National Institute of Economic and Social Research report on fiscal policy

The National Institute of Economic and Social Research have released their National Institute Economic Review today.  One of the articles has been reported by the BBC who focus on their recommendation of a tax rise equivalent to 6p on the basic rate of income tax.

It is important to understand that the focus of the NIESR research is on the scale of the fiscal adjustment though, not how it is achieved.  The main point is they don't think the cuts in borrowing that the parties are planning are sufficient.  Most commentators are pretty scathing about the politicians' failure to identify cuts that will be sufficient to meet their current plans.  The NIESR report adds another voice to the chorus suggesting that it might not be enough even if they did.  Their report isn't freely available but this is a summary of the key findings:


Before I get back to the bigger picture, NIESR are probably being too sanguine about the possibility of the risk premium pushing up government debt interest costs.  As they say, we haven't defaulted on our debts before but we have faced much higher interest rates on government debt.  That is because the cost of a government borrowing doesn't just rise when investors think it is likely to entirely or partially default - as appears to be the case in Greece.  Rates can also rise when markets think that the country might try to inflate its debt away or even when default is a remote possibility, but still significant enough to need to be priced in.

Even on Treasury projections, with no significant rise in interest rates, the cost is set to rise to the equivalent of £2,900 per family - or more than we currently spend on interest on mortgages.  Mike Denham explains how that cost will rise if debt interest rates go up in this video.  If politicians don't get a handle on spending now, expect to see more and more of your taxes go not to pay for services but to pay interest on the debt in the future.

To come back to their main point, there is a a very good case that the parties aren't planning a sufficient fiscal adjustment.  But the answer has to be greater cuts in spending.  In How to Cut Public Spending (and Still Win an Election) we've set out how to make those cuts.  Lower spending is likely to mean higher trend growth - as our research note last week showed, which will mean greater prosperity and ease the task of getting borrowing under control.  It is a big rise in spending, way beyond that seen in other developed countries, which has ruined our public finances, cuts in spending are the best way to get them in order again.

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