Economists Debate The Philosophy Behind British Budget Cuts : The Two-Way Some economists argue that cutting budgets and raising taxes during a downturn will only lengthen the economic hardship, not shorten it.
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Economists Debate The Philosophy Behind British Budget Cuts

The front pages of some British national newspapers are pictured in London, on October 21, 2010, following the governments spending review cuts announced Wednesday. LEON NEAL/AFP/Getty Images/AFP hide caption

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As people pore through the British budget cuts announced yesterday, some analysis critical of the move is making the rounds. First, who is being hit, well, the Telegraph ran some figures and says it's the middle class:

Households with an income of more than £48,000 will each lose about five per cent of their annual earnings by paying thousands of pounds extra in tax while losing benefits and access to public services, Treasury figures indicate.

And it's that kind of hit that has some analysts worried that these kinds of cuts will prolong the economic downturn, not help it. Writing in the Guardian, Joseph Stiglitz, says the moves by the British Government ignore economic reality.

There is a shortage of aggregate demand – the demand for goods and services that generates jobs. Cutbacks in government spending will mean lower output and higher unemployment, unless something else fills the gap. Monetary policy won't. Short-term interest rates can't go any lower, and quantitative easing is not likely to substantially reduce the long-term interest rates government pays – and is even less likely to lead to substantial increases either in consumption or investment.

The New York Times reports on this as a battle between supporters and antagonists of John Maynard Keynes, and the whole idea of Keynesian economics. To incredibly simplify, that the right response in a downturn is government stimulus. But some in Britain, and elsewhere in Europe, reports the Times, have a different view.

“Keynsians are regarded here as heterodox, not orthodox,” said Andrew Lilico, an economist at the London-based research institute Policy Exchange, which has close intellectual ties to the Conservative Party. “And it goes back to one thing: we have this internal fear of losing control of our deficits and having foreigners telling us what to do. There is also a sense that deficits of this scale are morally lax.”

Brad de Long, an economist at UC Berkeley, and a prolific blogger, is quoted in the Times as mourning the dismissal of Keynes. But he says it's not just Keynesian thinking the British government is ignoring, but that of legendary conservative economist Milton Friedman. de Long quotes Friedman at length, here's one paragraph where he describes his reaction to those economists who preach tighter government spending during a downturn, what Friedman called "the London (really Austrian) view."

The intellectual climate at Chicago had been wholly different. My teachers... blamed the monetary and fiscal authorities for permitting banks to fail.... [T]hey issued repeated pronunciamentos calling for governmental action to stem the deflation... "large and continuous deficit budgets to combat the mass unemployment and deflation of the times... Federal Reserve banks systematically pursue open-market operations with the double aim of facilitating necessary government financing and increasing the liquidity of the banking structure."