So looking back to my earlier blog the inevitable has happened, the UK has lost its AAA credit rating, surprise, surprise! It was just a matter of time but what does the loss mean to us? Well not a lot actually and this is the point. The chancellor has been using this rating to justify the drastic cuts the country has experienced, in order to reassure the markets. The reality is however that Britain is still seen as a safe haven for investors and in addition many other major countries such as America and France have also lost their AAA ratings. This means that the government will still be able to borrow at low costs for a while yet. So what has went wrong?
Well firstly you will here a lot from the chancellor about ‘the mess the last labour government left the country in’, however when the coalition was installed the economy was recovering albeit slowly. However at this time the chancellor decided to raise VAT this as argued in a recent guardian article wiped 1% of GDP annually by flat lining demand.
To further reduce aggregate demand in the economy, the government set about cutting spending in many areas, all in the name of reducing the deficit and reassuring the markets. However the total amount of debt in the economy has increased. Why? Well when the economy is shrinking tax receipts tend to go down whilst government spending on areas such as unemployment benefits increase. This is, in the classic Keynesian view, why cutting spending during a recession is self defeating.
The government has hoped that monetary policy through lower interest rates would counteract this fall in demand. It was also hoped that these lower rates would devalue the pound and make UK exports more competitive. However progress has been slow and the UK is still running a large deficit in its balance of payments. Demand in the global economy is at a low and therefore the gains from a currency devaluation are small. Even more worrying is that during a time when we are trying to re balance our economy towards net trade, David Cameron is proposing a referendum on the EU, the UK’s largest trading partner.
These facts again leave an observer like myself dumbfounded. Whilst monetary policy has failed to deliver the goods, Austerity hasn’t worked and if anything it has exacerbated the problem. Demand within the economy is flat, total national debt is higher than ever and the UK has lost its AAA credit rating. Its time for the government to hold its hands up and admit that an injection of spending is needed to kick start demand and economic growth as argued by prominent economists such as Joe Stiglitz. Ultimately economic performance is what will determine the confidence of the markets and thus the UK’s credit rating.