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The harmful myth of the balanced budget
Samuel Brittan The Financial Times 12/10/12

So you think it only common sense that a government budget, like that of a family, should balance? But what do you mean by balance? In Britain, for example, the last estimate prepared for the Treasury by the Office for Budget Responsibility says the government's current deficit in 2012-13 will be £95bn and its net borrowing £92bn.

As percentages of gross domestic product these come to 5.8 per cent and 6 per cent respectively. But do not think this is the end of the matter. Another item entitled "cyclically adjusted current balance" is put at 4.2 per cent.

Then there is, probably the most important, the primary deficit - roughly how far the government is from reducing its debt. This is put at 3.2 per cent and in its cyclically adjusted form at 1.3 per cent. And if you have not had enough numbers you will find a 5.9 per cent estimate for the deficit under Maastricht treaty definitions.

These numbers are likely to be revised unfavourably owing to the disappointing behaviour of the national economy. But the discrepancy between the various versions will remain, as will the conundrum about which total the budget balancers should target. All that we can be sure of is that the aim of almost eliminating government borrowing by 2016-17 will be pushed out further in time.

Is there no alternative to this dull drip-drip of austerity? Christine Lagarde of the International Monetary Fund has called for a slower pace of adjustment.

A much cited chapter in the new IMF World Economic Outlook cites the many pitfalls in policies of public debt reduction. The budget deficit is not the only factor affecting the debt to GDP ratio. The interest rate, inflation rate and real growth rate all matter. Indeed the largest debt reductions have usually been the result of hyperinflation.

The worst example cited of counterproductive fiscal austerity is the UK between the wars. Real output in 1938 was barely above the 1918 level. Yet for all these sacrifices it was not until 1990 that public debt reached its pre-first world war level. Admittedly policy in the interwar years was handicapped by the twin pursuit of an outmoded parity with gold and fiscal austerity. Today we have merely the latter. The most successful recent case of austerity, that of Canada a few years ago, benefited from rapid real growth internally and in the US.

Yet critics of austerity sell themselves short by merely calling for a deceleration in deficit reduction, as Ms Lagarde has done.

I have no doubt Oliver Cromwell could balance the UK budget with sufficiently draconian measures. But there are such things as conflicts of objectives. The aim of the macroeconomic side of a national budget should be to help balance the economy. George Osborne's comparison, when he took office as chancellor, of the national budget to "every solvent household in the country" was wrong, wrong, wrong. Around the same time Sir Mervyn King, governor of the Bank of England, called for a grand bargain in which lower domestic demand in deficit countries was offset by an increase in domestic demand in the surplus countries. Predictably there was no such bargain and the half- million increase in UK export sector jobs he hoped for did not materialise.

There is really no alternative to an "alliance of the willing" of countries deciding to go ahead with internal Keynesian expansion however much Bourbons protest.

But would not the puncturing of the balanced budget myth give the green light to vast government profligacy? There is no sure way of safeguarding fools from their folly, but there are institutional devices that could lessen the danger.

I suggest a threefold division of the national budget. The first would be normal current expenditure, such as spending on teachers or soldiers, which would be always covered by revenue. The second would be a capital budget some of which governments could borrow, but strictly at market rates of interest.

The third section would be a stabilisation fund which would inject purchasing power when depression threatens and remove it during periods of inflationary pressure. It would not be confined to the traditional public works but could include any types of public spending and also tax remissions. This approach would help to distinguish economic arguments about fiscal stimuli from political arguments about the size of the state.

This third section could best be financed at zero or low interest rates by advances from the central bank, as it would be a respectable form of the helicopter drop. The threefold division could perhaps be policed by a body such as the Office for Budget Responsibility. And in the background there needs to be a national policy goal such as a nominal GDP objective. Nit-pick these ideas as you like, they are more promising than everlasting austerity and slump.


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