Austerity Posterity

Updated: Dec 27 2012, 06:50am hrs
Shinzo Abe wants to dump austerity, this worked in the US, and the UKs paying the price for not doing so

Shinzo Abe may or may not be able to revive the Japanese economy, but the central plank of the new Japanese Prime Minister is to spend more money and to try and bring in inflation through greater monetary easingthis, the hope is, will cause the yen to lose value and help revive the economy. Sceptics have argued this is a high-risk gamble since higher inflation can play havoc given Japans huge debt, but the short point is Japan joins the list of countries whove realised austerity isnt delivering.

What have outcomes been Admittedly, long-term interest rates for sovereign bonds have declined to an all-time low for the UK, which sought to reduce its deficit from day 1. But, so have they for the US, which initially ran huge budget deficits to finance the $700 billion stimulus, much to the horror of the bond-vigilantes. But while the US, if it doesnt fall off the fiscal cliff, looks like its out of a recessionwith a projected 2% and 2.8% for 2013 and 2014, respectively. The UK, on the other hand, is almost certainly headed for a triple-dip recession. All in all, UK output today is 3.3% below the pre-Lehman GDP, whereas the US output is at least 2% more than pre-Lehman GDP. And George Osborne, the Chancellor of the Exchequer, has officially accepted that the government has failed to meet its budget targetsultimately, the fiscal deficit depends on revenue growth through growth in output. The UKs fiscal deficit is actually set to be more than the USs in 20136% as compared to the USs 4%.

So, there is good reason to believe that Keynes was right. Given sticky wages, restructuring takes time. And since highly leveraged households and firms cannot push spending and investment needed for speedy recovery, higher government-spend has to take up the slack, more so in post-recession economies that have spare capacity. Theres a lesson in here for Europe.