Tuesday, 15 February 2011

Pulling away from the fiscal precipice

The last couple of days, I've been raging about inflation. This is partly in anticipation of this week's Inflation Report. Doubtless, the report will contain the usual incoherence that we have come to expect from the Bank of England.

On fiscal policy, I have been more muted of late. I am quietly hopeful that the coalition's fiscal consolidation plans will pull us from the precipice. Perhaps I'm being too blinkered, but I really don't care one way or another about David Cameron's disappointment in multiculturalism or his vision of the big society. For me, if he manages to save us from fiscal disaster, then he has my support.

Gordon Brown would have had that support too, if he had been more true to his earlier rhetoric of prudence and an end to boom and bust. Personally, I don't much care for political parties, but I care passionately about policies.

Large, unsustainable fiscal deficits are frightening. They always represent a victory of short-term political expediency over the long term needs of the nation. deficits are about pandering to the electorate without considering the long-term implications of irresponsible fiscal policies.No sensible person would blow all their savings or accumulate huge debts in a mad frenzy of spending. The same is true of the governments.

Any government that continues run up large deficits and accumulate debts will sooner or later reach the threshold when it can no longer borrow. When that point is reached, the adjustment back to fiscal balance will be violent and disorderly. The expenditure cuts will be brutal, with little consideration for the usual niceties such as protecting the poor and maintaining key public services such as health and education.

This is why I find all this whining about the coalitions expenditure cuts so irritating. Of course they will be painful, but it is better to administer these difficult decisions while financial markets are still willing to keep credit lines open.


Jim said...

But the Left refuse to see that. They maintain that you can go on spending ad infinitum, and nothing bad will happen. And they are correct, right up to the point where we fall into the abyss. Until then it all looks OK. Given the last time they did it to us was 1976, you would have to be over 50 to have any real memory of it. Everyone else just cannot comprehend the problem.

We in the UK are screwed over the next 30 years anyway - our demographics, combined with our current high level of spending, virtually ensure that debt to GDP ratios will rise inexorably, giving rise at some unspecified point to the abyss. That is our future, unless we collectively have an awakening.

I'm not holding my breath.

bill said...

And what most people don't realise is the recovery in the 80's/90's was only possible from revenue from the North Sea. North Sea oil production kicked in just after the Tories came to power and we became a net oil exporter. In 1999 North Sea oil peaked and by 2005 we became an net oil importer.

Labour made a huge gamble that South Atlantic oil would provide revenues to pay off their debt, and although oil exploration is still taking place around the Falklands, its looking increasing like there isnt that much oil/gas in the region.

Ed Butt said...

The deficit is a big problem, the age timebomb will be a bigger one and the inflation brought on by rising commodity prices in a nation that imports food and energy and has little to export will be even bigger.

Anybody got any kool aid.

Anonymous said...

I fundamentally disagree with this post and the comments.

First, the article has not defined just what actually constitutes a "large, unsustainable fiscal deficit".

Seeing fiscal deficits as somehow inherintly unsustainable in themselves is operationally meaningless in the context of a fully sovereign government such as that of the UK. The fear of them is largely groundless and is mostly derived from political and ideological veiwpoints, not out of any kind of operational necessity.

Much of the deficit has arisen as a result of the automatic stablisers - any attempt to strangle such a normal function through ongoing mass government spending cuts will fail. Economic activity will be suppressed and the budget will be pushed toward deficit anyway.

Second - related to the previous paragraph - it is pointless to remain ignorant of (or willfully wish away!) the basic sectoral balances of the national economy.

As a matter of basic national accounting, the total government sector surplus/deficit exactly equals the total private sector deficit/surplus. This is not an opinion. It is not a theory. It is not a left-wing or right wing political stance. It is a basic fact of accounting, devoid of politics and ideology.

The total government sector and total private sector CANNOT both be in surplus at the same time. Not unless there is a truly enormous and sustained current account (external) surplus. If the private sector in aggregate wishes to de-leverege and be in surplus, the government will not be able to be in anything other than deficit. This is not an opinion - it is a simple fact, true by definition, as true as 2+2=4.

It is not deficits that are the problem in general, especially not for the fully sovereign government of the UK. The problem is the solidy entrenched (and deeply mistaken) belief that deficits are inherintly bad, are proof of economic incompetence on the part of government. There is no appreciation of the fact that for the most part it is not the government but rather, we the private sector that choose whether the budget is in deficit or not, through our aggregate spending/saving decisions.

Attempting to solidy "fix" something that is not broken in any realistic way, out of ignorance or for political and ideological purposes will fail to have the desired effect. Indeed, deep cuts made just for starters, to education will probably achieve little more than to dumb the UK down and reduce productivity in the long term.

The attempt to "strangle the economy back to health" is a gauranteed failure.

Jim said...

Thankyou Anonymous for proving my point. There's none so blind as will not see. I wish there were a parallel universe that you and the people who think like you could inhabit, and you alone would suffer the consequences of your actions, and not cause massive damage to innocent others.

I'm curious. Do you think that the current govt are actually implementing cuts? Or do you realise that actual cash spending will rise over the next few years to 2015? Presumably you want them to spend even more? How precisely will the debt level EVER be stabilised if we continue to grow public spending by inflation or more every year? Or is an ever expanding amount of debt a good thing?

You do realise that debt has to be serviced don't you? That as debt rises as a proportion of GDP the amount of spending on just on servicing the debt rises inexorably, both in cash terms and as a proportion of the whole budget? That eventually you are borrowing money to pay the interest on money you borrowed before? And eventually you reach a point of no return, when your debts are so large you cannot ever hope to service them, let alone pay them back?

And when that happens the money gets cut off, just like that. Like Northern Rock was one day a solid bank, worth billions, and a few weeks later an insolvent wreck. Just because the money tap was turned off. That can happen to nations too you know. And if it were to happen to us, God help us all.

Anonymous said...

"There's none so blind as will not see. "

A sterling example of it yourself, old chap.

Alice Cook said...

Thank you for your comment. Dissenting voices are always welcome.

Let me try and deal with your points one by one.

"Large unsustainable deficit" -The key word is unsustainable. This would be a deficit that the government could not repeatedly finance. For example, the fiscal deficit of the Greek government in 2009, could not be repeated in 2010 because financial markets were unwilling to extend credit to the Greek government.

I'm afraid you're wrong when you say that the deficit is due to automatic stabilisers. Normally, we think of automatic stabilisers as those components of expenditure and revenues that move with the cycle, such as unemployment benefit and some revenue items, such as PAYE and profit tax. Our recent deficits have been due to structural shocks such as the collapse of the housing market, and the related collapse of corporate taxation from the financial sector. Neither of these could be remedied described as cyclical events. Moreover, policies directly contributed to the size of the deficit. For example, the 2 percent of VAT significantly increased the deficit, and certainly wasn't anything that one could describe as an automatic stabiliser.

I wasn't sure if I fully grasped your point about the flow of funds. The fiscal deficit is determined by policy decisions on the part of the government. The private sector balance are likewise determined by savings investment decisions. The same goes the corporate sector. The residual, is the current account. However you appear to suggest that the fiscal deficit is the residual. I'm afraid I can't agree with that.

History is full of examples of countries that run into problems when they have large fiscal deficits. There are some extreme episodes, like the Weimar Republic. There are also other examples, like Italy over the last 30 years, which has struggled to to manage fiscal policy with a huge debt burden. So, I firmly believe that fiscal deficits are inherently bad. Of course, the government can run a few temporary deficits when the economy slows, but it must be compensated by surpluses when the economy is running above trend.

Finally, I don't think the question of "strangling the economy back to health" is the one that currently faces the UK economy. Currently, the UK macro position is full of grotesque imbalances. These imbalances range from an unhealthy current-account deficit, a huge fiscal deficit, a bloated and bankrupt banking system, and the central bank in denial about inflation (at least until today).

The path to stability will be painful. In truth, I don't think anyone denies this. The coalition seems fairly clear on this point. Even new Labour, when they were in office, more or less admitted this fact.

However, one thing we must be clear about. There is no road out of this mess that involves increasing the fiscal deficit.

Again, thank you for your comments. I hope to hear from you soon.


Alice Cook said...

Sorry, if it wasn't obvious, my previous comment was directed to anon 22:39.

miken said...

Anon@22:39, a debt of 1 trillion is completely irresponsible. Especially when you can fund the entire UK defence alone on the interest payments due on that deficit:


What's worse is this yearly interest bill could easily double if the UK economy goes back into recession and we lose our good credit ratings.

The problem with the previous government was that money didn't appear to have true meaning or worth. I heard stories first-hand from someone who worked in a Westminster department and he was telling me that some contracts worth billions were rounded up to the nearest billion.