Misguided calls for further stimulus misunderstand Britain’s downgrade
FRONTLINE ECONOMICS
BRITAIN’S downgrade became inevitable on 29 November 2011. Before then, the chancellor was committed to eliminating the structural deficit within five years, and to getting net debt as a proportion of GDP falling by 2015. But new forecasts, presented on that day’s Autumn Statement, indicated that he wouldn’t achieve the first target on unchanged policies. With the choice between more cuts or more debt, he chose more debt. He abandoned deficit reduction. He subsequently abandoned his net debt target as well.
Moody’s decision to downgrade Britain’s credit rating is therefore unsurprising. Public finance statistics have been obfuscated, and decisions required to get debt under control have been pushed into the future – with all the uncertainty of future elections and the demographics of an ageing population.
And now some have used the downgrade to push misguided calls for more borrowing. But the consolidation programme so far has only been “private sector austerity”, with front-loaded tax hikes and public investment cuts. Current expenditure and welfare costs have risen. In contrast, consolidation best practice requires significant reductions to public consumption spending and tight control of welfare, with taxes and investment left untouched. It would be foolish to change course, just as the coalition is about to start back-loaded cuts in the right areas. In fact, if further large savings in current budgets could be found for incentive-enhancing tax cuts, all the better.
Instead, neo-Keynesians want to throw away the programme completely and open the taps with additional “stimulus”. They ignore the fact that we already have debts above the threshold economists Ken Rogoff and Carmen Reinhart argue leads to two decades of stagnation. And there’s also little evidence that stimulus actually works in generating a self-sustaining recovery (ask Japan). At best, it might be a short-term shot in the arm – pain aversion, rather than a cure. The debate about short-term fiscal multipliers (the fact we are open and have high debts suggests they are near-zero; coordinated consolidation in Europe and near zero interest rates suggests they are higher) misses the point. New debt has to be paid back, inflated away or defaulted on eventually. There’s no free lunch.
Further, there are significant risks. Britain’s low bond yields don’t reflect reality, having been artificially held down by quantitative easing, regulation and a relative flight to safety. With the US recovering, and with the Eurozone set to improve eventually, continued high deficits will lose us our reward for safety. If markets think we are printing money to finance deficits, with little commitment to running surpluses in future, this will lead to inflation and a slow run on the pound (which is already sliding).
There are no easy answers, but there are simple ones. Public current expenditure must be cut substantially to enhance medium-term growth, and the coalition must also do all it can to aid private sector recovery: whether through tax reform, deregulation, or fixing the banks.
Ryan Bourne is head of economic research at the Centre for Policy Studies.