UK Austerity

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To try to show that I’m not an unreasonable person, let’s note that while I think austerity budgeting for the United States is nuts, the harsh cuts being planned for the United Kingdom are grounded in a plausible theory: “Clegg and colleagues such as Danny Alexander, Treasury chief secretary, share the Tory view that fiscal consolidation will allow the Bank of England to hold interest rates – currently 0.5 per cent – down for longer and that the private sector will pick up the slack.”

That is a real and specific reason to think that austerity is needed. If not austerity, rate hikes. The theory makes sense logically. How does it look empirically? Here’s recent inflation history in the UK:

This is a graph showing Annual inflation rates - 12 month percentage change

This chart seems open to multiple readings. On the one hand, the inflation rate is falling so the case for rate hikes is weak. On the other hand, the inflation rate is above the target level, so the case for rate hikes isn’t all that weak. The Clegg/Tory view that high deficits will prompt rate hikes is far from an open-and-shut case, but the belief has some basis. If I were prime minister, I would move more judiciously with the short-term cuts than Cameron seems to be—and of course I’d be more attentive to the interests of the poor and less attentive to the interests of the rich in designing the package—but the British seem to be in the “meaningful tradeoff between policy options” zone.

The United States, by contrast, is not. Inflation is low and falling and has been low and falling for some time. Rising inflation is both unlikely and desirable. There’s no reason to raise rates and no reason to worry that it will be necessary to raise rates in the near term.