There has been much in the news recently about the attempts of governments around the world to tackle two problems: (a) soaring deficits and debt and (b) a slow recovery and a possible slide back into recession. As the previous news item, Over stimulation? Trying to prevent a double dip as Japan’s debt soars, reported, Japan’s approach has been to tackle the second problem first and to give a massive fiscal boost to the economy. Its debt can be tackled later as the economy, hopefully, recovers.
The Irish government, by contrast, in its Budget on 9 December announced sweeping cuts in government expenditure. This included substantial pay cuts for public-sector employees. Getting the public-sector deficit down (projected to be 11.6% of GDP in 2010) was the government’s major priority.
Greece too is under tremendous pressure to cut its public-sector deficit and debt. Forecast to be 125% of GDP in 2010, its public-sector debt is the highest in the eurozone. There are serious worries as to whether Greece will be able to fund the debt.
Meanwhile in the UK, Alistair Darling presented the government’s pre-Budget report. This took a mid-course between the two objectives. He announced modest increases in tax, including a 1% increase in national insurance contributions from 2010, and modest increases in benefits. The overall effect was pretty neutral, leaving the projected public-sector deficit at around 12.6% of GDP in 2010/11, hopefully falling to around 4.4% by 2014/15 as economic growth increases tax revenues. So was this the best compromise: not too tough so as to stifle recovery and not too expansionary so as to cause a soaring of debt and difficulty in funding the necessary borrowing?
So what is the correct balance? Are the situations very different in the four countries or have they merely chosen to prioritise them differently? Should countries make cuts early in order to get their deficits down and avoid a collapse in confidence, but risk falling back into recession? Or should they get growth firmly established before tightening fiscal policy? The following articles look at the issues.
The UK
Key points: The pre-Budget report at-a-glance BBC News (9/12/09)
Alistair Darling to borrow more this year (including video) BBC News (9/12/09)
Walking the line BBC News, Stephanomics, Stephanie Flanders’ blog (10/12/09)
Larry Elliott’s analysis on the pre-budget report (video) Guardian, Larry Elliott and Mustafa Khalili (9/12/09)
Pre-budget report: All boxed in Guardian (10/12/09)
Tax and mend Economist (9/12/09)
Darling defends economic forecasts (including video) Financial Times, Chris Giles and George Parker (9/12/09)
Prevarication and Newspeak will not fix our finances Financial Times, Willem Buiter (9/12/09)
Is UK government debt really that high? BBC News, Richard Anderson (22/12/09)
The measures announced in the pre-Budget report along with a video of the speech, press releases and the full report as a PDF document can be found at the Treasury’s Pre-Budget Report 2009 site.
The Institute for Fiscal Studies has a part of its site dedicated to the pre-Budget report. This contains briefings and analysis. See Pre-Budget Report 2009
Greece
Why Greece Could Be the Next Dubai Time, Adam Smith (9/12/09)
Greece’s debt crisis signals problems for the European Central Bank Guardian, Nils Pratley (8/12/09)
Greek stocks fall 6% on fears over the country’s debt BBC News (8/12/09)
Greek stocks fall 6% on fears over the country’s debt (video) BBC News (8/12/09)
Greece threatens bankruptcy, and the eurozone The Atlantic, Megan McArdle (8/12/09)
Greece Struggles to Stay Afloat as Debts Pile On New York Times, Rachel Donadio and Niki Kitsantonis (11/12/09)
Greece ‘worthy’ of eurozone place BBC News (14/12/09)
Greek PM to unveil steps to allay deficit fears Forbes, Dina Kyriakidou (14/12/09)
Default lines The Economist (3/12/09)
Greeks denying gifts BBC News blogs, Stephanomics, Stephanie Flanders (29/1/10)
Davos 2010: Greece denies a bail-out is needed BBC News (28/1/10)
Ireland
Ireland suffers harshest budget in decades Financial Times, John Murray Brown (9/12/09)
Strong medicine fails to soothe Irish Financial Times, John Murray Brown (9/12/09)
Irish Wince as a Budget Proposal Cuts to the Bone New York Times, Sarah Lyall (9/12/09)
A time to grin and bear it Irish Times (10/12/09)
Germany
German government heads for record debt BBC News (29/12/09)
German minister warns of fiscal crackdown Financial Times, Bertrand Benoit (17/12/09)
Goverment’s draft budget includes record debt levels Deutsche Welle (16/12/09)
General
The banking crisis: Till debt us do part Times Online, David Smith and Jenny Davey (13/12/09)
Sovereign debt burdens keep traders on red alert Fiinancial Times, David Oakley (12/12/09)
Questions
- Are the objectives of tackling recession and getting the public-sector deficit and debt down contradictory aims, or is it merely a question of sequencing?
- To what extent are the situations in the UK, Japan and Ireland similar? Should they be following similar macroeconomic policies?
- Why does it matter if a country has a rising public-sector debt as a proportion of GDP?
- Distinguish between a cyclical deficit and a structural deficit. Why has the UK’s structural deficit got worse? Will it fall as the economy recovers, or will it be only the cyclical deficit that falls?
- Why does Greece’s debt crisis signal problems for the European Central Bank?
- What determines a country’s sovereign credit rating?
In a recession, the government’s budget will go into cyclical deficit as tax revenue falls and government spending on unemployment and other benefits rises. Provided the deficit is purely cyclical, it can be seen as desirable since it acts as an automatic fiscal stabiliser, boosting aggregate demand and helping to pull the economy out of recession. Once the economy returns to potential national income (i.e. a zero output gap), the deficit would disappear. At potential national income (Yp), government expenditure (including benefits) will equal tax revenue. The budget is in balance.
Again, provided that the deficit is only cyclical, discretionary expansionary fiscal policy that further deepens the deficit will not be a problem for public finances in the future. Once the economy pulls out of recession, the discretionary policy can be relaxed and the higher national income will eliminate the cyclical deficit.
But the problem the Chancellor of the Exchequer faced in the Budget (on 22/4/09) was not just one of tackling the recession. The UK economy has seen a massive growth in the structural deficit. His forecast is for the total deficit to be £175bn in 2009. But, according to calculations by the Institute for Fiscal Studies, even when the recession is over and the output gap has been closed, there will still be an annual deficit of around £140bn. This is not cyclical; it’s structural.
So why is there this huge structural deficit? And what is the solution? Will the solution slow down recovery? The following articles look at the issues.
Budget 2009: Tightening the Squeeze? Institute for Fiscal Studies (23/4/09)
We should start by admitting we’ve failed as an economy: Hamish McRae Independent (22/4/09)
Budget 2009: Experts cast long shadow over Darling’s sunny outlook Guardian (23/4/09)
Budget 2009: Economist warns of spending cuts and tax rises Guardian (23/4/09)
The chancellor’s Budget dilemma: Stephanie Flanders BBC News (23/4/09)
For a global perspective on structural deficits, see:
Why the ‘green shoots’ of recovery could yet wither Financial Times (22/4/09)
Outlines of the main Budget measures can be found at:
Budget 2009: Need to know Times Online (23/4/09)
At-a-glance: Budget 2009 BBC News (22/4/09)
Full details for the Budget can be found from the Treasury’s Budget site
Questions
- Explain the terms ‘cyclical deficit’ and ‘structural deficit’.
- Draw a diagram showing how government expenditure (including benefits) and tax revenue vary with national income. The diagram should show the sitation with no structural deficit: i.e. the two lines should cross at potential national income. Illustrate (a) a cyclical deficit where actual national income is below potential national income (a negative output gap) and (b) a cyclical surplus where actual national income is above potential income (a positive output gap).
- Now, on the same diagram, shift the two lines to illustrate a situation of structural deficit.
- Consider whether the government should attempt to increase or reduce the budget deficit at a time of recession.
- Why has the structural deficit become so severe over the past year?
- How quickly should the government set about tackling the structural deficit?
On 7 April, Brian Lenihan, Ireland’s Finance Minister, introduced an emergency Budget. He forecast that Irish real GDP would decline by some 8 per cent in 2009, that consumer prices would fall by 4 per cent (i.e. substantial negative inflation) and that unemployment, already at 11 per cent, would rise further. So what was his solution? Was it a massive fiscal stimulus to boost aggregate demand and turn the economy around? No: it was precisely the opposite. He announced substantial tax increases and cuts in government expenditure? Was this economic madness, or was there economic sense in the measures? The following articles explore the arguments.
Ireland’s shock therapy has got its merits Independent (9/4/09)
Ireland Faces ‘Challenge of Its Life’ BusinessWeek (8/4/09)
Few crumbs of comfort as incomes take severe hammering Irishtimes.com (10/4/09)
Republic’s Budget cuts ‘for the common good’ Belfast Telegraph (8/4/09)
Ireland unveils budget ‘challenge’ Financial Times (8/4/09)
Ireland unveils emergency budget BBC News (7/4/09)
When fiscal stimulus isn’t stimulating: Stephanie Flanders blog BBC News (7/4/09)
Ireland imposes emergency cuts Telegraph (8/4/09)
Questions
- Consider the arguments for and against the fiscal tightening measures adopted by the Irish government.
- Should the UK government also adopt a tighter fiscal stance?
- How important is investor confidence in determining the success of a Budget?
In the face of a Labour backbench rebellion over the abolition of the 10p tax rate in the most recent Budget, the Chancellor, Alistair Darling, introduced what has been described as a mini-budget this month. In this mini-budget he significantly increased tax allowances to try to alleviate the impact of the removal of the 10p tax rate on some of the poorest families.
Darling’s solution could prove costly, say economists Guardian (14/5/08)
FAQ: Formula that bought off the Labour rebels Guardian (14/5/08)
Brown risks £2.7bn tax cut to end revolt Guardian (14/5/08)
Mini-budget will put money in pockets of 22 million voters Guardian (13/5/08)
Darling’s statement in full Guardian (13/5/08)
Institute for Fiscal Studies highlights Chancellor’s dilemma after emergency tax cut Times Online (21/5/08)
Q&A on the Government’s ‘Golden Rule’ Times Online (15/5/08)
Basic rate taxpayers to get £120 BBC News Online (13/5/08)
Q&A: Tax changes BBC News Online (13/5/08)
Full statement: Tax changes BBC News Online (13/5/08)
Questions
| 1. |
What was the effect of the abolition of the10p tax rate on income distribution (before the min-budget measures)? |
| 2. |
Assess the extent to which these changes will alleviate the impact of removing the 10p tax rate on the poorest families. |
| 3. |
Discuss the likely impact of this change in the government’s fiscal stance on the main UK macroeconomic targets. |
The Budget 2008 was quite an under-stated affair, but was the first delivered by Alistair Darling as Chancellor. As ever, many of the changes had been announced well in advance, reducing the element of surprise. But the Budget remains an important event. Note that the Budget websites can also be useful reference sources for economic policy changes.
Budget 2008 Guardian Budget Special
Interactive: Budget 2008 Guardian (11/03/08)
What to tell us on Budget day: where our money is going and how it can be stopped Guardian (10/03/08)
Budget 2008 BBC News Online Budget Special
Videos and podcasts
Old Mother Hubbard Guardian (13/03/08)
Budget speech in full (Video) BBC News Online (12/03/08)
For details of the Budget measures, you may want to look at:
Budget 2008 HM Treasury Budget pages HM Treasury Budget microsite HM Treasury (March 08)
Questions
| 1. |
What are the key changes in the Budget? What effects are they likely to have on the economy? |
| 2. |
Assess the extent to which this Budget can be considered a ‘Green Budget’. |
| 3. |
How has the Budget changed the overall fiscal position of the government? |
| 4. |
Discuss the likely impact of the Budget on small and large businesses. |