What is the right fiscal policy? People differently placed on the politico-economic spectrum will give you radically different answers.
At one extreme, you have the hairshirt fiscal purists who think government borrowing is always wrong and who won’t be happy until all that debt has been repaid. At the other, you have the Keynesian fundamentalists who believe that the Government can carry on borrowing until the cows come home.
A lifetime in economics has taught me that the right fiscal policy changes with circumstances. And ours have been through a revolution.
When the Coalition government took office in 2010, although we hadn’t reached the stage of absolute panic about the public finances, there was a distinct danger on the horizon of things running out of control.
After the financial crisis of 2007-8, not only had GDP fallen significantly but there was also no assurance that it could soon recover and, what’s more, it was widely believed that if and when it did recover, the potential growth rate would be much lower.
Across the world, the financial markets were anxious about the stability of the public finances in umpteen countries. The UK faced a real risk of seeing its debt classed with some of the most worrying cases.
So, there was a strong argument for seeking to bring the debt ratio down soon, by radically reducing the gap between government spending and tax revenues.
The only real issues were about the optimal speed of this reduction and where the financial pain should fall. Although I had some doubts about the details, I was broadly in sympathy with the Coalition’s plans for deficit reduction.
In practice, though, government borrowing fell more slowly than envisaged. Indeed, it ended up higher even than it had been under the plans of the previous Labour chancellor, Alistair Darling. Wisely, in my view, George Osborne did not seek to reduce the deficit more quickly by imposing further fiscal stringency.
After the return of a Conservative government in 2015, however, Mr Osborne still had the stabilisation of the public finances as his overwhelming objective. He actually tightened fiscal policy by setting an objective for the budget, including investment spending, to be running a surplus by 2020. He even enshrined it in law that in normal times the public finances should be in surplus.
Would it be too cynical to believe that this objective was driven less by a careful consideration of economic imperatives and more by Mr Osborne’s political ambitions?
So the current stance of fiscal policy may well have been seriously inappropriate before the Brexit vote upset the apple cart. But if it was inappropriate then, it is doubly so now. Because of widespread fears about the consequences of Brexit, there is a realistic danger of substantially weaker GDP growth in the near term.
Meanwhile, the costs of a less restrictive fiscal policy have sharply diminished. The prospect of lower interest rates sustained for a long time has reduced the cost of borrowing.
I could not agree more with Roger Bootle’s conclusion. The UK government needs to encourage bold, entrepreneurial policies. These would help to reunite the country, cushion a near-term economic downturn and then lead to stronger GDP growth. This could reduce the UK’s deficit before the next general election in 2020.
A PDF of Roger Bootle’s column is in the Subscriber’s Area.