Duncan’s Economic Blog

Public Spending: Don’t Double Dip

Posted in Uncategorized by duncanseconomicblog on June 19, 2009

I want to keep the public spending debate running. I do worry that the public debate is now assuming that ‘crunch time’ in terms of concentrate steps to close the budget deficit is 2010. S&P in their negative outlook on UK debt (a stance not followed, it should be noted, by the other two ‘big three’ ratings agencies) said:

 “The rating could be lowered if we conclude that, following the election, the next government’s fiscal consolidation plans are unlikely to put the UK debt burden on a secure downward trajectory over the medium term. Conversely, the outlook could be revised back to stable if comprehensive measures are implemented to place the public finances on a sustainable footing, or if fiscal outturns are more benign than we currently anticipate.”

To take steps straight away, following a general election would be a mistake. I’d urge everyone interested in this debate to read Christina Romer’s article in this week’s Economist. She discuss the recession of 1937 and the lessons for policy makers:

 The fundamental cause of this second recession was an unfortunate, and largely inadvertent, switch to contractionary fiscal and monetary policy. One source of the growth in 1936 was that Congress had overridden Mr Roosevelt’s veto and passed a large bonus for veterans of the first world war. In 1937, this fiscal stimulus disappeared. In addition, social-security taxes were collected for the first time. These factors reduced the deficit by roughly 2.5% of GDP, exerting significant contractionary pressure.

 …

The 1937 episode provides a cautionary tale. The urge to declare victory and get back to normal policy after an economic crisis is strong. That urge needs to be resisted until the economy is again approaching full employment. Financial crises, in particular, tend to leave scars that make financial institutions, households and firms behave differently. If the government withdraws support too early, a return to economic decline or even panic could follow.

 

It’s worth bearing in mind Adam’s point:

There is a very widely held assumption in policy and media circles now that cuts are necessary and inevitable.  The only disagreement is over how much and when.  Apparently, those hard-headed bond traders and credit raters will only be satisfied when they see unemployed nurses weeping outside Jobcentres.  It seems to me though, there is one question no-one wants to ask: will cutting spending actually reduce public debt?

I only ask this because the government deficit went sky high in the early 1980s and early 1990s during recessions and only started reducing some time after the recessions had ended.  Even Mrs. Thatcher’s eye-watering cuts had no effect: the deficit was dropping rather well until the Iron Lady became PM, it then stalled, then rose rapidly and didn’t actually start falling again until a full six years after she came to power.

For anyone really interested in this topic I’d recommend ‘From New Deal to New Economics: The American Liberal Response to the Recession of 1937’ by Dean May. A superb study of how the ‘new deal’ of the early 1930s evolved into a whole new way of economic thinking and very interesting on the crucial role of then Fed Chairman Marriner Eccles. The kind of Central Banker I like…

Marriner Eccles is often seen as an early proponent of demand stimulus projects to fend of the ravages of the Great Depression. Later, he became known as a defender of Keynesian ideas, though his ideas predated Keynes’ The General Theory of Employment, Interest, and Money. In that respect, it is generally accepted that he considered monetary policy of secondary importance, and that as a result he allowed the Federal Reserve to be submitted to the interests of the Treasury.

6 Responses

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  1. Paul said, on June 19, 2009 at 1:43 pm

    V interesting. In terms of the ‘packaging’/sales pitch we’ve referred to, a decent analogy might be with antibiotic use, and the oft ignored injunction to finish the course even after the symptoms have cleared up.

    I’m starting to tryto put together an exploratory piece on how the public sector as a large set of financially independent and differentially accountable (and especially those bits that are still under elected democratic control) should act in the light of this kind of innovative Keynesian-ish economic analysis:

    That is, I want to kick off a bottom up meets top down economic analysis of how Labour /Left leaning local authorities should now be challenging the Thatcherite orthodoxies of cost control/rate capping in a sort of ‘1980s no cuts militant’ meets 2000s grassroots-dictated economic policy. The institutional/legal framework has of course changed out of recognition since 1984, but heh, that’s a challenge rather than an insurmountable problem, especially if we have proper economists like you on our side.

    • duncanseconomicblog said, on June 19, 2009 at 1:49 pm

      I like the analogy.

      Sounds like a very interesting piece you’re working on.

  2. VinoS said, on June 19, 2009 at 4:26 pm

    Interesting article. It does suggest the dangers if an incoming government tries to make big cuts in 2010-11. We could have another 1937 on our hands. And thus the planned spending cuts can’t materialise – since tax revenue will be lower and benefits spending higher than anticipated

  3. […] acknowledgment of the importance of labour to economic stability is thrown into sharp relief by Duncan’s excellent post on the very real risk of a ‘double dip’, with a longer and deeper recessionary period (cf. the 1937 dip) coming after an initial recovery, […]

  4. […] a comment at Dunc’s, Paul “Bickerstaffe Record” says: I want to kick off a bottom up meets top down […]

  5. The left and cuts | said, on June 30, 2009 at 5:31 pm

    […] to the RSS feed for updates on this topic.Powered by WP Greet BoxThe Guardian picks up a point leftie bloggers have been making for a while – that New Labour and the left should think properly […]


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