Economics Explained, by Evan

Here is a great little article on the Today programme’s website by Evan Davis, looking at the relative merits of Plan A - Austerity - vs Plan B - government spending. He takes the arguments of Jonathan Portes, director of the National Institute of Economic and Social Research, who believes that what’s required at the moment is a short term, temporary fiscal stimulus to boost output and jobs and of Roger Bootle, managing director of Capital Economics, who thinks it would be dangerous for the government to divert from its Plan A of spending cuts.

What we find is that they both agree that cutting won’t create growth. When looking at spending, one of the problems which is specific to the UK economy is that extra spending is likely to become a greater leakage from the circular flow as it will be spend in imports. So the multiplier effect from that spending is diminished. And again, they both agree on that.

(Incidentally, they also both suggest that, as the US is less dependent on imports than the UK, therefore the multiplier effect of government spending in the US is greater as more of the injection will be retained in the economy. Interesting to consider this against this report that the US trade deficit has just worsened due to higher imports….)

Where they appear to differ most is in considering the importance of the reaction of The Markets. For Roger Bootle,this is the major cause of risk and so retaining credibility by sticking to Plan A through thick and thin is the only option. Jonathan Portes agrees that this is an issue, but believes that the extra unemployment caused by the austerity is worse for the economy both in the short term and the long term..

So the conclusion is that it depends on what kind of risk you would prefer to take. Either way, its not very pleasant.