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Stale debate holds back Britain's recovery
Samuel Brittan The Financial Times 07/12/12

It is some relief that we have merely had a neutral Autumn Statement, with fiscal tightening measures balanced by reliefs and concessions rather than the extra dose of fiscal austerity that some had predicted. Largely because of disappointing economic growth the government has missed its targets for both deficit reduction and official borrowing and has pushed them forward from an original 2015-16 to 2017-18. For this relief some thanks. The chancellor, George Osborne, has followed the maxim "if you are in a hole stop digging", or, more accurately, "don't try to dig faster".

What more can one say? Some of us think that the whole strategy is misconceived, whether from the purist Keynesian view of aiding monetary policy to balance the whole economy or even from the compromise view of Ed Balls, the shadow chancellor, who argues Mr Osborne should originally have set out on a much slower path of deficit reduction - more haste, less speed. One can only say that the Autumn Statement is less bad than it might have been.

The main reason for the disappointing fiscal out-turn is disappointing economic growth. The Office for Business Responsibility expects gross domestic product growth in 2012 to be minus 0.1 per cent and a meagre 1.2 per cent in 2013, before hopefully recovering from 2014 onwards. Much of the blame is put on the troubles of the euro area, which are now regarded as not all that temporary. More fundamentally the UK output gap - the gap between actual and potential output - is now put at 2.7 per cent. Even if this were somehow filled we would still be well below the trend line of several years back. But a note of caution should be introduced by the OBR's Chart 3.4 showing independent estimates of the output gap ranging from 0.8 per cent, suggesting that the economy is now working at near capacity, to 5.2 per cent, suggesting that we are in a depression.

Financial analysts may be more concerned with public sector net debt, which is now expected to rise for several years ahead and is not expected to turn down until after 2015-16 when it may have reached nearly 80 per cent of gross national product. This is not all that high by historical or international standards. Those who do not believe me should read Lord Macaulay, the 19th century historian, on the numerous false alarms on this issue. The more easily understood current budget deficit is now put at 5.7 per cent of GDP, which is reduced to 3.6 per cent by the magic of cyclical adjustment. Both measures of the deficit are expected to vanish from 2016 onwards. Who was the American wit who said prediction is difficult, especially of the future?

Faithful readers will not be surprised that I am more interested in the OBR's analysis of nominal GDP, that is output and incomes at actual rather than constant prices. A reasonable rate of nominal GDP growth would be widely regarded as something like 5 per cent a year. This was slightly exceeded in 2007 but has never been reached since. Its present growth rate is put at 2 per cent, after which a gradual climb is expected with the 5 per cent rate not reached until 2017. What all these estimates suggest to me is that there is ample room to stimulate growth without unacceptable inflationary effect, but the chancellor is prevented from doing so by pre-Keynesian shibboleths.

There is, however, an approach which would separate partisan bickering from genuine differences in economic analysis. This is to divide the national budget into three sections: normal current expenditure; a capital budget; and a stabilisation fund. The first should normally be covered from revenue. If we want to have more soldiers or more science teachers the taxpayer would have to pay the full costs here and now. Some at least of the capital budget might be financed from borrowing at market interest rates, especially where a tangible financial return was expected. The material already exists for these first two divisions.

The third section, the stabilisation fund, would inject purchasing power in the face of threatened recessionary conditions and remove it during periods of inflationary overheating. It would not be confined to the traditional public works, but cover any type of public spending or provisional tax cuts. It might be best to finance such a fund from Bank of England ways and means advances, really a form of the helicopter drop.

A cynical reaction is that governments would be quicker to expand such a fund than to contract it. There are possible safeguards. Some outside body such as the OBR night be required to certify that conditions for such an expansion had been met. In the last resort, the BoE could penalise inflationary fiscal profligacy by raising interest rates. This proposed tripartite division would insulate consideration of fiscal economics from left-right arguments about the size of the state. It should not be lightly dismissed.


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