With much attention focused on the UK’s rapidly rising public-sector debt, fiscal policy will have to be tightened once the economy is recovering. This will entail substantial cuts in government expenditure and possibly tax rises too, whoever wins the election next year. The danger, of course, is that if aggregate demand is cut, or its growth is severely curtailed, the economy could lurch back into recession. For this reason, it is likely that monetary policy will have to remain expansionary for some time to come. Interest rates will stay low and further quantitative easing could take place.
This was the conclusion of a report by the Centre for Economics and Business Research (see link below). The CEBR argued that Bank Rate will remain at 0.5% at least until 2011 and not reach 2% until 2014. “The forecasts show that the fiscal consolidation is likely to be matched with an unprecedented monetary relaxation. … Douglas McWilliams, one of the report’s authors and Chief Executive at CEBR, commented: ‘We are likely to see an exciting policy mix, with the fiscal policy lever pulled right back while the monetary lever is fast forward. Our analysis says that this ought to work. If it does so, we are likely to see a major rerating of equities and property which in turn should stimulate economic growth after a lag.’
The following articles look at the report and the implications of its predictions for economic growth and exchange rates.
Bank rate to ‘stay frozen’ for five years Times Online (11/10/09)
Mortgage rates to stay low until 2014 Telegraph (12/10/09)
Tax and spending squeeze to keep bank rate low David Smith’s EconomicsUK.com (11/10/09)
UK rates ‘to stay low for years’ BBC News (12/10/09)
Pound plunges as UK markets rally to year high Telegraph (11/10/09)
Tough times ahead as traders poised to offload their sterling Sunday Herald (11/10/09)
CEBR News Release (12/10/09)
Questions
- Under what conditions would a combination of a contractionary fiscal policy and an expansionary monetary policy be most effective in delivering economic growth?
- What would be the long-term effect on private-sector debt?
- How would such a policy mix affect the rate of exchange? Would this help to stimulate economic growth or dampen it?
- How will the size of these effects depend on the mobility of international financial capital?
- Explain the following: ‘Our analysis says that this ought to work. If it does so, we are likely to see a major rerating of equities and property which in turn should stimulate economic growth after a lag’.
In 2008, as the economy was on the verge of recession, the UK Prime Minister said that we would ‘spend our way out of it’ despite rising levels of public-sector debt. In recent weeks, however, the focus has been much more on tackling the debt, which has now increased to over £800 billion (58% of GDP) – it was £500 billion at the end of 2006 (37% of GDP).
Although the current level of general government debt in the UK as a proportion of GDP is still one of the lowest of the G8 countries, it is rising the fastest. In other words, the general government deficit as a proportion of GDP is the highest (see Table A8 in IMF World Economic Outlook, Statistical Appendix A). The IMF’s forecasts suggest that, by 2014, government debt could be as much as 92% of GDP – the highest since World War II – and lower only than Japan (144%) and Italy (126%) of the G8 countries (although the USA, Germany and France are forecast by then each to have government debt over 80% of GDP).
Gordon Brown has said that public spending will have to be cut back once the recession is over, mainly by cutting out waste in the public sector. Conservatives too are looking to make substantial cuts in public expenditure if they come to office next year and have talked of an era of austerity.
But will such cuts be too little too late? Has government spending on saving the banks and trying to boost the economy by cutting VAT actually damaged our recovery prospects and are the British people going to be the ones to suffer? Or should the fiscal stimulus be retained for some time yet to prevent a lurch back into recession? The following articles look at the public debt situation, which poses some interesting policy questions, especially with the Party Conferences!
£805,000,000,000: UK’s monstrous debt The Mirror (19/9/09)
Osborne gambles with cut plans BBC News (6/10/09)
Governments will have legal obligation to reduce UK’s debt Telegraph (28/9/09)
We’ll spend our way out of recession Independent (20/10/08)
Public sector borrowing soaring BBC News (18/9/09)
Govt spending cuts ‘could help pound’ Just the Flight (21/9/09)
Deficit danger worries Cameron BBC News (4/10/09)
Public debt hits £800 billion – the highest on record Times Online (19/9/09)
Pay freeze ‘to protect UK services’ The Mirror (6/10/09)
This recession demands that we employ logic and spend our way out of it Telegraph (11/1/09)
Cuts and pay freezes ‘just the beginning’, Tories admit Telegraph (7/10/09)
Robert Stheeman: So what’s worrying the banker in charge of our £1trn debt? Independent (8/10/09)
Has Darling or Osborne the best plan for cutting the deficit? Observer (11/10/09)
This public-spending squeeze will be much tighter than people expect Independent on Sunday (11/10/09)
Tax and spending squeeze will keep Bank rate low Sunday Times (11/10/09)
UK rates ‘to stay low for years’ BBC News (11/10/09)
Questions
- According to economic theory, how does increasing government spending or reducing taxation aim to boost the economy?
- What do we mean by a budget deficit or budget surplus? How does a budget deficit differ from national debt?
- What is the ‘golden rule’ for fiscal policy? Discuss the advantages and disadvantages of such a rule-based approach to fiscal policy.
- What are the advantages and disadvantages of a policy of ‘spending our way out of a recession?’
- With spending cuts looming, many will be affected. How will cuts in government spending affect the UK’s ability to recover from the recession? Will you be affected and, if so, how?
- Last year £85.5 billion was spent by the government on bailing out banks. Do you think this was money well spent, or is it the main cause of the current spending cuts that could see the recession worsen?
The following two clips look at John Maynard Keynes’s contribution to macroeconomics and whether his theories have been proved to be correct by the events of the past two years.
“What would John Maynard Keynes make of the financial crisis and the credit crunch?” In the first clip, “Author Peter Clarke, former professor of modern British history at Cambridge University, and the former Conservative chancellor Lord Lamont consider whether Keynes’s ideas were twisted by modern politicians to support their desires to run big spending deficits.”
What would Keynes make of the crisis? BBC Today Programme (25/9/09)
Is Keynes influencing today’s politics? (video) BBC News (2/10/09)
Questions
- How is the recent crisis and recession similar to and different from the Great Depression of the inter-war period?
- Can recent fiscal policies adopted around the world be described as Keynesian?
- How would a government of a Keynesian persuasion attempt to manage the move from recession to economic growth and deal with the problem of mounting public-sector debt?
In an attempt to stave off recession, countries around the world have made extensive used of fiscal stimuli. Combinations of tax cuts and increases in government expenditure have been used to boost aggregate demand and thereby to halt falling national income. “The G20 group of economies … have introduced stimulus packages worth an average of 2% of GDP this year and 1.6% of GDP in 2010.”
But how much will national income respond to a particular fiscal stimulus? It depends on the size of the fiscal multiplier for each type of government expenditure increase or tax cut. The bigger the multiplier for each expansionary measure, the more will national income rise. Clearly, to estimate the effects of their fiscal measures, governments would very much like to know the size of these multipliers. But that’s not so easy, as the following article from The Economist explains.
Much ado about multipliers The Economist (24/9/09)
Questions
- What are the formulae for (a) the government expenditure multiplier; (b) the tax multiplier?
- Why is the value of the multiplier likely to vary with the type of government expenditure increase or tax cut that is used? Which types of government expenditure increases and tax cuts are likely to have (a) the largest effects; (b) the fastest acting effects?
- Why is the size of any particular fiscal multiplier difficult to predict? How do expectations impact on the size of the multiplier?
- Under what circumstances are fiscal measures likely to be ‘crowded out’? How can monetary policy be used to prevent, or at least minimise, crowding out?
The leaders of the G20 countries gathered in Pittsburgh on 24 and 25 September 2009 to discuss a range of economic issues. These included co-ordinated action to ensure the world economy maintained its fragile recovery; reforming the IMF; agreeing action on bank regulation and the limiting of bankers’ bonuses.
The following is a selection of podcasts and videos looking at various aspects of the summit and its outcomes. The first one, to set the scene, is a webcast from the IMF looking at the state of the world economy and the role of macroeconomic policy and banking regulation. There are also some articles looking at the achievements of the summit. (See here for G20 draft communiqué)
World Economic Outlook, September 2009 (video) IMF Webcast (22/9/09)
G20: Who will feel the pain and when? (video) BBC Newsnight (25/9/09)
G20 leaders meet in Pittsburgh BBC Today Programme (25/9/09)
‘Little change’ in bank regulation BBC Today Programme (25/9/09)
World Bank’s Zoellick on G20 Summit (video) CNBC News (25/9/09)
G20 ‘was a successful meeting’ BBC Today Programme (26/9/09)
Obama on G20 plans for financial reforms (video) BBC News (25/9/09)
Greater role for emerging powers BBC News, Amartya Sen (25/9/09)
Preventing Another Global Crisis (video) CBS News (25/9/09)
Obama hails progress at G20 (video) Reuters (26/9/09)
World map of deficits and stimulus spending
The cost of the financial meltdown: Deficits and spending BBC News
Articles:
G20: Banks to be forced to double capital levels Telegraph (25/9/09)
Will tough new G20 measures work? BBC News (26/9/09)
Analyst View: G20 ends reign of G7 in Pittsburgh Reuters (25/9/09)
Leaders bury differences over bonuses to agree standards FInancial Times (26/9/09)
Same tune, different fiscal instrument on bank bonuses Times Online (25/9/09)
G20: History and fudge Peston’s Picks, BBC News (25/9/09)
What the G20 said on bonuses (and why it didn’t say much at all) eFinancialCareers (27/9/09)
Hamish McRae: G20 communiqué signals transfer of power to the emerging world Independent on Sunday (27/9/09)
The G20 fantasy Guardian (27/9/09)
Questions
- Explain the issues faced by the G20 countries.
- To what extent is trying to reach international agreement on co-ordinated action a prisoner’s dilemma game? Is it, nevertheless, a positive sum game?
- What was agreed at Pittsburgh and to what extent will it lead to action as opposed to being mere rhetoric?
- The G8 is effectively dead, having being replaced by the G20, plus Spain, The Netherlands and various international bodies, such as the IMF. What are the advantages and disadvantages of this move?