Two Paths: Austerity vs. QE2

Prime Minister David Cameron’s coalition government took office after 13 years of Labour Party rule. Sensing that they had a mandate for change, the government declared that years of deficit spending were over and that they would put forth an austerity budget. As they moved forward, Greece began to falter and concerns about a possible default were raised. These concerns were also raised in regards to Portugal, Ireland, Italy and Spain. (The European Union finally put a plan in place, supported by both Germany and France, that calmed the global bond markets.)

As I pointed out in August (Cameron & Clegg’s Early Days), the government’s call for austerity and specific plans were well received, particularly in view of the contagion that was spreading on the continent. Now that they have been in office for more than six months, we are starting to see that the path they have chosen is not without obstacles as they try to stabilize the economy for the long haul. In mid-January it was announced that the U.K.’s inflation rate was 3.7%, substantially higher than the target rate of 2% and higher than any other western economy. While it may help reduce the high debt levels, it is clearly a reason for concern that stagflation could grip the British economy. This inflation report will make it more difficult to introduce QE2, which “doves at the Bank of England want to retain as an option, will stay stranded in the docks.” (FT January 18, 2011) This past week the U.K.’s fourth quarter GDP figures were announced, and rather than the forecasted increase of .5%, the GDP actually declined by .5%. Most commentators blamed this on the coldest December in the U.K. in more than 100 years. (FT January 25, 2011) It is clear that the Cameron government will need to digest this data and make some adjustments to their plan.

In the U.S. where unemployment remains at 9%, the Obama administration and the new Congress will soon be debating cutting the deficit and the need to continue to “invest” in the economy. The Federal Reserve under Ben Bernanke continues with its bond purchases. Inflation remains at 1.8%, below the Fed’s target rate of 2%, but GDP, which was reported this week for the fourth quarter, grew at 3.2%. If that rate can approach 4%, we should start to see the private sector create enough jobs to insure that we will start to see a substantial drop in the unemployment rate. Early in the week the markets reacted positively to this news and for a short time the Dow Jones rose past the 12000 level, but it quickly fell back based on the turmoil in Egypt. (WSJ January 29, 2011)

As we move forward into 2011, I trust that both governments will continue to monitor their own progress, as well as comparing notes and modifying their game plans where appropriate to insure that the long road back to recovery from the Great Recession continues. Both the Cameron government and the Obama administration appear very committed to expanding global trade with the fast-growing Asian economies, particularly China.

After experiencing summer a week ago in Melbourne and Sydney, Australia, Mary Claire and I are back in New York, where new snow records continue to be set each week! I am starting to be concerned that the weather could prove to be an anchor this quarter on the recovery in the U.S.