Those concerned that the drive to lower the deficit by cutting government spending in the near term will stall recovery and lead to the so-called double dip recession have had their views strengthened by the publication of Slash and Grow? Spending cuts and economic recovery by liberal think-tank Centre Forum.
The big hint is in the little question mark of the title. After twenty-eight pages of detailed analysis, Centre Forum summarises i its news release:
Osborne’s plan for cuts imperils Britain’s recovery.
George Osborne’s determination to cut the deficit at all costs risks leaving the economy sluggish and the government still mired in debt.
The Conservative Shadow Chancellor is determined to be tough with the government deficit, and says that the economy can withstand the shock by turning to exports and capital investment for growth. But the report, ‘Slash and grow? Spending cuts and economic recovery’ shows how this relies upon highly optimistic assumptions. Even with a monumental collapse in the pound, there is little reason to believe that Britain’s export sector could respond fast enough to drive economic growth. Instead, this policy may just as easily weaken confidence and drive interest rates up, which would wreck a fragile recovery.
In particular, we should take note of what author Giles Wilkes says when he sums up with these words,
… if the past few years tell us anything, it is that Britain’s macro-economy can be at far greater risk to private debts than public. What matters above all is that the public debt is sustainable – that we can reach a position where the outstanding debt is no longer rising, and the interest payments are affordable. This is as much about producing sufficient growth as debt reduction.”
It would seem that the redoubtable Wilkes has done it again, following his highly acclaimed pamphlet, A Balancing Act.
I just hope that Nick Clegg and his coterie have spent the last few days reading the pamphlet and adjusting ‘our’ inept economic policy of bright blue and savage spending cuts as a warm-up act for Cameron’s political strategy.
It is a national imperative that the threat posed by Cameron and Osborne’s economic policy is exposed or we shall face a decade of deflation, stagnation, lost opportunity – and, with these, the mounting inter-community tensions and social confrontation that could tear our towns and cities apart.
This wasted year has shown that the Labour Party is incapable of administering and implementing an effective economic stimulus package. Where has been the Government investment in capacity building? Where has all the funny money created by Quantitative Easing gone? And, because the Government has lost the trust of the public, it is unable to expose the danger of the Conservative economic prescriptions.
Step forward the Liberal Democrats.
* Bill le Breton is a former chair and president of the Association of Liberal Democrat Councillors.
Follow @libdemvoice.org on Bluesky
Like us on Facebook
Subscribe to our feed
Sign-up for our daily email digest
A journey along the Welsh Border in 1963
Recipe for a real change of direction
Day 9304: So Farewell Then, Kier Starmer
Dennis
Chloe
Slamdac
Nonconformistradical
Mick Taylor
29 Comments
I have no idea what ‘savage’ spending cuts are supposed to mean.
But the policy being pursued by Brown of deficit funded spending increases to get us out of the recession is failing, whilst germany which ha spursued the opposite policy has vacasted recession.
Cuts in themselves are not right or worng, its a matter of what you cut, and why you cut it it.
Its a Lib Dem policy to cut Trident and ID Cards and several databases.
Essentially what we need to do is divide spending into two sections, those items which add social goods to the economy and those which add economic goods to the economy.
Trident ID Cards and databases priovide neither..
In my view there are layers of buracracy which add enither and should also be cut.
Obviously the aim must be to avoid cutting anything which subtracts social or econiomic goods from the e onomy. I do believe that an economic reciovery can be engineered without taking social goods out of the economy.
But the debate must be framned in those terms, and not in the somewht simplistic shortahnd of cuts versus no cuts.
I think you’re being a little naive. The Tories won’t slash spending on anything that will harm the economy, that would be political suicide.
Can you tell me which cuts in particular would harm an economic recovery, because I can’t think of any. But then again I’m not an economics expert!
The only spending that I can see that should be maintained are efforts to support the unemployed, measures to get people back into work and measures to promote business growth (which is where most of the recent losses have come from, coupled with falling tax revenue from redundancies).
As I’ve said, I’m not an expert in economics, and I’m sure you’ll tell me I’m completely wrong. Please enlighten me!
I agree with you andrew about the tories attitude to cuts, however I wiuld say that since they support trident, that will have to be paid for by cutting something else, at least in comparison to what we would do
Cutting spending on things that dont help the economy (ID cards, Trident, etc) actually boosts the economy in the medium and long term, since the interest on that debt wont have to be serviced from next year – leaving it to be spent on better things…
thats precisely it mark…and the government have budgeted the money for trident and ID cards already….their borrowing and defiict figures incvlude these items…just by cutting them a saving is made…..
David,
For a quick idea of the size and quality of the Gernamn Economic Stimulus Package have a look here:
http://www.telegraph.co.uk/news/worldnews/europe/germany/4227690/Germany-agrees-biggest-economic-stimulus-package-since-World-War-II.html
The quickest way out of an economic recession like this is to devalue the Pound. The good news is that the markets have already done this for us. As the European economy grows, manufacturers will invest. Our minimum wage is already 40% below that of France. It’s a no-brainer…
Giles is spot on. The Tories opposed the economic stimulus to begin with, so logically they may well decide to go for cuts when they get in like Thatcher did before in in hope that growth might come back in time for the general election after.
It is a legitimate line of attack and it is up to the Tories to defend themselves on this.
Giles says: “What matters above all is that the public debt is sustainable – that we can reach a position where the outstanding debt is no longer rising, and the interest payments are affordable. This is as much about producing sufficient growth as debt reduction.”
I agree, but we need to relate that point to the actual UK situation and current budget projections. The government currently plans to be running a STRUCTURAL (ie underlying, adjusted for the economic cycle) deficit of 4.5% of GDP as late as 2013-14. The borrowing requirement itself will be considerably higher still.
That is the scale of the fiscal ruination; it is incomparably worse than previous peacetime experience, and it is also much worse than just about every other country in the world.
While the US has hit a similar peak in terms of the 2009 deficit, Obama’s budget plans involved a much sharper fiscal tightening from 2010 onwards – reducing the federal budget by over 10% in real terms next year, a seriously sharp reduction. And since the US economy now seems to be emerging from recession, they have more chance of hitting their deficits targets than we do.
Meanwhile most other European countries are expected to record peak deficits of around half our level and to return to some kind of sensible balance in the medium term.
The outstanding debt will carry on rising for as long as we keep adding to it with budget deficits, and will carry on rising as a share of GDP (which is I presume what Giles means) until at least 2015, even if the government’s optimistic growth forecasts are borne out.
In the light of the raw figures, all this talk about premature or excessive cutting seems to me a bit surreal.
Excessive compared to what? Compared to the government’s current plans? While reasonably tough in calling for a real-terms spending freeze for three years (not often achieved in our postwar history), they barely stem the tide of red ink.
They are the absolute bare minimum of what is required, and in my view don’t go far enough, potentially imperilling the UK’s credit rating and threatening higher interest rates that will do more to stall the recovery than some overdue restraint of government spending.
Vince Cable set out precisely this view in his pamphlet for reform, calling for a tougher timetable and a faster pace of deficit reduction, and I share that judgment.
If you mean excessive compared to the Conservative plans, that is meaningless because we don’t have any figures for what they think the spending envelope or deficit should be beyond next year (which they probably won’t be able to do much about if they win the election and take office well into the financial year).
As for the cuts being premature, there is some macroeconomic logic to this, but there are also respectable counter-arguments. It is not a gimme, nor are the arguments for early deficit reduction economically illiterate.
For example, keeping interest rates down while the deficit is this high is being achieved through QE, and this cannot go on indefinitely. There is a clear danger of higher bond yields driving interest rates up and killing off recovery. Higher interest rates on government debt will also mean a bigger debt service bill and even bigger cuts in “frontline” spending.
Equally, consumers are unlikely to spend more if they know that bigger tax rises are going to be required just around the corner. Etc etc.
Clearly there needs to be a sensible approach to the necessary tightening, and there may be an argument for delaying it until next year as the government intends, with the bigger cuts coming from 2011 onwards. On the other hand this runs the risk of triggering panic in the gilt markets, which are currently acting on the assumption that an incoming government is do something serious about deficit reduction pretty quickly.
It’s a high wire act either way. It’s not as if we can simply choose to delay as long as we like on the basis that there’s this huge risk to acting too soon and no risk to delaying. That is a dangerous delusion.
The best way of countering this danger this is to formulate and present a credible medium-term plan, of a more ambitious scale than the government’s current one and with more specifics about areas where the cuts are going to be made.
So, while there may be an argument for delaying action a little, there is no excuse for delay in presenting a credible plan. So far one has not been forthcoming from any of the parties, and the amounts that are being argued about are trifling compared to the size of the problem.
In my view this will probably entail freezing overall public spending in nominal terms for five years (real-terms reductions of 2-3% per year), which – once debt interest and unavoidable social security spending is taking into account – will mean greater cuts in departmental budgets than those currently being bandied about between the parties.
There may also be a need for increasing tax revenue, although there are real dangers of killing off the recovery with ill-judged rate hikes or arbitrary grabs of one form or another. Raising VAT to 20% would raise about £12-13m and I suspect this will be tempting for whichever government is in power.
As a final point, the big spending squeeze that lies ahead will inevitably involve some pain over the transition period, but in the long run it is desirable as well as necessary to reduce its share of GDP.
Remember, public spending next year is projected to take up just about half the economy (48.1%), close to the peacetime record (49.7%). A decade ago it accounted for 36.3% of GDP. So we’re starting from a point where there has been a huge and now unsustainable rise in spending, much of which has been either undesirable, ineffective, or both.
The trick will be to try to reduce spending through a reappraisal of the role and extent of government and a ruthless focus on priorities, rather than through the lazy option of ‘salami slicing’ across the board.
As Vince said in his Reform pamphlet, this means requiring all significant items of current government spending to be justified, rather than simply assumed to be necessary but on a slightly leaner scale.
It will certainly involve some more difficult choices for Lib Dems than simply scrapping Trident and ID cards, which we wanted to do anyway and is not therefore a particularly ‘tough choice’ for the party.
The ‘how’ of cuts is just as important as the ‘how much’ and ‘when’. But one way or the other, it will have to be done.
Bill, thanks for the headsup, and everyone else for the excellent comments. Can I add my recommendation of Vince’s Reform pamphlet? Easily the best publication so far on this – everyone right and left should read it.
Can I make it clear (with Alex),we have a HUGE structural deficit, it will eventually have to be fixed but there is no point doing it before the rest of the country is on its feet and able to generate demand of its own. If Osborn’e plan had been with the word “eventually” in it, then I would have few complaints. Timing is everything in this sort of recession. In other recessions (high inflation falling), then the moment inflation is falling it’s fine to withdraw support. Deflation/high balance sheet debts – those are the ones where you have to worry about timing.
So I largely agree with Alex, though I think the spending as a % of GDP figures are a little distorted by the state of the cycle, we have to cut a lot of structural fat away. Eventually.
Ta
Bill,
Thanks for that very interesting, the Germans have certainly got the balance right, especially with the various tax cuts to generate stimulus on the supply side of the ecvonomy.
I think its crucial as well that they had the money to do this, the British government dont really, thanks to their policies of the last number of years.
Thank you for everyone’s comments. Are we agreed that the overwhelming priority in the near term is to shore up and increase demand?
It does mean accepting the low hanging fruits of Trident and ID cards. It does mean transferring the incidence of tax to relieve those who will spend and to relieve those firms which will invest. It does mean an effort to rejuvenate the supply side. It does mean government intervention to help build the future capacity for innovation by increasing among other things skills, communications capacity and alternative energy supplies.
We need to package those ideas and approaches in a ‘Budget’ that is pitched to the public as the financial underpinning of a Plan for National Recovery. We should not wait for March to do this as it is a campaigning tool needed now.
In terms of addressing a ‘structural’ deficit, which is as much about the tax base as about its other elements, I am happy to be guided by Giles when he suggests, “timing is everything”.
But for Liberal Democrats a clock is ticking. The General Election is as certain as death and taxes. We can predict its timing almost to the day.
There is not much room for light and shade in political campaigning. You have to communicate boldly and emotionally.
OK, so it is good to have a simple story (narrative) but that story has to work on an emotional level. It has to be straightforward. It has to be direct.
“We are in favour of something, but not yet” or “We are against, but later” won’t get a hearing, however rational and reasonable.
Nor will “we are like them but less painful” or “we are not like them, we’ll hurt you less.”
Such a stance may be enlightened but it will be overshadowed and will consign us to the dim margins.
Perhaps that’s where we feel most comfortable. As liberals we tend to be ‘border people’. By that I mean that we are suspicious of the centre. We feel uncomfortable about belonging to hierarchies. We worry that leadership can become autocratic. It is the way we are.
Yet in the coming election the central issue may not and need not be ‘the economy, stupid’. It may well be more about political leadership.
So, for several months now I have been asking myself, “What would Lloyd George do now?” We have had some wonderful leaders from Gladstone to Clegg, but we have had only one great leader, one national saviour, one author of a ‘People’s Budget’, one anti-establishment Prime Minister.
And “How would Franklin Roosevelt have acted?” A leader who guided his country through the Great Depression with his economic programmes of the New Deal, his Works Progress Administration, National Recovery Administration and his reform of welfare.
Both leaders were distinguished by their message of *hope*, their *optimism* and their *economic activism*. They had confidence and a plan of national transformation. They exuded confidence. They gave heart and purpose to all.
Those benefits of national leadership will not come from Mr Brown or Mr Cameron. They must come from Mr Clegg.
We certainly all agree that ‘the overwhelming priority in the near term is to shore up and increase demand.’ Unfortunately, there is a deflationist lobby (to be distinguished from the devaluationist lobby that would benefit from further weak growth. People on fixed cash incomes. People with a lot of wealth.
Old style tories in other words.
If you read the RentaTroll comments on my Guardian CiF piece, you’ll see what I mean.
So, Bill, your manifesto has a lot of support from we liberals. But it may have to get a lot worse before we bring the country along with us. They’ll scream about debt, and shrug about unemployment.
It’s one thing to argue for somewhat bigger or earlier cuts, as Alex Sabine does, for essentially technocratic reasons. Alex may or may not be right in everything he says, but he is clearly trying to find the correct solution to a complex technical problem, not playing silly political games or lobbying on behalf of an interest group.
It’s quite another thing for Osborne, and others, to make their pitch on an emotional level in favour of hair-shirt policies. As Giles points out, the motivation for such policies can be that deflation favours the wealthy. Hair-shirt policies and savage cuts can also be an excuse for social re-engineering and dismantling welfare provisions, which some on the Right have always wanted to do, but couldn’t get away with doing, in the absence of a crisis.
It can also be a good right-wing campaign tactic to adopt the pose that nasty medicine is always the best medicine. The pretence that there is something inherently moral about spending cuts and sacking people does naturally appeal to many voters, most especially the sad losers who support Tories like Michael Howard, and get their kicks from seeing others suffer. When the nation turns towards this kind of hair-shirt nastiness, a naturally more optimistic party like the Lib Dems is the loser.
That’s why Bill is right. Vince’s realism is one thing, but the shrill rhetoric of “savage cuts” can only benefit the Right. Like Obama, we must retain a message of hope and optimism, a plan for recovery, not just managed decline.
Yes, the priority is to shore up demand; however, in principle this can be done through either fiscal or monetary policy (or both). It is the aggregate effect that matters. Provided inflation risks remain low it should be possible to continue with a loose monetary policy (and therefore also a competitive exchange rate) while tightening fiscal policy.
While this would mean policy wouldn’t be as expansionary as it is now, it could still be adding net spending power to the economy while private consumption and investment are still weak (but recovering). The key is to normalise conditions in the banking sector and address the availability of credit so that monetary stimulus is more effective.
The other point is that a failure to take serious and credible action on the deficit could easily lead to higher bond yields being demanded, a rise in real interest rates and therefore a contraction of demand rather than an expansion. As I said in my earlier post, it cannot be taken for granted that the markets will allow us a leisurely pace of fiscal consolidation.
Countries like China have plenty of scope to use expansionary fiscal policy if they deem it necessary, but given the size of the deficit and the rate at which the debt-to-GDP ratio is spiralling here in the UK, we’ve basically used up our room for manoeuvre and will have little option but to tighten fiscal policy in a situation where the recovery is fragile.
This is unfortunate, but it is an indictment of the record of the Blair/Brown government since 1999/2000. As David says above, the German government left itself scope to launch a significant stimulus through its relative fiscal restraint in previous years.
By contrast, Brown as chancellor turned the spending taps on full blast and kept them on even when the economy was growing above trend – turning a surplus of 1.9% of GDP in 2000-01 into a structural deficit of 2.3% by 2002-03 and running structural deficits of roughly 2.5% to 3% in every subsequent year.
While the ratio of public debt to GDP remained reasonably under control, it rose every year from 2002 onwards in a benign economic period when you would have ordinarily expected it to fall.
What’s worse, the Treasury now admits that its assessment of the underlying fiscal position in recent years (the figures quoted above) was far too optimistic, since it relied on tax revenue from an unsustainable boom in finance and the housing market and assumed the upsurge in revenue was permanent rather than temporary. The Treasury believes the extent of this misjudgment was 6.4% of GDP, so the true structural deficit was close to 9% of GDP by 2007-08.
This was a horrendous staring point from which to launch a fiscal stimulus. The clear implication is that spending was far too high for many years – including during those years where we as a party were calling on the government to spend even more.
In this respect our claim that Vince foretold the crisis needs serious qualification. He warned of the unsustainable rise in personal debt and asset prices, but did not draw the conclusion that the tax revenue on which the government was basing its spending projections was therefore equally unsustainable. The best that can be said is that he did belatedly move the party away from advocating higher spending to a position where we were working to the same overall spending level as the government.
But this level of spending was itself grossly excessive, as has become ever more apparent – yet as far as I’m aware, we have not recanted it.
Incidentally, the necessity of tight fiscal control is especially strong if you are an advocate of active fiscal policy, since you need to create the “head room” in the years of plenty to enable an aggressive stimulus when the economy turns down.
That implies that in the good times the debt-to-GDP ratio should be kept so low that it will remain at reasonable levels even after several years of large deficits. The economist Roger Bootle, who takes a broadly Keynesian view of fiscal policy, reckons this should be about 20% of GDP – half the UK level going into the recession.
As he says in his latest book, the UK’s record of fiscal laxity during the good times “amounts to a gross dereliction of duty. It is the equivalent of a government leaving a country undefended against its enemies; in this case undefended against itself. It is all very well racing up huge debts as the result of a war for survival, as Britain did three times in the last 200 years…but the amassing of huge debt as the result of peacetime fiscal incontinence, especially to finance burgeoning welfare spending, is unforgivable”. This is a Keynesian perspective, remember…
By contrast, the Australian government ran surpluses for year after year during the long boom and actually eliminated its net public debt altogether in 2006, giving itself maximum room for manoeuvre to respond to the recession. (It also did a notably good job of regulating the banking system, but that is another matter.)
So I guess what I’m saying is: Yes the question of when to start cutting and how fast is a tricky one, and it may be premature to try to tighten too much next year (although the US is planning to cut spending sharply, as I mentioned above).
But (a) we need to understand that we have extremely limited room for manoeuvre on the fiscal front. We will therefore have to rely largely on monetary stimulus to help us through the next couple of years. That means sorting out the transmission mechanism of monetary policy (ie the banking system) rather than trying to bypass it through reliance on fiscal policy.
And (b) our main focus should be on seizing the initiative on the medium and long-term fiscal repair work. To do this we need to set out what we believe to be the scale of the problem, how quickly it will need to be corrected, by what means, and what we think will be a more sensible approach to the management of the public finances in future (ie once the existing structural deficit has been eliminated).
As I said, I agree with Vince that this requires a more ambitious scale of deficit reduction and a faster timescale than the government currently proposes. I suggest freezing overall government spending in nominal terms for five years, which would be likely to imply real-terms cuts of 2-3% per year, or 10-15% over the period.
That doesn’t sound too demanding, but, to put it into perspective, the last time a British government froze nominal spending for even one year was in 1947-48. However, this is is a little misleading because inflation was generally much higher during previous spending squeezes. There was a real-term cut of 4% under Denis Healey in 1977-78, 2.5% under Nigel Lawson in 1988-89 and 2.2% under Ken Clarke in 1996-97 – but these were not sustained for a long period.
The “10% cuts” that Labour and the Tories are arguing about are the projected cuts in departmental budgets, not the overall figure. They are the figures extrapolated from a real-terms overall freeze from 2011-12 to 2013-14. An overall real-terms cut of 2-3% per year will therefore involve still larger cuts in departmental budgets and other discretionary spending.
The Canadian Liberals and the Swedish Social Democrats showed in the 1990s that it is perfectly possible to downsize the state on that scale – and did so in ways that made long-term improvements to their economic performance.
Increasing demand is obviously whats required, its a matter of how you do it without creating inflationary bubbles. Keynesiaism usually leads to inflation, and that method of doing things, which Brown is purusing is not the way forward.
The Canadian Liberals are the model to follow, they have shown how a small state(which is surely the guiding principal of a LIberal party) can be made to work to the benfit of everyone in the economy.
By axing trident ID cards and tyhe Databases you create some money, taking minimum wage earners out of the tax net is a very good way odf increasing demand, as they are the most likely to spend, rather than save or invest, their new windfall, and thats a Lib Dem policy at the moment.
Further to a much earlier point made by David and following Alex’s info about Australia, people might be interested in an analysis which Liberal Eye pointed followers of the Freethinkingeconomist to at http://www.debtdeflation.com/blogs/
Perhaps the health warning is Alex’s point that Australia started from a better position (with more headroom) but nevertheless Keen begins:
“The Australian result of only one negative quarter of growth, followed by a return to positive growth is the best in the OECD. This was driven by:
1. The dramatic positive impact on household budgets from the cut in interest rates by 4%, which reduced debt service from 15.4% to 10.3% of disposable income;
2. A stimulus package that was equivalent to 2.5% of GDP, the largest such package in the OECD;
3. Australia’s unusual position as a commodity producer—so that we benefited from China’s huge stimulus package and recent stockpiling of commodities; and
4. The enticement to households to take on additional mortgage debt that goes by the name of the First Home Buyers Boost.”
And there’s more detail and interest as the analysis develops. Well worth a visit.
But how does this help us defend 60 odd seats against Ashcroft financed challenges; win ten more from the Tories, win 100 from Labour and seize the opposition dispatch box?
The available empirical evidence does not support the idea that spending multipliers typically exceed one, and thus spending stimulus programs will likely raise GDP by less than the increase in government spending.
However, there is empirical support for the proposition that tax rate reductions will increase real GDP.
The private sector is bent on reducing debt and this offsets Keynesian stimulus more than standard flow calculations would suggest. Fiscal stimulus will not have much effect as long as the financial system is deleveraging. Even if that problem were to be more or less solved, the government deficit would have to offset both the decline in industry investment and the rise in household saving – a gap that is rising as the recession deepens. Here, too, the public is sceptical and prone to conclude that a program that only slows or stops the decline but fails to “jump start” the economy must have been a waste of tax payers’ money. The most effective composition of such a program is also a problem.
Pity some of you don’t go on CIF and actually thrash it out. The rubbish those Tory trolls are coming out with is mind bogling!
But alas, nothing new. It’s how they always win arguments and persuade people that they are right.
“We certainly all agree that ‘the overwhelming priority in the near term is to shore up and increase demand.’ Unfortunately, there is a deflationist lobby …that would benefit from further weak growth. …
Old style tories in other words.”
Hang on, Giles. This is Straw Man stuff !
Firstly, the “Deflationist Lobby” isn’t all people with vested interests. There are serious and genuine economists who believe that further inflation cannot cure a recession, but merely starts the process of the next one. One of them won the Nobel Prize for Economics. As a graduate of Oxford and the LSE you know better than to pretend that it is all self-interest.
Secondly, opposition to inflationary policies does not automatically make one a supporter of deflationary policies. There is a gulf between those who would actively deflate and those who would simply leave the market to find its own solution.
Thirdly, (responding to perhaps the most straw-mannish aspect), it is entirely possible to seek to actively “shore up demand” while opposing fiscal measures. While monetary measures (low interest rates; quantitative easing) correlate fairly well with recoveries, fiscal measures do not correlate nearly as well. In fact, more Monetarists have won Nobel Prizes for Economics than Keynesians.
To suggest that the only alternative to fiscal stimulus is active deflation, and that deflation is only advocated by vested interests (and, by implication, that inflation is not advocated by vested interests) is patently nonsense and flies in the face of mainstream economic theory.
Hey, Tom, you’re not a Tory, no need to take offence . . .
I ought to qualify my words. Every now and again you get some crusty so and so writing in to the FT complaining about how low rates are. It makes you realise that although an orthodox economist might call for rates to be as low as possible to counteract extremely high money demand, there are people for whom this makes no difference, or in fact impoverishes, and these people start applying pressure on their politicians, because we live in a democracy and they vote. It’s not some paranoid statement about what economists believe, rather the reality of how politicians confronted with angry people with savings might end up causing monetary medicine to be under-applied.
I would be interested in what you mean by inflation. I am not suggesting that it is fiscal policy or deflation; however, what is your view as to what QE has achieved so far? Asset price inflation is clear, which suits particular financial interests and well-off people like me. But real price inflation? No sign of it as far as I can see. So – whether one approves of it or not – it seems to be failing to reduce the real value of the liabilities that hang over the household sector and are maybe weighing down that sort of growth.
I am not sure what your evidence is that “monetary measures (low interest rates; quantitative easing) correlate fairly well with recoveries”. Sure, when the economy is in a normal recession, I fully support interest rates as the first port of call; but when it’s in a near-deflation slump, with rates at zero? Where is the evidence on QE? I find that Richard Koo makes a very strong case for QE being utterly ineffective in Japan.
So as far as I can see, we have a household sector unwilling to consume and trying to save more; a corporate sector hardly brimming over; an export sector structurally ill-equipped to seize a large extra amount (and in any case unlikely to be granted much by international partners playing at mercantilsm). Where do you see demand coming from? I would rather have debt at 100% of GDP with GDP at 30k per head, than at 90% of GDP with GDP at 25k per head (though my best guess is that in the last situation, the debt would in fact be 120% i.e. no less).
Interested to know your thoughts – on QE in particular
European policy makers are well-advised to question the usefulness of further stimulus packages. They ought to carefully monitor the impact of decisions already taken on the burden imposed on future taxpayers. The available funds and remaining borrowing capacity should be utilised where it is still most needed – to prevent a collapse of the financial system and finance the necessary re-capitalisations and toxic asset removals. If governments exhaust their fiscal space in measures that have little aggregate effect, they will instead stimulate scepticism of their capability to back up the financial system.
Thus, it remains crucial to focus fiscal efforts on the financial front.
What else can be done? Monetary policy is still an option. Sure, nominal interest rates cannot decline below zero. This is a serious constraint on conventional interest rate policy. However, monetary expansion remains feasible, and increasing the relative supply of base money to other assets will lower its value. In other words, the central bank can stimulate inflation and reduce real interest rates by means of quantitative easing if necessary.
Giles,
No offence taken. I was simply concerned that objectifying all those who oppose fiscal stimuli as crusty old Tories may be rather simplistic. To be clear, the original report for Centre Forum did no such thing. It was only that above comment that seemed to blur some important distinctions.
“…for rates to be as low as possible …people start applying pressure on their politicians, because we live in a democracy and they vote.”
This is perfectly true. Unless the interest rate equals the market rate (the level at which the quantity of investment equals the qantity of borrowing) there will always be one group (investors or borrowers) who are hurting. What is more, as long as interest rates are set by a political process (and I believe that B of E independence is still only nominal) it will be subject to vested interests and special pleading. ATM that is by those who are living off their savings – and I sympathise with them – but at other times it is those who have high net borrowing who lobby for lower interest rates.
Governments usually favour the latter, which is why we keep getting credit bubbles.
“I would be interested in what you mean by inflation”
Put bluntly, M4.
The effect of loose monetary policy on the FTSE and house prices (both roaring once again) was predictable. The lack-of-any-effect of the fiscal stimulus is also predictable. Unfortunately, this is difficult to prove because
1) If either has a positive effect, it will be difficult if not impossible to untangle them and demonstrate which was the useful tool
2) The economy would likely have recovered in due course anyway (as short-term serial correlation gives way to long-term mean regression), but now the politicians will be able to take the credit. We can play counter-factuals (would the economy have recovered sooner or later) until the cows come home, but we’ll never be able to prove it, and meantime we’re all >£4,000 further in debt and Brown can (try to) take credit for the recovery.
Generally, I’m in two minds about QE but I think FS is a bad idea. In as far as it goes on cutting taxes, this may stimulate household and industrial spending, but a lot of it is bound to end up being distributed by governments in manners of dubious economic value (bailing out car manufacturers, for example). Which is why I also disagree with Bill’s overall statement that “Why this is no time for “Savage Cuts”.
At the very least, unproductive expenditure should be cut ruthlessly. I can think of two aircraft carriers, a hundred Eurofighters and 23m ID cards we could do without, for a start!
“This is perfectly true. Unless the interest rate equals the market rate (the level at which the quantity of investment equals the qantity of borrowing) there will always be one group (investors or borrowers) who are hurting. What is more, as long as interest rates are set by a political process (and I believe that B of E independence is still only nominal) it will be subject to vested interests and special pleading.”
It is certainly a political process. Look at the massive real rates in the 1980s, compared with negative in the 1970s (particularly when tax is taken into account). Personally, I think people will claim to be ‘hurting’ even if the rate is at the clearing level you imply in your equation. I think the demand to borrowing plummeted in the recession, and the ‘clearing’ rate of interest probably went negative – but that would not stop a small vocal minority complaining about low rates, the ‘injustice’ of being punished for having been a (virtuous) saver rather than a wicked borrower.
I disagree about fiscal stimulus having no effect. VAT cut = no retail recession, as far as I can see. No-one likes it, but it put cash back into poor credit-constrained pockets. Put it this way: would putting VAT UP by 5% have had no effect? Clearly not. The problem is that the fiscal stimulus has been pretty small, and its effect will be very hard to untangle. But if Brown had run a smaller structural deficit before, and could have afforded 3% instead of about 1.5%, we would have grown more, I am sure: I can’t see how it could have crowded out any of the other components of GDP.
I love the elegance of this
“as short-term serial correlation gives way to long-term mean regression”
must quote that. Describes market action very well.
I am to the Right of Bill on whether FS can work when directed by Govt. The Green Road to Recovery would have been wasted on us insisting on our own wind turbine makers instead of cheaper foreign ones, for example. But how about joint funding of privately-directed projects? A National Investment Board? I see some merit in that if well structured.
“Personally, I think people will claim to be ‘hurting’ even if the rate is at the clearing level you imply in your equation.”
Yes, that is true. But if interest rates are set by the market and not by a political process, they cannot lobby, they can only shop around.
“the ‘injustice’ of being punished for having been a (virtuous) saver rather than a wicked borrower.”
Actually, in my experience it is usually the lender who is condemned as the usurer and the borrower as a victim of circumstances. The sooner we accept that lending and borrowing is just a transaction. like selling and buying, the better. (Not that people are too sympathetic to shop-keepers, either – especially if they keep 700 shops!).
“VAT cut = no retail recession, as far as I can see. No-one likes it, but it put cash back into poor credit-constrained pockets”
That is bang on! The mistake that everybody (including Nick and Vince, dare I say) made about the VAT cut was in believing that the idea was to make goods cheaper and so more attractive. A 2.17% cut in prices (if I’ve calculated that correctly) is merely background noise in the wider price battle (though, of course, as every good economist knows, everything is marginal). However, in aggregate it left £billions in people’s pockets that would otherwise have been siphoned off to the exchequer, and this then enabled them to spend or save or pay down debt as they felt necessary.
I realise that many (including Nick) see saving and paying down debt as bad whereas spending is good, and believe that the government spending is better than the private citizen saving. I fundamentally disagree with that.
Incidentally, your VAT example actually reinforced a distinction I should have made above, which is that tax cuts are far less damaging than discretionary expenditure. I’m somewhat sceptical about funding tax cuts with borrowing – it’s all a bit Reaganomics for me! – but it’s nirvana compared with Peter Mandleson doling out billions as he and his officials see fit.
“I am to the Right of Bill on whether FS can work when directed by Govt… But how about joint funding of privately-directed projects? A National Investment Board? ”
I shudder at the thought! But I would dispute your use of “Right” in this context. I simply refute the left-right axis. The Tory Party historically have a long and sorry reputation of interventionist industrial policy and – despite the accusations of some of our fellow LDs that the current lot are “market fundamentalists” – I suspect that a Cameron government would be intervene to pick winners and prop up national champions at will.
Right! I’ve got to go and focus on rather more local issues for the rest of the evening :oD
at the moment low arates are helpful…britian is a creditor and if you are the borrower low rates are a goold thing……the private sector deleveraging will; help offset the inflation in the public sector the problem with that is
1) the states % of gdp becomes much bigger which dont help
2) the level of aggregate demand doesnt incraese, or if ot does it happens in a non sustainabe way.. moving between boom and bust
We used to think that you could spend your way out of recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that the option no longer exists, and that insofar as it ever did exist it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy followed by a higher level of unemployment as the next step