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Does confidence matter?

Like Paul Krugman, I think Britain's decision to pair a sharp economic contraction that's outside its control with a sharp contraction in the part of the economy that's in its control (the public sector) will be a disaster. But it'll at least be an interesting experiment.

For one thing, it's a good test of whether austerity economics works amid a weak economy and low interest rates. Seems unlikely, and I think a lot of British people will suffer while the government tries to figure it out, but we'll know soon enough. But it'll also be interesting to see whether the fact that the government has a decisive plan creates some of the "confidence" that people are always saying we need.

If I were trying to make the argument for a plan like this, I'd say something like: "Business and consumers are wrong about the short-term danger posed by the deficit, but that concern, though mistaken, has consequences for their spending and investment decisions, and if they feel like it's being allayed, they'll begin spending and investing more. The fact that a market isn't rational doesn't mean you can ignore its demands." I'm skeptical that any confidence effect will last for very long, as hundreds of thousands of people will lose the jobs and benefits that let them participate in the economy, but I guess we'll see.

By Ezra Klein  | October 22, 2010; 1:02 PM ET
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The British econmoy is a curious case. They, probably more than any other major economy in the world are a service only economy. Most of their GDP growth is related to banking and insurance, not material production of any kind. For that reason the currency and fiscal concerns may be more relevant than employment statistics to their economy.

Posted by: 54465446 | October 22, 2010 1:19 PM | Report abuse

The solution could be straight-forward: do what is necessary to revitalize the economy now, but begin serious work to deal with the deficit in the longer term. If Congress (and the political parties) could demonstrate that they were genuinely willing to work together to resolve these challenges, then one could reasonably expect that to instill confidence. However, looking at the lies and horse-pucky that is dominating these mid-terms (and we get a lot of opportunity to see this in Colorado), I would say the chances of this happening are nil.

Posted by: TopeinCO | October 22, 2010 1:20 PM | Report abuse

Well, the first piece of evidence appears to be in: retail sales declined "unexpectedly" last month. Because who could have imagined that laying off 500,000 people in the midst of a recession would lead to a decline in their spending?

Posted by: PHOLMES | October 22, 2010 1:41 PM | Report abuse

The best thing about being a conservative is that your worldview is non-falsifiable.

Posted by: AZProgressive | October 22, 2010 1:42 PM | Report abuse

This is the equivalent of firing every single person in Manchester, plus some.

Scaled to the US, its like the US firing 2.5 million people. That is A LOT of people. That is an entire large city, or heck, its like firing every single person in Alaska, Wyoming, and both N. and S. Dakota altogether. There will be multiplier effects as all these people neither spend nor save, not to mention the strain it'll put on their safety net.

Overall, whatever gains the confidence fairy may offer will likely be short-lived as the disaster of wiping out a huge swath of the economy and firing an incredibly massive amount of people becomes felt by every citizen. Its a self-imposed recession being implemented when there is already a recession.

I really don't see how its a good idea.

But, Ezra is right, it'll make for an interesting experiment with the US and UK serving as proxies for each others' missing counterfactuals.

From a researcher's perspective, its pretty awesome, but I really don't think this is going to end well.

Posted by: Nylund154 | October 22, 2010 1:45 PM | Report abuse

There's no doubt that the short term effects of creating such a large number of unemployed will be extremely negative. Not, however, as negative as the effects would be of borrowing money they can't repay or taxing what's left of their productive economy in order to support their bloated public sector.

Posted by: bgmma50 | October 22, 2010 1:58 PM | Report abuse

It might be possible to tease some results out of the British decision using some fairly sophisticated statistics, but it probably won't be as good of an experiment as you imagine.

If the global economy starts to improve, that wave will pull the British economy up, austerity or not. And if the global economy continues to stagnate, the British economy will probably continue to stagnate. Unfortunately, the UK and most other economies are too integrated to make really good experiments.

Still, if we compare to similar economies that made different decisions, or the same decision with different timings or magnitude, and control for differences between those economies, we might be able to test the hypothesis. Not that this would persuade anyone...but another data point doesn't hurt.

Posted by: zosima | October 22, 2010 3:00 PM | Report abuse

"The best thing about being a conservative is that your worldview is non-falsifiable"

From the people who sell us "saved or created". Good one!

Posted by: ConservativeCabbie | October 22, 2010 3:05 PM | Report abuse

The Conservatives' decision for austerity is likely to bring back Labour sooner rather than later.

Posted by: tomcammarata | October 22, 2010 6:35 PM | Report abuse

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