27 June 2010

Will the UK austerity budget sink the Tories?

Probably not.

The conventional wisdom about the political economy of fiscal adjustments goes more or less as follows.  Deficit reduction policies cause recessions which (in addition to the direct political costs of tax increases and spending cuts) create political problems for incumbent governments.

Fortunately the accumulated evidence paints a different picture.  First of all, not all fiscal adjustments cause recessions.  Many even sharp reductions of budget deficits have been accompanied and immediately followed by sustained growth rather than recessions even in the very short run.  These are the adjustments which have occurred on the spending side and have been large, credible and decisive.  Second and this is most likely a consequence of the first point, it is far from automatic that governments which have reduced deficits have been routinely not reappointed. Governments which have initiated thorough and successful fiscal adjustment policies have not systematically suffered at the polls.  This has been especially the case when the electorate has perceived the sense of urgency of a crisis or in some cases in the presence of an external commitment.   On the contrary fiscally loose governments have suffered losses at the polls.

Alberto Alesina, Fiscal adjustments: lessons from recent history, April 2010

1 comment:

Anonymous said...

Alesina is wrong. Krugman has documented that the examples cited (I haven’t looked at the Alesina paper so can’t see if he has picked others) of large deficit reductions/spending cuts being followed by growth were accompanied by either or both a large drop in interest rates, and a large increase in exports. Of course, interest rates cannot drop any lower, and for the southern Eurozone, there can be no exchange rate depreciation (and so no large increase in exports) against their main trading partners. And Germany and France do not look like they are going to increase domestic consumption any time soon.


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