The decision by Moody’s Investors Service to cut the U.K.’s credit rating is significant, though not because it told financial markets anything they didn’t already know about Britain’s limping economy. The move puts George Osborne, the country’s beleaguered chancellor of the exchequer, under even greater pressure to change course.
He ought to do just that. The reason isn’t the downgrade; it’s that his policy is failing.
Osborne’s latest embarrassment is his own fault. He often justifies his austerity-first fiscal policy by saying that, without it, the country’s triple-A rating would be in jeopardy. He attacked the previous government and even called for an election when public debt was put on negative credit watch in 2009. Judged by his own criterion, he has flopped.
Osborne faces not just the routine derision of the opposition Labour Party but, tellingly, mounting skepticism within his own party. The course change the U.K. needs may require a new chancellor, and the downgrade may have moved that moment closer.
The chancellor isn’t relenting, however. Responding in Parliament to a question about the downgrade, Osborne argued to nobody’s surprise that the lowered rating didn’t matter. He said there would be no change of course. “This government’s economic policy is tested day in and day out in the markets, and it’s not been found wanting today,” he said.
In a way, that’s true. The pound, drifting down for months, fell to a new low against the dollar. Long-term interest rates, on the other hand, hardly budged. On the first day of after the downgrade, U.K. government bonds even performed better than their top-rated German counterparts.
It would be strange had the markets reacted otherwise. Aside from the timing, the downgrade wasn’t a shock: The ratings companies mostly follow rather than lead the markets. Yet Osborne’s critics inside and outside the ruling Tory Party will draw strength from the setback, which adds to the uncertainty about where economic policy is headed.
Here’s where it should head, as we’ve argued before. The fiscal squeeze turned out to be too much, too soon. The government’s zeal to stabilize the ratio of public debt to gross domestic product is admirable, but its front-loaded approach proved self-defeating. The Treasury subtracted too much demand at a time when monetary policy, trapped by the floor on nominal interest rates, can’t make up the difference. This has slowed growth so severely that the debt ratio, far from falling, keeps going up.
The U.K.’s continuing ability to borrow at very low interest rates isn’t a signal that all is well with fiscal policy, as Osborne says. Rather, it’s a sign of well-controlled inflation expectations and untapped borrowing capacity. In other words, it’s an opportunity to moderate the path of fiscal consolidation by borrowing more in the short term. Doing so would support the recovery and make the long-term goal of stabilizing, then reducing, total debt more credible.
This is an awkward adjustment for a chancellor who rashly emphasized the need for a big fiscal down payment and who likes to boast about his refusal to deviate. Retreating under pressure is something no politician -- least of all a tough-talking British Tory -- likes to do. Yet that is what’s required. If Osborne can’t find a way to do it, Prime Minister David Cameron should replace him with somebody who can.
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