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The British economy is an embarrassment. Embarrassing, that is, to the economists for whom it was exhibit A in the case against austerity.

For a while, it appeared to be doing what was expected of it – which was very little. But as Gavyn Davies notes in the Financial Times, things have changed:

“The acceleration in UK GDP growth during 2013 has far out-stripped that in any other leading economy, following a period of several successive years in which the opposite was the case.”

In fact, the British economy is going out of its way to leave the experts red-faced:

“According to ‘nowcasts’ for economic activity… UK growth has been running at above 5 per cent annualised for several months, compared to about 1.5 per cent at the start of the year. For a while, sceptics argued that these nowcasts were being over-influenced by buoyant survey data, but there is now evidence from hard economic data that the take-off in activity is genuine.”

In an ironic little twist, the left-leaning anti-austerity brigade are now resorting to an argument previously used by hardline rightwingers, which is that the Osborne austerity isn’t all it’s cracked-up to be:

“One possibility, which has been widely suggested, is that the recovery has followed from a reversal in the government’s fiscal squeeze. If this were true, it would suggest not that ‘austerity works’, but that it needs to be relaxed in order to allow the economy to recover further. This does not seem to be the case, however. After removing the effects on the fiscal arithmetic of large one-off financial events such as the privatisation of Royal Mail and the remittance of Bank of England profits to the Treasury, the underlying fiscal stance seems to have continued tightening in 2013-14.”

Davies quotes estimates of a fiscal tightening of between “1.2-1.8 per cent of GDP” this year, which is roughly what we’ve seen each year since 2010. So, no let up in austerity then – indeed as the Chancellor made clear in his Autumn Statement it is set to continue for years to come.

So, what does explains the British recovery?

Not an export boom, because there hasn’t been one. Nor have we seen a boost to business investment, which has “also stayed in negative territory.” Instead, Gavyn Davies puts it down to a recovery of confidence among consumers and in the housing market:

“This was not driven mainly by a recovery in real wages or real disposable income, though there has been some recent improvement as price inflation has fallen. It was driven mainly by a drop in the savings ratio, as consumer confidence suddenly recovered. That triggered a surge in pent-up demand for housing and consumer durables, which had been delayed in previous years…

“There is evidence that economic uncertainty fell sharply after the risk of a collapse in the euro diminished late last year. With the torrent of apocalyptic news flow abating, precautionary savings seem to have declined.”

This is all a bit awkward for europhile opponents of austerity. It wasn’t the restoration of fiscal sanity that scared consumers away, but the monumental folly of the single currency.

That said, it wasn’t just the left who got it wrong. There are some on the right who should also hold their hands up. The deficit-deniers for a start – and also those whose answer to the financial crisis was to let banks go bust and put up interest rates.

These measures might have helped to prevent the crisis if they’d been in place before it got started, but as a response they’d have amounted to a scorched earth policy that would have delayed recovery by years:

“One lesson from this experience is that the normalisation of the banking sector, which is the main fundamental force behind the easing in effective monetary policy (admittedly with some help from the fiscal bribe in the Help to Buy Scheme) can unleash a great deal of pent-up demand, even in a very depressed economy experiencing general fiscal tightening.”

Now, that recovery is finally underway, there’s no need to rush into raising interest rates. They’ll have to go up eventually, but there’s plenty of other things to do first, like ending QE, winding down Help to Buy and further banking reform.

Gently does it.

16 comments for: The British economy: Where did it all go right?

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