11 October 2009

The “cuts” debate: A question of leadership

The inevitable debate has has broken out about Osborne’s cunning plan to cut the deficit and whether he has the correct policy and if the timing is right.

David Blanchflower, ex-member of the Bank of England’s Monetary Policy Committee, argued in yesterday’s Guardian that the Tories have got it wrong:

Lesson one in a deep recession is you don't cut public spending until you are into the boom phase. Keynes taught us that. The consequence of cutting too soon is to drive the economy into a depression. That means rapidly rising unemployment, social disorder, rising poverty, falling living standards and even soup kitchens. The Tory economic proposals have the potential to push the British economy into a death spiral of decline that would be almost impossible to reverse for a generation.

In response, along comes Hamish McRae, who does have a habit of explaining these complex matters for us members of the “Using matchsticks to understand economics Society”:

There are two powerful arguments against permitting the deficit to continue at present levels. One is that beyond a certain point a fiscal deficit stops boosting the economy and actually has the reverse effect. The other is that you cannot go beyond a certain deficit because the markets won't let you: you simply cannot borrow the money at an acceptable rate.

Japan in the 1990s ran up huge deficits to try to combat the recession. The result was a decade of lost growth and a debt burden now approaching 200 per cent of GDP. By contrast, Britain famously cut its deficit in the 1981 Budget in the bottom of a recession and was attacked for it. It is still controversial but that Budget is now credited by many people with creating the circumstances for turning round UK economic performance.

Now comes the key bit for us economic novices:

As for the argument that the deficit cannot be financed, the position at the moment is that it can. But that depends on the Bank's quantitative easing programme continuing, and at some stage that has to end. You can have a debate about when that should be but no one, not even Professor Blanchflower, would argue that it should continue forever.

McRae’s historical examples can’t be dismissed because they are fact.  The key flashpoint is when quantitative easing programme ends.  The politics dictates that this will see us through until after the general election.

The above debate is rather fundamental.  The economics feeds into the politics.  If there is little understanding of the former, we all just lost in the fog of debate between Brown’s ‘optimism’ and Cameron’s ‘austerity’ over the next seven months.

It will all come down to which party can persuade us that their case is more credible.  With Brown as Labour leader, no prizes for guessing who the voters will believe, no matter if Blanchflower is right.

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1 comment:

  1. Interesting. But not all economists agree with the left leaning latter day Keynesian Blanchflower. The debt levels are huge and servicing costs will be so enormous that who ever wins will have to reduce it. Simple.