Why the Brown critics are wrong
Samuel Brittan Financial Times 21/11/08
The main object of the so-called pre-Budget report that Alistair Darling, the British chancellor, is presenting this Monday is to inject more spending power into the British economy by a mixture of tax cuts and spending increases, mixed in with a handful of populist gimmicks. The package is likely to be received with cries of "It won�t work" by many City analysts. It is possible to answer some of their objections in advance.
The most frequent objection is to ask: "Where will the money come from?" The short answer is: the Bank of England printing works in Debden. This is not just a debating reply. In a paper currency system there is no fixed pot of money, but a total influenced by human action. The most interesting information in the Bank of England�s Inflation Report is a chart on page 11 showing that the annual growth of broad money and bank credit (excluding certain financial intermediaries) slowed from about 15 per cent early in 2007 to 5 per cent in the third quarter of 2008. In that quarter alone, real money growth (that is, adjusted for inflation) was negative for the first time since the early 1980s. There is clearly scope and need for a pick-up in monetary growth. In the first place, however, the government is likely to finance its new borrowing by issuing government securities.
The next objection is that an already high budget deficit will be pushed into the stratosphere by the extra borrowing. This is psychologically the most difficult hurdle. Too few people understand that a government�s budget is not like a family�s or a company�s. It is precisely when the private sector is cutting down and saving that the government needs to spend more as an offset to maintain a reasonable level of total expenditure in the economy.
The most plausible argument against a fiscal stimulus is that by the time it takes effect, the economy will be in a boom and the effect will be destabilising. This may be valid for attempts to smooth out normal business cycles, but hardly for a possibly persistent slump. The pre-Budget report is likely to contain an illustrative path back to fiscal prudence as the economy recovers. But the outlook is too clouded to take such projections too seriously. The big uncertainties surround not only the likely trend of productivity, but even more the behaviour of savings relative to investment. It is more important to choose stimulants that take effect quickly and can be quickly withdrawn.
Does this mean tax reliefs or more public works? I have to admit that my immediate reaction to the latter was to envisage even more municipally dug holes in the London streets. Public works are notoriously difficult to bring forward quickly and even more to switch off later. Temporary increases in cash grants are better.
As for straight tax cuts, there are several ingenious arguments against using them as a stimulus. They boil down to saying that taxpayers will expect taxes to rise again and therefore save most of any windfall. This is the case for concentrating reliefs on poorer citizens who are cash-constrained. It is even more a case for temporary cuts in indirect taxes such as value added tax, which the Treasury can introduce overnight under its "regulator" powers.
The last resort criticism is that increases in UK spending will leak abroad into imports. Fiscal stimuli are certainly more effective if countries act together. But countries do not have to move in lock-step; and a floating exchange rate is an invaluable safety valve for a country that is seen to move a bit further.
"Is there not a danger of a run on sterling?" ask Tory Bourbons. Even they should by now realise that the exchange rate is a price and not a virility symbol. Indeed, if you think it important to narrow the current balance of payments deficit then sterling depreciation is needed. True, too big a fall in the pound sustained too long could bring back import-led inflation. But it is extremely uncertain how large such a feedback would be in current recessionary conditions. I was one of those taken by surprise by the smallness of the impact when sterling was forced out of the exchange rate mechanism in the recession conditions of 1992.
"But could we not avoid all these arguments by relying on monetary policy to reflate the economy?" There is a special reason for an emphasis on fiscal policy. Monetary policy works by encouraging people to borrow and spend. This must mean - barring an unlikely boom in business investment or net exports - an increase in consumer indebtedness which many observers think already too high. An increase in government debt is surely less dangerous.
Moreover, a full-blown monetary stimulus, once official interest rates are near zero, would require pretty unorthodox action. The Bank of England policy would have to shift its immediate target to the money supply itself. It would have to extend even further the range of securities in which it deals and the Government Debt Office would have to be directed to facilitate monetary policy. To put it more simply: the arm�s length relationship between the governments and central banks, however desirable in normal times, makes much less sense when faced with a slump.
|Published on www.samuelbrittan.co.uk
Contact - samuel dot brittan at ft dot com