To Save The British Economy, David Cameron Has To Do The Hardest Thing Any Politician Ever Has To Do

david cameron

Photo: Jeff J. Mitchell / Getty Images

The UK finally lost its AAA rating on Friday. Moody’s dinged it one notch.The downgrade is expected to have almost no real market impact, expect that it’s temporarily slightly negative for the pound.

That being said, it is a good time to take stock of the situation in the UK, which has not only been downgraded, it’s also on the verge of a triple dip recession.

When David Cameron came to power he won praise for pursuing an austerity agenda (unlike Obama) but it’s flopped.

In a great post, the brilliant pseudonymous finance twitter/blogger @barnejek, asks if Britain has finally cornered itself with its current mix of policy.

He starts by noting…

I would like to thank the British government for conducting a massive social experiment, which will be used in decades to come as a proof that a tight fiscal/loose monetary policy mix does not work in an environment of a liquidity trap. We sort of knew that from the theory anyway but now we have plenty of data to base that on.

This idea that Britain has conducted a huge social experiment is not spoken loudly, since it’s insensitive, but it’s one that economists have talked about. People like that Britain has blown its recovery, because it shows that the theory behind austerity is bunk.

After walking through some slightly technical economics, he goes on to argue that the only hope now is that Britain take a “stop loss” on its austerity agenda, and spend more.

I do believe that Britain has finally cornered itself into a situation where there is overwhelming evidence that Mr Osborne should really start spending. He should also assume that Mr Carney will not let that spending lead to appreciation of Real Effective Exchange Rate (a bit more on that mechanism in one of my previous posts entitled “Be careful what you target or am I in the right church?“). That is to say that the Bank of England will keep nominal and real rates very low. In my opinion this is the only rational way of the situation that we’re currently in. Then again, I am assuming the impossible here, i.e. that the politicians know what the stop-loss is.

This advice is very similar to a column by Dr. Gerard Lyons, the chief economic advisor to London Mayor Boris Johnson, and the former top economist at Standard Chartered.

Says Lyons: The UK must spend, and banks must lend.

Judging by the still pessimistic tone at the beginning of this year, it would seem few are expecting things to go well in 2013. Yet I just wonder whether this may be the year the economy surprises on the upside.

But if it is then the UK needs three things – to spend, lend and change. The economy is suffering from a lack of demand. There needs to be more spending by the Government on both infrastructure and construction and people and firms with the ability to spend need to be given the confidence to do so. There has to be more lending by the banks. And the supply side of the economy needs a helping hand and thus there has to be change – which is all part of repositioning the UK in the changing global economy.

The ratings downgrade by Moody’s reflects concern about the growth outlook. That is understandable but we should not panic. The UK has gone from the highest to a still high rating and its borrowing rates will stay low.

That’s right. In the wake of a debt downgrade, David Cameron must spend more money.

This is incredibly difficult, since prima facie, it would fly in the face of the downgrade.

And more importantly, it would basically require him (and his finance minister George Osborne) to admit that they were totally wrong since the crisis. That’s the really hard part. Perhaps even impossible. But that’s what it will take.

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