Why UK should not fret about national debt
Samuel Brittan Financial Times 27/03/09
Some characteristically cautious words by Mervyn King, the Bank of England governor, about fiscal stimuli have been hysterically seized upon by the nation's Conservative press. The central bank chief said that the automatic stabilisers that "kick in" during recessions (such as increased benefit spending and lower tax revenues) "are bound to lead to higher fiscal deficits for the next two or three years ... and it doesn't make sense to try and offset that". He added, however, that, given the very large deficits expected, it would be sensible to be cautious about further discretionary fiscal stimuli. "That's not to rule out targeted and selective measures that can do some good."
But at the risk of lèse-majesté, I have to say that while there may be a good many reasons to think twice about a further stimulus in the forthcoming UK Budget, the size of budget deficit or the associated national debt is not one of them. Since my undergraduate days, I have been pointing out that a government budget is not the same as that of an individual or company. Indeed, the more reluctant people and corporations are to spend, the greater the case for the state to spend to fill the gap. The message is still too counterintuitive to get across.
But is not all this budgetary red ink inflationary? Obviously, there could come a point when it would be too much of a good thing. But there is not the slightest evidence that this has happened or that the UK is anything like Zimbabwe. Some headlines about the return of inflation could not be more misconceived. The slight pick-up in the official inflation rate is explained by the inability of official statisticians to invent a "better than nothing" seasonal correction of the data. That is why the inflation numbers, unlike most other economic data, are stated on an annual basis. In fact, the official consumer prices index is actually a decimal point below where it was six months ago. Other measures, such as that old warhorse, the retail prices index, are at about the level of a year ago.
A better reason for caution given by the governor is that monetary policy should bear the main brunt of tackling booms and slumps. For normal times, I quite agree. Political memoirs show how amazingly little attention cabinets devote to monetary policy compared with the hours of agonising over the minutiae of public expenditure. Nevertheless, as Mr King himself has stressed, conventional monetary policy has almost reached its limits, with official interest rates of half a per cent. He might be able to deliver more stimulus by so-called quantitative easing, which is a highbrow term for increasing the money supply. But there could still be a problem in persuading the owners of these new deposits to engage in more spending - the so-called liquidity trap. The simplest new stimulus would be for the Bank of England to lend directly to the government through Ways and Means Advances to cover part of its deficit. This would lessen the dependence on City prejudice, which was revealed by the recent failed gilts auction. In any case, it was what the Bank of England was originally created to do.
There are two related arguments for scepticism about budget deficits. There is the so-called Ricardo effect, which is said to mean that citizens will fear future tax increases to pay for any short-term remissions. The other, related, argument is the permanent income hypothesis: people take a lifetime view of their disposable income and will be inclined to save any temporary tax cuts. Both these arguments boil down to caution about anything like straight income tax cuts of which the Tories are so fond. The arguments also favour boosting public expenditure, not only on unnecessary bridges and bypasses but also on social benefits, which recipients might treat as a windfall and be prepared to spend, especially if they are rather poor and, in the ugly economic jargon, "cash constrained".
Nothing I have said will convert people who have an instinctive fear of governments getting into debt. Let me therefore cite the distinguished English historian, Lord Macaulay: "At every stage in the growth of that [national] debt the nation has set up the same cry of anguish and despair. At every stage in the growth of that debt it has been seriously asserted by wise men that bankruptcy and ruin were at hand. Yet still the debt kept on growing; and still bankruptcy and ruin were as remote as ever." Harold Macmillan, as chancellor of the exchequer, quoted Macaulay in his 1956 Budget speech and remarked how the national debt had risen from £6bn in 1914 to £27bn in 1956, representing 27 and 146 per cent of gross domestic product respectively - about twice what is now in prospect. Yet these percentages were reduced in the postwar phase without any heroic reserve or "sinking" funds, through the simple forces of economic growth and inflation creeping at a rate not much above current inflation targets.
Of one thing I am sure. If we had the misfortune to engage in a major war, we would have far higher deficits and debts than anything now in prospect and few except some pacifists would worry. The second world war was financed in the UK with a 0.5 per cent bank rate. Why should it be more alarming for governments to get into debt to put people into useful work satisfying human needs than to borrow for guns and tanks whose only aim is to kill other human beings?
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Contact - samuel dot brittan at ft dot com