It's been more than three years since the U.K.'s coalition government began aggressively raising taxes and cutting spending in an effort to reduce its deficit. Many economists now agree that this program retarded the recovery, producing a slump worse than the Great Depression.
Yet Harvard economist Kenneth Rogoff, in a column in the Financial Times, argues that those measures made sense as a form of insurance against the sort of crisis that has afflicted countries in the euro area such as Spain and Italy. His case has two parts, neither of which is convincing.
First, Rogoff implies that the U.K. was vulnerable to the same sorts of shocks that battered Spain and Italy. He writes that “in that scenario, U.K. leaders would have been forced to close massive budget deficits almost overnight. That would have been truly catastrophic austerity.”
The comparison is misleading, however. Unlike the 17 countries of the euro area, which share a single currency, the U.K. uses its own. Debts and transactions are overwhelmingly denominated in pounds, which the Bank of England can always create if needed to prevent a crisis. Moreover, government bonds are uniquely useful to U.K. savers in a way that no other asset can be. If you are saving for retirement and expect that your future expenses are going to be denominated in pounds, you don’t have much choice but to own assets denominated in pounds. Anything else exposes you to needless currency risk.
This is totally different from the euro area. Since every country uses the same currency, savers in the euro area can stash their capital wherever they wish -- and move their savings from one country to another at a moment’s notice.
Rogoff’s second point is that previous episodes of high indebtedness in the U.K. were special cases that should not inform today’s policy makers. According to him, Britain’s imperial possessions made it easier to service the large debts incurred to fight Napoleon. Yet many scholars have argued that the British Empire actually cost more money to maintain than it brought in.
Rogoff also suggests that the U.K. was able to service its post-Napoleonic debts because the industrial revolution served as a tailwind. However, productivity experts think that the biggest gains occurred in the late 1800s and early 1900s -- long after the period when Britain’s government debt ratio had peaked. Finally, Rogoff dismisses the gradual repayment of the U.K.’s World War II-era debts because it was only made possible by persistent rapid inflation. That’s true, but Rogoff himself has repeatedly argued that the rich world needs more inflation, rather than less. In fact, at the bottom of his most recent column, Rogoff says that it was a mistake not to have pursued “even more aggressive monetary policy.”
To be fair, Rogoff acknowledges that governments missed an opportunity to invest in needed infrastructure. That caveat, however, doesn’t make Rogoff’s defense of the coalition’s fiscal policies any more convincing.
(Matthew C. Klein is a writer for Bloomberg View. Follow him on Twitter.)