Noted for March 14, 2013
Thursday Dozen Hoisted from the Archives: Keepers from May 2005

Martin Wolf: David Cameron and George Osborne in the Bunker

Martin Wolf:

Britain’s perilous austerity bunker: David Cameron’s “there is no alternative” speech last week on the UK economy has aroused much criticism. This is justified. The British prime minister’s arguments for sticking to the government’s programme of fiscal austerity were overwhelmingly wrong-headed….

How does one defend this record?…. Mr Cameron argues that those who think the government can borrow more “think there’s some magic money tree. Well, let me tell you a plain truth: there isn’t.” This is quite wrong. First, there is a money tree, called the Bank of England, which has created £375bn to finance its asset purchases. Second, like other solvent institutions, governments can borrow. Third, markets deem the government solvent, since they are willing to lend to it at the lowest rates in UK history. And, finally, markets are doing this because of the structural financial surpluses in the private and foreign sectors.

Again, Mr Cameron notes that “last month’s downgrade was the starkest possible reminder of the debt problem we face”. No, it is not…. First, Moody’s stressed that the big problem for the UK was the sluggish economic growth in the medium term, which austerity has made worse. Second, the rating of a sovereign that cannot default on debt in its own currency means little. Third, the reason for believing long-term interest rates will rise is expectations of high inflation and so higher short-term rates. But such a shift is going to follow a recovery, which would make austerity effective and timely….

The prime minister also stated: “[Labour] think that by borrowing more they would miraculously end up borrowing less…. Yes, it really is as incredible as that.” What truly is incredible is that Mr Cameron cannot understand that, if an entity that spends close to half of gross domestic product retrenches as the private sector is also retrenching, the decline in overall output may be so large that its finances end up worse than when it started. Bradford DeLong of Berkeley and Larry Summers, the former US Treasury secretary, have shown that, in a depressed economy, what Mr Cameron deems incredible is likely to be true. A recent International Monetary Fund paper argues that “fiscal tightening could raise the debt ratio in the short term, as fiscal gains are partly wiped out by the decline in output”. Mr Portes adds that, even if this is not true for the UK on its own, it is likely to be true for Europe since almost everybody is retrenching simultaneously.

Mr Cameron argues that “this deficit didn’t suddenly appear purely as a result of the global financial crisis. It was driven by persistent, reckless and completely unaffordable government spending and borrowing over many years.” In a way, this is the most worrying error – not because the fiscal policy of the Labour party, then in power, was perfect. Far from it. Fiscal policy should have been tighter. But that is not the main reason the UK has a huge structural deficit.

It is the economy, stupid….

Mr Cameron’s argument against fiscal policy flexibility is wrong. But, beyond this, we have to consider why the economy has proved so fragile and rebalancing so difficult. That is for next week.