Cutting the deficit sooner won't risk the recovery

Chris lancashire

However, the Tories need to reduce this to a simple message "Cuts means growth" or similar. New Labour is expert at such messaging and the Conservatives need to get as good.

Edward Palmer

Thatcher & Major cut spending wisely (as one would hope Osborne would too. But NuLab are so blinkered by dogma that they would, given the chance of continuing their path to disaster, be forced into making the wrong sort of cuts and choke recovery. So it's sensible and stimulating Tory cuts vs, NuLab's destructive ones.

John

Chicken and egg, surely? The deficit fell *because* the economy grew, not the other way round - and spending wasn't cut significantly at all.

Dean

I hate to be the one to point this out, but there's a serious flaw to your argument. This recession is totally different from the previous two, which were characterised by a combination of high inflation and unemployment. The key characteristics of this recession are (a) that it was triggered by a catastrophic shock to the banking system, which (b) massively constrained the supply of credit to the private sector, which in turn (c) exposed the economy to the risk of asset price deflation.

If you read any first year undergraduate economic textbook, you'll see that the appropriate policy response to stagflation is to reduce the fiscal deficit and raise interest rates to control the money supply. The correct response to asset price deflation is to revive the economy by allowing government spending to increase to offset the collapse of private sector demand. This is essentially what both the UK and US, and to a lesser extent continental European governments, have done.

So your comparison between the current recession and those of the early 1980s and 1990s is spurious I'm afraid.

Cuffleyburgers

Interesting and hought-provoking post, but it leaves me puzzled because the Economist whose opinion I generally rate, on economic matters at least, is banging the brownite drum.

My intuition tells me you are right.

I have for some time lost faith in many of the Economist's political judgements, it seems to be following its stablemate, the Pink'un, in new labour sycophancy/pinko eco-toadying, I should be dismayed if it was wrong on this as well?

I really would appreciate your opinion on the specific issue of the economist going haywire. Or is it just me.

Nicholas

New Labour have this infuriatingly "chummy" way of presuming that everyone agrees with them so their soundbites adopt this supercilious and arrogant manner which the media seem to follow. Of course they have so many allies to the deception in the BBC and the celebrity trendy comedian circuit. There is a socialist default which precludes truth beyond socialist created myth. The Tories have to crack this nut. Life in New Labour's Britain is full of charlatans, chancers and the lies of "conventional wisdom" that honesty and decency seem prey to. How to turn this around?

Good graph. Sound reasoning. But buried here will it do any good?

Gannic

I'm sorry Dean - first year economics text books are just that. Text books.

Out here in the real world, there are several examples of what you call the "correct" response to asset price deflation (i.e. increased government spending) being totally incorrect. Japan is the best one. They've had decades of sub-par growth, are stuck in deflation and government spending hasn't achieved anything. Except higher tax bills and a massive government debt stock.

The quick and dirty explanation is that unfunded (borrowed) government spending increases the burden of taxes and debt interest, crowding out other investment on one hand whilst dampening growth on the other.

Your text book answer might be correct in a classical Keynesian fashion, but it depends totally on a closed system model where a) capital cannot leave or escape the system and b) running budget surpluses in times of growth.

Viv Evans

I'm not an economist, so do explain to me why it is that these forecasts do not take into account the extra spending Brown has 'committed' this country to, to the tune of 1.5 billion ££ (Copenhagen) - and why its is that a recovery is assumed when the obligations stemming from Copenhagen are not factored in?

How can you achieve growth if industries have to comply with ever more stringent regulations in regard to CO2 emissions?

And don't say 'green jobs' - there aren't any, unless you count 'working' in a greenie NGO as 'green job'.
How is that creating the wealth we need?

Jez

Could someone please use a graph like the one above to indicate the loss of exports / domestic industrial turnout?

That would be interesting.

A quick reminder; Anything at all that was made in this country can be bought cheaper from China- through that place's endless (that word again) domestic quasi-slave labour pool.

Only as an opinion.

We've sold out- or should i say some people have sold us out.

papadoc

re John - "Chicken and egg, surely?"
The deficit figures shown are "cyclically adjusted", i.e. supposedly purged of the "automatic stabilisers" which cause changes in gdp to be reflected in the deficit.

PayDirt

The analogy to Japan’s lost decade does not seem right to me. OK so there they pushed money at brain-dead patients on life support, but here in England's green and pleasant land we’re no longer into manufacturing for the sake of exporting to the world, we’ve just been relying on trading money and taking fat commissions which last year went now down the tubes leaving us an almighty debt. Now it seems we’re just waiting for the creditors to realise the UK is a lost cause. A new model is required, somebody please invent something which the rest of the world can value, then we’ll have something to sell. Have we really been overtaken already by all those clever foreign folk? Or do we just need to stop buying all the unnecessary stuff they keep selling us? Or both.

Snowman

Dean has a point, whatever your gut feelings may be telling you. The alternative would have unleashed a downward spiral in all asset classes (not only housing), run on the banks, and massive unemployment.

Most of the financial sector would have moved offshore. Even if we were to have a go at regenerating the manufacturing sector it would take years.

The textbooks and the Economist have it about right. And even if you look at Japan, the case ain’t as hopeless as it seems. It’s not the size of debt that matters the most, but the ability to service it. On this, we are far from going broke.

Gannic

The Japan analogy is remarkably good - their problems left them with a lot of zombie banks, though their manufacturing sector was and is stronger than ours.

On to Snowman's points;

Sure, saving the banks probably saved the financial system and had to be done. That hasn't run up the huge deficit though - only somewhere between 10-40bn is actually being accounted for as a loss on government books. The rest of the deficit is pure overspend.

As for your point about Japan and debt servicing. They've had deflation for decades, which makes debt servicing easier for them. Inflation in the UK does not look so benign. Our debt servicing costs alone are set to hit 80bn by 2015 (under current plans), effectively doubling. That is 40bn which can't be otherwise spent or has to be raised from taxation.

Size of the debt does matter - its an overhang which has to be paid for. No-one says the UK is going broke (we can print money) but it IS bad for the economy to have such a huge fiscal deficit.

Let me spell it out.

Big deficit = more debt.
More debt = more tax
More tax = less growth.

nb. not only does poor fiscal management and high tax stifle growth at home, it also acts to deter inward investment from abroad.

Derek

Dean/Gannic discussion.

Central Bank balance sheet expansion between 15th September 2008 and 1st July 2009 was 39% in the ECB, 80% in the Swiss National Bank, 119% in the US Federal Reserve, and a whopping 127% in the Bank of England. Yields on gilts are at a five month high and are being held down by massive purchases by - the Bank of England... With an end to "quantitative easing", how much longer can that be kept up before the cork is popped? In 2010, about £200 billion of gilts must be sold without help from the Bank of England. Higher interest rates anyone? Of course,if the Labour government is no longer in power when massive inflation arrives the problem will not be theirs; but if they are, increases in public spending of funny money will mean they can seem to allocate more but in fact pay less. My money is on inflation - in spades. Either way, poor England.

El Sid

The other classic example is the recession of 1921 - which noone's heard of because it was stopped in its tracks by Warren Harding's cuts in taxation and controls on spending. It's the Austrians' favourite recession, but the Keynesians hate it. :-)

Snowman

Gannic @ 7.15:

Of course the size of debt matters, and of course it should be reduced, but what decides whether the market buys the paper is the country’s ability to service it in the first place. Look, if the debt stood at half of its present size, and the servicing costs were quadruple of what they currently are, we would be in a bigger shite.

Also, it’s not deflation but the opposite, inflation, that helps countries to clear their debt. This actually scares more than anything else. Derek @ 7.20 makes the point well, although nobody really knows what will happen when the easing stops. My view, whatever it’s worth, is that the hike in the cost of money will not be dramatic as we are not the only country facing the problem of higher bond issuance. Others are in the same albeit smaller boat. Also, to contemplate that the Britain will default on her sovereign debt is far fetched. Things ain’t that bad.

The quantitative easing was designed as an additional help for the banks. They needed and still need cash to boost liquidity (lending), and some more in case depositors demand their money back, and they are unable to unload any of the questionable assets on their books.

Overall, I have no quarrel with your cry to balance the books to a manageable level. To clear the debt mountain completely just cannot be done. The issuance of government paper is one of the avenues through which insurance companies, pension funds can meet their future obligations.

2trueblue

The Tories need to make sure that the details are made public if/when they get in. In the meantime they have to learn to get their message across and sit on every Labour lie.

Gannic

More debt drives up borrowing costs. Having more debt to service scares markets, who then require a higher return to hold the paper. It's a viscious circle.

QE's aim was to reduce long rates. Not to help the banks. In the UK all of QE has been used to buy Gilts which the government is issuing. In the US for example, QE has bene used to buy a greater range of paper - mostly corporate. That *has* helped banks get stuff of their balance sheets AND reduce borrowing costs for companies more. In the UK, it looks more like a slightly cycnical way of funding a ballooning budget deficit - the stuff banks actually want/need to clear off their balance sheets is not accepted in the UK's QE.

For various reasons, it is much harder to inflate away debt these days (notably no capital controls). It would also almost certainly entail a debasement of the currency, which isn't good for anyone either.

Snowman

Gannic: sorry to nitpick, but is ‘debasement’ i.e. the weakening of a currency vis-à-vis other currencies that bad for everyone? Dunno. Foreign travel doesn’t feature as a large proportion in the budget of most people, cutting on imported goods may boost or even re-start local manufacture, foreign investment gets a lift, exporters benefit, too, as does the home-based tourist industry. There are also drawbacks, of course, and inflation ranks top, if the country relies on importing stuff (fossil fuels for inst.) that cannot be substituted from local sources. All in all, however, the old mechanism of a country resuming domestic demand growth through devaluation ain’t that bad provided those in charge of policy can avoid a run of the currency.

Mark M

Dean - if everything went as in textbooks we would never need policy responses to recession because we'd never have recession. Don't worry though - thanks to our blessed leader we'll soon have that high inflation, high unemployment recession. Coming to a country near you, 2010.

Thom

Yes but those with money don't mind if there is high unemployment as long as their money is protected.