George Osborne yesterday presented his analysis of why the UK economy has turned the corner in recent months, arguing this demonstrated advocates of a “Plan B” had been proved wrong by events.
He identified two candidate explanations for the slowdown of 2011-12. One school of thought he called the “fiscalist” analysis. According to this view, the UK economy plateaued in 2011-12 because the government’s austerity programme had damaged growth. This was the view of those economists, commentators and politicians that advocated the government switch to a “Plan B” of cancelling spending cuts and raising spending in some areas.
The other school of thought he termed the “financial conditions” view. According to this idea, the 2011-12 slowdown occurred mainly because financial conditions were much worse than expected – partly because the damage to the financial sector was worse, but mainly because the Eurozone crisis meant there was the possibility of a widespread meltdown of the European banking system. Into the “financial conditions” view he added the impact of commodity price rises (raising inflation, though he did not use the word). This was the view of those economists, commentators and politicians that supported “Plan A” (or, he might have added, urged more rapid spending cuts).
Osborne said that the financial conditions view had a straightforward explanation for why the economy had picked up in recent months – namely the easing of financial conditions as the Eurozone crisis abated after the European Central Bank’s announcement of the “Draghi Plan” in late 2012. By contrast, the fiscalist view could not explain what had changed. The UK had proceeded with the chancellor’s planned spending cuts and tax rises, and indeed these have accelerated in recent months. So if the 2011-12 slowdown was the result of domestic not international factors, what were the domestic factors that explained the acceleration of 2013?
That seems a fair case, provided it is not taken too far. A number of Plan B advocates first claimed that Osborne’s plan would cause a huge slump, then switched to claiming it would trap the UK economy in a lost decade of Japanese-style flatlining. They contended that the 2011-12 growth slowdown proved that they were right and urged that Osborne switch tracks before it was too late.
But the 2011-12 slowdown was not overwhelmingly the result of government austerity. History will record that the UK economy slowed in 2011 as the Eurozone crisis