The Keynesian excuse for not cutting spending 2

Matthew Sinclair Economics 101

In a speech to the Bank for International Settlements by José Manuel González-Páramo, a member of the Executive Board of the European Central Bank first discusses the economics of deficits. He sets out a number of conditions under which we should be relatively sceptical of the kind of argument the Government are making, that cutting deficits too soon would imperil the recovery:

"If the fiscal starting position is precarious and the adjustment is credible;
If financial markets react by lowering long-term interest rates;
If households have correctly understood the need for fiscal adjustment and have factored this into their spending decisions; in other words, if households are – at least partly – “Ricardian”;
and if monetary conditions are accommodative."

Now given that Britain is facing particularly sharp deficits which are clearly affecting business confidence, there is a particularly strong case that we should be cutting deficits sooner rather than later. Which makes Mr. González-Páramo's comments about fiscal policy in the eurozone particularly telling:

"To conclude, it is therefore essential that consolidation targets are reflected as soon as possible in specific, detailed tax and spending plans. Credible and detailed fiscal adjustment plans should reassure investors, creating a more favourable, long-term financing environment. Credible and detailed fiscal adjustment plans should provide certainty for households making their saving and investment decisions. Credible and detailed fiscal adjustment plans would also facilitate the task of monetary policy in maintaining price stability, while gradually returning to a more normal, post-crisis monetary environment."

We need the same from our politicians here. Even if we accept the Government's case that cuts should be delayed till 2011-12 – and we don't – they should be trying to build credibility by setting out a specific plan to cut spending, not just a promise to cut deficits.

After all, the Government are claiming that they need deficits now to provide a Keynesian stimulus but they were running deficits long before the recession. Their failure to set out a credible plan for cuts suggests that they are mostly using "crass Keynesianism" (as the Germans called it) as an excuse for fiscal profligacy, rather than seriously trying to manage economic demand over the economic cycle. Buchanan and Wagner, in a classic work of political economy – Democracy in Deficit: The Political Legacy of Lord Keynes, made a powerful case that this is a critical flaw in the political economy of Keynesian stimulus. Regardless of whether it can work in economic theory, in reality politicians aren't responsible enough to use the licence Keynes gave them to run deficits responsibly:

"Keynesian economics has turned the politicians loose; it has destroyed the effective constraint on politicians’ ordinary appetites. Armed with the Keynesian message, politicians can spend and spend without the apparent necessity to tax."

- Buchanan, J. M. & Wagner, R. E. (1977)

To turn to a slightly less scholarly source, this appears to be the Government's real policy on the fiscal crisis:

"I've been working on a plan. During the exam, I'll hide under some coats, and hope that somehow everything will work out."

- Simpson, H. (1993)

Matthew Sinclair

Matthew is Director of the TaxPayers' Alliance, author of Let Them Eat Carbon and editor of How to Cut Public Spending (and still win an election)

Follow @mjhsinclair

John Payne

Sir,
The Government say their spending is to create jobs in those sectors of the economy in which they are investing; I find it difficult to understand how companies can create jobs before they have demand for their products. Such a Government stimulus has a very small affect on the whole economy. However, it turns a blind eye to the debt that exists in the overall population, which is restricting spending, and therefore jobs.
It seems clear to me job creation over the whole manufacturing spectrum can only return to pre 2008 levels when overall consumer debt is drastically reduced, and people start spending again. There is no magic bullet for that to be solved.
Everyone agrees we have far too many people in Government employment. An early reduction in their numbers seems to be to be a more positive approach. Whilst in making such people redundant one can argue that demand would be reduced and act negatively on recovery. But that is overlooking the argument that the difference between unemployment pay an their current salaries is a plus to Government coffers, and the money spent on supporting manufacturing jobs.
I end with a final thought, which no mainstream politician seems to want to talk about, and that is our contribution to the EU. We lose sight of the fact that our net contribution of £6.5 billion (Treasury estimate) 2010/11 equals 235,400 average wage jobs.
Now there is a way to create jobs!
John Payne
gillW

My son is always telling me that to fail to back him now when he is so in debt will push him over the edge; that he needs my guarantees just to continue borrowing at a fair and not excessive rate, which he must do so to continue funding the interest payments on his existing debts. when I tell him the whole family is in debt up to their ears he says we must start gambling to recoup some losses; borrow and set up some sideline business to increase our income; that to cut back now would be madness.