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Cameron's Leap Off the Fiscal Cliff

Britain embraced austerity instead of following the advice of its own economic giants. What was David Cameron thinking?

How did Britain end up with such a terrible economic policy? The birthplace of John Maynard Keynes, John Hicks, and other economic giants was just starting to recover from the global financial crisis when its new leaders forced it back into recession with enormous cuts to the public sector. Two years into their government, the failure of the Tories and their coalition partners, the Liberal Democrats, looks like a case of overriding ideology mixed with naïve mistakes.

The British economy is the same size now, roughly speaking, as it was at the end of 2006, well before the onset of the global financial crisis. Since the most recent peak in early 2008, GDP has shrunk by about 3 percent, after adjusting for inflation.

Clearly, the United Kingdom's problems are not all the fault of its current government, which took office in May 2010. After a promising start in economic policy -- independence for the Bank of England and "golden rule" budgeting, which eliminates deficits over the economic cycle -- the governments of Tony Blair and Gordon Brown lost their fiscal discipline and went along too easily as their American counterparts embraced financial deregulation instead of addressing systemic risk. Mervyn King, the governor of the Bank of England since 2003, and the Financial Services Authority, the industry's independent regulator, must also share the blame for the UK's travails.

Yet in the past two and a half years, the current government of Conservatives and Liberal Democrats, led by David Cameron as prime minister and George Osborne as chancellor, has chosen to inflict unnecessary economic pain on its people. The economy was on the cusp of its fifth straight quarter of growth when the government took office, but total employment had fallen for 7 of the past 10 quarters. The new government decided that the time was ripe for massive cuts to public services and employment. Over the next three years, 628,000 government jobs -- about 10 percent of the entire public sector -- would disappear.

As followers of the "fiscal cliff" debate in the United States surely know, a huge cut to government spending at a fragile moment in an economic recovery can risk sending a country back into recession. And indeed, this is what occurred in the UK: three straight quarters of economic shrinkage starting in 2011 and anemic growth thereafter.

How did this happen? Even in 2005, long before their alliance with the Liberal Democrats, Osborne and his cohorts in the Conservative Party were calling government spending unsustainable. As many right-leaning parties had done before them, they called for a combination of tax cuts and spending cuts that would, in theory, reduce the government's deficits.

At the time, the Lib Dems called the Tories' plans "flaky and unrealistic." In retrospect, the rhetoric on both sides was somewhat overblown. The UK's overall debt in the public sector did climb over the next couple of years despite the growth of the UK economy - apparently the result of a political choice to abandon the "golden rule." But the change in debt was only slight, to 36.4 percent of GDP in the 2007-08 fiscal year from 35.1 percent two years earlier.

By the time Cameron took over in May 2010, the situation was very different. After two years of crisis, the country's debt had shot up to 53.1 percent of GDP because of lower tax revenues, greater demand for public services, and some costly bank bailouts. The first two of these factors were to be expected in an economic downturn; the government used its ability to protect people, to the extent possible, from the full pain of recession. The third was unusual, but unlikely to recur anytime soon.

Nevertheless, the new government remained committed to the plans it had set down five years earlier, in a completely different economic situation. Rather than thinking twice about making deep cuts to the public sector while unemployment was still high, Cameron and Osborne doubled down. They had already decided that 35 percent of GDP was too high for the UK's national debt, even though only Canada had a lower number among the G-7 economies in 2005. Naturally, debt over 50 percent of GDP made them even more determined to wield the axe.

Their main mistake, of course, was in timing. At some point, the UK would have to cut spending and reduce its debt. But 2010 was not the right time. The recovery was young and still precarious, and the increase in debt had not resulted in higher borrowing costs for the government. On the contrary, rates were lower than what they had been in 2005.

So why did this happen? Perhaps, for a start, because the leaders of the governing coalition had little training in economics. Cameron's tutor in Oxford's Philosophy, Politics, and Economics program was Vernon Bogdanor, an expert on British history, constitutional issues, and political systems. Osborne may have had even less exposure to the fundamentals of economic policy; his degree is in Modern History, which sounds quite recent but ends at Oxford somewhere around 1914.

In retrospect, it seems likely that the Conservative Party's current leaders chose their economics via their politics. Their time at Oxford spanned the late 1980s and early 1990s, when Thatcherism and its laissez-faire doctrines were in full force. Embracing the party meant believing in small government and a diminished role for the state in the economy as a whole, with little consideration for the economic circumstances of the moment.

Starting in 2005, Osborne wrote repeatedly of the need to cut taxes and spending in order to compete with other advanced economies. Yet he and Cameron allowed these long-term goals to drive what should have been a short-term economic policy designed to mitigate the UK's recession. Today, most economists accept the importance of fiscal policy as a short-term stabilizer in the economic cycle, and few would recommend the sort of fiscal austerity that Cameron and Osborne inflicted on the British people in the middle of a severe downturn. In essence, they were trying to treat a gunshot wound with diet and exercise. The patient is still waiting for intensive care.

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Daniel Altman

The Self-Driving Economy

Will we even need central bankers in a few more years?

Are central bankers the most overrated workers in the global economy? When Mark Carney, the governor of the Bank of Canada, was hired by the Bank of England this week, the financial media reacted as though the young Brazilian soccer star Neymar had signed for Barcelona -- a well-known prodigy had finally jumped to the big leagues. It's hard to believe the hype around central bankers, though, when a computer might do the job just as well.

There's no doubt that the job of a central banker is an important one. Countries have increasingly come to rely on monetary policy to smooth out the bumps in their economic cycles. Central banks are usually charged with controlling inflation by expanding and contracting the money supply, and sometimes with protecting their countries from adverse exchange rates.

A few central banks, like the U.S. Federal Reserve, are also supposed to support employment through economic growth, an addition that makes the job more complicated both logistically and politically. Some others, like the Reserve Bank of India, are not even independent of the other branches of government; political leaders can thus impose their will on central bankers, with the result that the bank's credibility -- its main asset when setting expectations about interest rates and the money supply -- can diminish to zero.

Yet for central banks whose main job is simply to control inflation independently of the rest of government, there's not much mystery. You could easily set up a computer to open the monetary taps when inflation was too low and start sucking money out of the economy when it was too high, in both cases stopping as inflation reached a preset target. And John Taylor, an economist and former Treasury official, even came up with a rule-of-thumb that fit the Fed's broader mandate to maintain full employment.

Alan Greenspan did his best to create a mystique around his post as chairman of the Fed with oblique pronouncements and regal surroundings, but his performance through the 1990s -- and indeed up until 2002 -- seemed to follow the "Taylor Rule" quite closely. After that, of course, he left the taps open far longer than a computer would have, blowing up the American credit and housing bubbles that would burst with devastating effect.

Greenspan may have been trying to bolster the reelection chances of George W. Bush, whose tax cuts he backed in an unusual intrusion into fiscal policy. Or he may have been trying to ensure that his final term ended during a boom, in an attempt to cement his legacy. Either way, a dispassionate computer might have done better for the American people.

What's less clear is whether a computer would have done better than central bankers during the global financial crisis. The deep downturn in economic activity required them to take creative and dramatic action to save the global economy from freefall. Unprecedented forms of monetary support like Ben Bernanke's "credit easing" and the return of Operation Twist could hardly have come from a computer programmed to buy and sell the same government securities over and over again.

A computer would also have fallen short at the European Central Bank, despite its narrow focus on inflation. Last year, the growth rates of the 17 economies in the eurozone ranged from -7 percent in Greece to +7 percent in Estonia, adjusted for inflation. How could you set a single monetary policy for all of these countries? It would be impossible for anyone, human or machine.

With these experiences in mind, the right way to think about monetary policy may be like driving a car on the highway. Today's cars can be driven manually or using cruise control. Under normal conditions, cruise control works just fine, maintaining a constant speed by adjusting the amount of fuel going to the engine. When the driving gets a little hairy, you want humans in charge. Their reactions may not be perfect, especially in retrospect, but the cruise control computer doesn't have the same analytical ability or range of available actions.

The driving has certainly become pretty hairy in the United Kingdom, and so it's understandable that the Bank of England would want to draft a foreigner widely seen as at the top of his field. To his credit, Carney is nothing like Greenspan -- his statements are sharp and transparent, using a combination of plain language and data to convey his conclusions. But the days of stardom for people like Carney may be numbered.

Put simply, the computers are catching up. Within a decade, self-driving cars will likely become commonplace on American highways. Just like central bankers, the cars will have to process a lot of information quickly and use a limited number of tools to choose a safe path forward despite constant uncertainty.

Of course, self-driving cars will have to perform as well or better than humans, even in the most difficult situations. Yet if a rule as simple as Taylor's would already have performed as well or better than Greenspan did throughout his entire tenure at the Fed, then surely a computer to replace Bernanke or Carney is within the capacity of current technology. The only questions left are who will program it, and who will be the first to give it a test drive?

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