Public Spending & the ‘Crazy People’ Camp
Cuts are dangerous; a major programme of cuts risks forcing the UK back into recession and damaging our economic prospects for a generation. It doesn’t take much economic nous to recognise that sacking tens of thousands of public sector workers and reducing the amount of money the state spends in the wider economy will increase unemployment, increase bankruptcies and other financial difficulties for companies and will reduce demand and further constrain bank lending.
This is, of course, bad enough in itself. But there is a further threat. If the UK struggles on under recssionary conditions while other economies grow, we will not be able to seize global market share and we will not be able to attract new investment. The result will be a UK economy back in the doldrums for years just as it was in the 1970s and much of the 1980s – the “sick man of Europe”.
This is a much greater threat to our well-being and the future prosperity of our children and grandchildren than public debt. Asia is emerging from this recession far quicker than Europe and America. China is expected to post a stunning 8% growth soon despite the global crisis. If we take shallow economic decisions now, the UK will be left behind as the new economies rush past us in the innovation, productivity and investment stakes.
Agreeing with Adam puts myself and Richard in what Paul Krugman has dubbed the ‘crazy people’ camp.
There’s a tendency to treat worries about a double dip as outlandish, as something only crazy people like the people who, um, predicted the current crisis worry about. But there are some real reasons for concern. One is that the lift from fiscal stimulus will start to fade out in a couple of quarters. Another is that, as Yellen points out, most of the boost we’re getting now is tied to inventories. And that’s a one-time thing.
As I’ve argued for the past few months the ‘recovery’ we are seeing is driven by base effects and an inventory build up. Unemployment is still rising.
The Osborne line, that cutting the deficit will lead to lower interest rates and hence more private investment, is an extreme form of Rubinominics.
Rubinomics emphasizes the effect that balancing the government budget has on long term interest rates. Taxes should match government spending in the long run, and deficit-financed tax cuts are an ineffective way to increase growth. This can be seen as a form of the fiscal theory of the price level – fiscal policy affecting long term inflation (as expressed by long term interest rates).
Rubinomics has never rejected Keynesian approaches to economics, which call for the government to run a deficit in times of recession.
As the Wall Street Journal wrote last year:
Rubinomics never did have much economic basis, and even casual observation over the last 25 years has exposed its illogic. As deficits rose in the 1980s, interest rates fell. In the current decade, deficits rose and interest rates fell for a time, then later deficits fell but interest rates rose.
Even in the 1990s, the facts never matched the theory. The rate on the 30-year Treasury bond did fall in 1993 amid the Clinton tax increases, but it slowly climbed again throughout 1994. The historic market turn — in stocks and bonds — came exactly on the day in 1994 that Republicans won the House of Representatives for the first time in 40 years. Interest rates move up or down based on multiple variables, such as monetary policy and global capital flows.
Mervyn King spoke yesterday about the UK economic outlook – broadly put is forecast is low growth and low inflation.
Clearly a slower recovery implies worsening public finances and, according to Osborne’s logic, higher interest rates.
Yesterday the yield on UK two year bonds hit a record low.