Is the Chancellor's medicine marvellous or simply a sugar pill? Our panellists battle it outby Oliver Kamm, Simon Wren-Lewis / January 16, 2015 / Leave a comment
Published in February 2015 issue of Prospect Magazine
The economy may now be growing at a respectable pace but the scars of the banking collapse remain. The remedial measures to deal with the crisis were justified: near-zero interest rates, flooding the financial system with liquidity, taking big public stakes in the banks, and a rise in government borrowing. The recent outperformance of the United Kingdom compared with the eurozone is not due to the economics of austerity but the opposite. Monetary policy has been much more expansionary in the UK and since 2012 the government has eased up on its proclaimed fiscal austerity—indeed fiscal policy was slightly expansionary last year.
There is a large and essential role for government in promoting growth and investment, and in reducing inequality. But there is a big long-term problem with high and rising levels of public debt. That’s where we are. The Conservatives appear to be aiming for a tighter fiscal stance than either the current fiscal mandate or the plans of Labour and the Liberal Democrats, with an overall budget surplus by the end of the next parliament. This shouldn’t be a matter of right versus left but of managing risks. Public sector net debt, excluding public sector banks, amounted to £1,457bn (79.5 per cent of Gross Domestic Product) at the end of November 2014, a rise of just under £90bn from the level of a year earlier.
I would prefer a tighter fiscal stance because I worry about what would happen if interest rates rose to their long-run normal levels—about 2 per cent above inflation and roughly the same as the economic growth rate. Financing public debt will be more difficult, especially in an environment of weak inflationary pressures. It will require tax rises and spending cuts, which will reduce growth and thereby compound the problem: the deficit will be harder to eliminate, and the debt might go on rising. If there is to be a responsible economic debate at the general election, it will have to address the build-up of debt, and the vulnerability of the economy once interest rates do rise.