The irrelevant structural deficit

Is our current economic weakness merely cyclical or structural? The OBR is, to say the least, not clear: see pars 1.16 to 1.18 here (pdf). It says (par 1.3) that most of its downward revisions to GDP forecasts are "assumed to be cyclical" [emphasis added].

This assumption is very convenient for Mr Osborne. If weak GDP is cyclical, then it follows that much of the deficit is cyclical, which relieves the Chancellor of the percived need to tighten fiscal policy further to reduce the "structural deficit".

This, though, merely strengthens my view that the notion of the structural deficit is a load of hoo. As Rick says:

Because no-one can tell how much of our economic underperformance is structural and how much is cyclical, George Osborne can’t possibly have any idea how big the structural deficit is.

This raises the question. Even if we do have a "structural deficit" - and it's impossible to tell for sure -  would it then follow that fiscal policy should be tightened? I think not, for three reasons:

1. A world in which the deficit is "structural" is one in which productivity growth is low and trend output growth is low. But in such a world, investors' would have little demand for risky assets and a high demand for safe ones. It would, then, be easy to finance big borrowing, even if it were structural. To put it less strongly, the question of whether the deficit can be financed at low bond yields is separate from the question of whether the deficit is cyclical or structural.

2. Measure to tighten fiscal policy could aggravate the problem of low productivity. Many of you might think this would be true of tax rises. But it might also be true of any fiscal tightening that amplifies a downturn if - as for example in learning-by-doing models - cyclical downturns (pdf) can reduce long-term growth.

3. A good reason to believe the government's deficit might be structural is that the private sector has a structural(ish) financial surplus. This could be because the dearth of investment opportunities means companies' aren't recycling their profits into capital spending - something which the OBR expects to continue*. And/or it could be because this is a balance sheet recession and the private sector wants to pay off debt.In such a world, it might be better for the government to loosen policy, to give the private sector the room to repair its balance sheets. Fiscal tightening risks crashing the economy as the paradox of thrift takes hold.

These considerations, I think, mean that the idea of a structural deficit is not just imprecise, but irrelevant. Even if its existence could be proved, it would not be sufficient justification to tighten fiscal policy. That justification lies elsewhere.

In this context, perhaps Osborne deserves a little credit. In deciding against tightening yesterday, he's shown that he's not obsessing about whether the deficit is "structural" or not. Quite right too.

* Table 1.8 of its supplementary economics tables.

Comments

[Luis Enrique]

to my mind, the "structural deficit" is just the answer to the question: if we keep policy unchanged, what do we expect the deficit to look like once the economy has recovered?"

for a given value of "recovered". Isn't that a reasonable question to ask? For example, if you were, I dunno, a bond investor, or somebody who wants to form expectations concerning the future state of public finances, isn't that the sort of question you'd be asking yourself?

[chris]

It's a reasonable question, but the answer is subject to so much uncertainty that I'm not sure it make sense to hang anything - government policy or investment strategy - upon it.
As there are many things that affect gilt yields more than the budget deficit (cyclically adjusted or not), the question should be pretty low down on bond investors' priorities.

[Ralph Musgrave]

Chris, Having had a quick look at a few definitons of “structual deficit”, consenseus seems to be that it is any deficit over and above a cyclical deficit. That’s it. I don’t think it has anything to do (as you suggest) with whether productivity growth is high or low.

I.e. a structural deficit is where a government borrows for no good reason. Or to be brutally realistic, it’s where politicians fall for the temptation of funding too much government spending from borrowing rather than tax. (The attraction of that policy is that voters attribute tax increases to politicains much more readily than they attribute the interest rate rises that result from excessive borrowing to politicians.)

So the solution to a structural deficit is simply to raise taxes and cut borrowing.

[Ralph Musgrave]

My last sentence just above is inaccurate. If taxes were raised by £X a year and borrowing cut by £X a year the effect would probably be deflationary. So to cut borrowing while having no effect stimulus / deflation-wise, my guess is that one would need to cut borrowing by £X a year, raise taxes by less than £X a year, and third, get the rest of the money for debt repayment from printed money, i.e. QE.

[James]

This is an excellent blog from Bill Mitchell written a few years ago, when Structural deficits were starting to be used as an excuse.

"Structural deficits – the great con job!"
http://bilbo.economicoutlook.net/blog/?p=2326

[chris]

@ Ralph - productivity is relevant because if trend growth falls, then the deficit will rise without the deficit being cyclical.
You can define a structural deficit as one "where a government borrows for no good reason" if you want. But this renders the term superfluous. It just directs us to the reasonable question: is the govt borrowing for good reason or not? The concept "structural" does not illuminate this at all.

[guthrie]

It's a structural deficit when they want to cut things and a cyclical one when they want to look good.
Simple.

[Luis Enrique]

Chris,

well, I'm with you on the policy response not being obvious, partly because the recovery itself is affected by fiscal policy, and I'm with you on the near impossibility of forecasting.

but still, I don't see how policy makers can operate without some idea of where things are heading under current policies. It might not be something that should be cited as if it were an observable quantity, but I don't think the notion of a structural deficit, or not, can be avoided. I think you even you probably regard some future events as more likely than others, including the future state of public finances under current policies.

[David Ellis]

No doubt the UK runs a structural deficit. No doubt that is spends more in a year than can be collected in tax whether the times are good or bad which means that the national debt keeps rising whatever happens. At some point nobody believes that the debt can be repaid and you lose your credit ratings especially if you've been runnig a structural trade deficit of mammouth proportions for about thirty years paid for by a private sector driven credit boom turned Ponzi Scheme and your public spending was financed by taxing the profits of said scheme.

There is no way out of this. All this baloney about cutting public spending to ease the cost burden on the private sector whilst paying off the debt is just austerity and stimulus of one kind whilst taxing the private sector and individuals to pay for public spending is austerity and stimulus of another kind.

Nothing works when you have to remove money from circulation via tax and cuts to pay private (banks) and public (state) debts. There are trillions and trillions and trillions of counterfeit claims on social wealth out there created by banks and states looking to be monetarised. You can print your way out of debt hurting your creditors a bit but absolutely robbing your own population blind Weimar-style but bankruptcy is bankruptcy is bankruptcy.

I say there is no way out of this but the first thing that needs to be done when you are bankrupt is to admit that you are bankrupt and take it from there. Denial, Tory or New Labour, just draws out and deepens the pain. Time to take the economy into administration and start telling some of the creditors (especially the ones with bogus claims like the speculators who bought into the bankers' ponzi scheme) to do one. Neither plan A austerity or plan B borrowing or a misguided mixture of these two wrongs but plan C consolidation or all these national recessions will soon form up into a global and inescapable depression.

[gastro george]

Can we have a Godwin's Law-equivalent for comparisons to Weimar or Zimbabwe?

It seems to me that the structural deficit is a somewhat technical and rather unimportant economics concept that has been latched onto by politicians with an axe to grind.