Moody’s has downgraded Britain’s national credit ratings from AAA to AA1, and there is a lot of speculation as to its likely repercussions for the UK. It is probably true to say that this is a political disaster for the coalition government, than an immediate fiscal disaster. The government has justified its austerity policies by referring to the absolute necessity of maintaining the country’s credibility in the eyes of the markets, and to depart from austerity will result in a loss of confidence. Before the downgrade, the government saw its policies validated by the maintenance of the AAA rating. Now, the opponents will argue that austerity has not worked, and the course must be changed. Given that austerity has been the fiscal policy pursued by the government, such a change of course is extremely unlikely. If it were to happen, that would require a major reshuffle of the cabinet, including Mr Osborne vacating the Treasury, and such a possibility looks rather remote.
The main point is not whether austerity has worked or not, as it can be argued that the austerity policies have kept Britain afloat, just about, without the massive unemployment and a huge increase in the borrowing costs that have been observed in some of the European countries, or it can be argued that austerity has not worked because there has been no recovery, but whether there is a realistic alternative to austerity. The answer would seem to be no. It may still be the case that Britain could print more money, devalue the currency, and continue to borrow at a reasonable cost, without severe adverse effects such as inflation, but it remains unclear how much more it can pursue these policies. Britain may be approaching the point, where it has little or no choice. Without an increase in taxation, which is unlikely and undesirable, public expenditure will have to be cut one way or another, since printing more money and borrowing more money are unlikely to be viable options for much longer.
Perhaps one way to summarize the situation is that politicians are relatively powerless to improve the situation, but they can make things far, far worse. If the government were to abandon austerity, it may well result in a swift rise in the cost of borrowing. Yet, the political narrative, that austerity is working, will be difficult for the government to sustain. For this reason, there is a likelihood that the government will change its emphasis: it will stress that it is investing to foster growth, while sticking to an overall policy of austerity, which is possibly the only viable option. The difficulty is cutting spending further. Waste in public spending is all too easy to see in opposition, but it ceases to exist once in government.