Fiscal stimulus: Does Government debt really rule it out?
The voices arguing against any further economic stimulus on the grounds that the public finances are too weak are growing more numerous and louder every day. Leading the charge are the Tories and the CBI, now joined, unfortunately, by the Governor of the Bank of England. But it seems to me their claims are simplistic.
One of the main objections to raising Government debt further through a stimulus is that it will burden future generations with higher taxes. This is the favourite line of the tabloid press and, I’m told, is reflected very strongly in the focus groups. Whatever this argument’s political resonance, it can be rejected on economic grounds. Government debt and spending always rises very strongly during a recession as a result of higher social security bills and declining tax revenues. This is a fact of life and no amount of “efficiency” drives in government will make any significant difference to this. Both Thatcher and Major presided over significant rises in debt despite their ‘small state’ Conservative credentials.
In addition, the notion that holding off on further state action to limit the impact of the recession now will save our children and grandchildren from higher tax bills is not credible. Failure to act will only prolong the recession and raise unemployment further. This will ensure public spending stays high and for longer. It will also hard-wire in lots of expensive extra public services for decades such as long term unemployment benefit and extra healthcare, policing and education services for those families and communities forced into intractable deprivation. And that really will impose extra taxes on our descendants. How much public money might have been saved over the last thirty years, for example, if the Conservative Party had taken forthright and effective action in the 1980s to deal with the unemployment that arose in that recession and which has created deep problems in a variety of communities across the UK ever since.
In short, the only thing which will genuinely reduce the potential future tax burden is to create (or hope for) a recovery buoyant enough to generate the tax revenue to pay off the debt. A stimulus would play a central role in achieving such a goal. Those politicians who claim they can significantly reduce public debt by other means are simply wrong.
The more serious objection to rising public debt further is that it will sooner or later scare the markets into refusing to lend any further money to the UK state or raising the cost of what it does lend to much higher levels. In the worst case scenario, if there is a real fear about the solvency of the UK Government, then there could be panic selling of sterling. Any or all of these eventualities would make the UK economic situation much worse.
But is this likely? The truth is no-one is sure. The global economic situation (and increasingly the political situation) is so volatile that it is difficult to know exactly how the markets will respond at any one time in the future. However, despite Stephanie Flanders claim that the Governor’s comments could be judged uncontroversial, there are a variety of mainstream voices who do not share his view.
In their contribution to the IFS Green Budget, a team of Morgan Stanley economists (that included David Miles who has just been appointed to the Bank of England’s Monetary Policy Committee) acknowledged the “ballooning budget deficit” which will require the Government to borrow almost twice what was predicted in the 2008 Budget. However, they argued that demand for gilts (essentially opportunities to lend money to the Government) will remain high with banks particularly keen to lend. If they are right, then the higher deficit is less risky than might be supposed.
The highly respected commentator, Martin Wolf, has also asserted without any equivocation that the notion of a state insolvency for any advanced economy as a result of this crisis is fanciful. As Wolf states, the fiscal cost of the advanced economies’ aging populations will be far higher than the cost of this crisis and that has not spooked the markets to date.
Wolf also makes a very telling point when he argues that it is very odd to avoid an economic stimulus which could limit the worst excesses of a definite economic crisis now in order to avoid a hypothetical fiscal crisis later. As he puts its ” this would be like committing suicide in order to stop worrying about death”.
A very sober paper from the IMF also asserts that rising public debt was far from being on the “explosive” path which can lead to a collapse in market confidence. The IMF was clear that this did not mean market confidence could be ignored but that it needed reassuring through the adoption of clear policies to address deficits once economic conditions improve.
One might also add that reining in spending now may actually cause a deterioration in market confidence. Given that the biggest negative impact on the UK’s public balance sheet has been the fall in tax revenues resulting from the recession itself, action which suggested that the Government had gone cold on fighting the slowdown and may actually be making things worse (by withdrawing public funds from the economy and sacking public servants) is hardly likely to get a hearty round of applause from currency, bond and equity traders.
Unlike, Morgan Stanley, the IMF, the IFS and Martin Wolf, I suspect that some in the group of anti-stimulus voices aren’t actually looking at this issue dispassionately and are led by other concerns. All probably have a visceral dislike of Government debt which is essentially a hangover from Mrs. Thatcher’s commitment to a “household economics” approach to the public finances.
But over and above this, the CBI simply finds the idea of the state leading us out of the recession an anathema. It weakens their ceaseless claim that business always knows best and it means that the state may end up being involved in many areas of the economy that they see as purely the preserve of commercial organisations.
The Tories of course will say whatever gets them into power and their line plays well with key voters.
And Mervyn King? Well, I am absolutely sure his comments are genuine but he is a cautious, establishment economist to his fingertips. We should not forget that he voted against interest rate cuts for fear of inflation last year until recession was staring him in the face. And he resisted help for the banks for fear of moral hazard until the financial meltdown forced his hand. Now he resists fiscal stimulus for fear of weakened public finances. When you are in as deep as the economy now is, we need carefully considered policy for sure but its needs to be shaped by an informed boldness not a fearful caution.