Cameron and the Dark Ages of Economics
I’m starting to wonder… what on earth are the Tories talking about?
Cameron now is pushing a strange line:
“You need to start the process of bringing spending down now,” Mr Cameron said. He asserted that Treasury proposals to increase spending by £30bn in 2010-11 before tackling the deficit meant the election of “another Labour government could tip us back into recession”.
Is Cameron really pushing that line that increasing spending will cause a recession?
This is the same line as Niall Ferguson. As Paul notes:
Meanwhile, Ferguson writes and says what he thinks will please his readers and listeners, and what he knows will please most of his readers and listeners is the simplistic but dangerous certainties of fiscal conservatism.
How could Cameron be right?
The answer lies in crowding out. I.e.:
If increased borrowing leads to higher interest rates by creating a greater demand for money and loanable funds and hence a higher “price” (ceteris paribus), the private sector, which is sensitive to interest rates will likely reduce investment due to a lower rate of return. This is the investment that is crowded out. The weakening of fixed investment and other interest-sensitive expenditure counteracts to varying extents the expansionary effect of government deficits. More importantly, a fall in fixed investment by business can hurt long-term economic growth of the supply side, i.e., the growth of potential output.
But as wikipedia continues, things aren’t that clean cut:
However, this crowding-out effect is moderated by the fact that government spending expands the market for private-sector products through the multiplier and thus stimulates – or “crowds in” – fixed investment (via the “accelerator effect“). This accelerator effect is most important when business suffers from unused industrial capacity, i.e., during a serious recession or a depression.
That last sentence is important. UK Capacity utilisation is currently at 72%. The lowest since the data was first collected in the early 1990s.
Note to the Tory Economic team: Remember to read more than just the first paragraph on wikipedia.
Paul Krugman has written of those contending that government borrowing will always lead to a fall in private investment:
The answer, I think, is that we’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.
And that’s what seems to have happened to macroeconomics in much of the economics profession. The knowledge that S=I doesn’t imply the Treasury view — the general understanding that macroeconomics is more than supply and demand plus the quantity equation — somehow got lost in much of the profession. I’m tempted to go on and say something about being overrun by barbarians in the grip of an obscurantist faith, but I guess I won’t. Oh wait, I guess I just did.
Cameron: a barbarian in the grip of an obscurantist faith…