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US following Britain's lead -- speed bump's ahead?

In the wake of the November elections and the State of the Union speech, the differences in outlooks between the Democrats and the Republicans are clear. With respect to the economy, the Republicans contend reducing government spending will lead to prosperity while the Democrats fear a significant reduction in spending will hurt the economy at a time when it is still fragile.

Republicans and Democrats alike might do well to keep an eye on England. Fourth quarter GDP was just reported by the U.K. and it was surprisingly weak, down 0.5% after expanding 0.7% in the previous quarter. Analysts had been expecting 0.4%.

Factors in play --

Some say the quarter was so bad due to the severe snow storms and cold weather that the U.K. at the end of 2010.  That could be true but it does remind me of how retailers always blame the weather when they have a bad quarter.

Other analysts, politicians and even some members of the Bank of England worry that the decline in GDP is the result the current Conservative government's fiscal policy. Briefly stated, Britain has adopted austerity over stimulus in the bid to rejuvenate the economy. With deep spending cuts being implemented beginning in mid-2010, critics of the government policy are saying "told you so", contending that removing stimulus and cutting spending at a time when the economy was still weak would inevitably harm the nascent recovery.

Those who favor austerity, however, suggest Britain just needs to roll with the punches. The recovery will be choppy and the country should "stay the course." They point to strong business spending and business confidence in recent surveys showing that this quarter might be more of a one-time event in a generally improving economic trend. They also point to government borrowing that turned out to less than expected in the quarter.

After an extended period of low interest rates, Britain is now facing rising inflation that could soon hit 5%. That would likely result in the BOE raising interest rates which could further pressure the economy.

An experiment worth watching --

It seems that Britain's economic recovery has hit a speed bump. As the U.S. appears ready to adopt similar fiscal policies, we should keep an eye on how the "austerity brings prosperity" concept works out for our friends across the pond. The U.K. is at least six months ahead of the U.S. in implementing its policy of reduced spending. Perhaps our politicians and central bankers can learn a thing or two by watching Britain's progress. Hopefully, we can benefit from a few lessons learned in Britain's grand experiment.

Disclosure: none

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