Duncan’s Economic Blog

Sensible Economic Commentary

Posted in Uncategorized by duncanseconomicblog on October 2, 2009

Sam Brittan in the FT:

The British political classes are going through one of their occasional bouts of masochism, with party leaders vying with each other on the theme of who can cut public spending faster and more effectively. Spice is added by talk of leaks and secret plans; and ideology by arguing about the balance between tax increases and spending curbs. My own bottom line is that all this is in response to a largely imaginary budget crisis. If we have a normal economic recovery the red ink will diminish remarkably quickly. If we don’t, it won’t and won’t need to.

Debt ratios of this size are historically far from unprecedented. In the early Victorian period the ratio was nearly 200 per cent and almost reached that level again in the early 1920s. In 1956 it was just under 150 per cent. Harold Macmillan, who was chancellor at the time, quoted the historian Lord Macaulay: “At every stage in the growth of that debt it has been seriously asserted by wise men that bankruptcy and ruin were at hand; yet still the debt kept on growing, and still bankruptcy and ruin were as remote as ever.” In fact the debt was gradually reduced from the peaks mentioned above without any heroic gestures.

The danger of premature tightening was illustrated in the US in 1936-37, when the ending of a war veterans’ bonus and the introduction of social security taxes helped push the US back into recession when recovery from the Great Depression was far from complete.

The big error of the current discussion is to confuse the budget balances of individuals and companies with the government budget balance, which needs to be in deficit so long as attempted savings exceed perceived investment opportunities.

Paul Krugman in the NYT:

Stocks are up. Ben Bernanke says that the recession is over. And I sense a growing willingness among movers and shakers to declare “Mission Accomplished” when it comes to fighting the slump. It’s time, I keep hearing, to shift our focus from economic stimulus to the budget deficit.

No, it isn’t. And the complacency now setting in over the state of the economy is both foolish and dangerous.

The conventional wisdom is that trying to help the economy now produces short-term gain at the expense of long-term pain. But as I’ve just pointed out, from the point of view of the nation as a whole that’s not at all how it works. The slump is doing long-term damage to our economy and society, and mitigating that slump will lead to a better future.

What is true is that spending more on recovery and reconstruction would worsen the government’s own fiscal position. But even there, conventional wisdom greatly overstates the case. The true fiscal costs of supporting the economy are surprisingly small.

You see, spending money now means a stronger economy, both in the short run and in the long run. And a stronger economy means more revenues, which offset a large fraction of the upfront cost. Back-of-the-envelope calculations suggest that the offset falls short of 100 percent, so that fiscal stimulus isn’t a complete free lunch. But it costs far less than you’d think from listening to what passes for informed discussion.


3 Responses

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  1. freethinkingeconomist said, on October 2, 2009 at 9:36 am

    My view on Sam Brittan are near-worship.

    Though even I was surprised by his idea that most the deficit will disappear. Depends what you think a “normal” economic recovery will be, and how we will get it.

  2. dannyboy said, on October 4, 2009 at 8:00 pm

    An FT article that leaves an unexpected aftertaste of chartalism. Quite a surprise. Interesting and encouraging that informed debate is moving onto the real issues here.

    Duncan, related to the UK debt totals, do you have a feel for how far in excess of the UK M4 money supply the total debt figure is? What I’m after is how much horizontal re-relending of bank credit we have going on in our economy, compared to the US. From memory the total debt in the US is something like 48tn, and their M3 around 14tn or so, which implies a ratio around 4.

    Lastly, I hear that UK housing prices are returned to pre-lehman levels. I find this surprising given the ongoing weakness and meltdown in the US, and wondering why we are not suffering to the same degree, at least so far.

    • duncanseconomicblog said, on October 5, 2009 at 7:02 am


      The non-seasonally adfjusted stock of M4 outstanding as of the end of August was £1,999,857mn (or basically two trillion quid).

      Hard to get a total figure for debt from ma decent source. M4 lending is at £2,419,131mn – but that excludes lending to the public sector, lending to banks and the corporate bond market.

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