Can Contractionary Fiscal Policy Be Expansionary?: Consolidation, Sustainability and Fiscal Policy Impact in Britain in the 1930s

Abstract

This paper offer a guide to how the British experience of 1929–39 may provide useful macroeconomic lessons for the present once due regard is made for historical contingency and context. It re-examines the forces that shaped policy and what we know about policy impact, focusing on, first, the issue of fiscal consolidation amidst a cyclical downturn; second, whether the expansionary fiscal contraction (EFC) hypothesis which is now in vogue in certain quarters (so-called ‘expansionary austerity’) might provide insights for further understanding this earlier age and vice versa; and, third, debt dynamics and their implications for monetary and fiscal policy. Finding that Britain in the 1930s may well be a textbook example of monetary expansion made possible by fiscal conservatism, it also highlights the dangers of being a member of a fixed exchange regime in turbulent times and the risks of deepening and lengthening a depression if the automatic stabilizers are over-ridden. No supporting evidence is provided by the interwar British experience for the EFC hypothesis in current circumstances.

Keywords: Great Depression, monetary policy, fiscal consolidation, fiscal policy, Keynesian policies

JEL Classification: B22, E52, E62, N14