Britain’s Conservative Coalition Government Manages the Economic Impossibility – Creates Recession and Inflation at the Same Time

Blazing a New Path in Economic Policy Incompetence

It has now been about two years since British voters voted for a coalition government headed by the Conservative Party, with a partnership of the Liberal Democrats, a center left group that abandoned their principles (and their supporters) in order to get a few of its party leaders into leadership positions in the government.  This also means that it has been about two years since Britain’s Conservatives implemented an economic policy that was unique in that it had absolutely no basis in modern Macroeconomic Theory.

The gist of the policy was that the key to economic growth, higher employment and prosperity was to generate “confidence”.  In the Conservative Party’s view, this “confidence” does not result from the belief that the private sector will grow, supported by the public sector.  Instead in their world Conservatives believe that the business confidence needed to invest and hire will come from the fact that the government is reducing its deficit and from lower interest rates.

So the British government set forth on a policy to slightly raise taxes, some of which have been cut back already, and to cut public spending and cut public employment and put a whole lot of people out of work.  The results are exactly what Econ 101 would have predicted, an economy that has returned to recession, with high unemployment and a total absence of any business confidence.

But supposedly one positive aspect of such a policy is that inflation will not be a problem.

A SLUGGISH economy ought at least to enjoy low inflation. Price-cutting should be fierce when jobs are scarce and businesses are fighting for custom.

Instead the headline of that story from The Economist is this

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The economy

Hard going

Steady growth and 2% inflation seem a long way off

May 19th 2012 | from the print edition

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because it turns out that inflation in Britain is way above its target level.

 Inflation rose to 3.5% in March and is likely to remain above the 2% target for another year, according to the Bank of England’s latest Inflation Report.

There is plenty of blame

The committee has blamed high inflation on things beyond its control: the delayed effect of a weaker pound, successive increases in VAT and persistently high global oil and commodity prices. But that still leaves a puzzle as to why economic weakness at home is not doing more to pull inflation down.

The readiest answer is that there is less slack in the economy than the bank thinks. Business surveys suggest only a small proportion of firms are operating below capacity. That finding looks odd given the economy’s output is still 4% below its level at the start of 2008, and is much farther below the level it would have reached if GDP growth had continued at its long-term rate. The picture painted by surveys could be right if a chunk of the economy’s potential has been written off for good.

none of which reflects well on the Conservative’s economic policy.  But the part of the story that ought to concern everyone the most is this.

But Sir Mervyn King, the bank’s governor, doubts this. There is “no obvious reason” why the economy could not rejoin its pre-crisis path, though it might take a decade or two to get there, he said on May 16th.

Yes, you are reading that correctly.  Britain’s policy is so disastrous that it may well take 10 to 20 years to get back to pre-crisis growth levels.  That’s what Conservatives call a success.