BBC BLOGS - Stephanomics
« Previous | Main | Next »

A plan not a timetable

Post categories:

Stephanie Flanders | 17:30 UK time, Thursday, 8 October 2009

It wasn't a speech about economics, but today David Cameron found a simple way to tackle a complex economic argument about the deficit head-on. He said:

"[T]he longer we wait for a credible plan, the bigger the bill for our children to pay. The longer we wait, the greater the risk to the recovery. The longer we wait, the higher the chance we return to recession."

David Cameron

You can make a case for all three of those claims. The average person can also understand them. You can't always say that of a political leader's rhetoric on the economy.

What is more, the bulk of City opinion would sign up to the Cameron view. The financial markets almost always want governments to spend and borrow less.

Certainly, with a £175bn deficit, you'd be hard-pressed to find an economist who thinks the government is borrowing too little.

But it is important to note what Cameron did not say. He did not say that the longer we wait to cut the deficit, the bigger the bill for our children. He merely gave that impression.

He did not say that, because if he had, there would have been plenty of economists who disagreed, including Martin Wolf, the senior economic commentator of the FT and not a man who is known for his love of the state.

Of course, it's true in a tautological sense that borrowing will be larger tomorrow, if whoever is in power fails to make it smaller today.

The more interesting question is whether attempts to cut the deficit much more quickly than planned can succeed in a weak economy.

Why? Because, as I've said before, you're unlikely to be able to reduce borrowing as a share of national income (you may not even be able to reduce it in absolute terms) if national income declines at the same time.

Not only do you have a falling denominator (GDP), but you end up spending more on things like unemployment benefit, just as you are cutting elsewhere. Overall spending may not even fall.

If the next government withdraws too much demand from the economy, too quickly, that is what will happen.

I'm not suggesting that this is what the Conservatives will do. For all the rhetoric, I suspect that the shadow chancellor and his team know they can only take it so far.

That's why David Cameron spoke today only about the urgent need to have a "credible plan", not an urgent need to implement it.

Everything the shadow chancellor has said so far suggests that an incoming Tory government would pre-announce dramatic cuts for 2011 onwards, and some extra cuts - or tax rises - up-front.

But I'm not sure there would be dramatically more tightening in 2010-11 than Labour already plans. If the Tories won, they, too, would be looking at the strength of the recovery in making that call.

As I've said many times now, there might well be some economic benefit to announcing tough deficit cuts. We can expect the City to applaud, for all the reasons mentioned above.

And when you're borrowing this much, applause from the City is a very useful thing to have. That's why an early announcement of future cuts would make a lot of sense.

But we should remember that interest rates - short and long-term rates - are already extraordinarily low. In fact, one of the great surprises of recent months has been how easy it has been for the UK to fund this enormous deficit.

International comparison suggests that quantitative easing - the fact that the Bank of England is buying so many gilts on its own account - means that the interest rate on the British government's debt is perhaps 70 basis points lower than it would otherwise be.

But government bond yields have been low everywhere, despite record public borrowing.

In the Conservatives' view, interest rates will stay low for longer if there is decisive action on the deficit, which will help the economy. That's quite plausible. But it's hard to see how they could actually go much lower than they are today.

To believe that deficit cuts will bring lower interest rates - long-term ones, anyway - and boost the economy, you have also to believe that there will be a dramatic change to city sentiment - and a panicked rise in gilt yields - between now and the election.

In other words, you have to believe that the markets will start to doubt that a tough Conservative chancellor is about to take control. It's an interesting view for the opposition leader to take.

Enough already. If all of these permutations prove anything, it is that we now have an extraordinarily complex economic calculation at the heart of Britain's political economy.

David Cameron says "the longer we wait, the greater the risk to the economy". If we're talking about rhetoric, that is almost certainly true.

When you have a deficit as large as Britain has, politicians - whether they are in power now or have a good chance of winning it in future - all need to talk seriously about getting the nation's public finances under control.

If the government - any government - delays that conversation for too long, then they are indeed taking risks with the recovery. But when the prospects for private sector demand are uncertain at best, there are risks to translating that tough talk into action.

If any government does too much, too soon, then that could endanger the recovery as well. David Cameron talked of a plan today - not a timetable - because I think he knows that as well.

Error: Too many requests have been made during a short time period so you have been blocked.

BBC © 2014 The BBC is not responsible for the content of external sites. Read more.

This page is best viewed in an up-to-date web browser with style sheets (CSS) enabled. While you will be able to view the content of this page in your current browser, you will not be able to get the full visual experience. Please consider upgrading your browser software or enabling style sheets (CSS) if you are able to do so.