It’s reported that Gordon Brown wants to introduce a law committing future governments to reduce borrowing*. This is both very stupid and very cunning.
As macroeconomic policy, it scales the peaks of imbecility. To see why, imagine the following (which shouldn’t be difficult, as it’s what’s happened in the last two years). The domestic private sector decides to save more and/or invest less. This might be because job insecurity causes households to want to save more (pdf), or because banks are loath to lend, or because firms’ don’t need to invest as they have huge spare capacity. Whatever the motive, their desired financial surplus - their net lending, the gap between savings and investment - rises.
What happens?
In part, these plans will be frustrated. As some people cut their spending, others’ incomes fall and these are unable to save more; this is the paradox of thrift.
However, insofar as domestic private net lending does rise, one of two things must happen. These are mathematical necessities, because across the whole economy, net lending must equal net borrowing.
The first possibility is that the current account deficit - which is foreigners’ net lending to the UK - falls.
The second possibility is that government borrowing rises.
Note that both of these happen because spending falls; this reduces both imports and tax revenues.
Now, the marginal propensity to import is probably less than unity. It follows, therefore, that government borrowing must rise.
If the government were bound by a law committing it to reduce the deficit, it would then have to cut spending. This would exacerbate the downturn. Which is just moronic.
So, how can I say Brown’s idea is cunning?
Simple. Imagine the above scenario plays out after the next election under a Tory government**. Cameron then faces a dilemma.
Either he cuts government spending and deepens the downturn, in which case Labour says: “We told you so. Tory cuts are damaging the economy.” Or he repeals the law, in which case Labour says: “His talk about fiscal responsibility was just a lie. You can‘t trust the Tories.”
Brown, of course, knows this. His proposed law has nothing to do with improving the public finances, or about macroeconomic management. It’s an effort to embarrass the next Tory government.
To be clear: I’m not arguing here that spending cuts are unnecessary under any circumstances.
* A note to Telegraph subs: please distinguish between the debt and the deficit.
** Actually, you don’t have to believe the private sector’s desired financial surplus would rise. Merely not having the surplus fall would be sufficient to keep government borrowing high.
As macroeconomic policy, it scales the peaks of imbecility. To see why, imagine the following (which shouldn’t be difficult, as it’s what’s happened in the last two years). The domestic private sector decides to save more and/or invest less. This might be because job insecurity causes households to want to save more (pdf), or because banks are loath to lend, or because firms’ don’t need to invest as they have huge spare capacity. Whatever the motive, their desired financial surplus - their net lending, the gap between savings and investment - rises.
What happens?
In part, these plans will be frustrated. As some people cut their spending, others’ incomes fall and these are unable to save more; this is the paradox of thrift.
However, insofar as domestic private net lending does rise, one of two things must happen. These are mathematical necessities, because across the whole economy, net lending must equal net borrowing.
The first possibility is that the current account deficit - which is foreigners’ net lending to the UK - falls.
The second possibility is that government borrowing rises.
Note that both of these happen because spending falls; this reduces both imports and tax revenues.
Now, the marginal propensity to import is probably less than unity. It follows, therefore, that government borrowing must rise.
If the government were bound by a law committing it to reduce the deficit, it would then have to cut spending. This would exacerbate the downturn. Which is just moronic.
So, how can I say Brown’s idea is cunning?
Simple. Imagine the above scenario plays out after the next election under a Tory government**. Cameron then faces a dilemma.
Either he cuts government spending and deepens the downturn, in which case Labour says: “We told you so. Tory cuts are damaging the economy.” Or he repeals the law, in which case Labour says: “His talk about fiscal responsibility was just a lie. You can‘t trust the Tories.”
Brown, of course, knows this. His proposed law has nothing to do with improving the public finances, or about macroeconomic management. It’s an effort to embarrass the next Tory government.
To be clear: I’m not arguing here that spending cuts are unnecessary under any circumstances.
* A note to Telegraph subs: please distinguish between the debt and the deficit.
** Actually, you don’t have to believe the private sector’s desired financial surplus would rise. Merely not having the surplus fall would be sufficient to keep government borrowing high.
".... both very stupid and very cunning."
This seems a fair description of Brown's economic policy ever since he insisted on saying that the UK's underlying rate of GDP growth had risen to 2 3/4% p.a. That fouled up the Treasury arithmetic for several years. That might have made sense if what it was about was catching a Tory Government that he expected to win the last election on the hook of either cutting the "rate at which Britain can grow" below what it had been under Labour, or raising taxes when the published arithmetic said it was unnecessary. In fact it caught him, and the rest of us.
This time round, Labour just might prevent a Tory absolute majority, but a move like this would make it absolutely sure the LibDems would not allow a minority Labour government. (If, by any chance, the Tories manage to lose the next election, Gordon will have gaffed himself once again.)
Posted by: Diversity | September 27, 2009 at 04:12 PM
"across the whole economy, net lending must equal net borrowing."
Across the whole world net lending must equal net borrowing. But presumably the UK could be a net borrower from the rest of the world. That would leave the rest of the world as net lender (to us).
Posted by: ad | September 27, 2009 at 04:28 PM
ad - I was counting foreigners as part of the economy.
Posted by: chris | September 27, 2009 at 06:03 PM
He can pass a law but the binding aspect is a problem, because no parliament can bind its successors.
Posted by: ab | September 27, 2009 at 10:40 PM
Kind of hoping the Telegraph article is cod.
No doubt I've confused debt with deficit, but I thought we stayed out of the ERM to allow Government spending/borrowing.
And the "squeezed middle classes", the people who should be able to ride out any recession on their savings? What happened to the working class?
Posted by: (Layman) Mike | September 28, 2009 at 05:14 AM
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Posted by: Sarah Danes | October 05, 2009 at 11:20 AM