Monday's pre-budget report will tell us if the British government, like the US, is prepared to spend its way out of depression In the past half century, there have been only a handful of critical moments when the direction of Britain's economy could have changed fundamentally for better or worse. Sterling's 1967 devaluation, and the IMF crisis in late 1976 were among them. So was the deflationary 1981 Budget, and Black Wednesday in 1992, when sterling was ejected from the Exchange Rate Mechanism. We now face another pivotal period, and in Monday's pre-budget report the government will reveal where it stands on the fight against depression. At such moments, the macro-economic debate becomes polarised, in sharp contrast with the rest of the time when the differences in policy are only marginal. After 20 years in which the distinction between Tories and Labour on the economy has been, in all honesty, cosmetic, a philosophical divide now seems to be opening up between them. The outcome of this debate which will determine the shape of British politics for many years to come. David Cameron announced a fundamental shift in the opposition's strategy last week. His willingness to raise public spending less rapidly than Labour opens an entirely new front in the economic debate. For years, this would have been viewed as an own goal, because voters said they were much keener to protect the public services than to see their taxes reduced, and they acted accordingly in the last three elections. The Conservatives could be on surprisingly fertile territory here. There is a perception that the public services have improved considerably under New Labour, but not by as much as they ought to have done, given the amount of money thrown at them. More importantly, the recession is making voters far more sensitive to their own financial positions, and far less amenable to indulging their social consciences, than they were in the good times. If the Tories can make the charge of profligacy in public spending stick to Gordon Brown, they could win the tax-or-spend debate. There is a second debate, however, which has been opened by George Osborne's attachment to fiscal prudence in the face of deepening recession. He seems to be saying, albeit with some deliberate opaqueness, that the budget deficit is already too high, and that we should introduce tax cuts only where they are funded by savings elsewhere, and not when they are funded by borrowing. I imagine that this still allows for the budget deficit to rise automatically in response to the deepening recession, but fiscal activism is out. This ties the Tories' hands considerably, since any tax cuts they suggest will necessarily be small, and their effects on the economy will be offset by compensating savings elsewhere. I am dubious whether this will be supported by a business sector which faces nothing less than a fight for sheer survival, but we shall see. Gordon Brown, meanwhile, is arguing very directly for fiscal activism, implying that he favours either tax cuts or public spending increases in the immediate future, financed by extra borrowing, to combat recession. On this, he appears to be in agreement with the incoming Obama administration, which is discussing a fiscal package worth more than $500 billion, or 3% of GDP, despite the fact that America's public finances are in worse shape than Britain's. Translated into British terms, an Obama-style fiscal injection would require the chancellor to increase public spending or cut taxes by £45bn on Monday. That is £45bn a year, not £45bn spread over several years, which is the unhelpful manner in which the Treasury has expressed its policy changes in recent times. Such a large fiscal injection seems improbable, if only because Alastair Darling has appeared far less certain of this course of action than his boss. The chancellor repeatedly argues that the country must "live within its means", implying that any fiscal package must be temporary. I have even heard rumours that the Treasury may pre-announce medium term tax rises to pay for Monday's emergency package. The prime minister's aides were apparently told by the Obama team in Washington last weekend that the Americans intend, after the inauguration, to fight a war on recession. They added that, as in a real war, they would apply General Colin Powell's famous dictum: "use overwhelming force". Furthermore, it seems that they have the support of the Federal Reserve on this. Vice chairman Donald Kohn, who is often the annointed representative on earth for chairman Bernanke, said last week that therisk of deflation is now growing. He pointed out that the Fed has already started to print money to combat this threat, and suggested that it would do much more of this if necessary. Remember that we are listening here to the US Federal Reserve, one of the most admired institutions in the world, not the central bank of an emerging economy. And they are getting strong support for these unorthodox measures from many of the driest of free market economists in the US. If the UK faces the certainty of recession and a growing fear of deflation then, as in America, the use of overwhelming force is the surest way of addressing this. Those who fear eventual inflation or a run on the pound have legitimate medium term concerns, but the Americans have decided across the political spectrum that they need urgently to fight depression, and that other problems can wait. The pre-budget report will tell us whether the British government agrees.
Monday, 20 December 2010
Posts
