Friday, January 27, 2012

Demand Driven Stagflation?

It is pointed out by Brad DeLong that the British economy has fared worse than even during the 1930s, since 2008.

The numbers are even worse if you adjust for the fact that the British population has increased by more than 2% during the period, though population increased almost as much in the 1930s as well.

DeLong of course blames Cameron's austerity policies, but there is a problem (actually there are several). That would suggest that the slump is demand driven, and if that had been the case we would have seen price inflation fall. But as it happens, inflation has increased the last few years and is at an annual average of 3.6% the last 3 years the highest since the early 1990s, and also significantly above the alleged 2% target of the Bank of England.

British inflation has also been a lot higher than in almost all other advanced economies. For example Sweden, whose economy has fully recovered even on a per capita basis, had an average inflation rate of 1.75% during the last 3 years.

The part of the austerity package that involved higher taxes (mainly a higher VAT) is really the only part that can explain this since they represent a negative supply shock that both raise price inflation and reduce real output, but that should have largely been cancelled out in part by the reduction in real disposable income from the tax increases and in part by the spending cuts.


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