"Sir, Chris Giles argues (Comment, October 18) that austerity is not to blame for UK output growth being much weaker than forecast two years ago by the Office for Budget Responsibility. So far, he says “nothing suggests an effect of fiscal consolidation on growth. Austerity cannot explain feeble exports and private consumption.” But in fact the OBR assumed (except in the case of cuts to capital investment) that “fiscal multipliers” were much less than one – in other words, that cutting current public spending and raising taxes would actually lead to one or more of higher private consumption, higher business investment, or better net trade.
In normal times, this is plausible: lower deficits would lead to lower interest rates for businesses and consumers and a weaker exchange rate. But these mechanisms are not operating now: short-term interest rates are at the zero lower bound, and long-term interest rates, here and across the world, are driven primarily by low growth expectations (with corresponding expectations of extended low short-term rates) rather than deficits. Sterling has actually risen slightly, while no one seriously argues any more that the “confidence fairy” has boosted either consumption or business investment. If such a fairy exists, austerity has scared her away.
Mr Giles argues correctly that multipliers are likely to differ across countries and over time. But he draws the wrong conclusion. Both theory and evidence suggest that under current circumstances multipliers in the UK are likely to be considerably larger than the OBR’s estimates, based as they are on historical experience. As a consequence, the negative impact of fiscal consolidation on growth has been significantly larger than the OBR expected.
This time is different. The multiplier is high (and public investment has already been cut savagely); household deleveraging and emergence from a financial crisis are slow. All this was foreseeable in 2010."