The US and UK have similarities that go beyond speaking the same language: both had huge expansions in household credit; both had to rescue their financial sectors; both have watched their central banks push interest rates close to zero and adopt “quantitative easing”; and both have experienced massive post-crisis increases in fiscal deficits. Yet a big policy divergence is on the way. The coalition government of the UK will today announce details of their cuts in government spending. Nothing comparable is expected in the US. In its latest forecasts, the International Monetary Fund has noted this divergence. But the bond markets seem quite insouciant, at least so far (see chart).
We can identify differences in the post-crisis experience of the two countries: the US had a smaller decline in gross domestic product (a peak to trough fall of 4 per cent, against 6.4 per cent for the UK) and a bigger increase in the rate of unemployment (a rise of 5 percentage points between 2007 and 2010, against 2.5 per cent for the UK). US core inflation has fallen further than that of the UK (to 0.8 per cent in the year to September, against 2.9 per cent), largely because of the impact of depreciation on the UK.
Yet the countries share the lengthy and depressing process of post-bubble deleveraging and retrenchment explained by Carmen Reinhart of the University of Maryland and Harvard’s Kenneth Rogoff in their masterpiece, This Time is Different. Both economies are running well below capacity. Both must choose between the short-run risks of fiscal retrenchment for recovery and the longer-run risks of huge fiscal deficits for creditworthiness. Both rely on monetary policy. But the UK must rely on it far more, given its prospective fiscal tightening.