian.co.uk, Friday 16 November 2012 11.36 GMT

‘The best thing George Osborne could do is reject the siren voices calling him on to the rocks of more austerity.’ The credit ratings agency Moody’s has announced that it will review the UK’s top AAA credit rating early in the new year. This is the same Moody’s that, back in 2010, was keen to praise the government’s austerity drive as a major factor in preserving the UK’s good credit. So what has changed in the past two years?

Moody’s now appears concerned that, in its words, “the government’s efforts to achieve fiscal consolidation and reduce debt are being hampered by weaker than expected economic prospects”. This is quite obviously correct, if the economy is not growing strongly then tax revenues are weaker and social security spending higher than they otherwise would have been. A country can’t deal with high deficits unless its economy is moving in the right direction. In the past two years, however, the UK has achieved growth of just 0.6% against initial Office for Budget Responsibility projections of 4.6% growth over the same period.

So while it would be wrong to fault Moody’s for correctly pointing out that weak growth means the chancellor, George Osborne, is much less likely to hit his debt targets, it is worth asking exactly why it ever thought such a sharp fiscal contraction was a good idea in the first place?

Moody’s, in common with the government, appears to have seriously underestimated the impact of spending cuts and tax rises on the wider economy. Its warning is an excellent chance for the chancellor to reassess his plans.

Back in October 2010, as the chancellor was putting the finishing touches to his comprehensive spending review, the IMF published some important, but widely ignored, research. IMF staff looked at the likely impact of spending cuts and found that, in normal times, every 1% of GDP of spending cuts reduced the overall size of the economy by 0.5%, a painful but manageable reduction. However, the fund warned that this (relatively) benign outcome depended on interest rates falling and a country’s currency depreciating to boost exports. These two factors would cushion the blow from spending cuts.

In the absence of such factors (and it was always hard to see how UK interest rates could go any lower or sterling could have fallen much further) the IMF found that each 1% of GDP’s worth of spending cuts would reduce GDP by 1% – a one to one ratio. This is more painful and less manageable. Furthermore the fund argued that if countries’ trading partners were also embarking on austerity at the same time, then the impact would be magnified. In this case each 1% of GDP of spending cuts would potentially reduce GDP by 2%. In such cases austerity risks being self defeating, with cuts to government spending simply leading to lower growth, less tax revenue and a bigger benefits bill.

The respected National Institute for Social and Economic Research has now found that this is exactly what is happening across Europe as a whole. Co-ordinated austerity has pushed down GDP and is leading to debt/GDP ratios that are higher than they otherwise would have been. Much of this was foreseeable back in 2010.

The problem for Moody’s is that it was, and is, part of the problem. It was a combination of ideological politicians and fearmongering ratings agencies that launched the great austerity experiment. Two years on the results are clear – lower growth, higher employment and still-high deficits. The extreme cases are Greece, Portugal and Spain where austerity package after austerity package have been met with the same results. Each time the solution appears to be to try the same thing again.

Moody’s has now warned that the government’s “most significant policy challenge is balancing the need for fiscal consolidation against the need for economic stimulus”. The best thing the chancellor could do is reject the siren voices calling him on to the rocks of more austerity and launch the stimulus we need to get the economy moving. This is a U-turn we could all support.

George Osborne’s austerity is costing UK an extra £76bn, says IMF New analysis of figures throws doubt on chancellor’s forecast

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Heather Stewart
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.