A huge risk that’s hard to justify – or a viable strategy to restore balance to the economy? Two leading economists offer their views to Channel 4 News.
We must cut our fiscal deficit. How much and how fast? Fiscal soundness depends as much on economic growth as on taxation and government expenditure. Tax increases and budget cuts that are too aggressive and front-loaded may give us a ‘double-dip’ recession, not growth.
Then the fiscal position would worsen. Further monetary easing, though desirable (broad money is falling), cannot help much.
So the government’s plans are very risky indeed. Why take that risk? We are not Greece, nowhere near national bankruptcy. Our debt is well below historical peaks. Its average maturity is the highest among advanced countries. So the bond markets cannot do us much damage.
Nor have they threatened us, except verbally: interest rates on our long-term debt have been falling since February. That is just when the head of the world’s largest bond fund managers gave us an apocalyptic warning (did he short our bonds and lose money?). Long rates are now negative in real terms, short rates of course much lower.
Even at such low interest rates, what demand will replace the government expenditure to be cut? Not consumption, because taxes are rising, real wages are flat, and 500,000 public sector workers will lose their jobs. A multiple must fear unemployment and will want to protect themselves by saving more.
Net exports won’t rise anywhere near enough to fill the gap, with our major markets in the EU and US growing slowly. The substantial exchange-rate depreciation we have already seen has done little to improve our trade balance. Nor are we likely to have an investment boom in the face of excess capacity and weak final demand.
The Chancellor seems to think he can call Keynes’s animal spirits from the vasty deep of the private sector. Will they come when he calls them? Keynes himself and the experience of the 1930s suggest not.
The concern during the election was that none of the parties was talking about the burgeoning government deficit which had risen to over 11 per cent of GDP, and implied a doubling of government debt to about 80 per cent of GDP over the following four years.
The popular view is that this is entirely due to the banks and the recession they helped create. In fact government expenditures had exceeded revenues since 2001 (6 years before the recession) by about three per cent of GDP.
The recession only made things worse. As these expenditures were “permanent”, and not temporary and related to recession, the correct policy was either to fund them properly with tax increases or to reduce them to what people are willing to pay for.
The part of the deficit caused by the recession is temporary and this can be debt financed instead. The government has chosen to reduce the whole deficit with cuts of three per cent of GDP per annum for the next four years, thereby neatly reversing the 2001-7 period.
Tax revenues increase only a little. From the standpoint of macroeconomic policy this is clearly a viable strategy.
If the cuts are thought to be so harmful, there is of course a simple remedy: raise taxes instead. Significantly, even Labour preferred to reverse their expenditure policies than do this.