09 October 2009

Is the UK the Free Rider?

Britain was the first European country to move on fiscal stimulus. As other countries fell into line there was a fear that Germany might take the benefit of the boost to demand in other European countries while spending little of its own money on boosting demand in Germany. In time Ms Merkel came through and Germany has been pulling its weight.

Now Britain is going to be the first to withdraw the stimulus. From January the VAT rate will return to its old level and government spending will come under pressure. Of course the "automatic" stimulus of more benefit payments and lower tax take will still be there, and the government deficit will be as huge as anywhere in Europe. Which is the reason why the chancellor is reluctant to let the stimulus continue.

When Britain moved aggressively with monetary and fiscal stimulus the pound fell against the euro, potentially boosting demand from net exports. At the time I thought that this was fair as it gave the British economy some compensation for the demand which would leak to countries not making the same efforts to counteract the recession.

Now however, Britain is beginning to look like the free rider, and the low pound could be seen as a beggar-my-neighbour policy. (I remember Paul Krugmann using that expression when he visited Britain earlier this year.) I doubt that the pound will rise much. Monetary easing is continuing and interest rates are lower in the UK than Euroland.

Are we now going to gamble on other countries' fiscal expansion to get us out of recession?

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