I hope Zach Goldfarb's article on how the United Kingdom responded to a warning shot from Standard & Poor's gets some attention, as there are a number of lessons in it for us. As he says, the basic story sounds quite familiar: A year ago, the United Kingdom had a lot of debt, and S&P told the country that if it didn't get it under control, there'd be consequences for its credit rating. So far, so similar. It's what happened next that's instructive.
Conservatives won the following election and took control of government. They implemented a massive austerity program — remember that the British political system has a lot less trouble acting forcefully than the American political system does — and as often happens when you implement a massive austerity program, the economy tanked. “In the final three months of 2010,” Goldfarb writes, “growth turned negative, and the British economy shrank by half a percentage point.” S&P backed off, and the Brits now have low interest rates and a bad economy.
There are arguments that the United Kingdom is in a weaker economic position than America and had to move faster. Fair enough. But the point is that there are potential consequences to running big deficits and potential consequences to rapidly reducing big deficits. We have to balance the risk of contraction against the risk of debt and, luckily, there’s an obvious way to do that. Steven Hess, chief credit officer of Moody’s ratings agency, gave Goldfarb the formula. “You don’t have to have extreme austerity right now to come up with a plan that is long term,” he said. “It’s the long term trajectory that’s important.” In other words, we can move slowly so long as we’re moving convincingly in the right direction. That’s a real luxury, and not one we should ignore.
Related: The Washington Post is hosting a reader chat today with David Wyss, chief economist at Standard & Poor's. The chat begins at noon, so if you want to participate, hurry over.