This continued economic weakness will do long-run damage to the supply side of the economy. This will include the loss of motivation and skills of many workers who find themselves in long term unemployment. It will also lead to the loss of productive capacity, which had initially fallen into disuse but is eventually derelict and scrapped.
Interestingly the NIESR suggest, as I have, that there is a need for a moderate and targeted fiscal boost. They say:
It remains our view that fiscal policy could be used to raise aggregate demand in the economy with little to no loss of fiscal credibility. We have never and do not now advocate scaling back the government’s medium- to longer-term policy of fiscal consolidation. However, the UK also suffers from a lack of demand in the short term. As we noted in our January Review, a 1 per cent of GDP increase in government investment this year would boost GDP by around 0.7 per cent, assuming no reaction by the MPC. A temporary boost to net investment, which has been cut extremely sharply, would have no direct effect on the government’s primary fiscal target of balancing the cyclically-adjusted current budget in 2016–17.
Interestingly there is a one year estimate of the multiplier effect in that paragraph. Suggesting that governments are not really that powerful when it come to demand management.
I think this is a good interesting story, it once again highlights the ongoing conflicts of economic rationality vs politics. The sad truth is that yes a fiscal boost would be sensible and benefit the economy but it would undermine the views of the dominant conservative leaders; as they still stand behind their austerity measures. Another factor I think is an issue with this situation is the loss of potential investment. The fall in productive potential is more than just unemployment alone - it falls further due to a lack of innovation and willingness to invest due to the era of uncertainty on the horizon.
ReplyDeleteI agree mostly with Brendan in that a fiscal boost is pretty necessary right now, but I think that austerity has little part right now; it doesn't matter if the government budget is in problem; there will be no deficit to recover if the entire economy goes under.
ReplyDeleteIf you look at the multiplier statistic they give us; 70% of the injections are recirculated. This is also not assuming multiple circulations. It's clear that an increase in government expenditure can only do good for the economy. While it is true that currently the problem stems from a stubbed AS curve, I think it would be better in the short-run to move AD into the vertical strip of AS, then expand AS later, when the economy is in a more favourable position in terms of GDP and production. In a similar manner, government austerity can also be dealt with at a later time.
In my opinion, the fact that a government needs to "keep face" and let the economy bleed as opposed to throwing their hands up and admitting their failure is one of sheer stupidity. If they got voted out, they can get voted back in when the other party makes an equally stupid mistake; which it inevitably will - politicians are silly like that.
The underlying message of "permanent damage to supply side" is somewhat worrying, though. As mentioned, a big factor in slow growth and stunted economic performance comes from a shift of AS. If that's now suffering from cancer, recovery alone looks difficult, let alone new growth.
It'll be interesting to see how this will be tackled. Here's hoping something develops within the next few weeks so that we Grecians have more ammunition for the exam.
zy is wrong
ReplyDeleteThe multiplier effect is multiple circulations, its in the name.
The problem is not a 'stubbed' AS curve, but a lack of consumption and investment (which is AD)
We don't want to move up the vertical of the AS curve as this will just cause inflation.
We want to use up our spare capacity first, which can happen even with the necessary austerity measures.
Government austerity needs to happen now because the current deficit is unsustainable.
Is it better to have no money in 5 years, or less money now, and more in 8 years
Recovery does not look difficult it is happening now, we have been recovering since '09!
This problem of damaged AS is tackled by growth and encouragement for growth, which is mostly private sector anyway, which is currently having no problems.
which is whats happening
I think that the NIESR point is that AS is being damaged as capacity is lost. AD is a problem too of course.
DeleteHowever the private sector is having massive problems! In fact it is why the government plan has failed as it assumed private sector growth.