Yesterday’s GDP figures have led to calls for a relaxation of Osborne’s fiscal tightening. For me, though, another less-remarked development provides another case for doing so.
I refer to the fact that the government’s real borrowing costs have recently fallen to a record low. The average yield on index-linked gilts with a maturity of over five years is below 0.4%. When borrowing is so cheap, doesn’t it make sense to do more of it?
The counter-argument to this is that such a move would raise interest rates. But even if rates were to rise by one or two percentage points, they’d still be lower than they were in the 90s, when no-one worried about government debt.
The counter-argument here is that rates would rise by more than this. I doubt it, for three reasons:
1. History shows that gilt yields are just not that volatile. Of course, history is not always a guide to the future. But there is something paradoxical about people who normally extol the virtues of free markets being concerned about massive volatility suddenly arising in a market where it has not done so previously.
2. The UK’s fiscal position is reasonably healthy. Our debt-GDP ratio is now 61.9%. With long-term real borrowing costs of 0.4% and trend growth of 2.1% (if you believe the OBR) this implies that we’ll stabilize the debt-GDP ratio even if we have a primary budget deficit of 1% of GDP*. Yes, our deficit is higher than this now. But on current plans, we’ll have a surplus by 2014-15, implying a fall in the debt-GDP ratio by then. This, surely, gives us some wiggle room to loosen policy.
3. Low gilt yields are not simply - or even perhaps mainly - due to the markets giving a vote of confidence in Osborne’s fiscal plan. They also reflect pessimism about global growth, a global savings glut and a shortage (pdf) of safe assets in the world. These factors would keep yields low, even if fiscal policy were relaxed a little.
These thoughts tempt me to side with Ed Balls.
But not with any enthusiasm. I fear that our problem is not merely that the economy is in a temporary, short-lived “cyclical” slowdown of the sort that can be ameliorated by a modest fiscal easing. Instead, a combination of the investment dearth - which, remember, preceded the crisis - and the effect of the crisis in reducing trend growth has left us with (semi-)permanent slow growth. As Duncan says, Balls plan “isn’t enough to deal with the serious issues we face.”
* Even if we assume lower trend growth and higher borrowing costs, a tiny surplus would suffice to stabilize the debt-GDP ratio.