In my day job, I point out an obvious fact that's being somewhat overlooked in the fiscal policy debate. This is that government borrowing is determined not (just) by fiscal policy, but - insofar as it is amenable to policy at all - by monetary policy.
I say this is because monetary policy influences the private sector’s net lending, which is the counterpart of government borrowing. But monetarists would agree on the grounds that monetary policy determines nominal GDP which in turn determines tax revenues. And Keynesians would assent, because fiscal policy has little influence on the deficit as spending cuts reduce aggregate activity and hence tax revenue.
This means that a government that was serious about cutting borrowing would want a super-loose monetary policy, as Giles has suggested. Depending on your perspective, this would either raise nominal GDP and hence tax revenues, or cut saving and raise investment thus reducing private sector net lending, the counterpart to which would be lower government borrowing. And if such a policy inflated away the debt, hey, so much the better.
However, there’s little sign of either main party wanting this.
I’d draw three inferences here:
1. Despite all the talk, cutting the deficit is not really the top priority, for the Tories or Labour. The top priority is the preservation of market confidence. Politicians aren’t advocating loose money policy as a means of deficit reduction, because this would frighten the gilt market more than high borrowing does.
2. There’s something queer about the idea that the election will be about how to reduce deficit. If this were the case, a big election issue would be: what should be the Bank of England’s remit? But it isn’t.
3. The deficit reduction policy of either party, in the narrow sense of tax and spending decisions, is an example of post-modern policy-making. It is a manipulation of perceptions (an attempt to retain market confidence) more than of actual reality.
* You might object that I’m ignoring the structural budget deficit. I am. I don’t think the concept of a structural deficit is at all helpful.
I say this is because monetary policy influences the private sector’s net lending, which is the counterpart of government borrowing. But monetarists would agree on the grounds that monetary policy determines nominal GDP which in turn determines tax revenues. And Keynesians would assent, because fiscal policy has little influence on the deficit as spending cuts reduce aggregate activity and hence tax revenue.
This means that a government that was serious about cutting borrowing would want a super-loose monetary policy, as Giles has suggested. Depending on your perspective, this would either raise nominal GDP and hence tax revenues, or cut saving and raise investment thus reducing private sector net lending, the counterpart to which would be lower government borrowing. And if such a policy inflated away the debt, hey, so much the better.
However, there’s little sign of either main party wanting this.
I’d draw three inferences here:
1. Despite all the talk, cutting the deficit is not really the top priority, for the Tories or Labour. The top priority is the preservation of market confidence. Politicians aren’t advocating loose money policy as a means of deficit reduction, because this would frighten the gilt market more than high borrowing does.
2. There’s something queer about the idea that the election will be about how to reduce deficit. If this were the case, a big election issue would be: what should be the Bank of England’s remit? But it isn’t.
3. The deficit reduction policy of either party, in the narrow sense of tax and spending decisions, is an example of post-modern policy-making. It is a manipulation of perceptions (an attempt to retain market confidence) more than of actual reality.
* You might object that I’m ignoring the structural budget deficit. I am. I don’t think the concept of a structural deficit is at all helpful.
The basic problem here is this: the average voter is much, much thicker than the average blogger. Voters tend to work on the principle that if their money seems to buy the same amount of stuff that it bought earlier, then the Government in power must be OK; they don't get upset about the truly mindboggling state of public finances because all of this potential trouble has yet to actually impact upon them.
For this reason, all the major parties are being extremely coy about making cuts and tax raises and so on; they all know (with the possible exception of Gordon Brown whose stability of mind is reputedly to be largely down to the art of several highly skilled pharmacologists) that something is going to have to be done about the deficit and that the current "spending like a drunken sailor on payday" policy cannot continue. However, the average voter is fool enough to believe that this debt will magically go away if left alone, and in the mean time won't actually do anything to hurt him.
So, to the average thick voter the deficit doesn't exist. What does exist is the cocept of tax rises; these the voter does understand and most certainly doesn't want. Ditto cuts; cuts mean that the Great Government Money Machine won't be so generous so his ration of cheap lager and smuggled fags will be harder to come by; this the voter doesn't want to happen.
And here's where that bludgeoning stupidity comes in. The average voter thinks (dimly, very dimly) and believes that if he votes for a party that doesn't say it is going to cut things, then this won't happen, despite Labour having by comprehensively demonstrated that election manifesto promises are worth less than some mang cur's idiot yapping in the night.
So, all the major parties are therefore playing to the intellect of the average voter, and keeping well and truly schtumb over cuts so as not to scare the fuckwits with whom the future of the country is entrusted.
Posted by: Dan | March 15, 2010 at 04:02 PM
Dan nails it.
Posted by: Jim | March 15, 2010 at 07:24 PM
Presumably you are not worried by the latest OECD report and believe that this government will not be either.
Posted by: Frank H Little | March 16, 2010 at 07:05 AM
I'm with Dan. It's fairly clear there is a high degree of economic illiteracy among the electorate. The electorate is currently in denial about the scale of the fiscal tightening to come. (Even the bankers don't yet seem to have worked out what's about to happen to their personal tax bills.) But it's the same illiteracy that convinced them to increase their leverage to buy houses because prices would always rise. I fear the consequences when reality bites.
On your point about the structural deficit, I agree the pseudo-scientific precision is unhelpful. But let's be clear here. Gordon Brown fiddled around with his estimate of potential output growth (and the output gap) to engineer his own estimate of the structural deficit and justify fiscal easing. A structural deficit is a useful concept provided you recognize the judgment necessary to estimate it. If politicians are going to massage fiscal policy in this way, perhaps we need our own version of the CBO. Then, we could have a more considered discussion about fiscal policy.
Posted by: Econoclast | March 16, 2010 at 08:44 AM
Maybe what we're actually facing is a high degree of political literacy, rather than economic illiteracy. It is pretty much a certainty that whatever party is elected to power will not keep its election promises. There always seems to turn out to be a reason why they couldn't stick to what they said before the election ("politicians lie", "party X lies", "we didn't have all the information when we were in opposition", pick your own preferred reason). So why should the voter in the street worry if the parties' current policies seem economically impractical? It's not as if they're going to use them.
Posted by: Laura | March 16, 2010 at 11:23 AM
Dan does not "nail it". The deficit is merely what's left when you take everything else into account. There is no reason to cut the deficit, unless you are some kind of conservative knave who thinks that the country would be better off with a higher rate of unemployment. It's obviously not that easy to reduce something that is not set by the government (i.e. automatic stabilisers and tax revenue).
Agree that monetary policy *could* help to balance investment and saving flows. But given the state of private sector balance sheets, it's not clear that even very low interest rates could convince the public to go back into debt.
Posted by: vimothy | March 23, 2010 at 05:31 PM
On your point about the structural deficit, I agree the pseudo-scientific precision is unhelpful. But let's be clear here. Gordon Brown fiddled around with his estimate of potential output growth (and the output gap) to engineer his own estimate of the structural deficit and justify fiscal easing. http://www.fullmediafire.com
Posted by: Ben | August 25, 2010 at 07:10 AM